The new math for cost justification is no math

March 20, 2003
Some 20 years ago the management of this publishing company started thinking about buying computers to do word processing. At the time, copy for articles was pounded out by editors on manual typewriters and then fed through a time-consuming and complex process on its way to the printed page.

by Ronald Khol, Editor

Good editors constantly refine their work, recasting sentences, rewriting paragraphs, and perhaps even reorganizing an article several times. This meant I did a lot of cutting and pasting, literally, with scissors and a paste-pot. So you can imagine my euphoria when I saw how easily desktop computers could turn keystrokes into printed pages.

Among the vice presidents in our company was one who prided himself on his ability to keep a tight rein on operations. And he wanted a rigorous cost justification before any desktop-publishing equipment could be purchased.

I told him that justification for word processing hardly needed an analysis. Anyone could see we needed it almost regardless of cost. Also, I pointed out that he had not done a cost justification for his telephone, his fax machine, his copier, the rug in his office, or the potted plants beside his desk. So why did he need cost justification for word processing?

Fortunately, other forces were at work in our firm, and shortly thereafter our company bought desktop-publishing capabilities without a formal cost justification. The experience, however, showed me how some executives won't accept the obvious. They like to hide behind numbers because they simply don't understand the businesses they manage. And in today's lean times, the cost-justification of capital equipment is an especially hot topic, especially when it comes to tools for engineering and manufacturing. Operating by the numbers is more in vogue than ever, and it has never been more ill-advised.

Typical cost justifications rely on mathematical equations that yield numbers showing definitively whether or not an equipment purchase is worthwhile. But variables in the equations tend to be wild guesses on such things as projected sales, interest rates in the future, salvage values, and other imponderables not known with certainty.

For example, suppose you do a lot of business with automotive suppliers, and you make sales projections based on what they say they will buy. But what if these suppliers lose contracts with the primes? Or if their orders suddenly increase, will you be able to handle that? In all, managers have an obligation to know what kind of technology they need to stay in business, and what kinds of capabilities and capacities they should be able to offer customers.

When computer-aided design first arrived on the scene, many managers said it had to be justified on the basis of how it increased the output of engineering drawings. Today, justifying CAD on that basis would be laughable. It is largely impossible-to-quantify technical capabilities that justify all aspects of CAD/CAM. In manufacturing, there is a trend toward what is called mass customization. This means suppliers may have trouble staying in business if they don't have flexible machining capabilities, automated material handling, high-velocity machine tools, and up-to-date NC programming, despite what a cost justification might show.

The bottom line is that to know what customers need, there is no substitute for understanding the technological and industrial landscape. When you thoroughly know your business, the best math for cost justification may be no math at all.

-- Ronald Khol, Editor

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