Calculating the Return on Investment (ROI) for DMSMS Management. The Problem with Cost Avoidance

Transcription

1 Calculating the Return on nvestent () for DMSMS Manageent Peter Sandborn CALCE, Departent of Mechanical Engineering (31) October 28, 21 1 The Proble with Cost Avoidance The value of DMSMS anageent activities is usually quantified as a cost avoidance Cost avoidance is a cost reduction that results fro a spend that is lower then the spend that would have otherwise been required if the cost avoidance exercise had not been undertaken. B. Ashenbau, Defining Cost Reduction and Cost Avoidance, CAPS Research, March 26 While anageent can (with a bit of effort) understand cost avoidance, it is not necessarily sellable Requesting resources to create a cost avoidance is not as persuasive as aking a return on investent arguent 2 1

2 Evaluating the Associated with DMSMS Manageent What is? Return - nvestent nvestent (Arithetic Forulation) Why evaluate the? To build a business case for anageent activities To perfor cost/benefit analysis on different anageent approaches Evaluate when anageent ay not be warranted nterpreting : breakeven (no cost ipact) > there is a direct cost benefit < there is no direct cost benefit 3 for DMSMS Manageent So, how do we forulate an for DMSMS Manageent? Proble #1 The return in this case is the cost avoidance, i.e., a reduction in costs that have to be paid in the future to sustain the syste: V f Vi V i Cost Avoidance nvestent nvestent where, V f final value of the investent V i initial value of the investent 4 2

3 for DMSMS Manageent (continued) Proble #2 - copared to what? has to be relative to soething. Presuable one wants to copare to the no DMSMS anageent case, but what is this case? Are you coparing to a case where the syste becoes non-sustainable (if so, what is the life cycle cost of a non-sustainable syste)? Are you coparing to a case where the syste reains operational but at a higher cost (cost of what?) Whatever case you choose to easure fro it will be abiguous (no two folks will define it the sae way) One possible solution: A clearly definable stake in the ground is the perfect world case, which represents the sustainent of the syste if nothing ever went obsolete This is not a real case, but, it is a clearly definable point to easure everything fro (is it definable without abiguity?) However, the downside is that it will require soe anipulation of the final to create a useful/eaningful nuber 5 for DMSMS Manageent (continued) Proble #3 Separating the life cycle costs when DMSMS is anaged fro life cycle costs when DMSMS is unanaged ay be ipossible to do. 6 3

4 for DMSMS Manageent (continued) relative to the perfect world () case gives ( C C ) ( ) where, C total life cycle cost of the syste if nothing ever went obsolete C total life cycle cost of the real syste with DMSMS anageent investent cost in DMSMS anageent if nothing ever went obsolete investent cost in DMSMS anageent in the real syste By definition, (contains no investent in DMSMS anageent because there is no DMSMS to anage) becoes, C C (C -C ) excludes all the costs that are a wash (i.e., the sae whether parts go obsolete or not) solves the proble of splitting up costs C C gives (which is right, note C includes within it) 7 for DMSMS Manageent (continued) nvestent cost C + C NRE NF where, C NRE DMSMS anageent non-recurring costs C NF DMSMS anageent infrastructure costs DMSMS anageent NRE costs non-recurring cost of identifying and putting in place specific resolutions for specific parts DMSMS infrastructure cost cost of acquiring and keeping DMSMS anageent resources in place (people, training, software, databases, plan developent, etc.) 8 4

5 for DMSMS Manageent (continued) Not so fast! s coplete? Are there other investent costs too? This is a difficult question Exaples: What if y DMSMS resolution approach is to buy an eulated part that costs 2x the original part cost fro the original anufacturer. s the increase in the recurring cost per part an investent cost (i.e., part of )? What if y anaged DMSMS progra ends up buying ore parts than an unanaged progra. s the cost of the extra parts accounted for as part of the investent ( )? What if (for siplicity) y DMSMS anageent approach resulted in buying the exact sae nuber of parts for exactly the sae price per part as y unanaged approach, but buy the at different ties. Due to the nonzero cost of oney, this does not end up costing the sae. s the cost of oney part of? These costs would not be included in the investent cost because they are the result of the investent and are reflected in the life cycle cost C 9 Life Cycle Obsolescence Manageent Cost Life Cycle Obsolescence Manageent Cost (C DMSMS C C ): C C Actual total life cycle cost Life cycle cost if no parts had gone obsolete ncludes: All recurring costs (build and part procureent) All non-recurring design refresh and re-qualification costs All lifetie buy and bridge buy costs All inventory costs ncludes: All recurring costs (build and part procureent) No obsolescence events No design refreshes (for obsolescence anageent) No lifetie buy or bridge buy costs No inventory costs (for extra parts) 1 5

6 for DMSMS Manageent (continued) C C C DMSMS is always a negative nuber. n this for, the closer to zero the is, the higher the value of your DMSMS anageent, i.e., you are closer to the life cycle cost of the no obsolescence case (the best possible case would be an of zero). Re-writing the relative to a no anageent (N) case assuing N (rather than a perfect world case) we get, CN C C CS C CS N + Where the life cycle cost of a real unanaged syste be C N C +C S, where C S is the sustainent cost of the unanaged syste Why write the this way? N is the sellable quantity (it has a real eaning and a clear interpretation to anageent) is a calculatable quantity (people could keep track of it or predict it) C S is the apping between N and 11 Cost Avoidance Estiate Exaple Consider all the resolutions fro a particular DMSMS anageent organization (we ignored the redesigns). The conventional cost avoidance calculation would be: Resolution Existing Stock (No Action) Nuber of Occurrences Cost Avoidance 79 $2 $158, Reclaation $5 Alternate 15 $13, $195, Total Cost Avoidance Substitute 4 $32, $1,28, Afterarket 3 $23, $69, Eulation $47, Redesign-Minor - $328, - Redesign-Major - - Total 164 $2,323, For whatever itigation solution is chosen, one can consider an associated cost avoidance equal to the difference between the cost of your solution and the next ost expensive one. 24 DMEA Nubers The organization would report this cost avoidance to their anageent to value their DMSMS anageent efforts 12 6

