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Simplify Manufacturing by Saying Goodbye to Dead Weight

As companies become more successful, they tend to grow their business by adding parts and vendors. However, every new part or new vendor adds more complexity to the manufacturing process — which in turn adds more costs.

Complexity can come in many forms:

• Duplicate or conflicting parts
• Excessive contracts
• Expanding overhead

Reduce complexity

To help reduce internal manufacturing complexity, companies need to streamline their portfolios and simplify their product lines. This starts with consolidating vendors and producing the right parts that can be used across multiple product groups.

Every new part or variant added to a company’s portfolio increases the cost of complexity, which must eventually be offset by price increases or cost reductions. Eventually, the company must decide if the incremental cost of adding new products, parts, or vendors is worth the potential impact on its margins.

Start with the data

Manufacturers can use data analytics in conjunction with the 80/20 rule to determine component overlaps and standardization opportunities. Data analytics can help companies understand true product profitability in relation to overall operations. Companies can then develop successful strategies to keep complexity and costs under control.

Most of the company data to evaluate for product profitability is easily accessible, such as sales and purchase transactions. However, many companies fail to use this data because they lack the framework to properly analyze it and derive actionable insight from that analysis. Furthermore, handling the complexities of large data is nearly impossible without having a good grasp of analytics tools and data science.

The best way to analyze these large amounts of product and customer data is to use the Pareto Principle, aka the 80/20 rule, by comparing products and customers based on profit and cost data.

Streamline your portfolio and simplify the product line

To reduce internal complexity, focus on streamlining your portfolio and simplifying the product line. This starts with increasing reuse/standardization of components and consolidating the number of suppliers for certain product groups.

You can use data analytics and the 80/20 rule to identify component overlaps and standardization opportunities. This information can help you re-engineer products to reduce costs.

Companies can also introduce profitability early in the product design and development stage. The number of suppliers can be reduced through greater collaboration with existing suppliers, as well as more outsourcing of less strategic products and components.

Processes can be put into place to understand similarities among products and components and to increase, reuse, and standardize parts and vendors. The fastest way to reduce manufacturing costs is to cut your overall number of parts. Fewer parts means:

• Fewer purchases
• Fewer contacts
• Less inventory
• Less handling
• Shorter process and development times
• Shorter engineering and testing cycles

Reducing the number of vendors and components simplifies all activities related to a product — from its design to its final day of use.

About 70% of all manufacturing costs originate at the design stage. By simplifying manufacturing early in the process, with fewer vendors and parts, companies can focus on quality and time to market. In addition, reducing the number of vendors and parts can lead to more customers and greater revenue.

If you’d like to know more about how to simplify your manufacturing processes, starting with ridding yourself of extra vendors and parts, reach out to me below or or follow the author link.

Author: Patrick Mosimann

Posted on March 27, 2019 by Danielle Mosimann

Upgrades at What Price? Leveraging Direct Costing to Uncover the Hidden Costs of New Product Features

Companies constantly update their products to stay ahead of the competition and maintain customer loyalty. But beyond the obvious costs that go into modifying your products — such as manufacturing and shipping — do you know what might impact your final profit margins? Before you commit to new product designs, take a direct costing approach to get a clearer picture of what those upgrades will actually cost you.

What is direct costing?

Direct costing is a specific type of cost analysis that looks at variable costs (also called incremental costs). When you use a direct costing approach to determine cost, you ignore fixed costs.

Direct costing looks only at variable costs, such as the actual costs involved in manufacturing a product or the costs to increase production. When manufacturing activities cease, so do variable costs. For example, shutting down a production line would eliminate all of the direct costs associated with making the product. Likewise, if an entire division closes, all the costs associated with that division are eliminated. Variable costs can include raw materials and direct labor.

Adding product options increases pricing complexity

As you introduce new products or add new features to existing products, your variable costs go up. New materials, components, vendors, and support functions increase your overhead. Every new part or variant that you add to your product portfolio drives up the cost of complexity. And you must eventually offset these increases by increasing prices or reducing costs.

