How to Justify the Cost of a Rapid Prototyping System
How to Justify the Cost of a Rapid Prototyping SystemBy Chris Hoins, Stratasys, Inc.
To designers, engineers and product managers, the value of additive manufacturing machines for rapid prototyping is unquestionable. Yet, inspite of the obvious value, it may not be clear how to convince the managementand accounting departments that the benefits justify the capital expenditure.
The challenge is two-fold: 1) conveying the value in objective terms, 2) writing the business case in a style that executive management embraces and the finance department understands. To improve the odds of gaining approval, this whitepaper offers guidelines and tips for creating a compelling business case for the acquisition of additive manufacturing equipment for prototyping.
WHAT IS A BUSINESS CASE?
When the cost of new equipment exceeds the signing authority of amanager, funding will come from a capital expenditure (capex) budget that upper management controls. This means that the proposal may be one of many competing for limited funds allocated across the company. A business case is a tool that demonstrates the value of the proposed capex to management. Its goal is to validate a purchasing decision by transforming benefits into concrete, tangible returns.
A well-written business case shows that the capex proposal offers a great return with manageable risk. It becomes compelling when written with the approver in mind. Knowing the audience focuses the business case on the approver’s “hot” issues and it makes it simpler to include the “right” amount of information and detail.
Too much data can kill a capex proposalby making the business case unreadable or creating previously unconsidered objections. To make the business case with the least amount of detail possible, describe the advantages and financialgains in three parts:
1. Executive Summary 2. Situational Analysis 3. Support material type
The executive summary holds the two most important paragraphs of the business case. If written well, half the battle has been won. The decision maker has been hooked and has begun to buy into the proposal. In some cases, the busy executive may read no further. Instead, he/she may approve the proposal with the contingency that support staff confirms the details.
If, on the other hand, the executive summary has been poorly written, the proposal may be flatly denied with no further investigation. The executive summary is that important.
A good executive summary must be succinct. Limit it to two paragraphs, each with two to three sentences. If longer,there is a risk of losing the attention of your audience.
In these two paragraphs, include a statement of the problem, the solution and the intended results. Be clear about the investment and the financial return, which will be stated in the company’s preferred financial measure (such as ROI). While itmay be beneficial to project the financial gains over a number of years, place more focus on the short-term gains, especially when economic conditions are poor.
Although the executive summary will bethe first item that decision makers read, write it last. Because it summarizes the key points that follow in the situational analysis and financial justification, a strong executive summary can be crafted only after the business case has been fine tuned.
The situation analysis documents four areas that influence the decision-making process:
• Current situation • Proposed solution • Alternatives investigated • Risks
Like the executive summary, write the situational analysis concisely.
This is a statement of the aspects of thebusiness that the additive manufacturing system will address once installed. In a sense, it is a “diagnosis” of a problem and the proposed capex request isthe recommended “treatment.” Using concrete financial data as the foundation, state the current process and expose the associated problem or opportunity. In addition, note which departments/divisions the current situation impacts and who stands to gain from any improvement.
When describing the current situation, incorporate facts that have measurable financial components tied to them. However, do not go overboard or off on a tangent. Stick to the current challenge that is the basis for the financial justification. For example, if a reduction in prototype expense is the basis of the financial justification, omit details related to other benefits, such as sales revenue increases.
For example, do not state that sales revenue is down because of slow product introductions if the financial justification shows a reduction in overall prototype expenses.
Recommend the additive manufacturing system as the solution to the business challenges. State the proposed solution—purchasing a system — and the measurable benefits that will result.
As long as the description of the solution remains on-topic and succinct, it is okay to reference the benefits that are difficult to quantify, such as speed. However, rather than basing the whole proposal on these benefits, use them as added-value items that the company will also realize.
A good practice is to state end results rather than the intermediate returns. For example, if a capex proposal would increase operational efficiency, in terms of labor hours, state how the time will translate into profit. Would it be used to decrease head count? Would it be used to increase departmental output? Get tothe point and tell the decision-makers the bottom-line results.
The last item in this section is a statement of what the proposed solution will cost and how long it will take to get it operational. For the cost, use the up-front investment needed to start making parts.
The purpose of this section is to show that a sound evaluation was conducted. By stating the primary alternatives that were considered, it shows that a reasonable investigation was performed.
It is tempting to list every alternative considered, but doing so will lead to unwelcome questions and objections. Rather than being comprehensive, state the most obvious alternatives. For each, follow up with a short statement of why it is an inferior option.
