Up-to-date data measures profits down to the minute
A challenge faced by many manufacturers is the lack of a common metric for making the myriad daily, weekly and monthly operating decisions that impact corporate profitability. In the steel industry, for example, companies often have multiple production facilities and different information systems to manage different elements of the business.
ERP systems manage transactions and costs and do a sound job of generating a margin-per-unit metric. Production systems, on the other hand, are focused on providing a units-per-minute or per-hour metric. Attempts to optimize either one of these metrics can result in sub-optimal profits, exactly what they are intended to help maximize.
For this simple three-product example (Fig. 1), it is evident that making a decision to focus on sales and production of products A or B over product C will hurt profitability. Product A might be favored since it has the highest margin of the three products. Product B would be the favorite if production run rate were considered the key metric. Generally margin wins out over production velocity, so product A would be declared the ‘winner’ over B and C.
However, it is only when both margin and production velocity are taken into account that the best product is identified %%MDASSML%% in this case, product C because it generates the most profit over the course of the fiscal year.
Many steel manufacturers realize the problems associated with the lack of a composite metric and the failure to incorporate production velocity into the profitability equation. One particular steel company realized that, although they were obviously making products, what they were really selling was time on their hot-strip mill. Some companies have tried to build systems internally, either with spreadsheets or business information tools, to combine margin and production velocity information. The complexity presented by thousands of products, hundreds of companies and multiple production facilities makes this a formidable challenge.
Focus On Profit-Per-Minute
A profit-per-minute metric not only enables decision-making that will optimize profits but also has the added benefit of aligning all departments %%MDASSML%% sales, marketing, finance and production %%MDASSML%% with a common metric. Heated discussions over which are the ‘best’ products are avoided because the different departments are all viewing the same measure of profitability.
Manufacturers make numerous decisions on a continuing basis that impact overall corporate profitability. These decisions basically constitute answers to four questions:
1. What products should we make?
2. Who should we sell them to?
3. Where should we produce them?
4. How much should we charge?
Manufacturers generally make these key business and operating decisions using margin only as a metric. They are often quite profitable companies but, as suggested by the example above, they typically leak profits that are worth 3% to 5% of revenue. For a $1 billion dollar manufacturer, this amounts to $30 million to $50 million per year.
Steel manufacturers use the profit-per-minute metric at both the executive and operational levels. Reports can be prepared for top-level management that show rankings of product groups, markets, business units, sales teams and production facilities %%MDASSML%% all based on profit-per-minute rather than on a margin-only approach. Executives can also view top and bottom products or customers, as well as trends over time for any of these dimensions.
Such profit-per-minute reports are easily distributed among senior commercial, operational and financial management, enabling decision-making to be collaborative and quicker. One steel manufacturer changed dramatically how the mill was utilized when profitability was viewed by profit-per-minute rather than by profit-per-ton.
After viewing profitability through the new profit-per-minute lens, companies can identify opportunities for profit improvement not evident in a margin-only approach. One steel company got a much different view of the markets they sold into when using profit-per-minute.
The margin for products sold into the electrical market was slightly higher than that for those sold into construction (31.21% vs. 31.02%). However, construction generated cash at the much higher rate of $314 per minute vs. $247 per minute for the electrical market. With strong demand in the construction market, the company made a shift in its sales plan for the next quarter and sold 8,000 tons more into construction and 8,000 less into electrical. This shift alone increased cash flow by $359,000.
A number of steel companies are making changes in the mix of products they manufacture after adopting profit-per-minute as their key profitability metric. They are focusing sales efforts on products that had lower margins than others in their portfolio but which actually generate more cash per unit time.
Changing Manufacturing, Sales Focus
Once profit-per-minute is implemented as the key profitability metric, it becomes evident that remunerating sales teams based on revenue of the highest-margin products will not necessarily optimize profits. One steel manufacturer has changed their compensation system for their sales force to tie commissions to sales of the highest profit-per-minute products, which are not necessarily those with the highest margins.
Even after incorporating production run rate with margin to measure profitability, steel manufacturers were frustrated in their ability to create such a metric due to the complexity of their businesses. Now that a solution to this problem is available, numerous steel companies are implementing profit-per-minute to make all key business and operating decisions with respect to products, customers, markets and production facilities. The net result has been millions of dollars flowing to the bottom line instead of leaking out with every margin-based decision.
|Tons||Revenue||Cash Contribution||Cash Contribution per Minute||VMP Minutes||ROA%||Monitored Utilization% (G1)||Monitored Minutes (G1)|
|Viewing markets from a profit or cash-per-minute basis and modeling a potential change in quantities shows the impact of the change in market mix on profits.|
|Industry||Tons||Price per Ton||Tons per Minute||Total Revenue||Cash Contribution per Minute||Standard Margin%|
|Using a margin-only or production-run-rate-only metric will not optimize profits. Margin and production velocity need to be combined in a composite metric to accomplish this.|
|Price Cost Margin Products||Units Per Minutes||Margin||Units Per Minute||Profit Per Minute||Profit Per Year (525,600 min./yr.)|
|A $7 – $2 = $5||1||$5||X 1 =||$5||$2.63m|
|B $4 – $2 = $2||3||$2||X 3 =||$6||$3.15m|
|C $6 – $2 = $4||2||$4||X 2 =||$8||$4.20m|
|Richard Batty is director of product marketing at Maxager. He is a 22-year veteran of the IT industry with experience in marketing, product management and operations. His background includes prior experience at Hewlett-Packard and an IPO startup. He can be reached at firstname.lastname@example.org .|