Asset Management Insights. Celso de Azevedo

according to this definition, the procurement price is a secondary factor. However, it is the most prevalent in real-life procurement decisions, whatever else one would be inclined to believe. This rationale has led countries in which production costs were the lowest to gain situations as the “factories of the world,” for the simple reason that these states spoke the language of industrial leaders: that of the lesser cost. This geographical displacement of global production has generated a remarkable and generalized qualitative degradation of assets. Indeed, one should consider that the production realized from the assets depends on three modulable parameters: namely cost, timeframe, and quality. However, it is an often neglected fact that it is only possible to modulate simultaneously two of these distinct parameters. When buyers prioritize assets produced at the lesser price, it is only logical that the machines’ quality should decrease accordingly. Caught in a twisted game of which “minimal investment” is the golden rule, managers—the internal clients of the buyers—are bound to go from disappointment to disappointment as they are increasingly resigned to do without efficient machines (in the Asset Management understanding of the notion).

      By solely focusing on prices, the buyer favors his own interests; he strives towards the optimum of the “procurement” function to the detriment of the needs of other segments of the organization (and all too often, he does so in good faith). Yet it is obvious that these segments, which themselves heavily depend on the buyers’ decisions to reach their own realization, must be taken into account at the time of the procurement-related decision-making. Too little consideration is given to the well-informed opinions of engineers and operators—in fact, buyers and organizations often reenact purchases previously denounced by these agents. Hence the input of life cycle costing, and of a quickly-developing array of methodological tools. By monetizing the financial impact of an asset across its entire life cycle, one obtains an increasingly precise notion of the purchase’s profitability, as long as one considers its entire existence within the organization. However, design-to-cost remains the predominant method for assessing costs, whereas life cycle costing is still a marginal trend, or at the very least applied in a timid fashion—this will be developed in coming chapters.

      Agents of the “procurement” function cannot take the entire blame for this situation. From the perspective of enterprise sociology, the so-called “buyer’s mindset” is in fact determined by exterior factors such as corporate pressure or the lasting influence of a culture that rewards quick successes. Nonetheless, if this explains why the buyer cannot be an internal consultant (since he is not required to heed the needs of other segments), he should at least learn from his mistakes—which rarely seems to be the case. De facto, mediocre assets are becoming the norm within the industrial sphere, and operational expenses (OPEX) are on a rapid rise. The OPEX we are discussing are not those that are originally budgeted, but those that are eventually spent throughout the budgetary year, not to mention the shortfalls tied with unplanned production stoppages; these are such tremendous wastes of funds!

      Buyers are buying irrationally—and quite stubbornly so. One cannot help but to think of Albert Einstein, who defined insanity as the act of “doing the same thing over and over again and expecting different results.”

      When one engages a reflection of procurement processes, it is essential to discuss the question of the regulations imposed on the public markets. Indeed, we could synthetically assert that the public market regulations in most countries dictate that procurement be realized at the lesser price, following the cheapest bid. Disregarding the reasons supporting this present condition of the public market, it is quite clear that if the economic world embraces Asset Management in the near future, these regulations will quickly become totally obsolete.

      To support this assertion, one could enumerate a number of points:

      • What is known as the “negative elasticity” between low CAPEX and the consequently very high OPEX in the remainder of the asset’s life cycle. In other words, when equipment is bought for a period of at least 10 years in this fashion, the probability of not enjoying a functional and qualitative operation of the asset rises spectacularly. Allow me to detail this claim by providing an example closely tied with the concept of LCC: in the public transportation sector, it is common knowledge that by the time a piece of rolling stock is decommissioned, the value of the initial CAPEX will have been spent somewhere between five and seven times in OPEX (in updated currency). This ratio is quite similar in any other industrial or infrastructural sector. It is therefore clear that procurement at the cheapest price induces a harmful evolution of OPEX throughout the life cycle. However, intellectual honesty demands that we also point out that the injection of a CAPEX supplement in the procurement phase does not suffice to ensure the correct management of OPEX over the rest of the life cycle. As we know, it is the best-practice conduct of the procurement project (considering both what is integrated in capital expenditures and the anticipated expectations of OPEX performance) that will indeed generate desirable results.

      • The contemporary regulations inducing “cheapest bid” deals for public markets are inherently unable to avoid the pitfalls for which they’ve been designed; if they could, we would know it by now. Indeed, their enforcement is not (or not anymore) an obstacle to the occurrence of conflicts of interest, or even of events of corruption; once again, we would know it by now.

      One can only rejoice in the fact that some countries have really seized the opportunity to tackle this problem, and have succeeded in developing functioning models of public markets aligned with the fundamental principles of Asset Management, but not solely—they are especially very supportive of states that act as financial investment backers using public funds. New Zealand, in particular, has for the last decade led a successful campaign aiming at the redefinition of these public market regulations, taking a clear stand in favor of the consideration of the life cycle as early as in the procurement phase. Furthermore, it has operated this transition in great simplicity: the public market regulations in New Zealand state that the replacement of assets reaching the end of their life cycle must be priced by the assets which will replace them at the time of dismantlement—and that this must occur as early as in the purchase offer stage. This implies that the offer should integrate a global life cycle cost attractive enough for the renewal to be profitable for the buyer; hence, the system encourages a long-term sight by making bidders project a vision on the end of the life cycle and help their clients in the efforts they will have to deploy to renew the asset.

      In practice, this implies that the stated requirements should include a tender amount that will integrate the initial CAPEX as well as the CAPEX provisioned for the identical renewal during the end of life.

      Other countries are nowadays trying to draw inspiration from this model, not only in Australia but in various other parts of the industrialized world. This trend is all the more laudable if we consider that, historically, other attempts to include the notion of “life cycle” in public tenders had systematically failed. As an example, we could state the case observed in the United States in the 1980s. The Department of Transportation at that time, encouraged by the wave of liberalization and privatization of public infrastructure implemented by the Reagan government, had developed public market specifications whose only admissible tenders in the urban transportation field were those in which the life cycle cost of the equipment was eligible; in other words, instead of favoring the lowest procurement CAPEX, this initiative offered to award the markets to the lowest LCC. These clauses were successfully imposed for a few years in the United States, but they were abandoned as soon as the state agencies became aware that the bidders were in a situation of such ignorance regarding their LCC projections that the purpose of the initiative was fundamentally discredited.

      To conclude on a positive note, we could assert that despite market regulations remaining well under the standard set by Asset Management principles in most countries, undeniable progress is being made in the present era. The emergence of a dosage between price, technical quality, performance, and HSE criteria will potentially bring into question the habit of buying at the cheapest price, even if this may not suffice to induce a true taking into account of CAPEX and OPEX throughout the life cycle.

2.2 Outsourcing and Accountability

      Over the course of the last