To Buy, or Not to Buy?
Calculating ROI for tool and equipment purchases
By Gerry Davies
Several years ago, designer Michael Bondanza bought a laser welder for his New York City jewelry workshop. On several levels, the acquisition made sense. It was high-tech. It was a new tool sweeping through the industry. And, perhaps most important, his workers really wanted it.
Here’s the problem: The tasks for which Bondanza’s shop typically uses a laser welder—filling porosity, repairing weak prongs, and such—don’t come up very often because his fabrication processes are designed to catch them early, when a casting can simply be junked, rather than later, when it requires repair. In two and a half years, he says, the machine has had only about a thousand hours of use—nowhere near what was needed to justify the purchase financially. He’s usually staunchly pragmatic about such things, and he knows that in buying the laser welder he violated a basic rule of business:
Whether you’re running a 15-person workshop like Bondanza’s or a 400-worker factory, you should know before buying whether a piece of equipment will provide an adequate return on investment (ROI).
In other words, as Bondanza puts it, "Is this going to pay?"
That payment can take different forms. In addition to a financial return, there could be benefits on which it may be harder to put an immediate dollar amount. For instance, investing in the newest technologies may give you a marketing advantage over a competitor, or it may help you to retain a key employee or customer whose long-term benefit to the company far exceeds the cost of the new equipment.
However, most investments come down to dollars and cents, and whether the payoff justifies the cost. Sometimes it’s an easy call. A $300,000 milling machine that realistically wouldn’t be used for more than a few jobs a year is a no-brainer. Hand carving or outsourcing would get the work done much cheaper. Conversely, a CAD or casting setup that’s in regular use and allows a shop to meet proven customer demand more quickly and efficiently, and thereby sell more jewelry, is probably a no-brainer, too.
Other acquisitions, however, may be tougher to judge. Managers must ask the right questions and be diligent in their research to make reasonably sound decisions.
How Much Money Will Your Money Make?
Adequate ROI revolves around one crucial issue: the cost of capital. A company needs to invest its capital as profitably as possible, and equipment purchases are in competition with other uses. As a rule of thumb, machinery or other tools should pay for themselves within two to three years, according to Brian J. Hogan, editor of Manufacturing Engineering magazine. If they don’t, the money would have been better spent on something else with a higher return.
Before it can get into ROI calculations, however, a company has a basic task to perform: developing a realistic understanding of what it needs and what the the machine wil be required to do. For example:
• How often will it be operated?
• Is versatility an issue, or will it be used for a handful of specific tasks?
• How fast must it run? For just-in-time operations, speed can be especially important. Will it free up an operator to perform other tasks?
• Are production increases or new tasks expected, or will the machine simply do the same work as a previous machine? ("Doing the exact same job with a newer technology seldom provides [adequate] return on investment," says Peter Martin, author of Bottom Line Automation.)
• If more production is foreseen, will the equipment speed up one part of the line, only to have bottlenecks elsewhere negate the benefit?
Bondanza suggests another line of questioning: Are expectations of what the equipment can do realistic, or is the manager responsible for the purchase grasping at straws or seduced by the technology? "People love the fact that they have a new machine and that it’s cutting edge and all that," he warns, "but they may already have three machines [doing the same task as the new one would] that don’t make a profit for them now. They’re better off not producing those products, or outsourcing that part of the job."
Taking all that into consideration, the newest, highest-tech CAD/CAM system, for instance, really might be necessary. Unless, that is, ROI analysis suggests the company could fare better by purchasing an older, cheaper model or something used, or even by outsourcing to a CAD/CAM service bureau.
So how do you calculate whether the ROI will be high enough?
Click here to go to page 2: How to calculate ROI