Cost management and performance measurements for petroleum upstream industr p...
Shriram Article Version 3
1. MACHINE – PANDORA OR PROMETHEUS FOR MAN?
Shriram Adhishesha
F.Y.B.M.S
A/502 Gulmohar, Poonam complex, 90.Ft Road, Thakur Complex, Kandivali (E),
Mumbai – 400101.
Email: adsram@gmail.com
CBA – Man vs. Machine
Science and Technology Category
2. ABSTRACT
The purpose of business is to create and keep a customer…..Business has only two functions
marketing and innovation.-Peter. F. Ducker.
Both the functions are creativity oriented and can be done by man in a much better manner
than a machine. However without a machine, man cannot render quality product / service to
the customer. While machine can produce goods confirming to Six Sigma quality norms,
man cannot match it. Both are complementary to each other and not supplementary. Man and
machine are not totally mutually exclusive alternatives. However, a quantitative analysis is
carried out to show the financial justification of automation. When it comes to justifying an
automation investment, most businesses tend to overstate the hard quantifiable numbers,
which are usually the costs, and understate the soft correlations such, as higher quality,
reduced cycle times, greater flexibility etc. This is not to say numbers are not important, they
are. But all the numbers must be weighed and evaluated as a part of the whole. One will have
to consider sales; costs and profits all together while arriving at the conclusion. Appropriate
justification can be done for automation by considering all figures together after integrating
with the soft data to arrive at the cash flow statement and an appropriate discount rate has to
be used to arrive at the NPV, which is very much essential for the survival and growth of
organisation in a competitive market. Here there is an implicit assumption that machines are
for the overall benefit of the human society. But history has taught us otherwise. So this has
to be an explicit objective. As we cannot get guidance for machinery and improved
machinery. This raises the issue of machines a Pandora or Prometheus?
3. INTRODUCTION
The purpose of business is to create and keep a customer…..Business has only two functions
marketing and innovation.-Peter. F. Ducker.
Both the functions are creativity oriented and can be done by a man in a much better manner
than a machine. However without a machine, man cannot render a quality product / service
to the customer. With the improvement in technology and systems – high quality general
purpose and special purpose machines with computerised numerical controllers, artificial
intelligence and robotics; flexible manufacturing systems1
, etc. – many factories are able to
produce goods confirming to six sigma quality norms (Six Sigma equates to just under 3.4
defects per million opportunities (DPMO))2
with highly reduced cycle times. Even very high
end labour on its own cannot match it by a big margin. Both are complementary to each
other and not supplementary. Man and machine are not totally mutually exclusive
alternatives. However, a quantitative analysis is carried out to show the financial justification
of automation. When it comes to justifying an automation investment, most businesses tend
to overstate the hard quantifiable numbers, which are usually the costs, and understate the
soft correlations such, as higher quality, reduced cycle times, greater flexibility etc. Do these
translate into bigger sales? Yes, they do. What all these accounting methods fail to take into
account is the machine’s impact on the business as a whole? How does it support the overall
business strategy? This is not to say numbers are not important, they are. But all the numbers
must be weighed and evaluated as a part of the whole. One will have to consider sales; costs
and profits all together while arriving at the conclusion. Appropriate justification can be done
for automation by considering all figures together after integrating with the soft data to arrive
at the cash flow statement and an appropriate discount rate has to be used to arrive at the
NPV, which is very much essential for the survival and growth of organisation in a
competitive market. Justification for purchase of plant and machinery of high value / degree
of automation cannot be done with the help of profit figures alone. One will have to consider
soft data like product quality; reduced process time- the ability to react fast to the customer
requirements; flexibility in terms of product planning, design, manufacturing etc. which will
definitely help the company to obtain better market share not only in its target market but also
in other segments of the market - as the word passes on about company’s ability to give good
quality product in the shortest time. This interrelation of soft data is very important to arrive
at the total economies of the justification of automation. In short, one will have to consider
sales; costs & profits all together while arriving at the conclusion. The traditional model for
justifying the purchase of machinery considers only the cost figures and the profit figures.
This approach is very dangerous when considered from the total business strategy as a whole
for the growth and success of the organisation. The impact on the sales figures alone can
guarantee the growth of the company in long run. The growth in sales will increase the profits
to a very great extent because of the presence of operating leverage provided the costs are
controlled.
4. OBJECTIVES
Automation is financially justifiable.
The need to change the Implicit Assumption of ‘machines are essential for the well-
being and development of humanity’ to Explicit Objective.
Machines and their development is a Pandora or Prometheus?
RESEARCH METHODOLOGY
This is a Conceptual Research – Theory Development. It is based on learning and integrating
various concepts of Production Management, Lateral Thinking, Accounting, Tax Planning,
Financial Management (PV, CBA), etc. to reach to this conclusion.
FINANCIAL JUSTIFICATION
Assumptions
To get a fair idea on the traditional model on financial justification for automation, let us
consider that if one lakh worth labour and machine give the same production which
alternative is better and to what extent.
