Resetting capital spending in the wake of COVID-19
The COVID-19 pandemic will have an enormous impact on people’s lives and livelihoods that much is clear. The path to recovery is far less so, though it is evident that the crisis has significantly impeded many organizations’ ability to execute capital projects, and may continue to do so for some time.
The availability of labour and materials has decreased worldwide, while more and more balance sheets and cash flows are becoming capital-distressed. Physical distancing and travel restrictions have made it difficult for sectors and countries to get workers safely into plants and construction sites, and vital supplies into global production networks. Government-enforced public-health measures, for example, have disrupted the operations of fabrication yards and construction sites across Asia and Europe.
Freeing up cash by deferring capital expenditures is one of the fastest and most substantial ways to mitigate these ill effects. As such, companies across sectors and the globe have announced capital-expenditure cuts ranging from 10 to 80 percent. To gain insight on the extent to which specific industries have been affected, we analyzed publicly available notices from some of the largest companies in the world: 98 had announced capital reductions. Although many have announced top-line cuts to capital budgets, however, finance leaders often don’t know which projects to cut or where best to reallocate their capital.
A reset is difficult but worth the effort
In our experience, successfully executing this approach not only maintains delivery of business objectives and results they also reduce capital spending by 15 to 30 percent, and boost ROIC by 2 to 4 percent. Furthermore, our analysis shows that the reward will likely be worth the effort. In studying 1,500 companies based in the United States over a 20-year period, our colleagues found that those that dynamically reallocated their capital outperformed those that did not their median compound annual growth rate for total shareholder returns was 10 percent, compared with 6 percent for companies that did not. This evidence suggests that companies’ response to this crisis is critical for not just short-term liquidity but also long-term success once the corona virus crisis has passed.
Attaining these results is more easily said than done, however. Crisis situations require leaders to be well-equipped with facts to act quickly. Given the uncertainty surrounding the pandemic, however, fact-finding and knowing how much is necessary to cut to sufficiently improve cash flow can be difficult. Indeed, our April 2020 survey of 43 capital-projects leaders found that determining how deep to cut and a lacking fact base were their biggest challenges.
A better approach to resetting a capital portfolio
Once an enterprise has determined the level of capital expenditure it can afford, we recommend four steps toward a fast reset of its capital portfolio.
1. Triage the capital portfolio
The first step is to rapidly assess where to reduce or defer capital spending while minimizing liabilities. In some cases, physical threats to continued project execution, such as restricted site access, may cause more harm than financial ones do. In March 2020 for example, facing the rapid spread of COVID-19, many North American operators with strong finances closed sites to contractors and sent nonessential personnel home because of health and safety concerns.
2. Assess each project and prioritize
The second step begins with analyzing each project to develop a fact base to support informed decision making. These facts might include, for example, spending to date, committed spending, stoppage costs, as well as a measurement of expected benefits, stakeholder impact, and risk trade-offs.
3. Optimize selected projects
Once the priority projects are clear, the third step involves maximizing each one’s value by refining its business case and scope, enhancing design, striving toward contracting excellence, and improving construction execution.
4. Reset the portfolio
Finally, operators need to combine what they’ve learned in the first three steps to create a robust trade-off analysis. Portfolio decisions must be finalized changes implemented across the organization. A reinforcing fact base will help not only make adjustments in the near term but also adapt to changing conditions over time. In addition, principles applied during a rapid resetting may also yield substantial benefits when applied to existing capital-planning processes that may affect future allocation cycles.
Uncertainty surrounding the pandemic and economic recovery will persist. It will become increasingly important for operators to rapidly reprioritize their capital portfolios. Doing so will operationally and financially benefit both they and once they can continue their projects the broader economy.
McKinsey