Becoming a cost leader is a natural source of competitive advantage for manufacturers. Lower costs assist commodity producers to undercut their competition on price, while for branded product manufacturers with leverage over price, lower costs can significantly increase margins. Low-cost producers enjoy better cash flows than their more wasteful competitors. Assuming that a business is profitable, a low cost base enables increased levels of reinvestment and drives further growth. Given all of these benefits, one would expect that all manufacturing businesses would make operating on the lowest cost plane possible a priority. In my experience this is seldom the case. Why?
Poor cost management systems
What were your costs last year? Last month? Last week? Yesterday? Over the course of the last shift? For the last batch? In manufacturing, the consequences of poor cost management can pile up very quickly. If you only find out about a problem a week after it started, chances are that by the time you get to it, a few other problems have raised their (invariably ugly) heads elsewhere and are costing you money. Managers need information to do their jobs effectively, and cost data is required at short intervals to enable low-cost manufacturing. The information provided must not only highlight what the costs are, but should also measure and report on the drivers of manufacturing costs. These systems should extend all the way to the shop floor and should provide a single coherent view of costs that ultimately tallies with the costs that end up in your business’s financial statements.
Not adopting zero-based budgeting
Part of the problem is the complacency that comes with setting annual budgets based on historical performance, a scenario in which “beating the budget” is in many instances anything but a lofty goal. Compiling a zero-based budget requires more effort than simply looking at last year’s budget and using that as a base. There is also often a fear that the zero-based budget will be significantly smaller than historical budgets, and that it will be impossible to meet the new budget. If current cost paradigms are not continuously challenged, establishing a new, lower-cost trajectory will be impossible. For this to work, senior management need to acknowledge that new targets will be difficult to achieve, but that failure against these new targets will more often than not be an improvement over success against old, easily achievable historical performance levels.
Not integrating continuous improvement into the budgeting process
Let’s be clear, there is only so much saving that can be done. There are physical limits as to the amount of resources required to achieve a given task. My team and I have recently been doing quite a few energy saving projects at foundries, and in this industry electrical energy consumption is driven by the melting process. In fact, our analysis showed that at all of the foundries we assessed, the furnaces were responsible for >65% of all electricity used. We therefore focused on this area, and found some quite significant cost reduction opportunities related to furnace design and operation. We did however have to reconcile ourselves to the fact that melting metal is an inherently energy-intensive process, and we could only do so much – that’s just thermodynamics. The point I want to make is that slashing manufacturing costs by huge amounts every year over a long period is not a realistic goal. Over time your bigger challenge will become the maintenance of superior cost performance. You should however seek to reduce your cost base sustainably over time. It can be done, and the cumulative impacts for your business, particularly as regards variable cost reduction, can be enormous. The way to do this is to continue to tighten your budgets over time, albeit by smaller and smaller increments, based on practical steps you have taken to reduce costs.
A perception that operating on the lower end of the cost spectrum is somehow bad for the long-term health of the business
Running a business on a shoestring is difficult and demoralising. That is however a world apart from intelligently operating a manufacturing business at low cost. The idea is to be smart about how scarce financial resources are deployed. Consider an aspect of manufacturing costs such as plant maintenance. If the only maintenance being carried out is “breakdown maintenance”, and no preventive maintenance is being carried out, this philosophy can cost more than a strategy aimed at failure prevention. The latter strategy may incur small costs in terms of additional lubrication tasks, for example, while the breakdown approach may incur large costs as items that were not adequately lubricated have to be replaced. Before allocating funds for different aspects of your manufacturing entity, question how those funds are going to be used. “Enough” could be much less than you think, and smaller budgets do not necessarily translate into deficiency.
Managing fixed and variable costs in isolation
Manufacturing is a business, and in the final analysis, it is total costs that matter. Most manufacturing companies compile annual budgets for fixed costs and variable costs separately, which is perfectly acceptable. Where the problem arises is when they then go on to manage these budgets in isolation from each other. The typical result is that funds required to enable significant variable cost reductions are not made available because these were not budgeted for, and the opportunity to markedly reduce overall costs is lost. This kind of problem is reinforced by reward systems that favour meeting budgets over the overall health of the business. A good way to counter this is to drive cost management using an “income statement” approach, right down to process area level. Turn all of your managers into business owners and get them thinking about cost reduction in a holistic way.
Poor cost allocation
Production Managers can often tell you what their raw material yield performance is at a given point in time. Ask them about their electricity costs or water bills and that tends to be the Engineering Manager’s problem. This is generally because the Engineering Manager is accountable for the supply of services like compressed air or refrigeration, and these tend to be significant energy users. The Engineering Manager also maintains electrical infrastructure, so it seems quite natural for this professional to be responsible for electricity consumption. The problem though is that the services supplied are for the manufacture of product. And while the Engineering Manager may operate the compressor, he/she has little control over how much compressed air is used – these are systems that require holistic analysis for their optimisation. Of course it is possible for teams from different disciplines to work together for the good of the business. If however costs are not allocated appropriately and formally, chances are such teamwork will not receive priority. The appropriate allocation of cost requires carefully developed measurement strategies and comes with challenges, but your philosophy should always be to hold those responsible for incurring costs accountable for the management of those costs.
Poor integration of cost into other business goals
Particularly in large organisations, it is very easy for professionals to work in silos. Cost reduction can easily be viewed as the enemy where teams are dedicated to achieving goals in important areas such as product quality, safety, plant reliability, capacity expansion, environmental performance and others. The tendency can easily become to try to secure as many resources as possible so that these goals can be achieved, or to ignore the cost impacts of decisions made in the name of these goals. Low-cost manufacturing does not have to mean compromise. Truly world-class manufacturing businesses realise that they have to achieve a range of business goals at the same time, and manage their affairs in an integrated fashion such that the overall business is optimised. They also appreciate that a portion of cost savings should be reinvested, increasing the resilience of the business, and enabling improvements in so-called “softer” areas of their operations such as safety and human resources.
What is your manufacturing business’s posture with regards to cost reduction? Are you deploying your available fixed costs in a manner which maximises the value for your business? Do you understand the true, compound power of variable cost reduction and how, if you reduce variable costs effectively, you can transform the economic future of your manufacturing business?
Copyright © 2017, VWG Consulting, all rights reserved