The implications of TCO in investment decision making

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The implications of TCO in investment decision

making

Alieke Vos - s2016591 a.vos.9@student.rug.nl

MSc. Technology and Operations Management University of Groningen, Faculty of Economics and Business

August 2015

Supervisor University: W.H.A. Alsem Co-assessor University: J. Veldman

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Abstract

In contrast to traditional methods, Total Cost of Ownership (TCO) takes the entire life cycle of assets into account for investment decision making. Within academic literature, TCO is proposed as a cost saving tool for investment decision making. However, TCO is not broadly applied. A lot of research was done on the terminology of TCO and to causes of why TCO had not been applied. This study aims to contribute to the literature gap about the implications of applying TCO in the investment decision making process (IDMP). A case study is used to compare the traditional approach with the TCO-based approach. The study concludes that the main implication of applying TCO in the IDPM is that it requires a lot more effort. For investments with a low initial price the use of TCO does not influence the investment decision. For large investments decisions it may be a cost saving; however, it is unrealistic to include all cost elements as is aimed for in TCO. Cost elements need to be selected for being included or not. Therefore, the use of TCO in the IDMP is not considered to save large amounts when compared with a good use of the traditional IDMP.

Key words:

Asset Life Cycle, Asset Management, Implications, Investment Decision Making Process, Total Cost of Ownership.

List with Abbreviations

ALC Asset Life Cycle MTBR Mean Time to Repair

CAPEX Capital Expenditures NPV Net Present Value

CSR Corporate Social Responsibility OPEX Operational Expenditures

DCF Discounted Cash Flow PB Payback Period

HO Head Office (Wavin) POT Pay Out Time

IAF Investment Approval Form ROI Return on Investment

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1. Introduction

The dynamics in the global industrial markets are forcing companies to consider new investments from a wider perspective than ‘lowest operational costs only’ (Chan et al., 2001). Today’s playing field has become global and issues such as off-balance financing, Corporate Social Responsibility (CSR), cradle-to-cradle, and Mean Time Between Repair (MTBR) are affecting these investment decisions. Inflation, eroding purchasing power, budget limitations, and intensive (global) competition have created awareness in perceiving the total cost of products, systems, structures and assets (Durairaj, Ong, & Tan, 2002). A tool that considers total costs is Total Cost of Ownership (TCO). TCO received increasing attention over the last two decades. TCO is aimed to understand the true costs of buying a particular good or service over its life cycle so the options can be compared based upon these costs (Ellram, 1995). Comparing the costs of two options is a process step in the investment decision making process (IDMP). TCO can contribute to this process of companies by showing the cheapest option over the intended life cycle (Ellram, 1995). The asset with the higher initial price may have a lower TCO (Woodward, 1997). This makes TCO a tool that has the potential for companies to reduce opportunity costs the long run on investments (Ellram, 1993).

Total Cost of Ownership (TCO) has been developed to help systematically mapping the total costs of asset’s life cycle. TCO is aimed at understanding the costs of buying a particular good or service over its life cycle so options can be objectively compared based upon those costs (Ellram, 1995) whereas traditional methods are often based upon the initial purchase price and expected sales volumes. (Lindholm & Suomala, 2004). Comparing costs of options for an investment is one of the essential steps in the Investment Decision Making Process (IDMP). TCO can contribute to the IDMP within companies by showing the cheapest option over the intended life cycle (Ellram, 1995). The asset with the higher initial price may have a lower TCO (Woodward, 1997). Therefore TCO is a tool that has the potential for companies to save money on investments in the long run (Ellram, 1993).

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practices and suspicious attitudes towards the approach (e.g. Ellram, 1995; Lindholm & Suomala, 2004; Ardit & Messiha, 1999). It seems that the slow rates of adoption are rooted either in a lack of standard or formal guidelines, and in a lack of reliable historic data (Wouters et al., 2009; Ardit & Messiha, 1999). Few research projects are found addressing the issue of implementing TCO. Literature seems to focus on the concept, the drivers for TCO and the benefits for companies and in lesser extent about the implications of applying TCO, the systematics and the change management issues that may become essential. According Dowlatshahi (2001), it is important to determine relevant components of TCO to enhance the reliability and the usability of the model. Dowlatshahi (2001) also states that only very little work has been done to identify these components. This unclearness of important components to be used, results in a variety of models that are used among and even within companies (Butha & Huq, 2002). As a result, companies cannot learn from each other and are doing redundant work or are making the same mistakes. To decrease such inefficiencies, education and training might be required and cultural change might be needed within the organization to embed TCO effectively in a company’s process (Butha & Huq, 2002; Ellram, 1995). The slow progress and reluctant embracement of TCO seems rooted in a lack of preparation from the companies’ side; they do not know what to expect of applying TCO in their IDMP or how to behave when using it. Therefore, central in this study is:

“What are the implications for the decision making process of a company when applying TCO instead of the traditional method?”

1.1. Objectives of the study

An Investment Decision Making Process (IDMP) comprises several steps in which the final step is the decision to buy. By changing the nature of the process, it is unlikely that the remaining process stays the same. There has been little research on this subject in literature. For that reason, the first objective of this study is to expand the literature about the implications of applying TCO in the IDMP. In addition, the practical value of this study could be important. The study will result in experience with the implementation of TCO in the IDMP of a company. Therefore, the results of this study are beneficial for organizations that want to prepare for an application of TCO. Sub-questions are formulated in order to provide an answer to the central questions:

 “What are the characteristics of an investment decision making process?”  “What are the conventional methods to base investments on?”

