April - Library
April - Library April - Library
Maintenance Engineering and Engineering Economics José Guilherme Pinheiro Côrtes 1 jgcortes@terra.com.br; (Brazil) Arthur Wellington is recognized as the founder of Engineering Economics (EE) for having written the seminal work “The Economic Theory of the Location of Railways” in 1877. In it, he showed his disgust with his fellow engineers who took no account of the economic aspects of investment decisions regarding engineering assets. More than a century later, economics and engineering still live like worlds apart. And yet, one needs the other. This must change. One outstanding example of this long lived separation relates to the maintenance function. What happens and why? Let us see next. Engineering Economics and Maintenance Engineering One basic concept in EE is the capacity of an asset or group of assets to deliver an output of goods and/or services. Suppose the case of having to decide whether to acquire or not a new machine. How much is it worth? Basic economics tell us that any asset is worth the discounted value of its expected cash flow over its life cycle. However, the asset’s ability to deliver goods or services and therefore to produce a healthy cash flow depends on the physical capacity it puts at the organisation’s service. And this capacity depends on the maintenance services it gets. An The One Hoss Shay Capacity Model obvious connection, right? But not Capacity (t/y) to everybody, it seems. Until now, most EE textbooks implicitly assume that maintenance activities “just happen” and keep capacity constant until the very last moment of an asset’s existence. Then, they suffer “sudden death” and thus stop creating revenue and costs. This extraordinary behaviour of an asset’s capacity has been named “the one hoss shay model of physical depreciation”. 1200 1000 This approach is an obvious simplification of a problem that no doubt is much more complex. EE textbooks devote many pages to describe different models of fixed assets depreciation that do not mirror physical reality. A few pioneers, a long time ago, recognized the issue and tried to insert in their writings some useful information concerning real depreciation, or still better, real capacity decay. The theme has been recently brought again to discussion by some specialists in engineering asset management. It certainly deserves more attention and can possibly stimulate the joining of forces of Engineering Asset Management (EAM) – encompassing Maintenance Engineering (ME) – and EE 2 . There is a lot more to say about EE lack of realism that could be cured by some injections of good engineering knowledge and practice. But now let us see how ME interfaces with EE. Maintenance Engineering Needs Engineering Economics 800 600 400 200 0 0 1 2 3 4 5 6 7 Year Fig. 1: The One Hoss Shay Capacity Model ME as an engineering function demands resources that cost money, at the same time that it promises benefits that are badly needed by any organisation. Its worth derives from a positive balance between what it produces (benefits) and what it costs (sacrifices). It therefore must be subjected to financial screening, just like any other commitment of resources. An association of ME with EE is thus of extreme importance, be it to help to choose among alternative maintenance programs or to gain proper recognition of how much it costs and produces. To add tasks of financial planning, evaluation and control to the maintenance function is bound to face opposition. Resistance to change is everywhere, why should it be different here? ME has already a long history of conflict with operations management, to the point of being considered “a necessary evil”. Although entirely disagreeing with this, I know it is a real and widely diffused prejudice. I am also convinced that every engineering function should be more involved in the financials of its activities. To support this view, I will argue that: 1. All those who believe that any ME is worth more than it costs, please bring evidence. 2. It is time to improve the financial toolbox accepted and used by many authors in the ME field; it is embarrassing to admit that many tools are being imported from EE textbooks which are behind the more advanced “state of the art”. Take a look at the box opposite. Vol 24 No 2
AMMJ Maintenance Enginering and Engineering Economics Maintenance Engineering Deserves Better Financial Tools ME mixes old fashion with modern financial tools. Old stuff includes ROI (Return on Investment), a coefficient that express a measure of gain (return as profit or cash flow) as a percentage of sacrifice (investment); all these variables are measured in more than one way, to complicate matters still further. Also, simple payback rule that ignores the time value of money is no adequate solution. EE and Corporate Finance can offer better resources. What? There are proven discounted cash flow methods – NPV (Net Present Value), IRR (Internal Rate of Return), LCC (Life Cycle Cost), B/C (Benefit Cost Ratio) and DPB (Discounted Payback) – not to mention the more refined Real Options tools. All those require two (hard to get) inputs: the investment expected cash flow and the corresponding discount rate (adjusted by the systematic risk of the investment). This toolbox can certainly be upgraded to better satisfy the needs of any area of application. There is no reason to use old stuff. Even if sharp tools are used, EE is not able to properly formulate the problems ME faces and to supply the required inputs. None is more qualified to generate cash flow projections than the Maintenance Engineer. Acquiring skills in forecasting methods and accounting is recommended, nothing so difficult as to impede engineers to do the job. My favourite example is cost. ME cost is traditionally gauged by how much it spends, what is just a fraction of the whole “cost iceberg”. There are many other costs, including hidden ones such as loss of business reputation due to the deliver of poor quality goods, the final outcome of faulty maintenance activities. It seems that current cost models ignore the costs of not doing maintenance work. A rigorous cost model is still lacking. Discount rates come next. The use of “hurdle rates” to appraise capital expenditure projects with no justification of its value is common and undesirable practice in many engineering applications. Even textbook authors in Corporate Finance and EE fail in this respect. Is that a surprise? Not so much. To adjust a discount rate to the project level of risk is no easy task. But there are means to do it, starting from the basic financial theory of asset pricing under conditions of risk. The corporate wide cost of capital may be a good guess to begin with, because ME spending is much related to preserving the current business capacity. Engineering Economics Needs Maintenance Engineering EE needs more engineering. Gradually, EE was pushed out the more technical university departments, being restricted to industrial (or production) engineering departments. These may provide a better living environment for Engineering Economists, but it certainly limits the scope and reach of