Using Capital Expenditures to Reduce Operating Costs
Organizations have a number of competing financial requirements and obligations. When to invest capital versus when to spend operational funds is an exercise all financial teams try to balance on a daily basis.
Facilities departments play a significant role in these decisions, as facilities are one of the largest consumers of capital and operating funds. Based on how the organization wants to balance its investments, there are opportunities to make capital investments that will reduce future operational costs and vice versa. Being able to amortize a capital investment might be more financially advantageous, and this article will explore best practices for aligning the tactical, day-to-day facilities activities with the long-term strategic needs.
Organizations typically have more capital needs than available funds, but how to deploy those funds can be difficult with competing priorities and no easy approach to rank those needs. A data-driven approach can help facilities departments determine which capital needs are most important, which can have the biggest impact on the organization and which can impact future operational spending.
Best practices for defining capital needs
Capital expenses (CapEx) and operating expenses (OpEx) can be deployed to more effectively use organizational budgets. Three best practices show that there is an effective approach to targeting the right capital investments at the optimal time:
- Aligning facilities with organizational strategy
- Taking a data-driven approach
- Developing an effective, ongoing process
Aligning Facilities With Organizational Strategy
Tactical and strategic needs can be aligned by considering several factors. Are investments being made that support the business? Do the facilities enable the business to effectively deliver its goods and services? How do you know when you are in alignment?
Facility managers compete for capital funds just like the business units, so understanding how the facilities contribute to the bottom line is critical. Just like a company needs to understand its customers and their needs to be able to deliver products that are valued, facility managers need to understand their internal customers. How do they know where to invest if they don’t know their customers’ needs and requirements?
Successful capital plans — and their effective execution — enable teams to reduce both risk and cost, provide facilities that are less expensive to operate, promote a better working environment and better serve the overall organizational business and financial goals and objectives.
In this sense, the facilities capital plan needs to be integral to the organization’s overall strategic plan, or at a minimum, facilities capital planning should be concurrent with strategic planning activities and linked to the strategic plan goals.
Taking a Data-Driven Approach
Have a system that captures key business metrics and combines them with facility needs. Depending on the organization, key metrics could include financial measures (e.g., revenue or costs by square foot or headcount), demographics (e.g., who uses the facilities and when/how), production information (e.g., units or yield by square foot or headcount), etc. Having these metrics in a database allows facility managers to begin to systematically align facility needs with business needs.
Organizations that can look at the long-term needs of their facilities can better understand how they need to manage the portfolio. This strategy is driven by how your facilities are used over an assumed time horizon.
Are you an educational institution and going to keep your facilities long-term? What are the buildings used for? Do you need to look at how to adapt the use of those facilities as student and faculty needs change, and as technology changes? Or are you an organization, like many businesses or corporations that take a shorter-term view of facilities, and value flexibility? What type of space will you need in the next few years? Is the level of investment appropriate, or should you consider moving to a different facility rather than making the investment?
There are four key questions facility managers need to address. First, what is in the portfolio? This is not limited just to the buildings, but includes the infrastructure and systems within the buildings.
Then, what is the condition? If you don’t know your starting point or baseline conditions, it will be very difficult to develop goals and supporting objectives. This can combine information from a condition assessment and operational information from a computerized maintenance management system (CMMS).
Third, how much money will we need to achieve the strategy? What will it cost to address any issues (deficiencies, deferred maintenance) and the renewals that are coming up?
And finally, since you probably won’t get all the money you want, how should spending be prioritized?
Developing facilities data and linking it with organizational objectives can allow facility managers to rank required investments and act as strategic partners to the core business. FMs can then lay out a multi-year investment approach, as well as show how they can be more tactically cost effective (such as bulk purchases utilizing economies of scale).
Developing an Effective, Ongoing Process
In the capital budgeting process, the facility managers are competing with the rest of the organization for funding. To effectively make their case, they need accurate data and a transparent approach that is supported by strategic objectives. Facility managers need a repeatable, defensible process to define how to prioritize investments in their facilities.
