Yellow Iron, Black Smoke
Yellow Iron, Black Smoke
Costing Insights: Owning & Operating Costs
In this episode, Mike Vorster and I will dive into chapter 3 of his new book: Construction Equipment Economics version 2. We focus on operating and ownership costs and the critical distinction between the two. Be sure to check out the book on Mike's website at CEMPCentral.com
Welcome to Yellow Iron, Black Smoke, your podcast for engaging conversation on construction equipment Economics and Management. I'm Michael Kelley, your host today, Mike Vorster. And I will dive into chapter three of his new book construction equipment economics, version two, we focus on operating ownership costs and the critical distinction between the two, be sure to check out the book on Mike's website at CEMPcentral.com. Today, we're gonna be talking about costs for the first time, that's what in chapter three of the book kind of introduces his owning and operating costs? Sure seems like, in the time that I've known you that we've spent an awful lot of hours talking about exactly this. There's a lot there's a lot to owning and operating costs and an equipment fleet?
Mike Vorster:Well, there certainly is. And one of the things that I sort of wrestled with a lot is how do we structure that conversation. And I'm pleased that what we're going to do today is the is what I think is an essential, early part of that conversation. And that is to talk about why owning and operating costs are different, and how we can use those differences to give us insights into the into the whole cost question. And I think that that's important to understand the sort of difference between the costs and how we can use those differences, before we dive into the details of what constitutes owning cost, and what constitutes operating costs, and so on and so forth. So let's talk about the similarities and the differences.
Michael Kelley:Yeah, I think that that's important what but what's interesting to me is, I think it's so important that I'm wondering, why did it wait till all the way till chapter three before we got into it?
Mike Vorster:Yeah, well, so we think about cost as as important. And again, in structuring my thinking. And in structuring the book, I had to give chapters one and two to the sort of interpersonal aspects of running the business and running the fleet. Because if your organization doesn't work, and if you haven't got your interpersonal aspects, and your organizational aspects, right, you know, nothing, nothing is going to work. Because first and last business is about people. People do business with people. And transactions take place, between people. And so if you haven't got the organizational, interpersonal things correct, you know, those transactions are never ever going to be successful, we think about dollars and cents. And I think dollars and cents is too cold a term, I much prefer to talk about people in profits, because I think those two terms go together, much more importantly, and much more regularly than, you know, dollars and cents that makes it sound sort of hard and hard and cold. I think there comes a time when we've chatted enough about the softer aspects and the interpersonal aspects, the organizational aspects. Let's get diving down into the dollars and cents and into the owning and operating costs associated that.
Michael Kelley:Yeah, no, I think you're right. And, you know, I think that can happen in a lot of places. A financial statement of any kind, including counting costs, and equipment is an abstraction. That is a financial representation of what's happening in real life. It's only an abstraction. And sometimes I feel like that, and maybe maybe it's a broader culture thing, but that we tend to think of the abstraction first, and the real life second, and I and so so I completely agree. It's the it's the people and the profits. It's the it's the people that are doing business with the people that we're trying to represent in some way.
Mike Vorster:meaningful way. We concentrate too much on the scoreboard and too little on the game. And so and so, yes, you know, the scoreboard only really reflects how well game is being played, or has been played. And again, when one talks about the financials as being an abstraction of the financials as being the scoreboard scoreboard also only reflects how the game has been played. And it's kind of like driving your car by looking through the rearview mirror. Right. Yeah. Looking through the windscreen? Yeah, it's in forward and financials of routinely routine financials are very bad at doing that.
Michael Kelley:Yep, I agree. Well, so when we dive into this abstraction, this important abstraction of of this particular aspect of life or these particular transactions, which is owning and operating costs, there's a A lot of companies that I know that just have equipment costs, right? They just have this kind of lump sum down here somewhere in the indirects, usually, of their financial statement says, equipment costs. But you make a distinction here between owning and operating costs. what's what's at the heart of that? Why do you make that distinction?
