The Habit of OutPerformance - Optimizing Profit in Manufacturing

The Missing Piece in Sales & Operations Planning (S&OP)

By Rick Batty

Sales & Operations Planning (S&OP) is frequently a flawed process. While S&OP may succeed in balancing supply and demand, it does not help maximize profits. Why not? The problem lies in the fact that no true profitability metric is included in the process. The actual S&OP process typically consists of a logistical negotiation between the production team and sales & marketing to make the products in the quantities that sales & marketing have forecast. In preparing their forecast, sales & marketing may have used margin per unit of product to rank all products and the customers to whom these products are sold. In fact, they probably used margin as a metric to decide where to spend marketing dollars to increase demand.

Once the S&OP process itself is embarked upon, no profitability metric is incorporated at all. But why is profitability not maximized by sales & marketing’s use of margin in their forecasting efforts? The answer lies in the fact that in both the forecasting process and the S&OP one, no attention is given to the speed at which products are produced, i.e. production run rates. Why is this important? Well, the primary goal of a for-profit business is to generate as much profit as possible for the company shareholders in a specific period of time, typically the quarter or fiscal year. Margin per unit does not reflect how fast cash is being generated by a product. Only by incorporating production run rate, or production velocity, with margin can one create a metric that reflects the true profitability of a product or customer.

There exist a finite number of production minutes in the fiscal year. It therefore makes perfect sense that, in order to maximize profits, one needs to maximize the profit per production minute. This means that a product that does not have the highest margin per unit but runs through the production facilities quickly may actually be the most profitable product. In other words, ranking products by margin and then planning in the S&OP process to make as much of the highest margin ones as possible does not lead to optimal profits. Only by ranking them by profit per minute can this be achieved. Using profit per minute in the S&OP process itself to decide which products to make for which customers and where to make them will ensure that the planning process returns optimal results to shareholders.

Maxager and “Lean” Manufacturing

By Rick Batty

“Lean” manufacturing gained prominence with the revolutionizing methods advanced by Japanese manufacturers. Approaches such as “kanban / just-in-time” and kaizen dramatically changed manufacturing practices and brought about much greater efficiencies. A major focus and benefit of these approaches is the reduction of work-in-process inventories. This inventory reduction often exposes problems in the manufacturing process which can then be addressed. The common analogy is that of draining the water so that the rocks which were previously below the surface are now apparent. The rocks represent problems or inefficiencies in the manufacturing process. Once they become apparent, these inefficiencies can be addressed, thereby making the manufacturing operation more efficient and more profitable.

A profit-per-minute approach to profitability is actually an application of “lean manufacturing” principles to the financial operation of a manufacturing business. Rather than looking only at the numbers of units flowing through the manufacturing process and the time spent for different products in the process, profit-per-minute looks at the cash value of products or customers as they flow through the process. By combining margin per unit information with production velocity, a manufacturer can look at how fast or slow cash and profit flows through manufacturing at the key production steps. Profit-per-minute analysis at the product or customer level can be used to identify the “rocks” which are low-profitability products or customers decreasing the efficiency and profitability of manufacturing.

A profit-per-minute approach makes it possible to measure Return on Assets (ROA) at the operational or transactional level. Being able to view true profitability by product, customer, plant, production line, market or sales region at a granular level enables operational decision making which will increase “leanness” and maximize overall corporate profitability and ROA.

Dangers of the Status Quo

By Jason Stewart

Marketer extraordinaire Seth Godin had a great post on his blog late last year called “Top Ways to Defend the Status Quo” with the caveat that “All quotes actually overheard, or read on blogs /comments about actual good ideas.” Check it out here, but a few highlights include gems like "we'll let someone else prove it works... it won't take long to catch up” as well as "it's fantastic, but the salesforce won't like it."

It got me to thinking about some of the things we have heard from prominent manufacturers that might make the list.

Are your existing systems really “good enough”?
You have, undoubtedly, invested a fair amount of money in things like ERP, CRM, SFA, BI and more. These are incredibly valuable systems for a manufacturer, but how is strategic analysis information delivered to your team? Let me guess…could it be via spreadsheet? Another question…how many engineers did it take to create that report for you? One last question…is it in some form that your team can use it day-to-day while they actually do their jobs? Does that sound “good enough” to you?

