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TheCapexPhenomenon

Supply Management Insights - Edition 02/2019 INVERTO Customer Magazine

Lost in the Bermuda Triangle

Companies often miss budget and specification deadlines when procuring capital goods. Integrating procurement in planning and organization early on can make it possible to meet these goals, and also, to beat them.

On December 5, 1945, shortly after the end of the war, five fully-fueled US Air Force torpedo bombers set off from South Florida on a training flight. Not one of the aircraft returned to the Fort Lauderdale base. The subsequent search by air and sea was in vain. Flight 19 is now considered to be the beginning of the so-called Bermuda Triangle, and numerous myths surround other similar mysterious disappearances of ships and airplanes in the region.

Today, we sometimes get the impression that a new Bermuda Triangle has emerged in business. Generally, though, it is not ships or airplanes that disappear, but cash, capital and other assets. Notable examples are the Berlin-Brandenburg Airport, Stuttgart 21, and the Elbe Philharmonic Hall. It is not only major public projects that are affected by the phenomenon of such a remarkable waste of money, time and again, private business has problems with investment projects. This is because, in many companies, particularly mid-sized companies, CAPEX, as opposed to OPEX, is not professionally managed, to the considerable detriment of anticipated profit and operating results.

What is the difference between CAPEX, OPEX, and TOTEX?

CAPEX includes all capital expenditure within the company. In accounting terms, it is treated as fixed assets and is subject to tax depreciation allowances over a period of time. OPEX refers to business operating expenses. The term TOTEX represents the total expenditure of a business.

TOTEX = CAPEX + OPEX.

Global capital expenditure in billion US$ from 2002-2015*

Ø + 9 %
4000
0
2002
2008
2015

*Source: OECD Business and Finance Outlook 2016, Calculation based on 11,000 world’s biggest companies


Global CAPEX spend by the world´s top 11,000 companies amounts to > 3 trillion US$

CAPEX Expenditure Rising Steadily

CAPEX expenditure is many times greater than expected, and is continuing to grow. CAPEX requirements of the 11,000 largest companies in the world rose from USD 1 trillion to 3 trillion from 2002 to 2015. That represents an average increase of 8.7 percent per annum.

Capital-intensive industries, however, are way ahead of these CAPEX investment figures. Electricity suppliers come top of the CAPEX board, with an average of 13 percent of their turnover, closely followed by oil and gas companies, metal production, and mechanical engineering, with an average of 6.3 percent. But CAPEX also represents a significant share in all other industries, and can be essential for success.

Since CAPEX requirements occur in many product groups, their characteristics and complexities are very different. CAPEX expenditure is divided into three categories:

Day-to-Day

capex

Ongoing, day-to-day CAPEX for business operating expenses. Examples include IT (e.g. a server or high-cost software system), logistics and marketing

Large, recurring

capex

This includes investment in machinery in industry, or store fittings in retail

CAPEX projects

capex

One-off CAPEX investment in buildings or plant construction

The CAPEX Phenomenon

It is striking that OPEX procurement has achieved a high degree of maturity in recent years and is often structured in a very professional way. Expenditure on CAPEX requirements, though, is often only managed superficially in terms of procurement. This may result in companies negotiating intensively for OPEX requirements, while sometimes giving away millions on CAPEX. You could even dare say that the price of every paper clip is haggled over, while the responsibilities of procurement e.g. when determining complex requirements such as buildings, machinery, or IT systems, rarely extend to using total cost of ownership (TCO).

We are frequently seeing that the more complex the CAPEX requirement is, the less procurement is involved. However, even with demanding investment projects, price and performance transparency is just as indispensable as scrutinizing specifications.

While OPEX buyers frequently control the whole process, procurement is often called in at a late stage in large, recurring CAPEX requirements and projects – sometimes only for the final negotiations. Procurement cannot pursue its strategy because it is involved so late, meaning huge opportunities are lost. Moreover, while requirements and expenditure risks rise with complexity, procurement could cushion against this by taking effective measures.

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Provocatively said, the price of every paper clip is haggled over, while the skills of the procurement department are rarely used for complex requirements.