This can be accomplished by setting up strategies that are not just based on the condition of the buildings but also on business metrics, such as operational cost savings, revenue or mission criticality of a facility or other metrics the business might use to determine efficiency. It is critical that everyone agrees on those metrics and that when the facility managers ask for capital funds, the business leaders support those requests as they understand the rationale driving the investments. This process can build a level of trust that makes the facilities investment discussion meaningful and results in securing the necessary year-over-year funding.
Through capital budgeting workshops, facility managers can understand what is truly in their portfolio and what investments need to be prioritized. Having visibility into the portfolio condition is a necessary step for an effective capital planning process. As part of the process, it is important to include stakeholders from across the organization, not just the facilities department. Driving to consensus on funding priorities is important for gaining support across the organization and developing credibility.
Businesses Function Best When They Employ Consistency and Process
Many times in these workshops, different people have divergent or competing agendas, which is understandable. Therefore, having a third party moderate can go a long way to reaching consensus, as will allowing different scenarios to be examined and compared. If people disagree, compare the approaches using data to drive different strategies for different parts of the portfolio or scenarios. There is no one-size-fits-all answer. In the same way, targeting the right scenario and the optimal condition for each building will drive getting the best resources and necessary funding.
Businesses function best when they employ consistency and process. They want to make sure that, over the long term, there aren’t surprises or large swings in the methodology to develop budgets and plans. For facility managers, this means having a repeatable, defensible approach to developing an annual capital budget. For example, defining this approach through a process mapping workshop can create a methodology for producing the annual capital plan and budget. It is aligned with the organization’s needs, and year over year, the same approach is used. Facility managers can defend their requests and are partners with the business, so they will have broad support.
Deploying CapEx to reduce OpEx
There are a number of metrics that can be used to help define capital investment options. Prioritization can include the impact capital expenses can have on operating expenses. There are numerous examples of how these capital investments have helped organizations reduce their annual operating expenses. Once the priorities are defined, it becomes much easier to justify these investments. Some examples include:
- Replacing aging assets with more efficient alternatives prior to end of useful life
- Replacing chillers or boilers with more efficient models to reduce energy spending
- Replacing traditional roofs with new roofing alternatives (super insulated, reflective, green or living) to reduce maintenance and utility costs
- Enhancing curtain walls with more efficient systems or elements (super insulation, efficient glazing, shade structures) to reduce energy spending
- Leveraging technology to reduce OpEx
- Replacing analog with digital controls to increase flexibility and reduce run time
- Implementing alternative energy measures (combined heat and power units, solar arrays, wind turbines) to reduce dependency on the grid and manage OpEx
- Investigating alternative funding sources to defray CapEx for implementing new technology (utility rebates, private grants, government subsidies)
Organizations have various stages in their cycles during which the financial focus is on conserving capital or reducing operating expenses, and the stage will drive the timing of the deployment philosophy.
Through managing their organizations’ portfolios, facility managers can have one of the most significant impacts on the finances of those organizations. By taking an approach to defining capital needs and understanding the impacts, they can ensure facilities are in alignment with organizational objectives.
While there will always need to be a balance between capital and operating expenses, timely and targeted capital investments can significantly improve the bottom line by reducing annual operating expenses. The methodology described in this article gives facility managers visibility into both short-and long-term needs and an understanding of where operating expenses can be positively impacted through targeted capital investments.
Article courtesy Ed Zielinski: IFMA’s FMJ magazine
Edward Zielinski, SLCR, AIA, has expertise in developing real estate strategies to support corporate business plans, and in asset utilization, site consolidation, sustainable development and disaster recovery. His experience includes roles as vice president of global real estate and facilities for Nuance Communications and Boston Scientific, and 14 years as vice president of asset management at PerkinElmer.
Zielinski is a Senior Leader of Corporate Real Estate and holds a Bachelor’s degree in architecture from Carnegie-Mellon University and an MBA from Northeastern University. He is currently a consultant with VFA, Inc., an Accruent company, the leader in facilities capital planning and management solutions and can be reached at firstname.lastname@example.org.