INDUSTRIAL AND ENGINEERING CHEMISTRY
October 1951
and conclusions. Individuals and departments participating in the report should be identified to show conclusively to management that all necessary checks and balances have been made. Each important unreconciled conclusion should be presented on a factual basis with reasoning for and against the minority differences in conclusions. The chemical industry has experienced a long period during which plants generally have operated a t peak capacity. There have been temporary periods of modest-to-sharp recessions in demand, leaving plants partly or wholly idle. Where products are available from more than one source it is possible to gauge capacity to take care of peak demand, and then when demand slacks off, operations can be slower yet remain a t a point where reasonably good costs and profits can be secured. Matching capacity with demand is not easy for products that are special to one producer. Considerable overcapacity is often necessary to protect customers who have made large plant investments to use the products and to supply their trade. When demand slacks off, these oversize plants may become unprofitable; two or more plant locations may be a partial answer to this costly problem. The amount of overcapacity needed to maintain “sole producer” items has also increased as it has become necessary to provide greater protection against possible strikes or other prolonged interruptions. Thus, inflation is active in a forceful manner in the chemical industry’s most lucrative field, which has been created by large investments in research and plants. In calculating profit potentials for a proposed new investment, a 100% capacity operation should never be used. An average of 75 t o 80% capacity on a sole producer product and 80 to 90% capacity on products where two or more producers are in the field is more realistic. Inflation also is evident in the form of constapt increases in others costs of doing business: Transportation costs have greatly increased; salaries and travel costs of field representatives and clerical and management personnel must necessarily keep pace with the receding value of the dollar. New laws, regulations, and taxes a t the national, state, and local levels have multiplied the paper work of industry, and often require the services of experts
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in finance, law, transportation, purchasing, public and employee relations, safety, and health. The addition of new products and increases in sales volumes through new capital investment will, to some extent, reduce general overhead costs a t plants, but it is not safe to compute potential profits on new products by allowing only for out-ofpocket costs in the overhead and expense categories. Management would create only marginal and fair-weather businesses if new products were introduced on the theory that there would be no additional operating expenses. In considering the funds required to finance construction of plant facilities, allowance must also be made for the added cash that is represented by working capital, inventories, receivables, and reserves. This may range from 20 to 50% of the dollars required for construction depending on the nature of the product. The cost of this added capital must be provided for in the estimates of production and operating costs. Under present economic conditions, the percentage of net profit that can be retained in a business or passed on to investors of new capital funds provides little direct inspiration for the outlay. To the extent that certificates of necessity, which permit more rapid write-off on plant investment, are obtainable, expenditures will be restored t o the corporate treasury, but current dividends are not payable from these more rapidly accumulated reserves. Management and investors should not pursue major expansions unless the economics of the projects are fully and favorably established. On the other hand, it is not possible for industry to stand still. The results of research and development must be utilized, new and lower cost processes must be found and adopted, not always to improve a present profit position but to maintain it. More production is a “must,” and industry neither wishes nor dares to lag. It is not improbable that inflated production and operating costs will become the deciding factor to management in authorizing new construction. Management, therefore, should insist on a careful calculation, by neutral experts, of the final net profit prospects on every proposed capital investment both before and after federal income taxes. RECEIVED April 16, 1951.
PREDESIGN COST ESTIMATES A. r
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predesign cost estimates are defined and several types are described. The value of such estimates in the administration of industrial research and some of the questions that can be answered by them are discussed, bur stress is also laid on the limitations of predesign estimates. A separate group reporting to research management is in a good position to provide impartial, consistent, and reasonably accurate estimates in a minimum time. A study of data from various departments of the company for which the estimate is prepared will result in reports that are consistent with company accounting forms and use cost factors based an company experience. Equipment cost data from the estimator’s own engineering department or engineering firm are preferable to information from the literature. Several methods of presenting the results of cost estimates are suggested.
A
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URING the past five years, a number of articles have D appeared in the technical literature on techniques that are used in preparing predesign cost estimates. Little would be gained by repetition of these procedures, but it appears worth while to discuss the types of predesign cost estimates that can be
J. WELLS AND S. A. G. SINGER
Technical Division, E. 1. do Pont de Nemours & Co., Inc., Wilmington, Del.
made; the value that these estimates have in guiding industrial research and development; and the methods used by individuals or groups in preparing to make such estimates. For purposes of this paper, a predesign cost estimate is defined as any cost estimate not based on firm design information and made prior to submission of quotations on equipment. An estimate based on firm design information and direct quotations for equipment is termed a construction cost estimate. Predesign estimates include informal “guesses,” semiformal highspot estimates to help select the best of several agailable reseaxh routes, and fairly detailed estimates that are used by research management to persuade general management that a new product is worth the expense of a construction cost estimate. That predesign estimates have a place in the administration of industrial research is evident in the experience of research groups that have started cost estimating sections. In all cases with which the authors are familiar, these sections have been continued and expanded because their work has proved increasingly useful to research directors and general management.
