Focus on Margin Dollars

(Newsletter March 2007)

In this newsletter, we will discuss the main issues of margin and how more margin dollars can be added to the bottom line. So often, we feel that everyone within our organization understands what margins dollars really are and how they affect profitability.

First, “margin” for this newsletter is simply described as

Sales Price - (Labor Cost & Material Cost) = Margin

Some other terms used are Contribution Margin, Gross Margin and Gross Profit

Let me talk a little bit about sales dollars and profit. Would you agree that the total sales dollars for a given period only give an indication of possible profitability but not actual? Only the total margin dollars minus your indirect cost (overhead) will provide you the profit or loss for the given period. But where is your focus in your company? Is it focused on total sales dollars or margin dollars? Far too many companies have their sales team focused on total sales dollars instead of total margin dollars.

Here is a simple example that will focus the importance of margin for every order. Let us assume that there are problems on a specific order and you incur a charge back of $5,000. How many orders would it take to earn the $5,000 back? Well, if the normal margin is 30%, then it would take

$5,000 ÷ 30% = $16,667

So, this means that you have to sell $16,667 worth of components at 30% margin just to recoup the loss of $5,000. This does not cover the cost involved of lost time to problem solve and productivity of the initial issue caused.

Focusing everyone’s attention on margin dollars instead of total sales dollars has numerous positive benefits. It will affect sales, design and production. Here is just one example with the design department: When a truss designer is pressed for time, what is the first thing that he will cut corners on to save time? The answer is optimization. You can tell and train him to optimize but if he does not have any incentive to optimize, do you really feel that he is doing a good job of optimization? Does optimization have any effect with the margin? You bet your profitability it does! So, why not have the designer’s attention focused on total margin dollars so that he can pay attention on each and every order?

For most companies in the component manufacturing industry, a common formula is

(Material + Labor) divide or multiplied by a number = Sales Price
Or
(Material + Labor) plus a percentage markup = Sales Price

On the surface, this formula would guarantee an equal amount of margin for every job. If the cost of labor or material varies, the divisor properly adjusts the sales price. But if you look at the whole picture of manufacturing, does it really?

1) Material - We all pay what the markets dictate for our material cost. Lumber, plates and miscellaneous materials are all controlled by the prevailing market cost.
2) Labor – Similar to material, we pay the prevailing wages in our area. We maximize our efficiencies to lower our per-component labor cost, but it is largely fixed according to our manufacturing setup.

(Material and Labor Cost are referred to as Direct Cost)

Once the price is set, then direct cost affects the margin after the fact, but during the initial pricing point, direct cost has nothing to do with margin dollars contributing to profitability. Stated another way, direct cost is a pass-through cost that the customer must pay and the margin is the fee that the customer is paying you for your services.

If you are using the common margin formula (Direct Cost + Margin = Sale), you may be overlooking some important factors. Think of the production facility as a machine. This machine has limits that cannot change easily. Only a certain number of orders per day can be completed. Accountants refer to this as “opportunity cost.” To put it another way, this standard margin formula does not give equal weight to every job!

Most of us use common sense that tells you to add more margin dollars to complicated orders and fewer to orders that are easier to process. We adjust the pricing according to complexity, but is it really done with any consistency? Why not know immediately how much an order will contribute to the bottom line? Here is a test that you should do with the orders you are processing. Measure the margin dollars in your shop per hour, day and week. Why do the margin dollars vary on an hourly, daily and weekly basis in your company? Is there a better way to control this variation and create a system whereby orders have a more consistent minimum contribution (baseline) to the bottom line?

Drummond’s Margin Formula

Will automatically adjust every order pricing so that every order’s baseline is equally adding to the bottom line

You can still add or discount any order

Will add thousands of dollars to the bottom line over any given period of time
Will easily choose which orders are more profitable without the subjective guesswork

Everyone–designers, salesmen and so on—will be able to understand and use it

Will enable you to create an environment where your competitor’s production gets bogged down, based on a margin calculation that is flawed from the get-go

(Hint: It requires Lean Manufacturing Principles and Time Standards)

There is no better time than now for Lean Manufacturing Practices. They can give you the results that you have been searching for. And by lean manufacturing principles, I am talking about the real, meaningful practice of lean principles that were developed by Toyota and other leading companies.

Even the bean counters like the results of lean manufacturing :-)

Testimonial of Service

I wanted to let you know that I appreciate the consultation that you provided for us. One real benefit we experienced was that we had the opportunity to step outside the forest and get a new, fresh perspective on our operation. We found many of your ideas to be very straightforward and interesting, and are really looking forward to putting them into action.

We have begun equipment modifications, as well as looking into how to achieve the stated goals. We are very excited about our future based on the ideas that you have provided. Thanks for your help and feel free to use us as a reference.

Mark Smith, Director of Operations, Trus-Way Inc. Vancouver, Washington

See reference page for statements by general managers and owners about services.

A consultation by Todd Drummond Consulting can provide the following:

Lean Manufacturing Principles explained and demonstrated, tailored for the roof truss manufacturing industry
Common methods that could be used to gauge efficiencies among different facilities
Proven and practical methods of increasing efficiencies and productivity
Time standards for labor estimation of truss production

*** 3 to 4 Months ***
Normal Payback of a Consultation

Once these principles are implemented, you could expect

Increased profitability
Time standards system in your production facility (Better known as “Houlihan”)
Better communication and cooperation between different departments
Proper lean principles that would be the foundation to apply in every location and department

See my webpage “Consultation” for the details.

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Truss Shop Labor Tracker

Software

A powerful and yet simple software package to track your truss shop’s labor. Think about the idea of knowing the who, what and where of every order being processed in your shop.

You would be just a few mouse clicks away from…

Knowing how much labor was actually involved for every work order.
Knowing the estimated labor hours verses actual hours for every work order.
Knowing how productive every group and/or individuals are at any given moment in your manufacturing.
Real time tracking of any work order.

See "Labor Software" webpage for details

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