December 2016

Navigating volatility – do you change your business or the way your business works?

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  • By Andrew Carrick, Queensland Mining & Metals Leader, EY

The key to success is agility and getting into shape to deal with volatility now. It is important to focus on six areas that will lead to more effective cash management.

Mining companies must move faster to generate cash and strengthen their balance sheets if they are to successfully navigate ongoing volatility. This is a challenge that management will need to deal with for some time. EY’s recently released report, Navigating volatility: do you change your business or the way your business works?, identifies six key areas that mining and metals companies should focus on to strengthen their business and manage ongoing volatility:

  • cost reduction
  • working capital
  • productivity
  • capital effectiveness
  • portfolio strategy
  • financing.

Fluctuations in commodity prices have become more rapid and frequent as commodity demand has become increasingly unpredictable. The longer-term economic outlook is also volatile, leading to the possibility of substantial revisions to long-term metal price forecasts and making it hard for mining and metals companies to plan for the future.

The impact of China and emerging market demand is also difficult to understand or predict. Therefore, as prices fluctuate and there is limited pricing or demand visibility, management is struggling to plan operations and capital expenditure.

Brexit has brought additional uncertainty to this, with questions on how it may impact an already slow growth in the global economy. Locally, the Australian federal election has potentially provided further uncertainty.

Investment decisions and business strategy need to factor in the variability in outlook, particularly as long-range business forecasts (eg metal/energy prices, foreign exchange rates) are updated.

EY analysis is clear that mining companies need a different mindset in this environment if they want to maintain a strong balance sheet and develop plans for long-term profitability.

Too many companies have viewed cost reduction measures and productivity initiatives as a once-off, when what they need to be doing is embedding continuous improvement in their DNA.

Cost reduction – creating sustainable and long-term value

In recent times, miners started eliminating costs from all areas of the business, including reducing capital expenditure and labour. However, there are still a lot of opportunities to remove costs from the business.

Miners need to maintain a focus on building a long-term sustainable cost base while making certain that cost reduction activities do not contribute to value erosion.

The four key ways to achieve effective cost reduction are:

1. general expenses

2. low-cost country sourcing

3. offshoring/outsourcing support functions

4. procurement.

It is important that every activity in the business is challenged, as the ‘long tail’ of smaller costs are often overlooked in traditional cost-cutting approaches. Even small costs should be pursued because they become significant in number when combined. For example, challenging the need for travel and instead considering increasing the use of online and teleconferencing options for meetings can save millions.

One company has placed its safety equipment in vending machines accessible by staff cards, allowing for a better ‘think before use’ approach. This approach has accounted for several million dollars in annual savings, and safety equipment usage has been cut by as much as 50 per cent at some sites.

Many miners have  moved support functions such as finance, IT, procurement and human resources offshore to low-cost countries. There are two broad delivery models:

1. leveraging a captive shared service center that is owned and operated by the parent company

2. outsourcing to a third-party service provider.

From Australia or North America, every role moved offshore generates savings in the range of US$40 000-50 000 per role. In addition to labour arbitrage, service providers are offering 20-60 per cent productivity over the life of a five-year contract. Outsourcing has moved beyond the typical support function, with many technical areas now being delivered from offshore. These newer areas include:

  • maintenance scheduling
  • seismic/geological data analysis
  • engineering and technical drafting
  • spare parts catalogue management
  • strategic sourcing.

Miners have had a strong focus on procurement in the last three to five years. However, the pace of reform has not been fast enough, and there are still a number of areas they can consolidate and transform to achieve far greater value. Opportunities exist in the following three main areas.

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Automation and consolidation of operational procurement

Many miners are yet to fully institute and realise the benefits of the simple automated solutions that are readily available in their existing systems. There are a number of simple low-cost solutions to shift manual purchasing to ‘hands off’ channels that can be easily executed with a viable business case.

Strategic procurement

Many miners have had a strong focus on cancelling existing contracts and renegotiating new arrangements. However, it is evident that letting go of the old mindset and procurement strategies has not been easy or quick enough for some. Payment terms, for example, are still too generous in some markets, and alternative supplier strategies are not being aggressively pursued. This focus should continue with much greater speed and more discipline around outcomes in set timeframes and accountability for the implementation of new arrangements. Much of this activity could be outsourced.

Next-stage innovation and procurement service

Now is the time to aggressively explore innovations that can further streamline procurement activities and enable greater visibility and control of spend. Associated benefits include:

  • increased leverage and buying power
  • reduction in maverick spend
  • reduction in scope creep
  • more control over services and consulting expenditure.

The availability of smart technology and mobility solutions can further accelerate the automation of many basic ordering, buying and procurement activities. Digital solutions around automatic replenishment and guided buying are becoming more readily available. Digitisation of information also creates the right environment to explore areas such as smart contracting, which automates the contract and vendor management processes.

