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Engwall, R. L. 1989. Investment justification issues. Journal of Cost Management (Spring): 50-53.

Summary by Kent Jones
Master of Accountancy Program
University of South Florida, Summer 2002

CAM-I Main Page | Investment Management Main Page

The purpose of this article is to review investment justification issues in domestic manufacturing. Specifically, the article addresses the lag in new system and technology adoption as a result of a short-term rather than long-term focus.

Trends in US Manufacturing

Convergence of the following trends:

Spread of manufacturing capabilities worldwide resulting from: (1) foreign exploitation of US research, (2) failure of US companies to invest for long-term and (3) lag of US companies to invest in new systems and technologies that address significant indirect costs as opposed to direct labor costs.

Advanced manufacturing technologies integrated with systems have become cost-effective.

Process ownership, better information, improved material & distribution controls.

Evidence that organizational and management practices must change to improve manufacturing operations.

Decline in US defense industry can delay response times, increase manufacturing costs and ultimately create potential national security risks.

Emphasis on decentralization encourages individualism.

Lack of faith in building for future.

National Initiatives Needed

What can be done to shift the focus from a short-term to long-term focus in terms of investing in new technologies and productivity improvements?

Eliminate government disincentives for increasing investment in R&D, cooperative research, modernization and fair trade.

Encourage federal support to help fund development of better materials, processes, technologies, etc.

Federal support of intellectual property rights.

Form multidisciplined teams to:
solve problems,
increase public awareness,
develop tools to improve productivity,
effect change in education system to focus on the whole rather than the parts,
effect industry change to adopt the necessary elements to become competitive,
effect change in financial communities to focus on long-term as opposed to
short-term profits.

Industry Initiatives Needed

Companies need to get back to basics and evaluate investments strategically and implement optimal solutions. Companies must also focus on optimizing their investments for long-term goal attainment. Most companies use a three to five year outlook on projects that really need a five to ten year evaluation. Companies also tend to avoid projects that do not pay for themselves in the current fiscal year (short-term focus). The results are simple, standalone, low cost products that result in minimal savings. More generic, complex, multiproduct, interdependent, high-cost investments could lead to much greater financial benefits in the long run. Typically, companies postpone these types of projects due to higher risk and until short-term projects are able to subsidize them. This never happens and companies ultimately do not optimize their returns on investment.

Tracking Benefits of New Technologies

Companies typically evaluate and rank projects based on specific quantifiable data without regard to interdependencies across projects/products. Additionally, cost accounting data is aggregated at higher cost center levels making it difficult to determine true costs by product. Companies tend to allocate these higher level cost centers based on labor hours or material costs that may not reflect the "real cost incurred."

New technologies are creating even more complexities than current technologies. Computer integrated manufacturing (CIM) implementations are causing a need to shift from direct labor as the primary method for allocating overhead costs. Direct labor costs are decreasing while equipment and information costs are increasing in these more advanced manufacturing environments. Specifically, utility, maintenance and tooling costs are increasing while production planning, dispatching and materials handling are declining in the CIM environment. Changing cost patterns create a need for:

revised methods of investment justification,
integrated and timely information allowing planned measurements to be compared against
actual results, and
improved cost management systems.

Desirable Features of an Improved Cost Management System

The features include:

better allocation methods (in addition to direct labor),
accurate data collection and cost tracking systems,
reporting that focuses on nonfinancial measures,
standard job cost system,
emphasize significant costs and prospective costs,
exception reporting,
multidimensional product measurement,
integrated data systems,
product cost tracking,
integrate budgeting, estimating and scheduling information,
relate indirect costs to products and processes,
functional activity costs and time based system,
focus on nonvalue-added activities,
life cycle cost analysis, and
the multi attribute investment decision model.

Companies use discounted cash flow analysis with specific hurdle rates to evaluate projects. Engwall argues that long-term projects are saddled with large up-front costs and the "mature rate of return" is not considered because future benefits are heavily discounted. When evaluating projects both financial and nonfinancial information should be considered. Projects should also be evaluated from a portfolio perspective and not as independent projects to determine interdependencies and fit with strategic direction. The objective is to maximize short-term benefits while at the same time maintaining consistency with the long-term strategic plan.


Related summaries:

Berliner, C., and J. A. Brimson, eds. 1988. Cost Management for Today's Advanced Manufacturing: The CAM-I Conceptual Design. Boston: Harvard Business School Press. (Summary Chapters 1-3).

Engwall, R. L. 1988. Cost/benefit analysis. Journal of Cost Management (Fall): 64-70. (Summary).

Engwall, R. L. 1988. Investment evaluation methodologies. Journal of Cost Management (Spring): 40-44. (Summary).

Howell, R. A. and S. R. Soucy. 1987. Capital investment in the new manufacturing environment. Management Accounting (November): 26-32. (Summary).

Martin, J. R. Not dated. Investment management. Management And Accounting Web. InvestmentManageSum.htm

Martin, J. R. Not dated. Moving baseline examples from Sinason. Management And Accounting Web.  MovingBaselineExamples.htm

Sandison, D., S. C. Hansen and R. G. Torok. 2003. Activity-based planning and budgeting: A new approach. Journal of Cost Management (March/April): 16-22. (Summary).

Sinason, D. H. 1991. A dynamic model for present value capital expenditure analysis. Journal of Cost Management (Spring): 40-45. (Summary).