November 2013

Eye on Business

Approaches to lowering mining’s cost curve

By Thomas Struttman

Between 2009 and 2012, mining companies increased their capital spending from $58 billion to more than $120 billion. Yet, return on capital, having peaked in 2006 at 23 per cent, dwindled during this period, falling to less than eight per cent by 2012. This decline can be attributed to a range of factors, including lower commodity prices, record capital spending, project cost overruns and a focus on growth. Unfortunately, the outcome is many mining companies have been left with large writedowns, increased debt-to-equity ratios, and lowered returns.

To improve their margins, miners have embarked on numerous cost-cutting strategies, including project cancellations, reduced exploration budgets, deferred capital expenditures and staff layoffs. These actions may be effective in the short term but they do not fix the underlying problems facing the business today.

Rather than relying on quick fixes, management should focus on effectively organizing their companies to reverse the decline of their margins and position themselves to capture the inevitable uptick in future demand. Cutting costs can be much better achieved through a systematic evaluation of a company’s business strategy, operational plan and operating environment, which are the underlying forces that determine its margins.

Business strategy

A good business strategy is the foundation of any profitable organization, yet it is widely overlooked in the mining industry because management is often too focused on dealing with short-term problems. Developing an effective strategy begins with a rigorous review of a range of value drivers, such as grade and strip ratio, as well as price, costs and productivity. All of these variables may shift slightly or radically over time.

An effective strategy will predict several scenarios, providing managers with insights on operational changes and enabling them to explore options for achieving margin and growth goals. For example, at the simplest level, if grades are declining while all other drivers remain constant, then some variable must be adjusted to maintain margins. It is management’s job to determine whether a variable can be tweaked to maintain margins or if a deeper examination of the company’s operating model is in order.

Operational plan

Even when a company has a business strategy in place, management often falters when it comes to translating it into an operational plan. Ideally, managers should be able to understand with a level of certainty what the company will face in the next six months. However, many operate with a six-week horizon. For most mines this is simply not enough time to make changes to achieve margin goals.

To make accurate projections for a comprehensive operational plan, a high level of detail about financial, operational and geological data is required. When combined with other known data, such as productivity, costs, pricing, sales contracts and budgets, mining engineers can perform situational modelling.

Through modelling, engineers can adjust a wide range of variables and simulate forecasts with a high degree of accuracy, thus gaining the necessary insight to make informed production decisions. Unfortunately, few mining companies have accurate operational and cost data. As a result, it is impossible to determine the factors that are causing variation, which is ultimately the most crucial element of reducing costs.

Operating environment

On a day-to-day basis, the operating environment is constantly impacted by numerous factors that can bog down operations managers with details and prevent them from making solid production decisions. Processes like drilling, blasting, loading, hauling, crushing, grinding and floatation are all subject to variation. This situation is worsened when it is combined with unreliable assets, which are the foundation of the operating environment and one of the main sources of variation in overall production throughput.

Too often, managers make decisions without keeping the bigger picture in mind. Instead of addressing variation, companies will implement a range of inefficient strategies such as increasing inventory through the production chain, raising capital expenditures by acquiring more assets, and relying on costly last-minute airfreight for repairs.

Implementing asset monitoring technology is a key process that companies can put in place to control the operating environment. Predictive modelling can reduce asset failure rates and increase reliability. Another step toward better processes is designing an effective asset life cycle. When technology is combined with rigorous operational planning, mines can prioritize activities, which helps them minimize variation and achieve margin objectives.

To improve margins, taking the long view is not only smart but essential to the industry’s future. A mining company is a complex and unique matrix of moving pieces. Without proper attention to every working element, it will inevitably drift off course into decline.

Thomas_StruttmannThomas Struttmann is the CEO of Struttmann Consulting. He brings more than 30 years of industry experience leading projects, supporting M&A due diligence, and providing expertise on asset management and capital planning for top Fortune 500 companies.

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