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Articles from The Business Forum Journal

PROFITABILITY FOR SMALL MANUFACTURING  COMPANIES
By David J. Gardner

UNDERSTANDING MARGIN LEAKS

Manufacturers are under tremendous pressure to reduce prices and cut costs in today's competitive marketplace. A paradox has emerged creating "margin leaks" for manufacturers.

"Margin leaks" are those insidious, hidden, intangible costs of inefficiency that, for reasons that often defy explanation, keep driving up your cost of doing business and eroding your profits.

The source of the margin leaks lies between our mass production traditions and the "build-to-order" business methodologies required to support customers' demands that they "have it their way."

Current manufacturing systems and practices have their origins in a premise advanced by Henry Ford: "You can have it in any color you want, as long as it's black."

The implication behind Mr. Ford's statement is quite profound: The efficiencies within the factory that reduce your costs (and your selling price) can't be achieved if you allow any variation in the products you sell to your customers.

Can you imagine Ford Motor Corporation being limited to selling black cars? Of course not. They sell many diverse models of vehicles in millions of different configurations yet they are competitive with their rivals.

How can manufacturers offer great variation in their products and contain costs-an unthinkable concept for Henry Ford? The answers lie outside current solutions being employed by manufacturers. Current implementations of methodologies employed by manufacturers are inadequate to support "build-to-order" business strategies. A quick examination of four margin leaks provides clear evidence of the inadequacies.

Margin Leak #1: 

Shipping More "Specials" Than Standard Orders

Most "build-to-order" manufacturers make the mistake of creating a discrete bill of material for each configuration of product that might be sold. To reduce the documentation workload, Engineering and Marketing meet and agree to restrict the choices that a customer is permitted to make.

Gardner's Law concerning "Number of Bills of Material Required to Satisfy Customer Demand" is "there is a need to create 'n+1' bills of material, where 'n' is an unknown and very large number." It's not possible (or practical) to create a bill of material describing every configuration a customer might want.

"Special" orders occur whenever a customer has a requirement that falls outside the scope of the pre-defined configuration choices. When this occurs, people throughout the organization scramble like mad to (1) determine if the configuration is technically feasible and (2) create the documentation Manufacturing needs to build the order.

Your customers are sophisticated-they are not content with pre-packaged choices. They do not want to pay for more than they need nor will they be satisfied with less than what they want. Customers expect manufacturers to accommodate their need for flexibility and to help them satisfy not only today's needs, but tomorrow's.

If you are shipping more "specials" than standard orders, it means that the business process you use to define allowable configurations is (1) not representative of the true flexibility of your product and (2) is defined at too high and discrete a level to satisfy your actual customer demand.

Your margin leak costs:

1. Disruptive nature of "specials" creates organizational inefficiency increasing costs.

2. Lost selling opportunities when the customer's actual needs differ from published configurations.

3. Company creates large, deep bill of material structures that add to company overhead but do not add real value to the product.

Margin Leak #2: 

Giving Away Items That the Customer Should Have Purchased Just to Make the Configuration Work

Manufacturers of "build-to-order" products often give away items that should have been purchased because the order has already been accepted. It is too painful for Sales to go back to the customer and advise that the cables, power supplies, cabinets, etc., needed to complete the installation were overlooked.

If your business process doesn't allow you to easily identify your customer's product requirements before you take an order, you will have this exposure. Further, if your process doesn't allow you to easily configure add-on (upgrade) orders, you have additional exposure.

Your margin leak cost: Products that could have generated revenue are given away.

Margin Leak #3: 

Inability to Validate A Customers' Requirements

If you don't have a comprehensive means to validate your company's product offerings or capabilities against your customer's requirements you are at increased risk for margin leaks. Without such a mechanism, it often takes longer to validate requirements than Sales or customers can tolerate.

This problem is compounded by time zone differences, rapid changes in technologies, short product life cycles, the need for quick turn-around on orders, etc. As a result, commitments end up being made that the company cannot fulfill.

Your margin leak costs:

1. Lost future business due to dissatisfaction created during previous selling situations.

2. Processing delays while the company validates customer requests-disruptions create organizational inefficiency.

Margin Leak #4: 

Increasing Accounts Receivable Aging Due to Delays In Satisfying Customers

Are you finding it takes longer to collect your receivables due to problems or delays in satisfying your customers? This is a common manifestation of problems related to "build-to-order" products.

Your margin leak cost: The cost of capital during the collection delay.

How Much Are the Margin Leaks Costing You?

The answer varies--cost estimates range between 1-3% of revenues. This estimate is low. The estimates look only at inefficiencies in the factory, cost of replacing missing parts, etc.

The costs estimates do not consider the extra time Sales and Customer Service personnel invest with customers, lost selling time, additional travel costs, premium shipping costs, A/R collection delays, and the cost of customer dissatisfaction.

Solutions Are Available

Your cost of plugging the margin leaks is a fraction of their annual cost. Manufacturers of "build-to-order" products have special business needs not addressed by conventional processes.

It is possible to design and implement a comprehensive business methodology to plug your margin leaks--even in situations where clients believe their problems can’t be fixed.

Your margin leaks don't have to be a "cost of doing business."

Dave joined Tandem Computers in 1979 where he was responsible for Corporate Documentation Standards for Tandem's highly configurable and expandable computer systems.  In 1983, he designed and implemented a Configuration Guide for Dialogic Systems instituting a process that greatly simplified a complex, modular product such that the field sales organization and international OEM customers could easily define their order requirements. This methodology satisfied the product definition needs of sales, marketing, engineering, manufacturing, customer service and finance.

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