The Missing Metric in Manufacturing

Transcription

1 The Missing Metric in Manufacturing How a new profit performance metric, Profit Velocity, is being used to drive more revenue to the bottom line in complex, capital-intensive manufacturing businesses Michael Rothschild Founder & Chairman 2013

2 Introduction Investors naturally seek the highest rate of return on their investments. Making money faster from the money tied up in a business has always been the name of the game. When investing in complex, capital-intensive manufacturing businesses, this means finding ways to generate profit as fast as possible from expensive production facilities despite the many challenges that complexity breeds. Given investors intense focus on the speed of money---how fast dollars are being produced by the assets they own---it would be reasonable to assume that every manufacturer measures and manages in great detail exactly how fast (in dollars per machine hour) profits are being produced by their production equipment. However, virtually none have the tools to precisely measure this metric. This incorrect assumption has tremendous implications for shareholder s return on assets. Rather than running their business by focusing on profit per machine hour, manufacturers worldwide instead pay closest attention to the profit per product unit of the products they sell. In fact, very few manufacturers are even able to measure the profit per hour generated by their equipment. Most have never even tried. This is why we refer to profit per hour, or Profit Velocity, as the Missing Metric. Speed of money-making may be paramount to investors, but with few exceptions, manufacturers do not even attempt to measure---and therefore cannot manage---the result that matters most to their investors. On the surface, it would seem rather simple to calculate profit per machine hour to learn which product items, customer orders, market segments, etc. yield more money from the precious time they use passing through production equipment. But until recently, measuring and managing profit per hour in enough detail to make the Profit Velocity metric useful in decision-making has been too difficult to put into management practice. The performance measure that investors care about most is ROIC, but very few companies have systems that inform decisionmaking on the basis of profit per minute, per hour, per day or per week. Without ready access to precise and reliable profit per hour data, manufacturing executives and managers do the best they can by setting improvement priorities based upon the only detailed profit metric they have access to---the profit or margin per unit as reported by their accounting system. But, unfortunately for their investors, when manufacturing management teams rely on profit per unit rankings to set policy on customer priority, product mix, market focus, pricing strategy, new capacity investments, and the like, those policies are inherently biased in ways that actually slow the enterprise s overall flow rate of profit per hour. Consequently, a lower average profit per hour leads to lower profits per quarter and per year, and lower returns to investors overall. This problem is especially harmful to the thousands of High Mix manufacturers worldwide who produce extremely broad product lines with thousands of distinct part numbers from plants requiring significant capital investments. Their inability to measure and manage Profit Velocity leads to a pattern of decision-making that unintentionally drives investor returns down well below the results those businesses can otherwise deliver. Page 2 of 8

3 With the development of the PV Accelerator TM software, this is beginning to change. It is now practical to measure and manage profit per asset hour regardless of the size and complexity of a manufacturing enterprise. In short, the Missing Metric of Profit Velocity is no longer missing. 3+ percentage points of revenue may be added to the bottom line once the Profit Velocity metric is used by management to help guide decisions. Recognizing a rare opportunity to deliver a major increase in investor returns, leading manufacturers in High Mix, asset-intensive industries are increasingly taking advantage of the new insights revealed by the Profit Velocity metric. Using the formerly Missing Metric to help guide decisions on how they market, sell, and produce their products, these manufacturers have measurably accelerated the flow of cash and profits from their assets and significantly increased return on their investors capital. Why High Mix Manufacturers With Complex Product Lines Make Far Less Profit Than They Should All manufacturers everywhere use the profit per unit metric to understand which of their products contribute more to overall profit. For example, a product sold for $10 that costs $4 to manufacture is naturally considered more profitable with its $6 per unit margin than a product priced at $20 that costs $15 to make and yields just $5 per unit. But what if the machinery cranks out the lower margin product at the rate of 50 units per hour ($5 per unit x 50 units per hour = $250 per hour), while the high margin product moves through that machinery at 30 units per hour ($6 per unit x 30 units per hour = $180 per hour). Surprisingly, the low margin product actually yields more money per asset hour at $250 than the high margin product at $180. In less than two years, an electronic components manufacturer s operating profit per hour increased from $1,400 to $4,400, adding $8 million in profits on annual revenues of $80 million. To be sure, for a great many manufacturers the margin per unit metric has been and remains perfectly adequate to support good decision-making. In labor-intensive manufacturing that is not machine intensive, the speed at which the various products produce profits while moving through equipment doesn t matter very much, because the production process does not require investment in expensive capital assets. And in some capital-intensive industries, such as mining or bulk chemicals, producers tend to make just one or a few product varieties, giving them very little room to alter their product mix or refocus on certain customers or market segments. Getting good financial results for these narrow product line/capital intensive firms is mostly a matter of keeping the plants operationally efficient and fully utilized. But across a wide swath of High Mix industries including electronic components, specialty chemicals, packaging, semiconductors, textiles, fabricated metal and plastic parts, steel, contract pharmaceuticals, etc., a single manufacturer will typically produce several thousand product varieties (shape, size, capacity, strength, etc.) for hundreds of industrial customers from Page 3 of 8

