Remanufacturing: Overcoming the obstacles

By Ron Giuntini, Executive Director, OEM Product Services Institute, from an article published by Business Horizons, Nov/Dec 2003.

The evidence is convincing that remanufacturing can be a strong, stable source of profit for product manufacturers. Its societal benefits are also clear. However, many obstacles must still be overcome in order to realize the benefits. The good news is that, with few exceptions, those obstacles fall under the direct control of the individual enterprise. They are the result of internal policies and incentives that can easily be changed with appropriate management commitment.

Executive-level commitment

As with any change in a company’s focus, adding remanufacturing to the corporate strategic vision requires a commitment from the top first. Remanufacturing cannot simply be a sidebar appended to an existing department; it must be woven into the very thread of the firm.

In a letter to shareholders, employees, and customers, Jack Welch summed up the vision of GE’s service activities, a significant portion of which comprise remanufacturing, repair, and overhaul. His letter provides an excellent example of how a top-level commitment can spawn a completely new—and profitable—business paradigm (Welch 1999):

With this initiative, as with globalization, we are broadening our definition of services—from the traditional activities of parts replacement, overhauling, and reconditioning…to a larger and bolder vision. We have the engineering, the R&D, the product knowledge, the resources, and the management commitment to make the series of hundred-million- dollar investments that will allow us to truly change the performance of our installed base, and by doing so, upgrade the competitiveness and profitability of our customers.

Welch articulated a vision that went far beyond simply offering overhauled and remanufactured products. His vision included adding value to GE capital goods already in use through a combination of remanufacturing and upgrades. He committed all resources, including engineering and R&D, to achieving this high level of customer value. As a result, about 35 percent of GE Capital’s 2001 revenues came from other-than-new product and service activities, accounting for more than 60 percent of profits. This performance was the direct result of Welch’s top-level commitment to remanufacturing and overhaul.

Design engineering

For corporate vision to work, it must be operationalized into its processes from start to finish. Beginning with the earliest stages of a product’s life cycle, engineering plays a pivotal role. The product’s design is a critical element in enabling profitable remanufacturing, since 70–80 percent of its costs are incurred after production. Designing products in a modular fashion therefore becomes the key to being able to disassemble and reassemble efficiently.

Modular design allows technological upgrades to be infused easily during the remanufacturing process, reducing obsolescence and maintaining the competitive positioning of the resulting products vis-à-vis new ones.

Marketing, sales, and advertising

The marketing and advertising focus must include revising metrics and incentives in order to develop and maintain a customer base that is interested in remanufactured products. Equal billing must be shared with new product sales.

Moreover, savvy marketing departments will realize that remanufactured parts offer the capability to segment the market, meeting diverse customer needs with a broader range of offerings without straying from the company’s core business. For the sales force, which generally operates in response to financial incentives, a similar shift of attitude must occur, with a focus on solutions that deliver products regardless of whether they are new or not.

Production, material management, and reverse logistics

The remanufacturing process is more complicated than that of new product manufacturing. Production engineers, most notably Nabil Nasr of NCR3, have spent most of the last decade studying the processes of disassembling, cleaning, inspecting, and testing used parts. NCR3 has also been involved in product design and other areas of engineering directly related to successful remanufacturing. An expansion of such efforts will create a body of knowledge that enables enterprises to improve their remanufacturing process productivity, creating an even more compelling story for lower costs and improved quality.

Material management poses its own set of challenges. Conditions and configuration classifications must be established in order to plan, acquire, store, issue, distribute, and return materials involved in the remanufacturing process. New manufacturing assumes that all materials are in a new condition and have a single configuration, an assumption that does not hold for remanufacturing.

Reverse logistics is the process by which used cores are collected and returned to the remanufacturer for processing. On the surface, it may appear that this is simply an extension of forward logistics, but in practice it is much more complex. Ferrer and Whybark (2000) offer an excellent discussion of the unique issues involved, including transportation, storage, handling, packaging, and sorting decisions that are critical to remanufacturing success.

Accounting

Some of the greatest challenges faced by remanufacturing companies today lie in the accounting field. Several of these challenges are internal, such as educating accountants on the cost and revenue structure of remanufacturing. Others, such as tax credits, are unfortunately beyond the scope of a firm. The following paragraphs discuss a few of the major accounting challenges and offer suggestions on how to cope with them.

