CSCMP's Supply Chain Quarterly
November 18, 2018

A better way to calculate equipment ROI

Too many companies buy warehouse equipment and technology based on a "best case" scenario. Using an "engineered" approach to evaluating the return on investment will provide a more accurate picture of cost and productivity benefits.

Technologies for the warehousing and distribution center environment have progressed more in the past 10 years than they did in the previous 30 years, and new options are emerging virtually every day. Today companies that operate warehouses and distribution centers can choose from a vast array of advanced technologies and equipment solutions that promise to deliver attractive productivity benefits. These new technologies—from automatic pallet-wrapping machines to remotely controlled material handling equipment, and everything in between—can deliver tangible benefits, but most require substantial financial investments.

Few organizations have any margin for error when making decisions about new technology and equipment; competitively, one wrong investment decision can erase an operational advantage. Yet many investments in technology and equipment eventually fail to deliver the promised gains. One reason why this happens is that vendors' initial estimates of cost and productivity benefits often are based on a "best case" scenario. Those estimates often prove to be inaccurate, because each facility has unique physical, process, and data constraints, and it can be difficult to determine beforehand what a technology or piece of equipment could accomplish in a particular environment.

Article Figures
[Figure 1] Current and projected values for order-picking elements
[Figure 1] Current and projected values for order-picking elements Enlarge this image
[Figure 2] Projected labor savings with automated pallet jacks
[Figure 2] Projected labor savings with automated pallet jacks Enlarge this image

Moreover, the "cool factor" of new technology and the complexity of operations can distract decision makers from taking all the steps necessary to understand exactly what an investment will mean to the balance sheet. Most continue to take a high-level approach to evaluating the potential impact, using broad assumptions to estimate future performance and often failing to factor in support and maintenance requirements. Further complicating matters is the fact that vendors often do not have the opportunity to dig into the details of individual operations—an exercise that is necessary if they are to accurately quantify the benefit for a prospective customer. As a result, they use best-case examples, developed under ideal conditions, to promote their products.

Before any company commits to a large capital investment, it should have a realistic view of the cost savings to be gained from the new technology or equipment, as well as the likely impact it will have on operations. Instead of a best-case scenario, an "engineered" approach is a more effective method for evaluating potential capital investments. An engineered approach entails studying the current-state operations at a "micro" or elemental level (similar to the approach engineers use when creating engineered labor standards) and pinpointing the specific elements that will be affected by introducing a new technology. The degree to which each element will be affected can then be assessed using common work-study techniques and/or realistic estimates made by subject-matter experts.

In short, an engineered approach to evaluating new technology or equipment predicts the outcome that a future labor standard will require, which correlates directly to the labor savings one could expect from the technology. This approach develops a savings estimate that reflects the reality of a particular facility and operations—thereby improving a company's insight into the bottom-line impacts of cost-saving initiatives and reducing the potential for costly mistakes.

Consider the operational impact
Prior to embarking on any evaluation of new equipment or technology for warehouses and distribution centers, it is critical to have a true understanding of current operational performance, from receiving through shipping. With that information in hand, a company will be able to make the accurate "before and after" comparisons an engineered approach provides.

The first step of an engineered approach is to identify the specific aspects of an operation the company is targeting for improvement, and how each will change—for better or for worse—as a result of introducing new technology or equipment. Sometimes a vendor may include those specifics in its sales pitch, but most of the time someone who has the necessary expertise and is intimately familiar with the operation will have to pinpoint exactly what will change.

It is very rare for a large capital investment to have only positive impacts on an isolated aspect of an operation. For example, an automatic pallet-wrapping machine may reduce the wrap time per pallet but increase the amount of time that it takes to prepare the pallets to be wrapped. Remote-assisted material handling equipment may expedite the order-picking process by reducing the number of steps required, but it also introduces delays while the operator waits for the equipment to respond to the system's commands.

The next step is to consider how the introduction of new technology will impact other areas of the operation—both upstream and downstream processes, as well as maintenance and support functions—if at all. Consider the example of the automatic pallet-wrapping machine mentioned earlier. The machine may in fact wrap pallets more efficiently than a person could do manually. Automation could, however, create a bottleneck in the pre-wrap staging operations. If studies indicate that upstream bottlenecks would be introduced as personnel wait to utilize the equipment, then the buyer must evaluate how many units it would need to purchase in order to prevent those delays.

Another important consideration is the impact the solution may have on a facility's physical layout and traffic patterns. Some questions that must be answered include:

  • Can the equipment be positioned so that it does not impede the traffic flow?
  • How will the equipment interact with other pieces of equipment in the workspace?
  • Will the pre- and post-trip inspections or preventive maintenance programs for the equipment need to be modified and/or introduced to ensure the safety of those working with it or in its vicinity?

