1 justifying automation november 19, 2003 revised september 13, 2006

1

Justifying AutomationJustifying Automation

November 19, 2003

Revised September 13, 2006

2

AgendaAgenda

The Anatomy of a Capitol Request

– Example

The Project Roadmap

The 10 Steps to Justification

– Example

The 7 Deadly Sins of Failed Justification

A New ROI Tool to Do It Right

Credits

Demo

3

One Winter Day in Wisconsin….One Winter Day in Wisconsin….

Honey, we need a new snowblower.

Why?

Ours is old..

How Much?

$2,200…..on sale!.

Our’s work?

yes.

no.

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The Anatomy of a Capitol Request:The Anatomy of a Capitol Request:

“Honey, we need a new snowblower.”

Economic buyer,

Management

End-user,Gaining buy-in,

Ownership

Justification?

Specifications

Scope of Work

5

What Did We Miss?What Did We Miss?

The cost of not buying a new snowblower.

Any money we can make with a new snowblower.

E-bay value of old one.

The intangible joy of owning a new one.

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Project Road MapProject Road Map

REALIZEREALIZE

SPONSOR/SUPPORTSPONSOR/SUPPORT

DIRECTIONDIRECTION

JUSTIFYJUSTIFY

DESIGNDESIGN

BUILDBUILD

Checkmetrics

?

Checkmetrics

?

Consider

Board/Management?

Feasibility, Preliminary Cost/Benefit, Options

Return On Investment,

Select a team,

Execute…Support,Monitoring

Re-direct

In House

Partner

Both

Monitoring

Re-justify

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Realizing the NeedRealizing the Need

• Supply Side Requirements• EDI• JIT• Volume Discounts• Technology Demands

• Demand Side Requirements• Can’t Meet Demand• Can’t Make Quality• Losing Market Share• Losing Profits• Technology Demands

• You• Gut• Data• Experience• Standards• Directives

Supplier You Customer

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Sponsor/SupportSponsor/Support

Identify the “affected and involved” and develop support– Senior Management / The Economic Buyer…involved– The Current or Future Owner….affected– Technology Partners….involved– The Customer(s)….affected

Maintain your position as an agnostic soldier Provide data to supplement your gut Leverage:

– Fear of competitive disadvantage.– Worst case scenarios– Guilt by association: ”now that you know about this problem…”

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Your ConstraintsYour Constraints

Your NeedsYour Needs

Pick a DirectionPick a Direction

Develop aTeam

Develop aTeam

Secure aBudget

($+Time)

Secure aBudget

($+Time)

ChampionChampion

Users(Buy in)Users

(Buy in)

3rd Parties(HK)

3rd Parties(HK)

Study What’sBeen Done

Study What’sBeen Done

FreshIdeasFreshIdeas

Prelim DesignsPrelim Designs

PricePrice PlanPlan SchedSched

Prepare Your CasePrepare Your Case

ProjectSponsorProject

Sponsor

Pre-Justification Feasibility Testing(aka “Concept Study”)

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The 10 Steps to JustificationThe 10 Steps to Justification

1. Define the real task at hand

2. Define the planning horizon

3. Define your objectives based on your “Realization”

4. Specify the alternatives

5. Estimate the cash flows for each alternative

6. Specify the interest rate

7. Compare the alternatives

8. Perform sensitivity analysis

9. Select the best alternative

10. Check your results

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1. Identify Your 1. Identify Your RealReal Task Task

“To Protect and Serve”

Your task is NOT to justify theproject, it is to make the BEST use of your company’s money.

You’ve GOT to be willing to walk away.

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2. Define Your Planning Horizon2. Define Your Planning Horizon

Factors to Consider– Short term thinking kills companies. It is entirely possible to become

so efficient that you go out of business.

– Long term thinking kills companies in tough times.

$

timeExpense

EfficiencyProfit

$Expense

Profit

Revenue

time

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2. Define Your Planning Horizon2. Define Your Planning Horizon

Factors to Consider– Your vision gets worse as you age.

Proposal:– Study the rate of change in your environment

• Will the features of a new 2003 DVD player matter in 2020?

– Compare the life spans of the alternatives and evaluate the overlap.– 10 years?

