Financial Justification
Abstract
This chapter discusses the requirements for the financial justification of a proposed automation solution. The specific savings that may be available from each of the 10 key benefits of robots are reviewed together with some examples of how these can be expressed in financial terms. An approach towards developing a financial justification is discussed, including both savings and also other project costs that may be missed. The importance of providing the appropriate budget for a project is also highlighted.
Most projects will require the development of a financial justification to provide the budget against which the project can be purchased. The justification normally provides a comparison between the current costs of performing an operation or process, often using manual labour, and the savings that can be achieved by the introduction of automation. These savings are then compared to the anticipated cost of the automation solution to determine the point at which the investment starts to generate a positive financial return, often called the Return on Investment, or the ROI.
Most companies will apply a standard period, or payback period, over which investments are considered to be worthwhile. If the expenditure is covered within this payback period, then the project is considered financially viable and, to that end, worth considering. This is a major hurdle that must be addressed before a project can proceed. The decision to accept the project as viable often involves senior management, including financial personnel. It is, therefore, important that the benefits of the automation project be expressed in terms and language that can be understood by these people. The justification needs to be expressed in financial terms using criteria that are recognised and accepted by senior management. The development of these justifications can be a challenge for the project engineers because they often lack the knowledge and training to describe the benefits of the project in the appropriate way. However, the process is logical and it is not difficult to express the project using the appropriate terminology.
The main challenge is often the identification of the likely cost savings. These are not just the most obvious, typically the saving of labour. Based on labour savings alone it can be difficult to achieve the target payback period. This is particularly true in countries such as the UK and the USA where relatively short payback periods, such as 12 or 18 months, are the norm. By careful study it is often possible to identify additional savings that, by reducing the payback period, can make projects viable. This chapter reviews the process and, in particular, identifies examples of less obvious cost savings and explains how these might be derived.
It is also worth noting there are situations where the use of automation is not compared with alternative methods of manufacture. These are within companies where the use of robots is already fully proven, such as the automotive or automotive component sectors. In these cases, it is often a given that robots will be used for a specific project. The question is more about how many robots are required or how the systems will be designed. The justification for the purchase of the robots is not normally required because this approach is the norm. However, a justification may be required if a new automated process is being considered; in which case, the comparison is between the costs of the alternative automated solutions and the savings that are predicted for the new solution. The process and investigation of potential cost savings would follow the same approach as that discussed below.
7.1 Benefits of Robots
The 10 key benefits (International Federation of Robotics, 2005) that can be obtained by the application of robots were introduced in Chapter 2. These are as follows:
2. Improve product quality and consistency
3. Improve quality of work for employees
4. Increase production output
5. Increase product manufacturing flexibility
6. Reduce material waste and increase yield
7. Comply with safety rules and improve workplace health and safety
8. Reduce labour turnover and difficulty of recruiting workers
9. Reduce capital costs
10. Save space in high-value manufacturing areas
Each of these is reviewed below in terms of how they might contribute to the financial justification for a project. It should be stressed that these are potential benefits and may not be applicable in all cases.
7.1.1 Reduce Operating Costs
There are a number of operating costs that can be reduced by the introduction of robot automation. The most obvious being the labour cost previously incurred by the manual performance of that operation. Associated with this labour cost is the overhead that can be attributed to the labour; that is, the cost of employing the staff. This cost includes a proportion of the human resources function, payroll and supervision, training, and health and safety, as well as other costs such as the canteen and personnel protective equipment (PPE). If the number of personnel being replaced is small, these costs may not be significant. Additionally, if the labour is being redeployed elsewhere within the operation there may not be any actual reduction. However, even if the labour is redeployed there would have been additional headcount required if the automation was not introduced, so a saving is produced and the associated overhead should be included as part of the justification.
It may also be possible to reduce energy consumption. The energy per unit of output is optimised by the consistency of the robot and the reduction in scrap or rework. Additionally, robots do not require the same heating (or cooling) and lighting necessary for manual labour. Therefore, if the particular area of the factory can be fully automated, then it is possible to reduce energy input required to maintain the working environment.