To arrive at a conclusion we are making the following assumptions:
1. The economic life of asset is eight years;
2. Repairs and maintenance cost is 1% of the machine cost and will increase by 1%
every year;
3. As depreciation rates are different for different types of plant and machinery, we have
considered 20% on WDV basis both under The Income Tax Act, 1961 and The
Companies Act, 1956; Investment Allowance under Sec 32AC of ITA is not
considered due to monetary limits3
.
4. At the beginning of the ninth year machine is sold at book value. For simplicity
purpose, while calculating the present value (PV), present value factor (PVF) of
eighth year is considered;
5. Cost of training and cost lay-off / retrenchment at the end of eighth year is ignored;
6. To arrive at a better conclusion we are considering-
Labour costs will increase at 7% or 10% or 15% or 20% compounded every
year; and
Discounting rate will be 7% or 10% or 15% or 20%.
Analysis
Based on the above assumptions one will arrive at the following conclusions:
A] Based on the present value analysis:
Discount rate being 7% labour would be at least costlier by 588% when wages increase at 7%
compounded, 650% when wages increase at 10 % compounded, 768% when wages increase
at 15% compounded and 910% when wages increase at 20 % compounded.
5. Discount rate being 10% labour would be at least
costlier by 511% when wages increase at 7%
compounded, 562% when wages increase at 10 %
compounded, 660% when wages increase at 15%
compounded and 777% when wages increase at 20 %
compounded.
Discount rate being 15% labour would be at least
costlier by 414% when wages increase at 7%
compounded, 452% when wages increase at 10 % compounded, 526% when wages increase
at 15% compounded and 613% when wages increase at 20 % compounded.
Discount rate being 20% labour would be at least costlier by 343% when wages increase at
7% compounded, 373% when wages increase at 10 % compounded, 429% when wages
increase at 15% compounded and 495% when wages increase at 20 % compounded.
As per the analysis the financial conclusion is that the unit will have to go in for machinery.
B] Based on the charge made to the profit and
loss account:
If we consider only on the charge made to the
profit and loss account, labour will be costlier by
861%, 959%, 1151% & 1384% at 7%, 10%, 15%
& 20% compounded wage increase respectively
over a period if eight years. This means, the unit
will have to earn so much extra contribution to
break-even. The above analysis clearly reveals
that the use of labour is costlier when compared to
the use of machinery.
LACUNAE OF TRADITIONAL APPROACH
The criterion for consideration given above is that, given the same amount of production
which one is better. The underlying assumption made applicable for both alternatives in the
above working is that the output will be of the same quality, lead time will be the same and
the flexibility to adapt to market requirements will be the same. It is very well known that use
of sophisticated machines and adopting flexible manufacturing systems will enable a
company to give a better quality product, reduce its manufacturing lead time and increase the
flexibility in capacity, etc. This will definitely have a better impact on the market and the unit
will have better chances to capture a better share of its target market and sometimes even new
markets may open. This growth opportunity not being available for low quality products, the
two alternatives are not comparable unless sales figures are considered to arrive at the profit
figures. Do improved product quality, flexible capacity and superior response agility really
translate to bigger sales figures? Yes, they really do… What all of these accounting methods
fail to take into account is the machines impact on the business as a whole? How does it
support the overall business strategy? “A decision of this magnitude must be based on a
sound, high level business strategy, not on some short range financial or accounting
7% 10% 15% 20%
7% 5.88 5.11 4.14 3.43
10% 6.50 5.62 4.52 3.73
15% 7.68 6.60 5.26 4.29
20% 9.10 7.78 6.13 4.95
Wages
Increase
Discount Rate
Break-Even(No. of times) Considering Cash Flow -
Present Value
Year 7% 10% 15% 20%
1 4.76 4.76 4.76 4.76
2 5.94 6.11 6.39 6.67
3 7.25 7.66 8.37 9.11
4 8.60 9.35 10.68 12.13
5 9.94 11.10 13.26 15.72
6 11.17 12.83 16.02 19.82
7 12.26 14.47 18.89 24.39
8 13.17 15.98 21.81 29.38
Total 8.61 9.59 11.51 13.84
Breakeven (No. of Times)
6. procedures. This is not to say numbers are not important, they are. But all the numbers must
be weighted and evaluated from the part of the whole.”