INDUSTRIAL AND ENGINEERING CHEMISTRY
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Predesign cost estimates can answer many questions. For example, it is possible to calculate roughly, a t a very early stage in the chemical investigation, whether a new product is potentially low priced and warrants further laboratory work. At a later stage, it is possible t o decide which of several possible routes to a given product is most likely to result in lowest costs and which pipees of equipment make up the major part of the investment. This shows which route and which process steps deserve the greatest consideration. Near the end of a successful new product development, predesign cost estimates can be used to estimate
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PLANT
I N V E S T M E N T AT CGST
Figure 1.
P L A N T I N V E S T M E N T AT C U R R E N T C G N S T R U C T I O N COST
Maintenance Material vs. Investment
the saving in production cost per pound if a larger rather than a smaller initial plant is built. Thus the predesign estimate can be used to size the initial plant; this, in turn, may result in a saving in time and effort in the preparation of the construction cost estimate. In answering questions, such as the amount of money to be used in a construction forecast, the objective of the predesign estimating group is to give to management the maximum amount of good quality cost information per hour of technical time spent. This requires that no time be wasted on estimating t o a precision greater than the accuracy of the technical information available or on estimating one step to an accuracy greater than that of any other step. It is well to caution, a t this point, that there are questions which cannot be answered by cost estimates-predesign or otherwise. For example, an economic analysis of the prospects for a neiv product requires not only information on the variation of cost with plant capacity but requires equally accurate information on potential sales volume versus price. Such information on sales and price must be obtained independently after consideration of the product properties, use possibilities, and the prices and properties of competing materials. Price forecasts are never reliable when they are based on cost plus some arbitrary percentage of sales or investment. Estimates that are used to justify very early experiments can probably be made in an hour or two by any reasonably intelligent technical person who possesses a smattering of cost accounting know-how. On the other hand, detailed estimates that are used by top management in guiding the expansion policy of a company might best be made by an independent engineering organization reporting directly to top management. This is particularly true if there are several research groups competing for new investment money. Between these extremes there is need for a predesign cost estimating individual or group reporting to research management specifically for guidance of research and development programs. Even in a small research organization there are excellent reasons for segregating this function and concentrating it in one spot, Estimates made by a single cost estimating group are on a more consistent basis and have greater relative accuracy,
Vol. 43, No. 10
in general, than estimates made by individual research engineers or chemists actually carrying out the experimental work. A specialist in estimating procedures, who has the time and lesponsibility for ferreting out the sources of cost estimating information, is usually able to achieve greater absolute accuracy. Furthermore, such a group or individual can develop a central body of information jvhich can be used over and over again. Thus the work can be done much more efficiently and quickly than if it is scattered throughout the organization. It is not necessary to select design engineers or experienced estimators for predesign cost estimating work. -4s a matter of fact, experienced estimators ordinarily use such detailed procedures that they may find it difficult to adjust to the short cuts and rough approximations that are essential to rapid predesign estimates. Instead, selection of individuals, with fairly broad interests and with research and engineering background, who can absorb quickly the elements of accounting and design, is more satisfactory. The work of a cost estimating group provides useful training in the financial side of a business and an insight to management’s evaluation of the results of research. Men with this experience can return to a research organization where this knowledge represents good background experience. The size of a cost estimating group will vary with circumstances but a good average is about one estimator for each thirty-five technical graduates either doing or directing laboratory work. More personnel may be required if it is necessary to supply estimates for nonresearch purposes. If the research organization is smaller than thirty-five people, it is still worth while to concentrate the estimating function in one individual even on a paittime basis.
Sources of Estimating Data Once the cost estimating group has been properly staffed,
it must equip itself with the necessary information t o make the required estimates. As stated earlier, considerable literature has appeared in the years since Korld War 11, and this literature provides a sound background for procedures, particularly the publications of Williams (4-7) and Chilton (8, S ) , two recent books by Bries and Newton ( 1) and by Zimmerman and Lavine ( 8 ) , and the large number of articles in the bibliogiaphies in
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COST PLbS
B
RETURN
FORECAST S E L L i V G PRiCE
COST P L U S A 90 R E - U R Y
F U L L COST
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Figure 2.
