Managing RTLS Capex Risk

In early 2020, everything changed. No one could have predicted the economic downturn like the one that has been brought about like the Coronavirus pandemic. Business leaders now face higher levels of uncertainty and are faced with the tasks of sustaining cash flow, while mitigating risks and maximizing operational efficiencies.

The pandemic has caused problems that will live on past the pandemic itself. We have all heard stories or maybe even experienced cases where this economic crisis has significantly impacted even the best of businesses.

For those companies still in business, difficult decisions lie ahead. Even in this “new normal,” cash flow is still king, and when the cash stops coming in, the scrutiny around cash flow has expanded.

One way companies look to decrease the cash outflows is by deferring capital expenditures (capex). Many operational and financial leaders struggle to figure out which projects are worth the investment and which ones need to be cut. These are the tough decisions that have to be made during tough economic times.

Mark D. Mishler attempts to solve this problem in his article “Capex Risk Management during the Coronavirus Pandemic,” where he gives a 5-step risk-model to aid in capex decisions.

In times such as these, all capex, including investments real-time location services (RTLS), must be examined to determine if those investments are worthwhile. Using the framework laid out by Mishler can help determine if the timing of a Real-time location system (RTLS system) is right for you.

Step 1: Identify the Issues

Identifying the most important issues can be a difficult part of the process. The problems that have had the most impact on the business operations (including working capital) need to be identified and prioritized. These issues can come from a variety of factors - internal, external, tangible, and intangible. Things like cash flow, supply-chain and manufacturing, changes in regulation, employee morale, and ability to obtain financing should all be considered.

As an example, let’s say you’re a glass manufacturing or distribution company that ships its product on a rack that costs between $500 - $2,000. Due to slow-downs from the pandemic, your customers are taking longer to return racks (either because they are using them longer since product is not moving, or the customer is reducing their own costs by using your racks themselves). The issue is that you’re running short of racks or losing racks, and you need to know whether to invest in more racks to ship your product. We’ll follow this example throughout the rest of the blog.

Step 2: Conduct Risk Identification and Scenario Analysis

Companies are facing new risks from the pandemic that have never been faced. This step in the process really comes down to considering what could possibly go wrong and the impacts that would follow. By performing this analysis, you can identify the risks and take preventative steps to mitigate that risk. Many companies do risk planning about once a year, but in times of high volatility and uncertainty, risk management becomes even more critical and should be done more frequently. The ability to take preventive or corrective action is dependent upon identifying and analyzing the potential risks. Particularly during a crisis, especially if staff reductions have been made, you may feel so busy putting out the operational fires that it’s easy to put off risk management. Don’t fall for this fallacy because understanding and managing the risks is critical to preventing harm.

Once risk is identified, there are different ways to handle the risk. Scenario analysis identifies events that could happen and what the outcomes would be. Related to capex risk, scenario analysis would involve the impacts to cash flow outflows or operations if the purchase is not done.

Watch out for bias

When you’re evaluating risk, be sure to ask yourself what biases may be clouding your identification. Preconceived ideas create a cognitive bias. Are you using only information that supports your preconceived position (confirmation bias)? If you don’t understand the complexities of the decision, you may have a simplicity bias, or if you’re relying too much on an internal network, you may have a group bias. Are you placing too much confidence in unverified information (overconfidence bias)? An anchoring bias relies too heavily on only a portion of the evidence, and availability bias relies only on the information that’s easily available. These are just some of the ways people tend to make mistakes when evaluating risk.

Example

Let’s go back to our example of a glass company. You’re still having trouble recovering their shipping racks. The annual loss of these rack is normally between 10-20%. If we assume that a large manufacturer used 8,000 racks for shipping, an average value of $1,000 per rack, and the minimum 10% annual loss rate, that would cost this glass company $800,000 in replacements every year. In addition, the risk of not having enough shipping rack inventory on hand to cover shipments could mean that the company loses out on revenue opportunities. But having too much shipping rack inventory ties up cash flow and creates additional cost of warehousing and maintaining more racks than needed. Keep reading - we’ll see how evaluating an RTLS solution can help mitigate some of these risks.

Step 3: Analyze Identified Risks

There are two basic ways to analyze risks once you have identified them — quantitatively and qualitatively.

The first method, the quantitative approach, is less frequently used because identifying the actual dollar amounts can be difficult. Most companies use a qualitative approach which assigns a risk score based on a scoring methodology that the company has developed, such as the heat map shown below. An example is shown here (source: Mark Mishler).

