SME Annual Meeting

Feb. 21 - 24, 2016, Phoenix, AZ

Preprint 16-020

VALUE DRIVEN COST MANAGEMENT: A KEY TO CONTINUOS IMPROVEMENT OF MINING

J. A. Botín, Pontificia Univ. Católica de Chile. Santiago, Chile

M. A. Vergara, Pontificia Univ. Católica de Chile. Santiago, Chile

ABSTRACT
The decline of the “super cycle” has placed an end to a decade of
production-focused strategies, with operating cost growing at rates
higher than production. Today, the sector is placed on a tough ride and
forced to shift focus to cash preservation and efficient cost
management. However, most cost management systems in the
minerals industry are not conceived as value driving tools but to meet
financial accounting and reporting needs. This research draws from a
the development of an innovative cost management methodology that
applies Activity-Based Bottom-Up cost budgeting and continuous
improvement tools to develop a value-driven cost management system
for sustainable improvement of operational efficiency and cost
reduction. The methodology was successfully tested in the Andina
underground mine III Panel sector of Corporation del Cobre
(CODELCO), in Chile.
INTRODUCTION
Cost management is fundamental to profitability of any industrial
project. Even more essential in mining, an industry that deals with
commodities, which prices are dictated by the market and are beyond
the management capacity of the company.
The end of the mining “super cycle” and the advent in 2008 of the
Global Financial Crisis (GFC), placed an end to a decade of production
focused strategies, with operating cost growing at rates higher than
production. The sector was placed on a tough ride and forced to shift
focus to cash preservation and efficient cost management. Many
mining companies have seen themselves into the urgent need of cost
management systems capable of achieving sustainable productivity
gains and consistent profitability.
Cost management is composed of three main processes:
estimation, budgeting and control [1]. A number of conventional
techniques have been used for cost estimation and budgeting for many
years. However, most cost control systems in the minerals industry
cannot be referred to as “cost management” since they are conceived
to fulfil accounting and reporting needs, rather than to improve
operational efficiency [2]. In general, conventional cost budgeting and
control systems in mining use a “top-down” methodology, which lacks
of necessary details, and fail as a management tool leading to
undesirable results [3].
ABC, A BOTTOM-UP COST MANAGEMENT FOCUS
Activity-Based Costing philosophy underlies on the concept that
resources usage is not a function of the amount of final product, but
rather, resources are “consumed” by the elementary tasks and
processes required to produce a unit of the final product. Under this
concept, operating costs are allocated to the elementary production
activities and total operating cost is generated through bottom-up
consolidation of unit activities, sub processes and processes, as seen
on Figure 1.
Figure 1. Bottom-up ABC construction method.
From mathematical modeling of different costs of nature as
energy, labor and materials, each unit activity is constructed with a
significant level of detail. The structure of each formula is just a
polynomial expression based on resources intensity of use, resource
unitary price and performance at field executing the activity. An
example is shown next:
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑂𝑂𝑂 ∗ 𝑃𝑃𝑃𝑃𝑃𝑂𝑂𝑂 𝑈𝑈𝑈
𝐶𝐸 = � �
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝐿𝐿𝐿 𝑡𝑡𝑡𝑡𝑡
Where:
𝐶𝐸 : Energy cost in USD by moved metric tonne.
𝑃𝑃𝑃𝑃𝑃𝑂𝑂𝑂 : Oil price in USD.
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑂𝑂𝑂 : LHD’s Oil consumption in liters per operating
hour.
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝐿𝐿𝐿 : The performance of the LHD machine in
moved metric tonnes per hour.
Besides achieving the required level of detail, the equation
structure allows analyzing thoroughly cost deviations respect to the
activity budget and to explain it from the different variables implied in
the mathematical expression. This feature will be used as a powerful
analysis tool in the case study.
The final model considers a set of 128 different equations to
model each of the unitary activities carried out in the mining operation.
Mixing different sets of equations by an activities matrix, the cost of
each mining sub-process and mining process can be determined.
While an ABC model lends to a manageable cost estimation and
budgeting process, the problem is how to implement a practical
management system that will guarantee results. To achieve this
objective, a powerful continuous improvement methodology, the Plan-
Do-Check-Act (PDCA) cycle is introduced.
PDCA, A CONTINUOUS IMPROVEMENT TOOL
The PCDA (Figure 2), often referred to as the Deming Cycle,
contemplates four repetitive stages which, using the available
information, leads to the continuous improvement of operational
efficiency.