Mike Vorster:Well, really, I make that distinction. Because making it gives me an ability to have much better ability to analyze the cost. And making that that distinction gives me an ability to gain some additional insights into what's going on in the equipment account. And also, it gives me the starting point for fleet age management and the whole question of economic life, owning costs and operating costs. Like I said, kind of like having cattle and horses on your ranch, right, you've got to manage the cattle in a certain way and achieve the best benefit from that enterprise. And then the horses play a certain role on the ranch, you manage them, look after them, enjoy them, in a certain way. And, and please, please, please, you're not going to be successful if you manage the cattle the same way as you manage your horses, or if you manage the horses the same way as you manage your cattle. And so really, when you think about equipment costs, there are owning costs, which are very, very different to your operating costs, manage each with the attention, skill, care and diligence that each deserves. And I think that's what I would like this conversation to really to be about.
Michael Kelley:Yeah, well, I can see that. I mean, I don't have cattle myself, but I do have grapes, and apples. And when you when you said that that's exactly what I thought, if I tried to raise the grapes harvest the grapes care for the grapes the same way as I care for the apples. One distinction, for example, is you can spray broadly spray at the base of the of the apple trees, and it really helps to keep the weeds down. It doesn't get absorbed into the apples, it's all safe. And it makes it so that it's much easier to care for the apples. And if you get that even close to the grapes, the grapes die immediately.
Mike Vorster:Yep, has its own way of being managed. But then apples and grapes, yes, in good metaphor for the differences. And if you planted an apple tree, and then a grape plant an apple tree and a grape, fine, then you would get things all messed up. And if you just had one entry into your books of accounts and my horticultural enterprise, you would get things really messed up as well. Right?
Michael Kelley:That's right. That's right, exactly. Great. Luckily, for me, my grapes and apples are just somewhere to sink costs not have to make money off them. But But back to the horses and cattle metaphor. What's the horse? And what's the cattle in the equipment budget?
Mike Vorster:Well, I don't really, you know, I think the metaphor has kind of run out of gas by now, as long as the metaphor gives us the visual of two very different components to the enterprise called ranching, the same as the as the grapes. And apples give us the visual of two very different components to this enterprise operating costs. I think, when I think about owning and operating costs, I think, a little bit sort of on a timescale. And to me, owning costs, I define as the cost of bringing the machine into your fleet, and keeping it there. Okay, so all the costs associated with bringing the machine into your fleet, and keeping it there, some people call those the sort of cold and dry costs, then after you've brought it into your fleet, and kept it there, that is there. The next thing you of course, do as you turn the key and put it to work. And so my definition of operating costs, is then the next phase, all the costs associated with turning the key and putting it to work. And that is a kind of simple, straightforward, no nonsense definitions, which are, again, have good visuals associated with them. Because you can imagine you brought the machine into your fleet, you've parked it in the yard. Now what? Well, now what doesn't mean to say that there are no costs associated with keeping it there. But then once you've got it there, and you're brought it into your yard, and a shiny new machine is standing there, somebody takes it takes their hand, puts it on the key and turns it and all of a sudden, things start revolving and things start using oil and grease and parts and labor and things like that. And you put the machine to work. And so what are the costs of owning the machine, and then what are the costs of putting the machine to work. And that's a really simple distinction. I make it Is it safe to say that the owning costs are kind of the one off costs at the beginning? Yes, if you follow the sort of old style of saying that you buy, you buy things and pay for them, right. Whereas today, very many more of the assets that companies own are financed or leased or one way or the other. And so there are many costs of bringing in into your fleet that are ongoing. In other words, your lease payments are ongoing costs of bringing it into your fleet, your loan payments are ongoing costs of bringing it into your fleet. And then of course, on the owning side of things, we frequently capitalize those assets. In other words, we, we go to the company Treasury, and we say, we don't want to expense this purchase right now. Hey, Mr. CFO, as the custodian of the company Treasury, or Linda sub cash, we'll buy it and, and then we'll capitalize it and put it on the asset register, and depreciate it or write it down as it looks. And as it goes to work. And as we keep it in our fleet, we'll write it down. And then those become sort of ongoing charges that replicate or stand in the place of the big first cost of purchasing the machine. And so there are a lot of earning costs, which are ongoing, either finance costs, these costs are depreciation charges or ongoing costs. And then, of course, there are things like licenses, insurances and property, they can go on, according to the passage of the Earth around the Sun according to time. And so you will incur your owning costs on a monthly or an annual basis. And the way in which you incur owning costs, really has very little to do with the time that the key is turned on. And the machine is being put to work here. So our only costs are monthly or annual fixed costs. Okay,
Michael Kelley:yeah, that makes sense. So you can have a personal car that you bought from the proverbial grandma down the street that only drove it to church and back on Sundays, that might be a 1980. It's not very expensive, because it's old. But the operating side because she only drove her to church and back on Sundays. Now, now, she hasn't used a lot of she hasn't put a lot of cost and the operating costs, right hasn't been a lot of miles on the road. So it might be a very good 1980 car. But the ownership cost, he's she's used up all of the ownership costs, he's depreciated it out, over over the last 40 years,
Mike Vorster:she would have experienced ongoing costs of owning it on a annual or a monthly basis. But because the key was turned very little, and the car was used very little, the operating cost per mile would be proportional to the miles traveled. But owning cost per mile would be huge. Because you've got to take those monthly or annual fixed costs of keeping it in your garage in this case, and amortize those over a very small number of miles, right? over a very small number of miles. Right, exactly.
