Return on steam efficiency investment

Before reading this article refer to a companion article appearing in the January 2004 issue of PLANT ENGINEERING magazine.

This article illustrates a hypothetical manufacturer's step-by-step improvement of return on investment (ROI). Each of the consolidated financial statements in sequence (Steps 1, 2, and 3) shows the financial elements that make up ROI.

Step 1 is a financial snapshot of manufacturing operations before implementation of a steam efficiency initiative. There is nothing remarkable about this model statement. The highlights include a profit margin of 10% (line 22), which means the company earns 10 cents from every dollar of revenue. The revenue generated by these assets is twice the value of the assets (line 18). Together, margin and asset turnover (line 23) yield an ROI of 20% (line 24).

Step 2 shows the company's consolidated financial statement after implementing steam efficiency. The steam plant superintendent spends more on operations and maintenance, labor, and training. In return, the savings in fuel costs, waste reduction, and reduced overtime more than compensate for the increases.

Manufacturing now produces more gross margin (line 9). Savings from reduced emission penalties and hazard insurance (lines 10 and 11) add to income performance (line 15). The profitability of the plant is reflected in the increased margin (line 22), but this is facilitated, in part, by investment in new plant assets (line 16).

Accordingly, asset turnover (line 23) declines relative to Step 1. The magnitude of margin improvement more than compensates and ROI improves to 26.5% (line 24).

Step 3, the plant decides to capture the full economic value of its improvements. Step 2 generated an additional $456,000 in net income (Step 2, line 15). Since the plant is making money, it makes sense to reinvest this revenue in production.

Production is increased by 533 units. All manufacturing expenses (line 8) increase relative to Step 2, but this is mainly because of the increase in production. Higher salaries for better-trained plant staff (line 3) push overall expenditures even higher. But with margin per unit still at 15% (line 22), the increased production boosts the overall magnitude of net operating income even more (line 15).

Finally, the increased production in Step 3 is generated without increasing the asset base; asset turnover (line 23) improves relative to Step 2. Despite the constant margin, the improvement in asset turnover is enough in Step 3 to increase ROI to 28.8% (line 24).

This analysis omits some additional opportunities. For example, the steam efficiency initiative, as described here, simply increased capacity for making more of the same product. An alternative would be to let capacity serve a new product line. The energy-efficient plant may be able to market its product as a "green" alternative, thus commanding a premium price, which would ultimately drive ROI higher.

In the final analysis, an investment in steam system optimization provides benefits beyond the boiler room.

• Plant staff gets training and a boost in pay
• Steam plant superintendent gets the resources to upgrade steam assets and maintenance
• Product managers enjoy lower costs per unit
• Sales and marketing have more negotiating room because the spread between cost and price has widened
• Corporate officers demonstrate a higher ROI

More Info

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