From the Mine to the Sea:
Optimizing Multi-Party Logistics
Asset-intensive industries, including mining and industrial products, are often dependent on transportation and logistics assets that are owned or controlled by third parties. Developing an efficient, coordinated program to fund capacity expansion across each entity can involve a complex range of potentially conflicting objectives within each of these parties.
Optimizing multi-party logistics chains usually requires a high degree of investment coordination, as the individual parties will have different levels of access to capital and pricing power (i.e., ability to pass through costs to the ultimate customer). These disparities can lead to competing investment hurdle rates, which frequently impact contract negotiations over the amount, timing, and allocation of responsibility for necessary capital improvements. There are often opportunities, however, to optimize capital deployment throughout the entire logistics chain by working together in collaborative processes. Recently, Oliver Wyman has advised clients in projects involving multi-party, asset-intensive logistics chains on developing a structured, analytically driven, and objective process for addressing these inherent challenges and opportunities. Key components of this process include:
Leveraging international experience to establish utilization, capacity, and cost standards, adjusted for local conditions
Â„Â„Ensuring that robust analytical methodologies are deployed to assess all of the logistics chain components and interfaces
Â„Â„Assessing the relative benefits and risks of alternative investment and ownership/control options
Â„Â„Examining opportunities to coordinate investment programs by each of the stakeholders, in order to identify alternative capacity expansion mechanisms that reduce the total capital required to achieve desired goals
Â„Â„Developing and facilitating multi-party agreements that align investment objectives across all involved parties and provide coordination, transparency, and the ability to apply best practices (e.g., project structure and information sharing, relationship management, performance metrics and incentives)
A Case Example: Growing Capacity for Export
As an example, a large and growing mining company sought to increase its mining production by 50 percent over the next 10 years to take advantage of global demand for raw materials. This plan essentially resulted in a tripling in demand for capacity along the existing logistics chain, which involves material moving from mines via rail to a port terminal, where it is loaded onto vessels for export. The railroad and port facilities are both owned by a transport holding company, which operates them as separate entities with individual charters and objectives. This separation has often led to conflict, as each entity has attempted to maximize its individual performance, developed expansion plans that influenced its own required capital investment, and competed for internal resources. In this case, each developed a plan to meet the mining companyâ€™s expanded transport capacity needs, but the resulting costs threatened the commercial viability of the mineâ€™s expansion. Accordingly, the mining company sought an objective assessment of the capital required to meet the increase in throughput, based on relevant benchmarks and â€œbest practicesâ€ adjusted for local conditions. It also sought
a mechanism to allocate investment by each of the parties at a commercially viable rate of return. Finally, it wanted to redesign the commercial relationship between itself and the rail and port service providers to allow for more visibility and constructive feedback from the mine to continually improve the performance of the logistics chain.
A three-step program was developed to help the client constructively engage in capacity expansion discussions with the transport entities, with a focus on required capital and appropriate allocation of risk.
Phase I Multi-Party Capacity Expansion Approach
Benchmarking is an essential first step in determining the practical incremental throughput that can be achieved for a given level of investment in capacity enhancement. Benchmarking should focus on the productivity of individual assets and unit costs and their respective interdependence to ensure that the logistics chain is responsive to demand requirements.
Benchmarking to Establish Capital Expenditure Requirements
In this case, international experience conclusively demonstrated that current utilization of rolling stock and the port terminal, adjusted for local conditions, was well below benchmarks. It was clear that improving utilization of these assets would significantly reduce the capex required for capacity expansion. Also, the initial proposed unit costs for purchasing additional rolling stock and the overall costs for port expansion were not supported by comparable benchmarks
The data-driven benchmarks furthermore provided a basis for the transportation entities to negotiate lower unit costs with their suppliers and to launch an in-depth technical feasibility study of the proposed capital expansion.
Testing Opportunities and Reaching Agreement
Assessing and testing the technical feasibility of operational changes must be accomplished with the involvement of all parties through the establishment of joint teams (across entities and functions). These teams should be comprised of individuals with the requisite experience and collaborative know-how to develop and execute the project approach, timeline, and analyses, in order to ensure buy-in from all parties on the resulting findings and recommendations.
The teams in return should report to a steering committee made up of representatives of the project stakeholders who have requisite decision-making authority to resolve the inherent conflicts that can arise throughout the process.
In this case, the focus was on closing the gaps between benchmarks/ best practices and the existing performance levels driving the original capex proposals from the railroad and the port. On the rail side, technical feasibility studies uncovered operating issues (e.g., train schedules and operating performance, equipment availability, and utilization) that threatened throughput targets and inflated capital requirements. On the port side, the team identified throughput enhancements that would improve current performance and determined alternative capital expenditures that were needed to de-risk the planned operation and ensure reliability. These findings laid the groundwork for reaching subsequent commercial agreements and highlighted key decision and investment points.
Results of Options Testing
Developing Frameworks to Address Project Requirements
The third stage of the process involves formalizing the new operating model, finalizing estimates of operating expenses and capital expenditure requirements, building financial models to support negotiations, and developing protocols and agreements to support the coordination of long-lived capital investment programs. In this case, based on the prior two work steps, the team developed an estimate of the tariff charges needed to support the level and timing of the proposed capacity-related investments and to provide a reason-able rate of return for the transportation entities. In addition, options were developed around commercial terms between the parties that would minimize operational risks as an input to developing a tariff model and a range of commercial and contractual risk sharing and performance incentive options.
Developing Frameworks: Options for Commercial Terms
This collaborative effort led to an agreement on investment cost and funding mechanisms that were acceptable to both parties and provided the basis for a new commercial contract. The project was able to reduce the proposed tariff that the mining company would pay by nearly 40 percent and the overall capital required for the expansion by more than 20 percent, while still generating an attractive rate of return for all parties. The project also led to a better understanding
of the real capacity constraints of individual components along the entire logistics chain, which became the basis for an agreement between the parties to form a joint operational team focused on optimizing the capacity of the entire export channel.
Summary: Rethinking Complex Logistics Chains
The example above focuses on capital expansion issues for a logistics chain dominated by materials throughput and involving multiple entities. Operational coordination issues and the need for tradeoffs between capital and operating costs can arise both within a capitalintensive firm and between parties with large capital requirements that are part of the same logistics chain. The key to developing a result that maximizes effectiveness is to understand the operating and capacity relationships across all individual components of the logistics chain. Performance and capital benchmarking, a detailed understanding of the factors impacting optimization of the consolidated logistics chain, and an iterative process for framing and testing options can produce significant scale benefits for all parties involved and ensure the best use is made of scarce capital resources.