Michael Kelley:That makes sense to me. So let's let's talk about owning costs, then sounds like there's a there's a whole different regime with understanding ownership costs versus understanding operating costs. So starting with owning costs, within that side, where do we start with the purchase?
Mike Vorster:Yes, we start with a purchase. And then of course, at some stages, the proceedings at the end of the life of the machine will probably sell it and then recoup their residual market value. So the residual market value is in fact, is then a negative owning cost, okay. But one of the things I like to do is to make a very clear distinction between a cost and a charge. Because a cost is when you write out a check, or you receive a check or is money in and out of the organization. And so you're owning costs, is the money that you paid the dealer when you bought it. It's the money you get back from the auction house when you sell it. It's the money you paid for the lease or the finance those are all costs that you were you write out or receive a check. But if for instance, you capitalize it, and you charge yourself depreciation, then those charges are just book entries designed to keep the books of account, right? Because you've capitalized this brand new shiny machine, you've then put this brand new shiny machine to work. And as you capitalize that, you put it on your balance sheet, but it can't stay on your balance sheet at that initial value. So you have to write it down on your balance sheet. And so you have to chart your charge yourself depreciation, so that you can keep the balance sheet. And that's sort of the balance sheet impact of the pre of the depreciation charges. And then also, there's the matching principle, where if you use a capital asset to produce work, you have to charge yourself something for the use of that capital capitalized asset. And that again, is a depreciation charge. And that's then the p&l impact of the depreciation charges. So if it's a capitalized asset, you get involved with charges, charges, keep your books of account straight, whether those books of account as your balance sheet, where you've got to make sure that the assets are properly valued on the balance sheet, or whether book of account is your p&l statement, where you've got a debit the p&l statement for the use of that capitalized asset, difference between costs and charges.
Michael Kelley:Though depreciation is a major part of this ownership costs, it's a major part of how we look at it. And it seems like understanding how how the CFO looks at depreciation is an important thing for the equipment team.
