Automation -- Where the Smart Money Is

These days, many automated material handling projects would never get approved without some creative solutions. That could mean creative financing or just plain creative justification. Part 2 of a Series

You’ve done your homework. You’ve decided material handling automation is for you. You’ve even taken several cracks at return on investment (ROI) calculations for your company’s bean counters. You should have no problem getting the funding. Right?

Nothing’s that easy, especially getting approvals for a capital improvement project.

“The economy has been devastating with regards to capital investments,” agrees Ron Giuntini, executive director of the OEM Product-Services Institute. “Most financing has become difficult to get.”

What about vendor financing?

In the early part of the recession, as the economy started tanking and the credit worthiness of potential customers started deteriorating, that seemed to be a viable option.

“That blew up for many vendors,” Giuntini says. “They wanted to maintain and pump up their sales and keep them flowing, but they ended up selling equipment to not-too-credit-worthy customers. That happened a lot in the truck manufacturing industry and telecommunications; even Boeing is struggling with it now.”

Now OEMs are taking a different approach. Some are creating financial subsidiaries for financing transactions. Others have joint ventures with financial services companies. And many OEMs are positioning themselves to provide a host of other financing options to the users of their equipment.

“For some users who are strapped financially, these may be the only means they have to get this equipment,” Giuntini says. “On the vendor side, the OEMs have to find a way to improve their margins. One way to do that is if the financial arm becomes a powerful force within the corporation. For Caterpillar, 15 percent to 20 percent of its profits come from its financial subsidiary.”

Some OEMs are taking this route because the profits generated by products over their service life are shrinking. According to Giuntini, the financing side of the business can generate three to five times more profit.

What does that mean to you, their customer?

“We’re seeing a shift in power, where customers should be looking for what the vendor will do for them,” says Rebecca Wettemann, vice president, research for Nucleus Research Inc. She is an expert on the financial analysis of technology and is the author of numerous ROI studies and reports. “The sales rep is asking the customer ‘What ROI do you need to get and what payback period do you need?’ Then the vendor can decide in a more intelligent or quantifiable way whether it makes sense to discount, add services or provide special payment terms.”

But you bear some responsibility in making this work, too. Look at how many partners this automation will affect, as well as how often. If those numbers are significant, you may be well on your way to getting benefits that will drive a positive ROI. But scope this project out over a couple years and see if you can link the returns you get to payments to the vendors.

“We’ve seen lots of vendors working on extended payment plans, linking payments to certain benefits,” Wettemann adds. “In the procurement space, we’ve seen them link license fees with the overall dollar amount of the transactions going through the system successfully.”

MH is a good investment

Will material handling system vendors be open to such unconventional schemes? John Hines, executive vice president and CFO of HK Systems, says many customers don’t realize that now is a good time even for standard financing schemes. In fact, many aren’t even aware of the benefits available to them.

“Most people don’t know that automated storage and retrieval systems [AS/RS] qualify for an accelerated depreciation schedule,” he explains. “The tax court has ruled that they, in most cases, will qualify for a seven-year depreciation. Most people probably consider AS/RS a facility as opposed to a piece of equipment, but the recovery from a tax perspective is seven years, not 40.”

Hines did acknowledge that more customers are asking for cash flow concessions, where instead of progress payments or down payments, they’re pushing the envelope and asking for more of the cash flow to occur later in the project. But today, he adds, any investment in material handling automation can be a better deal than just leaving the money in the bank.

“A company with enough cash to invest is getting only two percent on the money, while the return on an automation project is clearly double digits,” he notes. “You like to invest when times are a little tougher because there’s more vendor capacity, and vendors may not be as busy as they were two years ago and they may have the time to get these things implemented quickly. Today is a very good time to set yourself up for the recovery. In fact, we saw a pretty healthy influx of business in the fourth quarter.”

Incrementalism or “big bang?”

Most material handling automation takes place in baby steps and is built on small successes. You must decide if your business has the time to build those successes or whether your competitive environment calls for a bold “big bang” approach. According to Sal Spada, research director for the ARC Advisory Group, it’s all about incremental improvements today, not massive overhauls.

“One dot-com company went from shipping 2,000 packages a day to maybe 10,000 a day over the last five years,” he recounts. “They could no longer use their labor-intensive packaging operations to prepare all these shipments. They did a cost analysis and it turned into a $9 million job to automate the last 100 feet of their packaging line. Packaging costs went from $10 per package to $4.”

That’s $60,000 in savings a day, and with a $9 million investment, that translates to, conservatively, an eight-month payback.

There are instances, however, where big results call for a big bang.

