For many companies, and their supply chain, the ‘Cost of Goods Sold’ averages between 40 – 65% of sales revenue.
Each year companies face and accept price increases for their materials based on their supplier’s notifications of increased labor and material costs. In turn, these companies simply pass these additional costs on to their end customers.
But, is this good business to regularly pass along these kinds of price increases? Probably not …
First, it’s not always clear what drives these increases. Secondly, by allowing regular increases, it can appear to end customers that your company lacks control over its supply chain.
By developing the ‘right’ supply chain, the company will find many opportunities to optimize performance leading to a reduction in total costs, so it may not be necessary to increase prices.
To serve customers at the right time, with the right product, for the right price, companies must build advanced supply chains. This means evaluating and selecting suppliers based upon,
1. A shared vision
2. ‘Trust’ (once developed)
3. Specific criteria (ranging from technical capabilities to issues like ‘supply chain maturity’
4. Collaboration, i.e., the ability to operate together as one organization, and;
5. Long-term contracts (with critical suppliers)
The Bottom Line. Companies spend over half of their sales revenue for the cost of goods sold. Each year there are pressures to increase costs. Businesses do not always have to increase prices. Companies can, through their evaluation and selection process, build the ‘right’ supply chains that optimize performance, reduce total costs and increase gross profits.
The manufacturing evolution began from entirely manual operations and spanned to the incredible sophistication of today. This evolution was accelerated in the past several decades as US manufactured goods increased in demand across the globe.
Successful companies conduct categorical review of their manufacturing processes to remain competitive. They modernize and refine their manufacturing methods to fully exploit efficiencies, without losing the quality their customers expect.
Process automation has grown to be one of the most prevalent considerations to achieve this goal. Automating processes within fabrication, assembly, and packaging will translate to a reduction in overall cost of the final product; in effect, widening the profit margin.
The Bottom Line. For successful manufacturers, automation is a viable solution to significantly reduce costs in this highly competitive environment. Implementation can be a costly investment, so it’s imperative that a comprehensive analysis is conducted on current processes to determine maximum impact.
Arguably, one of the most unknown and under-appreciated programs that helps organize a company’s sales, production and customer deliveries is the Manufacturing Planning and Control (MPC) system.
This topic is so important that APICS devotes many chapters in its publications and certification classes covering how Manufacturing Planning and Control (MPC) works.
In a testament to MPC, many software companies including Oracle and SAP use ‘very similar’ algorithms to the MPC program when designing their manufacturing programs.
Why is this important?
The heartbeat of MPC is a process called Priority Planning. Priority Planning is much like the operating system for a personal computer in that it integrates the company’s sales and manufacturing plans by organizing and controlling Sales & Operations Planning (S&OP), Master Scheduling (MS) and Material Requirements Planning (MRP).
MPC enables companies to manage orders, prioritize and re-prioritize manufacturing, and balance the demand side of the business with the supply side of the operation. This enables greater focus on the customer ensuring on-time deliveries and high levels of customer satisfaction.
The Bottom Line. Manufacturing Planning and Control (MPC) is well known for its process of integrating critical segments of a business. MPC is so important that many of the world’s software companies use the process when developing manufacturing programs. MPC’s benefits include integrating the S&OP, MS and MRP processes that enable on-time customer deliveries and higher levels of customer satisfaction.
Over the years, many studies have been commissioned by ISM, Industry Week and private companies to determine the ‘cost’ to process purchase orders.
The same argument includes Account Payables and Receivables. It costs money to manually process these transactions.
The numbers range from $25 an order, to hundreds of dollars per order (depending on type of purchase and size of the company).
Isn’t it about time to ask a tougher question, i.e., “Isn’t there a better way to handle these kinds of transactions?”
Fortunately, even for the smallest of companies, the answer is “yes.’
From simple Microsoft Office programs to personal computers, with the latest in Enterprise Resource Planning (ERP) programs, there are better and faster ways to process these transactions (many automatically).
And that is what it is all about, right? Spending time on the ‘value add’ activities while eliminating those elements that cost you money.
The Bottom Line. It costs the company money to process purchase orders, accounts payable and accounts receivable. Today’s computer and software technology allow companies to streamline these processes saving time and money.
Whenever executives talk about businesses, it is usually about the gross profit numbers. And let’s face it, increasing revenue figures or gross profits is sexy.
But what about the numbers showing the company’s working capital? Start talking about the Inventory Turnover ratio, Accounts Receivable or Accounts Payable, and you see people lose interest immediately (honestly, they go to sleep on you…).
But these figures tell investors or stakeholders how well the business is being managed.
Let’s look at what the Inventory Turnover ratio means for a hypothetical retailer. In the first part of the example, let’s speculate that the retailer has forecasting, stocking and lead time challenges that has caused the company to experience the following business conditions.
COGS = $300 Million Ending Inventory = $105 Million Inventory Turnover ratio = 2.85
Days Sales of Inventory (DSI) = 128 days
The company turns over its entire inventory once every 128 days.
However, let’s say that the same retailer now decides to manage its sales numbers and shelf inventory, reducing stock of slow-moving items and carrying more items customers want. Now, the retailer experiences an entirely different Inventory Turnover ratio.
COGS = $300 Million Ending Inventory = $35 million The Inventory Turnover ratio = 8.57
Days Sales of Inventory (DSI) = 43 days
The company is now turning over its complete inventory in 43 days.
The Bottom Line. Inventory Turnover ratios reveal how well retailers or manufacturers are managing working capital. Having current assets tied up in something that cannot be converted quickly into revenue is much like having money in a savings account at 0% interest, i.e., it does not provide any return or value to the investor.
