de Vries J, 2002.

in Proceedings Underground Operators Conference 2002, pp 127-

132 (The Australasian Institute of Mining and Metallurgy: Melbourne). Reprinted
with permission of The Australasian Institute of Mining and Metallurgy

Why Cost Cutting Fails to Deliver

By J de Vries 1

Abstract
Over the past decade most, if not all participants in the resources sector have been involved in
initiatives to improve margins, reduce costs and improve business profitability. In many cases the
initiatives undertaken have fallen short of their stated objectives, and in some cases have resulted in
terminal declines of the underlying business. In reviewing why many such initiatives fail, a common
theme of arbitrary cost reduction and a focus on minimising cost as opposed to maximising value and
cashflow emerges.

This paper proposes a structured process that allows mine owners and managers to develop an
understanding of their cost structure and optimise production and cost outcomes from the business.
The broad objective of cost optimisation is to create value by getting more out of existing and new
assets by focussing on operational areas, particularly production and maintenance. The paper uses
practical examples to highlight the application of cost driver trees as a mine improvement tool.

Introduction Successful cost reduction and margin improvement is rigorous,

When observing what went wrong in failed margin
improvement and cost reduction programs, what emerges is a
common theme of inadequate assessment of interconnectedness
between physical activities and their related costs. In many
cases actions taken reflect accounting decisions, as opposed to
business decisions.
Two distinct types of failure occur. The first type of failure is
simply making the wrong choice. Typically, this is due to
limited time or data to be able to complete the task. For
example in a cost reduction program, the use of emulsion or
ANFO explosive in stope firings might arise. To make the right
choice, a study should not only consider the direct cost of
explosive. The impact of hole size, drill spacing, cost to charge,
and blast induced dilution should be included in the assessment.
A more through analysis would include assessment of differing
fragmentation on LHD bogging rates, truck damage, and
crushing and milling cost and throughput.
The second type of failure relates to arbitrary cost reduction.
There is a very real probability that an across cost reduction
will reduce physical capacity to below sustainable levels. This
may have long term impacts on mine viability. The long term
negative impact of deferred mine development would be an
experience familiar to many mine managers.
The common theme in both types of failure is an inability to
identify the bottleneck in the business. If a bottleneck is not
identified prior to restructuring, further operational capacity
reductions could further reduce the bottleneck, crippling the
operation.
1. MAusIMM, MMICA, Principal Mining Engineer, Australian Mining
Consultants Pty Ltd, 19/114 William Street, Melbourne Vic 3000
Email: jdevries@ausmin.com.au
systematic and data intensive. It is only after the whole cost and
productivity structure has been studied and modelled that
effective and organisationally safe improvement initiatives can
be undertaken.
This paper reviews the use of cost and productivity driver trees
to provide a systematic framework to highlight relationships
within cost structures. To highlight the methodology a case
study is used.
The objective is not an attempt to discredit many initiatives in
place. Rather, it aims to present the use of cost and productivity
driver trees as a tool to assist mine management to take control
of their own destiny and act before somebody else does it for
them.
Over Time, Cost Structures Are Unstable
Over time most mine and processing plant cost structures lose
calibration with the activity or process that gives rise to cost
structure. Periodic reviews of the overall cost structure are
helpful in spotting early problems. This should not be confused
with routine reporting of unit costs. Common causes of cost
structure change are failed expansions, changes in operating
rates, increased depth, technology and management
restructuring.
The impact of failed expansions, or the inability of a mine to
reach design capacity can have important implications for cost
structures. For example Ward and McCarthy (1999) observed
that only 50% of underground base metals mines and mills
achieve nameplate capacity by Year 3, additionally 25% never
achieve nameplate capacity. Yet it is reasonable to assume that
both manning and equipment levels are sufficient to achieve the
nameplate operating rates at the completion of construction. In
cost terms, we would observe that both fixed and capacity costs
in the above projects are underutilised.
Recent implementations of Enterprise Resource Programs
(ERP) such as SAP, GD Edwards etc have done little to
Why Cost Cutting Fails to Deliver
improve the transparency and calibration of mine cost
structures. The common failure of many implementations is the
inability to readily reconcile the observed cost structure to
observed physical activities. Under such circumstances
management has very limited capacity to assess the relative
value for money being achieved. The lack of transparency also
makes it difficult to understand the relationship between
physical activities and the cost outcomes.
Unfortunately most ERP’s are accounting platforms and are
simply not designed as continuous improvement tools.
Additional software, involving data warehousing and similar
processes needs to be integrated into the ERP before the
platform has enough data to be transparent. This next step is
still a few years away.
Driver Tree Analysis
The objective of using a driver tree as an analysis tool is to
highlight the relationship between physical activities and the
resulting expenditure within a cost structure. Properly
structured, driver trees drill down from high-level Key
Performance Indicators (KPIs) to detailed operational cost
drivers. For the purpose of most analyses, the author has found
the maximum sensible level of precision of the driver tree is to
be one level below the cost centre. This allows the behaviour of
different cost types within the cost centre to be recognised and
modelled.
For example, the analysis might involve identifying drill
consumable costs in production drilling. The impact of
increases or decreases in production drilling rates can then
modelled, while unit ($/metre) costs are held steady.
Figures 1 and 2 illustrate the relationship between high level
and detailed cost trees.
High level KPIs are important as they explain what is going on
with the business, while low level detailed KPI’s explain why
those things are happening. Being able to relate the two types of
KPI is a fundamental first step in extracting value for money
from a cost structure.
