Return on steam efficiency investment

Putting it all together: impacts on ROI

01/14/2004


Please read the article on Return on steam efficiency investment in the January 2004 issue. Christopher Russell, Senior Program Manager, Alliance to Save Energy, Washington, D.C. 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 turn-over (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 im-proves 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 an alternative, thus commanding a premium price, which would ultimately drive ROI higher. Steam efficiency's contribution to manufacturing ROI Financial metric After implementation After reinvesting additional revenue Revenues No change Increase with production volume Operating expenses Net decrease per unit Increase with production volume Net operating income Increases per unit and overall Proportional increase greater than expenses Margin, % Increases as % of revenue No additional increase as a percentage Assets May increase* No additional increase in magnitude Asset turnover May decrease* Increases with production volume ROI Increases with margin Increases again with asset turnover *Assets increase only if capital investments are required. Some initiatives require only operational changes. When capital investment is avoided, assets do not increase and asset turnover does not decrease. One study shows about half of steam efficiency opportunities can be obtained without implementing capital projects (Griffin, 2003). 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 Consolidated Financial Statement STEP 1: Financial position prior to any energy efficient implementation Line 1 Revenue Units Price Per Unit Financial Result 10,000 $1000 $10,000,000 Cost of Goods Line 2 Per Unit Direct materials 10,000 300 $3,000,000 Any waste is reflected in the cost per unit. Line 3 Direct labor (fully loaded) 12,000hr. $66.67/hr. $800,000 Average fully loaded salary for staff of 6, each working 2000 hr./yr. Line 4 Overtime (fully loaded) 1000 hr. $100/hr. $100,000 Driven by extra shifts needed to compensate for downtime. Line 5 Operations & maintenance $700,000 Includes consumables, service contracts, etc. Line 6 Boiler fuel 400,000 MMBtu $5.00/MMBtu $2,000,000 Price is averaged across fixed contract and spot market purchases. Line 7 Other manufacturing expense $400,000 Overhead and any other manufacturing expenses. Line 8 Total cost of goods manufactured $7,000,000 Line 9 Gross margin $3,000,000 Value generated by manufacturing prior to administrative costs. Administrative expenses Line 10 OSHA & emissions penalties $200,000 Some companies actually budget for these Line 11 Hazard insurance $1,000,000 Line 12 All other expenses $800,000 Includes front office salaries, legal, audit expenses, etc. Line 13 Total administrative expenses $2,000,000 Line 14 Total operating expenses $9,000,000 Line 15 Net operating income $1,000,000 Assets Line 16 Plant and equipment $4,000,000 Line 17 All other assets $1,000,000 Line 18 Average operating assets $5,000,000 Financial metrics Line 19 Fuel cost per unit of production (total fuel cost÷ units produced) $200 Line 20 All other costs per unit (all other costs ÷ units produced) $700 Line 21 Total expense per unit (total expenses units produced) $900 The plant is like a money machine; put 90 cents in one end to get $1.00 out the other end. Line 22 Margin (net operating income ÷ revenue) 10% This plant makes 10 cents on the dollar. Line 23 Asset turnover (revenue ÷ average operating assets) 2.0 Assets pay for themselves twice a year in the form of revenue produced. Line 24 Return on investment 20% A modest return, more than treasury bills, but it can be better. STEP 2: Financial position after implementing steam efficiency initiative Line 1 Revenue Units Price Per Unit Financial Result No change 10,000 $1000 $10,000,000 Cost of Goods Cost Per Unit Line 2 Direct materials 10,000 $285 $2,850,000 Optimization of thermal resources reduces waste by $150,000. Line 3 Direct labor (fully loaded) 13,500hr. $66.67/hr. $900,000 Optimization requires greater labor input by $100,000. Line 4 Overtime (fully loaded) 500 hr. $100/hr. $50,000 Optimized performance, reduced downtime, and less overtime saves $50,000. Line 5 Operations & maintenance $900,000 Improved monitoring and maintenance increases costs by $200,000. Line 6 Boiler fuel purchases 360,000 MMBtu $4.90/MMBtu $1,764,000 Reduced fuel consumption and greater use of low priced, fixed contracts saves $236,000. Line 7 Other manufacturing expense $405,000 Training expense increases as staff skills are developed by $5000. Line 8 Total cost of goods manufactured $6,869,000 Fuel savings and waste minimization outweigh other cost increases by $131,000. Line 9 Gross margin $3,131,00 Gross margin isolates cost/price effectiveness of manufacturing from front office costs. Administrative expenses Line 10 OSHAand emission penalties $25,000 Optimization enhances safety; emissions drop proportionately with fuel consumption. Line 11 Hazard insurance $850,000 Clean log book is leverage for lower cost premiums by $150,000. Line 12 All other expenses $800,000 No change Line 13 Total administrative expenses $1,675,000 Summary of plant optimization cost benefits that accrue to the front office. Line 14 Total operating expenses $8,544,000 A net improvement in total expenses of $456,000 Line 15 Net operating income $1,456,000 Assets Line 16 Plant and equipment $4,500,000 Optimization requires investment innew or replacement equipment of $500,000 Line 17 All other assets $1,000,000 Line 18 Average operating assets $5,500,000 Financial metrics Line 19 Fuel cost per unit of production (total fuel cost ÷ units produced) $176 (was $200) Line 20 All other costs per unit (all other costs ÷ units produced)$678 (was $700) Line 21 Total expense per unit (total expenses ÷ units produced) $854 (was $900) Now the money machine only requires 85.4 cents in one end to get $1.00 out the other end. Line 22 Margin (net operating income ÷ revenue) 15% (was 10%) Margin reflects cost/price business efficiency.Line 23 Asset turnover (revenue ÷ average operating assets) 1.8 (was 2.0) Line 24 Return on investment (margin x asset turnover) 26.5% (was 20%) The improved margin more than compensates for decreased asset turnover. STEP 3: Financial position after reinvesting savings in production Line 1 RevenueUnits Price Per Unit Financial Result 10,533 $1000 $10,533,000 Expense savings from Step 2 are reinvested to produce more goods and revenue. Cost of goods Cost Per Unit Line 2 Direct materials 10,533 $285 $3,001,905 Cost per unit is unchanged from Step 2 but number of units increases. Line 3 Directlabor (fully loaded)14,200 hr. $70/hr. $994,000 Increased production requires more labor hours plus wages reflect value of training. Line 4 Overtime (fully loaded) 500 hr. $100/hr. $50,000 No change from Step 2. Line 5 Operations & maintenance $945,000 This increases proportionately with output. Line 6 Boiler fuel purchases 379,188 MMBtu $4.90/MMBtu $1,858,021 Fuel expense increases proportionately with production. Line 7 Other manufacturing expense $426,587 These increase more or less proportionately with production. Line 8 Total cost of goods manufactured $7,275,513 Higher output explains greater total expenditure relative to Step 2. Line 9 Gross margin $3,257,487 Higher production more than compensates for greater expenditures relative to Step 2. Administrative expenses Line 10 OSHA and emission penalties $25,000 No change from Step 2. Line 11 Hazard insurance $850,000 No change from Step 2. Line 12 All other expenses $800,000 No change from Step 2. Line 13 Total administrative expenses $1,675,000 No change from Step 2. Line 14 Total operating expenses $8,950,513 Higher than Step 2 but lower than Step 1 despite additional level of production. Line 15 Net operating income $1,582,487 Increase in revenue more than compensates for rise in expenses. Assets Line 16 Plant and equipment $4,500,000 No change from Step 2. Line 17 All other assets $1,000,000 No change from Step 2. Line 18 Average operating assets $5,500,000 No change from Step 2. Financial metrics Line 19 Fuel cost per unit of production (total fuel cost ÷ units produced) $176 (same) Line 20 All other costs per unit (all other costs ÷ units produced $673 (was $678) Line 21 Total expense per unit (total expenses ÷ units produced) $850 (was $855) Line 22 Margin (net operating income ÷ revenue) 15% (same) Line 23 Asset turnover (revenue ÷ average operating assets) 1.9 (was 1.8) Line 24 Return on investment (margin x asset turnover) 28.8% (was 26.5%) 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.