%

time

Accuracy of Estimations

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3. Define Your Objectives3. Define Your Objectives

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• Moral• Obsolete Components• Unsafe/OSHA• Business Changed• Customer/Supplier

Demands


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IBM Crane Replacement: ObsolescenceIBM Crane Replacement: Obsolescence

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• Pure ROI• Labor• Maintenance• Parts


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Automating Car Assembly: Pure ROIAutomating Car Assembly: Pure ROI

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• Expansion Capacity• Increased Customer

Demand• Quality Demands• Reduced Delivery

Time


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Automating Delivery To Press: Automating Delivery To Press: Extending Time to PublishExtending Time to Publish

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• Image• Enter New Markets• Improve Market Share• Improve Reputation

• Quality• Delivery• Price


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Automatic Library: Space Saving & Very CoolAutomatic Library: Space Saving & Very Cool

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If you do nothing … over time, your situation will shift to the left


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4. Specify the Alternatives4. Specify the Alternatives

A - Automation Project

B - Do Nothing

C - Upgrade Current

D - Hybrid Solution

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5. Estimate Cash Flows for Each Alternative5. Estimate Cash Flows for Each Alternative

Identify the complete cost of doing the project– Initial investment

• Include labor and expenses of your company staff

– Cost to cover the gap between today and completion– Long term costs of ownership and use

• Do these costs change over time?• How do economic changes influence these costs (inflation)?

Determine what it will cost you to do something else…or nothing.– Do these costs change over time?– How do economic changes influence these costs (inflation)?– Will there be other subtle investments required later?

Can you increase revenue with this investment? Make intangibles tangible

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Back to our ExampleBack to our Example

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Determining Real Cost Benefits - ExampleDetermining Real Cost Benefits - Example

Figure out what time frame you care about– At what time will the investment results and your current situation

become indistinguishable? ( At what time will your new snowblower be in the same shape as your current snowblower?)

– When does the cost-of-ownership and revenue data become fuzzy?– 10 years?

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Identify the complete cost of doing the project– Buying the 14hp Sears 2WD 2-stage blower $2,200– Will need a shop rebuild once in 10 years $

210– Oil changes the other years 9 x $30 = $ 270

TOTAL $ 2,680

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Determine what it will cost you to do something else…or nothing.– Need to hire the kid around the corner

when it’s broken. 4 x $30 x 10 years = $ 1,200– Will need shop maintenance every 3 years

$210 x 3 $ 630

– Oil changes the other years 7 x $30 = $ 210– Auger will last 1 more year $ 230– Burns 1qt oil per month $2 x 5 mo x 10 yrs $ 100

TOTAL $ 2,370

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Can you increase revenue with this investment?– Son can clear neighbor’s driveway 10 x $30 = $ 300– Can sell the old one to your friend at work $

60

TOTAL $ 360

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Make intangibles tangible– The effect of morale:

If you are not screaming about the old snowblowerwhen you come in the house, your wife will not beirritated with you and may cook you dinner insteadof demanding that you take her out to dinner to compensate for your bad attitude. 10 years x 2 times x $30 ea. Save: $ 600

– Competitive advantage

Your neighbor will be very jealous Priceless

TOTAL: $ 600

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Net Result– Investment - $ 2,680

– Plus money made + $ 360

– Plus the intangible savings + $ 600

TOTAL COST - $ 1,720

– Do nothing cost - $ 2,370

NET SIMPLE DIFFERENCE + $ 650

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What Did We Miss?What Did We Miss?

How does the effect of the economy impact cost?– Does the cost of oil changes go up every year?– Will your son raise his prices?

Will time impact the volume or frequency of costs?– If you lose a quart of oil per month now, will it be more over time?

What is the lost investment opportunity for the $2,200?– At 8%, in 10 years it would be $ 4,700!

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6. Specify the Interest Rate6. Specify the Interest Rate

This will account for the effect of inflation Does NOT account for the change in frequency or

volume of a cost item. Tie to:

– Historical Trends in your field– An accepted index (CPI?)– A fixed number that you can explain away in the future

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7. Compare the Alternatives7. Compare the Alternatives

You have 2 choices...

– A Beauty Contest

A vs. B vs. C vs. D

– A Control Scenario Comparison

A vs. B A vs. C A vs. D

}Less likely to be hypnotized intofocusing on the differences betweenthe challengers. Compare to astable control Alternative.

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Forgetting the Objectives When ComparingForgetting the Objectives When Comparing

I can’t be bothered by some crazy salesman,I’ve got a battle to fight!!!

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8. Perform Sensitivity Analysis8. Perform Sensitivity Analysis

Adjust– Rates– Interest rates– Annual change in frequency and volume of a cost item

Perform “What if” Scenarios– Interject periodic unplanned events– Revenue opportunities– Intangibles bear fruit

Watch Your Output– Are the categories of influences balanced?– Is the change in time smooth or drastic?– Does it make sense?

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9. Select the Best Alternative9. Select the Best Alternative

Is This a “Have To”?……….

Intangibles Override ROI?– Market Position– Future Interface & Integration

What’s the ROI?– Payback Method (months)– IRR (%)– NPV ($)

Compare to Other Uses for That Money

• Moral

• Obsolete Components

• Unsafe/OSHA

• Business Changed

• Customer/SupplierDemands• Moral

• Obsolete Components

• Unsafe/OSHA

• Business Changed

• Customer/SupplierDemands

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The 7 Deadly Sins of Failed JustificationThe 7 Deadly Sins of Failed Justification

Not accounting for the costs of not conducting the

project.