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1.2. Managerial interest

This study will be performed at Wavin. Wavin is a producer of plastic pipes and fittings with 31 production sites in Europe. Wavin invests between 3-5% of her net turnover in replacement, expansion or innovation of her manufacturing footprint. Investments are daily practice and Wavin is keen on continuous improvement, not only of production and logistics but also in the best possible allocation of investment funds. Wavin‘s IDMP nowadays is based mainly upon conventional mathematical methods. Pay Out Time (POT) must be shorter 3 years whereas Return On Investment (ROI)/ Net present Value (NPV)/ ‘Earnings Before Interest Tax Depreciation and Amortization’ (EBITDA) / Internal Rate of Return (IRR) are considered the other dominant criteria for investment decisions. The Head Office (HO) of Wavin would like to investigate the value added by using TCO compared to the traditional method in order to identify the potential of having ‘more value for money’ using TCO for future investments. The HO would like to receive an advice whether or not TCO should become part of her IDMP. This ambition reflects the problem situation sketched in the introduction and this makes Wavin a suitable case company. In order to apply TCO, cultural change may be needed (Ellram, 1995). Wavin is interested in what changes are needed, which stakeholders are affected and what consequences TCO may have. Therefore the management question is:

“What are the implications of TCO on Wavin’s IDMP and should they consider TCO as an improvement of the current way of working?”

To find out the implications on Wavin’s IDMP by applying TCO, a case study will be performed to simulate a comparison of the traditional way of working and the application of TCO.

1.3. Reading guide

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2. Theoretical Framework

2.1. TCO

TCO is an approach that attempts to provide the management with a clear overview of the total costs of an asset during its useful life (Gram & Schroeder, 2012; Ellram, 1995). TCO requires companies to calculate all costs incurred by an asset during the life cycle of the asset. An Asset’s Life Cycle (ALC) (Figure 2.1) can be described by using 3 phases; (1) acquisition, (2) operation and (3) decommission (Ellram, 1995). The figure (Fig. 2.1) shows that costs occur in every phase of the life cycle. In this figure the curves indicate cost elements. Mostly, elements of alternative assets do not behave similarly throughout their lives (Barringer & Weber, 1996). Having an overview makes that assets can better be compared (Gram & Schroeder, 2012; Ellram, 1995).

Figure 2.1: Example of phases of an asset's life cycle; asset A may behave different from B in for example the operational phase (source: Barringer & Weber, 1996).

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Figure 2.2: Kaufman's LCC approach (1970)

2.2. Investment decisions

The resulting overview of TCO of the costs over the ALC of the investment can be useful in case of investment decision making. Investments can be defined as expenditures for assets that are intended to have a useful life that exceeds one year. These expenditures have the objective to contribute to a company’s competitive capabilities (Herman, 2000; Alkaraan & Northcott, 2006). Subsequently, an investment decision is about the choice that has to be made for a specific asset (Herman, 2000). The Investment Decision Making Process (IDMP) is the process to go through to make the best possible investment. The process is completed once the final decision is made. This process can be applied for tangible assets as well as for intangible assets (Herman, 2000). Examples of intangible assets are licenses, rent and exclusive distribution rights. Although the decision making process may show large similarities, the cost drivers of intangible assets are quite different from e.g. equipment and building. This study focuses on investments decisions for tangible assets only. Within an investment decision three important issues can be distinguished: The process of implementing an investment decision, the stakeholders involved, and the decision criteria used to base the decision on.

2.3. Factors of the IDMP related to TCO

2.3.1. The Process

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and due dates and financial and non-financial goals (Alkaraan & Northcott, 2006). The objective is not just to build the product or to deliver a service, but also to build or supply it in a way that will create a competitive advantage (Patanakul & Shenhar, 2012). For investment decisions, this means that the goal of the investment decision goes further than just buying an asset. The asset should add to the company’s competitive position. To create a process as transparent, as objective and as tangible as possible, process phases can be identified in the IDMP (Alkaraan & Northcott, 2006). Kwak and Ibbs (2002) proposed a process with five phases that can be linked to the IDMP. The process can be found in Figure 2.3. The phases are explained underneath.

Figure 2.3: Stages within a project. Source: Kwak & Ibbs, (2002)

 Phase 1: Initiation. The process starts at the moment the initial plan arises to prepare an investment proposal. An investment decision support team is formed, which serves to mobilize the various expertise and competences needed.

 Phase 2: Planning. In this phase the investment is shaped: what is the goal, what is desired, what is required, what are the options, what is the desired outcome, when needs the decision be made? These questions are all part of the feasibility study , the feasibility study is to indicate the feasibility of the desired investment.

 Phase 3: Execution. The execution phase is the succeeding phase of the feasibility study. In the feasibility study, one option proved to be the most suitable, so in this phase the actual investment application is done. Thereupon an inquiry for the investment is made to the final decision makers. This involves a(n) (extensive) business case.

 Phase 4: Control. The control phase is about the approval process which the inquiry has to go through. Is the investment approved? It succeeds to the final phase if successful.

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These phases are identified for investment decision making based upon the traditional way. Using TCO in investment decision making requires other data. This may influence these phases in terms of content, goals, tasks, and the responsibilities of each of the process phases.

The content of the phases of a TCO based IDMP differs from the content of the phases a traditional IDMP. The differences lie in the fact that the TCO based IDMP is more extensive (Korpi & Risku, 2007). The first phase of the IDMP is not expected to be changed by the implementation of TCO. However, the second phase; the planning phase, does include more elements in case of TCO. Especially the feasibility study will require more attention. Ferry and Flanagan (1991) found difficulties in forecasting these elements over a long period of time. Factors, such as life cycles, future operating costs and maintenance costs are difficult to forecast over time. The difficulties are found in the later phases; the necessity for preciseness of the application phase, the responsibilities of the approvers in the approval phase, and lastly monitoring and controlling the forecasted costs in the final phase and even thereafter (Ahmed, 1995). This indicates that the application of the TCO will increase the complexity of the IDMP.

