March 2, 2012

Reducing Materials Cost Volatility – Escalators

Escalator UpThere are a number of ways to reduce materials costs or at least make them more predictable in volatile times. One of those is the use of escalator clauses in customer and supplier contracts.

Escalator clauses indicate that you and your customer/supplier agree that prices should change under certain conditions. When market conditions are volatile and you use longer-term contracts, commodity price changes can put you or your customer/supplier in a risky position. Worst case, they may lose significant amounts of money because of post-agreement price fluctuations. Note that escalator clauses work both ways, moving up and down based on a mutually agreed-upon benchmark such as Consumer Price Index, Chicago Mercantile Exchange or various industry benchmarks.

Escalator DownEscalator clauses are common in business-supply contracts, labor agreements, utility pricing and even leases. Over the last couple of years I’ve seen escalator clauses for fuel prices. I also know of several companies that use escalator clauses for steel and for molding resin (due to petroleum price volatility).

The essence of escalator clauses is that they work both ways, protecting the margins for both parties whether prices go up or down. Many companies think their customers won’t accept escalator clauses, but as long as they work both ways, they are in both parties’ best interest.

© 2012 – Rick Pay – All Rights Reserved

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February 28, 2012

Late Shipments – More Damage Than Just Customer Relationships

Recently I wrote a blog post that suggested that if you were going to measure one thing it should be shipped on time. I have found that many companies not only don’t measure this important factor, but they don’t have any idea what the measure would be if they did. Late shipments cause lost profits in three ways.

First and foremost, late shipments can be very damaging to the customer. Many companies subscribe to Just-In-Time methods of inventory control, which require predictable lead times. If you ship late, it can disrupt their production or worse, their customer relationships. The results can be lost customers, lost sales and depressed profits.

Another negative impact is the need to expedite shipments to get late orders to the customer quickly. This often requires using expedited freight services and airfreight, which can amplify freight costs, directly impacting the bottom-line.

Finally, in an attempt to reduce late shipments, many companies build up inventory levels, adding to the costs of holding inventory. More warehouse space is needed, handling and counting costs go up, and worst case, some of that inventory might eventually become obsolete.

Late shipments can be very costly to a company. Companies can become more profitable and have happier customers by paying attention to this vital element.

© 2012 – Rick Pay – All Rights Reserved

 

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February 22, 2012

Strategies for Managing Raw Materials Price Volatility

We can’t control raw materials price volatility, but we can employ specific strategies to maximize price security and establish a seamless supply chain that reduces price risk and cuts costs overall.

C level executives are invited to join Steve Rosvold and me for a breakfast seminar on Thursday, March 8 in Vancouver, WA to address how hedging and supply chain management can protect your margins. Click here for a printable flyer.

© 2012 – Rick Pay – All Rights Reserved

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February 17, 2012

Riding the Wave of Innovation

In an excerpt from his book, “Relentless Innovation,” author Jeffrey Phillips addresses the need for, among other things, speed and attention to the customer. This echoes what I’ve been writing and speaking about lately in terms of innovation and the one thing that can unify your operations strategy: your customer.

Where some companies go wrong is in imitating their competition’s products or services, inevitably wasting time catching up with the competition rather than being so in tune with their customers that they can predict their customers’ needs and wants. Think of surfing: if you’re not riding the crest of the wave, then it has passed you by.

Phillips writes that even “‘fast’ followers often don’t understand what features and benefits the customer values in a product, and what challenges or issues exist in those products.” So by following the competition rather than taking cues directly from the customer, companies not only sacrifice innovation for imitation, but they risk recreating the exact qualities that customers don’t want.

This is another great argument in favor of letting the customer be your guide. When was the last time you asked your customers for their opinions of your products? Do you know what they want next?

© Rick Pay 2012 – All right reserved

Authors: Paige McKiney, Rick Pay

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February 15, 2012

To Radically Reduce Materials Costs, Seek First to Understand

Many companies try to cut materials costs by simply buying better. That is a nice way to say that they try to negotiate lower prices, often beating up their suppliers in the process. In many cases, they change suppliers or expand their supplier base over time in an attempt to get better prices. Unfortunately, both of these practices introduce additional costs.

More Than Just Part Price

To reduce materials costs, the first place to start is by reviewing the components of cost. A close look at the materials section of the income statement reveals all of the items that get booked as materials costs. The cost of materials is much more than just part price. It includes freight, customs, scrap, yield, cost of holding inventory, quality, accuracy/inventory adjustments, tooling, and obsolescence. Often, in addition to the part price itself, obsolescence and inventory adjustments can be very large and usually present themselves as an ugly surprise at year-end.

Looking beyond part price to see all the elements of cost can reveal great opportunities. Those who seek first to understand those elements will find fertile ground for cost reduction.