Mike Vorster:Yes, you fell right into the trap, right? You said to print these depreciation charges are a major portion of equipment cost, okay. And the depreciation charges are a way in which the ownership costs manifest themselves during the life of the machine. Because during the life of the machine, you actually don't from a buy and sell point of view, you don't experience any owning cost, you experience the big one at the front. And when you sell it, you're going to experience the residual value when you sell it. In the end of all you are seeing these charges. Now one of the things that makes it all workable, or straightforward or simple, if you wish, is that if you have set your depreciation charges too aggressively, too high, and your book value is very low, you get to sell it and you make a gain on book that gain on book goes straight to the bottom line and in fact chews up those interim charges that you have been living against that your CFO has been living against the equipment account. If on the other hand, your depreciation charges are too benign. And, and the CFO has been leveling very small charges at work, which you've rejoiced about probably, in the fullness of time when it gets to be selling it, its book value is high, and you sell it for less and you experience a loss on sale, awesome book, then that loss comes straight to the bottom line as well and chews up those benign charges that you've been rejoicing in over time. Okay. And so it's really important that your depreciation charges bear a good relationship to what the market value is for the machine. So that you don't get these big paybacks from gain on sale. Or you don't get these big debits from a loss on sale. So that sort of gain or losses on sale in reason one to the other. And if that's the case, then of course your charges and your costs are plus minus the
Michael Kelley:sale. How do we manage this? Because one of the one of the questions I get from from contractors all the time is how am I supposed to know how much this How long is this gonna last? I don't know if I'm gonna utilize this five years from now. And it seems like that they have they have this do that, should they? Should they redo their depreciation every couple years,
Mike Vorster:having a very aggressive depreciation policy, writing down their assets very aggressively, is inclined to say pretty close to standard practice in the construction industry, especially with small closely held businesses. And then what we do is we sort of leave the profit in the iron. We depreciate our assets very fast and in the end when we sell them for a gain on book, we rejoice and celebrate that gain when it occurs and we take that gain Then go by the proverbial villa in Spain with a tour, right? Because we've left some of the profit in the iron. And many folk in closely held private companies in my background as well. You know, the the equipment is a storehouse of family wealth, you get to that point by writing it off company wise, very aggressively. Of course, one of the things we've got to say, and you've led very nicely into this concept, and that is that the receiver of revenues caught on to this long ago and far away. And when it comes to reporting your taxable income, the receiver of revenue says you can't use any depreciation policy, you care to dream up, you use a depreciation policy that I stipulate in my tax codes. And that's your modified accelerated cost recovery makers depreciation system, because the depreciation is a receiver revenues, you know, seeing the opportunity to leave the profit in the iron. And I said, there's some of the profit you can put in the iron according to my tax codes, but you can't leave too much of it in the eye. With regards to changing depreciation policies, in my experience, there is very little that way of the red flag to an auditor as much as a change in your depreciation policy. Because your auditor will want to say, Hey, have you had a bad year, and you wanting to increase your net income by softening your depreciation charges for this year? In other words, taking some money out of the iron ore Have you had a very good year, and you're wanting to hide some of your net income by toughening up your depreciation policy? In other words, leaving some of the profit in the iron? I've been involved in situations where there was very good reason to change the company's depreciation policies because we'd been systematically making gains on sale. And the ownership said, No, we can't do that, because it will be, you know, red flags to the to the auditor's red flags to the financial management folks, we just want to keep them systematic, conservative and consistent, are the three words I use very often when it comes to depreciation policy. Fourth word, systematic, conservative, consistent and market related. And of course, there are policies which kind of fit that role and you get your, your double declining balance or your some of yours digits or things like that, which gives you a curve. Or you get the customary straight line down to either zero or some depreciated book value that sort of mimics a curve. But you know, if you really want to know what depreciation is, wait until the market tells you what it has been?
Michael Kelley:Well, that's, that's great. That's great. Except for that. It Like you said, we can't run our business in the rearview mirror. So it's so what happened in 2008 2009, when everybody wanted to sell their stuff, and nobody wanted to buy it. I mean, I, you know, I was kind of getting started in that timeframe was a terrible time for construction in the US.
Mike Vorster:Well, you know, what do we say we learn a lot from stories, okay. 2008 2009, residual market value of equipment was lower than normal, sort of systematically. The company we're going to tell a story about experienced a lot of loss on book because the market value had been, it had been some gain some losses on books in prior years, was experiencing started experiencing a loss on book systematically. And so they said, Our depreciation policy is too benign. We need to toughen it up. And so the analysis was done. And they went to the president and said, We need to increase our hourly rates for our machines, because our owning costs are understated, because current experience tells us our depreciation policies to benign, please approve an increase in rates based on the fact that our depreciation policies to deny and the President said no, I cannot do that. Or I would find it very, very difficult to do that. Because doing that would acknowledge the fact that our depreciation policies to burn line, which simultaneously acknowledges the fact that our equipment assets are overstated. Right. And, as President, I cannot certify my books of account knowing that our equipment assets are overstated, because one of my responsibilities is to make sure that our assets are reasonably stated in our balance sheets. Right. And so please don't tell me that our equipment assets are overstated. You know, there are those sorts of issues to this thing called a depreciation policy, the degree to which you state your equipment assets in your balance sheet, and then of course, there's the impact on the p&l and on your bidding, and on your market competitiveness from a rate and rate setting point of view. Very good. We've entered we've gone to graduate school under pressure.
