The Formula For Profitable Manufacturing

By Paul Peyton

                             Revenue minus cost equals profit.

                                 "I already knew that!" you're thinking.

                                  Or maybe, "But it's not that simple."

                                   Or, "This is not rocket science..."

Let's go with comment number three: This is not rocket science. Most of the reading available to manufacturing practitioners today would make a new person in the field think that rocket science is simple compared to manufacturing management. We are inundated with concepts so complex that entire books are written about single topics: time-based competition; supplier partnering; empowerment; benchmarking; and many more. All of these concepts are valid parts of a well-rounded practice of managing manufacturing. However, many of us are spending an inordinate amount of time and money mastering the details of a complex management technique when we should be concentrating on more basic practices. Let's talk basics.

Never lose sight of the fundamental formula of profits: Revenue minus cost equals profit. The quality of every decision - the priority of every action - should be based on a respect for that formula. And pay attention to the significance of revenue and cost. Which deserves the most attention: revenue or cost?

Of course, both are essential. But consider this example. If you had a choice of investing $1,000 on either increasing sales by $10,000, or reducing costs by $5,000, which would you do? At a 10% profit margin, you will realize $1,000 of additional profit if you choose to increase sales. If you choose to reduce costs, you will increase profits by five times as much - $5,000.

"Not rocket science," you say.

Right! But many manufacturers are concentrating on sales increases instead of cost control. The Japanese began their industries with a total emphasis on cost-controlled production. They entered markets with known potential and offered high-quality, low-cost products from the beginning. High quality and low cost create a self-perpetuating cycle for a manufacturer, one that is at the top of the list of desirable outcomes. Here's how it works:

Assume that you have chosen to invest your $1,000 in a cost reduction project. You reduce costs by $5,000. The cost reduction not only improves profitability, it improves cash flow. You get the benefit before the product is sold. Plus, reduced costs enable a lower selling price. Lower selling prices tend to increase sales volume. Increased volume enables further cost reductions through economy of scale. Lower prices equal more sales. More sales equal lower prices. Each complements the other throughout the life cycle of the product. Get it?

"Not rocket science," you say.

Right again. Now, imagine that you have the opportunity to invest your $1,000 in a project that will both increase sales and reduce costs. In the example above, you would add $6,000 to the bottom line. Actually, the increase in profits would be even greater, because the increased sales would be of product that costs less. The perpetual cycle of improvement in this case will start sooner and each cycle will show greater improvements in sales and profitability.

One word describes a characteristic project that will both enhance sales and reduce costs. The Japanese have used it in manufacturing for decades. America has fallen behind because we, simply stated, didn't understand the pure power of one single manufacturing concept: quality.

Specifically, internal quality. Internal quality means that components fit. They work, the first time. No repairs. No rework. Efficiency goes up. Schedules are kept. Back orders drop. If components work, the product works. Warranty claims diminish. Efficiency goes up more. Dealers are happy. Product is delivered on time. Dealers are profitable. Customers are happy. Sales go up. Production volume goes up. High volume tooling can be justified. Costs go down. Prices go down. Sales go up. Costs go down. Profits soar. Get it?

"Not exactly rocket science..."

That's right. There are some contributors to quality. Contributors that American manufacturing frequently overlooks in the rush to promote sales. Simplicity is a major contributor.

Simplicity of design means fewer parts and easier assembly. Fewer parts and easier assembly mean fewer errors. Fewer errors equal lower costs, fewer product failures equal high levels of customer satisfaction, which equals more sales. You get the idea.

"Not exactly rocket..."

I know. There's more.

Simplicity of the product line is a contributor to quality. We Americans violate it. When we see sales of a product begin to decline, our first response is to offer more models. Two dozen options. Thirty colors. Custom configurations. We do get the sales increases, so we believe that we have "success." We fail to look into the shop to see the added complexity of scheduling, purchasing and supervision. Inventory increases. Schedules become unmanageable. Errors crop up. Back orders increase. Field failures occur. Costs go up. We increase prices. Sales go down. Costs go up. We buy an MRP system. We buy user training. We flex schedules. We scramble. Costs go up more.

Always strive to simplify the product line.

"Simple," you say. "Not exactly rocket science."

Right. The formula for profitable manufacturing is simple. That is the philosophy behind Intelligent Manufacturing. Pay attention to simple cause-and-effect. Logic. Correct priorities. Simplicity. Quality. Human resourcefulness.

Our international competitors are doing a fine job of beating us in the marketplace. They have no affinity for the complex "solution."

Develop a company attitude that places quality and simplicity at the top of the priority list and profitability will follow.

It's not exactly rocket science. We need to remember that.