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Investing in High-Speed Converting Equipment

By AICC Staff

June 1, 2018

The latest class of fast-setup, ultrahigh-speed converting equipment is an absolute game changer from a production point of view. The output of each machine, run full out, can equal the entire output of an average-sized sheet plant. They are costly to install, occupy a large footprint in the plant, and require a lot of expensive maintenance. It is also difficult for human beings to keep up with them, so pre-feeders, fast stackers, dedicated banders, and robotics are required in most situations.

Economists and analysts who follow the paper and converting industries can predict capabilities and capacities down to seemingly the nearest ton, but no one knows what the converting capacities are in any given market. What we do know is that there is immense extra converting capacity in almost every plant. Certainly, this is true of any plant not running three full shifts, but most converters have lots of open time on their existing equipment and shifts. So why are converters so eager to purchase expensive fast-setup, high-speed equipment when their existing equipment may not be full?

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Often buying one piece of these new machines will enable a plant to shut down one or more existing machine centers, which can translate into significant direct and indirect labor savings and free up valuable manufacturing space for other endeavors. The newer equipment will print better and consistently make a perfectly square box to a precise tolerance, which is important for customers who use them with automatic case erectors and other applications in which consistency and precision are paramount. They may enable some converters to eliminate a partial shift, which is often not as profitable due to the additional supervision and material handling personnel needed, and may help limit overtime on existing shifts.

The bottom line is that if your competitor can convert 10,000 boxes in half an hour and it takes you five hours, he will likely be able to charge a lower price for the order, putting you in a competitive disadvantage. The new tax law also makes buying equipment very attractive, since you can write off 100 percent of the cost of investment in equipment in the year of acquisition. Lots of profitable companies would rather speculate on a new piece of equipment than send money to the IRS.

So, with all this said, let’s talk about some practical considerations when you are making a sizeable investment in a single piece of equipment. For illustrative purposes, let’s assume that the cost of the equipment installed is $4 million (let’s assume this includes training, spare parts, etc.), and that you will be able to close one machine center and eliminate five plant employees. You expect to have enough business to run the machine for 2,000 hours in the first year, and preventative maintenance will cost you $20,000 per month, whereas the maintenance on the existing equipment was about $25,000 per year. Your old machine that you are selling is worth $250,000. How will this investment affect your financial statements and your estimating system?

In this fairly simple example, to pay for the machine, the company needs to generate an additional $116,000 of sales at an estimated contribution of 25 percent. Not the end of the world, right? The problem often lies in your estimating system architecture, which is geared to calculating a machine-hour cost. When you put a $4 million machine into your estimating system calculation, with an estimate of 2,000 hours, it is likely to add a $150 to $200 per hour cost to your system. It will also treat the increased maintenance cost as a variable cost and add $100 per hour to the machine-hour cost for that. At the end of the day, you will go to market with an additional $250 to $300 per hour cost in your estimating system, and most of the orders you run through it will look extremely unprofitable and may show little or no contribution.

Typically, the company decides that they had better “pretend” that they are running the machine for at least two full shifts to lower the “hit” to the estimating system. Companies do this when their system spits out suggested prices that are way off from what the market is willing to pay. My view of the world is that, as shown in the example on Page 70, the company’s fixed costs have increased, meaning it needs additional contribution dollars to break even. If the company were out there looking for orders with a lot of contributions that are at or near the 25 percent contribution margin shown in the example, they might have an easier time coming up with a marketing and sales plan to fill up the new machine.

One of the great problems in cost-​estimating is how to reflect a very large capital expenditure in your costing system. When a single machine can cost more than $4 million, this problem is greatly exacerbated. Looking at orders based upon variable profit per hour versus fully loaded cost per hour may sound like a cheap accounting trick, but it can have far-reaching implications to profitability.

This new class of equipment is greatly changing the converting industry. Based upon the historically low interest rates we are experiencing and the most favorable tax write-offs we have seen in U.S. taxation history, more and more converters will be making these investments in the next few years. Anyone who travels down this path needs to take a hard look at the incremental costs and savings associated with the investments, the effect on their balance sheets, and the amount of leverage they can handle. The final factor for many will be how they reflect this investment in their estimating systems. If there is $1,000 of contribution in an order and you can run it in half an hour, that translates into $2,000 per hour. If it takes five hours of machine time to run the order, it is generating only $200 per hour. A potential tenfold increase in the hourly contribution generated by the machine can more than justify the high price tag.


width=150Mitch Klingher is a partner at Klingher Nadler LLP. He can be reached at 201-731-3025 or mitch@klinghernadler.com.