7.1.2 Improve Product Quality and Consistency
The consistency of the robot automation will reduce defects as well as providing a consistent production rate. The reduction of these variables provides savings that should be measurable. The known throughput can lead to reductions in overtime or other administrative costs related to dealing with a variable production output. The reduction in defects will reduce the scrap rate as well as any rework requirement. This leads to savings in the labour, tools, and facilities required to perform the rework. The reduction in the scrap rate not only leads to savings as a result of the reduced production time required to produce the necessary quality output but also the cost of dealing with the scrap.
7.1.3 Improve Quality of Work for Employees
By improving the quality of work, the workforce is likely to have increased motivation and, consequently, productivity and quality will improve. The introduction of new manufacturing facilities also increases the confidence of the workforce because it shows the company has belief in the production facility and is willing to invest in new equipment. The investment provides opportunities for new jobs, such as maintenance and programming, which again has a positive impact on attitudes. Overall, these positive impacts provide increased workforce motivation but this is very difficult to quantify and, therefore, show as a financial benefit.
There may also be a reduction in labour turnover as the unpleasant jobs are those most likely to have high labour turnover. This reduces the costs of hiring new staff (see Section 7.1.8) and the human resources costs related to training and introducing new staff.
7.1.4 Increase Production Output
As mentioned above, the consistency of robots ensures a regular and potentially increased production output. This can increase the output of other machines, providing more efficient utilisation of those resources. It is also possible to operate machines unattended, which means they can continue to produce during operator breaks or can be set up to run at the end of a shift, overnight, or at weekends.
The value of this increased output can be determined. In some cases it may mean there is no need to purchase additional machines leading to significant savings, not only in capital and running costs but also in space and energy.
7.1.5 Increase Product Manufacturing Flexibility
The flexibility of robots can reduce changeover time between different products, which provides cost benefits in terms of reduced downtime. The reduction in changeover times can also allow the production of smaller batches, reducing the costs of storage and work in progress.
7.1.6 Reduce Material Waste and Increase Yield
As discussed in Section 7.1.2, reducing defects leads to cost savings in terms of the handling of those defects. It also leads to savings from a reduction in the costs of the materials fed into the system because these are utilised more effectively. This reduces the work in progress through all processes prior to the automation, including goods in and all the operations and activities associated with handling those materials including, potentially, stock control, and purchasing.
In addition to increasing the yield from the input materials, by reducing the production of defects, the automation can also work to tighter tolerance bands and, as a result, only apply or use exactly what is required. In some industries this can be a significant cost saving. For example, in the food industry minimum pack weights must be achieved and the use of automation allows the weight to be more tightly controlled reducing the amount given away to guarantee the minimum pack weight. This also applies to the use of consumables, which are used more efficiently by automation and, then, not only is the cost of the consumables reduced but also the cost of replenishing and storing those consumables.
7.1.7 Comply with Safety Rules and Improve Workplace Health and Safety
In addition to the improved production output and quality that can be achieved by automating dirty, dangerous, and demanding tasks (which would be covered by Section 7.1.2) other savings can be achieved. First, the requirement for PPE is reduced, which can also reduce the indirect costs associated with the PPE, such as purchasing and storage. There is also a potential reduction in employer insurance costs because the risk of claims due to injury is reduced.
There may also be a reduction in labour turnover as the unpleasant jobs are those most likely to have high labour turnover. This reduces the costs of hiring new staff (see Section 7.1.8) and the human resources costs related to training and introducing new staff.
7.1.8 Reduce Labour Turnover and Difficulty of Recruiting Workers
The most repetitive, dirty, or demanding jobs are those that normally have the highest labour turnover. The opportunities that automation provides generates new roles that are more challenging, less repetitive, require higher levels of skill, and also lead to higher levels of pay. The investment by the company also demonstrates confidence from the management and, consequently, generates a positive attitude within the workforce. All these factors, particularly the removal of the most arduous or repetitive jobs, leads to a reduction in labour turnover.
By improving staff retention, the costs associated with hiring new workers are reduced. This includes not only the direct costs associated with the hiring process but also training costs and the cost of workers’ lower productivity as they come up to speed on the job.
7.1.9 Reduce Capital Costs
As mentioned in Section 7.1.5, the flexibility provided by robots can enable smaller batch sizes, which reduces the cost of work in progress and inventory. Robots can provide the opportunity to run other machinery more efficiently or perhaps over extended hours, which may mean it is unnecessary to purchase additional machines (see Section 7.1.4).