4 many production lines and plants. For these High Mix, capital-intensive manufacturers, ranking products solely by unit margin without considering Profit Velocity undermines management s ability to fine-tune the business to maximize the profit yielded by their product, customer, and asset portfolios. For these High Mix manufacturers, the evidence shows that 3+ percentage points of revenue will be added to the bottom line once the Profit Velocity metric is used by management to help guide their decisions. Example: Accelerating Profits with the Missing Metric To be able to see their previously invisible profit gain opportunities, manufacturers need to measure the profit generated per hour for every product as it moves through production. By aggregating this information, especially by customer and product group, to understand how much profit per hour each order, each product variety, each customer contract, and each production line contributes, managers will see a much clearer picture of the true sources of profitability in their business than that revealed by relying solely on margin per unit. Figure 1: In complex manufacturing environments, there is a wide range of speeds at which various products generate profit per machine hour In Figure 1, representing actual data, we show the conventional picture of profitability, unit margin, on the vertical axis. By this measure, both Product 1 and Product 3 are more attractive to manufacture than Product 2, because they both produce a higher profit per unit. However, although Product 2 has a lower unit margin, it can be produced at a faster speed. As a result, Product 2 generates profits more quickly than Product 1 and Product 3. The low margin/high Profit Velocity Product 2 actually generates more cash per machine hour, and as such contributes more to the number investors care most about at year-end. Page 4 of 8

5 Being able to see a product portfolio from both the unit margin and Profit Velocity perspectives at the same time reveals new options for pricing, promotion, market development, deal negotiation, product definition, capacity planning, and operations. Manufacturers who have exploited the enhanced visibility that the Profit Velocity metric provides have shown significant increases in their bottom line. For example, by measuring the Profit Velocity of its product varieties and then steadily cultivating the sales of its higher Profit Velocity products, a leading global packaging manufacturer drove pretax margins in its $2.0 Billion annual revenue North American business from 11% to 16% from 2007 to Annual operating profits rose by $88 million, an amount equal to 4% of revenue. Figure 2: Analyzing by profit per unit and profit per hour reveals both Hidden Winners and False Profits in the product line Among several profitable initiatives, managers at the packaging manufacturer refocused scarce sales resources on those customers whose purchases tended to generate higher Profit Velocity. In one case, management discovered its business with one high-volume customer that was believed to be among its most profitable customers, barely made money on a profit per machine hour basis. Huge volumes consumed vast amounts of time on the facilities, but precious little money was produced by all the effort. With information revealed by the PV Accelerator software, management was able to see exactly how fast each of the dozens of product varieties sold to that customer (from each plant and to every shipping destination) made money. When the customer s annual contract came up for renewal, management renegotiated the deal in light of this Profit Velocity information, and soon made this key account highly profitable. Between 2007 and 2009, a consumer products container manufacturer drove its pretax margins in its North American operations from 11% to 16%. It increased annual pretax profits by $88 million over the period, equal to 4% of revenue. Once the packaging manufacturer saw exactly how it could use Profit Velocity to squeeze more total profit from less total unit volume, it was able to shut down four plants, significantly reducing overhead, and further boosting profits. At the same time, it kept reallocating more capacity to its high Profit Velocity products and customers. Within 7 quarters, this refocusing of the product mix and customer mix Page 5 of 8

