Appraisal of Development Projects by James B. Weaver, Atlas Chemical Industries, Inc.
Costs and economic analyses are required for development appraisal -and much more
COSTS
has been the heading on this column since its initiation in 1954. Although the actual subject matter has ranged far and wide from this focal point, the central theme has remained the development of economic analyses which can assist engineers and chemical company management as well. The purpose of this final column is to tie the usual coverage into the other phases of appraisal of new company developments. Over the years the column has dealt with product cost accounting, fixed capital cost estimating, manufacturing cost estimates, and several of the other factors which affect the future of company investments, including working capital, taxes, etc. All these pieces add up to a n analytical function related to capital investments, whether for new plants, expansions, or replacements. Since the engineering profession deals largely with the erection and operation of such facilities, it is natural that great emphasis has been placed on evaluation of proposed capital investments. Economic analysis is also practiced widely for economic balance in design size optimization, to assist decisions on research and development projects, and for choices between alternative pieces of equipment which perform the same function. What else is needed? Do these cover the analyses needed for all of managernent’s problems, and provide the background data for their expansion decisions? Some additional analytical functions seem almost equally important to the broad decision-making needed to chart a n over-all prcfitable course for a company, for example, the course chosen by Atlas Chemical Industries in its Development Appraisal Department. No claim is made that it is perfect, but it should provide food for thought.
Marketing Research
The most familiar of these additional analytical functions, not discussed in detail in these columns, is marketing research. This specialty used to be known as market research, and the chief chemical organization in the area still bears that titleChemical Market Research Association. However, marketing research is now generally considered broader by the members of that society, more descriptive, and therefore preferred. Market research is, in essence, the determination of the size of a certain market-marketing research investigates its nature as well. Market research is still a n important part of the total function, including the estimation of past, present and future markets and capacities for the nation or for the world, and, when possible, estimation of market shares for each major supplier. There is also a more ephemeral market volume-the potential. This generally refers to the market that might exist, now or sometime in the future, if a product of certain characteristics (not always available) were to replace completely certain other products now filling certain needs. To this, marketing research adds essential knowledge concerning the characteristics of the market that will be important to any supplier. A company’s entrance into a new field can be made easier if it has information concerning such things as the identity of the person who genuinely makes the decision to purchase the product. Other examples -are the proposed product specifications proper? How influential will price be in determining eventual market volume? Chemical marketing research is quite different from consumer marketing research. I n general, chem-
icals are intermediates sold to a much smaller group of outlets than most consumer products. While analysis of published information and company history is of great importance in both fields, the chemical market analyst is less concerned with statistics and sampling as a means of obtaining his information. Because of the limited number of good sources of information, a series of interviews is usually the chief technique used to gather the essential information. Marketing analysts must, therefore, be experts at field interviewing, and a t summarizing the valid results in a concise report. The survey can go beyond a mere opinion survey when the answers being received develop into a common pattern which amounts to strong corroboration. Information may also be gathered on growth of the consuming industries. A forecast for the product itself is basically the product of the analyst’s thinking and not of his interviews alone. Marketing activities to be chosen in the future will often determine whether or not any such forecast comes true. Besides presenting results, the marketing research report must, in general, discuss the assumptions and the reasoning which resulted in the forecasts presented. This is the only way (short of waiting for actual results to come about) that management, who must use this research for important decisions, can gain confidence in the results and make suggestions for change if better assumptions are available. A market forecast essentially is a forecast of income for a proposed plant. The price forecast involved should be a conscious one, based on a forecast of possible competitive activity, rather than any assumption that current price levels will continue. As competition increases, price levels fall, but forecasts seldom predict it. I t has been said many times that more chemical plants fail to meet profitability forecasts because of erroneous market estimates than beVOL. 53, NO. 12
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cause of any other single factor. This is still true; marketing researchers not only adm.it but emphasize that their occupation is more a n art than a science. Nevertheless, this valuable analytical function can provide information about a proposed new market which can influence a management’s decision, far beyond the numerical forecasts.
search studies may make recommendations, and in some cases the “answ-er)’ may be obvious to management. More often, the operations research study merely clarifies cost and profit relationships, which makes it easier for the decision-maker to concentrate upon them in reaching his decision.