“If your business circumstances are just incrementally changing, typically you want to change your business process and systems to adapt to those smaller changes,” says Fran Korosec, manager of business development for material handling solutions, Lockheed Martin. “If, however, you’re a retail company and want to expand so that 30 percent of your sales come from e-commerce, your existing systems will probably not satisfy that new business venture. Incremental change probably won’t help you achieve your end game.”

Peter Falcigno, technical manager for Southeastern Container, invested in automatic guided vehicles from AGV Products to help make better use of the limited material handling space he had in his Enka, North Carolina, bottling facility (see story in our December 2002 issue, “AGVs Flow Through Bottled Up Spaces”). His company is now building another factory, which will be completely automated with AGVs and robotic palletizing. Falcigno says he thinks his company will have an easier time with total automation.

“A new, totally automated factory is a lot easier to go into because the people you hire have never seen anything else,” he explains. “Our newest factories are our most efficient.”

Leasing

Claude Imbleau, president and CEO of Transbotics, manufacturers of AGVs, says smart companies are no longer relying solely on ROI analysis. They’re looking at operating costs vs. operating costs. The easiest way to do that is through leasing.

“Seven years ago, leasing companies were not looking at leasing automation equipment, especially AGVs,” he says. “They were seen as having no resale value. Then the leasing companies realized the equipment was not that important; what’s important is the financial credibility of my customers. After all, if they’re expecting an 18-month payback on the purchase price, AGVs rarely meet that requirement. But if they look at an operating lease, comparing payroll cost vs. the lease cost, they’d still save 40 percent to 50 percent. The CFOs of the world are seeing those savings come immediately, and they’re not tied down with complex IRS rules on what they can depreciate and what they can’t.”

Return on assets

Whether you lease or purchase, you should understand all the ways an automated material handling system will reward you over the course of its service life. For example, how will it increase your sales? To help you understand that, involve your sales and marketing people in the project. They should be able to help you project the increase in sales resulting from improvements in customer satisfaction. They should also be able to help you make your customers understand how they benefit.

“If you can tell customers when their order was shipped, on which truck and with which bill of lading, that results in increased sales,” says James Tompkins, president of the international logistics consulting firm Tompkins Associates. “We’re trying to capture incremental sales and then we’re calculating that as part of the ROI.”

But Tompkins suggests you also look at ROA — return on assets. You can maximize that number by working with a third-party logistics (3PL) provider.

“Taking the distribution center off the books, selling it, and divesting yourself of the labor in that DC can improve return on assets,” he adds. “You’ll turn that fixed asset into cash, then you can take that cash and improve the balance sheet. The investments made in automation can now be better justified because the 3PL is going to be using those facilities more fully.”

Part of your logistics automation investment may include a warehouse management system (WMS), and that can also accentuate your ROA by helping you understand which customers you can no longer afford to serve. A WMS can enable data mining and warehousing, which will let you stratify your customer base.

“Data mining can give you information about which customers not to sell to anymore,” says Tompkins. “And by using a WMS in conjunction with a TMS, you can consolidate loads and, therefore, get transportation savings. A WMS can also reduce inventory, not only in one link, but all the way down the supply chain.” In addition to ROI and ROA, however, you need to consider risk. A 37 percent return on investment with a high risk isn’t nearly as good as a 14 percent ROI with low risk, according to Tompkins. Any substantial interruption in service can negate a decent ROI.

Whenever and however you decide to finance your project, you should find that the hurdles to automation aren’t as high as they used to be. That’s good, because as service demands in your industry increase, automation of some kind may cease to be an option. It will be a necessity. MHM

Part 3 in our Automation series will cover the challenges of project management.

ROI Analysis Imposes Discipline on Project

In its new report, 2003 Economic Outlook and IT Spending Trends, Delphi Group says that during the last two years, information technology and other business managers have been compelled to justify the business value of IT investments. However, while nearly 65 percent of surveyed organizations use some form of ROI analysis, fewer than 10 percent used that analysis as the basis for a purchase. Most resorted to an ROI study to head off excessive financial scrutiny.

“This is likely due to the fact that in most cases the level of scrutiny required in an ROI exercise doesn’t require accounting for every dime,” the report concluded. “It sets up a logical framework for building a consensus that all issues of high and moderate importance have been accounted for and profitability is all but ensured.”

If you use ROI analysis, which of the following is true?

A. We conduct a formal ROI analysis, which is reviewed by finance.

B. We have an established rate of return that the ROI must meet.

C. We use ROI only as a way to avoid undue financial scrutiny over IT decisions.

For more information ...