Michael Kelley:Yeah. And, you know, thinking about this, this president that said, you know, don't Don't tell me that. You're in a sense he was he was also correct, because you if you wait two years, the market did recover. Right. And, and so writing down that for that period of time, when Yes, residual market value was terrible, you couldn't give away equipment, in some cases, especially specialized equipment, then, but in a couple years, when the market had recovered, then then what changed again?
Mike Vorster:Yeah, and your point on the transient nature, nature of the of the story is, is absolutely critical. It's of course, what makes it a good story. Imagine one of the company's assets was a quarry site containing a certain certain type of rock. And all of a sudden, the D o t, rewrote its specification for asphalt aggregates, it said that type of rock was no longer useful in asphalt, then that asset would be permanently diminished. And then you are required to write that asset down because of the permanent diminishment of that asset. Alright, that's not the correct English, but I couldn't find the right word right away. But if it's a temporary sort of blip, because of a downturn in the industry, then yes, there's nothing wrong and it's perfectly justifiable to, to ride it out and say things are going to improve,
Michael Kelley:it seems like that there's more to the ownership costs than just than just the cost of purchase and the resulting depreciation, and then the the market residual market value, what are the other parts that we need to think about?
Mike Vorster:Whether are then the true costs of licenses, insurances, property taxes, and those sorts of things associated with the keeping it in your fleet definition, sort of what the what we were talking about the purchase and the depreciation, and the leases and the loans that's associated with bringing it into your fleet. And then we have the licenses, insurance and all the statutory costs associated with keeping it in your fleet. Now, those, of course, are costs, you write a check out to the licensing authorities, but but they as well occur on an annual or a monthly basis. And so they are fixed costs that don't depend on how long you've got the key turn?
Michael Kelley:Sure, sure. And I can see that being different, even different jurisdictions, I definitely see an outflow of equipment from California to less regulated states, for example. And I would guess that's part of it is that the cost of keeping it in your fleet in California is going to be higher?
Mike Vorster:Yes. Is that varies from location to location? Yeah.
Michael Kelley:The interesting thing about ownership costs that almost seems like this is a spreadsheet. calculation. This is something that a, an accountant does behind a computer screen. And, frankly, it seems like something maybe I even I could do it, but it doesn't have much to do with getting out there and changing out the tracks and going in and replacing the hydraulics in going in, in tracking down the electrical, electrical component failure. Absolutely, yeah.
Mike Vorster:Yeah. Yeah. Because one of the things you're owning costs are the province of the folk who are involved with accounting and finance and cash and cash flow. And, and those sorts of things. Another characteristic of owning cost is that, as you've said, it's almost a spreadsheet calculation. They largely fixed when you ink the deal. And so there's very little in terms of the dollar value of your owning cost. That's there's not a lot of risk associated with $1 value of your owning costs because you've made the deal. You've struck the deal. You entered into the agreement. And it's now a matter of making good on that agreement. Of course, the big risk is the utilize utilization, the hours work, the number of hours that you work that you can have in hand to make good on the deal that you have already struck. You can't go to someone and say, Gee whiz, I'm, I'm not driving this car an awful lot. Could you take it back? Could you take parts of it back? Work it, the dollar values are largely known, the dealer struck the undertakings and made you've entered into the agreements. It's now a matter of making good on those deals. Someone said to me one day that owning costs, were kind of like buying back from you. Okay, and it's all about the number of hours you work the machine that gives you the charges or the revenue or the money or the completed construction that you can use to buy back the new front. Sure. Sure.
Michael Kelley:So in that sense, if the if our proverbial grandma had bought herself a really nice Cadillac, and had a parked in her garage, she wouldn't have used it, she wouldn't have shown off that Cadillac very often over the last 40 years. But if she instead had driven it, a considerable amount, she would have recouped her ownership cost simply by by per mile driven anyway, that she would have been able to show off the Cadillac a little bit while it was still new.