Assuming all costs are one-time or recurring and

ignoring random periodic costs.

Looking only at costs not potential income opportunities.

Ignoring salvage and resale values.

Blowing off the intangibles. Misunderstanding the effect of the economy. Confusing the change in volume and frequency of cost

with the inflation of costs.

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10. Check Your Results10. Check Your Results

REALIZE

SPONSOR/SUPPORT

DIRECTION

JUSTIFY

DESIGN

BUILD

Checkmetrics

?

Consider

Board/Management?

Feasibility, PreliminaryCost/Benefit, Options

Return On Investment,

Select a team,

Execute…Support,Monitoring

Re-direct

In House

Partner

Both

Monitoring

Re-justify

All Good Control Systems Need Feedback Tune Your Process for the Next Time Establish Credibility…so there is a Next Time

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An ROI Tool - OverviewAn ROI Tool - Overview

Listof

Costs&

Revenues

EstimatedCash Flow

if weAutomate

EstimatedCash Flow

if wedon’t

Automate

• Net Cash Flow

• Impact of Inflation

• NPV for various durations

• ROI to-date per year

• Month investment pays back

• Graphs

INPUT OUTPUT

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An ROI Tool - List of Costs & RevenuesAn ROI Tool - List of Costs & Revenues

Listof

Costs&

Revenues

EstimatedCash Flow

if weAutomate

EstimatedCash Flow

if wedon’t

Automate

INPUT

Definition/ Example

COSTSAutomation Project Investment The total cost of going forward with the project

Remedial / Upgrade Costs of Current Asset What will it cost to make current asset viable for 10 years of operation?

Periodic Major Upgrades/Rebuilds To overcome obsolescence, wear, technology upgrades, etc

Ownership Costs (Indirect) Non-operating (day to day added value production) costs

Operational Costs (Direct) Day to day added value operational costs

REVENUESProject Related Money in due to conducting the project

Business Related Added profits resulting from conducting the project

INTANGIBLESValue of "Best Practices" Value to the company to do things the "right way"

Secondary value of information availability Results of having better access to information

Employee Satisfaction Vlaue of having motivated, dependable employees

Customer / Market Effect Is there an advantage in the marketplace to automation?

Economic Impact

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An ROI Tool - Data Entry: AutomationAn ROI Tool - Data Entry: Automation

Listof

Costs&

Revenues

EstimatedCash Flow

if weAutomate

EstimatedCash Flow

if wedon’t

Automate

INPUT

UoM

Value per Year (Hrs, etc) UoM

Rate (Curr.

Yr $) Total 1 2 3 4 5 6 7 8 9 0

3 Mgr 2000 hrs 120$ 720,000$ 100% 1 1

2 SW 1000 hrs 100$ 200,000$ 100% 1

-$ 100%

1 PM 2000 hrs. 100$ 200,000$ 100% 1 1

12 Trps 3 days 500$ 18,000$ 100% 1

AUTOMATION

Year Applies (1/0)Chng per year

%

Quantity (No.

People, etc)

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An ROI Tool - Data Entry: AlternativeAn ROI Tool - Data Entry: Alternative

Listof

Costs&

Revenues

EstimatedCash Flow

if weAutomate

EstimatedCash Flow

if wedon’t

Automate

INPUT

UoM

Value per Year (Hrs, etc) UoM

Rate (Curr. Yr $) Total 1 2 3 4 5 6 7 8 9 0

1 ea 1 upgr. 240,000$ 240,000$ 100% 1 1

2 eng 2000 hrs 115$ 460,000$ 100% 1

1 kit 1 parts 55,000$ 55,000$ 113% 1 1 1 1 1 1 1 1 1 1

-$ 100%

1 ea 1 kit 10,500$ 10,500$ 100% 1 1

-$ 100%

Year Applies (1/0)

ALTERNATIVEChng per year

%

Quantity (No. People,

etc)

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An ROI Tool - Results: ROI DataAn ROI Tool - Results: ROI Data

1 2 3

(COST) / REVENUE SUMMARY

Automation ImpactToday's Dollars (7,457,800)$ (3,249,550)$ (1,788,550)$ Today's Dollars Accumulative (7,457,800)$ (10,707,350)$ (12,495,900)$ Escalated (7,457,800)$ (3,379,532)$ (1,934,496)$ Accumulative Escalated (7,457,800)$ (10,837,332)$ (12,771,828)$

Alternative ImpactToday's Dollars (4,761,200)$ (4,656,400)$ (4,940,900)$ Today's Dollars Accumulative (4,761,200)$ (9,417,600)$ (14,358,500)$ Escalated (4,761,200)$ (4,842,656)$ (5,344,077)$ Accumulative Escalated (4,761,200)$ (9,603,856)$ (14,947,933)$