The ease with which a robot system can be reconfigured can also provide longer-term capital cost benefits. If a product design change is required or a new product is introduced, a robot system can be reused. There will be some cost associated with the reconfiguration but this would be lower than the cost required for a completely new machine.
7.1.10 Save Space in High-Value Manufacturing Areas
An automation system can often be much more compact than an equivalent manual system. The more efficient utilisation of the equipment involved and the greater production throughput can also result in a reduction in the floor space required.
This space saving has a value that can be included in the financial justification. In some cases, the use of automation could remove the need for a building expansion, which provides a very significant financial benefit.
7.2 Quick Financial Analysis
It is often worthwhile performing a quick check of the financial benefits to determine if a particular project has any chance of being approved by senior management. This quick check would determine if the financial payback is likely to achieve the internal payback requirement; that is, the number of months required for the financial return to cover the cost of the investment.
The first step is to determine the budget cost for the automation system. This will require the development of an initial concept (see Chapter 5) and the determination of the anticipated cost of this solution. It may be worthwhile involving suppliers at this stage for two reasons. They may be able to assist in the development of the concept as they may have ideas, based on their experience and knowledge of the capabilities of their products, which provide a better solution. They may also be able to provide a better indication of the likely cost of the system; again, based on their experience and also their knowledge of what is required to deliver the solution proposed.
Once the concept is defined it will be possible to identify the direct labour saving that results from the implementation of that solution. Please note that if the system is to operate over multiple shifts it is the total labour saving – that is, the sum of labour savings per shift – that should be considered. The total labour saving can be calculated from:
or:
Either of the above will provide the cost saving resulting from the labour reduction.
If there are other very obvious savings it would be worthwhile introducing these as well. If the introduction of automation means increased throughput can be achieved, to meet increased production demands, there may be additional saving from the extra labour that is not required to meet this increased production or the savings that result from other machines and facilities that will not be required. The total value of these savings can be calculated on a monthly or yearly basis.
The payback is then determined by dividing the estimated cost by the total saving to provide a payback in months or years (dependent on whether the savings was calculated on a per month or per year basis). This payback can then be compared to the criteria specified by the company to determine how close to the target payback the project would be.
Having determined this budget payback period, it is then worthwhile to consider the factors discussed next.
7.2.1 How Conservative Is the Calculation?
This decision is based on the knowledge of what is included in the budget costing and what additional expenditure may be required, such as internal training and the ramp-up time from the completion of the installation to full production (see Section 8.1). Also, there may be known additional savings that can be quantified, given further work, which would shorten the payback. The assessment of these issues will provide an understanding as to the likelihood of the payback period either reducing or increasing given further analysis.
7.2.2 What Is the Technical Risk?
If the concept uses proven equipment and solutions that provide a high level of confidence that the project will be trouble free, then it is likely the anticipated payback will be achieved. If the project requires unproven solutions or is a significant step forward in technology there should be some allowance for the associated risk and the likely costs that could result, thereby increasing the payback period.
7.2.3 Is the Solution Flexible?
The concept may provide the opportunity to include other products and, therefore, improve the utilisation and payback, or it may be dedicated to a specific product, limiting the payback to the savings achieved on this product.
7.2.4 What Is the Driver for the Investment?
The requirement for the automation solution may be driven by customer requests for your product. This may be due to quality requirements, increased output, or even products that can only be produced using automation. In this case, the investment decision will need to consider the implications of the retention of this business and also the impact if this business is lost, potentially including other business that is conducted with that customer.
7.2.5 Is the Solution Future Proofed?
If the concept contains a significant element of equipment dedicated to the product for which it is designed, the flexibility of accommodating changes in product design or changes in production volumes, by introducing other products, will be limited. The justification can, therefore, only be based on that specific product, and there may be a future risk if that job is lost or the customer changes the product design.
If the concept has a high degree of flexibility and the cost of introducing new products or product changes is small, the system can be reconfigured for limited additional cost. The automation solution is thereby future proofed and could potentially be justified over a longer period.
7.2.6 Competitive Position?
It may be known that competitors have or are introducing automation and, as a result, may gain competitive advantage. This, in itself, should not be an overriding factor because the competitors may be making a mistake but this factor should be considered, particularly if the project is implementing proven technology and, therefore, is not seen as a risk.