7 Cost Avoidance Estiate Exaple (continued) But what does the $2,323, ean? s this real oney? Would the life cycle cost of the syste actually have been $2,323, higher if the DMSMS anageent organization had not existed? s $2M in Progra A valued the sae as $2M in the Progra B? These are all really good questions for which there aren t generally any answers 13 Cost Avoidance Estiate Exaple (continued) Let s take one ore step with the conventional approach: Assue the following costs: C NRE $471,648 (ignoring redesigns) C NF $2, (DMSMS infrastructure costs) for the period of tie covered by the data software licenses, training, etc. With these values the organization using the conventional cost avoidance calculation could copute an for their progra: Cost Avoidance - nvestent $2,323, - ($471,648 + $2,) 2.46 nvestent $471,648 + $2, This gets us past the value of oney proble (it divides out), but, this is relative to what? t s relative to the next ost expensive resolution, which isn t a fixed point. So the eaning of this is unknown. 14 7

8 Cost Avoidance Estiate Exaple (An Actual Calculation) We need to deterine the recurring cost (C REC ) for the organization s DMSMS anageent of their progra: Resolution Recurring part price ultipliers Nuber of instances Alternate-Coon $225, 1999 DMEA Nubers Substitute-Desktop $138, Substitute-Noral $384, Substitute-Coplex 1 9 $81, Afterarket-Coon $1,95, Lifetie Buy 1 12 $3, Total (C REC ) $3,87, Additional Recurring Cost (due to DMSMS anageent) (15)(1)($1)(2.5-1) (12)(1)($1)(.25) Other assuptions: Average deand per part at obsolescence 1 (nuber of parts needed) Average price per part at obsolescence $1/part Lifetie buy buffer size 25% 15 Cost Avoidance Estiate Exaple (An Actual Calculation - continued) C NRE + C NF $2, + $471,648 $671,648 (sae as for the conventional calculation) Total cost of DMSMS anageent: C DMSMS C REC + $4,478,648 (relative to the no obsolescence case) for the progra: C $4,478,648 $671,648 DMSMS 6.67 n order to calculate the relative to the unanaged case, the reaining unknown is C S (the sustainent cost of the unanaged syste) 16 8

9 Cost Avoidance Estiate Exaple (An Actual Calculation - continued) CS CS N $671, (N) Breakeven C S $4.48M -8. $ $2,, $4,, $6,, $8,, $1,, $12,, Cs (sustainent cost of the unanaged syste) Exaple, if C S $8M, the of this DMSMS anageent progra relative to an unanaged progra will be Cost Avoidance Estiate Exaple (An Actual Calculation - continued) Conclusion (for this exaple): f sustaining this progra without DMSMS anageent costs less than $4.48M, then there is no econoic advantage to having a DMSMS anageent progra. f the sustainent cost of the unanaged progra can be estiated, an actual can be found The eaning of the $2,323, cost avoidance found using the conventional approach is unknown calculations incorporating the conventional cost avoidance are easures that are relative to a coplex oving scale associated with the next ost expensive resolution approach You can still cast the final answer in ters of a cost avoidance if you want Cost Avoidance- nvestent N Cost Avoidance ( N + 1) nvestent 18 9

10 for DMSMS Manageent (continued) More probles: Proble #4 How is a design refresh that concurrently resolves ultiple current and future DMSMS probles valued? includes the NRE costs associated with the design refresh (true for both the conventional cost avoidance analysis and ethods) n the approach, the life cycle cost value (or possibly lack of value) of the design refresh is part of C (the actual life cycle cost of the syste) so all future ipacts on the syste of doing a refresh are accounted for correctly n the conventional cost avoidance calculation, the value of the design refresh is calculated for the resolution of a current DMSMS event (possibly ultiple current events) no accounting for future DMSMS resolutions avoided is possible Coent Only a siple calculation exaple was presented here one really needs to do a discounted cash flow, i.e., perforing a cuulative tie dependent calculation that includes the discount rate on oney 19 Suary We have no idea what the costs or s generated by the conventional cost avoidance calculation approach really ean (the relative to a case where nothing goes obsolete) can be deterined fro data collected by DMSMS anageent organizations today, and is a valid easure of DMSMS anageent value, but is it sellable? Probles of coparing differing values of oney ($1 at Boeing $1 at Raytheon) are solved by since it is a ratio f a C S (sustainent cost of the unanaged syste) can be established (or estiated) for a syste, then a real for the DMSMS anageent effort can be found, alternatively, application-specific breakeven C S can be calculated The conventional cost avoidance calculation has the potential to significantly undervalue design refreshes because does not account for future DMSMS resolutions that have been avoided ( does account for the) The conventional approach ay capture how hard the anageent organization is working, but does not easure how sart it is working 2 1

11 Quantifying the Benefits of DMSMS Manageent DMSMS MANAGEMENT? 21 11