When Cost Reduction Commandeers Budget Certainty
When working with an investment advisor, one of the first questions asked is, “what degree of uncertainty are you willing to accept with respect to negative changes in your pursuit to maximize returns?” Why don’t we ask the same question in setting annual capital and operating budgets? Budget conversations are rarely focused on anything more than reducing cost. Are there times it makes sense to spend more to create a lower probability of an operational or financial disaster during the year?
Listed below are two of the most common scenarios where a focus on cost reduction may actually increase the risk of incidents that end up costing you more or impacting other areas of your budget.
Capital Budget Diversions
When unexpected costs occur during the capital budget year and you must divert money from approved projects to emergency repairs and replacements.
Decision: We have decided not to replace the chiller again this year. We had to reduce our capital budget somewhere.
Unexpected Result: We must identify a million dollars of capital in the middle of our budget year to replace the failed chiller. We’ll have to cancel another capital project that WAS in the budget to free up the capital.
Are you saving money or delaying the inevitable?
Decision: We have decided not to perform maintenance on our substation again this year. We need to reduce our O&M budget.
Unexpected Result: Our 37-year-old transformer failed. We have to pay exorbitant fees for a rental and there is a 35-week lead time on a new transformer. Now we must pay rental fees for 9 months AND buy a new transformer. We can’t afford an outage, so we’ll just have to pay the rental fees and reduce O&M somewhere else or have a budget over-run and explain what happened. We also must find capital for the transformer purchase.
Other potential impacts (beyond the budget) from failed infrastructure can include loss of customers, injury and damaged corporate image.
Many customers tell us that while they could keep some “cushion” in their budget for unforeseen circumstances in the past, this is no longer possible, as budget pressures are cutting into the “have to have” categories. This makes the issues above even more impactful.
Do you build your budget on a “best case scenario”, assuming nothing unexpected will happen? Are you considering long-term impacts of near term investments in your infrastructure? There is only one thing certain about budgets. They are like economic forecasts – even the best ones tend to be wrong.