7.2.7 Company Attitude to Automation?
In some companies there is a very positive attitude towards automation, and senior management believes in the benefits and understands the need for automation. In these cases they are likely to be receptive to a proposal even if the justification demonstrates a payback that is close to or slightly over the defined cutoff. The senior management is also likely to accept some of the less direct savings that can be identified as a benefit from the automation (see Section 7.3). In most companies where successful automation projects have been executed and the savings have been demonstrated, management is often more supportive because it has seen the positive results that can be achieved.
In companies where management is less aware of the benefits of automation, the justification is much harder and management is less likely to support projects that require less tangible savings to achieve the justification or the payback period is relatively long.
7.2.8 Project – Go or No Go?
Having performed the quick payback calculation and considered the other issues identified above it should be possible to determine whether it is worthwhile developing the project and the justification further. If the driver is an end-customer requirement or it is known that competitors are already introducing automation, the decision may be simple and the payback criteria may not be as important.
If the project is not driven by external issues, then the payback is important and the decision needs to be made as to whether further work could improve the anticipated payback period, if that is required. If it is determined that the project should continue to the next stage, it is worthwhile reviewing the sources of additional savings because this can assist in ensuring the appropriate budget is allocated (see Section 7.5).
7.3 Identifying Cost Savings
As discussed above, in addition to direct labour savings there are many different cost savings that could result from the implementation of the automation solution. Examples include the following:
• Fixing product quality and inconsistency
• Improved safety
• Increased manufacturing flexibility
• Improved operations reliability
• Improved regulatory compliance
• Increased product yields
• Increased productivity
• Reduced manufacturing costs
• Reduced scrap or rework
• Reduced floor space
To determine which of these, or others, may be applicable requires a study of the current situation and the likely benefit of the particular automation solution resulting in a comparison of the two. It may be necessary to involve finance, human resources, and other departments to identify some of the costs because these would fall outside the data normally accessible to manufacturing. However, this can be an enlightening activity because some of these costs may not have been directly linked to specific production operations, from which they originate, and may also be higher than anticipated.
Once the list of likely benefits has been identified, the next step is to determine the cost savings that could be obtained. Some examples of how the savings might be calculated are provided below as a guide.
7.3.1 Quality Cost Savings
If rework is currently undertaken and the consistency of the automation is expected to remove or reduce the need for rework the saving can be calculated from:
or:
If there is currently an amount of scrap produced and this is to be reduced the saving can be calculated:
or:
Likewise, there may be an anticipated reduction in warranty costs due to the improved and consistent quality. This could be determined from:
or:
Many companies capture warranty costs as a percentage of sales and therefore this cost can be identified.
7.3.2 Reduced Labour Turnover and Absenteeism
If the operation to be automated suffers from an unusually high labour turnover rate, then the costs associated with replacing the labour can form an element of the justification. These would be determined as follows:
Plus:
Likewise, if the operation has a greater level of sickness or absenteeism than is normal for the rest of the production operation, the additional cost of labour to provide cover and the training required for that labour can be included in the justification.
7.3.3 Health and Safety
In addition to the costs of the PPE, which can be quickly calculated by the PPE cost per person per year multiplied by the reduction in the number of jobs, there may also be a reduction in claims due to injury or illness. The latter example can only be used if there have been claims made by workers who are directly working on the operation to be automated, but if these claims are made their inclusion in the justification can significantly improve the payback period.
7.3.4 Floor Space Savings
The company may have an annual floor space cost, which could include maintenance, heating, and lighting. If this is known or can be obtained and if the automation solution reduces the floor space required for an operation, the saving in space can be converted into a financial saving that can then be inputted into the payback calculation.
7.3.5 Other Savings
The calculation of other savings would be done on a similar basis to those illustrated above. For example, if the consumption of consumables is expected to be reduced, the cost saving would be the percentage reduction multiplied by the annual consumable cost. If the yield from the input material is to be increased through the greater control and consistency of the automation, the saving would be the percentage increase in yield multiplied by the cost of the input material.
The above discussions are based on direct labour cost. This would not necessarily include the administration, training, human resources, and other costs associated with the labour. These additional costs would be included in the overhead costs or the burdened labour cost. It is certainly justifiable to use these higher costs in any justification. If the total labour cost per person, including this overhead, can be obtained and used in the examples above as well as the labour-saving calculations, it will assist the financial justification.