Ease of use refers to the degree to which the use of the target system is free of effort (Pavlov, 2003). Li and Lai (2004) found in their study that the ease of use has a positive effect on the use of a system. For applying TCO in the IDMP more data is required, so this may decrease the ease of use and subsequently it may have a negative effect on efficient and effective use of the IDMP.

The duration of the process is the time the process takes from the start to the end of the process. Once TCO is applied, the content and tasks within each phase may be influenced in order to make better investment decisions. Changed content of tasks decreases the ease of use of the IDMP. This may extend the duration of the IDMP because more data are required to come to a decision. It occurs that companies have only limited time to make a decision. Concluding; the IDMP must not take too much time.

2.3.2. Stakeholders

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asset, therefore he is indirectly involved in phase 2 and 3. The authorized approvers are restricted to criteria, but sometimes the stakeholders. Each stakeholder has different biases and capabilities that may influence decisions. Decision makers may be judged for the performance of the investment. Short term results may be favored above long-term. The personal interest may become more important than the company’s interest (Bushan & Rai, 2003). In the feasibility study, options need to be selected. The capability of the project manager determines the quality of the feasibility study, good options may be overlooked. Or when the project manager is biased towards a particular solution, other solutions will be laid aside. Also the engineering manager’s biases and capabilities are of importance. He is trusted for his expertise so he can easily misuse that by focusing on ‘wrong’ aspects. The approvers are involved based upon their authorization. The authorization is determined by the expertise and type and level of the investment. Approvers’ preferences may cause unjustified investments to get approved and justified investment to be declined for unclear reasons (Ferris & Treadway, 2012). The involvement of more people from various professional disciplines helps to reduce the dominance of a personal bias. However, enlarging the size of the team may make the IDMP more complex, time consuming and more expensive (Ferris & Treadway, 2012). Therefore it is interesting to assess the influence of the different stakeholders within TCO.

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Figure 2.4: Cost trade-offs CAPEX vs. OPEX. Source: Woodward (1997)

2.3.3. Decision criteria

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with company’s strategic objectives (Tangen, 2004). A proper balance between strategic and economic factors needs to be established within a company.

The IDMP becomes more complex due to a larger number of decision criteria, the existence of tangible factors, non-tangible factors and the interaction between these factors (Saleh et al, 2001). This complexity may be decreased by determining which factors are considered as to be most important. Alkaraan and Northcott (2006) identified 10 non-financial strategic factors for investment decisions (Table 2.1). Controlling and evaluating these factors can be achieved by providing clear definitions of the features of the required asset. For instance, if lead time is taken as requirement the selected options have to meet the set criterion (Alkaraan & Northcott, 2006). Care should be given to unintended effects, the aggregate financial information may draw attention away from those elements that are not included in the overall measure (Morssinkhof et al., 2011).

Table 2.1: List with non-financial strategic factors. Source: Alkaraan and Northcott (2006)

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replacements (Al Najjar & Alsyouf, 2003; Woodward, 1997). However, as mentioned, this delivers difficulties with the duration and responsibilities of the investment decision and thereafter. Traditional approaches often use standardized cost estimation methods to determine maintenance costs. Whereas TCO tries to calculate the elements of the maintenance costs as precise as possible. This indicates that TCO is more useful for the determination of the best maintenance strategy.

Figure 2.5: Cost-maintenance relation. Source: Woodward (1997)

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2.4. Conceptual model

As described in the theoretical framework the IDMP has five process steps. Whether there are many implications in case of applying TCO in the IMDP. Due to time constraints it is not doable to treat these all in one study, therefor this study focuses on the content process steps, the criteria for the final decision and the stakeholders. With the application of TCO in this IDMP, it may be expected that these aspects will be influenced. This study is looking for the implications of the adaption for the aspects and the related attributes. This is displayed in conceptual model in Figure 2.6.

Figure 2.6: Conceptual model

2.5. Research questions

o What is the traditional IDMP?

 How is a traditional IDMP organized?  What determines the final decision?

 What stakeholders are involved in the current IDMP? o What is the TCO-based IDMP?

 How is a TCO-based IDMP organized?  What determines the final decision?

 What stakeholders are involved in the TCO-based IDMP? o What implications can be identified between the both cases? o If required, how should Wavin implement TCO in the IDMP? Method used in IDMP

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3. Methodology

This study is looking for implications of the implementation of TCO in the IDMP. The indicators are summarized in the conceptual model (Figure 2.6). These indicators are compared for the traditional approach and the TCO approach. For the comparison an exploratory multiple case study is performed (Yin, 2009). A case study is the most appropriate method to use because the purpose of case study research in business and management is to use empirical evidence from real people in real organizations to make an original contribution to knowledge or to understand how ‘a phenomenon works’ (Karlsson, 2009) i.e. what does it imply when TCO will be implemented in the IDMP? Eisenhardt (1989) states that using an explorative research design is most appropriate for the early stages of research on a given topic. In literature the main focus is on the concept of TCO, the drivers for TCO and the benefits of TCO. Therefore, it can be argued that the topic of finding implications is in its early stages.

This study is executed by comparing two cases. The first case is a traditional IDMP whereas the second case is an IDMP where TCO is implemented. These are compared with each other based on theory described in the previous section. The traditional IDMP is determined by an internal study at focal company Wavin, the internal study was focused on an investment decision which she has to make quite often: investing in a mould. The TCO based IDMP is determined by a field study at 3 companies that have implemented TCO in their IDMP. These cases are compared and thereafter, a simulation of an investment decision for a 3D printer is provided. Figure 3.1 visualizes this.