A further very useful outcome from driver tree analysis is the
establishment of agreed definition of metrics. Rigidly defined
metrics are useful when comparing cost and productivity
differences between different mines, and across time periods.
Rigid metrics form the basis of any continuous improvement
process.
Figure 1 – High level driver tree
Drilling
Loading
Development
Ground
support
Production
Services
Revenue Ore handling
Mine Back-fill
Margin Mill Services &
Mgt
Return Costs Site
on
capital Admin
Capital
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Figure 2 – Detailed driver tree
Cost/ person
People
Productivity/
($/drifter m)
person
Cost/ rig
Development
Equipment
drilling ($/drifter m)
($/drifter m) Productivity/
rig
Supplies
($/drifter m)
Cost Behaviour
Most managers are familiar with fixed and variable cost
analysis. However when assessing the potential for
restructuring, it is useful to consider a third type which may be
described as a capacity cost.
Capacity costs may be thought of as being short run fixed costs.
They are independent of the level of utilisation of a cost centre.
However, an essential distinction between a capacity cost and a
fixed cost is management’s discretion to change the level of
capacity available, and hence total cost at relatively short
notice. In effect capacity costs are discretionary fixed costs.
Capacity costs represent the real cost of having an increment of
capacity available for production, but not necessarily used.
Capacity costs can be thought of as representing an option to
increase physical activity within a cost centre with the only
increase in total cost being the variable cost component.
Alternatively, being able to identify excess capacity is good
first step in a structured margin improvement program.
Individual increments of capacity can be small, and can be
thought of as additional items of plant such as trucks, loaders
and drills. As utilisation rises, the capacity of the fleet remains
constant, until at full utilisation, additional capacity is
introduced, and the cost of supporting the increased capacity
rises.
A detailed cost driver tree will involve splitting out components
of a cost centre and catagorising behaviour into the three cost
types. The process allows incremental capacity additions and
re-engineering options to be tested against capacity utilisation.
Access to databases of industry performances makes this
process particularly powerful.
Figure 3 illustrates the behaviour of the three cost types.
Capital Costs
Most ERP platforms report depreciation and amortisation as a
component of total cost. While not important in terms of most
restructuring, depreciation and amortisation are important
considerations when assessing owner mining or expansion
decisions.
To avoid confusion over the cost definition, depreciation and
amortisation should be shown as a separate branch of the driver
2
Why Cost Cutting Fails to Deliver
tree. Where depreciation and amortisation are associated with
ongoing expenditure such as fleet replacement, they should be
considered as cash proxies ensuring the full cost of operations
are recognised.
Expansion or contraction options pose unique issues for
inclusion or exclusion of depreciation and amortisation. A at
times heated debate exists over inclusion or exclusion of
historical capital is assessing future mine options.
Figure 3 – Cost behaviour types
30
20
Total cash
expensed
10
0 significant capacity cost. This normally becomes apparent as
0 20 40
Unit of production
70
60
50
Total cash 40
expensed
Unit of production
Total cash
expensed
Unit of production
Most mine owners use Net Present Value (NPV) as a decision
tool. In an NPV analysis, sunk capital should be irrelevant to
the operational decision which is based on cash flows. Sunk
capital is important in tax calculations, and should only be
modelled in tax calculations and considered where tax impacts
cash flows.
An accounting view would suggest that undepreciated capital
represents historical expenditure of shareholder funds. A
decision to ignore this expenditure during an analysis of future
mine options is equivalent to writing the value off a mine’s
balance sheet. Conceptually, residual capital should be thought
of as being the part of a loan advanced by equity holders that is
still outstanding. Depreciation and amortisation may be thought
of as the principal repayments of the loan, with profits forming
the interest component.
The authors experience is that at the end of the day “cash is
king”. Models should consider cash flow on an after tax basis.
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However, the cash flow must make adequate provision for
future capital.
A final word on expansions. It is more important to consider if
a proposed expansion is simply making an inefficient mine a
bigger inefficient mine, or is the expansion doing something
about structural inefficiencies within the mine. It is not possible
to answer this question without a detailed review of the cost
structure.
Volatility, Capacity Costs and Scales of Economy.
A premise articulated by many mine owners is that expansion
or simply being big will permit better utilisation of fixed and
capacity costs. With capacity costs typically representing 60%
to 70% of total cost for most underground mines, the
“economics of scale” argument is reasonable.
Even those mines with a “schedule of rates” contractor have a
variance claims or stand by charges when operating rates fall
below some agreed level.
The use of expansion strategies to reduce costs poses two risks.
The first relates to the ore grade of the expansion. The grade of
additional production must pay back the capital and operating
costs of expansion without lowering the returns to the existing
mine. To do otherwise will marginalise the business. Inclusion
of the existing capital base is critical in making the right
assessment.
A good example of the relationship between mining rate and
head grade is illustrated in Figure 4. (Mikula and Lee 2000).
McCarthy (2002) reviewed a number of such time based
tonnage grade curves and concludes that in most cases it is
quite common for a significant reduction in grade to occur as a
mine increases production rate.
Figure 4 – Mt Charlotte annual production 1966-2000
(Lee & Mikula 2000)
6
Head grade
(g/t) 3
2
1
0
0 500 1,000 1,500 2,000
Annaul production (kt)
A second risk of expansion strategies is that working stocks are
consumed at a rate faster than they can be replaced. As stocks
are diminished, production volatility rises, as ore available for
production becomes increasingly scarce. These mines are
characterised by high instantaneous rates of production,
interspersed with lengthy low production periods. In cost
structure terms, these mines are paying for capacity, but not
using it. In such a scenario, industry practice of making a
marginal mine bigger will results in increased losses.
3
Why Cost Cutting Fails to Deliver

