Budgeting: trains, planes and pulp and paper.

If you happen to have the unfortunate experience of riding an overnight train in the United States these days, you may easily find yourself in rather shabby surroundings. The "roomette" cars often date from World War II, and, unless you are on this conveyance just for the historical aspects, it will leave you with a feeling of total inadequacy.

Compare this to one of the modern, low-cost airlines and the differences are striking. On Jet Blue, to pick one, you will find yourself on a new aircraft with a television at each seat, and a journey length measured in hours, not days. Yet the price on the Jet Blue flight (operated by a company without government subsidy) will be a fraction of the train ride cost (operated by a government-owned, heavily subsidized company). Further, the train assets are made of non-exotic materials (primarily steel), ride on steel rails and the whole system was fully depreciated years ago. The new plane, on the other hand, was recently purchased, at high cost, carrying a heavy depreciation schedule and made of primarily aluminum and titanium.

How can one system, with obviously higher cost assets, be profitable while the other with low cost assets continues to require heavy government subsidy? Efficient use of time and space is a large part of the answer. On the airline, you occupy a volume of approximately 1m X 1m X 1.5m, or 1.5 [m.sup.2], for 3 hours (a total of 4.5 hr-[m.sup.2]) to go from New York to Miami. In the train roomette you occupy an approximate volume of 2m X 3m X 2m or 12[m.sup.2], for 22 hours (a total of 264 hr-[m.sup.2]) not including an allocation of space and time for use of the rails. Looked at another way, the airline achieved the same objective as the railroad using only 1.7% of the time-volume assets, all the while conveying you in a manner that is, overall, far more pleasant, safer and less onerous for the passenger.

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The second part of the answer is liability. The shorter the time you are being conveyed, the less the insurance costs assigned to your journey, so the airline has less exposure time to risks associated with conveying you than does the train. No wonder the airline can afford modern, high cost assets, charge low prices, and be profitable. Think about this example as you prepare your budget for the coming year. It gives us two key clues to preparing a budget of profitability for next year and all years to come in your pulp and paper manufacturing facility.

The first clue, or issue, is time. While pulping and bleaching processes may be measured in hours, papermaking can be measured in seconds--on the fastest machines it takes less than 15 seconds for a discrete fiber to make the journey from forming section to being wound onto the reel. So, while the total time you are actually working on a fiber in your mill can be viewed as less than 24 hours, it is most likely that that fiber is on your site for months. This time starts with a surge pile of long logs, followed by an aging time in a chip pile, and is completed with a storage time in your warehouse (do not forget the hidden, off site warehouses).

ANOTHER FAD?

At this point you are probably saying to yourself, "wait a minute, this sounds a lot like the old just-in-time fad of a decade or so ago," and I agree with you up to a point. However, the just-in-time concepts were often more simplistic than what I am suggesting here, for they often only looked at the carrying costs and shrinkage of inventories, either work-in-process or finished goods, and did not consider the much higher costs that a time-volume calculation will expose.

As you prepare your operating budget for next year, think about the time-volume relationship of the fiber you transform from raw material to finished product (whatever the definition of finished is on your site or in your profit center). Consider these questions:

1. What no or low cost changes in handling and processing can be implemented before the next budget year starts?

2. What do these changes do to risks of supply of raw materials? What can we do to mitigate these risks? Can these risks be transferred to our suppliers?

3. What do these changes do to servicing our customers? How can we assure no deterioration in service?

4. What will these changes do to our infrastructure?

a. Can we reduce the footprint of our mill--moving more of our site to outside the fence and converting the tax base for this land, for instance, from manufacturing to forestry?

b. Can we tear down some tankage or warehouses, reducing maintenance and insurance costs?

c. Will we see savings in powered transport equipment such as fork trucks, cranes, etc.?

d. Can we reduce our labor costs with these savings?

e. Can these changes result in lower insurance costs?

On a longer-term basis, consider other opportunities.

1. Can log storage be transferred to our suppliers and done by them at a lower cost than we can do it on site?

2. Have we researched ways to reduce chip storage time through process changes?

3. Can we live with less in process storage through better and more efficient use of computer process control?

4. Will radio frequency identification (RFID) allow us to reduce the inventory between the end of our reel and our customers' docks?

5. In general, what can we do to keep a given fiber on this site for a dramatically shorter length of time?

You may want to consider revamping your profit center's management organization chart with the intent of putting a high level manager in charge of all in-process and finished goods storage. I believe one of the reasons we have all this inventory is that we have never put anyone in charge of it who has the objective and responsibility to simultaneously keep the quantities to a minimum while assuring all process departments run to planned production schedules. Historically, these in-process storage functions have been the responsibility of the operating departments that do not focus on eliminating storage costs.

ASSET COSTS & DEPRECIATION

The second key clue from the train/plane example involves asset costs and deprecation. In this example, low asset costs and fully depreciated assets are not the key to success. There is plenty of evidence that this is also true for pulp and paper manufacturing. The challenge is to buy the assets that are truly proven to be necessary (through rigorous cost justification exercises) and maintain them well.

