Value driven maintenance
Encyclopedia
VDM - Value Driven Maintenance is a maintenance management methodology.
VDM was developed by Mark Haarman and Guy Delahay. Both former chairmen of the Dutch Maintenance Association (NVDO) and authors of the book entitled “Value Driven Maintenance, New Faith in Maintenance”.
Value = the sum of all free future cash flows, discounted to today.
A cash flow is the difference between income and expenditure. It is not the difference between turnover and costs, because this is easy to manipulate through accounting. There are companies that use highly creative lease, depreciation and reservation techniques to keep book profits artificially high or low; this does not always contribute to shareholder value. Recent stock market scandals are a painful but revealing illustration of what sometimes happens as a result of this. The second part of the definition concerns the knowledge that the value of a cash flow is time-related, given the term "present value". Future cash flows must be corrected or discounted to today.
Managing by value necessitates maximizing future cash flows. Managing by value obliges companies constantly to search for new free cash flows. It's no longer enough for a company to go on doing what it is already doing. Today, it's all about creating value.
Now that we know what value is, we can translate the concept into maintenance. Within VDM, there are four axes along which maintenance can contribute to value creation within a company. The axes are also called the 4 value drivers (see fig 1.).
logic dangerous to use and might not be accepted by all legislation world-wide (specially in the US).
The importance of the SHE value driver becomes apparent when looking at the recent incident with the BP Oil Spill in the Gulf of Mexico; the Deepwater Horizon oil spill
. Poor maintenance is believed to be the cause of one of the biggest oil spills in history, causing massive damage to the environment. Total accumulated consequence costs (both clean-up costs and loss of company value) are estimated on 12 billion.
program, higher technician productivity, lower procurement prices for materials and services and the right ratio of the number of technicians, managers and indirect personnel. Controlling maintenance costs is called "Cost Control" in VDM.
As figure 1 shows, a natural tension exists between the four value drivers. That is why today's maintenance manager is continually searching for the right balance between these value drivers. It is important to know how they square up to each other. Which are the dominant ones and which are the subordinate ones? One can determine this instinctively but many corporate managers require a financial validation because, for example, it will be a decisive factor in investment decisions or because stakeholders (e.g. financial manager, production manager) are not prepared to accept a judgement based on instinct. This is a situation where one should use the VDM formula.
PVmaintenance = ∑ {FSHE,t x (CFAU,t + CFCC,t + CFRA,t + CFSHE,t) / (1+r)t}
where:
PVmaintenance = present value potential of maintenance
FSHE,t = SHE factor in year t
CFAU,t = future free cash flow in year t from Asset Utilization
CFCC,t = future free cash flow in year t from Cost Control
CFRA,t = future free cash flow in year t from Resource Allocation
CFSHE,t = future free cash flow in year t from Safety, Health & Environment
r = Discount rate
SHE stands out prominently in the formula. This factor shows how great the probability is that the License to Operate will be retained in the coming years and that the expected cash flows from all four value drivers will actually be attainable in the future. Consequently, the SHE factor is a probability factor with a value of 0 to 1. A SHE factor of 0 means 0% probability of retention of the License to Operate, for example in a fictitious case where a company decides to stop performing all maintenance for cost reasons. The free cash flow that this creates on Cost Control will be enormous. But because the company fails to satisfy SHE laws and this loses its License to Operate, this cash flow will not create any value.
The VDM model can be simplified in certain situations. Assume that we work with Perpetuity
. This means there will be indefinitely be a free cash flow that is the same year after year and the SHE factor is constant; the VDM formula thus becomes:
PVmaintenance = FSHE,t x (CFAU,t + CFCC,t + CFRA,t + CFSHE,t) / r
VDM was developed by Mark Haarman and Guy Delahay. Both former chairmen of the Dutch Maintenance Association (NVDO) and authors of the book entitled “Value Driven Maintenance, New Faith in Maintenance”.
Value drivers in Maintenance
What exactly is value? In financial literature ; value (net present value) is defined as:Value = the sum of all free future cash flows, discounted to today.
A cash flow is the difference between income and expenditure. It is not the difference between turnover and costs, because this is easy to manipulate through accounting. There are companies that use highly creative lease, depreciation and reservation techniques to keep book profits artificially high or low; this does not always contribute to shareholder value. Recent stock market scandals are a painful but revealing illustration of what sometimes happens as a result of this. The second part of the definition concerns the knowledge that the value of a cash flow is time-related, given the term "present value". Future cash flows must be corrected or discounted to today.
Managing by value necessitates maximizing future cash flows. Managing by value obliges companies constantly to search for new free cash flows. It's no longer enough for a company to go on doing what it is already doing. Today, it's all about creating value.
Now that we know what value is, we can translate the concept into maintenance. Within VDM, there are four axes along which maintenance can contribute to value creation within a company. The axes are also called the 4 value drivers (see fig 1.).