Using our glass company example, if you believe that it is probable that you will face a yearly loss of $800,000 and the loss is a risk of minor severity, the result is that the decision is moderate risk. If the risk of not having enough shipping racks on hand is possible but the severity is major (due to lost revenue impacts), the risk level is high.

Once the risks are identified and then analyzed, a company is ready to move on to the fourth step of the process.

Step 4: Develop Risk Mitigation Alternative Solutions

Risk mitigation is a strategy that is used to either lessen the effects of the risks faced by a business or reduce the probability of the issues occurring in the first place. A few different types of examples exist. First, a company may look at their problem, and realize that there is nothing that can be done as a solution; they accept the risk and don’t engage in any sort of special effort to control it. They carry on business as usual.

A second risk mitigation strategy is risk avoidance. In this strategy, a business adjusts program requirements or constraints to eliminate the risk altogether. A change in funding, schedule, or technical requirements usually comes from using this type of risk mitigation strategy. Some examples of this strategy at work are eliminating capital investment and lowering operational costs.

Another risk mitigation strategy that can be used by businesses is risk control. By using this strategy, a business implements actions to minimize the impact or likelihood of the risk. Examples of this type of strategy include improving efficiency of processes, increasing reliability, and improving quality of data.

It may be tempting for many businesses to look into cutting capex, especially in times of financial crises, but business leaders must remain strategic when making these decisions. What are the opportunity costs surrounding scaling down capital projects or growth strategies? On the contrary, where boards and leaders are more risk tolerant, strategic capex spending can position the company to rebound from an economic crisis and to come out of it ahead of their competitors.

Let’s look back again at our glass company example. You don’t feel comfortable accepting the fact that nothing can be done about the losses, so you need to take some kind of action to minimize their risk. Alternative solutions are evaluated such as RFID and RTLS solutions. The return on investment of an asset management system such as AirFinder is evaluated because it allows for seamless indoor and outdoor asset tracking, which is an unusual combination. In addition, the AirFinder platform provides the analysis and reports to provide inventory projections, inventory turnover and real-time location updates on whether glass shipping racks are where they are supposed to be to prevent losses and reduce inventory holding costs, delivering demonstrable value and reducing risk to the company.

Step 5: Select and Implement the Best Solution

This step naturally follows the fourth step of the process. After deciding on which alternative is the best, decisions have to be made on how to implement that solution. Many companies don’t realize the costs involved with an implementation and scaling of an asset tracking system. The evaluation process should consider the costs of implementing and maintaining the chosen RTLS solution. While there is usually a capex purchase initially, the cost of RTLS includes operating costs on an annual basis (things like battery replacement, subscription fees, and maintaining the system).

The Importance of Leadership

Strong leadership qualities are more important than ever in times of crisis. These qualities can be demonstrated throughout the entire risk management and decision-making process. Whether it's in evaluating an asset tracking solution or providing other operational leadership, an effective leader envisions and recognizes the effect that uncertainty has on both employees and external parties. A leader understands that perfect information is not always available (especially during crisis) and is able to evaluate alternatives and be decisive. Finally, a strong leader knows how to focus on the most critical issues at hand. The stakeholders of your company are looking to your leadership team to maintain a certain level of cash flow, liquidity, and solvency, while solving operational needs and efficiencies. These issues become even more important in an economic crisis. An excellent leader prioritizes what’s truly important to the company and can come through even stronger.

A Final Note

Do you need help evaluating the risks and benefits of implementing or not implementing an RTLS solution? Whether you need indoor asset tracking, outdoor asset tracking (GPS asset tracking), or both, Link Labs can help you follow these steps: identify the issues, conduct risk identification and scenario analysis, analyze your risks, develop risk mitigation alternatives, and select and implement the best asset tracking software. Contact us now for additional resources.

Jennifer Halstead

Written by Jennifer Halstead

Jennifer Halstead, MBA, CPA brings more than 20 years financial industry experience to Link Labs. She began her career in finance within the pharmaceutical industry and has continued in both public accounting and private companies. She passed the CPA exam with the 3rd highest score in the state and completed her MBA with an accounting concentration (summa cum laude). Jennifer has worked with several software companies and has led multiple venture financing, merger and acquisitions deals. She has helped companies expand internationally and has managed the finance department of a startup to 33 consecutive quarters of growth prior to acquisition. After the acquisition, she served as the Controller of Dell Software Group’s Data Protection Division where she managed a portfolio of multiple hardware and software products to scale and achieve over triple-digit growth worldwide in 18 months. Jennifer brings a depth of finance experience to the Link Labs team.

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