Production volatility may be defined in a number of ways. A
definition used by the author is simply the ratio of actual to
planned outcomes. Such a ratio measures the stress induced on
management by production shortfalls.
Production volatility is related to both stock levels and
distribution of stocks. Where adequate stocks exist, and are
appropriately distributed, a mine is able to cover a production
shortfall from any one source by supplementing production
from other sources.
Figures 5 and 6 illustrate the relationship between total stock
availability and its distribution and the capacity to maintain
production. Clearly, having alternative sources of ore available
is an important cost management strategy for a mine.
Reducing volatility to an acceptable level is an ideal avenue for
reducing costs. If volatility can be lowered, capacity can be
reduced, or utilisation increased, resulting in lower unit costs.
When an expansion is considered there must be a planned
increase in working capital (ie developed and drilled ore) to
sustain the increased production rate.
million tonnes per annum. Maximum monthly production
achieved was 110 kt. On an annualised basis, capacity (as
defined by the best monthly hoist) was 32% above the annual
production rate. Historical development requirements were
approximately 180 metres per month. Poor productivity in
development required a combination of owner mining and short
term contracts.
Owner jumbo development was characterised as being both
slow and expensive. Monthly advance averaged 140 metres per
month, with occasional peaks of up to 200 metres per month.
Owner development costs were in the order of $3 100 per
metre. Distributed overheads contributed another $600 per
metre. Development shortfalls were made up with short-term
contracts. Contractor unit costs were similar, however after
amortisation of mobilisation charges and allocation of owner
supplied ground support, contract costs on an equivalent basis
were estimated to be $3 900 per m.
As part of the re-engineering, a significant short term increase
in development rates was required. Development rates were
required to rise to 400 metres per month for six months, and
then drop to 150 metres per month, for the next couple of years.