... on the material discussed in this article, use the following contacts:

AGV Products, www.agvp.com

ARC Advisory Group, www.arcweb.com

Delphi Group, www.delphigroup.com

HK Systems, www.hksystems.com

J.D. Edwards, www.jdedwards.com

Kingway Material Handling, CAPS Division, www.king-way.com

Lockheed Martin, www.lmco.com

Nucleus Research, www.nucleusresearch.com

OEM Product Services Institute, www.oemservices.org

Tompkins Associates, www.tompkinsinc.com

Transbotics, www.transbotics.com

Wei, www.weinet.com

Case History

Automation Improves Pick/Pack, Brings Payback

The last time Cook Communications Ministries did anything about the way it picked, packed, shipped, stored and controlled orders was 1955. Then, a couple years ago, as it entered the new millennium, automation not only looked like a good idea to Cook, but it became a mandate.

Cook Communications Ministries is a creator, printer and distributor of Christian educational material, books, toys and games. Founded in 1875 by David C. Cook, the company conceptualizes, designs, writes, prints and distributes hundreds of different items globally from its Elgin, Illinois, complex. Today, the editorial and graphics departments are located in Colorado Springs, and are connected electronically with Elgin.

In 2000, Cook finally decided that operational modifications were necessary to improve efficiency, as a number of its current buildings are more than 100 years old. In addition to the challenges presented by the building housing its material handling operations were the changing demographics of the workforce.

Cook’s vice president of operations, Dick Clarke, and the logistics manager, Ron Wisser, designed a new addition for the Elgin plant and then partnered with systems integrator, WEi, Warehouse Engineers and Integrators (formerly Warehouse Equipment Inc.) of Elk Grove, Illinois. WEi, in turn, joined with manufacturer and implementer Kingway Material Handling and its CAPS division of Acworth, Georgia. The three companies then set to work to create a system that has boosted order-pulling accuracy up to 99.6 percent from ranges as low as 85 percent, and reduced the cost of orderpicking direct labor by 40 percent.

“Our previous system used to clog up regularly because it was one single threaded line,” says Clarke. “That is, if you ran orders through stations A to F, and C clogged up for some reason, then the whole line stopped. Today, with our pick-to-light system, that does not happen. We now pick to box and utilize take-off conveyors that prevent the backing up of the picking process. This, in turn, allows the order fillers to pick product continuously without delay. Success in utilizing the new process is achievable due to the integration of the various aspects of the new infrastructure.”

Cook’s new accuracy and speed are aided by Kingway’s “aisle directors” and the way the overall material handling in the plant is integrated and controlled by the central AS/400 computer. A CAPS (computer-aided picking system), with some modifications, includes 1,680 lights as well as 61 Kingway aisle directors.

Integrating the J.D. Edwards advanced warehouse system (AWS), RF bar code scanners and DSI scripts, warehouse inventory has improved in efficiency, accuracy and visibility. The RF equipment directs warehouse employees in the most efficient manner to process replenishments for the fulfillment lines and full case picks. This high level of accuracy is made possible as both locations and product transactions utilize bar code technology, according to Wisser.

“We use all the small parcel carriers; Fed Ex predominantly, as well as UPS and the post office,” says Clarke. “The new system directs the packages via conveyors to the truck bays, which have adequate space for backing in, but no room for serious mistakes. The conveyor lines make sharper-than-normal turns from the plant to the loading docks. These close quarters are made even more cramped by the volume limits placed on Cook by Elgin’s municipal regulations for new additions. That is, the plant was not allowed to erect an addition that exceeded the original building’s height of two stories.”

WEi and Kingway were able to add to the plant’s capacity and efficiency without any worker crowding by installing a mezzanine floor into the new 40,000-square-foot addition. The mezzanine was designed by WEi’s vice president for sales and marketing, Robert A. Trenn. The mezzanine added a great deal of processing room to the facility without exceeding size limits imposed on the plant by the Elgin municipal regulations.

Clarke says Cook’s investment in automation has just about been paid back in full. It also keeps them well ahead of the competition in its industry.

“Since some of the smaller players can’t keep up with the automation we put in, their costs will continue to rise as a percentage of net sales, and in another two or three years they’ll be going the way of the last seven or eight people in the business,” Clarke concludes. “The more automated you are, the better you can spread your workforce out over the cyclical peaks in our business. We not only have a 40 percent labor reduction in absolute terms, but we’ve dramatically improved our practical plant capacity [PPC]. That shows how many direct labor hours you’re using vs. the direct labor hours available. Our PPC jumped from around 60 to around 85 because we can spread out the work a lot more than we were.”

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