Should data quality concerns stop you in your tracks?
You don’t want to make the perfect the enemy of the good. Data can be improved incrementally, but in the meantime you should keep in mind that the data you are pulling out of your existing systems is what you are basing your decisions on now, and it should continue to be used throughout the improvement process. In our experience, data is never perfect, and probably never will be. The quest for “perfection” is a fruitless one, though, and could make you a prisoner of the status quo.

Is I.T. really too busy for any new projects?
With more and more software and services moving to a SaaS model (Software as a Service), software initiatives cost less, are faster to implement, and have quicker return on investment. IT organizations are still busy, and need to carefully prioritize any new projects – but SaaS is designed to take some of the weight off of the shoulders of IT and generally has a much faster rate of return on investment than more traditional projects. Time and personnel commitments of SaaS projects need to be evaluated differently than those other projects, and the business needs that are addressed need to be the driving force behind whether a project gets the green light.

On the flip side, many mature IT organizations are required to try and build a solution “in-house.” But how long will it take them to do it? And how much time and money might you lose while you are waiting for a product that may be “customized” for your individual needs but is also ultimately handicapped by usability and performance issues?

Status quo is a dangerous thing, and is often the biggest competitor to any new initiative.

Business Intelligence as a Service

By Rick Batty

Why the Market is Now Ready for Business Intelligence as a Service

A rapidly growing business model, Software as a Service (SaaS) has many advantages over the typical enterprise software approach. Unlike applications which need to be installed and maintained internally in a company’s environment, SaaS applications are accessed by the company’s business users over the Internet through a browser.

The benefits of the SaaS model are plentiful — from no required purchase of hardware, to lower IT requirements both for installation and maintenance, to the significantly lower implementation, maintenance and entry costs.

The move toward BI as a service is being accelerated by the emergence of BI applications and their appeal to a broader range of users. A relational database could be thought of as a tool and a CRM software package (based on a database) as an application directed to particular business area. Similarly, differing from BI tools with their horizontal focus, BI applications are now emerging that target individual business challenges.

Consider the challenge for a manufacturing company making hundreds or thousands of products, selling these to perhaps hundreds of customers and producing them on multiple production lines in various plants. Many manufacturers have long known the importance of considering production speeds as well as margin per unit when analyzing the profitability of individual products. However, there has been no BI application to date capable of combining the margin and production run-rate data for such a complex combination of products, customers and production facilities. Furthermore, while existing BI tools might be able to perform some historical analysis after a significant investment in data organization and manipulation, certainly none could perform simple, rapid what-if analysis to model proposed changes in product, customer and asset mix.

The graphic below shows an example of a chart created in minutes by a business user, rather than a BI expert, showing the profitability measured in profit per minute for a selection of a company’s products. The rapidly produced, powerful chart quickly lets the business user, perhaps a marketing product manager or a financial analyst, see which products are truly the most profitable and which are poor from a profit-per-minute perspective. By plotting margin against production speed, such a topographical map enables the ability to view profit not must by margin alone but by combining it with the production run rate.

As companies have implemented more and more systems over the years to capture information such as sales and production data, they are now ready to use this data to address very specific business problems. This reality is now stimulating the move of BI from being a horizontal tool to a set of very targeted applications. As these applications provide enormous value to a wide variety of users across the company (who are thus quite likely geographically dispersed) and since SaaS applications provide very attractive benefits over traditional enterprise software delivery models in general, BI applications as a service will continue to grow strongly in the years to come.

Capacity to spare? Use a profit-per-minute approach to make better decisions

By Rick Batty

A frequent question posed by manufacturers concerns whether a profit-per-minute approach is still useful when production is not at capacity. If production is indeed running at 100% capacity, manufacturers readily realize the value of using a profit-per-minute approach to increase profits by making some products rather than others, by taking orders from certain customers rather than from less profitable ones or by selling into only the most profitable markets.

However, when plants and production lines are not fully utilized, companies may feel that there is no real need to apply a profit-per-minute perspective to make decisions regarding which products to make and to whom they should be sold. They believe that when production is not at capacity, it is necessary to take in any business that can generate a profit, no matter how low that profit might be. So in their minds, there are no profitability trade-offs to be made.

