“We are so good at being good that we forget to be great!” This was the opening comment by a CFO to the company’s management team at a retreat I spoke at last week. As I thought about this it occurred to me that many companies fall prey to this focus. But, what is great?
Great is a focus on the customer. As I tell many of my clients, you need to deliver what the customer wants when they want it. Who defines quality? The customer! What is the most important metric? Shipped on time!
Great is constant innovation. Innovation can be related to new products which is what most companies think, but it can also be related to constantly pushing the limits of growth, service, quality and cost. Apple is innovative and is great, Microsoft is focused on good. Look what has happened to the relative stock prices over the past couple of years.
Great is continuous improvement. CI is a management approach of small constant process improvements that lead to competitive advantage in providing the customer with what they want, when they want it at the lowest possible cost.
Good is use of technology and cost reduction to gain temporary competitive advantage. Great is relentless process improvement with a focus on the customer which provides long term competitive advantage that is hard to copy.
Are you good or great? Good might mean survival, great means success!
I am developing a new area of thought I call Operations Discipline. This area of thought comprises those elements required to most efficiently and effectively execute the key aspects of manufacturing, distribution and service operations. Operations Discipline includes the elements of systems/processes, constructs/rules and behavior/accountability. These elements are all within a framework of continuous improvement.
A strong culture of Operations Discipline results in a highly profitable operation with strong customer service and effective use of assets such as inventory. Weak Operations Discipline results in not only the antithesis of the above, but also low morale.
There is another similarly named area of thought called Operational Discipline, but it tends to focus more on safety and environmental issues particularly in process industries. Operations Discipline deals at a much more strategic level, affecting the very culture of an organization and its ability to carry out its mission. I will be writing more on the elements of Operations Discipline in future postings.
As the recession begins to wane and business picks up, companies are looking at how to most effectively manage their labor. Some are cautious about hiring as they aren’t sure things are really going to stay better, and some now know they can conduct business with fewer employees because of the productivity they gained during the downturn. What strategy is best? How can staffing flexibility be built in?
There are three types of labor resources that can be used; regular employees, temporary employees and overtime. Regular employees are actually cheaper in the long run and usually provide the best quality. Overtime is the most flexible in the short run, but can cause burn-out which can lead to poor quality and low morale. Temporary employees can be a very effective solution with proper management of sources, effective training, and progressive management of the temps.
Many purchasing people I talk to place a very high level of importance on the cost of freight. As they develop purchase orders, the cost of freight often drives the size of the PO. In an effort to reduce freight cost, they often increase the size of the order significantly to “make freight”. Making freight might include getting to a full truck load for a cheaper rate or getting to an order size where the supplier pays for the freight. However, if you look at total freight as a percent of total materials purchased, while the dollars add up, it is most often a very small percentage of the total. If you factor in the cost of holding inventory, especially warehousing costs and obsolete inventory (see my article “Avoiding Obsolete Inventory…” on my web site); freight can become the proverbial tail that wags the dog.
The following graph (prepared by one of my clients), shows the impact of warehousing and logistics on total costs. As you can see, once you get to a certain point, order size gets counterproductive, and the freight cost you save can drive up other costs to the point where they are far greater than freight. Be careful to keep freight costs in perspective.
I was just listening to one of the business news networks and they mentioned that American Eagle (the clothier) is moving a significant amount of their production back to the western hemisphere. They also mentioned that The Gap is moving from China to India.
I also recently had lunch with an operations manager whose company has sourced many of their raw materials in China, and this manager said they were having problems with lead times moving out, costs rising and quality declining (three strikes!). As I talk to operations executives, this is becoming a consistent theme.
The news suggests that labor costs are rising in China, raw materials prices (i.e., cotton) are rising and the Yuan will be slowly revalued. Many of the companies moving out of China are looking for speed more than cost reduction and thus are coming back to North and Central America. That would suggest being close to the customer with your plants and distribution centers is an important consideration.
The tide is turning. It is time to be looking at your supply chain strategy to make sure it is up to date in meeting the overall strategy of your company and your Operations objectives.
If you talk to your local cost accountant, they will tell you that labor costs (along with materials and supplies) are recorded as variable costs. In reality, they should be treated as fixed costs. Why is that? Because, in the short run, it is not easy to turn this asset into costs that can vary with revenue which is the definition of a variable cost. It is very difficult to lay off people in a low revenue month and then rehire them in a high revenue month. If you try to do that, hiring costs, training costs and cost of quality all increase usually to the degree that they more than offset keeping the people through the downturn.
