REPLACEMENT ASSET VALUE (RAV) IS A PERFORMANCE INDICATOR OF EXPENDITURE RELATED TO THE OPERATION AND CARE OF PLANT OR EQUIPMENT VS. CAPEX EXPENDITURE NEEDED TO REPLACE THE PLANT OR EQUIPMENT. MANY PEOPLE ASK IF THERE IS A REPLACEMENT ASSET VALUE BENCHMARK FOR THE OPERATING COST.
I have been reading with interest your articles on maintenance cost as a percentage of Replacement Asset Value. I am familiar with using the kpi and the benchmarks for direct and overhead maintenance costs but am interested to know if you have a Run and Maintain Capital Expenditure as % of Replacement Asset Value benchmark?
I really like the car analogy which you used but normally cars are replaced after a certain number of years. We can’t usually do this with manufacturing assets and I have been asked to find an equivalent benchmark to the maintenance cost for capital expenditure associated with run and maintain.
Your advice is to calculate this separately, do you have any guidance on how? Thanks in advance for any advice you can give.
It’s a curious performance indicator that you have been asked to develop—the operating capital expenditure caused by use of plant or equipment compared to a measure of total capital expenditure to replace the plant or equipment.
Run and Maintain Capital Expenditure is called Operational Capex here in Australia.
I presume the Operating Capex vs. Replacement Asset Value benchmark you want to develop will have some useful purpose that leads to a better outcome for your company, or that ensures your people make better decisions. Otherwise it belongs with the many other indicators that are measurable but pointless, since its use helps no one understand what they have to do to improve a situation.
From purely a math perspective, I see no reason why you can’t compare any cost spent on an asset against another cost applicable to the asset to arrive at a ratio of costs. Provided you use the same units, dollar to dollar, then you get a mathematically correct number. What the ratio means or indicates is a different question.
You’ll need to adopt a robust and unquestionable definition for both Run and Maintain Capital Expenditure and for RAV so the values used in the Replacement Asset Value benchmark calculation surely belong in each category. You don’t want to have a dollar value used in the calculation that pollutes the correctness of the resulting ratio.
The time period during when the Run and Maintain Capital Expenditures were spent is also going to need to be specified. You will need to decide the period over which the ratio applies—I imagine annual Run and Maintain Capital Expenditure verses current RAV on the day the equation is calculated would be reasonable. The ratio will not have a standard base line across time, and a comparison of ratios over the years could be an unreliable trend indicator, as the value of RAV will differ each year from what it was in prior years due to the time value of money.
To me, a more meaningful indicator that is valuable for making a capital replacement decision is if an asset has yet earnt its capital value back so you can justify replacing it with the latest modern solutions and technology. Presumably, the new plant would be cheaper to run and more reliable, thereby lowering production costs and increasing operating profit.
This leads one to the discussion of when an asset ought to be replaced. The analysis of the economic replacement of assets, like plant and equipment, is known as Asset Economic Life determination. It’s a net present value (NPV) costing method that uses Equivalent Annual Costs of a stream of equal annual imaginary costs to determine the optimal replacement date.
Economic Asset Life is defined as, that life after which the asset is retired to minimize the Long Run Average Cost of Production, if necessary across several asset replacement cycles.
You create an economic model of the asset’s future running and maintenance costs, including expected rebuilds (scheduled overhauls) and renewals (operating capex) to find the point in time when the unit cost of production begins to increase. Because the cost to keep an old and tired asset in service causes you to make more expensive product, there comes a time when the unit cost of production starts to rise, and this is supposedly when you get a new, modern replacement asset.
If I put on my businessman’s hat I’d disagree with that accounting logic. You actually want to replace an asset as soon as an alternative asset available in the marketplace becomes economically viable to buy and operate, compared to keeping and using the current asset. For example, if a new discovery or innovation allowed a new asset design to make product at far less cost than what you can now make product, it becomes sensible to look into buying and using the new asset verses staying with the current asset. In cases where the new solution has a great Return on Investment, retaining use of the old asset is not sensible and changing to the new asset becomes a vital profit imperative. If a competitor brought the new asset and you did not, your business future would be in jeopardy because your products will cost much more than those from the competitor.
Get new plant and equipment as soon as the business life cycle economics, not the asset life cycle economics, justify the replacement. It is not the asset’s least life cycle cost that drives the replacement decision, it is the higher profit gained from the production cost reduction with a new asset that justifies early replacement of plant and equipment. What matters the most is what profits your business the most!
You are right to consider and use the economics of remaining operating life in your asset replacement choices. In the end we want to make those business, maintenance and operating decisions that bring the most lifetime operating profit and the highest chances for long term business survival.
All the best to you,
P.S. If you have questions on life cycle asset management, equipment maintenance strategy, defect elimination and failure prevention, or plant maintenance and reliability, please feel free to contact me by email.