This viewpoint fails to consider certain fundamental benefits of using a profit-per-minute approach. Without using profit-per-minute, companies will still be generating sub-optimal profits even when capacity is not constrained. If profits are down because production is not fully utilized, it is more important than ever to look at other ways to increase profits and corporate ROA. A profit-per-minute approach can be even more valuable in this scenario. Profit-per-minute can help in (1) the search for new business to fill production and (2) optimizing existing business.

Determine Which New Business to Pursue
While it may make sense to accept any new profitable business to utilize production capacity, salespersons must still seek out this business. It does not magically appear for the company. A profit-per-minute approach’s profit-per-minute metric enables Sales to determine which products and customers merit the most effort for securing new business.

Evaluate Existing Business
When profits are down because of idle capacity, it is more important than ever to look at ways to increase the profitability of existing business. Various areas can benefit greatly from the use of a profit-per-minute approach.

1. Uncover previously hidden lower-margin, high profit-per-minute products that could sustain a price decrease which would increase demand and thereby increase production.
2. Determine which products or customers are possibilities for price increases.
3. Decide which products or customers are the most profitable and redirect sales and marketing programs towards them. Current programs are probably concentrated on the highest margin products, which may or may not be the most profitable ones for the company.
4. Focus attention on the most profitable customers from a profit-per-minute basis rather than a margin-only one. Redirecting this focus may take the form of greater contact from Sales, better payment terms, prioritized production runs etc. Such increased focus may increase demand from the most profitable customers and thus generate more production volume.
5. Consider switching products to production lines where they can be made more profitably. This is an option that is very attractive and which may not be available when production is running at 100%. A profit-per-minute approach allows manufacturers to see how profitable products are when made on different production lines.
6. Better prioritize which products or production facilities to target for productivity improvement initiatives. When production is not at capacity, it is the perfect timing for carrying out these initiatives. Downtime will not take away from production time, which would result in lost revenue and possibly unhappy customers. Productivity improvements can target products that will have the most immediate and significant profit improvements.

In summary, it is readily apparent that profit-per-minute provides significant value even if production is below capacity. A profit-per-minute approach enables (1) targeting new business that will not only help fill production volume but will also generate as much profit as possible under the circumstances and (2) optimizing existing business to maximize corporate profitability and Return on Assets.

Software as a Service (SaaS) and some Interesting Predictions

By Jason Stewart

Maxager Technology is a Salesforce.com customer, and is (like Salesforce) also a “SaaS” company (Software as a Service) -- delivering our solution in terms of a yearly subscription, accessible via the internet.

Salesforce.com is widely considered to be a pioneer of SaaS, and at their "Dreamforce" user conference in San Francisco this past October, the No Software buttons were omnipresent and analyst quotes were flying. In his keynote address, CEO Marc Benioff noted that Gartner Group projects that 25% of all new business software will be delivered as a service in five years. Another firm, Triple Tree , has the number at 40% -- but within 3 years. The thing he said that really struck me, however, was the Gartner Group claim which states that nearly two-thirds of the entire IT budget in midsize businesses is spent on IT infrastructure (servers, software licenses, maintenence, etc.) and that none of that money contributes direct value to the business or to the improvement of the enterprise performance.

That’s 66 cents out of every IT dollar spent contributing no “direct value to the business.”

So what does 66 cents on the IT dollar pay for? Security? Any SaaS company that is going to succeed likely has you beat with regard to security. Maxager, for example, provides a SAS 70 compliant remote hosting facility with state-of-the-art security technologies and ongoing evaluation of emerging security developments and threats. Strict in-house procedures ensure any access to a customer’s system has specific prior customer approval, and redundancy throughout the infrastructure ensures the highest possible reliability.

Support? If you have ever noticed that support or contact with your software vendors typically improves around the time your maintenance contracts are up for renewal, you will appreciate the fact that SaaS companies typically include support in the cost of the subscription. Same with upgrades, which are done automatically for you, typically with nothing to download or install save for maybe a newer version of Internet Explorer -- but you probably have that already. And best of all, there are no servers or hardware to upgrade or replace when the new version of the software doesn’t play nice with your current infrastructure.

Implementation? SaaS is typically installed in less than half the time of on-premises solutions.

