Hunting Out Lazy Capital

During the second phase of CSCR, process redesign, the challenge is to match the project scope tightly with the optimised business case. The changes to the business case almost invariably require a serious rethink of the proposed flowsheet. This starts with a review of each of the major component pieces and progresses to the task of optimising the entire system.

In an interview with The Strategist, McKinsey principal Jeremy Carter, one of the iniatiors of the CSCR methodology, explained, The CSCR approach places a lot of emphasis on hunting out lazy capital and optimising across interfaces. CSCR also seeks to identify low cost solutions to managing risk. Finally, it requires that competitiveness be proven, rather than assumed, before an activity is set up in-house.

 

Hunt out lazy capital

Capacity is a major driver of capital cost. This means capital spend can be reduced by avoiding bottlenecks wherever possible and using capacity to full. It is unrealistic, of course, to imagine that a plant will never suffer from bottlenecks: capacity expansions, technological developments and unexpected production challenges are bound to throw the system out of balance at some stage during the life of plant. Nevertheless, due attention to lazy capital during the process redesign phase will pay dividends in three important ways.

First, it will minimise the amount of capital that is planned lazy. After 10 years on the drawing board, the technical experts were convinced that the main circuit in the chemicals plant had been optimised. Undaunted, the project team used a dynamic model to stimulate operations over several years, incorporating uncertainities such as unplanned maintainence. A wide range of capacity, sparing, surge and maintainence schedule combinations were investigated. Many size adjustments resulted -- most of them downwards -- and a number of unneccessary surge items were eliminated. The base case design was improved by $ 40 million (Australian) without any operating risk.

Anticipating future expansions is a second major source of lazy capital. In one, situation, the design team had to work out how to cope with a doubling of volume through the pipeline linking the plant to its shipping port, three of four years into the projects life. The conventional response would be to increase the diameter of the pipe. However, the CSCR philosophy resents waste and team members were concerned about the pipeline working at half capacity in its first few years. The sequential introduction of viscosity modifiers and higher-pressure pumps minimised lazy capital and improved project NPV by 10 million dollars.

Fibre trunk routes in atypical broadband network carry telephone traffic and video signals from the telephone switch and the cable headend out to nodes for local distribution. To provide basic services such as multi-channel TV and standard telephony, these trunk routes require only limited bandwidth (500 Mhz analogue for TV and 0.5-1.0 Gbit/sec) for telephony. However, in a future world of true video-on-demand, 500 times more capacity would be needed. For this reason, network designers like to include a spare section of plastic duct in each trunk route to allow for future capacity requirements.This is costly, especially whern the extra space required to house more than a single duct forces construction beyond the pavement and into the street.

More often than not the capacity precaution is completely unnecessary. In a dedicated 10 Mbit/sec path between the headend and every home passed by the network. This is enough fibre to meet expected future needs. For those who are concerned about future needs that have not been thought of, developments in multiplexing telephony traffic (wave division multiplexing and synchronous digital hierarchy) promise to make efficient use of basic fibre capacity. The latest research on pure potical amplifiers suggests that the ultimate capacity of a single fibre could be 1,000 times greater than the 1 Gbit/sec available today.

Project start-up, a notoriously difficult period of some new operations, is a third major source of lazy capital. Past experience of problems at this stage often leads companies to allow for them in both their schedule and economic projections, so that a lengthy start-up period becomes a self-fulfilling prophecy. In semiconductors or zinc mining, to cite two examples, plants can take several years to reach full capacity -- which is plenty of time to have a major impact on the projects economics.

The problem is that the best practice is poorly documented,which means operators of each new plant have to reinvent the wheel. Yet with the benefit of hindsight, many start-up problems are quite avoidable. Poor circuit designs can be identified with system dynamics models of material flow; construction contract specifications can prevent the use of inferior components; specialist start-up managers and a few additional employees can overcome specialist staff and skill shortages during a sdtart-up period. Even a modest improvements to the proposed learning curve was worth $ 60 million to the owners of a metallic concentrate project. Learning while a plant is up and running is unnessarily expensive!

Optimise across interfaces

Taking a total system perspective, a mining project team changed its initial decision to purchase, a mining project team changed its initial decision to purchase 240 tonne haulage trucks. The original recommendations recognised the superior economics of the largest trucks in tthe world in transporting ore from the pit to the processing plant. However, the very large haul loads required the plant being designed as a batch rather than continuous process. The knock-on effects were both insidious and severe. The most obvious interface problem was a 15 million dollar intermediate stockpile. Beyond this, however, were higher operating and maintainence costs, lower plant utilisation and a serious reduction in control over the quality of the product. Today, the mine operates with a larger number of smaller trucks than originally envisaged. The projects owners are better off to the tune of about 50 million dollars.

The timber plant team realised it should holld inventory in partly processed form as master batches in the centre of the plant rather than as a finished product. As a result, predicted inventory stocks were slashed by 60 per cent, a six million dollar warehouse was eliminated and customer service is improved with much faster lead times.

