Now is the time to determine the cases where maintenance spending can deliver more return on invested capital (ROIC) than higher risk-associated growth initiatives. Companies are wrestling high inflation and unreliable supply chains, with a backdrop of pandemic-related budget cuts and ongoing pressure to generate shareholder returns. So, CFOs are facing a backlog of maintenance projects and tough choices on where to prioritize capital expenditures (capex).
While capex budgets should always keep an eye toward growth, it's more critical than ever for finance leaders to evaluate deferred maintenance needs to ensure that they protect current revenue by shoring up the assets they hold. When factoring the operating cost and lost revenue implications of capital asset failure, maintenance capex generates substantial return by de-risking operations.
Instead of relying on fixed annual capital allocations for maintenance based on revenue as many companies do, finance leaders can better support long-term value creation by taking a more rigorous, informed and agile approach to capex budgeting.
For example, when a leading life sciences manufacturer poured resources into high-stakes, strategic growth opportunities triggered by the pandemic, it diverted maintenance dollars from plants responsible for producing 90% of the company’s existing revenue. To assess the impact of this capex shift from maintenance to growth, EY teams assisted in assessing the target maintenance spend based on in-depth modeling and peer benchmarking, as well as a measurement of the potential long-term value dilution associated with continuing to defer maintenance. The analysis results ultimately compelled the CFO to approve a 20% increase in its maintenance capex budget, without a reallocation from growth capex initiatives.
To change your company's status quo approach, you may need to start by challenging the inherent bias against maintenance spending and debunk the common myth that it’s just a "sunk cost" with zero ROIC. If you spend $1 on maintenance capex and save $1.25 through lower operating costs or avoiding unplanned shutdowns, you’ve achieved a 25% return. Consider a beach rental property: $5,000 in new improvements could increase income from a 10-week summer rental by 10%. Alternatively, reallocating half that amount to replace an aging air conditioner could mitigate against an untimely outage, resulting in two weeks of lost rent (a 20% impact) and adding the benefit of reduced energy consumption.
In this difficult supply chain environment, consider that the unplanned need to replace equipment or a critical part can take weeks or months instead of days – taking production down, including dependent growth capex assets. Moreover, in a competitive labor market, companies need to consider how neglected equipment that leads to graveyard shift breakdowns and unplanned overtime will impact worker morale and retention.
3 steps to sharpen maintenance capex
To help companies make better maintenance capex budgeting decisions, finance teams can begin by evaluating current spending levels, creating structured capex decision-making programs and driving accountability by tracking results.
1. Assess current maintenance spending.
- Benchmark growth, profitability and capex patterns against peers to inform overall competitive capital expenditure levels.
- Analyze historic spend, depreciation and current replacement costs to assess sustainable maintenance capex levels.
2. Create a disciplined decision-making program.
- Link projects to specific, quantifiable goals, such as "replacing this component will extend the life by X years" or "upgrading this equipment will enable us to lower our energy consumption and reduce emissions by X%."
- Choose metrics that help quantify cost avoidance and risk mitigation. Include qualitative measures that will be important considerations for employee safety, environmental performance, and community and industry perception.
- Create a separate maintenance capex project prioritization tool that queries key information as part of the capital asset request process and assigns a score with ranges for approval and rejection. This helps focus analysis and discussion on projects that aren’t obvious "slam dunk" approvals or rejections.
- Allow flexibility to consider projects that may never rise to the surface as critical but can have a significant impact on employee morale, such as upgrading a cafeteria, an important factor in the current labor environment.
3. Track outcome to drive accountability.
- For projects approved for funding, monitor results to incentivize managers to ask for only what they need and spend it when they get it, avoiding unrealistic projections and budget padding.
- For projects denied for funding, acknowledge some accountability if deferred maintenance results in an adverse outcome.
- Establish a "memory mechanism" for tracking projects that were deferred. There may be reasons to auto-approve or give it a scoring advantage in the following year.
A disciplined capex budgeting process supports a business culture that recognizes the need for both growth and maintenance spending, helping drive value creation while reducing risks across the entire enterprise. It mitigates unexpected shutdowns that drive higher operating costs and can put revenue at risk. By investing in preventive maintenance, companies can replace their assets on their terms and in line with other strategic objectives.
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The views reflected in this article are those of the author and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.