Complexity can result from:

• New parts
• Tailored parts that interfere with standard parts
• Low-volume products that hinder production of high-volume products
• Inconsistent and variable designs that impact inventory management

Too much variety can affect your business functions and customers while compromising your costs, quality, and delivery. Unfortunately, many companies approve new products and features without understanding how these new variables will affect their bottom line.

As you can see in this example, as variable costs increase, the ultimate amount of operating income can decrease. Looking at your contribution margin will also give you a more accurate picture of true profitability; contribution margin is revenue minus variable costs.

Contribution margin will be explored in a future article; SG&A expense refers to selling, general, and administrative expense.

Benefits of using direct costing

Breaking out costs gives organizations a better grasp on the effect of the costs associated with each new product or feature. Using direct costing can help you reduce your overall number of transactions and associated reports because costs are easier to understand and more difficult to hide. Focusing on your final production costs makes it easier to plan based on actual costs.

While it’s important to keep your products fresh, it’s equally important to understand the costs and complexity that new features introduce. One of the keys to reducing complexity is to eliminate products that aren’t profitable enough.

Direct costing is a powerful tool that lets you see through the complexity of standard accounting methods. When you use direct costing in combination with data analytics, it can help you see how to improve your profitability.

Having trouble determining the true cost of your products? AlignAlytics can help you employ a direct costing approach to improve your profitability. Reach out to me below or or follow the author link.

Author: Patrick Mosimann

Posted on March 26, 2019 by Danielle Mosimann

The 80/20 Conundrum: How to Improve Your Margins

In most companies, the top 20% of customers generate close to 80% of profits. But there are ways to improve the performance of the other 80% of customers. By using the Pareto Principle — also known as the 80/20 rule — in tandem with the true cost of complexity, you can effectively tailor specific actions to your portfolio and successfully raise your margins. Unfortunately, standard financial absorption costing does not provide accurate guidance on how to best allocate your resources on the remaining 80% of your customer population. By segmenting both the 20% and the 80% into distinct strategies, performance improvements can be achieved.

Don’t be held ransom

Many businesses using the 80/20 rule are hesitant to raise their prices for those customers in the 80% bracket, for fear that they will lose sales. In fact, businesses tend to focus on their lower-performing customers because they see them as potential growth opportunities. Dig a little deeper, and you’ll discover that 40% of U.S. business revenue comes from repeat customers — but these customers account for only 8% of all customers.

What does this mean for the growth-oriented business? Break out of the cycle of working for a dime, not a dollar — don’t be held ransom by fear.

Making 80/20 work for your business

All this means making some big decisions. But don’t be discouraged; there are a number of ways to strategically apply the 80/20 rule within a business portfolio to generate profitability and reduce complexity across the board.

  1. Pricing — Resist the urge to apply a one-size-fits-all approach to pricing. Refine your cost structure by layering true profitability segmentation with the 80/20 rule to optimize pricing results and reduce pricing leaks. Why? Margin-driven profiles of clients and products allow for a clearer understanding of which need specific pricing actions. As a result, businesses will be able to observe which clients and/or products are most profitable within their portfolio, including those in the 80% bracket. Isolating profitable products not only drives revenue but also reduces complexity by removing focus on redundant processes.
  2. Assess complexity — Assess the scope of complexity within your organization by identifying the reasons behind particular clients and/or products not generating the intended margin. By evaluating complexity from a true profitability perspective, you restate the contribution margins of the 20% of your customers who make 80% of your profit and define different portfolio priorities. This process makes it easier to determine specific problem areas.
  3. Divide and conquer — Illuminate redundancy while enhancing productivity and effectiveness by defining specific 80/20 tasks that deal with not only product complexity but also the underlying drivers and processes. Don’t allow the groups to exist in a vacuum; look to align them with key priorities and ensure that effective lines of communication exist. Strong communication will allow those dealing with process complexity to provide valuable insights into platform redesign, Direct Material Optimization (DMO), product modularization, or commercial processes that avoid excessive complexity and inefficiency.
  4. Spring cleaning — Most businesses are burdened by more processes, clients, products, suppliers, etc., than are needed for positively impacting their true bottom line. Despite this adding to operational complexity, organizations tend to expand their operations over time, meaning that obligations become increasingly expensive and cumbersome without ever evaluating their true worth. Is it easy to throw away your favorite pair of sneakers? No, but in the end a good spring cleaning is more important than sentimentality — and the same idea can be applied to businesses. Conduct an 80/20 audit (known as managing the long tail) on vendors, clients, processes, products, etc., and get ready to cut some of those losses.