Figure 3.1: Representation of the research design used in this study

Research design Implications of TCO

Chapter 4 Chapter 5 Case 1: Traditional IDMP Wavin 'Standard' investment Injection mould Comparison cases Case 2:

TCO based IDMP

3 companies

TCO Theory

Chapter 6 'New' investment decision

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3.1. Case explanations

In this study two cases are compared. The focal company for the first case, the traditional IDMP is Wavin. In 2012, Wavin has been taken over by Mexichem, a Mexican organization. Wavin produces her products mainly by using two production techniques: injection moulding and extruding. For this production, three types of materials are used the most: PP, PVC and PE. Wavin invests between 3-5% of her net turnover in replacement, expansion or innovation of her manufacturing footprint. This means that investment making is daily practice and Wavin is keen on continuous improvement, not only of production and logistics but also in the best possible allocation of investment funds. TCO is proposed to be a tool that can be helpful for investment decisions. This makes Wavin a suitable focal company. Currently, Wavin does not make use of TCO. Therefore, Wavin’s IDMP is characterized as traditional. For identifying an IDMP where TCO is implemented, three companies have been visited. On behalf of privacy the companies are referred to as ‘Company X’, ‘Company Y’ and ‘Company Z’. Only three companies were visited because after these three, it was possible to provide a complete overview of the TCO-based IDMP. The three companies are doing business in various business environments. This variety has the advantage that the described case is not for a specific business environment.

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3.2. Data collection

Very different classes of data were used in this study to enhance construct validity of the study (Yin, 2009). For investigating the traditional IDMP, data is collected from Wavin’s policies and procedures, previous investments, and a semi-structured interview is conducted with a finance controller of Wavin North West Europe (NEW). The finance controller is responsible for filling in the investment application forms and is therefore actively involved in the IDMP. He could verify the policies and procedures. Shortcomings of the current approach were mentioned. Moreover, data is found in informal conversations on the SCOPEX department of Wavin’s Head Office (HO). Besides these qualitative data, more quantitative master data is gathered from management information systems of Wavin. These data sources have made it possible to investigate all process steps of the IDMP and the outline of each of the steps is identified.

A semi-structured interview is done at each of the companies. The interview was structured by the indicators found in literature. The interview at company X has been done with a former purchasing manager who was responsible for the purchase of all production related assets, such as moulds to produce their products with. The interviewee responded carefully on the questions, this means not many company insights were given. At company Y, the interview has been conducted with was with the Health Safety and Environment (HSE) coordinator. He is actively involved in the IDMP of his company since HSE-factors are of great importance for this company. Finally, Company Z: at this company the interview has been conducted with the project manager of the company. At this company, investment decisions are approached as projects and so the manager gets involved in many investment decisions. This project manager was very willing to share his knowledge about their way of decision making.

3.3. Data analysis

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more than one sub-category, this indicates the existence of a relation between the categories. When during coding the data, parts of the interview or conversations were unclear or missing, the gap was filled by returning to the respondent to provide more clarity on that specific issue, in order to increase reliability of the data.

Category Sub-category Definition

Process The investment decision making process consisting of the

five process phases as defined by Kwak and Ibbs (2002).

Content of the phases

The content, goal, tasks, responsibilities, of each of the process phases.

Duration The time the process takes from the first phase until the fifth phase.

Complexity/Ease of use Ease of use refers to the degree to which the use of the target system is free of effort (Pavlov, 2003).

Final decision The criteria defined by a company for approving or declining an investment application.

Economic The economic criteria that are defined by a company. These are often based upon conventional methods like: ROI, NPV, PB, POT, DCF (Alkaraan and Northcott, 2006) Strategic A company defines strategic criteria. The criteria are

non-economic factors that have the aim to enhance the business’ continuity (Morssinkhof, et al. 2011).

Stakeholders Actors that are direct or indirect involved in the IDMP. Number The number of stakeholders that are involved.

Authorization The authority that stakeholders have within the IDMP. Expertise The capability of a stakeholder to execute his tasks. Table 3.2: Category definitions as used for the analyses

After reducing and coding the data, the within-case analysis started by analyzing the coded data for both cases, this within-case analysis is in chapter 4. A conclusion for each case is drawn and written down based upon the data from the interviews and company documents, this is called explanation building (Yin, 2009). Chapter 5 continues with the cross-case analysis. The cases are based upon qualitative as well upon quantitative data, this lends to cross-case analysis of showing graphs and tables. The other part of the cases is qualitative data, for analyzing this, patterns of data are matched.

3.4. Investment decision: A simulation

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well, the mould can only be used for the production of that specific product. Other production techniques may be considered for the production of the mould as well, perhaps investing in a 3D printing a better solution than in a mould. Simulating this investment decision for Wavin is supports Wavin’s goal; being keen on continuous improvement.

Wavin is familiar with investment decisions for moulds, while the market of the 3D printers is completely new. Approaching this investment decision with a TCO-based IDMP, provides insight in the flows and bottlenecks of the approach. For gathering information about the 3D printer many independent companies are approached. Suppliers of 3D printers are contacted as well companies that are offering services related to 3D printing. 3D printing is a relative new production technique. This makes it hard to find objective information.

3.5. Limitations of the methodology

The used methodology used has limitations even though choices were made to enhance the reliability and validity of the data. Firstly, the fact that only one interview has been conducted for the identification of the traditional IDMP. However, the interview has been discussed with the OPEX manager, who is receiving all large investment applications. Also for the TCO case, this interview has been used, but now in combination with company visits which contributes to the triangulation; the use of multiple data sources, ensures that the validity can be increased further (Karlsson, 2009).

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4. Findings

4.1. The traditional IDMP

4.1.1. The content of the phases

Wavin uses an IDMP without TCO. The current IDMP of Wavin represents the same chain of process phases as identified by Kwak and Ibbs (2002). The content of the process phases is summarized in Table 4.1.

Initiation Planning Execution Control Final

Realizing that something is missing/ required. This realization is the point for an initiation of an investment.

Answering to questions:

 Why is it desired?

 What are the requirements?

 What options are available to accomplish that?

 What are the pros and cons of the options?

 What option is preferred?