,
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3GJNDS PER T E 4 R
Cost, Return, and Selling Price vs. Volume
these books. However, the best source of cost estimating information is probably right in the estimator’s own company. For example, the elements of the cost accounting system used by the company must be learned and folloved in any estimates that are made. No search of the literature can help in this regard. Only through close liaison with accounting departments
October 1951
INDUSTRIAL AND ENGINEERING CHEMISTRY
can all the details be learned that are necessary t o an understanding of the many terms used in costing chemical processes. Once the meaning of the various direct and overhead cost items has been learned, a company’s past experience should be analyzed to determine relationships, if any, among the various elements. For example, an average factor for overhead on direct labor derived from company books is a far better guide than any factor copied from the published literature. Likewise, experience on maintenance cost as a function of plant investment, power consumption, or other parameter, is usually more valid for estimates when based on experience within the estimator’s company; similar remarks apply to research and selling expenses. An example of the method used to develop experience factors is shown in Figure 1 where current maintenance material cost is plotted against plant investment. The correlation is improved and the slope is lowered considerably when book investments are corrected upwards to a current construction index. In making such correlations against investment, correction to a current basis is necessary to avoid overestimating these factors. While accounting procedures are being studied, it is equally important to look to the engineering organization for Rources of data to be used in estimates of plant investment. The literature may be used to estimate the cost of equipment pieces that are encountered only rarely, but new and up-to-date curves should be prepared for equipment pieces commonly used by the company. These new curves should be based on recent quotations obtained through regular engineering sources. Similarly, factors for design and construction overhead costs, although approximated in the literature, should be obtained directly from the cnmpany’s group and should be kept up to date. I n addition to engineering and accounting, it is necessary to become acquainted with purchasing and traffic experts in order to obtain current quotations on raw materials and freight rates. Finally, it is necessary to maintain the closest possible contact with chemists and engineers in the laboratory since the process Ltssumptions that must be made are the most important part of any predesign estimate. The judgment of the experimenter and estimator must be combined in order t o work into the estimate as much as possible of the experimental evidence that has so far been brought to light. Although the new literature on this subject is useful, particularly for general principles and for occasional detailed costs, the more important and often-used cost elements should be derived from the experience of the estimator and his own company.
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Presentation of Estimates The results of predesign cost estimates can be presented in a number of different ways. After some experience with them, the authors believe that graphic methods are very effective, particularly since they make it easy to present results for many different plant sizes. Figure 2 shows a chart of the type recommended by Williams (6) showing full cost, including selling expense and other overhead charges, and several levels of net return, all in dollars per pound a t capacity operation of plants of various sizes. This type chart, as Williams showed, is easily combined with price-sales volume information (shown in Figure 2 as a dashed line) to show whether a new venture appears to be good, bad, or indifferent. A single chart of this type backed up, if necessary, with several pages of tabulated information gives a much better general picture than a tabulation of an estimate for a single size of plant. It is particularly important, as stated earlier, to present results in the same accounting terms that are used in the cost analyses of the company’s everyday operations. Thus, management is less likely t o misinterpret the cost data presented and can concentrate its attention on all the other new ideas that must be learned about a promising development. A new estimating group of the type described here must expect criticism from all sides. Those who have made and used detailed engineering estimates usually believe that short-cut, predesign estimates are necessarily wrong and usually low. On the other hand, chemists and engineers in research laboratories who have no design experience believe that the overhead factors are entirely unfair and that the estimates are high. Nevertheless, the cost estimating group will soon become known as a useful source of quantitative cost information that can be prepared on short notice with reasonable accuracy. literature Cited (1) Aries, R. S., and Newton, R. D., “Chemical Engineering Cost Estimation,” New York, Chemonomics, Inc., 1950. (2) Chilton, C. H., Chem. Bng., 56, 97-106 (1949). (3) Ibid., 57, 112-14 (April 1950). (4) W-illiams, Roger, Jr., Ibid., 54, 102-3 (1947). (5) Ibid., pp. 124-5. (6) Williams, Roger, Jr., Chem. Inds., 61, 622-4, 682 (1947). (7) Ibid., pp. 996-8. (8) Zimmerrnan, 0. T., and Lavine, L., “Chemical Engineering Costs,” Dover, N. H., Industrial Research Service, 1950.
RECEIVED April
16, 1951.
END OF SYMPOSIUM ON PLANT COST ESTIMATION Reprints o f this Plant Cost Estimation Symposium may b e purchased for 50 cents each from the Reprint Department, American Chemical Society, 1 155 Sixteenth St., N.W., Washington, 6,
D. C.
