Are you a Private Equity or a Venture Capital firm that has finalized the asset with a huge manufacturing base? Then read on….
Valuing a factory or a manufacturing company can be tricky. Number-oriented investment bankers derive valuations using financial models and feel more comfortable with the results. They assess all assets—such as land, factories, machinery, inventories, and vehicles—while applying depreciation assumptions to determine the value a manufacturing-based asset deserves.
Financial models often overlook one important factor. That is the potential for factory to save costs or improving productivity in future. Assessing this has significant element of experience and intuition. It can have an impact on the final COGS and thus improve the bottom-line of the overall organization. An improved bottom-line that is possible in future will have a bearing on the current valuation. It also decides if the asset managers will be able to derive the value that they plan from the asset in the future.
I will detail a few tools here, that can give experienced operations personnel, a quick and dirty guide to indicate the improvements that are possible in the operations of a manufacturing company or a factory.
Productivity Improvements Studies
DILO: DILO stands for “Day in the Life Of”. It has been used for years now by productivity improvement consultants. DILO is shadowing personnel for a whole shift/day to understand nature of all activities performed by him, and whether they are value adding or not. Teams perform DILO on the activities of the first-level supervisor in the plant. They do not conduct it for top management or for workers at the lowest level. First supervisory level DILO gives a firsthand idea about the cultural DNA of the organization. It also helps zeroing on the productivity improvements that is possible. A 20% productivity improvement using improved systems is not exactly unheard of.
Management Control Systems: Teams conducting an effective Management Control System study chart the flow of information within the organization and track the actions taken. They consider production planning, production control, and production reporting. All KPIs/KRAs and review mechanisms are studied too. This study should be able to show gaps in the processes and improvements possible. Teams can repeat this for functions such as Maintenance, Quality Control, Supply Chain, R&D, or any other function that significantly impacts the final output.
Pit-stop studies: Teams conduct a pit stop study to examine whether the flow of material, personnel, and information mirrors the seamless coordination seen during a pit stop in F1 racing. It also records all the bottlenecks for not achieving the pit stop level efficiencies. Analysis of these bottlenecks give a fair idea about the improvements possible
Bottleneck Study: In multiple industries, teams often find it challenging to identify a clear line of value addition, but if the processes are visible and logically connected, they can conduct a bottleneck study to identify the bottleneck process or machine. Once teams identify the bottleneck process or machine, they clearly see that any improvement made there increases the productivity of the entire line. We need to study the bottleneck machines/processes in further details to find out downtimes and reasons for the same. More avoidable the reasons are, more chances of improvements. A bottleneck process improvement has been able to show 10% improvements in throughput even across process-wise mature plants.
Process Maps: A simple flow of material and information exposes the gaps in processes. Material waiting for information or material waiting for other material or machines or men, all cause delays. According to the established principles of the Toyota Production System and lean methodology, teams must identify wastes and then determine whether these wastes are avoidable. Again, more avoidable the reasons, more chances of improvements.
Quality Processes: Reduction in quality rejected items directly adds to the throughput. Finding out the effectiveness of quality systems can point towards improvements possible due to reduction in quality rejects.
5S and other housekeeping systems: It makes the workplace clutter free. Absence or presence of these systems point towards the current processes maturity and thus improvements possible.
Cost Optimization Studies
Material Cost: Material costs most often are the highest cost bucket for a factory. There is some raw material fed at the beginning of the production line and there is output in terms of finished product at the other end. Process industries refer to material lost during production as material yield loss. Teams identify opportunities to reduce this waste to ensure future direct bottom-line benefits.
Inventory Cost: In some industry cost of inventory is huge. If inventory turns are not monitored carefully, it leads to working capital being tied up in inventory. Finding out if A, B, C classifications are there and if there are inventory standards for each classification can be a starting point. In case there are standards, a quick audit of some A class materials will show potential of releasing stuck working capital back to P&L.
Procurement Costs: A quick look at procurement processes reveals whether tighter procurement standards can deliver additional value. Procurement professionals finalize contracts, include penalty clauses, negotiate terms, review the RFQ process, source from low-cost countries, reduce supply chain costs, secure mass discounts, and rationalize vendors. These actions, when implemented effectively, often result in 10% savings in material-related expenditures.
All these studies will also need to be supported by number crunching exercises. It all depends on the extent and quality of data available in the factory.
A team of 3–4 people can conclude a dipstick study in 2–3 weeks. For a plant that produces stock worth around 200–1000 Crore. This exercise gives an input to valuation of the plant and the company. It also acts as the road-map for the management in case the asset gets acquired.
Prabhash Choudhary, CEO, Magistral Consulting.
Magistral (www.magistralconsulting.com) is a leading consulting research and analytics firm that helps PE/VC firms globally in performing operational due diligence. The author can be reached at prabhash.choudhary@magistralconsulting.com for queries.
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