One of the options is chosen. For this option the Investment Application Forms (IAFs) need to be filled in for a time span of 10 years. Also the type of the investment needs to be determined in this sub-process (Summary in Appendix A). Depending on the type of the investment, some parts are not required*.

Depending on the type and the height of the investment various levels within the organization are authorized to give their approval for the investment. An overview of the approval requirements can be found in Appendix B.

Once the last approval has been given, the IDMP can be closed. The decision is made, money will be transferred and the execution can start (which is a new process and is not considered in the study)

Table 4.1: Process steps and content of Wavin's IDMP

*Mexichem distinguishes 5 types of investments which are in Table 4.2.

Maintenance “M” Keep in current condition or marginal improvements of the current assets. Growth “G” Increase capacity/substantial cost reduction, increase storage or distribution,

should have a Return on Investment (ROI).

Compliance “C” Compliance with local or global regulations or norms.

Strategic “T” Investments that allow entering new markets, create new products and/or services or imply structural change in business, should have a ROI.

Information Technology “H” Investments in hard- & software, including licenses. Table 4.2: Types of investment as used by Wavin

 For “M”, “C” and “H” investments  only fill in some parts of the IAFs: a summary, business case description, investment’s, project startup cost (the rest is optional);

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The content of the process steps is for most investment decisions depending on the type and height of the investment. Likewise, the duration of Wavin’s IDMP depends on these variables. The duration varies from four weeks to several years. The relation between the height of investment and process duration is very clear in the approval phase. The duration of this phase is measured from the date of the first application to the date of the final approval. The graph visualizes this relation (Figure 4.1). The graph shows that the higher the investment, the longer the approval is. This is partly due to the approval authorization process: the higher the investment, the more approvers are involved. But it also indicates that more factors are considered or more time is spent on the application for higher investment decisions.

Figure 4.1: Graph of the height of the investment and average number of days before approval

Complexity is the last factor that influences the process and that is included in this study. As found in literature, the complexity is positively correlated with the ease of use. The process phases of the IDMP as identified by Wavin, are used as structure for investigating this attribute.

Initiation phase, this phase is based upon creativity so the complexity can be considered as low. There are no fixed structures or procedures to be followed, so the ease of use cannot be defined.

Planning phase, the level of complexity is quite high for this phase because there are several steps to be taken. First step is to determine what is required. The outcome needs to be described very precise, this results in a list of requirements for the product. Based on this list a field study has to be completed in order to get an impression of what options are available in the market. This indicates that this is a very complex task decreases the ease of use. For that reason Wavin developed several group specifications

0 10 20 30 40 50 0 € 50.000 € 100.000 € 1.000.000 50000 € 100.000 € 1.000.000 < # d ay s

Amount of the investment

Days between application and approval

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for asset that can be used for investment decision making. With these group specifications only details need to be adjusted i.e. clamping force, screw diameter. Sometimes these group specifications result in inertia. In such cases, not all options are considered. The quality of the feasibility study relies on the expertise of the project manager and his team.

Execution phase, the complexity of this phase is high because of the IAFs that have to be filled out. The required parts of the IAFs dependent on the type and height of investment. This means that the complexity is dependent on the type and height of the investment. Appendix A shows a summary of the IAFs, this includes inter alia: initial purchase price, estimated direct costs, estimated indirect costs, expected sales, discount rate, but also a business case including a step where the options are considered. The high complexity indicates that the ease of use is low. The ease of use is increased by standardized business cases and standardized cost estimations.

For instance; maintenance costs is one of the direct cost elements considered in the IAFs. The estimation of these costs are calculated as 5% of the initial purchase price of the asset. The maintenance costs are approached as cumulative budget for plants and not per machine or workstation. The same goes for energy and labor costs. Besides the standardized cost estimations, the quality of the filled in IAFs seems also to rely on the capability of the project manager. Some project managers are less capable than others because they are unfamiliar with the concepts in the IAFs like ROI, or their computer skills are insufficient.

Approval phase, the complexity of this phase dependents on the height and type of investment. The higher the investment, a higher level of authorization is required, and the complexity increases. Besides, the type of investment may increase the complexity of this phase, for example; IT related projects need to be approved by an IT manager in addition to the others. The ease of use of this phase is attempted to be increased by the procedure provided by Mexichem for streamlining the approval process and by indicating the checks within this process (Appendix C). However, the financial controller had not seen the scheme before. He knew it, he recognized the tasks that were assigned to him. However, experience appeared to have more influence on the ease of use than the scheme had.

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4.1.2. Current decision criteria

Wavin’s current most import criterion is that the POT must be shorter than 3 years. The finance controller confirmed this criterion: “If an investment does not comply with the 3-year POT, we not even do an application”. This statement can be tackled since nearly 7% of the approved applications have a POT which exceeds 3 years. For some (types of) investments, it is not required to fill in all parts of the IAFs. This is reason why the POT cannot be calculated for all investment applications, in such cases the POT cannot be used as criterion. Besides the missing POT, Figure 4.2 shows the POT of the approved investments that exceed €500.000. 14 of the 35 investments have a POT > 3 years and moreover there are another two with a POT of exactly 3 years. If POT is the most important criterion, why are so many applications approved which are not meeting this criterion? Seven of the 14 investments that have a high POT are typified as ‘Maintenance’. From the description in 4.1.1 is known that these types of investments are defined as: ‘Keep in current condition or marginal improvements of the current assets’. This definition is probably used as strategic justification for the approval above the economic.

Figure 4.2: POT of approved investments higher than €500.000

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4.1.3. Current stakeholders

During the whole process several stakeholders are directly and indirectly involved. The number, roles, and expertise are investigated and summarized in Table 4.3.

Phase Direct Remarks Indirect Remarks

Initiation Project manager

The project manager is often the production or logistic manager of a plant. The project manager is not always highly educated which may have implications for the process, for example: low computer skills, unfamiliar with concepts like ROI

Optional: people from the floor, sales manager

People from the floor may be involved because they know the best what is desired on the floor. The sales manager may be involved in this stage since he is able to identify a gap in the market, for which a solution is aimed.

