Asset Replacement: The Price is Right
September 09, 2010
by Dan Malovany
Blame it on the economy, tight lending practices, rising commodity prices, a lack of consumer spending, deep discounting by competitors or the penchant by retailers and food service chains to pressure their suppliers to do anything to offer them even lower everyday prices. It’s all part of a massive chain reaction that’s making the payback time when it comes to buying equipment a whole lot quicker compared with just a few years ago.
Granted, “invest to be the best” remains a longstanding philosophy for many companies, but the reality of the marketplace seems to have created a new benchmark for return on investment (ROI) in the current capital planning process, according to Bill Zimmerman of Zim’s Consulting, Gresham, OR, a longtime industry veteran who has bought his share of equipment over the years.
“It’s gone from three to five years to two years because money is so tight,” he said. “You’ve seen what wheat prices are doing. They’re just going through the roof right now. If we didn’t just have the bad situation because of the economy and consumers trading down instead of trading up, bakers are going to have a tougher time operating with wheat prices going up.”
At a time when margin-pinched companies remain totally focused on the bottom line, two years may be good, but 12 months or less is even better, according to Gary Swymeler, vice-president of engineering, The Long Co., Chicago, IL. “If it’s anything more than a 2-year return on investment, then it’s looked at very hard,” he noted. “If the payback is less than two years, it should be a no brainer. When you look at your ROI and determine that you eliminated breakdowns and saved your investment in six months on just parts and downtime, that’s the piece of equipment you’re going to buy.”
ROI or “hurdle rates” can differ significantly, depending on the company. While the cost of capital is fairly similar for businesses across the board, financing capital investments to some degree has become more challenging with the current economic conditions, asserted Rob Burch, c.o.o., Labriola Baking Co., Alsip, IL “Whether you’re a small private entrepreneur or part of a large corporate organization, capital equipment purchases are being scrutinized more closely by management, shareholders and investment bankers,” he said. “There’s certainly an appetite for reduced risk and quicker payback in this economic environment.”
While the ROI timeline has become much more condensed, baking companies are broadening how they calculate the total cost of a production line or piece of equipment. “The economy always causes companies to tighten their expectations no matter what levels they normally operate at,” noted Jeff Dearduff, director of US bakeries at East Balt, Chicago, IL. “The change in views on ROI over the years has started to incorporate energy savings, safety and other ‘soft’ criteria to accompany the financial gains credited to effi ciency and quality. The other piece that sometimes ties into an ROI is when you can determine the added capabilities of an investment beyond what it was originally purchased to do.”
THE MAIN HURDLES. In any economic environment, baking companies and snack producers always follow certain hard-and-fast rules, especially during the initial stages when determining whether to rebuild or replace a piece of equipment. “What’s really important if you are replacing a line or installing a new one is reliability of the equipment and how sturdy that equipment will be throughout the years,” Mr. Zimmerman said. “I think the baker’s mentality is still, ‘I buy it once. I use it forever.’ Or, ‘I just bought that 10 years ago. How come it’s falling apart?’”
As a part of its continuous improvement culture, Grecian Delight Foods, Elk Grove Village, IL, tracks machine reliability, and if downtime becomes a reoccurring problem, it initiates a lifecycle analysis followed by an equipment strategy session by a collaborative team of production personnel to determine whether to repair, rebuild or replace it. “If the age of the equipment suggests that the repairs will continue and there’s an elevated cost with running it, that’s when we make the recommendation for it to be replaced,” said Tom Valnoha, vice-president of operations, who’s currently overseeing the construction of the company’s second, 130,000-sq-ft bakery, scheduled to start up in October.
To assess the real cost of asset replacement, the answers often are found in those specific questions asked about the direct costs that fuel the bottom line, according to Tony Tristani, senior vice-president and general manager, Oakrun Farm Bakery, Ancaster, ON. Usually, those questions involve the lowest of the low-hanging fruit, namely cutting labor and controlling ingredient costs. “The main thing is how can we automate more? That is a big, big issue for us,” he said. “”How can we automate our lines to take labor out? What can we do to reduce waste levels? Is there equipment out there that’s more accurate in terms of depositing so we can tighten our tolerances on scaling and minimize variations? What can we do to bring those raw material costs and direct labor costs down?”
Currently, Oakrun Farm Bakery, a division of Toronto, ON-based Pineridge Foods, is targeting the front end of the production process to boost capacity, deposit more accurately and reduce variability in dividing to drive bottom line growth. “Is there equipment out there that can give us a 2 to 3% throughput increase? That may not sound like much, but when you have a line that’s running 500 pieces per minute , if you can get a 2 to 3% increase in throughput on that line, over a year, that’s a lot of money,” Mr. Tristani said. “And it also gives you a competitive edge when your sales team goes out to give a quote on a particular product and win that business.”
With the wild fluctuations in ingredient costs, he added, minimizing waste on some lines can easily trump labor costs that historically have been the main criteria for justifying capital expenditures. “We can automate labor, but sometimes, labor is now only 13% of your direct costs while raw materials typically are 40 to 50%,” Mr. Tristani said. “For some products like pre-deposited muffins and cookies, you can get your raw materials up to 65 or 70% of costs. Saving a quarter-ounce here or a couple of grams there can result in big-time savings.”
Accurately topping sesame seeds on buns might be another reasonable investment where bakers can hit the trifecta by reducing ingredient costs, minimizing allergen risks and cutting down on maintenance and sanitation issues, Mr. Swymeler said. “The savings of toppings can be astronomical if the system does what [the vendor says] it can do,” he noted. “If it can give the bakery better product quality at a lower cost, then it’s worth investing in.”