Figure 5 – Metal output volatility vs mine inventory Ground conditions ranged from moderate outside of sheared
levels ground to very poor in and around fault and shear zones. The
mine is deep, and subject to closure in and around zones of
Metal Volatility poor ground. Ground support methodology involved jumbo
80.0% scaling, meshing and subsequent rockbolting.
70.0%

60.0% The key decision in the restructure was a change in the primary
50.0%
ground support methodology. Primary support was altered to
install surface control first. This involved fibrecreteing
40.0%
followed by split sets. Mesh is only applied where required.
30.0%
Scaling was limited to large slabs and obviously loose rocks.
20.0%
The revised support methodology was applied to all headings in
10.0% ore and waste with the exception of the decline.
0.0%
0 50 100 150 200
The results of the re-engineering are illustrated in Figure 7.
Inventory or Mine Stocks weeks Average monthly advance increased from 140 metres per
month to 250 metres per month. Direct costs fell from $3 100 to
$2 500 per metre advance.
Figure 6 – Tonnage outcomes as function of stope
availability Figure 7 – Restructuring impact on monthly advance
350
140.0%
Actual tonnage
as a percentage 300
Monthly advance (m)

120.0%
of budget
100.0% 250

80.0% 200

60.0% 150
40.0% 100
20.0% 50
0.0%
0
0 2 4 6 8 10 12
Aug- Dec-99 Mar-00 Jun-00 Oct-00 Jan-01 Apr-01 Jul-01 Nov-01 Feb-02
Average number of stopes on line during study period
99

Case Study The operational impact of the decision was as follows:

The case study relates to restructuring of jumbo development • Ground support cycle involving the jumbo reduced
for a medium to large underground mine in Australia. It from 4.0 to 5.0 hours to approximately 1.0 to 1.5
examines the use of driver trees to isolate problems with the hours. This effectively doubled the time available for
productivity and cost structure of jumbo development. face drilling;
• Elimination of jumbo scaling and rockfall during the
The mine in question, budgeted approximately 1.2 million ground support component of the cycle. This in turn
tonnes per annum yet achieved an anualised production of 1.0

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Why Cost Cutting Fails to Deliver

eliminated the need to re-bog the heading prior to gaps to be identified. Typical gaps include poor operator
face drilling; productivity, high maintenance costs, and poor utilisation.
• Rockfall damage to jumbo reduced, lowering
maintenance costs and increasing availability; While the mine in question had all of the above, the most
important feature identified was the high percentage of drilling
• Shotcrete reduced rock surface deterioration, effort devoted to rock bolting. Close examination of the data
lowering re-support requirements, increasing the suggested that not only did the jumbo spent a lot of time
amount of time available for face drilling. rockbolting in development headings, it also spent a lot of time
rehabilitating older development. It was estimated that 37% of
In developing the solution the cost structure was mapped. Costs drilled metres were devoted to rockbolting. Of this
within the jumbo development cost centre were broken down approximately one third was associated with rehabilitation.
into individual behaviour types. With the cost centre now
dismantled into its individual components, the impact of Another feature of the data was high unit drilling costs ($ per
increased development rates and alternative operating scenarios metre drilled). Drilling costs are related to rockbolting effort.
could be readily modelled and communicated to mine Figure 9 is illustrates the relationship between unit drilling
management. A summary of the cost structure prior to costs and rockbolting effort. The relationship simply states that
restructuring illustrated in Figure 8. jumbo tramming, scaling, and single boom drilling is clearly
less productive for a jumbo than development drilling.
After mapping the cost and productivity structure, it was
compared to peer mines. Comparison to peer mines permits

Figure 8 – Detailed development cost driver tree before restructure. Zcost components are grouped by behaviour type

Jumbo drilling
( 13.56 $/m drilled )
Jumbo development ( 746 $ per m advance )
( 3,158 $ per m advance )
Blasting
( 111 $ per m advance )
Materials handling
( 348 $ per m advance )
Services & supplies
( 769 $ per m advance )
Metres Drilled
Cost / person ( 110,866 m per annum )
( 90,554.0 $ per person ) ( 1,441.2 $ per person )
People
( 6.53 $/m drilled )
Productivity / person People ( 8 )
( 13,858 m per annum ) Operator ( 8 )
Nipper ( )
Maintenance labour Other ( )
( 2.27 $/m drilled )
Maintenance
( 4.31 $/m drilled )
Parts / supplies & contracts
( 2.04 $/m drilled )
Supplies & Consumables
( 2.72 $/m drilled )
Allocated drilling
( 34.18 $ rockbolt )
Rockbolts Rock bolts
( 635 $ per m advance ) ( 38.77 $ rockbolt )

