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OEE as a financial KPI

How to explain OEE in financial terms to "C" level executives and use DuPont model to visualize the impact that manufacturing improvements can have on financial performance

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OEE software
by Marc Leroux

A customer, I’ll call him Fred, mentioned to me that executive management often discounts OEE because it is a manufacturing metric, not a business metric.

After looking into the three main components of OEE - Availability, Performance and Quality - described in "OEE as a performance KPI", Total Productivity measure described in "OEE as a business KPI", our discussion shifted to the perspective that the upper management had about OEE.
"OEE was one of our better projects, and that got immediately recognized, but our management feels that this is a manufacturing KPI that has no tie to the business"

The challenge of OEE

“Everyone agreed that it was great to have the system in place and they were quite excited about the response they were getting” Fred stated. “It turns out that this was one of our better projects, and that got immediately recognized. But the problem is that our management feels that this is a manufacturing KPI, and it really has no tie to the business.”

Now it was my turn to smile. I told him that this was an area where I might be able to provide him some helpful hints. We started with a diagram and excel model that I have based on the DuPont model.

I’ve found that engineers aren’t very comfortable explaining improvements in financial terms, and that hurts them when they are trying to justify projects to the “C” level, particularly to the CFO. I’ve found that the DuPont model is a great way to depict the impact that manufacturing can have on financial performance.

The DuPont Model of Financial Analysis was devised in 1914 by F. Donaldson Brown, an electrical engineer employed by the E.I. du Pont de Nemours and Co. In 1918 DuPont bought 23% of the stock of General Motors and gave Brown, now working in the treasury department at DuPont, the task of cleaning up the tangled finances of the car maker, possibly the first major re-engineering effort in the US. The DuPont model was the principle method of financial analysis for 60 years, until the mid 70’s. Its real purpose was to analyze financial ratios, but it also provides a very simple way to visualize the effect of manufacturing improvements from a financial perspective. Let’s take a look at a simplified version below:

Engineers aren’t very comfortable explaining improvements in financial terms, and that hurts them when they are trying to justify projects to the “C” level, particularly to the CFO

The earning power of a facility

If you take the number of planned hours for production and multiply that by the maximum throughput that can be achieved you get a theoretical production total for the year. Accounting for losses, represented by OEE, you can come up with your actual production on an annual basis. Multiplying this by the contribution margin (price minus variable cost) per manufactured unit gives us the contribution margin, and subtracting fixed costs gives us our profit. From there we can generate our profitability and other metrics like Return on Capital Employed (ROCE).

These are metrics that the “C” level understands very, very well. I set the initial parameters for Availability, Performance and Quality close to the ones that Fred had when he started his OEE exercise. I set the Availability to 77%, Quality to 91% and I rounded Performance down to 85.7% so that it would give me a nice, round 60% OEE. The rest of the numbers came from a fictional customer I had modelled. At 60% OEE the numbers came out at 11.3Million profit and a ROCE of 6.81%.

OEE increase of 10%

I then asked Fred if he thought that a 10% OEE improvement was possible. “Sure. We’re almost there now” was his reply. So I increased Availability by 6%, Performance by 6% and Quality by 2%. Most organizations have a good handle on quality, I explained, and Fred agreed that would be the hardest category to improve. These improvements almost doubled profit and ROCE.

I then explained that having financial improvements of this magnitude are difficult for people to accept, and most people acknowledge that to improve availability and performance we should increase spending in the area of maintenance, so I increased the amount allocated to that. Fred joked that his management would want to see the same improvement while decreasing spending on maintenance, but was impressed enough with the results to ask for a copy of the spreadsheet.

Reducing inventory levels

Then I suggested that he sit down with one of his plant finance people and look at a couple of other areas. One of the key benefits of improving OEE is that the organization becomes more predictable, and a predictable organization has savings in many other areas. I asked Fred what he thought the savings could be if you could shave one day off of the delivery of materials. He thought about it and said “You know, we haven’t looked at that for a while. You’re right, we could shave a day, maybe more, for some materials. Others, it just wouldn’t make sense. We haven’t thought that a day’s worth of inventory would warrant the risk, but maybe we need to re-evaluate that.”

At the same time, I suggested, perhaps he could ask his finance guy what shaving a day off of the order to cash cycle would mean, or reducing inventory levels by 1 day. Typically these types of savings have a tremendous impact on the bottom line, but they are seldom associated with manufacturing improvements.

One of the key benefits of improving OEE is that the organization becomes more predictable, and a predictable organization has savings in many other areas.

Reducing demurrage costs

When asked if they ever had to expedite deliveries or make multiple shipments Fred rolled his eyes and said “Oh yeah. And I see where you are going, there is a lot of potential savings there!”

I suggested that he also check on what his demurrage costs were, and if they could be reduced if they had better visibility into when products were available to be loaded. That would mean that they could order trucks or rail cars to arrive just when they would be needed, and not have to sit in the yard waiting. Fred thanked me for the advice, we shook hands and went our separate ways.

More on OEE meaning

I got a call from Fred about three weeks later. He started the conversation by saying “You need to come down here and buy me lunch real soon.”

I agreed that would be a good thing to do and asked if there was any special reason. He explained that he had sat down with his controller, and they had jointly put together a presentation for the executive level. “That went really well. They’ve asked me to start a new project to look at how we could implement some of the ideas.”

I replied that it sounded like he should be buying me lunch if that was the case. Fred started to laugh; “Right! No, you’re buying. Now I have all this extra work to do!”
Now that people understand the value of OEE, it looks like we can provide the justification for some of those upgrade projects we were talking about.
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