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(Section C)
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2.1 Capital Investment Justification: The formal argument for making a significant investment in a depreciable item that will provide a wide latitude of capability and capacity alternatives quickly and with minimal cost. Here the emphasis is on a procedure that enables the acquisition of agile equipment and other agile capital items, though an agile procedure itself is also necessary to insure that it too can evolve. Typical Agility issues across industry generally include production and support resources with narrow capacity bandwidths, restricted capability ranges, and complex or rigid interfaces that optimize costs for specifically targeted output, but severely limit the ability to take advantage of additional opportunities and satisfy changing requirements.

At Remmele this practice has a solid foundation in the Strategic Policies’ (see Appendix) emphasis on growth, technological excellence, and knowledge-based informed risk, serving as the framework for allocating investment resources to capital requests that satisfy strategies and investment guidelines. In general, highly mature practices will reconfigure resources and investment guidelines to fit a broad range of capital areas and opportunities.

Permitting capital investments that specifically accommodate an unpredictable business environment
  • Capital equipment is "cost justified" in the traditional financial sense only when it is being acquired specifically for reducing costs. The majority of capital investment at Remmele is for equipment expected to open or expand market potential, and that potential is the focus of the justification process. Capital is allocated among competing requests not on the basis of financial justification numbers, but rather on the strength of accumulated knowledge and the resulting gut feel of the people involved in the decision. Ultimately the president, with board of director concurrence, approves the annual total capital budget and allocation plan, but does so in consultation with the cross-divisional management committee responsible for recommending the annual capital plan. Remmele's president directly attributes their high hit rate on successful market entry to the fact that they don't justify on rate-of-return financial data alone, but rather on a broadly shared and deep-studied knowledge base. Recognizing the unpredictable nature of their markets (aerospace decline, computer disk-drives using less machining, etc), capital is funded from profits only, never from borrowing. So cash availability can be the limiting factor on next year's business—but uncertain or mercurial markets will not catch the company over-leveraged.
  • Supporting Remmele's knowledge-based intuitive approach: "Whenever we allow ourselves to ignore the truth, the computer becomes the ally rather than the enemy of our conceptual errors. Those who live by the numbers may find that the mathematically inspired techniques of modernism have sown the seeds of a destructive technology in which computers have become mere replacements for the snake dances, the bloodlettings, the genuflections, and the visits to the oracles and witches that characterized risk management and decision making in days of yore."1

Reducing risk and increasing return

  • Capital equipment for the General Machining and Repetitive Batch Divisions (Plants 10-20-40) is generally bought before any jobs are secured or sales activity begun, in order to reduce the risk associated with the learning curve for brand new technology. Investment decisions recognize equipment and technology that have multiple uses, such as five-axis machines that can do three-axis machining—so if the bleeding edge potential cannot be realized there are alternative ways to productively employ the new resources.
  • The company ideology leans heavily on the concept of informed risk: There is a lot of tolerance for making mistakes if you have done your homework; but you will get called on the carpet if you cannot demonstrate and communicate a serious homework process. This ideological pressure comes from everywhere, not just from above: the people in the shop have questioned why computers were purchased and want to know what was
  • behind the decision. When equipment was purchased for the Production Machining Division that didn’t work out, management had to spend a long time explaining to the shop people how they had reached the unfortunate decision. "Decision making is a real key factor in what we do," so the decision-making process is constantly scrutinized by everybody.

Keeping up with new technology and new process

  • Remmele's investment guidelines favor new, top-of-the-pyramid technologies—those that offer new and under-served markets which can sustain the margins necessary to fuel the capital and learning-curve investments. A proactive commitment in the form of technical resources and market-search provides a grasp of emerging opportunities. This process has led to the current push-the-envelope investments in high-velocity machining, flexible manufacturing systems, and lights-out operation. Conversely, Remmele turned down a major job opportunity that required too much "new" process technology. It was new to Remmele, as they had no real in-house experience with screw machines, but old in terms of technology—and not leverageable into leadership competitive capabilities. Had the customer been better known to Remmele they might have accepted the risk. "It’s a question of knowing that the customer will work with you when you try things that you are not experienced with. We prefer customers who understand about the new-process learning curve."

Investment decision turns out to be incorrect: market doesn’t materialize or technology is insufficient

  • Remmele has been known to sell off new technology quickly when it has become apparent that the motivating potential cannot be satisfied—sometimes because the technology is not ready for the application they had in mind, sometimes because the suspected market does not materialize for them quickly enough. In any event, the company is highly conscious of capital limitations and will convert disappointing experimental equipment to cash quickly for reinvestment in other promising areas.

Different plants want different things, each on their own growth curve

  • Depreciation plus 40% of generated profits are suggested to the divisional managers as a capital investment guideline. On occasion, some programs require major and disproportionate capital investment relative to the divisional guidelines, such as the high velocity machining program for the General Machining Division. When this occurs it is evident that the company is capital-restricted, as some divisions must settle for less so that another can utilize more than the overall guidelines suggest.

Business is capital-intensive and growth requires increasing investments

  • Corporate guidelines consider debt instruments as too risky for capital investment funding: The nature of the business is capital intensive, and investing through debt is a seductive path to being owned by the bank. As a result, strategic policies restrict business to that which returns healthy margins to ensure an adequate pool for investment; and specify that capital investment each year will at least equal the prior year’s depreciation. Actual investment amounts have consistently exceeded this depreciation minimum by a large margin. Supporting this Remmele practice: "The most important management act is the allocation of the company's capital. It is the most important because allocation of capital, over time, determines shareholder value. Deciding what to do with the company's earnings—reinvest in the business or return money to shareholders—is, in Buffet's mind, an exercise in logic and rationality….If the extra cash, reinvested internally, can produce an above average return on equity, a return that is higher than the cost of capital, then the company should retain all of its earnings and reinvest them. That is the only logical course. Retaining earnings in order to reinvest in the company at less than the average cost of capital is completely irrational. It is also quite common."2

Adding equal capabilities for investment in areas other than machining and process technology

  • The Remmele capital investment practice is highly effective but narrowly focused, being heavily biased by the intuitive grasp that management develops for emerging machining technologies and markets. The industry is now on the verge of employing information technology as a competitive infrastructure for both customer interaction and for internal operations. To secure necessary capital, information technology investments will compete for the same pool of funds and will not compete evenly until the same breadth and depth of knowledge gathering and sharing is brought to bear.
Footnotes:
1 P. Bernstein, "The New Religion of Risk Management," Harvard Business Review, March–April 1996.
2 R. Hagstrom Jr., The Warren Buffett Way (New York: John Wiley & Sons, Inc., 1995), pp. 80–81.


View Next Part: Section C-3.1

View Executive Overview: Abstract, Preface, Table of Contents

View Section A: Intro to Model | Change Proficiency Maturity Model | 24 Business Practices | Summary

View Section B: Intro to Remmele Case Study

View Section C: Integrated Model & Case Study | C-1.3: Strategic Plan Buy-In | C-2.1: Capital Investment Justification | C-3.1: Business Unit Relationships | C-6.2: Operating Metrics

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Order Hardcopy Bound Report: An Agile Enterprise Reference Model and Case Study of Remmele Engineering


Features: Home | Library | Corp Info
Major Concepts: Realsearch ||| Enterprise Model ||| Maturity Model
                        Knowledge & Agility ||| Agile System Principles
Book: Response Ability - The Language, Structure and Culture of the Agile Enterprise
Book: Value Propositioning - Perception and Misperception in Decision Making

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