INDUSTRIAL ENGINEERING APPLICATIONS IN HOTELS AND RESTAURANTS:CONTROLLING CAPITAL COSTS

CONTROLLING CAPITAL COSTS

Overview

As with any industry, controlling capital costs is an important ingredient in developing and main- taining a successful operation. Earlier sections presented information on controlling production costs by increasing worker productivity. Equally important is the need to control capital cost. While capital costs for restaurant and hotels may not be as large as for heavy industry, they are significant when compared to the revenue generated by the respective operations. Therefore, it is important that op- erations not waste money on capital expenditures. By using value engineering and life-cycle costing, operators are able to control costs by making better capital-expenditure decisions.

Value Engineering

In its simplest terms, value engineering is the process of reviewing purchase decisions to determine whether they are cost effective. Value engineering seeks to determine whether the value added to the operation by the purchase provides the greatest possible return or whether there is a more cost- effective way to accomplish the same thing. When performing value engineering, it is important to have a good understanding of the operation and its goals. More than one concept has been diminished or destroyed by the improper application of value engineering. Deleting the required equipment to produce a restaurant’s signature item in an attempt to cut cost has been a contributing factor in more than one business failure (Foster 1998). Foster also points out that operators should avoid doing last- minute value engineering. Last-minute budget cutting does not allow for proper evaluation of the options and can lead to the cutting of necessary pieces of equipment or options that will have to be added later at an increased cost. The problem for kitchen equipment is further compounded by a lack of understanding of the reasons behind the relatively high costs of commercial food-service equip- ment. A microwave oven designed to meet the sanitation and operational requirements of a com- mercial kitchen can cost $2000 or more. If the kitchen designer does not start the value-engineering process early and demonstrate the need for each piece of equipment and option, these items are likely to be the prime targets of last-minute value engineering. Foster recommends that designers start their own value-engineering process at the beginning of the design process. They should describe each piece of equipment and each option, noting its importance to the successful operation of the business. It is also helpful to obtain multiple bids for each item.

Life-Cycle Costing

Overview

In evaluating the different pieces of equipment and options, it is important to consider more than just the initial cost. Purchasing a holding cabinet made of anodized aluminum instead of stainless steel can significantly reduce the purchase cost. However, aluminum cabinets are not as durable and typically have shorter lives than stainless steel cabinets. Further, the salvage value of the steel cabinet is typically higher. If these other factors are not considered as part of the selection process, then the chance of selecting the most cost-efficient piece of equipment is greatly reduced (Borsenik and Stutts 1997). The challenge is to compare today’s dollars with periodic payments and future dollars. For- tunately, relatively simple formulas can be used to bring all amounts back to present value so the different options can be properly evaluated.

Information to Be Included in Life-Cycle Costing

The process begins with collecting all pertinent information. The more information collected, the more accurate the prediction. Typically, information is collected on as many of the following items as are applicable.

1. Initial costs: This includes purchase price and installation costs.

2. Periodic costs: This includes energy usage, maintenance, supplies, and labor estimates. It can also include lease payments and service contracts.

3. End of service costs / revenues: This can be a revenue such as salvage or a cost such as a residual lease payment.

4. The organization’s standard return on investment and anticipated inflation rate.

Converting Amounts to Present Value

The equation used to return all amounts to present value depends on when the amount is paid or received. First, it must be determined whether the amount is a cost or revenue. Since this is a costing method, costs are treated as positive numbers and revenues are treated as negative numbers. Once the sign of the amount has been determined, the next step is to determine whether it is a one-time payment / receipt or a periodic payment / receipt. Examples of one-time payments / receipts include purchase price, installation costs, and salvage value. Examples of periodic payments / receipts include rents, monthly charges such as energy cost, wages, and increased income directly attributed to using the equipment.

If the payment / receipt is a one-time event, then the next step is to determine when it occurs. If it occurs now, it is already in present value and no conversion is necessary. If, however, it occurs some time in the future, it must be converted to present value using the following equation from Newman (1980):

The length of the compounding periods must agree with the interest rate; that is, if the interest rate is an annual rate, the number of compounding periods must be expressed in years.

If the payment / receipt is periodic in nature, the following equation derived from information contained in Newman (1980) is used.

As before, the length of the compounding period must be the same for all terms. Equation (2) will work for all combinations of interest rate and CPC except those where the interest rate and CPC are equal. If the interest rate and the CPC are equal, Equation (2) is undefined. If this happens, the present value of the periodic amount can be found by multiplying the periodic amount by the number of compounding periods. Once all amounts have been converted to present value, the last step is to sum all payments / receipts. The equipment / option with the lowest sum is the most cost-effective alternative.

4. SUMMARY

The industrial engineering techniques discussed in this chapter are but a few of the techniques cur- rently being used by hospitality operations. Successful food-service operations of the future will find ways to change the negative productivity trend that the industry has been experiencing for the last 20+ years. They will become more productive by making better use of existing resources and ex- ploiting the benefits of new technology. The prudent application of the principles and techniques of industrial engineering will help make a positive productivity trend a reality.