Feel the cash flow
Capital spending balances can act as barometers of an organization's effectiveness at turning investments into assets.
BY JOHN CIMINO, PMP
When executives ask how work in progress is going, more often than not, they mean, “Are you done yet?” Ongoing projects consume capital without tendering any of the associated benefits such as returns and depreciation.
Known as construction in progress, assets under construction (AUC) represent the cumulative value of corporate spending on capital items that are not yet capable of generating revenue. AUC is a normal and expected part of a capital construction program. However, high levels of AUC can be a symptom of a poorly managed capital program; high work in progress balances can affect operating costs through interest incurred during construction.
As part of a corporatewide program to optimize operations and asset performance, Vancouver, British Columbia, Canada-based TELUS Communications reduced AUC balances by implementing just-in-time principles in its capital program. As a result, year-end AUC balances were successfully lowered from 23 percent of capital expenditures in 2001 to 17 percent of capital expenditures in 2002.
TELUS’ Corporate Emergency Operations Centre (CEOC) discloses the location for selected TELUS representatives from across the corporation who can run the company and business operations locally. CEOC allows the team to effectively manage resources should there be a major impact to operations such as fire, flood, earthquake or terrorism.
At TELUS, “bad behaviors” were partially to blame for the higher 2001 AUC balance. For example, as a result of the technology sector boom experienced 4 to 5 years ago, certain materials such as DC power plants were extremely difficult to source and had very long lead times. (Batteries had lead times exceeding 24 months.) After the tech sector's meltdown, these materials were no longer difficult to source, and lead times dropped. (Maximum lead time is now eight weeks.) However, past practices persisted. Staff continued to order these materials earlier than required, leading to an AUC balance higher than required.
TELUS has 40,000-plus capital work orders, and it was difficult to know where to begin on the AUC reduction initiative. To start, AUC data from the previous two years was sorted—by company code, business unit, asset class, cost element, investment initiative and project manager—and then analyzed to see what major elements contributed to the higher AUC balance.
Once the major contributors were identified, investigators uncovered the top 10 elements’ root causes. Material costs, for example, made up 70 percent of the AUC balances, leading the investigative team to target the material procurement process.
Don't Just Sit There
Materials that sit waiting for installation incur interest charges, generate no revenue and thus provide zero value to shareholders. Part of the focus on the material procurement process involves adopting just-in-time principles to ensure materials arrive at the exact moment for implementation to optimize value.
A large portion of TELUS’ work is installed via internal resources, and due to an existing union agreement, contracting work entails certain restrictions. In an effort to align material delivery and labor availability, process changes were initiated to book internal resource capacity against planned work prior to committing to material delivery dates.
Figure 1. A sample project AUC profile.
As a result of changing corporate priorities, some projects inevitably get rescheduled. Currently under development, a corporate priority system soon will help TELUS to identify less crucial work to postpone when work demand exceeds internal labor supply. A steering committee also will help resolve escalated issues, for example, where there is a large gap between demand for work and supply of resources.
Spread It Out
But to implement a true just-in-time process, materials must be planned to arrive on site in a staggered arrangement reflecting their order of installation, especially for projects with long schedules that involve multiple asset classes, because the practice of delivering all materials to site prior to the project start unnecessarily raises AUC.
At TELUS, material delivery is staggered by scheduling relative to the labor activity that will be performing the installation. Staggered material delivery is reserved for big-ticket items to reduce the risk that a project cannot be completed due to late delivery, for instance, of a low-cost special connector or cable.
Bulk ordering (accepting all required materials at the project's start for a reduced purchase price) or bundled ordering arrangements (buying bundled equipment at lower cost) often are entered into secure favorable pricing from vendors, but these arrangements tend to raise AUC. At TELUS, bulk and bundled purchasing is undertaken only if economically favorable after accounting for all associated costs (capital, warehousing, handling). Instead, vendor discounts can be negotiated based on total volume. However, negotiations should consider, staggered delivery and payment as determined by the project installation schedule.
Figure 2. A sample corporate AUC profile.
Figure 3. AUC can be used to calculate a corporation's average construction turn (its annual corporate capital expenditure divided by its average cumulative value of AUC). For example, an average AUC balance of $200 million on capital expenditures of $1.2 billion results in 6 average construction turns for the year, or an average construction cycle time of 2 months to deliver a revenue capable asset. Average construction turn and average construction cycle time are useful metrics for benchmarking capital program performance against others in the same industry.
Good business relationships also contribute to improved pricing and shortened lead times for materials, and thus reduced AUC. Providing vendors with accurate material forecasts and then updating the forecasts as reprioritization occurs throughout the year is critical to establishing a good relationship. Updating material forecasts is especially important after major changes to the capital plan such as capital claw backs.
At TELUS, loose materials, or material not yet connected to the telecommunications network, have been purchased under a work order that either has been completed or cancelled. If the material cannot be returned to the warehouse or to the vendor, TELUS uses a system to inventory the material so it is visible to the whole corporation. It is the responsibility of all participants involved in procurement to be aware of the materials identified as “loose” and to draw from this inventory prior to procuring new.
Figure 4. High AUC can be a symptom of poor project management in delivering a company's capital program.
Get on Board
During the implementation of these just-in-time principles, communication played a big part to create enterprisewide buy-in. An online manual was created to explore AUC minimization techniques based on just-in-time principles.
The manual hit on why AUC was important to the organization and illustrated corporate alignment and endorsement. It emphasized the significance of determining critical path to shorten cycle times, and it instructed users how to set up a proper project system financial structure to facilitate capitalization. The manual also discussed how to manage materials to reduce AUC, as well as how to manage third-party work. Guidelines covered when equipment could be placed in service.
Year-end AUC balance and annual capital expenditure figures appear on financial statements—typically a note in the financial statement under capital assets—so data for benchmarking with other companies is readily accessible. Upon examination of these balances, consult with companies consistently in the lower end of the AUC to Capex ratio to uncover differences in process and methods that deliver their capital program more efficiently.
For instance, benchmarking indicated that best-in-class telecommunication companies were achieving year-end corporate AUC to Capex figures in the 11- to 12-percent range, and these figures were used to drive TELUS’ 2002 and 2003 targets. Once variance or anomalies are identified, such as construction window impacts due to weather differences or cost impacts due to local regulatory or government factors, discussions can uncover valuable process and method differences that are enabling best-in-class companies to achieve better results. PM
John Cimino, PMP, is a project manager employed with TELUS Communications Inc., based in Vancouver, British Columbia, Canada, where he manages switching projects. Most recently he led a just-in-time provisioning initiative as part of TELUS’ Operational Efficiency Program—an ongoing commitment to best-in-class performance.
An online manual was created to explore AUC minimization techniques based on just-in-time principles.
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PM NETWORK | SEPTEMBER 2003 | www.pmi.org
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