Call it the era of "asset-smart." Wary of long-term capital investments, many companies have reacted to today's economic uncertainty with a spin on the "asset-lite" strategy popularized during the 1990s, when companies rushed to lighten their balance sheets by slashing plant-and-equipment outlays, wringing as many sales as possible from existing assets, and spending as little as they could on upkeep.
This time, however, the approach is much more cautious. Finance executives are determined to squeeze the most out of existing facilities, machinery, real estate, and inventory, even if that means spending more on upkeep or, as counterintuitive as it sounds, buying new equipment.
The strategy is driven by the tentativeness of current economic conditions. "You can develop the most sophisticated financial model in the world about what the cost and revenue implications of a decision will be, yet the fuel price you plug in this morning may be all wrong by tonight," says Peter Ingram, CFO and treasurer of Hawaiian Holdings, the parent company of Hawaiian Airlines.
Facing tepid consumer demand and volatile commodities prices, most companies have put off capital spending and are holding on to their cash (see "Captains of Capex," September). That may put them at a disadvantage should demand surge, but few are willing to spend now to head off that possibility. Instead, many are working to improve their asset utilization, essentially buying time by "not immediately investing their capital, or investing it in a more targeted fashion," says David Garfield, managing director at consulting firm Alix Partners.
Asset utilization is typically calculated by dividing revenue by assets — revealing, for example, the volume of sales linked to a given factory and the equipment inside it. Hence the appeal of asset-lite: strip your balance sheet of assets and your asset-utilization ratios improve dramatically. Investors tend to like that, and often fail to look beyond the improved ratios.
Finance executives, however, are now focusing on a second metric related to asset use: the "opportunity gap." Calculating it requires estimating a company's maximum theoretical output, the number of widgets it could crank out if its assets were running 24 hours a day, seven days a week, at maximum efficiency.
By subtracting actual output from that theoretical maximum, a CFO can get a sense of how much the firm is falling short of its ideal — and how much of the difference it can make up before resorting to capital outlays. "In the real world you can't get to that perfect state. But the closer you get, the more efficient you become," says Garfield. "That's the opportunity."
Managers must, however, resist the temptation to game the system. Since they know that perfection isn't achievable, they might, for example, ignore such things as the cost of regularly scheduled maintenance when calculating ideal output.
That, in turn, might cause them to overlook potential efficiencies by failing to acknowledge that unused machines might need to be checked just quarterly, rather than monthly. Says Richard Sehring, CFO of Consolidated Container Co. in Atlanta: "We want to go with the largest number [for maximum theoretical output] so that we can see the best opportunity to improve."
Speed the Plow
On the hunt for such opportunities, CFOs often find them in unlikely places. In agribusiness, an industry not usually known for advanced production strategies, potato farmers are installing new Global Positioning Systems that enable them to plow fields 22 hours a day without human intervention, according to Michael Boehlje, an agricultural economist at Purdue University.
If bleeding-edge plowing techniques aren't directly relevant to your company's operations, other investment strategies might be. Companies can, for example, get more sales out of their assets by buying new machinery on the cheap. TriMas Corp., a diversified equipment maker, was able to use the tactic to expand its customer base. "One of the things we've done through the economic downturn was to take advantage of other people's misfortune by buying assets out of bankruptcy," says CFO Mark Zeffiro.
Until mid-2009, TriMas's packaging business couldn't lure certain lucrative customers, because it didn't offer a broad enough product line. Seizing an opportunity, the company bought injection-molding equipment, presses, and assembly equipment for "pennies on the dollar" from a competitor that had just gone out of business.
After installing those machines, which enabled the company to start making specialty dispensers for hand cream and other liquid products, TriMas quickly built a business generating $5 million a year in sales. "We had more orders before we even started producing than [the amount] we paid for the assets," Zeffiro says. "We were turning somebody else's trash into cash."
Another way to narrow the opportunity gap is to buy assets today with a mind to future efficiency. When Hawaiian Airlines confronted the reality of its aging fleet of aircraft, the company knew it had to think long-term. It currently derives about 60% of its revenue from flights between the West Coast and Hawaii, a consumer-oriented business under recessionary pressure. Over the next 5 to 10 years, however, the company plans to boost its penetration into the growing market for flights to Asia. That led it to pick Airbus A330s as the replacement for its Boeing 767s, because they can fly farther and carry more cargo.
A third strategy is to reevaluate your product portfolio with an eye toward reducing the assets needed in-house. If, for instance, a company outsources the manufacturing of 50 of the 100 parts it offers, the equipment needed to make those parts would be owned by another organization, notes Richard Fearon, CFO of Eaton Corp. While sales would remain the same, the company would have far fewer assets.
Eaton, a maker of transmissions for large cargo trucks, embarked on such a process about eight years ago. The company divided the transmission components into three categories: those for which it was by far the most efficient producer or had proprietary technology; those for which it, although as efficient as other producers, didn't have proprietary technology; and those for which other firms were more cost-effective because they had more volume.
Eaton outsourced the manufacturing of all products in the third category and many of those in the second, while continuing to manufacture components in the first. "That significantly dropped the asset intensity of the business," says Fearon. "And we believe it led to better returns on capital."
David M. Katz is New York bureau chief at CFO.