Mike Vorster:Yes, if your payment on your Cadillac is$1,000 a month, and if you drive 1000 miles a month, that's $1 a mile. If it's payment is $1,000 a month and you drive 100 miles a month, it's $10 a mile, right? Right. Right, as much you can do about that arithmetic, it's in place, there's just a numerator divided by denominator, and the numerator is pretty well known. It's the denominator, which is the risk.
Michael Kelley:So So it sounds like then that a lot of the risk is in the operating costs, although in some ways they seem more straightforward. Is that? Do I have that right?
Mike Vorster:That's right, they straightforward, they're more straightforward. First done in two dimensions, but higher risk in the third dimension, they're what they're most straightforward in one dimension. And that is the costs there, none of these depreciation Charges and all that sort of thing. But it costs you write out check, when you bought checks when you buy parts. And when you buy fuel, and tires and tracks and things like that. The other one is that they proportional, largely proportional to the hours worked. And so the longer you have the key turned, the more work you're going to be doing. But also the more operating costs you're going to be incurring, so they proportional to hours worked. They're complicated, because of the risks associated, you have your relatively constant operating costs, like fuel and tires, tracks were parts, but then you have the big uncertainty called repair parts and labor, right. And that's where the risk comes. And that's, of course, dependent on application age operation, and all sorts of things like that. So with operating costs, your risk is in the numerator. And the denominator sort of travels along with owning cost, your risk is in in the denominator, because your numerator is largely fixed. Okay. Or our
Michael Kelley:cost per hour, right? Yeah. So the more the more hours you run the machine, the more you're going to spend. And so it doesn't matter how many hours it's, it's really and how can I How can I manage this cost? Yeah.
Mike Vorster:So before we dive too deep into our operating costs, all right, and and what are their kind of defining characteristics? Somebody said to me the other day, you know, machines, we all we always think about machines as assets. And I said, Yes, of course, they were assets. He said, Yep, they're only assets when the key is turned and they working. The minute you turn the key off or become a liability. And I thought that, together with his visual visual of keys and turning keys, right, went very well, this, this visual that says, I've got the key Turn the machine is working, it's an asset, I put my right hand out, I grabbed the key or turn it off, the machine stops working, it becomes a liability. And that in many ways sums up this key on key off kind of story that we're we're weaving.
Michael Kelley:Right? Yeah. I mean, and that's just it, if you don't need the machine. In other words, the key is always off, then it's not going to generate any revenue in the future. If you generate any revenue in the future, it's not an asset.
Mike Vorster:Yep. And one of the things about life is We want to keep our list of assets as long as possible and our list of liabilities as short as possible.
Michael Kelley:Right, right. Right. That's interesting. So you end up with this, with these liabilities masquerading as assets. Yep.
Mike Vorster:Yep. And that's, that's, that's what a lot of people do, and what a lot of people don't understand our ads. And if we, if we achieve anything, this, let's achieve a situation of, you know, machines moved from a list of assets to a list of liabilities, as soon as you switch the key, often, we want to keep our list of liabilities as short as possible.
Michael Kelley:I feel I feel like that, that you're Dorothy and you just pulled the curtain back on the Wizard of Oz for 35. Companies that are going to listen to this, they are all still in the in the I have to build my asset list up a place of their business.
Mike Vorster:I hope they do build it as a separate because I hope that they do turn the key and put the machines to work. That's the objective.
Michael Kelley:Exactly, exactly. Well, going back to the operating costs, then how do we categorize the operating costs? is there is there useful? Is there a useful way to kind of break those down?
