CASE ANALYSIS - Total Cost of Ownership Analysis

CASE STUDY 11-1

Northwest Gas & Electric Company

Liz Gates, senior buyer at Northwest Gas & Electric Company (NG&E) in Portland, Oregon, was reviewing a proposal from Covington Meters (Covington) for the purchase of 2,000 rotary gas meters. Alex Butt, sales manager at Covington, had provided information in his proposal suggesting that operating costs for their meters provided significant savings over the life of the product, justifying a higher purchase price. It was Thursday, March 24, and Liz needed to finalize her recommendations by March 31, when she was to meet with her boss, Larry Lin, director of procurement. Larry was expecting a convincing case to justify the acquisition of a higher cost meter.

NORTHWEST GAS & ELECTRIC COMPANY

NG&E was one of the largest combination natural gas and electric utilities in the United States. Based in Portland, the company employed approximately 15,000 people who carried out its primary businessthe transmission and delivery of energy. The company provided natural gas and electric service to approximately 12 million people throughout a 50,000-square-mile service area in the Northwest.

The transportation system for natural gas consisted of a complex system of pipelines, designed to efficiently move natural gas from its origin to where it was needed. These networks consisted of gathering, feeder, transmission and distribution pipelines. Gathering systems consisted of low-pressure, small-diameter pipelines that transported raw natural gas from the wellhead to the processing plant. Transmission lines were the superhighways of the system, moving large volumes of natural gas within a state and across state or international boundaries. Feeder pipelines moved natural gas from processing facilities and storage tanks in the field to the transmission pipelines. Local distribution companies operated natural gas distribution lines to homes and commercial customers. Compressor stations, consisting of large turbines, were placed along the pipeline to increase pressure and push the natural gas through the pipe to its destination. NG&E operated approximately 33,000 miles of natural gas distribution pipelines and 5,000 miles of transmission pipelines.

Utilities and pipeline companies used metering systems to measure and regulate the amount of natural gas entering, exiting and flowing through their pipeline systems. Metering requirements differed based on the diameter, pressure, and volume of the pipeline. For example, transmission pipeline networks were often large in diameter, designed to carry high volumes of natural gas compressed to as much as 1,500 pounds per square inch (psi). In contrast, distribution pipelines were smaller in diameter, requiring as little as 3 psi of pressurization. Natural gas meter capacity was measured in standard cubic feet per hour (CFH), with sizes ranging from 600 CFH to 56,000 CFH.

METER PURCHASES

NG&E purchased several different types of meters for its pipeline network each year, representing an annual spend of approximately $10 million. Liz Gates took over responsibility for meter purchases the previous year and had committed to achieving cost savings, defined as year-over-year price reductions, representing 3 percent of NG&E's spend on meters for the current calendar year as part of the purchasing department's overall cost-reduction target.

The company had two approved strategic suppliers for its meters. Becker Meters (Becker) had been a long-standing supplier to NG&E and was one of the world's largest providers of natural gas meters. Headquartered in Germany, Becker had 8,000 employees with operations in Europe, North America, South America and Asia. The company's U.S. operations were based in Chicago. The majority of the meters currently installed in NG&E's network had been supplied by Becker.

NG&E had recently approved Covington as a new supplier after a thorough audit of its manufacturing operations, quality processes, engineering capabilities, customer service operations, human resource practices, and financial position. Larry Lin had been concerned that Becker's 12-week lead times were too long, and he felt it prudent to have an alternative source. Located in Cincinnati, Ohio, Covington was a privately held company that had been in operation for more than 40 years, specializing in rotary gas meters. Company revenues in the most recent fiscal year were approximately $20 million.

Each year, NG&E purchased approximately 2,000 meters with capacity of 1,000 CFH for use in its distribution network. This equipment was regarded as a capital expense, which was amortized over a 20-year period. The company had been using the B-1,000 diaphragm meter from Becker, which was approximately 20 inches tall and 14 inches wide and weighed 55 pounds. James Flynn, the sales rep for Becker, quoted a price of $950 for the B-1000 meter, conditional on Liz committing to a three-year contract with annual volumes of 2,000 units. This price represented a $60 reduction from the price in Becker's previous contract with NG&E, which was due to expire.

THE COVINGTON PROPOSAL

Liz asked Alex Butt to submit a proposal in order to compare price and lead time. She indicated to Alex that NG&E would be prepared to sign a three-year contract.

Alex met and with Liz in her office on March 21 and recommended the COV-1,000 rotary meter, for a cost of $1,700 each, based on a three-year contract with annual volumes of 2,000 units. Lead times were eight weeks. During the meeting, Alex commented: "I expect our price is higher than you are used to paying for diaphragm meters from Becker, but there are factors other than price that need to be taken into consideration. Rotary meters are more durable, requiring less maintenance. Our engineering department has analyzed the differences between our product and comparable diaphragm meters, and we estimate that you can save at least $1,700 per meter on a total cost basis over a 20-year period. I have provided the details in the quote, and I think you will find our proposal very attractive."

The Covington proposal included its COV-1,000 rotary meter with a diaphragm meter conversion kit, complete with required piping, gaskets and bolts, and the instructions to facilitate replacement of existing diaphragm meters. The conversion kits were pre-sized and factory tested, so there would be no need for welding, pipe cutting, and other extensive labor. Installation costs would be similar to the diaphragm meter.

The proposal from Alex indicated several advantages of the COV-1,000 rotary meter compared to comparable diaphragm meters. First, the rotary meter would require fewer field service inspections, at an interval of every 11 years. Diaphragm meters required three inspections during a 20-year period, with intervals of seven years for the first inspection and every five years thereafter. Second, the higher flow-rate accuracy of rotary meters provided higher revenues. Alex provided test results indicating that the COV-1,000 meter increased gas registration by 0.05 percent, which resulted in approximately $66 per year in additional revenues. A third potential advantage was the opportunity for NG&E to reduce its inventory of meters used as replacements when meters were removed from the field for inspections in order to avoid interruptions in operations. NG&E currently held 2,000 diaphragm meters in inventory to support service inspections. Alex's proposal suggested that this number could be reduced to 665 meters if NG&E used the COV-1,000 rotary meter in its pipeline network. Lastly, the Covington meter offered a 50 percent reduction in weight and 70 percent reduction in size compared to the B-1,000, allowing for easier and safer handling and installation. A summary of the analysis provided by Alex in his proposal is in Exhibit 1.