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How profit-per-minute can help you maximize profitability
Most manufacturers rely on standard margin data to evaluate product profitability. The problem with using margin information alone, however, is that production time is not properly represented in most costing data, skewing overhead charges and the resulting margins. In addition, shareholders are not typically interested in maximizing margin, loosely defined as the amount of profit generated per unit, whether it is a ton, pound, gallon, spool or wafer. What they are interested in is maximizing profit relative to the company’s asset base, or more precisely, the return on their equity investment in the assets (return on assets: ROA). However, standard product margins do not directly correlate into ROA. That is, a high-margin product that moves slowly through the plant may not be as profitable as a low-margin product that can be made twice as fast.
Furthermore, production organizations in highly complex manufacturers face a fundamental problem: They measure success with units-per-minute and cost, but the rest of the company is living in the margin-only world. With conflicting priorities across the operational team, collaborative decisions that contribute to true profitability are impossible. If a particular product generates a healthy margin based on traditional measurement techniques, it receives significant attention from the sales and marketing teams. The production team intuitively knows, however, that the company does not make much money from this product as it runs slow and is difficult to manufacture. Unfortunately, they have no way to communicate this challenge in a meaningful way to the rest of the organization.
The solution to this dilemma is to combine margin and production run-rate data so that there is a common tool that production, finance, and sales and marketing can use to eliminate conflicting priorities. This combination of product margin and production data produces a profit-per-minute metric that enables manufacturers to compute return on assets at the product level. The profit-per-minute approach — the operational equivalent to ROA — enables manufacturers to make decisions that truly contribute to profitability.
Combining the financial and velocity data together to generate dollars-per-minute information finally equips the production team with a metric everyone can understand. For the first time, production and sales teams can be engaged with a common language that aligns them toward producing and selling products that generate higher profits.
What if one now takes this metric of profit-per-minute and applies it at a granular level, that is to say, one determines how much profit-per-minute is made by product, by production line, by plant, by customer, by market, by geography? Taking this approach enables the numerous ongoing production, sales and marketing decisions mentioned above to be made with a view to maximizing profitability and ROA.
Applying Profit-per-Minute to your Day-to-Day Operations
For production teams, the profit-per-minute concept brings an entirely new outlook to the initiatives they are already working on such as facility profitability, capacity planning, capacity loading, alternate routings, lot size profitability, dollarizing downtime and dollarizing yield losses. By using a profit-per-minute metric to measure success, production can contribute to the heart of the company: profits.
Many factors can impact a facility’s profitability, including age, production efficiency, energy and raw material costs, personnel rates and abilities and maintenance. Products may run more efficiently or have greater yields at particular plants or on certain production lines. Without detailed knowledge of true profitability by product, plant and production line, it is just not possible to maximize overall company profitability. With this information, orders can be scheduled on the most appropriate production lines to achieve target ROA.
Furthermore, when considering capital expenditures, detailed profitability by product, facility and production line enables investment prioritization to ensure the greatest profit impact.
A profit-per-minute approach may help in the following areas:
Products made in Plant C tend to run slower than in Plant A. Profit-per-minute analysis at the plant level identifies Plant C as a candidate for productivity initiatives.
Manufacturers all face critical questions regarding capacity planning. Which production lines or plants should be added (or cut) to maximize cash flow and return on assets (ROA) as well as to meet market demand? If capacity is added, where should it go? Should an existing line be expanded, or a new one built closer to customers? Which production facilities are the real winners? Should operations be expanded, or a few production lines consolidated? Should the company look at acquiring a new facility or building a new one?
Answers to these questions are generally made based on revenue, margin and productivity factors. However, if capacity planning is not based on detailed analysis of profitability and ROA by product, product type, production line and facility, overall company profitability will never be maximized. A profit-per-minute approach enables companies to accurately predict the cash and profit impact of changes to capacity:
A profit-per-minute approach also enables better decisions on how to most profitably load your facilities when capacity is at a premium. With a detailed view of profitability by product, plant, production line or process, manufacturers can prioritize and schedule the products whose real time cash contributions are going to bring in money to the company fastest.
Use profit-per-minute, price, yields, lot sizes, and cost to load facilities with the most profitable products to increase cash and ROA
Decisions on where to produce certain products are typically based upon costs and the scheduling constraints of manufacturing facilities. But, what about profitability? Certain production lines and facilities may be better at producing certain products but measuring that with any degree of certainty has been a challenge. Ultimately, a decision has to be made about where to produce that order, but the information available to manufacturers about the profitability impact of that decision has been incomplete. A profit-per-minute approach at the production line or plant level allows you to discover alternative production routings that increase profits.
Profit-per-minute analysis shows Product A produces a higher ROA when run on Production Line 2. Product B, on the other hand, generates a higher ROA on Line 1 than on Line 2. It may be worth considering changing which product runs on which production line.
Lot size profitability
It is common knowledge that the larger the lot being produced, the more profitable it will be. That is why customers get discounts when they order larger volumes of product — order size justifies price breaks. But exactly how much more profitable is this product is produced in batches of 1,000 units/tons/kilograms vs. 500 units/tons/kilograms? How much does profitability vary with the length of the production run? Looking at production at a granular profit-per-minute level allows manufacturers to:
Being able to see the profitability for a product by lot size serves as a guide for pricing in order to achieve target RAO levels.
Various factors can reduce production line efficiency. Shift changes, setups, maintenance, process troubleshooting and starving machines can all contribute to the downtime which reduces profits.
Deciding where to focus and invest in improvement efforts is much more clear when a company can see how much cash per minute each product makes for each production line and facility. Opportunities could well be evident in the following areas:
Dollarizing yield losses
Waste on a production line falls into two areas – materials and time. There are many analytical tools available to help minimize wasted materials, but wasted time is not as readily considered. Traditionally, manufacturers have not been able to determine scrap time – that which was used to make products that end up getting scrapped – and the resulting cost to the organization. A profit-per-minute approach enables a company to:
For complex manufacturers with large number of products and customers and expensive assets, today’s margin-based measurement of profitability is simply flawed as it does not address what shareholders want. However, t he profit-per-minute approach yields a measure of profitability directly in line with what interests shareholders the most – ROA – and one which constitutes a metric that enables production, finance, and sales and marketing to make key operational decisions from a common perspective. By applying this true measurement of profitability to initiatives you area already working on, you can go beyond just doing your job, to making a direct impact on attaining overall profitability goals.
About the author:
Richard Batty is the director of product marketing for Maxager Technology. For more information, visit www.maxager.com.