© 2012 – Rick Pay – All Rights Reserved

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February 10, 2012

Shipped on Time and Other Measures

If you’re going to measure one thing in an organization, it’s shipped on time. If you can’t ship on time you won’t have any customers and then nothing else matters. Measuring shipped on time by orders, not line items, makes a big difference. An incomplete order – even if it’s on time – doesn’t make customers happy.

Tracking inventory turns is another important aspect to measure. Inventory absorbs money, takes up storage space, requires people to move it, accrues interest that you pay to the bank, and in many cases eventually goes obsolete and becomes an expense. Gross profit margin is another important measure, because it reveals improvement (or lack of improvement).

Key measures are not only a way to show people how they’re doing, but they have the power to change behavior and establish accountability. One of my clients had a 24% shipped on time rate when they came to me a few months ago. This week it’s in the mid-80s. They also cut their backorders partly by tracking them and posting the numbers every day. In the past at this company, the sales department saw operations as an adversary. Now the sales manager is applauding operations and saying, “Now we’d better get out there and sell.” Keeping sales in the critical path is what allows the business to flourish and revenue to grow, and forecasting and planning is the front end of it.

© 2012 – Rick Pay – All Rights Reserved

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February 8, 2012

The Power of Scoreboards: Key Performance Measures That Get Results

Scoreboard

Keeping score

Key performance measures serve to increase accountability and should include a scoreboard to make the results visible. When I do evaluations for companies, one of my favorite questions to ask is, “At the end of the day, how do you know you did a good job?” The most common answer by far is, “I didn’t get in trouble.” Clarifying expectations for employees is essential to getting them out of this “Avoid getting in trouble” mindset. When a clear plan for the day is in place, employees know if they met their goals or not.

Scoreboards

One client saw output skyrocket after putting up scoreboards in the work area showing the goal for the day and updated actual results every two hours. Quality stayed high as well. At my previous company, I used to post the sales forecast and the actual revenue by salesperson in the sales department. We took the salesperson whose actual revenue most closely matched their forecast out to lunch, and we started getting reasonably accurate forecasts.

In my next post I’ll talk about tracking shipped on time and inventory turns.

© 2012 – Rick Pay – All Rights Reserved

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February 3, 2012

Speed and Agility

How are some companies able to continuously improve and gain competitive advantage, while others fall behind in the race? Speed and agility are essential components of operations strategy – so essential, in fact, that they can make the difference between winning and losing.

My latest Executive Briefing, “Leadership and Strategy in a Lean Environment,” delves into speed, agility, and more. Click here for a free download.

© 2012 – Rick Pay – All Rights Reserved

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January 31, 2012

Even the Best Can Fall

Brownie cameraEastman Kodak Company recently filed for bankruptcy. This is a sad day for those of us who learned to take pictures with the Brownie and the Instamatic camera and showed our slides using the Carousel Projector. Kodak was an icon of photography and the arts. In fact, Kodak invented the digital camera in 1975, the very innovation that is largely responsible for the company’s demise.

Rates of Change

Over the last eight years, Kodak has undertaken a number of cost cutting moves in an attempt to arrest its cash flow problems, but it wasn’t enough. As Jack Welch said – “When the rate of change inside the company is slower than the rate of change outside the company, the end is in sight.”

Two Lessons

What can companies learn from this? First, that cost cutting alone is not enough. Embarking on a Lean journey to cut costs and improve productivity may achieve those things, but it can do nothing to arrest the passage of time or to prevent disruptive technologies from threatening your position in the market. Second, that innovation and change management are vital for success. A focus on the costumer while delivering value as an Operations Strategy is critical.

© 2012 – Rick Pay – All Rights Reserved

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January 27, 2012

Does Productivity Trump Cost?

The author of a recent article on MSNBC’s web site points out that China’s labor cost is now only about 10% lower than the US. The article seems to suggest that once the lines cross, which is estimated to happen in 2015, it will make sense to bring manufacturing back to the US. Later in the article, the author states that US workers are 4 times more productive than Chinese workers.

US and Chinese FlagsIt seems to me that higher productivity outweighs the labor cost differential. Many companies forget to measure productivity improvement when looking at labor cost. Productivity is measured as units of output per unit of input, so if a company has $20 revenue for every $4 of labor, the productivity metric is $5.

My point is that there are two sides to the equation: cost and output. If American workers produce four times what Chinese workers produce in the same time period, it appears to me that the lines have already crossed and manufacturing should be brought back now.

As a footnote, there are several other important considerations in this question: cost of inventory in transit, quality, speed to market (closeness to the customer), protection of intellectual property, etc. Cost and output are important, but they aren’t the whole story.

© 2012 – Rick Pay – All Rights Reserved

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