The AlignAlytics approach

At AlignAlytics, we’ve found that most product simplification approaches only focus on the symptoms; few companies have a formal process to manage portfolio optimization, product line simplification, or complexity governance. This is why we developed 80/20 Align, a system that provides data-driven complexity management by illuminating the true cost of complexity, its related causes, and the actual margin impact.

Complexity doesn’t need to get the best of your business, nor does its ebb and flow need to be dictated by the standard patterns of the 80/20 rule. With some honest evaluation of every aspect of your business and widespread data analysis, you can find ways to tighten margins and improve profitability while reducing complexity.

Want to maximize the 80/20 rule to help your business to grow? Reach out below or follow the author link.

Author: Patrick Mosimann

Posted on March 13, 2019 by Danielle Mosimann

How much is product complexity costing your business?

Author: Pedro Ferro with 80/20 Align

Every established company has a certain amount of complexity in its product portfolio. Adding new products, variants and features is very seductive because it helps grow the business. That growth usually comes with a cost – creating complexity. Product proliferation inevitably leads to internal complexity in the form of excessive overhead, too many vendors and a myriad of components, resulting in:

  • Tailored parts increase every day and interfere with standard products.
  • Numerous subtle variations in similar designs, with minimum component standardization and reuse, creating slow and obsolete inventories.
  • Out-of-control variety impacts all business functions and customers, compromising cost, quality and delivery.

Very few companies understand true product profitability before they decide to add a new feature or new design to satisfy a customer.

Adding New Products 

Every new part or variant added to the portfolio increases the cost of complexity and must eventually be offset by price increases or cost reductions. It gets to a point where the incremental cost of adding a new product variant is way higher than the incremental margin gain that can be attained.

To make the problem worse, most companies do not measure cost of complexity and so do not know the real impact that proliferation has on the bottom line.

In our experience, the main reasons companies do not have proper metrics or processes to manage complexity are:

    1. They do not have a reliable and practical way to measure the cost of complexity and understand true product profitability
    2. They do not segregate their portfolios into groups of products and customers according to economic value, in ways that they can apply different strategies to recover the cost of complexity.

The key management challenge is to balance scalability and variety (customization), given that scale is rapidly compromised when complexity is mismanaged.

The use of data analytics to understand true product profitability, coupled with a complexity management process, which can differentiate between the vital few and the trivial many, can lead to a successful strategy to keep complexity costs under control.

How to understand and optimize your offering to improve true product profitability?

1. Use data to understand true product profitability and to streamline your offering (cut the “long tail”)

Use data to understand true product profitability 

Most companies are sitting on a wealth of data that they can use to understand complexity, especially data at the intersection of customers and products, such as sales and purchase transactions. The reason why most companies do not use data to track complexity is that they don’t have a workable framework to analyze and from which to derive actionable insight.

The best way to handle large amounts of product and customer data is to resort to the empirical and age-proven Pareto Principle, aka the 80/20 Rule.

80/20 Rule Pareto Principle 

Using the Pareto Distribution to classify and overlay products and customers based on profit and cost data is a simpler way to segregate the portfolio. And it’s no surprise when, time after time, the analytics keeps pointing to the fact that only a few customers and products account for the majority of margin dollars and growth.

By using Pareto to distribute overhead and support costs amongst all products, in proportion to individual economic contribution and complexity level (measured in terms of revenue, number of transactions or parts-count), we can arrive at true product profitability. This is the equivalent of having an individual P&L for each product.