Depreciation versus expense. In the case of capital equipment, the system for depreciation and its interrelationship with remanufacturing must be thoroughly understood. The legal precedent of expensing rather than capitalizing the remanufacturing process came in October 2000 from the case of Ingram Industries, Inc.& Subsidiaries v. Commissioner of Internal Revenue, when Judge Joel Gerber of the US Tax Court held that Ingram’s marine engine overhaul outlays were indeed expenses required to realize the expected life of the equipment. Because they did not appreciably extend that life, they could be written off as preventive maintenance expenses for tax purposes. Many tax, GAAP, and managerial accounting issues must be scrutinized to ensure that a firm chooses the most favorable way of reporting the impact of remanufacturing on its income statement and balance sheet.

Material valuation. There are a wide variety of ways to valuate remanufactured materials, with differences in tax, GAAP, and managerial accounting approaches. Many expenses are out of period with revenues, requiring income statement and balance sheet accrual accounts. Unfortunately, most financial accountants are ill-equipped to handle these transaction streams effectively because they are primarily educated in new-condition material valuation. For remanufacturing to grow, the FASB and the Federal Tax Court must create a comprehensive body of knowledge and rulings, respectively, to provide guidance for remanufacturers.

A recent example of tax court rulings clarifying material valuations came in the case of Consolidated Manufacturing, Inc. v Commissioner of Internal Revenue (2002). The US Court of Appeals for the Tenth Circuit stepped in and ruled against the IRS, which traditionally viewed the book value of cores in inventory as the remanufactured product exchange price, and held that the appropriate book value of used cores should be the fair market value of used cores in the marketplace. Accountants can thus use independent broker prices to determine a “fair market price” regardless of the exchange price surcharge. This means that the actual profitability of remanufacturing will now be visible, where previously it was often grossly understated. It also means the asset values on the balance sheet will be reduced.

Trade groups

Active involvement in trade groups is one of the best ways a firm can help itself. These groups can have a tremendous impact on an industry by helping to remove external obstacles that fall beyond the control of individual firms.

Recent efforts to pool the resources of government agencies, academic institutions, and segmented trade organizations have succeeded in bringing remanufacturing issues to the attention of the public and its elected representatives. One such effort, which has already had a big impact, was the formation of the Remanufacturing Industries Council International (RICI) in 1995 and its sister organization The Remanufacturing Institute (TRI). Created to pool the concerns and resources of the many trade groups already active in remanufacturing, RICI includes interested representatives from government and academia.

Its original stated purpose was to “foster cooperation among remanufacturing industries in areas of common interest, promote the use of remanufactured products, and increase public awareness of remanufacturing’s contributions to the economy and the environment.” That purpose, and the council’s strategic vision, are well articulated at www.reman.org. Participants in RICI are diverse and span most of the major remanufacturing activities in the US.

Figure 2

RICI charter members

American Retreaders Association

Argonne National Laboratory

Automatic Transmission Rebuilders

Automotive Engine Rebuilders Association

Automotive Parts Rebuilders Association

Boston University

Business Products Industry Association

Diamond Research Corp

Electrical Apparatus Service Association

Environmental Protection Agency

Environmental Protection Agency, Office of Solid Waste

International Compressor Remanufacturers Assoc

Martin Marietta Energy Systems, Inc

National Engine Parts Association

National Tire Dealers and Retreaders Association

North American Valve Rebuilders Association

Production Engine Remanufacturers Association

Professional Cartridge Remanufacturers Institute

Remanufacturing Consulting Group

Rochester Institute of Technology

US Dept of Energy, Office of Industrial Technologies

US EPA, Pollution Prevention

United Laser Toner Recyclers Association

Valve Remanufacturers Council

The United States has enjoyed the benefits of enormous labor productivity gains over the past century. Now it has begun to tap into the potential of material productivity as well. Of the different types of initiatives mentioned in this article, material substitution is the most mature and has yielded the most impressive results to date, in terms of both material reduction and technological improvement. Recycling has also become almost a way of life in the US over the past 25 years, adding to the gains of material substitution and further increasing material productivity.