Planning Project manager

Project manager looks for verification of the project. Sometimes the first option is considered as the best

immediately, no further research to options is done. This means; the feasibility study delivers not the best result

Sales manager, technical expert

Experts are getting involved because of the expertise. The sales manager’s expertise is to estimate the sales better than the project manager does, the technical expert is for controlling the technical requirements/capabilities of the investment Execution Project manager, plant controller

Project manager delivers information to the plant controller, the IAFs are being filled in. The plant controller is responsible for everything in the IAFs. All managers related to the type of investment: Sales manager, technical expert, logistic manager, HSE manager, etc.

Expertise is desired for filling in the IAFs. Therefore the related managers may be demanded for that.

Approval Authorized actors from Local finance director up to Mexichem’s CEO

Depending on the type and height of the investment, people are authorized to give their approval. It should work like gate keeper system, however, if the highest authorized person considers it an important investment, it often succeeds

Optional: All previous involved people

If the approver wants an explanation of details in the IAFs, the one responsible may be asked

Final Final approver (derived from the

authorization

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pyramid), project manager, OPEX manager

transferred; the project manager has 6 months for the execution before the approval is revoked.

Table 4.3: Stakeholders in the traditional IDMP

4.2. TCO based IDMP

A field study is performed to get more insight in the IDMP in case TCO is implemented. Three companies are visited. The visited companies are analyzed individually first. This is summarized in Table 4.4. Thereafter the company specific analyses are merged into one overall overview that is considered as a TCO-based IDMP.

4.2.1. Company specific analysis

Company X Company Y Company Z

Content of the process steps

The process contains the same process phases. The planning phase receives the most attention. Focus is on supplier selection and evaluation

The process contains the same process phases. It is a gatekeeper design. Every gate has its own requirements. Some are embraced very strict where others are so called: ‘nice to have’

The planning phase is important for the orientation of several solutions, trade-offs between options. Same phases are recognized Initial idea is important, all processes in the production line are measured. Ideas arise. Duration Duration depends on

the investment

Duration depends on the type and height of the investment

Duration depends on the type and high of the investment

Ease of use/ complexity Many elements, hard to use. The available model has a list with cost elements that need to be estimated.

There are models. However, these are not used very often

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Criteria final decision

Economic A 3-year horizon is used. Sales at maturity, PB, NPV, investment costs.

ROI is leading certain percentage must be achieved within 4 year.

PB needs to be within 3 years. (May be depended on the type of

investment) Strategic Six strategic factors are

used for investment decisions. These are weighted and reflected to the financial criteria.

Quality most important, failures are very costly

Reliability of the production line is most important. Failures are very costly.

Stakeholders .

Expertise After using the model more often, it gets easier. Actors depend on the help of others

The models existing are not embedded in the IDMP. The existing process is the result of the repeating actions

The production manager is the one that is most involved, he is having the lead in the IDMP. The process is not pre-described, so expertise is important.

Authority/responsibility There is a strong hierarchy. That is why the pre-described process has to be followed carefully. This enhances the

controllability of the process

Gatekeepers sometimes misuse their position.

There is one production plant to control. There is one office, the

stakeholders know each other and are working together very intensively

Table4.4: Outline of the way TCO is implemented in the visited companies

4.2.2. Integrated analysis TCO based IDMP

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Figure 4.3: Web of factors used for TCO objectives by on Company X

On the other hand, Company Y seems to be more focused on costs and potential cost savings than on other strategic factors. This can be illustrated by an example of an investment that was made recently. Within the IDMP they faced the choice between two options where one option would be €200.000 cheaper in the end than the other. But the cheaper option was not proven to be reliable. The choice was made for the cheapest option. So the entire investment was cheaper than budgeted in advance. However, after only two months the new parts broke down. This resulted in a production stop of two weeks. The total cost of that production stop was way more than €200.000.

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5. Cross case Analysis

The implementation of TCO in the IDMP appears not to have any influence on the number and sequence of process phases, since Wavin as well as the companies in the field study use the phases as described by Kwak and Ibbs (2002). Also the objective of each of the phases remains the same.

Traditional TCO Remarks

Initial idea Project manager comes with an idea

A good application of TCO helps with determining replacement/

maintenance investments. For other investments, production managers comes with the idea

TCO is a more sophisticated tool for determining replacements and maintenance ideas. They announce themselves because of measuring systems in the production process. For other types of investments the content of the phase remains the same

Feasibility study

After a simplified evaluation the best option is chosen to be selected for the application

Is often considered as most important phase. Elements considered differ among companies.

The feasibility study is often more extensive in case of TCO. More detailed information is required for the

considered options. Advanced cost estimations are required already in this phase of the process for TCO

Application study

The costs are estimated for a predetermined period. Is depending on type and height of the investment

The application must be about the entire ALC of the investment. Cost elements considered and importance of strategic factors differ among companies

Time span considered in the application forms are different. For TCO the determination of the ALC of the asset is leading. Moreover, for TCO, all cost elements should be considered, which appeared not to happen at all

companies that have applied TCO

Approval process

Depends on type and height of the

investment

Depends on type and height of the investment. Often a gate keeper system

This is more complex in case of TCO since more elements need to be checked

Final decision The final approval indicates that the decision is made. The investment can be further executed

The final approval

indicates that the decision is made. The investment can be further executed

This phase remains the same for both approaches

Table5.1: Cross-case analysis

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Traditional TCO Remarks Initial acquisition

costs

Are taken into account

Are taken into account It is included in the traditional

approach, however, it is not determined for all investment decisions. Moreover, in case it is used in the traditional approach the level of detail is higher for TCO

Operating Costs Only standardized estimations

All cost elements should be considered into a detailed level. However, this varies a lot among companies that have applied TCO

There should be a difference in level of detail. For TCO this should be specified more.