IMPLICIT ASSUMPTION EXPLICIT OBJECTIVE
Without considering the benefits of improved sales, reduced costs (operating leverage), these
figures still show investment in machine is highly beneficial. While this point is proved
(where both can give the same results) certain points which need to be considered are the
extreme damage it can cause to humanity e.g. improvement in machinery leads to
improvement in arms leading to greater calamity. Wars over the last five centuries have
proved it – the negative impact of the war has been disproportionate compared to the
improvement in the technology. We have also exploited and on verge of exhaustion of
critical resources due to use of advanced machinery. We have not learnt our lessons and in
spite of huge effort in educating Environmental Science, the damage is increasing to
environment. If Social Impact is considered overall, the cost – benefit analysis will go for a
toss. Currently improvement in AI, Robotics and allied technologies is very high and the
science fiction movies like, ‘I, Robot’, ‘Terminator Series’, ‘Resident Evil series’ ‘Total
Recall’, etc. show the damage machines can do to the society at large. As Edward De Bono
says “The need to be right all the time is the biggest bar to new ideas”. So we need to move
ahead but take immense precaution due to the inherent dangers involved. Again as Edward
De Bono says “You can analyse the past, but you have to design the future”. This will
require one to be highly creative. (Creativity involves breaking out of established patterns in
order to look at things in a different way – Edward De Bono). All along machines were
developed with an implicit assumption that they are required for the betterment of the human
society. We have seen above certain negative developments which have hurt the bio-cycle
(and estimated to increase further) and caused immense damage in wars. Many are not
comfortable with WMDs. Another factor is certain unintended developments which happen
either in the research process or at the time of usage. This makes it necessary to make the
implicit assumption to explicit objective. With this the potential damage could be reduced.
PANDORA OR PROMETHEUS
Another view against the machine is, one does not know whether it falls under ‘Obedient
Knowledge’ or ‘Forbidden Knowledge’4
. Weapons of Mass Destruction will definitely not
come under Obedient Knowledge. The Answers to inquisitiveness of development does not
always lie in Obedient Knowledge. Discovery of such answers may sometimes threaten
humanity. This becomes more difficult going by the fact that we tend to favour personal
good when there is a clash with common good. The proof for this is the rogue elements
(State and Individuals) who threaten the society with advanced weapons. With this we can
say that machines are required for development of human society but should be handled with
extreme care so that machines are used only for the wellbeing of the Society at large.
Unguided curiosity with action leads to Forbidden Knowledge. Effects of which are
disastrous over a period of time. The magnitude of risk is very high here. (Everybody can
take a decision but managing the impact of the decision is very difficult - few can control the
intended impact and may be none can control the unintended impact of the decision.) This
7. Depriciation Repairs Depriciation Repairs 7% 10% 15% 20%
20,000 1,000 6,800 (660) 6,140 5,738 5,582 5,339 5,117
16,000 2,000 5,440 (1,320) 4,120 3,599 3,405 3,115 2,861
12,800 3,000 4,352 (1,980) 2,372 1,936 1,782 1,560 1,373
10,240 4,000 3,482 (2,640) 842 642 575 481 406
8,192 5,000 2,785 (3,300) (515) (367) (320) (256) (207)
6,554 6,000 2,228 (3,960) (1,732) (1,154) (978) (749) (580)
5,243 7,000 1,783 (4,620) (2,837) (1,767) (1,456) (1,067) (792)
4,194 8,000 1,426 (5,280) (3,854) (2,243) (1,798) (1,260) (896)
16,777 Nil 16,777 9,764 7,827 5,485 3,902
Total 16,149 14,619 12,649 11,183
(1,00,000) (1,00,000) (1,00,000) (1,00,000)
(83,851) (85,381) (87,351) (88,817)
Present Value
Purchase price of Machinery
Cash Flow
Dep.+ Repairs
Net Cash Flow
Before Tax After Tax
makes it very imperative to get guidance before going in the new path. As we don’t know
from whom to get guidance this leads to a question whether machines are a Pandora or
Prometheus?
CONCLUSION
Theory 1: ‘Automation is financially justifiable.’
Theory 2: ‘The need to change the Implicit Assumption of ‘machines are essential for the
well-being and development of humanity’ to Explicit Objective.’
Theory 3: ‘Machines and their development is a Pandora or Prometheus?’
From above we can conclude that automation is financially justifiable and there is a need to
move from the implicit assumption of ‘machines are essential for the well-being and
development of humanity’ to Explicit Objective. As we don’t know whether machines fall
under obedient knowledge or forbidden knowledge we need to get guidance. And we also
don’t know from whom to get the guidance. So we are not sure whether machine is a Pandora
or Prometheus for man?
REFERENCES
1. Production and Operations Management by S N Chary, The McGraw-Hill
Companies, 4th Edition, Page No. 39.1 to 39.
2. http://www.villanovau.com/resources/six-sigma/what-is-six-sigma/#.VJ0eW14AKA
3. Students Guide to Income Tax by Dr V K Singhania and Dr. M Singhania, Taxmann
Publications, 2014-15, Page No. 146-148. Schedule XIV of The Companies Act,
1956. Schedule II of The Companies Act, 2013 is not considered as it will be
implemented from this year only. Deferred Tax is not considered as depreciation rate
is assumed to be the same under both the Acts.
4. http://www.wisdom-square.com/movie-prometheus-analysis-conclusion.html
5. Genesis concerning Adam and Eve in Genesis 2:16–17
6. Tax Rate considered at 34% (Tax 30%, Surcharge 10%, Cess 3% = 33.99%).
TABLES
A. Calculation of Cash Flow when Labour ₹ 1, 00,000/- P.A. is Employed:
