Cores, Cores and More Cores
No meaningful conversation can be had concerning remanufacturing without delving into the treacherous and confusing subject of cores. Ah, just the word, CORE, elicits the full gamut of emotions depending on the audience. “They’re dirty,” “It’s a crooked industry,” “They’re killing my balance sheet,” “I can’t get enough,” “I have too many,” “How do I value them?” I think many of these ideas about core arise because there is a lack of a holistic understanding of why cores are important and how they should be dealt with and perceived. The need and use of cores creates a unique business model for the remanufacturing industry and causes remanufacturers to analyze their businesses in terms of supply-loops and not chains. This is one of the many areas where remanufacturing diverges from traditional manufacturing. We’ll leave a discussion on “Remanufacturing and Lean” for another post. Let’s take a look at some terminology before we begin a more thorough discussion of cores.
Over the years I’ve heard a variety to sophisticated and elaborate definitions of what a core is, but I prefer the simplistic approach to defining a core, which is simply, a used part of any kind. Most of the time this part is not referred to as a core until it has been separated from its original-use application. This vague definition heightens the confusion on the need, use, and value of a core. It is why cores have such a wide spectrum of worth and value. The same terminology is used for a part that has only been in an application for 1 hour and the exact same part that has been in an application for 5+ years. A part that was removed due to failure is considered the same as a part that was disassembled from that same application due to obsolescence. The term core covers a broad spectrum of appearance, functionality, and completeness and therefore can create a high level of anxiety to the unsuspecting and unwary receiver.
Peddlers are those individuals that go into the salvage yards and pull the parts off the. Armed with shopping carts, wrenches, and wire snips they search for parts that they can sell directly to core brokers.
Core brokers have long provided a valuable service to the remanufacturing industry supply chain here in the US. Core brokers serve as a consolidation center for cores. Brokers work with peddlers to purchase cores from crashed vehicles, OEM/OES surplus, and dismantlers and consolidate, sort, and in many cases link to customer part numbers. In the early years, cores were purchased by type and make, but as remanufacturers became more sophisticated and more discerning, they began “cherry picking” for certain part numbers. This approach put a lot of the risk on the core broker who was forced to guess on what part numbers their customers would want in the future. Since they were adding more value, cores purchased this way became more valuable, and therefore more expensive. Remanufacturers send the core brokers a bid list of the part numbers and quantities that they want and the core broker will submit a price quote for these cores. After some negotiation, cores are purchased and shipped to the remanufacturer.
Core Deposit/Core Charge:
Core deposit and core charge will be interchanged in this discussion. The core deposit is the “bounty” placed on the core when the part is sold for aftermarket purposes. The intent of the core deposit is to ensure that when the aftermarket part is sold, the failed part (core) is returned to the remanufacturer. For those that live in states with bottle deposits, the principle is the same. The end-user purchases the beverage and pays a bottle deposit up front. When the beverage is consumed and the bottle is returned, the deposit value is returned/credited back. Similarly, when a remanufactured part is sold, the customer also pays for the core deposit up front and is credited for that cost once the core is returned. The amount of the deposit is predicated on a variety of factors which include but are not limited to; part value, part price, availability of core, market competition, price of a new part, etc.
Core Book Value:
Core book value has nothing to do with core deposit value, unless you are in the distribution channel of the part and then the book value is the deposit value. As with any asset in your business, the core book value is the price you paid for that asset, in this case the core. This particular issue becomes tricky when you have different purchase prices for the same part.
Now that we have established some common ground in terms of terminology, let’s discuss cores relative to the remanufacturer. A whole other discussion could be had concerning the distribution channel partners, but we are going to focus on the remanufacturers for this discussion.
Core as a commodity
A core can be categorized in a similar manner to precious metals, natural gas, or oil as its value is based on supply and demand principles. Core brokers and remanufacturers engage in the bartering process, each with the goal of maximizing their profitability and minimizing their risk. Hard to find, in demand cores are sold at a premium, while common, low demand cores are much less expensive. The entire process is won or lost on the grounds of information. The party with the most accurate, up-to-date information will almost always win. Knowing how high the demand will be at what time in the life cycle is a critical piece of information. Those who develop life cycle charts from historical data, current data like VIO (vehicles in operation), can more accurately determine what a particular cores value is at any time in the aftermarket life cycle of that part. Cores may be a dirty business, however, the principles employed to succeed in obtaining the most valuable resource to a remanufacturer can be a sophisticated as any precious metal or energy resource intensive company.
How should cores be valued?
The IRS has determined that cores can either be valued by their costs or market value, with enough extra “accountantese” to choke an adult white rhino. Reference the IRS Core Valuation Method (http://www.irs.gov/newsroom/article/0,,id=106087,00.html) for a detailed legal approach to core valuation.
