SPOTLIGHT: Paper Machines with Returns Greater than 100%, Solutions!, May 2005, Vol. 88(5)

Surprisingly, and defying all logic, paper machines with returns greater than 100% apparently exist in abundance in our industry. I once worked in a mill, for instance, where it was said if all the justifications for all the incremental improvement projects implemented over a 10-year period were totaled, the raw materials, energy, consumables and people engaged in the activities on that machine should be free. Since this was obviously not the case when one looked at the profit and loss statement, what was going on?

Most obviously, of course, many of the incremental justification projects were calculated incorrectly. Either through honest error, genuine optimism or downright chicanery, the calculations were incorrect. This often happens, especially in companies that do not go back and do a post-mortem audit upon project completion. (After all, if you have minimal concern about ethics, why not stretch the numbers a little to make your project fly if no one is checking up on you?)

Another great way to get fantastic results is if your company calculates return based on RONAE (Return On Net Assets Employed). In this case, the bottom number in the overall return calculation for your machine is its current depreciated value. The result is large numbers because the denominator is so small. In fact, using RONAE on an entire production unit operation (one paper machine, one pulp line, etc.) that is 10 years or more old, you had better have a RONAE greater than 75% in order to be competitive.

But what if these scenarios are not the case, i.e., you have always done honest calculations, you calculate your return against a reasonable base asset value and so forth? Why, when you add up all the incremental projects, do you still get a silly answer indicating all inputs to the manufacturing process should be free or nearly so?

WHAT I LEARNED IN KINDERGARTEN
Fifty years ago this fall, I started kindergarten. I thought I should go directly to Wittenberg College in Springfield, Ohio, as my dad had just finished an executive management course there during the summer, but my mother said that would have to wait. As of the first day of school, I put Wittenberg behind, for kindergarten held some neat toys, one of which was a little bench with some pegs sticking up out of it. A little hammer went along with this and as you tried to pound one peg down, another popped up. Little did I know then that this little bench and hammer set would be the perfect physical model for the economics I am attempting to convey here.

This is what happens, one by one, to all those incremental savings projects over the years resulting in the previously mentioned silly results when they are summed. First, there are things that happen on the cost side. For example, a paper machine superintendent thinks, “I could accomplish so much more if only I had another young process engineer to place on my staff.” She goes to the mill manager with this idea. He says, wait until your machine is more profitable, and we will see what we can do. Time passes, a couple of incremental cost savings projects are implemented and, voila, the machine is making more money. The new process engineer is assigned to the machine and the savings are consumed in paying his salary. The operation pounded down costs in one place, but they popped up in another, just like the kindergarten toy.

Second, things happen on the sales side, too. The VP of sales says, “Brand X has just come out with a smoother, cheaper sheet. Can we make it profitably?” After much discussion and technical consultation, the answer is yes. In fact, we discover while we are doing this that we can reduce the costs of all our products with the same revelations. A very precise calculation is made with very accurate savings projected, and the project is implemented. In fact, the new product is so successful in the marketplace that customers for our higher priced grades find the new one just fine for their purposes, too. We have just cannibalized our own business and given all the costs savings to our customers. But, at least we have a business, for our competitor who did not notice our ideas, lost theirs and are now listed in the used machinery classifieds in the back of Solutions!.

In a business as complex as ours, with as many manufacturing inputs and product outputs as we have, it is easy to see how we can think it is possible to sum the savings projects of an era and get a significant result. Yet, if one adds to this the complexity of inflation, exchange rates, depreciation schedules, interest rates and tax rates, it is easy to see that this exercise, while perhaps humorous, holds little meaning.

ABOUT THE AUTHOR
Thompson is CEO of Talo Analytic International, Inc. (www.taii.com), a member of the Solutions! editorial board and executive editor of PaperMoney (www.globalpapermoney.org), which is published by TAPPI and TAII. Contact him at jthompson@taii.com.