Working capital – unlocking cash

Despite some improvements across the sector, the report notes that working capital is another area that remains ripe for improvement, with aggregate levels of working capital in the sector of more than US$200 billion. It points to processes and systems across the supply chain as the biggest area for miners to make gains. Releasing cash from working capital will require cultural change and data analytics.

Both areas also have a critical role to play in improving productivity, particularly when obvious opportunities across operations have already been addressed.

Mining companies focused on working capital have typically achieved reductions of 30 per cent or more. For larger mining companies, this can mean reclaiming hundreds of millions of dollars of capital back into the business.

Processes and systems across the supply chain, particularly with regard to inventory, accounts payable, and work-in-progress and finished goods, are the biggest areas where gains can be made. The next wave of improvements will require cultural change and data analysis.

Mining companies need to challenge themselves on best practice in order to find the next 10-20 per cent of productivity savings, and they must learn from other sectors, particularly manufacturing, airlines and industrial products.

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Productivity – a transformational end-to-end approach will have significant impact

This is still the number one operational risk in the mining sector. A transformational, integrated, systematic end-to-end approach will drive significant improvements. Companies have made progress to improve labour productivity, but have hardly scratched the surface on asset productivity. The focus needs to be on building a productive, cost-effective end-to-end value chain. Adopting a process model and digital approach will be key enablers to addressing the productivity risk.

The key to achieving long-term sustainable productivity improvement lies in:

  • A focus on the assets via an end-to-end view. To achieve an end-to-end focus, mining companies need to consider:
  • an integrated governance structure across productivity initiatives
  • optimal asset utilisation via loss elimination analysis and practices
  • data analytics to provide quality information to support effective decision-making and productivity gains
  • engaging the whole workforce and ensuring that targets drive the right behaviors.
  • Relentless pursuit of loss. Loss needs to be transparent, understood and acted upon. In our experience, reasons for loss fall under four major categories:
  1. reliability – eg equipment and material supply losses
  2. utilisation – eg labor supply and integration losses
  3. throughput – eg payload and rate losses
  4. quality – eg ore quality and ore to waste losses.
  • Focus on leadership and culture. Productivity is an issue on the CEO’s agenda and needs a CEO solution to be resolved. The productivity journey requires a change of mindset, enabling and empowering operations to pursue losses. Leadership plays an important role in making this happen. The critical role that people will play in the productivity transformation cannot be overstated; productivity improvement is the role of everyone in the organisation. Relentless pursuit of loss, such as ensuring zero harm, can transform the business entirely.

Three key focus areas to address integration and improve productivity include engagement, measurement and reward, and ongoing talent management.

Mining companies have generally been too slow to consider how they can apply best practice processes from other sectors. Consumer products companies have historically had lower margins, so capital and cost efficiency has always been a focus. There are examples of some of these companies embedding process improvements that have enabled year-on-year savings of US$1.2 billion over the past three years.

Miners can no longer rely on conventional wisdom and expertise from within the sector; they must cast the net wider and seek outsiders’ experience to get that next productivity and efficiency boost.

Capital effectiveness – making your existing assets work harder

A program built on the back of good asset management fundamentals will work as a platform to drive productivity and manage risk. Extracting more value from existing assets presents an opportunity to improve asset management capability. This can help to drive productivity and manage risk in a cost-constrained environment.

Key areas to achieve this are advanced asset management, sustaining capital and capital productivity.

Portfolio strategy – capital allocation and portfolio strategy are critically linked

Empirical research suggests that companies that actively and dynamically manage their portfolio of assets achieve better longer-term returns than companies with a buy-and-hold strategy. Effectively managing portfolios is a difficult task for the mining sector as capital decisions are played over a long period of time and profitability is intrinsically linked to broader macroeconomic factors. This is made
even harder by the current heightened level of volatility.

Active portfolio management will remain a key priority in constructing an optimum portfolio. There needs to be a focus on optimising the performance of assets through portfolio improvement and cost-control measures.

Financing – balance sheet flexibility is key during this period of volatility

While there is a significant level of debt across the sector and leverage is high on the back of lower earnings, a large proportion of debt is covenant-lite and many corporates have taken action to push out maturities and reduce servicing costs. Therefore, the associated distress is perhaps lower than might otherwise be expected in such difficult market conditions.

Balance sheet flexibility remains critical during this period of volatility, as does the associated ‘right-sizing’ of debt levels to the underlying profitability of operations. Releasing capital to pay down debt can be achieved via dividend cuts, divestments and streaming.

Where to go from here?

The following is a summary of the next possible steps:

  • consider all six levers
  • break free from pro-cyclical, short-term behaviour and consider the impact of your actions on long-term productivity and future growth
  • look to other sectors for business optimisation ideas
  • the importance of people as success requires leadership from the top
  • always consider the reaction of stakeholders and shareholders
  • don’t limit your thinking as to
    what’s possible.
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