Once you understand your cost, cores can be treated as any other asset. The issue arises when, during the same calendar year, your cost are different for the same part number core. I have found that the best way to deal with this is to keep accurate part number data on all cores purchased and take the weighted average of all purchases to determine the annualized weighted cost of the core. If done on an annual basis, this cost can be used to value your core as well as expensed in your Cost of Goods Produced through your MRP system.
The weighted average can then be calculated as follows:
WA = (($15*100)+($20*50)+($13*100)+($17*75))/(100+50+100+75)
WA = (1500+1250+1300+1275)/325
PART A VALUE: $16.38
Multiply this value by the quantity you have in inventory and you get your core inventory value. If you receive free cores for some “must be livin right” reason, these cores will lower the weighted average by that quantity multiplied by zero. If you view your financials on a monthly basis, I would suggest an MS Excel program to create a rolling 12 analysis.
In future posts we will discuss the differences between the independent remanufacturer and the OEM/OES, however, you can clearly see the significant advantage of the OEM/OES, where much of their seed core is sitting on the vehicle that leaves the manufacturing plant. Each time an aftermarket part is sold a core is returned at no purchase price, or zero value. Hugh advantage…
Core Amounts (too much, too little)
There are several trains of thought when it comes to the question of how much core is enough. Some feel you can never have enough core, others feel that the less the better. I think there is a happy medium between the two.
The life cycle charts developed in the commodity section of this post is a good place to start to begin the process of managing core needs. Cores can be broken down into categories depending on where they fall on the life cycle curve. The following chart is one way to categorize cores so that better decisions can be made by the corporation.
Smart core buyers with good life cycle charts and a good gut feeling for their industry would purchase as many CODE A as needed to properly seed the program and then manage the core deposit values through the life cycle so that by the time the core moves from C to D, the deposit value is lowered to keep the formula at (Core Return = Sales). By time sales are zero, core returns should be zero. Of course, anyone who does this for a living knows that this is the “holy grail” of core management, but should be the goal. Since I like to live in the realm of reality, let’s talk about the two scenarios that arise when cores cannot be managed so well.
Not Enough Core
This can be a very frustrating and expensive problem. When there’s not enough core to meet your customer’s demand, there are finite amount of profitable remedies. I’ve listed them in order of typical cost from lowest to highest. You may find examples where some of the remedy costs are switched but this is a good guide to begin your analysis.
Salvage – In this scenario, you’d better be salvaging every core that you own. In many cases you may have to tool particular parts so that you can drive your salvage percentage well above 95%.
Conversions – Look for similar core that you may have excess of and convert that core to what you need. You may have to tool up some parts and do extensive validation testing, but it will, in most cases, still be less expensive that the following options.
Buy New – Buying a new part seems counterintuitive to a remanufacturer, but this method can be very successful. You’re buying new to seed the core you need with the expectation that when you sell that part, you will get a core back to remanufacture. If you can “turn” that core several times in a fiscal year, you may be able to break even on the purchase, and then it’s profit from there on in. There are now some opportunities to purchase “new” parts from overseas, but buyers beware. Proper validation is needed or you will tick off some of your best customers.
Tool-up – This is usually the last resort for a remanufacturer. It is costly, difficult, and sometimes prohibited by patented technology. This process includes reverse engineering, drawing, tooling, manufacturing every component of the part and then assembling, testing, and shipping. There is a great amount of engineering know-how needed to choose correct material specification and well as validate each and every part.
Too Much Core
This scenario can be just as bad as too little core because every core you have left over at the end of it’s life-cycle will need to be written off your balance sheet unless you find other avenues for it. As discussed earlier, the best scenario is to manage the deposit value throughout the lifecycle to minimize your risk at the end. For those parts that slip through the cracks there are only a few remedies outside of a right-down after scrap value.
Conversions – We discussed earlier the option of converting one core part number for another with greater demand.
Secondary Uses – This is a bit of a stretch, but desperate times call for desperate measures. Window lift motors can make an attractive automatic commercial trawler fishing line retriever. You get the point. If we remanufacturers are anything, it’s creative. It’ll be a fun project for someone.
The key is to try to avoid these problems in the first place and be sure to have enough core at launch of the program to supply your customers shelves and then manage the core deposit to be sure you are getting back to amount you want to satisfy present orders, once dropout is factored in.
Finally, I leave you with the most basic question in this whole discussion, “Should I own the core?” I will answer that with the truest truism in all of reman, “He who owns the core owns the market.” There were programs where I owned 95%+ of the core and I could control every aspect of the market. Then there were programs where my customer owned the core; moved the program to another reman and I was powerless to do anything about it. If you can’t own the core, have some aspects of the process that only you can do and know how to do. This will protect you somewhat, but only for a while until your competition figures it out.
Happy core purchasing and management!