Maintenance costs

Standardized estimations are used and are included in the operating costs Should be estimated based upon a calculation. A good estimation helps to determine maintenance philosophy

Maintenance costs can be determined

Overhaul costs Included in operating costs ‘direct costs other’ or in indirect costs

Included, all overhauling costs should receive attention

In essence the overhauling costs are included in both approaches. However, for the traditional approach, it is often neglected for the options considered.

Decommissioning Included,

decommissioning is not considered to be of great importance for the final investment decision

Included, in case the duration of the ALC of the options considered differ a lot (5y vs. 10y) decommissioning may be interesting. The new cost cycle may start earlier.

Considering the ALC may be of importance and thus TCO should be preferred above the traditional

approach. However, when the expected life time of one option doubles the other, it will be considered in the traditional approach as well. Table5.2: Analysis of the cost elements involved in the traditional and the TCO based IDMP

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From theory in Chapter 2 is derived that TCO requires more reliable and precise data for investment decision making. In practice the TCO-based IDMP pays indeed attention to this. The traditional IDMP, the pre-described process, includes most cost elements as well. However, standardized business cases and cost estimations are used or elements are ignored. This may decrease the quality of the final decision.

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6. Simulation of an investment decision

To illustrate what practical implications the theoretical findings of chapter 5 will have, an investment decision is simulated for Wavin. For this investment decision a TCO-based IDMP is used, from the findings it is found that both approaches make use of identical process phases. These phases are leading in this simulation as well.

6.1. Phase 1: Initiation

The idea arises to invest in the production for a fitting; of the SiTech range. It will be a branch 50*50 45° (Appendix D). When being able to produce this product, the SiTech range is considered to be more complete, which may attract more customers. The production manager is taken the lead in the IDMP and can be considered as project manager.

Implications of TCO in this phase: This phase would have been the same in case the old approach was used.

6.2. Phase 2: Planning

In this phase the feasibility study is done. Questions are asked like: ‘what is the goal, what is desired, what is required, what are the options, what is the desired outcome, when needs the decision be made?’

The goal of the investment is to stay attractive for the customer by offering the entire SiTech range. The sales manager is asked for the expected future sales, this helps with defining the selection criteria for finding option. For this fitting an annually sale of 15.000 is expected (according Wavin’s sales manager). With help of the technical expert, the project manager searches for options in the market. Two options remain suitable after the checks: investing in a mould (an injection moulding machine is available) or a 3D printer (Appendix E). Some details both options can be found in Table 6.1. ‘Standard’ data is data that will not be influenced by the investment and is therefore derived from Wavin’s current databases.

3D printer Mould

Initial price €250.000 €30.000

Deprecation period 5 years 8 years

Time-to-market Software is available  Quick to the market

Mould needs to be developed  requires time

Raw material price Up to €250 /kg (Polymer Science Park [Spaans, 20151])

€1.52

1

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Cavities / batch size > 40 (Spaans, 2015 ) 1

Labor hours 0,5hour per batch (Spaans, 2015) Standard

Maintenance Total of 20% of the initial price (is included)

Annual 5% of the initial price

Energy €0,22 kWh

6h per batch

Standard

Packing Standard Standard

Other direct costs Standard Standard

Table 6.1: Information about both options Clarification:

 Batch size for a 3D printer is dependent on the product that is printed. Each printer has a specified print range. The products that will be printed need to fit into that range.

 For 3D printing the labor hours and energy consumption are related to the batch size in such a way that it is dependent on the load of the machine. For this study, the assumption is made that the printer is fully loaded every time.

 Packing and other direct costs are not expected to be changed for one of the two options. This phase ends with the preference for one of the options. To make a decision between the two options, more information is required about the two. With the knowledge that the weight of the fitting is 0,159kg, the cost price of the fitting can be calculated for both production techniques (Table 6.1). In Figure 6.2 the cost prices are displayed in a pie chart, this shows the differences clearly.

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Figure 6.2:Pie charts of manufacturing costs of the SiTech fitting

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Table 6.2 Price per product in case 10 products are produced by the printer

The biggest difference is found in the consumption. Today’s raw material prices for 3D printing compounds are more costly than the thermoplastic material used for injection moulding. Since the application of 3D printing is growing from $2billion in 2012 up to an expected $6billion in 2017 (Wohlers Associates, 2013), it may be reasonable to assume that the material prices will drop down. Hellings (2014) mentions an expected decline of 10-15% per year. The scenario of 10 products with an annual production of 100 pieces is used. A decrease up to 70% from the current price is displayed (Figure 6.3). Besides varying with volume, number of different products, and material price, also the weight of the products must be considered. Varying more with these variables, may cause a tipping point for when 3D printer is economic a better option.

Figure 6.3: Graph of cost prices for both production techniques with declining prices for 3D printing compounds

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From the first point of view, an investment in a 3D printer gains the advantage above an investment in a mould. Reasons for that preference are: the lead times decrease, there are lower costs for the inventory of spare parts and the supply chain may be shortened (Ponfoort, 2014). On the other side, when using the ten factors of Alkaraan and Northcott (2006) and using the approach of Company X, the preference goes to investing in a mould instead of in a 3D printer.

