Managing costs is critical to the operation of any mining company. While revenues can be difficult to control due to the underlying geology of the deposit or the market determined price, costs are normally within the control of a business. Costs can be kept at previous levels, scaled back, eliminated or increased with high levels of control.
The flexibility to reduce costs has often been used strategically to improve the profitability of the business and, importantly, its value to shareholders. Regrettably though, there are also too many examples of revenue reduction as a consequence of across-the-board cost reduction. The net impact is substantially reduced project profitability and a destruction of shareholder value. What is needed is a framework to determine which costs are excessive and should be reduced and which costs are not and should be maintained or even increased.
Which measure should be used?
When many objectives are specified, analysis for each objective is undertaken, similar work being undertaken for each objective. This is both time intensive and frustratingly wasteful. Once the work is completed for each objective, there is the problem of which one to use. Ultimately, only one choice can be made for each decision, and each objective normally has a slightly different option.
How then do you ensure that the best option for the company is chosen? By choosing the best overarching measure of shareholder value, which appropriately balances revenues (e.g. from all the metals or products), costs (e.g. exploration, mining, processing, marketing, sales), productivities (e.g. truck and shovel utilisation and efficiency, metal recoveries) and all project constraints (e.g. mining fleet, processing, infrastructure, safety and environmental).
Net Present Value
Net Present Value (NPV) is widely used in the mining industry (and all other industries) and is normally considered the best proxy for shareholder value in every industry (Principles of Corporate Finance, Brealey & Myers). While there are some limitations, it is a far superior overarching measure of shareholder value than individual department objectives and all other financial measures (including payback period and internal rate of return). NPV allows a fair weighting between different departmental costs and capital injections and also recognises the monetary value of time over the life of the project. This inherent balancing of costs, revenues and current and future values has also led to NPV being used by stock market analysts to estimate the share price position of listed companies.
While the impact on NPV is sometimes difficult to measure, it remains the standard instrument that major capital decisions are best measured with. The projects being considered are large, typically over ten years, and need to determine the best capital cost management strategy over the life of the project.
Three case studies have been provided to demonstrate how cost management optimisation can be implemented.
