This is the second of a two-part series on capital equipment value models. For part I click here.
In last month’s post, I explained how the economics of virtually all capital equipment purchasing decisions can be described using a value metric derived from the comprehensive value expression for capital equipment. However, a piece of capital equipment can play a variety of roles in the buyer’s pursuit of profit. These different roles require different value models. The number of value model variations you may come across in your capital equipment career is probably uncountable. However, you are likely to encounter these five.
- Adjacent affects
- Defect processing
- Getting ready
- Capital life
I reviewed the first two with you last month. Now its time to explore the remaining three.
Capital equipment can be used to handle defects in the profit-making process. Defect processing equipment often finds itself in failure analysis labs and quality assurance departments. It typically receives a workpiece anytime that a defect takes down the profit-making process or causes it to run inefficiently. See the figure below.
Differences in defect-processing-equipment-cycle times often manifest as differences in throughput, uptime, yield, or costs in a portion of or all of the profit-making process. Therefore, the value model for defect processing equipment must consider a portion or all of the profit-making process, not just the defect processing equipment.
For example, let’s say your equipment type processes a certain catastrophic defect in the production of solar cells. When this defect occurs, the solar cell manufacturer must stop the production line and resolve it.
In this case, the defect-processing equipment affects the solar cell manufacturer’s profit in two ways. First, the cycle time of the defect processing equipment affects the overall throughput of the factory, and therefore its revenue potential. Second, the defect processing equipment’s depreciation expense and operating costs will affect the manufacturer’s profit margin. See the example below.
|Units||Your Equipment||Competitor’s Equipment|
|Time to resolve defect||Days||0.5||1.0|
|Gross capacity – cells/year||M||10.0||10.0|
|Net capacity cells/year||M||9.3||8.6|
|Price per cell||$||12.0||12.0|
|Your equipment type cost||$M||10.0||5.0|
|All other equipment cost||$M||100.0||100.0|
|Total equipment cost||$M||110.0||105.0|
|Depreciation expense (5 Year)||$M||22.0||21.0|
|All other cost of goods||$M||50.0||50.0|
|Total cost of goods sold||$M||72.0||71.0|
|Total gross profit||$M||39.8||32.6|
Time to Profit
Sometimes capital equipment is not used in the profit-making process. Instead, it is used to “get ready” to make a profit. For example, if your equipment performs processes during product development, its job is to help its owner get ready to make a profit. The value of your equipment, in this case, is directly related to how quickly it helps the customer finish development and get to the profit-making process.
The value model for this scenario considers the total profit from the time the get-ready process starts to some relevant time after profit making begins. See the figure below.
To illustrate, let’s try another example. Suppose a solar power company is developing its next generation solar cell. During that development, the company will need to analyze the results of many design iterations before the solar cell design is ready for production. If
- your equipment type is responsible for analyzing the design iterations,
- there are differences among alternatives in the time it takes to do it, and
- that time drives the buying decision,
your value model might look like the example shown below.
|Units||Your Equipment||Competitor’s Equipment|
|Time to develop (each)||Days||15||15|
|Time to analyze (each)||Days||0.5||1.5|
|Total development time||Days||465||495|
|Total development time||Months||15||16|
|Factory capacity – cells/month||M||1||1|
|Production months 1st 3 years||#||21||20|
|Net capacity cells/year||M||21||20|
|Price per cell||$||12||12|
|Your equipment type price||$M||10||5|
|All other equipment||$M||100||100|
|Total equipment cost||$M||110||105|
|Depreciation expense (5 Year)||$M||22||21|
|All other cost of goods||$M||50||50|
|Total cost of goods sold||$M||72||71|
|Total gross profit||$M||177||166|
This example shows how shorter design-analysis-cycle time accelerates time to market for the solar power company. That acceleration translates into more profit in the three years after product design started. Like an adjacent effects value model, tremendous value can be created by a single piece of equipment when it makes other equipment and operations more profitable. For the equipment seller, that translates into a lot of pricing leverage if the value can be substantiated during the sales cycle.
When your customer’s buying decision considers the timeframe that your equipment can produce revenue, you may need to employ a value model that considers capital life. Two common situations where this applies. The first is when the buying decision considers when the equipment must be replaced due to failure. The second is when the buying decision considers the equipment capability over multiple generations of the customer’s product.
The first case is less common for the primary reason that it’s difficult to substantiate during the buying process. Your beefier parts and more rigorous testing certainly are consistent with long equipment life, but you’ll have a hard time proving it. If you find yourself making a “our machine lasts longer than their machine” argument, be prepared to back it up commercially. For example, you may have to guarantee a free replacement if your equipment fails before the promised time.
On the other hand, it is not unusual for equipment buyers to consider the ability to produce multiple generations of their product when making equipment purchases. See the figure below.
For example, in semiconductor-chip manufacturing, each chip generation requires new equipment that can process smaller features and new materials. If the buying decision considers the purchase of new equipment for future product generations, the capital-life value model may be appropriate.
To illustrate, suppose your equipment is five percent slower than your competitor and costs more per system. However, only your equipment is capable of producing process-A products and next generation process-B products. If your customer chooses your competitor, he will need to buy a new set of equipment when he switches his factory over to process B. See the value model for this example below.
|Your Equipment||Competitor’s Equipment|
|Throughput process A||kU/yr||285||300|
|Throughput process B||kU/yr||285||300|
|Target factory capacity||kU/yr||25,000||25,000|
|New systems for process A||#||88||83|
|New systems for process B||#||0||83|
|Total capital expense||$||48,245,614||83,333,333|
In this example, your equipment saves your customer more than $35M despite being slower and more expensive.