their work. Take a look at the bestsellers textbooks: there is ever less engineering content in them. I do not want to disrespect anyone’s intellectual production, but this a sad truth. If you are sceptical, please search inside any EE textbook for engineering subjects like innovation, maintenance and retrofit; you will find nothing. From my thirty six years of experience teaching to undergraduate and graduate students of Engineering at Universidade Federal do Rio de Janeiro (UFRJ), I learned that it is easier to teach Economics to them rather than to teach Technology to students of Economics or Business Administration. My students – they alone deserve credit for this – never offered any major resistance to become learned in Economics. Although it was not my intention, some of them became very good economists… To my greatest satisfaction, most of them became better engineers. Where I found some opposition was in the academic staff. To many of them, Economics is not a necessary intellectual competence of the engineer. In Brazil, to the best of my knowledge, engineers tend to reach high management positions and, also, many times become very successful entrepreneurs. In the beginning of their professional careers they look for opportunities to strengthen their intellectual capital, such as the MBA programmes, a clear recognition of the missing ingredients in their undergraduate preparation. What ME can supply that EE needs? Much, but I will draw the attention to only two themes: 1. First and foremost, ME is indispensable to shed light on the matter of production capacity. Once a production facility is started up, ME enters the game to preserve its capacity. How do ME activities relate to capacity levels? I assume that Maintenance Engineers can answer this question in their own language. What we (Engineering Economists) need is to get this answer in a language that we understand. We, on both sides, must therefore strive to understand each other. The financial health of private and public organisations alike will much benefit from this. And, of course, we will be doing a much better job. 2. ME is a service that can be supplied in many ways. Different strategies and technologies make a host of investment (and current spending) alternatives, with varying implications for the availability of production capacity. We must explore this territory together. Vol 24 No 2
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Maintenance Engineering and<br />
Engineering Economics<br />
José Guilherme Pinheiro Côrtes 1 jgcortes@terra.com.br; (Brazil)<br />
Arthur Wellington is recognized as the founder of Engineering Economics (EE) for having written<br />
the seminal work “The Economic Theory of the Location of Railways” in 1877. In it, he showed<br />
his disgust with his fellow engineers who took no account of the economic aspects of investment<br />
decisions regarding engineering assets. More than a century later, economics and engineering still<br />
live like worlds apart. And yet, one needs the other. This must change.<br />
One outstanding example of this long lived separation relates to the maintenance function. What<br />
happens and why? Let us see next.<br />
Engineering Economics and Maintenance Engineering<br />
One basic concept in EE is the capacity of an asset or group of assets to deliver an output of goods and/or services.<br />
Suppose the case of having to decide whether to acquire or not a new machine. How much is it worth? Basic economics<br />
tell us that any asset is worth the discounted value of its expected cash flow over its life cycle. However, the asset’s<br />
ability to deliver goods or services and therefore to produce a healthy cash flow depends on the physical capacity it<br />
puts at the organisation’s service.<br />
And this capacity depends on the<br />
maintenance services it gets. An<br />
The One Hoss Shay Capacity Model<br />
obvious connection, right? But not<br />
Capacity (t/y)<br />
to everybody, it seems.<br />
Until now, most EE textbooks<br />
implicitly assume that maintenance<br />
activities “just happen” and<br />
keep capacity constant until the<br />
very last moment of an asset’s<br />
existence. Then, they suffer<br />
“sudden death” and thus stop<br />
creating revenue and costs. This<br />
extraordinary behaviour of an<br />
asset’s capacity has been named<br />
“the one hoss shay model of<br />
physical depreciation”.<br />
1200<br />
1000<br />
This approach is an obvious simplification of a problem that no doubt is much more complex. EE textbooks<br />
devote many pages to describe different models of fixed assets depreciation that do not mirror physical reality. A<br />
few pioneers, a long time ago, recognized the issue and tried to insert in their writings some useful information<br />
concerning real depreciation, or still better, real capacity decay.<br />
The theme has been recently brought again to discussion by some specialists in engineering asset management. It<br />
certainly deserves more attention and can possibly stimulate the joining of forces of Engineering Asset Management<br />
(EAM) – encompassing Maintenance Engineering (ME) – and EE 2 . There is a lot more to say about EE lack of<br />
realism that could be cured by some injections of good engineering knowledge and practice. But now let us see<br />
how ME interfaces with EE.<br />
Maintenance Engineering Needs Engineering Economics<br />
800<br />
600<br />
400<br />
200<br />
0<br />
0 1 2 3 4 5 6 7<br />
Year<br />
Fig. 1: The One Hoss Shay Capacity Model<br />
ME as an engineering function demands resources that cost money, at the same time that it promises benefits<br />
that are badly needed by any organisation. Its worth derives from a positive balance between what it produces<br />
(benefits) and what it costs (sacrifices). It therefore must be subjected to financial screening, just like any other<br />
commitment of resources. An association of ME with EE is thus of extreme importance, be it to help to choose<br />
among alternative maintenance programs or to gain proper recognition of how much it costs and produces.<br />
To add tasks of financial planning, evaluation and control to the maintenance function is bound to face opposition.<br />
Resistance to change is everywhere, why should it be different here? ME has already a long history of conflict with<br />
operations management, to the point of being considered “a necessary evil”. Although entirely disagreeing with<br />
this, I know it is a real and widely diffused prejudice. I am also convinced that every engineering function should be<br />
more involved in the financials of its activities. To support this view, I will argue that:<br />
1. All those who believe that any ME is worth more than it costs, please bring evidence.<br />
2. It is time to improve the financial toolbox accepted and used by many authors in the ME field; it is embarrassing<br />
to admit that many tools are being imported from EE textbooks which are behind the more advanced “state of<br />
the art”. Take a look at the box opposite.<br />
Vol 24 No 2
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