Flexibility? Most vendors allow you to customize fields or labels to adhere to your current corporate standards. And, most importantly, many SaaS vendors allow you to trial their products for a short period of time at limited or no cost. How’s that for flexible?

I tend to lean more towards Triple Tree’s estimates. If the option is there to subscribe, I just can’t imagine buying software ever again.

Business Intelligence

By Rick Batty

Business Intelligence (BI) software has brought a powerful ability to use data that companies have captured to make informed business decisions. The ability to look at masses of different types of data allows companies to look at many dimensions of the business in a variety of ways. However, bringing different sources of data together is not a simple task and it requires specialized applications that go beyond the focus of BI tools’ horizontal focus.

A good example of this is the bringing together of margin and production data. Companies have long managed profitability by looking at margins by product or customer. However, attempts to maximize margins do not maximize profits. Why? Using a margin-only approach fails to take into account the speed, or velocity, at which products are made. A lower-margin product may generate far more cash than a higher-margin one if it can be made much more quickly.

Many companies have long realized the importance of production velocity for profitability but they had no means to incorporate it with margin. So they settled for margin as the best available proxy. But in doing so, they leave money on the table, often 3-5% worth of revenue. For a company with $1 billion in sales, this amounts to $500,000 to $1 million per week. The challenge of combining margin and production velocity data would not be difficult if a company produced only a few products. But for manufacturers that make hundreds of thousands of SKUs, the problem becomes insurmountable.

A BI tool can look at either margin or production velocity data in detail and from many viewpoints but it does not inherently map the production data to the margin information and have a built-in ability to analyze the combination of the two. This requires a specialized application with built-in algorithms to calculate true profitability as a function of both margin and production data. This combination is profit velocity, which represents how much cash is being generated per minute by a specific product, customer, sales region, market or production facility. The ability to calculate profit velocity in detail, as profit per minute, quickly and easily for a company making hundreds or thousands of products in multiple plants and selling them to numerous customers requires a specialized application that goes beyond the basic capabilities of BI tools. Furthermore, if forward-looking modeling to look at changes which might increase profits and company return on assets (ROA) is required, a specialized application is highly recommended. This new breed of applications which is now emerging will sit on the BI and ERP technology stack and further increase companies’ ability to use their data for improved corporate performance.

What Manufacturers Can Learn from Wal-Mart

By Jason Stewart

According to Wikipedia, a company’s “Return on Assets (ROA) percentage shows how profitable a company's assets are in generating revenue” and “is an indicator of how profitable a company is.” Regardless of what type of company you are, ROA is calculated the same way:

ROA = Net Profit / Total Assets =
(Sales/Total Assets) (Net Profits/Sales)

Total assets is a key component in the equation, so obviously asset structure plays a vital role in how ROA is measured and controlled -- but asset configurations can be very different from industry to industry, which leads to interesting problems in how companies can proactively monitor ROA. The equation, after all, is based on historical performance – so how can it be applied to your business while you are negotiating contracts or making scheduling decisions?

Major retailers like Wal-Mart have this problem licked. 80% or more of their assets can be tied up in the inventory sitting on the shelves in their stores, and the rest could be classified as plant, property and equipment. The faster that inventory moves, the higher the ROA percentage. They aren’t making their money off of the 100 plasma TV sets they sold last month – they take up too much shelf space and have a razor thin profit margin. The batteries, greeting card and the shaving cream you picked up when you bought the TV? Pure profit.

The bottom line is that retailers know this, and have it wired in to the way they do business. The systems are in place to monitor inventory turn, and corrections can be made on demand. But what about manufacturing? The asset structure is the opposite of a retailer – 80% or more of their asset base is plant, property and equipment while 20% (or less, hopefully) is tied up in inventory. So is thinking about “inventory turns” even applicable? Yes, but with a twist.

Take a look at your products from a profit-per-minute perspective, and not just margin. It’s like the “inventory turn” for Wal-Mart, but instead of basing your strategy on “inventory turn x margin” you base it on “production speed x margin.” Take a look at this example:

The decision to make Product A rather than Product B due to its higher margin results in over $1.5 million less profit over the course of a year! And don’t stop at the product level. What is the average profit-per-minute of the products that customer A bought from you last month? What about customer B? Without factoring in production velocity along with margin, you are very likely focusing on the wrong products and the wrong customers.