Mike Vorster:To me, what's been very useful in breaking operating costs down is to separate the relatively constant ones, like fuel tires, tracks, where parts, which don't change much over the life of the machine, from the one which does change significantly through the life of the machine, which is your repair parts and labor. Okay, your maintenance expenditure also doesn't change significantly through the life of the machine is, is the repair parts and labor. And in thinking about repair parts and labor, something that's helped me a lot is something that I've first read, if I'm an excuse to say so in the 60s, and that is that repair parts, car repair costs come in spurts. And if you think about it, that's exactly what happens, the machine goes down, and you get a spurt of repair expenditure. And so what we talking about when we talk about repair parts and labor, is we're talking about the magnitude of the spirits, and the frequency of the spirits, because the magnitude and the frequency together will determine the cost of repair parts and labor per hour. So sometimes we have lots of little spurts, sometimes we have a few big spurts. But the relationship between little spurts and big spurts and infrequent spurts, and frequent spurts is a very interesting thing to sort of contemplate, okay. But one of the things we do know is that as the machine ages, and as the machine experiences wear out failure, and all machines experience wear out failure, even a machine like myself, okay, the we, the magnitude of those spirits, and the frequency of those spirits are going to increase both the magnitude and the frequency. Sure. So your repair paths are going to increase exponentially, because it's the product of two things, each of which is increasing the magnitude and the frequency of the Spirit. And that's helped me a lot in conceptualizing repair parts and labor is to kind of think about it like that. But very, very difficult to estimate repair parts and labor, depend on age depend on application operation. Bearing in mind, all the studies I've done, have shown that the thing which has the most impact on operating cost is the hand that turns the key. Again, we have this visual of the hand, turning a key, it changes it from an asset or liability. The hand that turns the key massively impacts the magnitude of your operating costs.
Michael Kelley:Yeah. So when we were talking, you said to me that, Michael, we're blessed by the fact that we have these two different characteristics. In that, that struck me that word that we're that we're blessed by the fact that we have these two different. Talk to me a little bit about why you said that then.
Mike Vorster:Well, to start with, I think our ability to estimate the cost of owning and operating our fleet. Notice I ran the two words together, they're very quickly our ability to estimate the cost of owning breath in and operating our fleet is improved if we look at each of the two cost types completely separately when it comes to estimating. Okay, in other words, words, we have the ability to bring together the folks whose skills are in accounting and finance and loans and leases and depreciation, and say to them, please, please, please focus on this aspect of our fleet costs. And then we have can bring together the focus skills are in repairs, labor, maintenance, parts, oil, grease, electronic component tree, and so use their skills to help us estimate this aspect of the cost of our fleet. And so I think we're in a position our first placing, if you wish would be that we can and we should divide and the two components of cost and make the estimating process focus on on owning in one case and operating in another, I would hate to have a mechanic estimate owning costs. And I'd hate to have a CFO estimate operating costs. But so we have the two components to cost and we can bring the skills necessary to bring them to bear. The second one blessing, I think, is the fact that owning costs and operating costs have such diametrically different risk profiles. Only cost the risk is in utilization in the denominator of the cost per hour calculation. operating costs, the risk is in the numerator of the operating costs per our calculation. That means that from a cost management and cost control point of view, if I look at a cost report, and I don't divided into other gains and losses in owning or other gains and losses in operating, frankly, I don't know what to do. Right? I look at a cost report and I see there are gains, there are losses on the owning side of the house. I know I need to go out there and fix utilization. Okay. folks who don't split their cost knowledge and their cost information between owning and operating, I've seen them make rific mistakes. When it comes to analyzing the causes of cost overruns. You hit the knee jerk reaction, oh, we've got an egg in the equipment account, let's find out the mechanics and by non OEM parts a little deeper, we see utilization is down. Well, firing the mechanics and buying non OEM parts is not going to fix a utilization problem. In fact, it might even make it worse. So the fact that we can separate these two cost types, massively improves our ability to unscramble the equipment account, to dig deeper in the equipment account to analyze the problems in the equipment account and take appropriate action. In fact, when I go somewhere and folks say to me, Hey, Mike, there's an egg in our equipment account, what can you do to help us? And I say, well, let's have a look at the earning side of the house. And they say what, I've only got this one number, like you said under indirect costs somewhere. I look at them and I say, Well, you know, the flight out of here leaves later this afternoon, I'm sorry, there's very little I can do to help you. Because from a analytical point of view, you absolutely have to separate the two and do the analysis and fault finding if you wish on the earning side of the house, and the analysis and fault finding if you wish on the operating side of the house, otherwise you completely flying blind.