1 Copyright © 2016 by SME


Figure 2. PDCA cycle.
The “PLAN” stage refers to the construction of annual budget
through the bottom-up integration of elementary mining activities. The
data is obtained from historical records and is fed into the cost model,
in this case the ABC model, allowing to analyze thoroughly the current
state of the operation not only in order of detecting problems, but also
to track their possible causes.
At the “DO” stage, the actual operational results are captured and
registered. If it is the first PDCA cycle in study, the real operational
parameters under current operational conditions will be obtained.
Otherwise this stage allows to register the real operational parameters
after the changes implemented in the Act stage of the previous cycle.
The “CHECK” stage allows to detect, quantify and understand the
deviations relative to the budget. With the information provided it is
possible to inquire into the deviations sources and identify a set of
problems, propose potential solutions and evaluate its economic
impact.
Finally, a plan of action is decided and implemented in the “ACT”
stage. Once the plan of action is implemented, a new cycle starts to
detect other deviations and new enhancement opportunities, thus
pointing to the continuous improvement of the entire operational
process.
CASE STUDY
The model was constructed and tested in the underground mine
III Panel sector of the Andina Mine (Codelco). Model validation was
limited to the activity of Draw point Load-Haul-Dump (LHD), consisting
of loading the ore at the draw points, transport it through the tunnels to
finally dump it into the shafts which derive to the reduction level.
The activity cost of natures considered to model its cost were
labor, operating materials, maintenance material and energy. The chart
in Figure 3, compares the cumulative LHD activity cost calculated by
the model using historical data and the actual cost (“PLAN”).
Figure 3. Model results.
Using the current data (“DO”) and the model deviation analysis
feature previously named, it is possible to know in detail the differences
between the reality and the budget at nature of cost level. Figure 4
chart shows the total deviations effect split up in detail. While, the black
bars represent the budget (left) and the real (right) cost, the grey and
2 Copyright © 2016 by SME
SME Annual Meeting
Feb. 21 - 24, 2016, Phoenix, AZ
white bars represent the deviations associated to each nature of cost
(i.e. labor, materials, energy) that impact on the budget cost. A grey
bar represents a positive deviation (higher cost), and a white bar
represents a negative deviation (lower cost).
Figure 4. Draw Point LHD. Analysis of Cost Deviations.
A first glance shows that there is a cross-subsidization in terms of
cost of nature, with a negative deviation (cost below budget), in
maintenance materials which is hiding positive deviations in the other
costs. Furthermore, the analysis allows the detection of inefficiencies,
problems and opportunities in the operations, which would be
unnoticed if conventional cost accounting had been used.
A detailed analysis of cost deviations can do much more. It can
help management to perform an in-depth analysis at elementary
variables level for each cost of nature (“CHECK”). Just as an example
the operating materials deviations analysis is shown in table 1.
Table 1. In Depth analysis of cost deviation by nature.
Deviation Explained
Variable
(USD/tonne) percentage
Tire’s life effect (USD/tonne) 0,00343 87%
Tire number effect (USD/tonne) 0 0%
Tire Price effect (USD/tonne) 0 0%
Performance effect (USD/tonne) 0,00053 13%
Operating materials deviation
0,004
(USD/tonne)
Budget operating materials cost
0,058
(USD/tonne)
Real operating materials cost
0,062
(USD/tonne)
The overall deviation in the cost of operating materials is 0,004
USD/tonne is mainly (87%) due to a lower-than-expected tire life and,
in a lower amount (13%), to a lower LHD performance. As the result,
the tire life variable should be studied in depth. A possible explanation
of the tire’s behavior can be found analyzing both, the floor conditions
in the tunnel and the LHD operator’s skills. If the floor has not been
well paved or the operators do not handle the material properly, there
is a higher risk of getting a flat tire. Under this assumptions the
responsibility of the cost increases could rely on the LHD operators
and/or the tunnel construction crew.
Just like this cost of nature, the rest were equally analyzed and a
set of 17 potential corrective actions where proposed by the experts.
Since resources are limited, not every measure can be carried out. To
decide which will be, experts focus on every measure’s implementation
difficulty and impact. Both, implementation difficulty and impact
consider several factors. While implementation difficulty considers
investment cost, how reversible the measure is and the implementation
time; the impact considers activity costs changes, relative performance
improvement, and externalities. The potential opportunities are plotted
in a 2D impact-difficulty model, where the more attractive opportunities
are B, M and K, which plot on the 4th quadrant (“ACT”).
 SME Annual Meeting
Feb. 21 - 24, 2016, Phoenix, AZ

