How to Work in a World of Growing Costs

Equipment operations must recognize and account for increases in costs such as fuel

Construction Equipment - December 1, 2006

Mike Vorster
Contributing Editor

It seems that we are about to experience a bow wave of cost inflation pushed by record highs in commodity prices amid world-wide demand for resources. It is pretty clear: We need to prepare for the worst and learn to work in a world where inflation cannot be ignored.

Most operations follow the simple input, process, output model shown here, with many of these models working in series to make up a supply chain. These three steps, working in series, greatly affect the equipment executive.

First, equipment manufacturers take inputs such as steel, energy, manufacturing labor, facilities and expertise to produce the equipment we use. Their success depends on their ability to source the required inputs and the efficiency of their manufacturing and distribution processes.

Second, equipment managers take the machines produced by manufacturers, add fuel, ground-engaging tools, consumables, repair parts, labor, expertise in equipment management, and good processes to produce our output: equipment that is available, reliable and competitively priced.

Third, construction operations use the equipment and other inputs such as labor and materials to complete the work requested by the project owner. Their success, and the company's success, depends on theirexpertise and the efficiency of the processes they use to produce completed construction on time and on budget.

Inputs for each stage in the supply chain are bought for a cost, and outputs are sold at a competitive price. Growth in input cost must clearly cause an equivalent increase in output price unless there is an improvement in the process or a reduction in available margin.

Many colleagues have told me: "We have not increased our equipment rates for the past three years" or "we have not increased our rates to accommodate the increases in fuel price." They say it with pride, and they have obviously improved their processes and reduced costs in many areas. It certainly is possible to do more with less, but in the end you must either reduce the level of service you offer or build a problem for the future by living off the quality of your fleet, deferring maintenance, extending age, and skimping on necessary repairs. Not recognizing the reality of cost increases is a short-term measure that catches up with you and becomes progressively more serious.

In order to survive, we need to do four things.

First, we must recognize and not deny the impact that cost increases have on the cost of owning and operating our fleet. A 26-percent increase in fuel costs will cause the hourly cost of a mid-size wheel loader to increase by close to $5 per hour, an amount equal to a 25-percent increase in repair parts and labor or a 15-percent increase in purchase price. Cost increases of this magnitude cannot be denied or covered up by buying cheaper filters, extending maintenance intervals, or squeezing the last few hours of the life out of a critical component. Nothing is achieved if we seek to compensate in other areas rather than directly address the problem. Cost increases of this nature must be recognized, managed, and reduced by measuring performance, increasing accountability, and changing the way we do business.

Second, we must constantly seek to improve our processes. Increases in input cost cause efficient companies to become more competitive. The only way to reduce the impact of inflation is to improve efficiency and reduce consumption. It costs no more to save fuel now than it did a year ago, but the returns are 26 percent greater. The operator training or oil-analysis program that saved a $20,000 engine failure a year ago will now save a $24,000 engine failure. The efficient are rewarded and the inefficient severely punished.

It is unlikely we will achieve the improvements we need by simply working harder. We must also work smarter by adopting new technologies, changing the way we do business, and going where we have not been before. Wireless communication, GPS-based asset-management systems, self-reporting machines, and other information technologies must all be used to improve business performance and increase the output of ever more expensive input resources. (Read "Don't Be Seduced by Technology," December 2005)

Third, we must take care not to confuse cost reduction with cost deferment. Increases in replacement cost cause managers to extend the life of current equipment and defer replacement as a way to reduce capital expenditure. Maintenance can also be deferred, and repair costs can be shaved to a level where little is achieved other than simply returning the machine to work. This is an extremely dangerous strategy that neglects the effect that an over-age or under-maintained fleet can have on field production. High levels of inflation demand efficient high-tempo construction operations, and companies that succeed focus on reliability and productivity. They take a disciplined-need rather than cost-based approach to fleet replacement and maintenance.

Fourth, you must seek to develop and use physical measures of performance and steer clear of metrics based on cost. Mechanic hours per operating hour is a timeless measure that can be converted into a cost per hour for an appropriate time and location. Similarly, fuel consumption is a better measure than fuel cost, and component life is a better measure than repair cost. Traditional cost-control and cost-management methodologies presume that input costs will remain at the same level and that you can manage the process by comparing input costs with the value of outputs produced. Periods of high inflation require that we move from a focus on cost control to a focus on resource utilization, efficiency and productivity.

It all sounds like normal good business practice, and in reality, it is. There is, however, an important difference. Cost inflation amplifies the gains possible through efficient operations and provides an opportunity for the best to excel. It seriously punishes those who do not.