All capex proposals have some riskassociated with them, so don’t pretendthat the additive manufacturing solution isrisk-free. Instead, discuss the risks to showthat they are manageable and that theinvestigation included consideration of allcontingencies.
As with the alternatives, include the mostobvious risks. Dispose of each with a shortstatement of the countermeasure shouldthey occur. Then be prepared to field thequestions from management regarding therisks not listed in your business case.
The core of the business case is thefinancial justification. It presentsthe anticipated return on the capexinvestment. There are two parts to thejustification: 1) the capital expenditure andrelated expenses 2) the financial benefit.When combined, these items produce thefinancial indicators that measure the valueof the investment.
When building the financial justification,seek guidance from your financedepartment staff. They will assist youin selecting the proper performancemeasures—such as return on investment(ROI) or payback period. They can alsoprovide assistance with data collection andcalculation methods and offer guidance onitems such as “hurdle” rates.
The elements included in the financialjustification will depend on many factors,so it is important to understand thedecision-making process and the decisionmakers’ concerns. For example, if thedecision is made at the corporate level,shifting expenses from one business unitto another does not yield any net savings.
Ideally, the justification will show a largereturn for a small investment. This is thewinning combination, but the processof getting to this combination may notbe so simple. In fact, it is often best toinclude only what is necessary to show acompelling return. While it is temptingto boldly state that all prototypescompanywide will be produced on thenew additive manufacturing machine,making this claim may threaten otherdepartment heads, set unrealistically highexpectations or make the business caseunbelievable.
To achieve a balance between compellingand realistic, fine-tune the numbersthrough several revisions. After each pass,review the return on investment. If it istoo low, add more prototyping work. Ifunnecessarily high, remove items thatcreate questions or conflict.
STRATEGIES: HIGHER REVENUES VS. LOWER EXPENSES
Current business conditions and thegoals of the decision makers will dictatewhether you should build the justificationon increasing revenues or decreasingexpenses. In most cases the strongestapproach is to justify the purchase interms of cost reductions. However, if yourcompany is pursuing a major revenuegrowth initiative, showing returns in termsof increased sales revenues may be a wiseoption.
Also consider the measurability of theproposed returns. Calculations from hard,tangible numbers are easiest to sell. Yet,in most cases, a cost reduction proposalprovides more of these measurablebenefits. With few exceptions, the primesource of savings will be from bringingoutsourced prototype, pattern and toolproduction in house. These savings are thestarting point for a three-tiered approachto cost justification of an additivemanufacturing system.
The value is the financial gain that resultsfrom the capex before the investmentexpense and ongoing costs aresubtracted. It is the gross profit potentialfor the company, division or departmentthat results from expense reductions,revenue increases or a combination ofboth.
Assuming that savings will takeprecedence and that the financial returndemands hard numbers, an effectivestrategy is to try to justify the purchasebased on replacing current prototypingprocesses with in-house additivemanufacturing. This is tier one. If thereturn is not large enough, then proceedto tier-two and tier-three benefits.
TIER ONE – REPLACING EXISTING PROTOTYPE METHODS
Begin by collecting historical data for anymodels, prototypes, patterns and toolsthat are representative of the parts thenew additive manufacturing system willmake. Use a 12- to 36-month look-backperiod. For items in this time span, gathercost data, process information and partdescriptions.
There are two sources of parts for thejustification: outsourced parts fromsuppliers and those made in-house. Forboth sources, include not only additivemanufactured parts but also those thatare machined, molded, cast, formedand hand-fabricated. Collect data for allitems that could be transitioned to theproposed additive manufacturing system.Parts produced in-house must not beignored, but they should be included onlyafter careful consideration of corporatedynamics, process ownership, andbudgetary approval level.
Building from the historical data, projectthe additive manufacturing workload forthe near term, which is typically one to fiveyears. Estimate if the same or similar partswill require prototyping and pair that withcorporate projections related to changesin R&D spending, rate of new productdevelopment and changes to productmix. This review provides a baseline of allpotential part candidates.
To keep the cost justification relativelysimple and somewhat high level, reviewthe part candidates to determine overallcategories to which averages may beapplied. For example, consider thenumber of plastic parts, simple sheetmetal components, complex machinedparts and bulky cast metal parts. Subdividethese categories with other qualifierssuch as size. For each of the categories,determine if they are suitable candidatesfor the additive manufacturing process.Finally, review the parts within eachcategory to determine the percentagethat will be run on the new additivemanufacturing machine. This provides agross estimate of the number of parts,their size and their volume. This data willbe used to determine the savings potentialas well as the cost to construct them onthe new machine.