[4] Moen, R., & Norman, C. Evolution of the PDCA Cycle, 2006.
[5] Beare, M. An Introduction to Mining Business Improvement
Initiatives - Mapping the Steps to Increased Profits. Minex Forum
and Expo. Moscow: SRK Consulting, 2009.
[6] Govindarajan, S., Shank, J., & Govindarajam, V. Strategic Cost
Management: The new Tool for Competitive Advantage. Hanover:
Free Press, 2008.

Figure 5. Measures impact and implementation difficulty.

After deciding which measure implement, a new PDCA cycle
starts over. In this new cycle, results should be better and new
operational issues will be probably detected in the pursuit of
operational excellence and continuous improvement.
CONCLUSIONS
The proposed methodology implies a shift in corporate policy,
from the conventional top-down approach to budgeting and control to a
bottom-up integration of cost management functions and
accountability. In this regard, the methodology had to be tested in a
real mine, which was carried out at the Andina underground mine III
Panel sector, a Codelco copper mining operation in Chile. The test
results have demonstrated the potential of the methodology as a mine
management tool for achieving sustainable gains in operations
efficiency and productivity.
The methodology is based on Activity-Based Costing (ABC) and
PDCA’s Deming cycle tools, both full proven techniques in
manufacturing industries. However, the combined application of these
tools to mine operation management as proposed here, produced an
innovative and powerful tool that stands out for efficiency and ease of
application. The results of the Case Study here presented, have
proven the capacity of the model to generate a bottom-up baseline cost
budget, to identify and understand cost deviation sources and to
suggest possible solutions in a continuous improvement cycle.
The key feature of the model lies in its alignment with the
management structure of the operation so that managers and
supervisors understand -and assume responsibility for- the value
drivers of the operation and the impact that day-to-day decisions have
on operating costs. Though the model was tested in an underground
mining operation, the cost modeling methodology is easily adaptable to
any other mine and plant operation.
ACKNOWLEDGEMENTS
Special acknowledgments to Corporacion del Cobre (CODELCO)
for the funds provided for this research work through the Codelco-
Mineria UC Research Group. Our sincere appreciation to the staff and
supervision of the Andina Division of Codelco for their support and
assistance during the execution of the field work.
REFERENCES
[1] Turney, P. Activity-Based Costing An Emerging Foundation for
Performance Management. Portland: SAS Institute Inc, 2008.
[2] Michalska, J., & Szewieczek, D. (2007). The improvement of the
equality management by the activity-based costing. Journal of
Achievements in Materials and Manufacturing Engineering, 2007,
p. 91-94.
[3] Lind, G. (2001). Activity Based Costing: Challengign the way we
cost underground coal mining systems. The journal of The South
African Institute of Mining and Metallurgy, 2001, p. 77-82.
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