RETURN ON INVESTMENT

Payback Method - Today's Dollars

Cost of Automation Investment (6,204,200)$ (1,476,000)$ -$ Accumulative Cost of Automation (6,204,200)$ (7,680,200)$ (7,680,200)$ Annual Savings 3,507,600$ 2,882,850$ 3,152,350$ Annual Total Payback / (Cost) (2,696,600)$ 1,406,850$ 3,152,350$ Accumulative Payback / (Cost) (2,696,600)$ (1,289,750)$ 1,862,600$ ROI to Date Per Year -43.5% -16.8% 24.3%Month Project Pays Back

Payback Method - EscalatedCost of Automation Investment (6,204,200)$ (1,535,040)$ -$ Accumulative Cost of Automation (6,204,200)$ (7,739,240)$ (7,739,240)$ Annual Savings 3,507,600$ 2,998,164$ 3,409,582$ Annual Total Payback / (Cost) (2,696,600)$ 1,463,124$ 3,409,582$ Accumulative Payback / (Cost) (2,696,600)$ (1,233,476)$ 2,176,106$ ROI to Date Per Year -43.5% -15.9% 28.1%Month Project Pays Back

Net Present Value

F = Annual Total Payback/(cost) n = period analyzed in years I = interest rate

n

i

ni iFNPV

1

)1(

9 10 TOTAL IMPACT AVERAGE/YR

(1,988,550)$ (1,773,550)$ (23,006,200)$ (24,779,750)$ (24,779,750)$ (2,477,975)$ (2,721,468)$ (2,524,315)$

(25,877,939)$ (28,402,254)$ (28,402,254)$ (2,840,225)$

(3,890,900)$ (3,890,900)$ (37,714,400)$ (41,605,300)$ (41,605,300)$ (4,160,530)$ (5,324,965)$ (5,537,964)$

(43,991,984)$ (49,529,948)$ (49,529,948)$ (4,952,995)$

-$ -$ (7,680,200)$ (768,020)$ (7,680,200)$ (7,680,200)$ 1,902,350$ 2,117,350$ 24,505,750$ 2,450,575$ 1,902,350$ 2,117,350$ 16,825,550$ 1,682,555$

14,708,200$ 16,825,550$ 16,825,550$ 1,682,555$ 191.5% 219.1%

-$ -$ (7,739,240)$ (773,924)$ (7,739,240)$ (7,739,240)$ 2,603,497$ 3,013,649$ 28,866,934$ 2,886,693$ 2,603,497$ 3,013,649$ 21,127,694$ 2,112,769$

18,114,045$ 21,127,694$ 21,127,694$ 2,112,769$ 234.1% 273.0%

YEAR

22

19

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An ROI Tool - Results: Cost/Savings GraphsAn ROI Tool - Results: Cost/Savings Graphs

COST/SAVINGS COMPARISON PER YEAR

$(8,000,000)

$(7,000,000)

$(6,000,000)

$(5,000,000)

$(4,000,000)

$(3,000,000)

$(2,000,000)

$(1,000,000)

$-

1 2 3 4 5 6 7 8 9 10

YEAR

Esc

alla

ted

$

Automation

Alternative

ACCUMULATIVE COST/SAVINGS COMPARISON PER YEAR

$(60,000,000)

$(50,000,000)

$(40,000,000)

$(30,000,000)

$(20,000,000)

$(10,000,000)

$-

1 2 3 4 5 6 7 8 9 10

YEAR

Acc

um

. Esc

alla

ted

$

Automation

Alternative

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An ROI Tool - Results: Category Analysis An ROI Tool - Results: Category Analysis

-7000000

-6000000

-5000000

-4000000

-3000000

-2000000

-1000000

0

$

1 2 3 4 5 6 7 8 9 10

YEAR

PROJECT INVESTMENT

-5000000

-4000000

-3000000

-2000000

-1000000

0

$

1 2 3 4 5 6 7 8 9 10

YEAR

PERIODIC UPGRADES

0

100000

200000

300000

400000

500000

$

1 2 3 4 5 6 7 8 9 10

YEAR

REVENUES

-12000000

-10000000

-8000000

-6000000

-4000000

-2000000

0

$

1 2 3 4 5 6 7 8 9 10

YEAR

TOTAL CASH FLOW

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Navagating the SpreadsheetNavagating the Spreadsheet

50

4 Pages

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Thanks To:Thanks To:

John Usher, Professor - University of Louisville John M. Hill, Principal - ESYNC

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Demo TimeDemo Time

1 justifying automation november 19, 2003 revised september 13, 2006

Documents

new snowblower

planning horizonfactors

real task

serveyour task

planning horizon3

considershort term thinking

long term thinking

pure roilabormaintenanceparts3