7.4 Developing the Justification
In many cases potential end users only consider the cost benefit of the direct labour saved as a result of the automation, but often the financial justification can be improved by also assessing the other benefits. In some cases, significant savings from another benefit may outweigh the saving in labour cost, resulting in the achievement of acceptable payback periods that otherwise might not have been achieved.
The justification should be based on all the relevant factors; that is, all the potential cost savings. These should be identified in turn with the rationale provided detailing why the automation will achieve a specific benefit and the anticipated annual cost saving resulting from that benefit. It is beneficial to start with the direct labour savings, followed by other tangible savings, with the less tangible items at the end. In cases where the benefit and, therefore, cost saving is not guaranteed, it is better to provide a range for the cost saving to indicate what may be achieved along with the rationale explaining the limits of the range. This approach provides credibility to the justification because the uncertainty will be understood. Having itemised all the annual cost savings the total can be determined, showing both the minimum and maximum anticipated saving based on the ranges for some of the items.
The budget cost for the automation system will be included based on internal estimates or budget quotations provided by suppliers. It is important that the costing covers all the items required to deliver the project and so a number of other items will be added to cover costs associated with the internal resources required for the project. This might be travel expenses to visit the supplier, training costs, and possibly an external consultant to assist with the execution of the project. It is also important to consider the potential for disruption to production during the installation and commissioning phase, and the likelihood of incurring additional costs as a result of this disruption. There is likely to be the need to provide parts for trials, programme development, and preproduction runs. These parts are often scrapped afterward and, therefore, the cost of these parts should be included. It may be worthwhile including a contingency, based on the perceived risk involved in the project (see Section 7.2.2). All these cost items should be identified and the rationale explaining the cost included. In particular, it is worthwhile identifying and explaining any contingency as this demonstrates a conservative approach.
It may also be worthwhile explaining any factors that have not been covered in the financial case. These may be items such as the market perception of the investment, the potential to impress future and existing customers, the opportunity for publicity, the motivation of the workforce, and other benefits that would be impossible to quantify financially.
Finally, the payback period can be calculated based on the total cost and the total savings. If ranges of numbers are included in the previous calculations, the result will also be a range. If the company has a specific cutoff for payback periods, there is little value in providing a payback outside of the allowable range as the project will not be approved.
The process may be iterative in that the first pass may not meet the payback criteria but with further work, either on the automation concept and costs or the identification and valuation of the anticipated savings, it may be possible to shorten the payback period. However, it is not worthwhile adjusting the numbers to achieve the desired payback period if this is not realistic (see Section 7.5).
The objective is to achieve a payback within the desired company objectives based on realistic project costs, realistic benefits, and cost savings for activities or items that are recognised by the company as valid to include in a cost justification. If this can be achieved, the project has a chance of being approved. However, it should be recognised that senior management may be considering a number of different projects from different areas of the company. The total funds available for investment may be constrained and so this project may be competing with others for the available financial resource. Accordingly, the calculation of the anticipated payback must not be too cautious because the project may not proceed as other projects with better anticipated paybacks may be preferred.
7.5 Need for Appropriate Budgets
As a final comment regarding the development of cost justifications, it is imperative that the budget proposed provides enough resources to execute the project successfully. The wrong approach is to use the payback period as the main driver, reducing the budget to a level where the necessary payback can be achieved.
Under this scenario, it is likely that the budget does not provide the resources required to execute the project successfully. It may be that internal resources cannot be utilised or the lowest cost supplier has to be selected (see Section 8.2) to meet the constrained budget. As a result, there are likely to be problems at some point during the project that will result in delays or unforeseen costs. Neither of these outcomes is beneficial, and it is unlikely the expectations of senior management will be achieved. The final result will either be an automation system that does not perform as planned or one that costs more than planned. The anticipated payback is, therefore, unlikely to be achieved and in the worst case there may be longer-term reliability or performance issues. If this type of project does occur, it not only affects this project but also provides a barrier to future investment in automation by the company.
Hence, if the desired payback cannot be achieved, based on the anticipated project costs, it is better to reconsider the benefits and anticipated savings to ensure these have been fully identified and assessed.
The overall objective of the justification process is to identify reasonable cost savings that, by showing a payback period within the criteria set by the company, justify the budget required to execute the project successfully, and thereby deliver the anticipated cost savings.