BROADER ROI EQUATION. In addition to allergen concerns, several highly publicized recalls involving peanut butter and pistachios last year have pushed maintenance and sanitation to the forefront and made sanitary design the latest buzzword for equipment. For some bakers such as Oak State Products, Wenona, IL, it’s become a vital factor in the ever-expanding ROI equation. “If it doesn’t pass the test for sanitation, we’re not even going to look at it,” said Dave van Laar, president and c.e.o. of the contract manufacturer and private label cookie producer.
A lack of sanitary design may become a veto factor for some food companies, but it’s still not considered as important a primary variable as labor count or ingredient costs for justifying a purchase, according to Mr. Swymeler, a 47-year veteran of the baking industry. “I haven’t heard any plant engineer say they’re going to buy a piece of equipment because it’s a whole lot more sanitary,” he observed. “That just doesn’t happen in my experience. Most are just focused on the bottom line.”
Many baking and snack companies, however, are redefining how they calculate the bottom line as they try to document any previously ignored indirect or hidden costs. Grecian Delight Foods, for example, conducts a thorough equipment design review as a part of its equipment replacement strategy, according to Mr. Valnoha. Afterward, the operations team meets to discuss equipment criteria, including the labor needed to clean and maintain a line. In addition, the team explores the possibility of engineering out harborage points for allergens, pathogens and pests. The company also will rely on the Safe Quality Food (SQF) program of the Global Food Safety Initiative to provide a guideline for evaluating equipment. “If you use SQF activities to review the design of a machine, you will engineer out sanitation harborages,” he said. That’s something that many companies didn’t consider three years ago at the IBIE in Orlando, FL.
REBUILD OR REPLACE. Sanitary design also can become a more critical factor when deciding whether to replace or rebuild equipment, according to David Dixon, senior director, strategic accounts, Burns & McDonnell, an engineering firm based in Kansas City, MO. “It’s hard to get sanitary design from anything but a piece of equipment that was built that way from the bottom up,” he said. “You can’t retrofit. You’re going too deeply into the machine to redo it from a sanitary design standpoint. You can rebuild for automation, but you can’t rebuild from a sanitary design standpoint.”
Additionally, maintenance and sanitation have become more prominent in the budgeting process as bakeries redefine what exactly constitutes capacity on a production line, added Allen Baiamonte, a former bakery engineer and current associ- ate project manager in the food and consumer products group for Burns & McDonnell. A decade ago, many bakeries considered a line to be at capacity when it ran 135 hours out of a 168-hour week. Now, they’re running production lines longer, up to 150 hours or more per week. “How can you effectively do the same amount of maintenance and sanitation in 18 hours when before you had 33 hours to do it?” Mr. Baiamonte asked.
Hiring more people to do sanitation simply defeats the purpose of running production lines longer per week, he added. Moreover, cutting corners on maintenance just raises the risk for equipment breakdown and costly downtime.
That’s why many production personnel are searching for toolless components and smartly designed equipment to streamline the preventive maintenance process. “Is there something that will be easily maintained and doesn’t have a million parts?” Mr. Tristani asked. ‘So when you strip it to clean or maintain it, you don’t potentially lose something in the process.
Lack of proper maintenance also can shorten the lifecycle of equipment. Often, bakers bemoan that today’s mixers, dividers, ovens and packaging machines aren’t built to last like they were in the past. Proper maintenance might be why, suggested Mr. Zimmerman. “With bakeries running longer hours into the week, attrition on equipment is greater than what it used to be,” he said. “Some of these old-time bakers say, ‘I had this oven for 37 years, and I have this newer one, and now it’s worn out.’ If you double your throughput through the oven and not maintain it, you’re going to wear it out sooner.”
In many ways, equipment suppliers today face a Catch-22 when it comes to the lifecycle of equipment, according to Mr. Baiamonte. “They may have overengineered it before to make it last a long time, but it’s a lot more expensive to do that today,” he said. “They’re looking to find ways to reduce the cost of materials to make the equipment more affordable.”
Additionally, the technology of rebuilt equipment should be compatible with other processing lines in the bakery as well as with the skill set of the maintenance and engineering staff. While installing the latest in PLCs and servo-driven motors looks good on paper or makes for a good cocktail discussion, companies now need to consider how they fit into their current operations.
“You have to ask, ‘Do you really want all of this automation?’” Mr. Baiamonte noted. “You’re getting ready to buy an F-16. Do you have somebody who can fly it or maintain it? Sometimes, automation isn’t as glorious as you think, especially if it overwhelms the existing maintenance staff in terms of their ability to maintain it.”
Energy savings also has emerged as a more important component in the ROI equation as manufacturers search for any way to lower overall fixed costs, including enabling those sustainable practices that also impact the bottom line. As part of its overall business decision-making process, Grecian Delight Foods conducts equipment audits to evaluate all of the electrical motors in its facilities to determine if there are energy-efficient or Energy Star replacements available, Mr. Valnoha said.
At Labriola Baking, which just opened its new facility, Mr. Burch searches for equipment that provides a broader value proposition. In the end, bakers just need to determine if the price is right for the ROI they want to achieve. “Having superior software controls or placing a greater emphasis on sanitary design can be an added differentiator bakers are looking for,” he said. “However, equipment design, brand performance, reputation, prior experience, after-sales service, technical ability and a host of other factors still weigh heavily in a baker’s purchase decision. You might say the sales process is even more complex than ever as bakers try to evaluate or force equipment benefits.” •