Remanufacturing remains the least mature initiative, and as such presents the largest potential for productivity improvements. The benefits of remanufacturing, though not widely understood, are extremely attractive. Businesses that incorporate it into their strategic plans, as GE and many others have done, can reap a stable source of long-term growth. The workforce benefits from additional training and a more varied workplace. Consumers have a broader range of products to choose from in meeting their needs, along with a corresponding broader range of prices. Society arguably benefits the most, with an 85 percent energy savings over the production of new products and an associated reduction in the use of scarce natural resources.

Progress will not be without its challenges, but it can be achieved. It takes serious strategic planning by manufacturing firms; rethinking product design; experimentation with new organizational structures; reengineering or creation of new business processes; reconfiguration of reward and compensation systems to align with desired business outcomes; implementation of support infrastructures; and training or hiring of qualified people. Most important, it takes the commitment, courage, and willfulness of the executive management team to implement and sustain the type of environment needed to support a business model in which new-condition and remanufactured products are both incorporated into one strategic enterprise focus. With a little bit of effort, everyone wins, regardless of perspective.

References and selected bibliography

Bailey, Ronald. 2001. Dematerializing the economy. Reason Online. @ reason.com/rb/rb090501.shtml (5 September).

Consolidated Manufacturing, Inc. v Commissioner of Internal Revenue. 2001. US Court of Appeals for the Tenth Circuit. T.C. No. 6176-96. @ www.kscourts.org/ca10/cases/2001/05/98- 9027.htm.

Ferrer, Geraldo, and D. Clay Whybark. 2000. From garbage to goods: Successful remanufacturing systems and skills. Business Horizons 43/6 (November-December): 55-64.

Ginsburg, Janet. 2001. Once is not enough. Business Week (16 April): 128B-128D.

Giuntini, Ron. 2001. The US market size of capital goods remanufacturing process expenditures. Lewisburg PA: OEM Product-Services Institute (OPI).

Guide, V. Daniel R., Jr., Rajesh Srivastava, and Michael S. Spencer. 1996. Are production systems ready for the green revolution? Production and Inventory Management Journal 37/4 (Fourth Quarter): 70-76.

Guide, V. Daniel R., Jr., and Luk N. Van Wassenhove. 2001. Managing product returns for remanufacturing. Production and Operations Management 10/2 (Summer): 142-155.

Hamper, Ben. 1991. Rivethead: Tales from the assembly line. New York: Warner Books.

Ingram Industries, Inc.& Subsidiaries v. Commissioner of Internal Revenue. 2000 US Tax Court, Docket No. 14175-98, T.C. Memo 2000-323 (October).

Jayaraman, Vaidyanathan, V. Daniel R. Guide, and Rajesh Srivastava. 1999. A closed-loop logistics model for remanufacturing.

Journal of the Operational Research Society 50/5 (May): 497-508.

Judge, Tricia. 2002. Remanufacturing industries deliver solid economic and environmental benefits; Council finds strength in solidarity. National Center for Remanufacturing and Resource Recovery. @ www.reman.rit.edu/news/news_arch/01.22.02. html.

Lund, Robert T. 1984. Remanufacturing. Technology Review 87/2 (February-March): 19-29. ———. 1996. The remanufacturing industry: Hidden giant. Boston: Boston University.

O’Brien, Christopher. 1999. Sustainable production—a new paradigm for a new millennium. International Journal of Production Economics 60-61/3 (Special issue, 20 April): 1-7.

Steinhilper, Rolf. 1998. Remanufacturing: The ultimate form of recycling.

Germany: Fraunhofer IRB Verlag Press.

Thierry, Martijn, Marc Solomon, Jo Van Nunen, and Luk Van Wassenhove. 1995. Strategic issues in product recovery management.

California Management Review 37/2 (Winter): 114-135. US Department of Commerce. 2001. Statistical abstract of the United States, 2000. US Census Bureau home page @ www. census.gov/prod/2001pubs/statab/sec06.pdf>. US Department of Labor. 2001. Bureau of Labor Statistics. @www.bls.gov/lpc/home.htm.

Welch, Jack. 1999. Letter to share owners, employees, and customers. General Electric Corp. @ www.oemservices.org/opi_products.html.

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