A Health Checkup For Your Business

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Measuring key variables keeps you strong.

Imagine you’re going to your doctor for an annual physical. You’re expecting the usual round of poking, prodding and blood work, but the doctor just smiles and pronounces you fit without so much as a pinprick, blood pressure check or a tap on the knee with a rubber hammer. You dole out your co-pay, and in five minutes you’re out the door, still wondering how your cholesterol is and what you can do about that stiff back.

Sound fishy? You bet. Yet that’s how many manufacturers run their companies. No one is monitoring the “vital signs’ of the business— the telltale metrics that give managers and c-suite executives a clear idea of how the “patient” is doing. Worse yet, many in charge don’t even know what to measure or what to do about what they discover. Fortunately, keeping tabs on the health of a manufacturing business is a lot less complicated than earning a medical degree. By monitoring a few key variables and then acting on the data, executives can help keep their businesses operating at peak efficiency and thriving in challenging times.

Trends in manufacturing

It’s no secret that segments of American manufacturing, especially furniture, textiles and consumer electronics, have gone overseas to take advantage of lower labor costs. Meanwhile, other manufacturing sectors that have remained in the country (the auto industry for example) still face fierce competition from abroad. While some manufacturing sectors have succeeded until the recent recession, their future is now uncertain.

In the past, they may have been able to tap into lines of credit, but those dried up as banks turned off the lending spigot. In response, some manufacturers have stuck their heads in the sand and used “hope” as a strategy to ride it out, even as their revenue began to dry up. On the other hand, smarter manufacturers are taking a closer, careful look at their operations. They are learning to identify and recognize inefficiencies through key variable analysis and focusing on how they can reduce costs and increase throughput in their production department and throughout their company—essentially becoming the “best of the best” at what they make or do.

Four cornerstones

There are four cornerstones in any business: sales and marketing, production, finance and management. Every company that is struggling has problems in one or more of these areas. Fixing the fundamentals of its four cornerstones is absolutely essential for survival, which is why managers need to be ultra diligent in using metrics to guide them in this task.

Successful manufacturers are finding ways to elevate their competencies to make more technically sophisticated products that may not end up offshore—products requiring machinery capable of very narrow tolerances and an educated workforce, for instance. Manufacturers need not abandon their core strengths, but simply refine them and expand into new markets. Often this means shifting from making common machine parts to making something like medical equipment, or from knitting sweatpants to weaving sophisticated fabrics for the military and biotech fields.

For example, IBM is an American icon that has had its share of trouble in the past, but it has also been successful at reinventing itself. In 2009, for example, IBM’s sales dropped by eight percent, which was not unexpected, given the global recession. But the company’s net income actually increased by 13 percent.

Similarly, Ford Motor Co.’s sales dropped 15 percent in 2009, but its net income was $2.7 billion, a whopping $17.5 billion increase over 2008. The automotive giant credits its success to the aggressive restructuring plan and turnaround of its entire operation.

Key variables

First, a simple SWOT analysis—Strengths, Weaknesses, Opportunities and Threats —can help a manufacturer get started in the process of measuring itself against its competitors and determining directionality. If there were business plans and market studies completed in the past, they need to be revisited and updated in light of the current economic climate. Then the manufacturer can identify its key variables that, when monitored and measured, provide insight and information necessary to run a business.

These variables are equivalent to the basic tests that a doctor would order to monitor a patient’s health and help guide his or her decision-making process. They include:

  • Variable costs. The costs that increase as manufacturing activity increases, which include things like raw materials, electricity, water, transportation and shipping, and even labor if extra shifts are added or employees earn overtime.
  • Inventory costs. What does it cost the company to hold items in inventory, whether they’re in process or finished products? This includes costs such as warehousing, taxes, insurance, shrinkage and product obsolescence. And it begs the question, what could your cash be doing if it weren’t tied up in inventory? Think of Eliyahu Goldratt’s Theory of Constraints: Is your inventory the constraint holding back your company?
  • Productivity. Productivity is the measure of productive time to paid time. How efficient are your employees at utilizing their time and efforts? Are you letting employees “coast” because your company’s sales have decreased?
  • Throughput. How effective are you at the process of bringing cash in the door and efficiently converting it to cash receipts without bottlenecks, waste or nonproductive employees?
  • Efficiency of equipment. This takes into account many factors, including equipment maintenance and optimal sizing and operating speed of equipment for the task at hand.
  • Utilization of equipment. How is the equipment on a manufacturing floor being put to use? Is some equipment idle while other production lines are backed up? Which equipment and production lines offer the most profit to the company?

