Earlier this week, a client came to us and asked how they could calculate a return on investment (ROI) between automated and manual manufacturing operations. No one has directly asked our team that question before. We often complete ROI calculations as part of our work but at this stage. The question made me realize that there are likely many other companies that do not know how to do this sort of calculation.
What we are offering here is a high-level method to calculate ROI. It needs to be at a high level as each industry, and even company, presents a wide range of situations and manufacturing requirements. Some of these circumstances require automation while others are best left to a minimal amount of automation. It really depends.
Important to note that “manually” does not mean shaped with hand tools. Instead, it means that there are a lot of processes that need humans to do them such as welding, assembly, painting, etc.
The calculation makes a number of assumptions. If these assumptions are not met, then the ROI calculation will not hold.
Assumptions
- You know your current costs.
A surprising number of companies do not actually know their costs. For example, we worked with a factory in China that did not track its spending so would simply look at the end of the month and see if they had more money than went out. That is no way to run a modern organization. “Knowing your costs” means knowing how much labor is required to produce each unit, what the cost of material per unit, and your overhead costs. That is a minimum.
- Production is viable either way
There are some products that need to be automated and some that can only be produced manually. Musical instruments are often produced by hand rather than by automation, so are artificial organs. Semi-conductors, complex vehicle components, and high precision military equipment need to be manufactured using automation. We are looking for products that could be produced manually but automation is an option.
- Automation is implemented correctly.
We have written numerous times that automation is a tool and not a solution. Companies often overlay automation on bad processes which automates waste rather than improving the outcome. The assumption here is that automation is effective.
If those assumptions hold, here is how you can calculate a high-level ROI.
Hypothetical Situation
We will use a hypothetical situation where your company produces containers. You are building a new facility with two potential paths. The manual path requires 100 people and $50,000 for machinery with a 5-year life. The automated path requires 20 people and $1,000,000 in machinery with a 5-year life. Each method will produce 1M pieces per year. Wages are $10,000 per person per year and material costs are $200,000 per year.
First compare labor costs:
- 100 employees x $10,000 = $1,000,000.00
- 20 employees x $10,000 = $200,000.00
Labor costs are $1,000,000 (manual) vs $200,000 (automated)
Equipment costs are
- $50,000 for manual options
- $1,000,000 for the manual option.
Total costs are:
- Manual: $1,250,000
- Automated $1,400,000
Every product produced costs you
- Manual: $1.30
- Automated: $1.40
For the first year, manual production is clearly the most cost-effective. However, the situation changes as time goes on. The rates decrease per year as the equipment is paid off.
In the following years, the equipment will pay off and the costs change.
Years two through five the costs are
- Manual production: $1,200,000
- Automated production: $400,000.
There is a surplus of $800,000 for automation. Over the life of the automation equipment, the surplus adds up to $2,400,000. More than enough to offset the replacement of the equipment. In this case the automation route makes the most sense.
You should perform due diligence on all suppliers. This was true in China and remains true even now as companies are looking to move out of China. It is a new frontier but don't forget the old lessons.
Read World Example
The preceding example was an idealized representation. There are usually many more factors at play when choosing between manual and automatic production models. Often times, companies want automation to cut down on labor costs and to produce a higher quality product. MTG designed a manufacturing system to reduce the labor used by two thirds and increase first past yield to above 95%. That method was only viable because the existing more manual production was woefully inefficient.
Another example is a client implementing automation with other manufacturing improvements. Between the reorganization and equipment costs, the client will break even (i.e. the gains from the results overtake the cost of implementation) in 25 months after the start of production. A repayment period of less than five years is often considered quite good.
Simple calculations, while insufficient for a final decision, can be a good way to understand at a high level the viability of a plan. If it is not viable at high level, then it is rarely worth going further.
Are you having trouble understanding the ROI of a new investment?
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