The contrast between True Costing vs. Being Profitable
Every plastics manufacturer has some idea of what their cost-of-goods-sold are for most of their products and jobs, right? Could it be otherwise? To even prepare a bid or close the books at the end of a job, there has to be some data about the costs involved, but how much of that relies on assumption?
If we’re willing to be honest with ourselves (and others) the truth is that most often processors and converters relying on old data, assumptions or incomplete assessments that could lead to under- or overpricing, overly optimistic margin estimates, unfavorable business decisions, and unpleasant surprises at month-end or year-end reconciliations.
Price increases are often difficult to pass off and there is simply nothing wrong with a lost leader so long as you know exactly what your true costs are and how and why they are affecting your profitability.
Here’s How
Costs are usually calculated when a product is first developed or a process first installed. Sometimes these costs are strictly based on engineering estimates or theoretical run rates unproven in actual practice. Seldom are initial cost estimates questioned or re-evaluated unless there is a process or equipment change (and maybe not even then). Actual run rates are often different from the theoretical – sometimes better, sometimes not so good – and can change over time, with different operators, different machines, different materials, different mold designs, etc.
Complacency (thinking you know your costs; thinking you are profitable enough) can be disastrous to the health of the business. Incorrect pricing (pricing too high because costs are over-estimated) can lead to lost opportunities. Overly optimistic (low) cost estimates lead to unprofitable business commitments. Finding out after-the-fact that you are losing money on jobs, or making far less than you assumed, is an unpleasant surprise that nobody wants to face.
Initial cost estimates are nearly always based on standards or experience with similar products, and there’s nothing wrong with that. The problem arises from not validating the costs and re-evaluating cost assumptions when conditions change or simply from time-to-time to see if anything has changed.
A prime example is a well-known company with a reputation for quality and efficiency that was producing a particular part at 160 units per minute when the process was capable of producing 400 units/minute with no loss of quality – just because they’ve always done it that way. They never questioned that run rate; never tried to increase it and see the result.
Your plant information systems (PLC, MES, ERP) likely already collect actual performance data and actual cost for each production job. The company should use this information for more than posting to the P&L statement. Engineering and cost accounting can exploit this information through variance analysis (why was our actual cost different from standard?) and follow-through – route cause analysis, updated standards if warranted, process improvements make this information truly valuable. You can identify costs that are not in line with expectations (standards) and either bring them back in line, if they are higher than expected, or adjust the standards so you have better information to support future decisions on pricing, scheduling, and process improvement efforts.
Even if you know your costs and have fairly recent calculations to work from, you are likely leaving money on the table. There are always opportunities to improve efficiency, reduce costs, and increase margins. Don’t accept the status-quo. Look for opportunities to scoop up more of the money that is currently being left on the table. The only way to do this it to adopt a consistent methodical approach to tracking labor and machine time, setups, rejects, downtime and actual material being consumed on a per job basis. With limited training Shop flop control systems coupled with touch screens and bar coding can drastically improve the accuracy and timeliness of actual performance than should be compared against the standard on all orders.
Process improvement and cost cutting are not always difficult and expensive undertakings and don’t necessarily involve a compromise in quality or a burden on production workers. To get started, you need to take a close look at actual costs – particularly machine run rates and efficiency.
Look at performance (run rates) across multiple products and materials, through time. Identify favorable trends (things are improving, what are we doing right and how do we extend that trend?) and unfavorable trends (why aren’t we running as fast as we showed that we could in the past? What has changed and how can we reverse that trend?) Be aware, however, that run rate and quality often have an inverse relationship. Any run rate increase must be watched carefully to ensure that quality does not suffer. Find the “sweet spot”, the maximum sustainable run rate that delivers the required quality level. Consider other factors in this analysis as well, including possible changes to temperature, cooling, material handling and even material formulation as ways to increase run rate without reducing quality.
And don’t forget set-ups and equipment down time. Most companies have made efforts and investments to reduce set-up and changeover time but this, too, should be continuing effort. Just don’t forget to factor in the latest and most accurate set-up costs in product cost standards so you can understand bid with confidence.
Equipment failures and down-time can be significant costs of production that are not reflected in product costs. Reduce your overhead while improving on-time schedule completion and customer service with predictive and preventative maintenance.