Michael Kelley:The first question is what's what's more important, oh, managing your ownership costs or managing your operating costs?
Mike Vorster:You absolutely need to do them both. You absolutely need to manage each with a skill care and diligence because the cost of your fleet is the sum of those two. Okay. Now, here's another set of our blessings. We've said we had a blessing with regards to improving bringing the right skills to the estimating table. We've said we've had a blessing with regards to our ability to unscramble the egg and manage the yolk and manage the weight of the egg separately as they deserve. But the third one is of course, that operating costs go up operating cost per hour goes up as the machine ages and owning cost per hour goes down as the machine ages and we get evermore hours over which to just spread the fixed cost of ownership. So if you've got a very young fleet, and if you tend to run your fleet very, very young, you need lots of expertise in loans and leases and read ROI, and return on capital. And then your ability to manage owning costs become very important. If your fleet is very old, and you're spending a lot of money over the parts counter, and you're spending a lot of money on mechanics and mechanic trucks and that sort of thing, then your ability to manage operating costs, of course, becomes massively important. But if your fleet age balances, well done. And if you're not spending, if your fleet is round about the optimum lifecycle period, where you're not spending inordinate amount of money on, I mean, cost per hour, and you're not yet spending inordinate amounts of money on operating costs per hour, then you really need to manage both
Michael Kelley:very, very competently, very, very. So it sounds then that those two depend whether you concentrate and owning or whether you concentrate and operating in relation to each other, more, more, one more one than the other. Depends on age. That kind of leads to my second question, which is, is age management really the ticket here? Is that actually more important than cost management?
Mike Vorster:Yes, short answer is yes. Okay. long answer is yes, as well, because really not a lot, we spent too much time trying to manage cost, and too little time trying to manage age. Because if you think about it, your optimum life cycle period is that time when you're the aggregate of your owning and operating costs reaches a minimum, because you are no longer in the in the world where you spend lots and lots of money on on owning costs. And you haven't yet reached the point in the life of the machine, where you're spending inordinate amount of money on repair parts and labor. So your optimum life cycle period is going to be the be at the point where the sum of owning and operating costs per are reaches a minimum. If you can keep your fleet round about the optimum life cycle period, then one of the things you do know is that you're not throwing good money after bad. And perhaps that should be our goal to stop ourselves to give ourselves the information that tells us when we are starting to throw good money after bad, but then manage the costs and let them lie where they fall. Because the true thing we want to avoid is throwing good money after bad by running a fleet, which is too expensive. Or we want to invoke a profit on the operating side. Or we want to avoid a situation where we are owning machines and experiencing high owning costs and haven't yet amortize them to the extent that they merit.
Michael Kelley:So it sounds like that managing cost is more like managing a symptom. and managing age might be getting more towards the actual root cause of the problem.
Mike Vorster:Yes, if I had the option of being world class at cost management, or being world class at age management, without a doubt, I would take being world class at age management over and above being world class at cost management. Because if I can manage age, let the cost lower. They fall I know it's the minimum. What good. So that brings us close to the end of this chapter. What do we do next? Well, we've sort of done on owning and operating costs. We've sort of done a 45,000 foot overfly, I think before we dive deeply into cost management and time management, I'd like a little more time to chat about owning costs in detail cost categories, what makes them up and perhaps how to estimate them. I'd like to chat a little bit more about operating costs as well. And particularly I'd like to chat about how best to to estimate what tools we've got available to help us estimate these repair parts and over these specs, the magnitude and the results of the magnitude and the timing of the Spirit. So I think perhaps you don't mind I'd like to spend a little more time talking about owning costs and operating costs that sort of reach on the ground level. Before we start talking about cost management and age management, which will also need to be done at a boots on the ground level. Or perfect. That'll be fun. Chapter five is boots on the ground. With regards to operating,
Michael Kelley:gotcha. So I'll put my boots on the desk and get a cup of coffee for chapter four so that I can be a good accountant.
Mike Vorster:Okay, you need to get your slide rule out so that you can be a good analyst to do chapter farm. Perfect. I'll do it.
Unknown:Thanks for listening today. Be sure to check out the overhauled book for sale now on Mike's website. CMP central.com. See you next time.