Many companies will try to furlough people or send them home early in an attempt to turn this fixed cost into a variable cost. While this works in the short run, people will get tired of the lower income and unpredictable work schedule and eventually will look for a new job. This again raises the cost of hiring, training, etc.
The only true variable labor cost is the use of temps and overtime. If your company is in a volatile market, it is best to plan for a level of temps and overtime to create a variable environment.
Industry Week just published an article I wrote in their June 2010 issue – Avoiding Obsolete Inventory – Possession is 9/10ths of the Problem. In the article, I mention that many executives are unwilling to admit that obsolete inventory even exists. Why is that? Can’t they see the damage it does to the company in terms of locked up working capital, warehouse costs, and just as important, morale? Yes, morale! The employees see the damage that obsolete inventory does. It gets in the way, often has to be moved several times, and must be counted every time a physical inventory is taken. The employees know that it exists because of decisions made by purchasing, sales or perhaps the CEO/owner himself believing that big sales were going to occur that never materialized. The obsolete inventory is the red flag waving in their faces that bad decisions were made that now are costing the company money and the employee’s aggravation. Management needs to step up and get rid of it. Sell it at reduced prices, return it to suppliers, redeploy it to other parts of the company, donate it, give it away or throw it away. The cost of holding it can accrue at 2 – 3 % per month and the morale impact is un-measureable.
Many companies today are outsourcing the purchase of materials, parts and end products overseas believing that they are saving a lot of money. Upon examination, I find that they are comparing the item cost of on-shore suppliers to the item cost of off-shore suppliers. This is often referred to as PPV buying, for Purchase Price Variance. PPV is the difference in cost between what the bill of materials says an item should cost with what the item actually costs. In many cases, especially if there is a large labor component, off-shore sources are significantly less expensive than on shore based on PPV.
Enter the world of Total Cost of Ownership or TCO. TCO includes all of the costs associated with sourcing an item including freight, customs/duties, inventory holding costs, quality, sourcing itself (e.g., trips to Asia), supplier selection and support, etc. TCO can add significantly to the cost of a part, many times more than off-setting the savings achieved on a PPV basis.
I see many companies ignore the TCO element of off-shoring often because the responsibilities for many of those costs are dispersed throughout the company. If Purchasing is not responsible for those costs, they can overlook them when doing the cost trade-off studies for off-shore supply. With labor costs in Asia rising, TCO may suggest that on-shore supply is now actually cheaper. Be sure to look at the Total Cost picture when making off-shore decisions.
Parkinson’s Law – work expands so as to fill the time available for its completion, first appeared in 1955 in an article in The Economist. This law applies to almost every manufacturing and distribution company I have toured. If times are slow, people seem to be working just as hard as if times are busy. They can be masters at this to help save their jobs.
I have also seen the law apply to inventory. Just the other day I was touring a plant and there were gas bottles in a rack. The rack was filled by the supplier and the key word is filled. The rack was big enough to hold about 15 bottles, yet the usage was about one per week. Thus, when filled, there was 15 weeks’ worth of bottles. The supplier visited the plant weekly to resupply various items. Why should the company buy so much when two, maybe three would do? Clearly, being careful to size storage containers correctly can contribute greatly to inventory reduction and matching of expense to activity.
Watching for Parkinson’s Law in any company should help reduce waste and increase profitability.
In the world of manufacturing and distribution, labor costs are usually considered to be a variable cost – that is they vary directly with revenue. In fact, in the short run, direct labor is in reality a fixed cost. While revenue may cycle up and down from month to month, labor generally stays flat. Companies don’t usually lay people off one month and then hire them back the next. So how do you increase the opportunity to reduce costs in down times and yet have the workforce you need for stronger times? The use of temps and overtime is the answer. There are only a few truly variable costs in manufacturing and distribution, and overtime and temps are two of them. I will talk about fixed and variable costs more in future posts.
I have seen companies use temps for as much as 35% of their work force. Many companies prefer not to do that as they believe that temps reduce productivity and quality because of the irregular nature of the resource. In fact, that can be easily managed using several approaches. First, single source your temps. Working with one, or at most two, temp agencies allows you to develop expectations as to the quality and skills you will be getting. Second, have the temp agency pre-train the temps on basic quality and assembly skills. Third, if you provide a positive work environment, even if you release temps, they will want to come back to your company when you need temps again, thus bringing experience with them.
As you can see, with proper management, use of temps can maximize the effectiveness of your variable costs, thus allowing you to manage your labor to significantly increase the profitability of your operations.