Manage rather than submit to risk

As a project firms upand the team gets a clearer picture of the assets that will be put on the ground, the tension builds up to sign off on the scope. Unfortunately, some of the uncertainities persist. All too often, the way that a team deals with these residual risks is to throw money at them. Alternatively, plants may be designed to meet a single set of projections about demand and product specification. This leads to a fixed cost componets that cannot be tailored to variations in demand, and highly specialised processes and equipment which are difficult to adapt if customers need change. Both of these apparoaches tio risk are sub-optimal.

Getting a better answer depends on improving the dialogue between management and project engineers. This generally requires two changes in managements approach as illustarted by one mining project team. First, engage the projecvt team in discussing options rather than recommendations. Second, concentrate the teams effort on reducing the risks associated with low-cost options.

Step 1: The inital plant design submitted to management had a conventional flowsheet with three distinct crushing stages. This was characterised by the project team as low cost low risk...and management was left wondering whether there were no better alternatives. There were, but management needed to ask to discuss the other options that had been considered and discarded. In particular, advances in crusher technology and the relatively friable ore in the deposit indicated that two crushers should suffice.

Step 2. On paper, the two-crusher option was clearly more attractive for shareholders. Yet doubts remained as to whether product quality would be acceptable to customers. Management broke the deadlock by encouraging the project team to design the plants layout to allow the third crusher to be retro-fitted if it were needed. The cost to the project team to design the plants layout to allow the third crusher to be retro-fitted if it were needed. The cost to the project of buying thye option was half a million dollars. The original design, complete with three crushers, would have

cost an extra $ 10 million in up-front capital.

By the way, the mine is now operating and the two crushers do the job just fine.

Outsource non-core activities

The conventional approach to big projects, especially in remote areas, is for the project owner to build, own and operate the whole box and dice. Though outsourcing has become common practice in some idustries, the owners of heavy plant underestimate its value.

Mining companies, for example, have long been accustomed to owning, driving and maintaining haulage trucks as an integral part of their business. The weight of evidence, however, suggests that specialist contractors can be leaner, hungrier and more cost effectivein carrying out this set of activities. Since the ore is moved but not transformed during the process, the mining company loses none of its ditinctive knowledge provided it retains control of day-to-day mine planning. At one new mine, the NPV benefit of outsourcing the hauling function was estimated at $ 20 million.

In our chemicals example, the intial capital estimate included $ 30 million for a lime calcination facility. Sourcing the lime from a producer that could achieve economies of scale represented an attractive deal for both parties. The chemicals company was able to defer expenditure and improve NPV by $ 10 million.

Sytematically examining outsourcing options invariably results in a project that is more competitive in the long run -- whether or not a specific function wins up in-house. More importantly, perhaps, outsourcing frees up capital and management attention to focus on what the company is good at and can make money from. One major energy company systematically sells down its equity in established power stations so that it can invest the capital in the early stages of new projects.

Engineering Redesign: Tighten the screws on unnecessary costs

The third phase of CSCR, enginneering redesign, is a highly structured commercial, as well as technical review of every aspect of the project. Here, the objective is to relentlessly tighten the screws on the unneccessary costs that all too often creep in during the detailed engineering work, when the team is under pressure to make sure the plant works and the project stays on schedule.

Detailed drawings should be avoided up until this point because work in the business and process redesiugn phases will make a lot of them redundant. It is only in this third and final stage of CSCR that the project team is finally allowed to turn its attention to the nitty-gritty.

The engineering redesign process challenges the project team to submit every component to a rigorous fit-for-purpose test. It also seeks to establish a set of fresh activity-based benchmarks so that designs keep abreast of best practice.

Design fit-for-purpose components

It is very easy to be glib about the concept of fit-for-purpose. Most people assume that their designs already match this description. Unfortunately, their confidence is foten misplaced either because of a tendency match this description. Unfortunately, their confidence is often misplaced either because of a tendency to allow a bit extra into the design to just to be sure, or because this design is based on ill-founded assumptions or unquestioning of historical practice. Why, for example, build a railway line that can withstand a once-in-100-year flood when the plants life is only 15 years and a rapid response capability can be counted on? Why waste time incorporating extra functions ina control pendant that operators have no intention using? Why build walkways on both sides of a conveyor belt if a single walkway is safe and functional?

Benchmark the way things get done

The march of time can play tricks on the most experienced and capable of project designers. Major projects are relatively infrequent events so it is not uncommon for people remember a decision but forget the detailed assumptions which underpinned it. The initial design that is thrown together quickly in a pre-feasibility study is far more likely to reflect earlier assets than earlier thought processes. Since the technical and managerial disciplines advance rapidly all the time, relying on what you did last time rather than why you did is fraught with danger.

Not a panacea

CSCR is not a quick-fix for a project that is truggling to get the boards approval. It is a methodology that allows management to begin a revolution in the way organisations think about their capital spending. This revolution requires project teams to embrace radically different norms of performance, which in turn requires intense attention and consistent support from senior mana-gement. Throughout, the teams attention has to be focused on making money for shareholders, and tight management systems will be required to capture, manage and implement ideas for improvement.

Embarking on a CSCR effort is therefore not a proposition for the faint-hearted. Bringing a big capital project to life is apeople intensive process. Accepting the CSCR challenge is, in effcet, to embrace a major change program. Our case studies suggest, however, that the prize will be well worth the effort. For many firms in capital intensive industries, CSCR could be the single most important lever for increasing shareholder value.