The ABCs of High-Speed Converting

One would think that with a high unemployment rate, finding people to work in your plant would be easy, but in my travels, this is still one of the biggest complaints that I hear from converters. Almost everyone is busy, and lead times on orders are getting longer and longer. And while the larger issue is a shortage of paper and sheets, the longer-term problem may very well be difficulty in finding quality people. In the last issue of BoxScore, I talked about whether the current economic conditions for converters would continue, and if they do, what moves converters should be making to secure their futures. I’ve written many articles on the fact that for most of you, machine hours are your most finite resource, and I still firmly believe that. But many of you have challenged this thinking by telling me that they are having massive problems finding people to run the machines. So, in an environment in which converters need to find more machine hours to be able to sell and are having difficulty finding good factory workers, the obvious answer is to embrace high-speed converting.

This means machines that set up quicker and run faster. It means robotics, pre-feeders and automatic takeoffs, palletizers, more conveyorization, and improved systems. In short, it means a significant retooling and reinvestment in your businesses. But how can you justify this investment, if it does not add any new capabilities for you to sell to your customers? Unless you are a three-shift operation, it is unlikely that labor savings alone will justify the expenditure, unless you are OK with long payback periods. So why spend the money?

The short answer is that, for the most part, the more people you have, the more headaches you have, and as I said earlier, it is very difficult to find people who are happy working at fairly menial jobs in your plant. In addition, people are far more prone to error than machines are, so your defect and damage losses will be minimized. But the key to all of this is that by running faster with more uptime, you will create more machine hours per shift to sell. Every plant has a different set of constraints that they have to overcome, but the biggest common constraint that everyone shares is the finite number of hours they have to utilize their productive capabilities. In my opinion, the goal of every manufacturing company should be the maximization of the number of hours that the company has available to utilize. Management will then have the most options available to it use in the effort to maximize profits.

In some circumstances “speed-based” investments are easy to justify. If you assume that the overall cost of each person per shift is $50,000, and you are looking for a three-year payback on your investment, then each person you eliminate per shift will justify a $150,000 investment. In a two-shift operation, each person you eliminate justifies a $300,000 investment, and in a three-shift operation, eliminating one person per shift will pay for a $450,000 investment. Obviously, if you can eliminate an entire shift, you can justify a fairly large investment just by the savings in labor and related costs. At the end of the day, it is fairly rare to find a large capital investment that can be justified entirely by plant savings.

In most cases, the justification scenario must be based on more intangibles than on calculations, and it often becomes a leap of faith. Many larger corporations will run complex internal rate of return scenarios and attempt to calculate the effect on the overall economic value of the company. While these may be useful things to do in the realm of large publicly held corporations, for most privately held companies, I think it comes down to the following.

The risks associated with not making the investment:

1. Will we run out of machine hours to sell? Many of you are at this point already.
2. Can we find “acceptable” plant personnel? That’s a real challenge that will likely get worse if the economy continues to heat up.
3. Will we be at a competitive disadvantage? Many converters are pretty far down this path already.
4. As the mill system moves to lighter board and the customers start demanding lighter-weight boxes, will my existing equipment be able to convert the board? That depends on how light they go and what bells and whistles you currently have.
5. If my competitors embrace high-speed converting, will I be able to continue to compete with them? Speed kills, especially when evaluating longer-run business. When you start looking at margin per hour, someone with equipment that sets up and runs two or three times faster than you do has a significant advantage.

The risks associated with making the investment:

1. Can my current balance sheet support the investment? Many businesses with weaker balance sheets have tried to structure “operating leases” in the past, to keep the additional debt off of their balance sheets. The new lease pronouncement that was made a few years ago by the Financial Accounting Standards Board is supposed to become effective in 2021. This new standard will force businesses to capitalize all leases and show a depreciable asset and a liability on the balance sheets, so this strategy will no longer work.
2. If I do not generate new sales for a period of time, can I afford to make the payments? Remember that the IRS is still giving you 100% bonus depreciation through 2022 and then 80% bonus depreciation in 2023 and 60% in 2024, so as long as you are making money, you can use the depreciation expense to reduce your taxes and fund some of the negative cash flow.
3. If I take on a lot of debt and am looking to sell my company in the near future, won’t this adversely affect me? While it is true that interest-bearing debt will generally reduce the amount of money that a seller will put in his pocket, the flip side of this is that the buyer of a company with poor equipment will likely reduce the price by the cost of upgrading the equipment anyway.

High-speed converting equipment and increased plant mechanization is not cheap, but with so many converters getting into this game, you will be forced to pull the trigger at some point if you are going to stay competitive. It’s always best to take risks when you are strong, and the converting business has been booming through the pandemic, so this may be the right time for you to start moving in this direction.

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