What time is it?? It’s metric time!! This month we’re talking about Fixed Asset Utilization. If you have clients in industries like utilities, telecomm, retail, or manufacturing, you no doubt hear this term frequently – but how is it really measured and why is it meaningful? Read on….
Who uses it? Industries like manufacturing, telecomm, energy, airlines, mining and retail that have a significant investment in property, plant and equipment, which is also called fixed assets. How is it measured? Revenue divided by net property, plant and equipment, or fixed assets. For example, a company has $1,000 in revenue and $200 in fixed assets so its fixed asset utilization is 5.00. Which means through the year, that $1.00 invested in fixed assets generates $5.00 in revenue. What’s in it? Examples of fixed assets include for telecomm – central office, cable, and cell towers; energy – oil and gas production, refinery, and pipelines; manufacturing – plants and warehouses; and retail – stores, on-line infrastructure and distribution assets. Common fixed assets are IT infrastructure, unamortized software, and land.
Why is it important? Fixed assets typically are the largest investment for the industries listed above. How well these assets are managed is a key driver of a company’s ability to grow revenue and earn a competitive return.
What drives it? An industry’s production technology is one of the most critical drivers since it dictates the investment in fixed assets. For example, energy companies engaged in exploration and production invest tens of billions of dollars in long-lived assets to have the capacity to generate revenues. The median fixed asset utilization is approximately $0.35. Meaning $1.00 invested in fixed assets only produces $0.35 in revenue. Or thought of another way, $2.85 ($1.00 / $0.35) is invested in fixed assets to generated $1.00 in revenue. The median fixed asset utilization is approximately $0.40 for a utility; $1.15 for telecomm; $5.00 for manufacturing and $6.00 for retail. Wholesale distribution is an example of an industry with very little invested in fixed asset. The median is in excess of $25.00!!! Business model is another key driver. A utility that purchases a lot of power will have higher fixed asset utilization since it has less invested in very expensive generation assets. A company that contracts out its manufacturing will have higher utilization than a company that manufactures its products. How fixed assets are managed has a significant impact on utilization. This includes items like demand forecasting and planning, scheduling, capacity utilization, maintenance and many more.
What's the Goal? Typically, the higher fixed asset utilization, the better. But the optimal fixed asset utilization is that which aligns with a company’s strategies. A company with a competitive advantage in manufacturing likely will manufacture its own product whereas a competitor with competitive advantage in product development and sales may outsource it manufacturing to concentrate on what it does best. It is also important to note that utilization can often be increased in the short run by not investing in additional, replacing, and/or properly maintaining fixed assets. This may increase utilization in the short run, but likely will cause increased operating expenses and loss of revenue. Finally, there a strong relationship between fixed asset utilization and profitability. As we saw above, utilities have one of the lowest fixed asset utilization. Viewed in isolation this would suggest the utilities are not an attractive industry. But that is only part of the story. The other part is profitability. Industries with low utilization tend to have higher profitability which they need to earn a competitive return. For example the median operating income margin for a utility is in excess of 20%. The median for non-financial companies is less than 10%.
So how do you translate this into conversation about value with your clients? We’ll follow this up on Thursday with The KPI Connection, connecting this month’s metric to key business processes and ultimately measurable impact on your clients’ business, so check back for that.