In addition, it is important to understand the degree of reliability the new solution must have and the maintenance that will be needed to support the new solution. Many people fail to consider that certain skills will be required and costs will be associated with maintaining the equipment or defining alternate procedures to continue operations during machine downtime and maintenance. These are just a few examples of the types of considerations that are often overlooked or omitted in the sales and business-case evaluation process used by most buyers.

Baseline versus future state
Once the buyer understands the potential impact of a new technology or piece of equipment, it is important to gather a baseline value (often measured in time when it comes to labor savings) for each step of the task that is being examined. Each step should be broken into smaller steps called elements. Elements that will be unaffected by the new technology can be ignored, which allows the buyer to isolate the true differences between the operation before and after the new technology or equipment has been implemented. There are various methods of collecting the times required to carry out each element, including stopwatch studies and predetermined time-and-motion studies. Companies can use information from their existing engineered labor standards to help them quantify the current environment, as long as the current standards are accurate and have been updated within the last 18 to 24 months. Those that do not have engineered standards in place can still follow this approach, but it requires a bit more data gathering beforehand.

It is important to understand how a new technology will affect the structure of engineered standards or incentive programs that are in place to manage the workforce. A company that does not intend to adjust its engineered labor standards or incentives to reflect the impact of a new technology is not likely to get a true picture of the anticipated savings, nor is it likely to achieve the benefits it expects.

With baseline information about the current state of operations in hand, the buyer can then project how each element would be affected after the new technology has been implemented. Under ideal circumstances, a potential buyer would introduce the equipment or technology into a facility, train individuals in how to employ it, and then study how it performs and what impact it has in the environment in which it would actually be used. Testing the equipment or technology at a facility can reveal unforeseen pitfalls and shortcomings as well as provide fact-based information for subsequent discussions with the vendor.

Because many equipment and technology capital investments are large and complex, it may not be possible to "test drive" them at a working facility. In such cases, simulation models can be valuable. When using simulation models, however, it is imperative to document all assumptions used, as they should form the framework for any conclusions drawn from the data.

After assessments of both the current and future-state values of the affected areas have been completed, the next step is to calculate the differences, and then apply them to the labor model and affected processes in order to determine the new equipment or technology's cost and productivity implications. (See the sidebar for a sample calculation.) Companies that have a labor management system with simulation capabilities can send actual work assignments through the future-state model and feel confident that they are accurately applying the frequencies of their key labor drivers, such as cases per location, cases per assignment, pallets per assignment, and percentage of walk travel versus ride travel. For those that do not have this capability, it is essential to look at as large a data sample as possible in order to be confident that the labor-driver assumptions reflect the long-term operational environment.

Once buyers have quantified the impacts of the new technology or equipment, it can be easy to "fall in love with the number." Since so much effort has been put into calculating an accurate savings projection, many executives want to immediately plug that number into a return on investment (ROI) model and begin translating the savings into dollars. But it is very important to consider factors that cannot be quantified in the model just described. Examples of questions to be asked include:

  • Will the introduction of the technology create new bottlenecks in the operation that may interrupt the flow of goods?
  • Does the technology have the potential to be "process limiting"—that is, it would improve the overall average but would limit high performers in the warehouse?

When such questions remain, it may be wise to take a more conservative approach to estimating future benefits.

An accurate projection of the savings to be gained from a capital investment can be an extremely valuable tool when negotiating with the vendor. Suppose that the equipment or technology under consideration fails to meet the required ROI. In that case, the buyer could identify a lower price that would keep the equipment or technology as a viable option. If there is no price flexibility, then the buyer could require the vendor to make modifications to the equipment to compensate for the ROI shortfall.

Benefits for both sides
An engineered approach to evaluating equipment and technology has benefits for both buyer and supplier. For distribution executives, having a realistic sense of the anticipated savings from a capital investment not only assists in decision making but can also provide substantial support for the business case required to secure investment funds. Moreover, it can provide valuable information for price negotiations. Equally important, it provides fact-based information that is specific to a particular operation—something that will help buyers avoid making poor capital investment decisions that could disrupt operations and negatively impact an organization's performance.

For vendors, the use of an engineered approach can improve the accuracy of ROI projections and increase their confidence that customers will be satisfied with the results of an implementation. Finally, this approach can help vendors identify potential problems and unique environmental characteristics before a technology or piece of equipment has been completely installed, providing the opportunity to customize or adapt the product while improving the odds of a win-win situation for both vendor and customer.

Aaron Lininger is an industrial engineer and project manager for the consulting firm West Monroe Partners.

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