Asset Utilization
The first value driver is Asset Utilization. Asset Utilization seeks to increase the technical availability of a technical equipment. With higher technical availability, it is possible to produce and sell more products with the same invested capital, generating more income while the fixed costs remain the same. In other words, the free cash flows increase, which automatically means value creation. Maintenance can increase technical availability by preventing unwanted breakdowns, scheduling plant maintenance in a smarter way and performing repairs and inspections faster. A point to note is that higher technical availability produces value not only in growth markets. In markets where demand is stable or declining, greater availability can also create value. By making a plant more efficient, the number of shifts can be reduced or it may even be possible to close down sister plants. At corporate level, this does not generate more turnover, but it does significantly reduce costs, which is another way of creating value.Safety, Health & Environment
An increasingly important value driver for maintenance is Safety, Health & Environment, or SHE in VDM terminology. Compliance with legal directives covering SHE creates value in two ways. Firstly, it avoids the imposition of government penalties for breaches of legislation. Secondly, a good SHE policy has a positive effect on retention of the License to Operate. This is something else that has value, because it increases the likelihood of future cash flows actually materializing. Without a License to Operate, there will be no future cash flows and thus no value. Problem here is that it does not take the other error type into account (related to a lower false safety trip rate, but higher accident rate). It is very controversial to put a value on human life and therefore this VDM theorie is just like the ALARPALARP
ALARP stands for "as low as reasonably practicable", and is a term often used in the milieu of safety-critical and safety-involved systems. The ALARP principle is that the residual risk shall be as low as reasonably practicable...
logic dangerous to use and might not be accepted by all legislation world-wide (specially in the US).
The importance of the SHE value driver becomes apparent when looking at the recent incident with the BP Oil Spill in the Gulf of Mexico; the Deepwater Horizon oil spill
Deepwater Horizon oil spill
The Deepwater Horizon oil spill is an oil spill in the Gulf of Mexico which flowed unabated for three months in 2010, and continues to leak fresh oil. It is the largest accidental marine oil spill in the history of the petroleum industry...
. Poor maintenance is believed to be the cause of one of the biggest oil spills in history, causing massive damage to the environment. Total accumulated consequence costs (both clean-up costs and loss of company value) are estimated on 12 billion.
Cost Control
Even though maintenance is not a cost center in itself, it does gobble up a lot of money. The maintenance budget consists mainly of wage and training costs of technicians, managers and indirect personnel, the costs of spare parts and tools and the costs of contracted personnel and outsourced work. Savings on the maintenance budget automatically generate free cash flows in the future and, by consequence, value. The savings are achievable by having a smarter Preventive maintenancePreventive maintenance
Preventive maintenance has the following meanings:#The care and servicing by personnel for the purpose of maintaining equipment and facilities in satisfactory operating condition by providing for systematic inspection, detection, and correction of incipient failures either before they occur or...
program, higher technician productivity, lower procurement prices for materials and services and the right ratio of the number of technicians, managers and indirect personnel. Controlling maintenance costs is called "Cost Control" in VDM.
Resource Allocation
Finally, maintenance can create value through the smarter management of resources. This is called "Resource Allocation" in VDM. It is not about the consumption of resources, because that is already covered in the Cost Control value driver. Within VDM, a distinction is made between four types of resources: technicians, spare parts, contractors and knowledge. One need to think only of cash flows freed up as a result of smarter management or savings on warehouses, logistical employees, insurance and the avoidance of obsolete and surplus spare parts. In practise, it often turns out that the value potential of smart management of spare parts by far exceeds the value potential of the other resources.As figure 1 shows, a natural tension exists between the four value drivers. That is why today's maintenance manager is continually searching for the right balance between these value drivers. It is important to know how they square up to each other. Which are the dominant ones and which are the subordinate ones? One can determine this instinctively but many corporate managers require a financial validation because, for example, it will be a decisive factor in investment decisions or because stakeholders (e.g. financial manager, production manager) are not prepared to accept a judgement based on instinct. This is a situation where one should use the VDM formula.
VDM Formula
The VDM formula is derived from the net present value formula and can be used to calculate the value of maintenance. The VDM formula is:PVmaintenance = ∑ {FSHE,t x (CFAU,t + CFCC,t + CFRA,t + CFSHE,t) / (1+r)t}
where:
PVmaintenance = present value potential of maintenance
FSHE,t = SHE factor in year t
CFAU,t = future free cash flow in year t from Asset Utilization
CFCC,t = future free cash flow in year t from Cost Control
CFRA,t = future free cash flow in year t from Resource Allocation
CFSHE,t = future free cash flow in year t from Safety, Health & Environment
r = Discount rate
Discount rate
The discount rate can mean*an interest rate a central bank charges depository institutions that borrow reserves from it, for example for the use of the Federal Reserve's discount window....
SHE stands out prominently in the formula. This factor shows how great the probability is that the License to Operate will be retained in the coming years and that the expected cash flows from all four value drivers will actually be attainable in the future. Consequently, the SHE factor is a probability factor with a value of 0 to 1. A SHE factor of 0 means 0% probability of retention of the License to Operate, for example in a fictitious case where a company decides to stop performing all maintenance for cost reasons. The free cash flow that this creates on Cost Control will be enormous. But because the company fails to satisfy SHE laws and this loses its License to Operate, this cash flow will not create any value.
The VDM model can be simplified in certain situations. Assume that we work with Perpetuity
Perpetuity
A perpetuity is an annuity that has no end, or a stream of cash payments that continues forever. There are few actual perpetuities in existence...
. This means there will be indefinitely be a free cash flow that is the same year after year and the SHE factor is constant; the VDM formula thus becomes:
PVmaintenance = FSHE,t x (CFAU,t + CFCC,t + CFRA,t + CFSHE,t) / r
See also
- Planned maintenance
- Condition Based MaintenanceCondition Based MaintenanceCondition-based maintenance , shortly described, is maintenance when need arises. This maintenance is performed after one or more indicators show that equipment is going to fail or that equipment performance is deteriorating....
- Reliability Centered MaintenanceReliability Centered MaintenanceReliability Centered Maintenance, often known as RCM, is a process to ensure that assets continue to do what their users require in their present operating context....
- Corrective maintenanceCorrective maintenanceCorrective maintenance can be defined as a maintenance task performed to identify, isolate, and rectify a fault so that the failed equipment, machine, or system can be restored to an operational condition within the tolerances or limits established for in-service operations...