This starts a 9 part series of conversations about Maximizing Profitability the TOC (Theory of Constraints) Way. While Science of Business, Inc. focuses on highly custom job shop scheduling and machine shop scheduling, we will make sure the content of these conversations will apply equally well to all other organizations. Feel free – please- to leave comments below this post.
Brad: “In my opinion, most businesses are not making nearly as much money as they should. In fact, too many go through a tremendous amount of work and risk just to breakeven or a little better. What do you think?”
Dr. Lisa: “For sure. And they do not have the systems and processes in place to cause a productivity improvement, either. Management’s role is to implement systems and processes that will make more money now and in the future.”
Brad: “The problem is not that the business owner does not want to make more money.”
Dr. Lisa: “Correct. The business owner and management are dealing with so many issues; they find it difficult, if not impossible, to focus their collective attention on the things that will result in making more money.”
Brad: “If you look at their strategy, or plans, or to-do lists – if they even exist – you will not see what is needed to really improve profitability.
Dr. Lisa: “Let’s consider what is possible. If a company improved the productivity (and I do not mean efficiency) of its resources (people and machines), and then could sell that additional capacity, the additional margin drops to the bottom line.”
Brad: “So, let’s talk about what might be possible for a small machine shop, even though we know that the solution is equally scalable for larger organizations, as well as, for different types of organizations.”
Dr. Lisa: “Let’s also be conservative about the numbers. Say that the machine shop has only a million dollars in sales. Its (Throughput) margin after paying its vendors (the Truly Variable Costs) is only 50%, though we know that in many cases it’s much higher. And the productivity improvement the machine shop gains is only 20% with its current resources, though we know that is usually much higher, too. That capacity is sold at typical prices, creating $200,000 in additional sales. At a 50% margin, that means that the bottom line improves by $100,000.”
Brad: “If the company started with $10 million in sales, the bottom line improves by $1 million.”
Dr. Lisa: Yes, BUT many of our readers will just think that’s nice talk and they’ll want know if it’s actually possible for them and how.
To be continued.
Dr Lisa Lang and Brad Stillahn
P.S. Feel free – please- to leave comments and questions on this post.
P.P.S. To find out more about improving productivity in highly custom job shops and machine shops, watch our How to Get More Jobs Done Faster webinar.
P. P.P.S. If you have plenty of capacity, but can’t sell it, visit www.MafiaOffers.com.
P.P.P.P.S. For help putting YOUR financials in throughput accounting terms, pricing and making decisions, visit www.VelocityPricingSystem.com for one on one help or TheoryofConstraintsCPE.com for self study courses.
Great to hear from you. We’ve been to that winery on lake Wanaka. It is beautiful!
BTW, a new CCPM software is now out. I recommend it, you can check it out here: CCPM Software
It is in the cloud and very affordable compared to the other options.
Stay in touch,
Not understanding how you can consider overtime premium as a “fixed cost” regardless of sales volume. What kind of manager would keep his team on overtime if he had no sales? What am I missing in your logic?
If you had no sales you probably would not need overtime. But if you did need OT, we categorize it as part of Operating Expense. Deciding that you need OT and how to categorize it in your chart of accounts are two different things.
The reason we call it part of OE is because you don’t
work OT with every sale. Truly Variable Costs(TVC) are those costs that you must pay as a result of the sale and they vary one for one. In other words, if I sell one more I will have to pay for the raw material and the outside processing for the item I just sold. (Along with any other costs that you have to pay when you sell one more would be included in this TVC category.)
Operating Expenses tend to be period costs. They don’t vary by the ONE sold but by the period. If in a period you are slammed and you’re going to work some OT, then your OE is going to increase in that period.
Thanks for the question. We’ll get more into this as the series continues.
I’ll post some additional reading material as well.
Happy birthday to Lisa.
You and Brad are still at the center of every conversation we have about scheduling.
Thanks. And Happy Birthday to Ann as well.
I am a Proj. Mgr. for a company who’s primary market is improving the “performance” of distribution centers/warehouses. Usually my clients look to improve their labor metrics using flawed concepts like ABC inventory to minimize travel distances for their order-pickers, ignoring the fact that most orders involve products from the B and C locations as well completely upending any distance savings. A classic example of local optima. However, when I talk about how the DC is a cash machine where shipments are actually cash flow back to the company, they look at me like I’m from another planet.
Second item is … my company functions like a General Contractor where each contract is believed to be “unique” although the infrastructure is always the same. Someone needs to do an 80-20 analysis of our business, focus on the highly profitable 20% (or even the top 4%), then assess and exploit the constraint.
I recommend you take a look at https://www.VelocityPricingSystem.com. That program includes a full analysis of all products and customers to REALLY understand how, where, when, and why you make money (or not).