CAPEX purchasing risks vs. Maturity of procurement Procurement Maturity

Common KPIs show that, in general, CAPEX procurement maturity decreases as spend and complexity increases

OPEX
Day-to-Day CAPEX
Large Recurring CAPEX
Project related CAPEX

Procurement Capacity

(Ø-spend/FTE)

Established Governance

(% of companies)

Qualification level

(relevant Ø-experience in years)

Procurement involvement

(Ø-stage of involvement)

(Ø6-12m€/FTE)

>90%

5-10

Demand planning

(Ø8-15m€/FTE)

>80%

5-10

Supplier selection

(Ø20-30m€/FTE)

~50%

3-5

Supplier selection

(Ø70-150m€/FTE)

<10%

3

Negotiation

Significant risk overhang in the recurring and project CAPEX areas

Procurement Maturity Procurement Risk
high
medium
low
OPEX
Day-to-Day CAPEX
Large Recurring CAPEX
Project related CAPEX

Significant risk overhang in the recurring and project CAPEX areas

CAPEX Procurement Challenges

CAPEX requirements are often not as standard as OPEX requirements due to their complexity and rarity. Even recurring investments and projects are only procured irregularly, so there are no standardized procedures. Depending on the project structure, the roles of the project partners also vary.

Company interfaces, complex technical specifications, and interdependencies require close, early cooperation with engineering, key project partners, and core suppliers.

Due to the high level of investment, decisions on CAPEX requirements in mid-sized companies are often initiated by senior management. Because of its “exceptional character”, otherwise customary forms of involving departments and procurement are not sufficient, or specialist expertise is not called upon until it is already too late to make key changes to the requirements. Moreover, in investment procurement, companies often do not think in overarching terms of projects and locations, so they do not benefit from the considerable potential of standardization and bundling.

Procurement can support the specification of requirements by providing information on hidden costs, qualifying suppliers in advance, and identifying possible problems.

Procurement: More Than Commercial Knowledge

The role of procurement has changed significantly in recent decades – away from the purchasing clerk, toward the strategic entity. Successful procurement involves not only obtaining an overview of the procurement processes themselves, but also the upstream and downstream processes. Buyers are used to thinking across departments and processes, identifying potential risks and countering them in good time. Using methods such as cost breakdowns and TCO considerations, buyers ensure transparency and in-depth analyses, providing the necessary background knowledge to plan budgets, processes, and timeframes.

Of course, detailed knowledge of departments is needed to ensure large CAPEX projects are successful, but procurement can assist from the beginning of the planning process by including market prices in the calculation, while also taking into account possible price changes. When specifying requirements, procurement can help by providing information on hidden costs, pre-qualifying suppliers, and identifying potential problems.

Practical examples:

A company was planning underground transport facilities as part of a large construction project. After installing the rail tracks, bridges and tunnels, it became apparent that only one provider’s trains could be considered because the clearance heights and widths had already been fixed. Involving procurement in the planning process early on could have avoided this.

Another typical example is store layout in retail, initially often a design-driven process whereby procurement can check whether the design department’s drafts can actually be implemented in the budget from the outset. In addition, procurement can point out the bundling and standardization opportunities from the beginning, allowing the design department to plan ahead.

Specifications prepared across departments, coupled with detailed process planning and scheduling, are prerequisites for a successful procurement process. In this way, procurement can determine the optimal purchasing levers for the requirements of the tendering process, the negotiations and, ultimately, the supplier contracts.

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Avoiding Budget and Time Overruns

Active risk control by procurement is crucial for completing CAPEX projects successfully within cost and on time, while maintaining optimal quality. Only if it succeeds in anticipating existing risks, balancing them, and counteracting the threat of undesirable developments does the project remain within the planned framework. CAPEX projects in particular that span a long period of time, such as in plant construction or the building industry, are exposed to constant risk, whether because of political or regulatory constraints, natural phenomena, or supplier circumstances. However, uncertainties must be taken into account in the planning. In risk management, procurement acts as a navigator and shows ways to avoid, or at least reduce, these risks.

In addition, involving procurement has another advantage in that it oversees the whole process. Furthermore, it can directly negotiate services linked to capital goods. Additional savings can often be achieved by tendering out service packages.

The following practical example illustrates the consequences when this does not happen:

As part of an extensive construction project, sliding doors were procured and installed as a CAPEX requirement, with the construction department taking responsibility for this. However, they did not take into consideration that these doors would need regular maintenance after installation. Procurement was responsible for securing the maintenance contracts, but was now severely restricted because it was only possible to negotiate with the appointed supplier (lock-in effect). Considerably better terms could have been obtained if the purchase of the sliding doors and the maintenance work had been negotiated immediately as an entire order.