Operations Research
long-Range Forecasting
Together, marketing research and economic evaluation provide the quantitative information which is available for new capital investment decisions. However, after the equipment is installed, there are many subsequent decisions about the operation of that equipment which have a considerable impact on company profits. Most plants have technical staffs themselves which attempt to improve the productivity of certain equipment, accomplish production scheduling efficiently, etc., as well as general trouble shooting. Cost control within the plant is also a n important function for profit. As the product mix from a given set of equipment, or from several similar pieces of equipment at one or more locations, becomes more complex, it is harder to determine by intuition the most profitable course of action, even when considerable engineering talents are applied. Several new mathematical techniques have been developed to approximate, by equations, the complex interrelationships in many phases of the business world, including order processing, production allocation, inventory control, distribution, and marketing. The need for large amounts of data and data handling has resulted in the greatest emphasis on operations research studies where large savings are indicated and where computers are available to do much of the work. Therefore, operations research has, in general, been restricted to the larger companies. By use of consulting firms or by establishment of small groups which utilize outside computers, mediumsized and even small companies may also benefit from this staff analysis. As with economic analysis, the staff analyst does not make the decision. Reports of operations re-
Discussed here are the main analytical functions which assist particular project decisions at Atlas. Naturally, it is preferable not to ignore the forest and look only at the trees. The fashionable word for any conscious integration of company expectations these days is planning. It is largely a matter of semantics, but Lve use the word forecasting to avoid any implication that a staff analytical group can substitute for the management function of planning. Staff analysts can present various alternative courses of action and forecast the results to be achieved from each, but management must choose among these. An expectation is only turned into a plan by management agreement that one of the alternatives is satisfactory to it. By careful review of the company’s product lines, consuming industries, and expected new products, trend forecasts can be prepared indicating how much growth will be achieved if the historical trends continue. Informed sales and management judgment can be substituted for the trend lines whenever they foresee a change in trend. Such forecasts can be cumulated into a forecast for the entire companyAtlas does it for five years into the future. By studying relativc growth rates and profit potentials, management can then spend its time analyzing the product; and consuming industries which are forecast to have the major effects on profits forecast for the company’s future. Product lines which are in a decline can be spotted fairly early by this means, and, depending on their importance, plans can be laid to minimize their impact on the company. By comparing the resulting forecast product volumes with the facilities available, production management receives a “distant early warn-
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ing” of the need for additional facilities. New products likewise call either for new facilities or for a share of the available production facilities, moving u p the time of expansion. Only after a review of such a relatively long-term forecast do we believe it is possible for a management to study the expected picture and decide whether this sum of all of the parts is a sufficient total objective for the firm. If it is not, steps can be taken to alter it in comcious ways-e.g., acquisition, or more research. Intangibles
Certainly there are many more noncontrollable factors than controllable, about almost every decision. The economic climate must enter into every management decision. The impact of one project upon every other project under way deserves careful review. The company’s projects must also be related to its financial picture, so that money is available, without undue excess, when needed. The bigger a single project is, relative to the size of the company, the more hazardous it will be, even if all the quantitative calculations show it to be equally desirable with some smaller project. Similarly, the closer a new project is to accustomed linea of activity, the more the general knowhow within the company will be applicable and the less likely a project is to “fall on its face.” Judgment is still the key to good management. As the industrial picture becomes more complex, it is harder to apply that judgment without the considerable benefits available from detailed staff analysis. If there is some way to make the judgment automatic, we don’t know about it, however. All we can try to do is to provide, for the judgment, all available information in the most understandable possible manner.
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