Ground support Mesh Bolt rate

( 1,184 $ per m advance ) ( 188 $ per m advance ) ( 8.70 bolts per metre )

Cablebolts
( 224 $ per m advance ) Shotcrete
( 550 $ cubic metre )
Shotcrete
( 138 $ per m advance )
Application rate
( .25 cubuc m per m advance )

Figure 9 – Relationship between jumbo cash cost and Similarly, maintenance costs are related to rockbolting effort.
rockbolting effort The key conclusion here is that maintenance costs for jumbos
are driven by the amount of rockfall damage the machine
experiences.
Jumbo cash cost ($\m drilled)

18
16
14 While it is obvious the rockbolting rate was high and was
12 contributing to the high unit cost of development, the solution
10 was less obvious.
8
6 On a high level, rockbolting was costing $635 per metre, or $73
4 per installed bolt. Applying a 25mm layer of fibrecrete was
2
estimated to cost $140 per metre. To break even, application of
0
fibrecrete would have to reduce rockbolting from 8.7 bolts per
0% 10% 20% 30% 40% 50%
metre to 6.7 bolts per metre. Most mines would stop the
Percentage of jumbo drill effort related to rockbolting analysis at this point. The decision to proceed would be
assessed as marginal. Adoption of fibrecrete would be a 50/50

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Why Cost Cutting Fails to Deliver
proposition, or alternatively a contractor would have been
brought in.
The process adopted in this case was to review the behaviour of
each branch of the driver tree. Once the behaviour was
identified, the branch could be scaled according to the proposed
change.
Labour costs were modelled as a capacity cost. Total labour
costs were assumed to remain constant. Under the proposed
change, jumbo productivity (metres drilled per operator year),
was estimated to rise by 40%. This was estimated to reduce
labour costs from $6.53 per metre drilled to $3.92.
Supplies and consumables were assumed to be totally variable
and remain constant at $2.72 per metre drilled. The analysis
neglected to examine drill costs in sufficient detail and missed
the relationship between consumable cost and scaling. In
hindsight it is estimated that jumbo scaling contributed between
25% to 40% of drill consumable costs.
Maintenance costs were split into labour and supplies. Labour
costs were further divided into owner and contractor costs.
Owner labour costs are again assumed to be a capacity cost, and
were held constant. Maintenance costs were re-estimated with
reduced maintenance contractor costs and reduced maintenance
supplies, as a result of reduced scaling.
Ground control costs were assumed to be variable, and a
function of metres developed. Unit ground support costs were
estimated using 5.7 bolts per metre, 20% of existing mesh rates
and 0.30 m3 of fibrecrete per metre developed. Total ground
support costs were estimated to fall from $1 184 per metre to
$780 per metre
The study estimated that total costs would fall by between $500
to $600 per metre and development rates rise to between 200 to
220 metres per month. The result was a drop of almost $600 per
metre, and development rates rose to 250 metres per month.
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Conclusion
To maximise the potential benefit of cost cutting and
restructuring, a through analysis of relationships between
differing cost types and their physical drivers is a primary first
step. Failure to complete a through analysis before embarking
on restructuring can lead to unexpected outcomes, and
potentially threaten the viability of the mine being restructured.
Cost driver trees are a useful method of increasing the
transparency of cost structures and assessing alternative
operating scenarios. The transparency generated using cost
driver trees is further enhanced when rigidly defined metrics
are compared between differing mines. Such comparisons
generate insights not normally available within a single mine
References
1. McCarthy, P, 2002. Setting plant capacity, in
Proceedings Metallurgical Plant Design and
Operating Strategies, (CD ROM) pp 21-30 (The
Australasian Institute of Minng and Metallurgy:
Melbourne).
2. Mikula, P A and Lee, M F, 2000. Bulk low-grade
mining at Mount Charlotte Mine, in Proceedings
MassMin 2000, pp 623-635 (The Australasian
Institute of Mining and Metallurgy: Melbourne).
3. Ward, D and McCarthy, P, 1999. Startup
Performance of New Base Metal Projects, in Adding
Value to the Carpentaria Mineral Province,
Australian Journal of Mining, April.
6