Now it is time to calculate the actual costof all of these prototype parts when madewith conventional manufacturing processesor by third-party additive manufacturingcompanies.
For outsourced work, use invoicesto determine average costs for eachcategory of parts. Make sure to include allexpenses, such as:
• Part cost • Engineering charges • Labor charges • Expedite fees • Shipping/handling charges • Taxes
Optionally, advantages and efficiencygains that occur when outsourced work isbrought in-house may be included. Note,however, that the labor-oriented itemsare subject to challenge unless they resultin staffing reductions or fewer new hires.If not directly included in the financialjustification, reference them elsewhere inthe business case since they are benefitsof in-sourcing prototype development.Include time estimates for:
• Engineering documentation anddetailed drawings • Solicitation of quotes • Placing orders • Accounting: – Purchase orders – Accounts payable • Project management: – Phone calls, emails and meetings • Incoming inspection • Maintaining and protectingconfidential information
If including the savings on in-house workthat will be transitioned to the additivemanufacturing system, a cost estimate forthese parts must be created. For largecorporations, internal cross-charges makethe calculations simple. Records of theinter-departmental charges document theexpense of these parts. If cross-chargesare not used, seek advice from the costaccountants in the company. They willbe able to devise a cost estimationmethodology.
In a cost justification worksheet (figure 1, below), enter the sum ofall of these costs in the first year columnfor return (value). Note that this valuedoes not reflect the net “true” returnsince it excludes the cost of making theadditive manufactured parts, which will becalculated in the expenditures section ofthe justification. Unless there are corporateprojections that would lead to year-toyearincreases (or decreases) in prototypeconsumption, keep the justification simpleby using the same financial return for yearstwo through five.
TIER TWO – INCREASING PROTOTYPING ACTIVITY
If larger financial returns are needed toobtain approval of the capex proposal,move to the next area of benefits thatadditive manufacturing offers. This tierplaces a dollar amount on the inherentvalue of developing concept models,prototypes and prototype tooling. Usingmachine capacity that remains after tierone parts are produced, the business casewill show that additive manufacturingenables the production of more models,prototypes and tools.
It is readily accepted that additivemanufacturing promotes the creationof more prototypes in more stages ofthe product development process. Thespeed, efficiency and capability of theprocess remove the barriers of time, costand effort when making prototypes. Soadditive manufacturing makes it easy andpractical to produce more prototypes. Thisis a defensible position. The challenge iscalculating a measurable value that resultsfrom the prototypes.
The strategy for tier-two benefits is toleverage what corporate managementhas already accepted as fact. Use anyacknowledged values of prototypingin the calculation of return from theadditive manufacturing machine. Forexample, if a rule-of-thumb exists for aratio of prototyping investment to moneysaved from error avoidance, use it in thejustification. Another option is to buildfrom recent situations that had direct,measurable impact in financial terms. If itis a reoccurring situation, use this data tovalidate the estimates. For example, if anexpensive injection mold was reworkedbecause of a problem that a prototypewould have exposed, use the estimatedcost and lost time, for rework as a basisfor value calculations.
Figure 2 presents commonbenefits of prototyping that are candidatesfor tier two of the justification. Use thelist to start the brainstorming processto find areas of value that managementcan appreciate and will accept. If adollar amount is associated, include thevalue in the justification. If not, excludeit from any calculations. However, if theexcluded benefit has a lot of impact,consider referencing it as an additional,but unquantified, benefit of additivemanufacturing that sweetens the deal.
Armed with the justifiable benefits,review current and proposed productdevelopment programs for candidateparts. As with tier one, keep theinformation at a high level and use grossaverages for each category of parts. Applythe value of prototyping to the additivemanufactured parts and add it to the tieronesavings in the return row of the costjustification worksheet.
TIER THREE – PROTOTYPING RAPIDLY
Additive manufacturing’s greatest benefitis making things fast. Instead of waitingdays for a CNC-machined prototype,an additive manufacturing system canmake the part overnight. In a fast-paced,pressure-filled business environment, itis obvious that reducing delivery by daysis extremely beneficial. This potential iswhat draws many to the technology, buttime can be very hard to quantify in a costjustification.