80/20 True Proftability 

When we look at cumulative profits in a Pareto Chart (using gross or contribution margins), we don’t observe the loss of profitability that comes from complexity.

Only when we overlay the true profitability curve on the same chart do we see the impact on the bottom line caused by the “long tail of complexity”.

Managers need to use true profitability as a guide to eliminate low-profit contributors and rationalize the portfolio. They also need to apply different marketing strategies for different groups of customers and products, based on their strategic and economic value, since not all “freeloading products” can be phased-out or replaced in the short-term, especially those that serve strategic customers.

2. Repair true profitability of remaining products in the portfolio

Repair true profitability of remaining products in the portfolio

Every portfolio will contain a number of products that fall below a true profitability threshold. As companies prune the “long tail” they also need to be able to heal true profitability of remaining products, by either recovering the cost of complexity by better pricing or by reducing the cost of the product. There are several options to repair true profitability, depending on where the product is in the economic value matrix created by the Pareto analytics:

  • Reduce cost of goods sold (COGS) by reducing material cost. Companies should pursue a 10 to 15% reduction in material cost for products sold below the true profitability threshold via direct material optimization.
  • Rationalize the offering of non-strategic products. Replacing products sold to non-strategic customers with those sold to core customers is another option.
  • Build marketing strategies around true profit contributors. By understanding the entire product P&L, sales organizations can focus sales efforts on true profit contributors.
  • Develop pricing mechanisms for different product and customer groupings. Non-strategic products sold to non-core customers should reflect the full cost of complexity.
  • Stop creating more low-profit contributors. The best way to sustain true profitability is to keep freeloaders from entering the portfolio.

3. Diminish internal complexity by rationalizing components and vendors

Diminish Complexity

To reduce internal complexity companies, you need to focus on two sets of actions: streamlining the portfolio (cutting the long tail) and simplifying the product line.

However, reengineering a product line is not a trivial or an overnight exercise. Product line simplification needs to start with pragmatic goals, for example increasing reuse/standardization of components and consolidating the number of suppliers for certain product groups in the portfolio.

The use of data analytics in conjunction with the 80/20 rule can be instrumental in determining simplification priorities. Linking bill of materials (BOM) and finished SKUs data for example, can determine component overlaps and standardization opportunities.

Typical techniques used to reduce internal complexity are:

  • Reengineering the product to reduce cost. Based on value engineering and similarity index teams develop ideas to reduce cost without compromising quality.
  • Standardization and modularization. Teams set goals for complexity levels desired within a segment of the portfolio.
  • Design and develop for true product profitability. When companies account for true product profitability early on, they have a better chance of creating sustainable value – products designed not only with sales specifications in mind, but also with the ability to be manufactured in existing high-volume production lines.
  • Supplier consolidation, category management and outsourcing. Reducing the number of suppliers through greater collaboration with suppliers and more outsourcing of less strategic products and components are great ways to reduce complexity.

4. Manage future complexity to sustain true product profitability

Manage future complexity to sustain true product profitability 

Finally, to sustain true profitability, companies need a stronger complexity governance process composed of four elements:

  • Clear roles and responsibilities. Assign a complexity manager to coordinate the entire process. This individual is the connection point between the external and the internal complexity arenas.
  • Decision-making forums. The organization needs effective cross-functional decision-making forums to expedite decisions at the right levels of the organization:

    R&D, sales, sourcing, operations and finance.

80/20 True Proftability 

  • Analytical tools and KPIs. Visual representations of product portfolios using data analytics with simulation tools allow for timely, accurate decisions. Monitoring true product profitability performance is the most effective way to measure progress.
  • The right behavior. New ways of working must be integrated into the complexity management process. They need to be present in the work routines of sales, sourcing and R&D to induce the desired behavior.

Living with complexity demands a clear understanding of true product profitability. It also requires that mechanisms are in place to control future complexity and sustain profitability.

Author: Pedro Ferro

80/20 Align provides a data driven complexity management process that better manages the causes of complexity and diminished margins. It can support you in all the above steps to ensure you don’t reach chaotic mode.

Posted on June 20, 2018 by Danielle Mosimann