When manufacturing companies grow, so do their revenues and costs of production.
When the COGS are scaled in direct portion to production levels, the company maintains its gross profit. But when COGS grow faster than necessary, gross profit decreases.
Many entrepreneurs are inventors first, and business men second. Creatively, they make something work and meet a need, but this is where their interests end.
Businesses are built to produce and make money (read profit here).
That is why, today, supply chain has become one of the fastest growing disciplines. This group’s activities can also help the company set realistic selling prices. And that helps sales.
The Bottom Line. By following fundamentals and employing advanced tools and techniques, supply chain management can lower costs and increase profitability.
A step below the Strategic Business Plan is Sales and Operations Planning (S&OP) – a technique used to revise the business plan and communicate the revision with the other departments in the company.
The process begins with Sales and Marketing, looking at historical sales, analyzing current market trends, and then compiling what they believe to be the forecasted demand.
The emphasis at this level is on monitoring the dynamic changes in the markets and industry, and then taking actions when necessary to revise the company’s business plan.
Likewise, senior management reviews the Sales and Marketing plan and, based on feasibility and any adjustments, approves the forecast. This approved plan now is communicated to Operations, i.e., Manufacturing, Engineering and Finance. It is now up to these departments to determine what resources are needed to meet the revised business plan.
The Bottom Line. The Sales and Operations Planning process allows for the revision of strategic plans regularly. A key element here is the proactive nature of this process. By creating a ‘realistic’ plan, ahead of time, it forces the departments to communicate and allows the company the opportunity to adjust resources accordingly to meet the revised market demand.
A common philosophy, in most companies, is that Operations’ sole focus is to support the sales of the company’s products or services and that other issues are a ‘distant’ second.
But this ideology ignores the ‘upside’ that the Supply Chain group can provide to a business and its revenue stream, and that is the formulation and implementation of a Strategic Cost Reduction program.
If a company experiences cyclical business activity, including a ‘flat line’ or a decline in sales, it must survive. Sometimes companies make temporary reductions in staff and labor. But this can be very disruptive or detrimental to a business.
As an illustration, think of a legacy company that has grown in sales revenue from $10MM to $25MM. Accompanying this growth has been increases in direct material, direct labor and overhead. This in turn, without reducing costs, usually means raising selling prices.
Now, imagine that this market growth has attracted competitors that are smaller in size and lower in cost position, yet all are competing for the same customers (possibly with lower selling prices). If this happens the legacy company will either lose sales and market share or sell with less profit.
The Bottom Line. It is important that the focus in Operations is on supporting sales of the company’s products or services. However, a properly formulated and executed cost reduction program can confront competition and help maintain gross profits.
Considering the following:
- How do you define value?
- What do your customers value in your products and services?
- How do you measure it?
Value is what a customer perceives and receives in exchange for the price paid. To identify a product or service’s value requires a customer value assessment.
One way that manufacturers dial in on this ‘value’ is by building Customer Value Models. A model should be constructed to correlate with each product or service as part of the company’s toolbox.
What can be discovered through this analytical exercise? ‘Minimal order requirements’ is one example that also highlighted the difference between price and value.
A customer had a concern with a price structure that included a minimum order quantity. The supplier’s solution was to institute a small prototype cell/process to produce smaller lot sizes.
Immediate benefits included,
- Quick changeover resulting in reduced lead time
- Quality improvements – smaller lot size reduced defect replication
- Work in process (WIP) inventory were significantly reduced
It is important to note that the total cost was less, but the customer’s ‘perceived value’ had increased.
The Bottom Line. Within these customer value models, a company can meet customer needs and use methods like continual flow processing and other end-to-end solutions to increase customer perceived value of any product.
Likewise, all other things being equal, the market leader of products or services must address price and value from the customer’s perspective.
Let’s look at some formulas concerning Profit and Selling Price keeping in mind the customer’s perceived value.
1 Profit = Selling Price – Cost 1
2 Selling Price = Cost + Profit 1
If the company uses formula one and stipulates that they will only accept a profit of X, then the company must either control selling price or costs. And if the company opts not to control ‘costs,’ the company will have to increase its selling price to meet its profit forecast.
Whether or not an increase in the selling price will be accepted in a market depends on the customer and their perceived ‘value’ of the product. It also depends on the competition and their approach to this same issue.
Now let’s look at formula two. Let’s assume that the company fixes the selling price because of the market and perceived customer value. This means that the business will have to address ‘Cost’ or ‘Profit.’
To gain as much profit as possible, the company will have to control the ‘Cost’ of their product(s). For manufacturers, competing means hiring the right people, being efficient, and finding the right suppliers.
But the important point is that the selling price is maintained and thus meets the customer’s perspective of price and value.
Managing costs has become an important issue for many companies because of competition and dealing with unexpected changes in their industry (e.g., new tariffs on imported products and raw materials).
And it isn’t as difficult as many people think. Cost reduction solutions can be found by improving processes, removing antiquated or manual tasks, updated tooling, or locating new sources of raw materials.
One client realized a 45% increase in its production rate of a major product simply by updating their tooling (significantly reducing costs). Another client reduced their ‘total raw material spend’ by 16% increasing their Gross Margin! These are not anomalies, but a disciplined approach to managing the business.
The Bottom Line. The interaction of profit, selling price and cost determine a participant’s place in the market place. A company that looks at profits ignoring costs could end up with higher selling prices. The customer’s perceived value (and the market of the products) limits a company’s options on selling price. Controlling costs can help a company meet the customer’s perceived value; yet, still allow a reasonable selling price.