Return on steam efficiency investment

An addendum to this article, with an example of cost savings, is on our web site, plantengineering.com.

Steam efficiency is a major opportunity for manufacturers to boost financial performance in an increasingly competitive environment. A major barrier to accomplishing this is the communications disconnect between plant managers and financial decision makers who set capital budgeting priorities.

Strong financial justification is the key to full realization of steam efficiency opportunities. That premise is followed by a step-by-step review of the ways steam efficiency can boost a manufacturer's return on investment (ROI).

Steam system savings potential is within practical reach. One comprehensive study of 66 major steam plants found that 12.3% of fuel consumption, totaled over all plants, was avoidable (Griffin, 2003). The payback for these opportunities, overall, equaled 1.7 yr. But while this volume of savings was identified, the actual implementation rate of enabling projects represented only 3.9% of fuel consumption. In other words, only one third of the opportunities were implemented.

An additional point worth noting is that about half of the opportunities identified required capital investment; the balance required only operational or behavioral changes.

Why do companies forfeit additional earnings? Many companies simply fail to capture the full range of opportunities that occur when financial and engineering priorities intersect. Steam and other energy efficiency proposals may be stalled by a variety of corporate barriers; indifference, technical incompetence, capital budgeting procedures, and investment biases are a few examples.

Financial criteria are paramount, as must be the case for any profit-motivated enterprise. The challenge for plant managers is to advance steam plant optimization not simply as engineering projects, but as effective contributions to financial performance.

The actions which provide steam efficiency are: training, proper technology selection, adequate maintenance, and disciplined monitoring of fuel and other system inputs. Data describing plant operations provides a window on system performance. Because of system optimization, anomalies are more often detected before they become failures that shut down the plant or injure employees. As downtime is reduced, so too is the need to run overtime shifts to catch up to production targets. Combustion emissions decline proportionately with decreased fuel consumption.

In addition, optimized plant equipment increases productivity. When thermal losses are contained, a greater portion of boiler capacity can be directed to productive functions, enabling the plant to extend production runs or perhaps begin new product lines.

Global competition and decentralized corporate structures provide formidable challenges for manufacturing industries. Decentralized corporate structures give rise to virtually independent profit centers within a corporation. This fosters internal competition among profit centers for the allocation of investment capital.

The overarching measure of success within the manufacturing corporation is ROI, which becomes a benchmark for deciding how well managers are employing currently invested capital and which profit centers should get new investment capital. If steam plant superintendents are to be successful in securing capital budget funds, their proposals must clearly demonstrate an effective contribution to plant-level ROI.

ROI is derived from certain financial elements:

Net operating income/Sales X Sales/Average operating assets = ROI

or

Margin X Asset turnover = ROI

A few concepts in Fig. 1 are worthy of additional discussion.

Net operating income represents earnings before interest and taxes.

Average operating assets is the mean dollar value of all assets held over the course of an accounting period, usually a year.

Margin is the ratio of net operating income to sales revenue. It does not incorporate asset utilization, so it is only a partial measure of overall manufacturing performance. Manufacturing involves amortized plant assets, which incur interest and carrying costs that accrue daily, regardless of production volume. It makes financial sense to maintain asset utilization rates as close to 100% as possible.

Asset turnover is margin's complement. Asset turnover expresses sales revenue as a multiple of the value of assets that produced the revenue. In effect, asset turnover is a measure that compares the relative revenue-making effectiveness of two or more plants, or to track one plant's performance over time.

Return on investment is a simultaneous measure of the profit center's control of expenses as well as its utilization of production assets.

Why must margin and asset turnover be used together? Think of these analogs: margin is to speed as asset turnover is to time. Taken separately, speed and time are of limited interpretation. But multiplied together, speed and time describe distance, or the product of travel. Similarly, margin times asset turnover describes the financial product of a manufacturing facility.

A review of the elements in Fig. 1 reveals that there are five ways to increase ROI:

Increase product price

Increase production volume or number of product lines

If the market will accept the plant's additional output, fine. But does the plant have the capacity to produce more output? Steam system efficiency can recapture thermal resources that were lost and apply that to new production initiatives.

Reduce operating expenses

The impact of steam optimization in this instance should be obvious — become energy efficient to spend less on fuel. There are additional impacts:

• Plant optimization helps to preclude downtime. In turn, production schedules become more predictable. This gives the manager tremendous leverage when negotiating with fuel marketers.
• Overtime salaries are avoided.
• Thanks to diligent monitoring and maintenance, the optimized plant is safer, which should reduce hazard insurance premiums.
• The same actions reduce the exposure to penalties imposed by safety and emissions regulations.
• For some processes, scrap reduction is achieved through the same actions that enable energy efficiency.

Reduce asset holdings

This is an option frequently favored by corporate leaders whose expertise is more financial than engineering-based. ROI embodies the do-more-with-less concept when attempts are made to reduce the volume of assets employed per unit of sales.

Reduce the downtime of asset holdings

The price for avoiding new assets is to endure the failure of old ones. Corporate leaders can maintain ROI by avoiding asset additions, but eventually the downtime imposed by failing assets begins to defeat this strategy.

It is worth repeating that assets impose the same carrying costs whether they are operable or not, so financial performance is improved by moving asset utilization factors as close to 100% as possible. From a financial perspective, plant optimization permits greater yield from assets in place.

If you have any questions about this article, contact Chris Russell at 202-530-2225. Article edited by Joseph L. Foszcz, Senior Editor, 630-288-8776, jfoszcz@reedbusiness.com.