Supply Chain Lessons Can Save Capital Projects
Capital spending can improve corporate performance — but only if projects are properly managed. The best way to do that? By managing capital costs as a supply chain challenge.
It’s not often that the terms capital projects and supply chain management are used in the same breath — but they should be.
Capital spending is a significant business cost. In the U.S., it tops $500 billion annually, and is led by energy, telecom, and automotive companies. On average, companies spend 7 percent of their revenue on capital projects. For companies in capital-intensive industries, capital projects are, unsurprisingly, a critical factor in their profitability. A Booz Allen Hamilton analysis of energy company performance from 2001 to 2003 found that although the amount most businesses earmarked for capital projects was proportional to their size, companies that executed projects best — cutting costs by 20 percent and closely monitoring schedules — reported net earnings as much as 25 percent higher than the average.
Despite the value that well-managed capital projects have for corporate performance, these investments frequently founder. In our work with aerospace and pharmaceutical companies, we routinely found cost overruns equal to 10 times the initial budget, and schedule slippage that resulted in projects taking five times as long as originally planned.
Capital projects suffer primarily because managers mistakenly see them as complex, individual efforts — each requiring a new blueprint. Whether a company is building a factory, a warehouse, or an oil production platform, it tends to believe that the geography and the technology are inherently sui generis — not predictable from past experience. So management fails to coordinate projects or to cultivate supplier relationships outside the boundaries of a single project. This approach is wasteful and pricey, and removes access to the information that is needed to produce a budget with reasonable cost expectations.
What’s the answer? Manage capital costs as a supply chain challenge. Successful supply chain management involves implementing strategies to efficiently supervise internal and external lead times, deploy the supply base, and optimize inventory and logistics globally. With only minor tweaking, the same can be said of capital projects management. That’s because capital projects, like supply chains, are driven by relationships with third-party companies. In most capital projects, close to 90 percent of the expenditures — including material, equipment, and labor — are external.
There are common aspects to virtually all capital projects that, as with supply chains, can be leveraged, modularized, and standardized to reduce expenses and time. For example, one pharmaceutical company that built several new office buildings, research laboratories, and manufacturing plants found that through the use of standard design principles — such as modularizing office spaces and common infrastructure — overall project costs could be cut by 13 percent. These savings were gained mainly through the application of supply chain management techniques, such as working closely with selected contractors and suppliers, to optimize their participation across all the projects.
Companies can take four steps to adapt supply chain management techniques for capital projects:
• Find commonalities across all capital expenditures; avoid fixating on the unique. Capital spending plans should be broken down by the services and materials that will be needed to complete the projects, the regions for which these projects are slated, and the potential suppliers located in these regions.
• Drive design modularization and standardization. Create standard specifications for components and subsystems of even the most complex projects. This way, a majority of the engineered and fabricated equipment can be designed with the maximum use of recurring manufacturing processes and off-the-shelf options.
• Leverage relationships with contractors and suppliers. Building and sustaining contractor and supplier relationships across capital projects is critical to cutting costs. It’s important to prequalify an appropriate number of contractors and suppliers, develop long-term relationships with them, and integrate them into project planning and design standardization. These closer relationships with suppliers, though, should be balanced with appropriate competitive tension. If the suppliers fail to meet performance goals, usually involving cost, quality, and deadlines, the partnership can be reevaluated. Sharing risk is also important. Companies can offer contractors financial incentives to complete projects on time and under budget, while financially penalizing those unable to meet these criteria.
• Deploy adequate organization and governance processes. Deficiencies in corporate structure and culture can be obstacles for companies trying to limit capital project costs. If the projects are going to be viewed by their commonalities, it is equally essential that companies develop capabilities at the corporate level to handle activities common to all projects through a leaner support infrastructure for procurement and contract management.
Once companies realize how essential capital projects are to their operations, their adoption of supply chain management techniques for managing capital projects can drastically alter the traditional relationship with key suppliers and unlock incremental value. This approach requires a fundamental shift in thinking, but is gaining momentum in several industries. It is a trend no company can ignore.
Matt McKenna (email@example.com) is a vice president with Booz Allen Hamilton in Houston. He has more than 20 years of experience in helping clients across industries improve their business performance.
Herve Wilczynski (firstname.lastname@example.org) is a principal with Booz Allen Hamilton in Houston. Working with companies in various industries, he specializes in supply chain management, manufacturing strategy, and large-scale transformations.