While it is advisable to stress the timeadvantage, exclude it from the financialjustification and include it in the situationalanalysis. Use the speed advantage asthe item that puts a financially justifiedproposal over the top. Show a significantfinancial return that concludes with astatement that the company will achievethe stated savings while decreasing cycletime for prototypes, product developmentand product launch.
Another strategy, if tiers one and two donot provide enough value, is to locateoperations that are the final stages of aprocess and are subject to frequent delays.These final operations often have toabsorb the delays of previous operations,and therefore, may be held accountablefor delays in moving to beta testing, pilotoperations or product launch. If additivemanufacturing can prevent the delayin this operation, there will be an linkbetween it and a timely launch of the nextmanufacturing phase. Usually, the delayhas a measurable financial component thatcan then be used in the cost justification.
INITIAL INVESTMENT AND ONGOING EXPENSES
The investment component of a financialjustification includes all of the expensesto acquire the equipment, get it up andrunning and to operate it. There are twoexpenditure categories: initial investmentand ongoing expense. For additivemanufacturing, the initial investment isa straightforward calculation with easilydefined expenses. The ongoing or annualexpenses, are a bit more difficult tocalculate since they are dependent on howmany parts are made.
For the initial investment, items to include are:
• System price • Ancillary equipment and softwarecosts • Installation and training costs • IT expenditures: Items such asnetworks, data storage, andcomputers • Facility modifications, if any: – Items such as utilities, build-outs(for isolation), floor stabilization,door widening • Shipping expense
Ongoing expenses may include:
• Maintenance contracts • Routine maintenance costs • Materials • Other consumables: Items suchas cleaning solutions, tips, buildplatforms, sandpaper • Labor: Direct labor for machineoperation, maintenance and partfinishing • Facility charges
In both categories of expenditures, includeonly the incremental costs for items such aslabor, IT expenditures and facility charges.This is the difference between currentexpenses and those incurred after systemacquisition. For example, if no employees willbe added, there will be no labor costs listedeven if direct labor will be needed.
To present an accurate assessment of theexpenditures, the additive manufacturingvendor will supply much of the data, so atrusting business relationship is crucial. Thisis especially true for ongoing expenses.Without hands-on experience, it is impossibleto estimate build time, throughput, capacityutilization and material consumption todetermine the operational expense.
To calculate these items, supply the vendorwith information on the parts included inthe value section of the justification. Witha moderately detailed description of theparts—size, configuration and quantity—thevendor will be able to estimate the cost ofmaterials and related operating expenses.Also, ask the vendor to estimate the totalrun time in order to confirm that the partsused in the justification do not exceed theadditive manufacturing machine’s capacity.
For the projected machine utilization, thevendor can also estimate the direct laborneeded to prepare builds, operate themachine and post process parts. As noted,include direct labor only if it is incremental.So, if the current staff can absorb thevendor-estimated increase in labor hours,exclude them from the cost justification.
Combine all elements of ongoing expenseand enter them in the year one column inthe cost justification worksheet’s on-goingexpenses section (figure 3, below).Do the same for years two through five,using the same, if any, multiplier that wasapplied to the annual returns for thoseyears. Beyond a breakdown by expensecategory, no other detail should bepresented in the business case to keep itconcise. However, it is vital to documentall calculations, assumptions and detailedexpenses for reference. There will bequestions, so be prepared to answer themwith supporting, well-documented data.
RETURN ON INVESTMENT (ROI)
The hard work is complete. The financialdata that you have put together can beused to generate any company-desiredmetric that proves the value of the capex.Simply enter the financial data in theequations for return on investment (ROI),payback period, net present value (NPV) orinternal rate of return (IRR). Calculate theresults for the appropriate measures, notethem on the financial worksheet, referencethem in the situational analysis and stressthem on the executive summary (figure 4).
With this approach, additivemanufacturing’s value is connected tofinancial gain, which gives managementobjective data in the favored language ofprofit and loss.
A high return on investment and a solidexecutive summary can lead to theapproval of a capex proposal for anadditive manufacturing system. That isthe power of crafting a business case thatuses the information, methods, issues andlanguage that is relevant to the decisionmakers.
While the benefits of additivemanufacturing are obvious to the teamthat is making the proposal, it is theirresponsibility to express that advantagein terms that are understood, appreciatedand welcomed by those who control thedistribution of funds from the capitalexpenditures budget. Compiling adefensible, clear and concise justificationgives the business case the edge neededto get an agreement to invest in anadditive manufacturing system.