Monitoring key variables is not an end in itself; nor is distributing reports in regularly scheduled management meetings. Reports are only the beginning. Understanding the data and their impact on the company is a job for the entire management team.

Only then can management begin to use the data to make better decisions that will have a positive impact on the profitability of the company.

The production line

Here’s an example. Managers can use key indicators to analyze the heart of every manufacturer: the production line. They should treat each production line as a profit center with its own measurement of throughput and breakeven. Breakeven is simply what the periodic direct costs are for each line—material inputs, labor, electricity—plus each line’s periodic share of overhead.

If the products produced in that timeframe can’t be sold at a price that at least matches those costs and allocated overhead, production should be shut down, or management should find new ways to reduce costs or further increase the operation’s throughput.

An analysis of the production line will also reveal which ones should be used more frequently, possibly adding second and third shifts, or even replacing or bringing in additional equipment. Often, the company may be saddled with old, inefficient equipment. To be competitive, the manufacturer may need to invest in new equipment if the current machinery is holding them back from exceeding breakeven or necessary throughput. Many manufacturing managers are afraid to pass on to their customers any product cost increases, especially the cost of materials.

Further, each line, machine center and shift should be incentivized. In this way, employees will have a strong vested interest in increasing the quality and rate of their production, and will also know the consequences if production doesn’t meet agreed-upon minimum levels.

Other considerations

When manufacturers lost sales at the start of the recession, they naturally looked at reducing production costs, particularly labor costs —in other words, whom do we cut? However, what they often didn’t examine was their ratio of overhead to direct costs. Odds are that their overhead became inflated relative to the actual costs as compared to previous periods or norms for their manufacturing sector. Having a bloated overhead coupled with the reduced production demand can only force higher overhead allocations on fewer production parts, causing non-competitiveness in pricing or, more commonly, bottom line losses. Even worse, nothing had been done to address the bloated overhead. The owners forgot that overhead’s primary role was to ensure maximum throughput, not have it wasted in its own department.

Another area to consider, related to throughput, is the sales staff and its contribution to bringing revenue in the door. Is the sales staff on commission or salary? Too often, salaried salespeople will underproduce with no incentive to bring in new business. The best salespeople will jump at a chance to earn commissions over salary. Sales staff should have rewards and consequences built into their compensation plan. However, the only way to pay out those rewards and consequences is if managers measure what the sales staff is doing and collectively set goals. Ideally, salespeople will be incentivized to sell those products that use production lines that aren’t maximized or are idle, and/or those that make the most money for the company, based on direct costs compared to what price the product can be sold to the customer.

In such trying times, it is important for sales managers to determine what they need to do to motivate the sales staff to achieve the desired goals. When sales managers are part of the leadership team of the company and have a vested interest in seeing their sales staffs succeed, everyone benefits. To accomplish their goals, it is important for sales managers to track metrics such as:

  • How many cold calls are being made?
  • How many calls result in sales?
  • How many sales truly impact the profit of the company?
  • What is the customer attrition rate?
  • How many customers are repeat?
  • How many are new customers?

If a salesperson is having trouble meeting the preset goals, the sales manager needs to be held accountable for getting to the source of the problem. Is the problem unqualified leads, an inability to close, ineffective sales techniques, or even a bad product? If a customer leaves and goes to a competitor, then it’s up to the sales staff and the sales manager to find out why and determine if there is an actionable solution that could have been utilized or if customer migration is an ugly trend beginning to happen.

Looking ahead

Just as water runs downhill to seek the lowest point, manufacturing always seeks the lowest labor costs. As Thomas Friedman made clear in “The World is Flat,” the world is a smaller place due to a variety of factors: the Internet, faster transportation and nonstop media, but also increased rates of development and industrialization in countries like China and India.

Shifting work from the United States to Asia’s cheap labor markets is as easy and commonplace today as was shifting manufacturing from the Northeast and Midwest to the South in this country in the last century.

For today at least, this country continues to enjoy a lead in technology and tech-intensive manufacturing. The successful U.S. manufacturers of the 21st century will constantly review their business model and develop plans to exploit this strategic advantage. By measuring and responding to key variables, coupled with new and innovative markets for their products, manufacturers can thrive in a changing global economy.

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