Top Plant
The Top Plant program honors outstanding manufacturing facilities in North America.
Product of the Year
The Product of the Year program recognizes products newly released in the manufacturing industries.
System Integrator of the Year
Each year, a panel of Control Engineering and Plant Engineering editors and industry expert judges select the System Integrator of the Year Award winners in three categories.
June 2018
2018 Lubrication Guide, Motor and maintenance management, Control system migration
May 2018
Electrical standards, robots and Lean manufacturing, and how an aluminum packaging plant is helping community growth.
April 2018
2017 Product of the Year winners, retrofitting a press, IMTS and Hannover Messe preview, natural refrigerants, testing steam traps
June 2018
Machine learning, produced water benefits, programming cavity pumps
April 2018
ROVs, rigs, and the real time; wellsite valve manifolds; AI on a chip; analytics use for pipelines
February 2018
Focus on power systems, process safety, electrical and power systems, edge computing in the oil & gas industry
Spring 2018
Burners for heat-treating furnaces, CHP, dryers, gas humidification, and more
April 2018
Implementing a DCS, stepper motors, intelligent motion control, remote monitoring of irrigation systems
February 2018
Setting internal automation standards

Annual Salary Survey

After two years of economic concerns, manufacturing leaders once again have homed in on the single biggest issue facing their operations:

It's the workers—or more specifically, the lack of workers.

The 2017 Plant Engineering Salary Survey looks at not just what plant managers make, but what they think. As they look across their plants today, plant managers say they don’t have the operational depth to take on the new technologies and new challenges of global manufacturing.

Read more: 2017 Salary Survey

The Maintenance and Reliability Coach's blog
Maintenance and reliability tips and best practices from the maintenance and reliability coaches at Allied Reliability Group.
One Voice for Manufacturing
The One Voice for Manufacturing blog reports on federal public policy issues impacting the manufacturing sector. One Voice is a joint effort by the National Tooling and Machining...
The Maintenance and Reliability Professionals Blog
The Society for Maintenance and Reliability Professionals an organization devoted...
Machine Safety
Join this ongoing discussion of machine guarding topics, including solutions assessments, regulatory compliance, gap analysis...
Research Analyst Blog
IMS Research, recently acquired by IHS Inc., is a leading independent supplier of market research and consultancy to the global electronics industry.
Marshall on Maintenance
Maintenance is not optional in manufacturing. It’s a profit center, driving productivity and uptime while reducing overall repair costs.
Lachance on CMMS
The Lachance on CMMS blog is about current maintenance topics. Blogger Paul Lachance is president and chief technology officer for Smartware Group.
Electrical Safety Update
This digital report explains how plant engineers need to take greater care when it comes to electrical safety incidents on the plant floor.
Maintenance & Safety
The maintenance journey has been a long, slow trek for most manufacturers and has gone from preventive maintenance to predictive maintenance.
IIoT: Machines, Equipment, & Asset Management
Articles in this digital report highlight technologies that enable Industrial Internet of Things, IIoT-related products and strategies.
Randy Steele
Maintenance Manager; California Oils Corp.
Matthew J. Woo, PE, RCDD, LEED AP BD+C
Associate, Electrical Engineering; Wood Harbinger
Randy Oliver
Control Systems Engineer; Robert Bosch Corp.
Data Centers: Impacts of Climate and Cooling Technology
This course focuses on climate analysis, appropriateness of cooling system selection, and combining cooling systems.
Safety First: Arc Flash 101
This course will help identify and reveal electrical hazards and identify the solutions to implementing and maintaining a safe work environment.
Critical Power: Hospital Electrical Systems
This course explains how maintaining power and communication systems through emergency power-generation systems is critical.
click me