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Identifying Operational Opportunities to Increase Asset Utilization During Due Diligence

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A few years ago we conducted a diagnostic review for a large commodity manufacturing and distribution client. They had a fleet of hundreds of rail cars and contracts with many rail roads. Most of our time was spent reviewing and benchmarking the rail contracts and rates. As we asked questions about their processes, metrics and reports, we found that they tracked the utilization rate of their rail car fleet. The report showed a 100% utilization rate. Naturally, this seemed too good to be true. So we talked to the manager and asked how the utilization rate was calculated. We were anticipating that they tracked loaded ton miles vs. a standard, or something similar. Instead, we found that they tracked whether each rail car was used in a month. They had 213 rail cars, and they had 213 loads in the month, so their utilization was 100%. This discovery led to a process
review and, eventually, process improvements that allowed the company to reduce their fleet by 70%. This reduction did not diminish customer service levels. The excess rail cars were the result of a loose process and a lack of thoughtful oversight. The new improved process allowed the company to stop incurring non-value adding expenses.

This is one of many articles in our series on Identifying Opportunities to Improve Operations, and it focuses on identifying opportunities to improve asset utilization. We have divided the opportunities to increase the market capitalization of a company into seven value lever buckets. For each area we describe the signs we look for that indicate the company can improve their financial performance, position in the market and their enterprise value. In other words, we are highlighting points you want to know BEFORE you buy the company; things that expose opportunities to increase EBITDA, capacity and asset utilization.

The Seven Value Levers include:

  1. Throughput. Can we increase the output of a plant, office, service location, or other facility?
  2. Variable Costs. Can we reduce the costs directly tied to our volume and revenues?
  3. Fixed Costs. Can we reduce the costs that do not change in the short term, based on customer demand?
  4. Order to Cash Cycle. Can we shrink the time between investment on our part and collection from our customers?
  5. Pricing. Can we collect more revenue for the services we are providing?
  6. Risk. How can we reduce risks related to running our business
  7. Asset Utilization. Can we increase inventory turns, the use of plant equipment, or the use of facilities?

A company leverages its assets to create and fulfill customer demand. In this section, we are looking for indications that the company can increase EBITDA, decrease working capital and increase return on capital through:

  • Consolidating facilities
  • Increasing turns on inventory
  • Realizing more revenue and throughput from existing assets and equipment
  • Reducing days of sales outstanding in Accounts Receivable
  • Tapping the latent capabilities of the existing IT system
  • Rationalizing private fleets and other fixed costs vs. outsourcing / variable cost alternatives

This is a powerful topic. Often, risks are not readily visible above the surface to the naked eye. We need to look for the following indicators that could show a company is susceptible to the risks listed above.

A consumer products client manufactured and distributed their own branded products. They built a tremendous brand and a loyal customer base. They also realized that their plant sat idle for part of the year due to seasonality. We helped them complete a make vs. buy analysis comparing contract manufacturers and 3rd party distribution to their internal cost structure. The analysis and eventual results showed that the company’s EBITDA would go up 40%, and their return on capital would grow by more than 4 fold by making this move. Today they are a brand management company focused on sales and marketing. The manufacturing and distribution are left to the dedicated experts. While this example requires that a company defines who they are to evaluate the relevance of such an approach, many other make vs. buy decisions allow us to move a cost, step or process to the party best able to manage or complete the step. Look for these signs and do the math. You will help management focus on core competencies, grow the company, and earn a better return on your capital.

If you have any questions or requests, please feel free to contact me at tvm@proactiongroup.com.

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