6 drove the formerly Missing Metric of Profit Velocity to rise nearly 50%, from $1031 to $1,509 per hour---from the same machinery. Figure 3: From 2007 to 2009 speeds at which the packaging manufacturer generated gross and net profit steadily increased Typically, manufacturers using the Profit Velocity metric to rethink trade-offs and complex, interrelated choices drive 3+ points of revenue to the bottom line as they find new ways to squeeze more cash from the same assets, products, people, and cost structure. New Capabilities in the Planning and Control of Profitability PV Accelerator has been used to improve the profitability of many High Mix, asset-intensive manufacturers in industries including specialty chemicals, electronic components, packaging, industrial parts, plastics, pharmaceuticals, textiles and metals. It enables these high-productvariety manufacturers to increase cash contribution by gaining precise control over their complex mix of customers, products and assets. Profit Velocity provides manufacturers with entirely new capabilities in the planning and control of profitability. By enabling manufacturers to maximize ROA by prioritizing incoming customer orders, executives are able to focus on the opportunities that make money faster from existing assets. Improves cash contribution by zeroing in on high Profit Velocity orders for more aggressive competitive pricing. Ranks products, customers, and markets by Profit Velocity to prioritize resources, marketing initiatives, sales programs, and capital investments. Maximizes cash contribution and profit impact of changes in mix, pricing, volumes and asset configurations by running What If scenarios. Optimizes sales and operations planning (S&OP) with a common metric (Profit Velocity). Increases ROA by refining asset utilization and capital investment planning. Page 6 of 8

7 Conclusion Time is money. And in the world of High Mix, asset-intensive manufacturing this old adage takes on new meaning. Executives who run complex manufacturing businesses know that significantly higher profits are buried in small pockets here and there within their broad product and customer portfolios. But they have never been able to see precisely where those extra bottom line dollars are hiding or exactly what action steps they can take to start harvesting those elusive profit dollars. Thanks to many recent advances in information technology and the development of the PV Accelerator, there is a solution to this dilemma. By analyzing Profit Velocity, profit per time along with margin per unit, decision-makers in marketing, sales, production, operations, and finance can make more profitable choices from the complex options they face. Manufacturers committed to improving their performance have embraced the Missing Metric of Profit Velocity and have delivered bottom line gains to their shareholders consistently worth 3+% of revenues. Page 7 of 8

8 Contact: Based in San Francisco, with offices in key manufacturing centers worldwide, Profit Velocity Solutions offers PV Accelerator, a breakthrough in the power and sophistication of business analysis and planning tools for manufacturers. Available exclusively through its global network of consulting firm alliance partners, PV Accelerator reveals new profit improvement insights to drive continuous profit improvement. By supplementing traditional profit-perproduct-unit margin analysis with the previously unavailable missing metric of profit-per-machine-hour, High Mix manufacturers can tap previously hidden opportunities to accelerate cash flow and achieve major gains in annual profit and ROA. San Francisco New York One Market Street 245 Park Avenue 36 th Floor 24 th Floor San Francisco, CA New York, NY Info@profitvelocitysolutions.com Chicago Singapore One South Dearborn Street One Raffles Place Suite 2100 Level 24 Chicago, IL Singapore Shanghai Taiwan 9/F Eco City Shin Kong Manhattan Bldg 1788 Nanjing West Rd 14F, Section 5, No. 8 Jing an District Xin Yi Road Shanghai , China 110 Taipei, Taiwan For more information, visit us at Page 8 of 8