For example, if an asset could be purchased that reduces the time your profit center possesses a given fiber, it should be rigorously examined from both technical and financial perspectives. To my knowledge, this is an entirely new class of assets heretofore unemployed in our industry.

Another current problem, especially prevalent in the United States, is the idea of reinvesting less than full depreciation. This fad, which seems to have been started some-where in the financial community, has spread throughout the North American industry. In the short term it causes manufacturing disruptions and in the long term destroys our assets, both acts of negligence committed in defiance of senior management's responsibilities to shareholders.

In reality, depreciation is not a number against which one should multiply a factor in order to determine a facility's reinvestment, maintenance and repair budgets, but rather a number to which we should compare the sum of our reinvestment, maintenance and repair budgets. In other words, it should be used for validation, not the genesis, of these budget components. There is absolutely no justification to arbitrarily applying a factor to depreciation as a way to plan next year's investment budget, unless the mill is planning on going out of business within a few years.

The proper way to prepare one's investment budget, of course, is through continuous evaluation of new technologies, examining how to make products in less expensive and more innovative ways, and by looking at what competitors are doing. This takes qualified people on your own staff and active involvement with institutions such as TAPPI and PIMA (pardon the advertisement) and research universities. None of these are popular activities these days, but hopefully this is just a phase and the industry will soon wake up to the efforts necessary to effectively compete with their peers and with other materials, such as plastic.

HISTORICAL DATA

Regarding repair and maintenance budgets, a facility can develop these from known or easily acquired data. Past maintenance records and expenditures are a good place to start. High maintenance operations can be examined with special scrutiny, making sure the expenditures are indeed required and a better way, with less maintenance, cannot be found to do the same process operation. As for facilities and standard operating components, other exacting methods can be employed. Here are some examples:

1. Roofs. Keep accurate data on roof types, repairs, and costs. With this data you should be able to build an accurate prediction of required roof expenditures for each budget year.

2. Pumps. With historical data by application, manufacturer and repair history, an accurate model of pump repair expenditures is easy to develop.

3. Rotating paper machinery elements such as suction rolls, calender rolls, roll covers and so forth. Again, historical data allows one to build a good model of future expenditures.

4. Electrical gear, substations and instruments. These are also areas where good detail should be plentiful.

These budgetary categories (and others) can be easily built from historical records. Today's computerized maintenance systems can help build an accurate expense model based on historical trends. Using this model, the sum can be compared to depreciation. Deviations from depreciation of plus or minus 10% are worth examining. They may still be correct, but management should be comfortable that they know the reasons the variance exists and that it appears valid.

I have focused this year's budget article on two specific areas--inventories and reinvestment (new and repair). These areas are just two of many required to compile and execute a successful budget. In reality, you should be gathering the data needed to develop next year's budget every day. Every time you purchase a raw material, make a repair or handle a product, you are creating historical information applicable to next year's budget. The challenge is to gather this information in ways that are useful for future budget planning.

With modern company wide computer systems gathering this data from every transaction, you can have all the data needed for such exercises. Do you? If your company has invested in such systems, yet the data is not coming down to your area of responsibility in a way that is helpful for budgeting, demand it. The gathering and presentation of such data was no doubt part of the sales pitch your senior management accepted when it decided to make this large expenditure. This investment should help you receive a myriad of useful data. It can help you create a better budget--a goal that should please all levels of management and especially that all-important stakeholder, your company's stockholders.

WHAT YOU WILL LEARN:

* What we can learn about budgeting from trains and planes.

* New ways of looking at asset costs and depreciation.

* New tools for the budgeting process.

ADDITIONAL RESOURCES:

* "Budgeting: Confront the myths, build a true plan," by Jim Thompson, Solutions!, August 2003. Product Code: 03AUGSO28. To access this article, type the product code in the search engine at www.tappi.org.

RELATED ARTICLE: VIRTUAL SEMINAR TARGETS BUDGETING

PaperMoney, an electronic publication published by TAPPI and TAII, will sponsor a virtual seminar in October titled "Budgeting Experiences." Willis Potts Jr. (above), recently retired vice president and general manager at Inland Paperboard and Packaging and TAPPI's Vice President, will be interviewed by Jim Thompson of TAII in this lively one-hour session.

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Potts began his career with Union Camp in 1969 as an industrial engineer and worked his way through various operational, management, and executive positions. He joined Inland Paperboard and Packaging in 1999. Potts has been active in several industry associations and is a past president of the Paper Industry Management Association (PIMA).

In addition to his current TAPPI activities, Potts is active in numerous community, civic, and industry groups.

Participate in this virtual seminar to learn from a successful industry leader's lifetime of experiences in preparing and executing budgets.

Learn more about the "Budgeting Experiences" Virtual Seminar by visiting www.tappi.org or www.globalpapermoney.org.

JIM THOMPSON, TAII

ABOUT THE AUTHOR

Jim Thompson's day job is managing TAII (www.taii.com). He is a member of the Solutions! Editorial Board and writes the weekly column "Nip Impressions" in TAPPI's "Over-the-Wire." He is also the Executive Editor of "PaperMoney" (www.globalpapermoney.org), which is published by TAPPI and TAII.

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