3D PRINTER MOULD WEIGHT

Consistency with corporate strategy

4 In line with company’s pillars; route to market, offer to market, innovation

3 Trying to attain market leadership by delivering high quality products

9

Improved company image

1 The knowledge of using a printer does not need to be shared

2 Is conform company’s image 5

Requirements of customers

1 Quality is insufficient 3 Mould delivers as defined in the List of Requirements

8

Keeping up with competition

4 It is unknown that competitors are using 3D printers, so maybe ahead of competitors

5 Competitors are also using moulds

7

Obtaining greater manufacturing flexibility

4 Ability to be used for the production of other products

2 Once the mould is installed, only that product can be produced

6

The ability to expand in the future

5 Not fixed to the production of 1 product

1 The mould is only useful for 1 product

7

Quality and

reliability of outputs

1 Quality and reliability of the output is not proven

5 Injection moulding has proven to be reliable

6

Reduced lead-times 1 Printing is slower than conventional production techniques

3 No influence on lead-times 6

Reduced inventory levels

5 Produce only when needed

1 No influence on inventory 6

Experience with new technology

1 There is no experience 5 Moulds are daily business 5

SCORE 183 194

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6.3. Comments

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7. Discussion

Wavin’s current IDMP is characterized as traditional IDMP. It contains the same process phases as defined by Kwak and Ibbs (2002). Overall, it can be argued that the implications of the application of TCO in the IDMP can be found in the fact that all cost and strategic elements of the asset must be considered.

The first point is about the strategic and economic factors that need to be considered for investment decision making (Chan et al., 2001). In the traditional approach, strategic factors receive attention in the feasibility study, to select the options as well as in the application phase, where the motivation for the selection is based upon strategic factors, for instance decreased cycle times for a shorter time-to-market. Then approvers need to interpret these motivations and determine whether it is good enough. The IDMP can become more complex due to additional strategic factors (Saleh et al., 2001). In case of TCO, the strategic factors should be weighted as company X does in their TCO model. This decreases the influence of personal biases towards the strategic elements.

The next implication can be found in the required level of detail of the elements: when Wavin applies TCO in her IDMP the number of process phases remains five. Also the objective of each of the phases remains the same. The duration of the process still depend on the type and height of the investment. Although, with TCO all cost elements of the investment must be considered and included. The complexity of the system increases due to an increasing number of factors to deal with (Saleh et al., 2001). A higher complexity also leads to a decreased ease of use which may have a negative effect on the motivation of the people that work with the system (Pavlov, 2003). This is showed by Companey X. Company X uses the the TCO models. However, the employees use them is not voluntary but they are pushed to be used. The hierarchy in the organization is reason for that. For using TCO, more elements need to be considered. Caused by that, it was expected that the total duration of the IDMP would increase. The cost estimation and data collection can be done simultaneous so the duration of the process does not necessarily increase. However, the complexity of the process will increase, since more people are involved and more elements need to be considered.

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(Cooremans, 2012). Wavin uses a POT of 3 years, this puts the focus on first three years of the asset. The horizon Wavin enhances is 10 years. The period after year 3 is receiving less attention which is not desired for TCO. More attention is expected to be paid to the long term of an asset if TCO is applied. However, it may be more likely to post it as misuse of the traditional IDMP. The POT of 3 years is seen as a leading criterion, therefore most effort goes to that, but the IAFs are designed for a period of 10 years. If the awareness of the importance of long term thinking increases, it is a step in the direction of TCO-thinking within the traditional approach.

Besides the theoretical implications, this study has also a practical value. For companies like Wavin, investment decisions are daily business. The process must be smooth and the ease of use must be high. Knowing the implications, the question is whether TCO is desired. TCO can be cost saving in two ways (1) cost elements that are not considered in the traditional approach, and appear to differ between options and (2) cost elements that are considered in the traditional approach but appear not to be estimated precisely.

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8. Conclusion

This study found interesting implications of applying TCO in the IDMP of a company in two key elements: the required level of detail for data about the investment and the time considered for the investment. Applying TCO in the IDMP implies that an increased level of detail of data is required; more detailed data is required as well more elements need to be considered and this must be determined for two options. This requires more effort and time of the people involved, both, for the feasibility study and application process as well for the approval process where the application needs to be checked completely. The application of TCO increases the complexity of the IDMP and with that decreases the ease of use. This is only justified when it delivers economic value for the company. In this study it is not found that TCO is able to deliver that economic value. TCO shows an overview of the expected costs of an asset over the time. However, it appeared that when the traditional approach is used as meant, a similar overview is derived.

Applying TCO in the IDMP had the expected implication that the time required to go through the IDMP should increase. But like previously said, if the traditional approach is applied as it is desired it has many similarities with the TCO approach, additional elements need to be considered but that can be done simultaneous with the other elements that already needed to be considered. Because it can be done in once, it is not expected to cost a lot of extra time.

8.1. Conclusion for the management

The tradition IDMP of Wavin is described in several policies and procedures. However, it is found that the IDMP as described in the policies and procedures is not always how it is performed. The actual process is not as fixed as described. For example, big investments that exceed €1M are not made based upon the POT of 3 years only. Many (strategic) factors play a role in the decision as well.

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Based upon the aforementioned, the advice that can be given to Wavin’s management is to not add TCO structurally into their IDMP. For the lower investment decisions there is hardly space to gain any value, whereas for the higher investment decision a good use of the current approach is sufficient as well. Many elements of TCO are used already when the current approach is used at a good manner. Important is the good use, this is not always the case now. It appears that not all stakeholders are featuring of equal capabilities and are not featuring the same motivation. These elements may influence the quality of the IDMP. Wavin should take care of that.

8.2. Limitations and suggestions for future research

Overall, this study makes a start with closing the gap in literature about the implications of the application of TCO in the IDMP. This study uses a multiple case study. Wavin’s case with a traditional IDMP is compared with a TCO-based IDMP. For the TCO case, three companies were visited; Company X, Company Y and Company Z. Based upon these three companies a TCO-based IDMP is described. Since most of the study is performed at Wavin, a lot of details are known about the traditional case. The TCO case is based upon three less intensive investigations. The companies involved are very different so many insights are provided, however, the level of detail is less than in the traditional case. And because the companies had all applied TCO in their own way, this was hard to deal with in the cross case analysis. Especially, when choosing the right examples to illustrate the findings.

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The implications of TCO in investment decision making