Thursday, September 03, 2009

Free Cash Flow and the Competition for Capital Dollars

Here’s an all-too common scenario: It’s capital budget time. Everyone lines up with proposals. Industrials tend to favor capital projects that build the business—equipment to establish new product lines, plant expansions, new plants, and so on. And they should. Now, compare that to the typical facilities department offerings: stuff like chiller retrofits, boiler replacements, lighting upgrades. To say that these proposals fail to excite corporate decision-makers may be an understatement. Facility managers everywhere routinely see valuable energy improvements passed over, year after year.

Here are some thoughts on how to change that situation.

You’ll notice I didn’t say “fight back.” This is not an us-versus-them discussion (for now, at least). What I propose is a win-win partnering strategy. Here’s how it works:

· If yours is like most other organizations, you justify your capital investments using “simple payback.” I have railed against that metric elsewhere, but for now, let’s recognize “payback” as a fact of life. Let’s use it to our advantage.

· You are accustomed to competing with other departments for funds. We can’t totally reverse that, but we can strike up some alliances in certain situations.

· Identify the product manager for a new initiative for your organization. Understand the hurdles for getting that new initiative underway. For example—it MAY survive a proof-of-concept analysis. It MAY graduate from prototype to full production. You MAY secure the inputs to effectively make that product. Customers MAY buy it. Competitors MAY refrain from entering your market. Remember that ALL payback calculations are estimates. Which is a better investment: a two-year payback with high risk, or a two-year payback with low risk?

· Understand what you provide. Typical energy prime movers—chillers, boilers, air compressors and so on—operate year-in, year-out. We know that greater energy efficiency means reducing the expense of running these assets. But more to the point, you’re not just saving money—you are creating a LOW RISK source of free cash flow. Here’s where it gets interesting.

· Partner with that new product manager. Instead of competing for capital funding, arrange a package proposal—one that combines your energy efficiency project with the new product concept. If the company accepts the package, they accept not only your energy improvement, they obtain free cash flow that directly subsidizes your ally's new new initiative. Win-win for the proposal managers, win-win for the company as a whole.

What’s the alternative to this approach? Business as usual. Compete with each other for capital funds. Use boring titles for your capital budget proposals like “10-ton chiller retrofit.” Or, think about the strategy offered here. Submit a capital budget proposal entitled “Free Cash Flow Subsidy for New Product Development.” Drop me a line and me know what happens.


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