At my first meeting with many companies, they’re often stressed by trying to deliver 3% to 5% per year cost reductions to their customers. They frequently have inventory turns of four or less, which consumes cash and erodes profitability.
Companies really can achieve dramatic improvement with profit numbers in the 20% of sales range and inventory turns over 12. Rick’s Materials Management Manifesto will challenge your thinking and put you on a path to world-class performance. Click here for an expanded description of all eight points.
You can sell out of an empty wagon
Don’t waste your buyer on buying
RFQs increase costs
Annual cost reductions of 3% to 5% are peanuts
Unplug your MRP – it’s likely an ineffective buying tool
Too many suppliers spoil the soup
Manage products throughout their life cycle
Consigned inventory can destroy supplier relationships
Supplier partnerships, process discipline and striving to improve flow though Just-In-Time inventory management can provide exponential improvements in profit and cash flow. Use Rick’s Materials Management Manifesto to guide your thinking and achieve world-class performance.
Competent suppliers and competent staff are essential for increasing business value. The higher your staff and suppliers’ competency, the higher the value provided by partnerships. Your supply chain staff’s skills need to go beyond those of buyers to those of supplier business managers. Those duties include analyzing materials and services as they relate to the design of your products and services to optimize quality, cost and lead-time. The more competent your suppliers are, the more they will be able to participate in planning and design to help optimize those things as well.
One of my clients has been implementing a partnership program with several key suppliers and just announced a 12% increase in their stock price over the last quarter. A good portion of that came as a result of the increased margins, service levels and cash flow that came from the partnerships. My client has spent about a year changing the focus of their supply chain team and building supplier partnerships. As a result, their performance has risen to world-class and the value of the business has increased dramatically. That’s a huge ROI on a short-term investment.
Audi knows that supply chain strategy can separate the best from the rest. Global sales are up 11.7% with an operating return of over 10%. In a recent article in the Wall Street Journal, the writer explains that part of Audi’s success is based on the idea of using modular design throughout the family: VW, Audi, Porsche and Bentley.
Modular design is a supply chain strategy that uses commonality among products that offers reduced costs and greater production efficiency. For example, there are three common wheel base lengths among the various SUV models in the family. At the same time, Audi engineers still bring in top of the line styling and finishing along with distinct engineering in the transmissions and engines.
Use of modularity is an example of innovative strategy in the supply chain. As you consider your supply chain architecture, don’t just focus on problem solving and cost reduction, but look for innovative approaches that will provide you with competitive advantage while producing world class profitability. Audi knows how to do this and is overtaking the other premium brands on the global stage.
Inventory management and inventory control are both vital to improved performance in manufacturing, wholesale distribution and retail operations. Unfortunately many companies confuse the two, resulting in excess inventory and higher operations costs.
Inventory management is the process of making sure the right materials are in the right place at the right time at the lowest possible cost. Good inventory management leads to high levels of customer service, high inventory turns, good use of assets and increased profitability.
Inventory control is the process of knowing how much inventory you have and where it is. Good control results in smoother operations and improved purchasing productivity because knowing what you have (and where it is) saves time from ordering materials you don’t need to order, and from running around looking for parts.
Without good inventory control, inventory management becomes very difficult. Without good inventory management, customer service and profitability suffer. Both are vital to breakthrough operations performance.
When thinking about process improvement in your business, the first thing to consider is, what do business buyers buy? I recently spoke at a CEO peer group about how to improve business processes that lead to increased valuation of the company. That increased value might drive a higher price for a sale of the business, greater value in a transaction with the management team, or higher return when transferring to family members or other related parties.
In my experience with several business transitions involving private equity, the buyers were looking for three things – revenue growth, profit growth and cash flow. When you think about this, the reasons are obvious: buyers want a high return on their investment, and growth and cash flow provide that. They don’t typically buy a level of revenue or whether your company is Lean or not. They are interested in an expanding return for their investment.
When you ask the question, what business processes should I improve, the answer is, any process that results in increased revenue, increased profitability and improved cash flow.
I remember in college, which was longer ago than I care to admit, studying a technique called PERT. PERT stands for Program Evaluation and Review Technique. It is a method for controlling and analyzing a system or project using critical path analysis. Usually there are multiple paths through a project, with each step of each path requiring a certain amount of time and money.
Think of building a house. There is framing, plumbing, electrical, finishing etc. One of the paths takes the longest and is thus known as the critical path. Unless you shorten that specific path, you don’t change the completion date of the overall project. Managing the critical path is the key to improving the results of the process or project.
To me, a key objective of Operations is to not be in the critical path. Operations should not be the element that delays performance for customers. By creating and maintaining a flexible, Lean, effective Operation and Supply Chain, some other area of the organization becomes the critical path. Ideally, it should be Sales. That way, revenue and profitability can be maximized. So, a key objective for Operations is to be as flexible and effective as possible thus keeping Sales in the critical path.
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.
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.
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.