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The 5 Most Important Procurement Levers

Day-to-Day CAPEX
  1. Coordinating goals between procurement and internal customers
  2. Dedicated resources for CAPEX procurement
  3. TCO-based procurement approach
  4. Supplier-neutral specifications
  5. Systematic risk management
Large Recurring CAPEX
  1. Early involvement of procurement
  2. Anchoring procurement within the project organization
  3. Well-defined processes and responsibilities
  4. Legal skills and abilities
  5. Demand and specifications management
Project CAPEX
  1. Interdisciplinary cooperation
  2. Bundling and standardizing similar requirements
  3. Consolidating requirements into product groups
  4. Generating and utilizing benchmarking
  5. Requirement-based specification

Leading European procurement experts from different industries discussed the topic of CAPEX at the Boston Consulting Group’s annual Procurement Round Table. In a workshop, the most important points for optimizing the procurement of investment requirements were determined based on the experience of these experts.

CONCLUSION: Escaping the Bermuda Triangle

A company’s procurement department ensures transparency through TCO considerations and provides the necessary details for planning the budget, processes, and timeframe. In so doing, it complements the departments that do not always prioritize cost-performance optimisation in procurement, and do not always recognise the consequential costs. While procurement is, of course, responsible for meeting OPEX requirements in practice, CAPEX decisions often lack a balanced distribution of tasks between procurement, departments, and senior management.

This leads to a considerable loss of synergy and untapped optimization potential when budgeting and scheduling the projects. While monitoring and analyzing the reasons for budget overruns in CAPEX projects, it is striking that these could be avoided by involving procurement and professional project management early on.

Your contact persons

Kiran Mazumdar

is a founder and Managing Director of INVERTO in Cologne and is responsible for procurement cost optimization, category management, and process and organization optimization projects. With his extensive experience in strategic procurement, he mainly advises customers in retail, the consumer goods industry, and media on their OPEX and CAPEX procurement.

E-Mail

Thibault Pucken

is Managing Director of INVERTO GmbH in Cologne and has considerable experience in supply chain management, strategic procurement, and management consulting. With his wide-ranging experience in strategic procurement, Thibault Pucken mainly advises companies in industry and the automotive sector.

E-Mail

Selected CAPEX Use Cases

Different types of CAPEX vary widely in their characteristics and specifications and, as such, need to be treated very differently. The following projects exemplify procurement success, without taking into account other levers such as demand management.

PROCEDURE

SUCCESS FACTORS

ACHIEVEMENTS

Store Layout in Food Retailing - converting the entire store network

PROCEDURE

  • Involve all areas of responsibility
  • Carry out test phase
  • Increase competition through a broad market approach

Erfolgsfaktoren

  • Specifications
  • Standardization + volume bundling
  • Structured tendering and negotiating

Erreichte Ziele

  • 7-month timeframe met
  • 18% under budget
  • Framework contracts signed for entire renovation phase
  • Optimized + expanded supplier pool
Industry - New plant / assembly line

PROCEDURE

  • Plan process steps in accordance with technical specifications and risk factors
  • Specify calls for tender for the individual construction phases
  • Negotiate with suppliers, including technicians

Erfolgsfaktoren

  • Interdisciplinary teamwork
  • Comparison with reference projects
  • Process optimization
  • Active risk management and TCO considerations

Erreichte Ziele

  • Came within budget, even under budget in some phases
  • Kept to schedule
  • Avoided risk of default
Construction of New Shopping Center

PROCEDURE

  • Break down the overall plan into individual phases
  • Demonstrate saving and bundling potential according to construction phase
  • Create a supplier pool for short-term contracts

Erfolgsfaktoren

  • Coordinating the entire team and the planning offices
  • Defining procurement processes and guidelines
  • Standardizing construction phases
  • Detailed description in the catalog of services

Erreichte Ziele

  • Identified appropriate suppliers for all phases
  • Reduced complexity through standardization
  • Complied with budget and timeframes
IT - Server Procurement

PROCEDURE

  • Plan requirements
  • Standardize specifications and requirement profiles
  • Include relevant maintenance services
  • Issue call for tender + negotiate the annual requirement

Erfolgsfaktoren

  • Defining procurement strategy and processes for servers
  • Total support contract for services with one supplier

Erreichte Ziele

  • 12% under budget
  • Best possible cost control
  • Reduced the risk of default
  • Data security ensured
  • Cologne
  • Copenhagen
  • London
  • Munich
  • Shanghai
  • Stockholm
  • Vienna

We deliver results.