NOV 26, 2019 | BLOG
Targeting Your ‘Hidden Winners’ and ‘False Profits’ to boost EBITDA
How to identify previously invisible profit opportunities by adjusting your total manufacturing cost formula & revealing hidden SKU profitability.
All manufacturers rely on production cost per unit to calculate their product SKU profitability. But with few exceptions, they run their total manufacturing cost formula without properly considering the crucial factor of production time per unit to determine profit per time. That’s like planning a trip by using Google Maps simply to measure the distance between two points, without factoring in speed limits or real-time traffic flows.
To chart the best path to reach your profit goal on time, you first need to understand the true return on assets of each item you make. To do that, you simply cannot ignore the impact of each product’s physical speed as it passes through key production steps.
The flaw in traditional manufacturing analytics is that it doesn’t provide a true picture of production cost per unit. Without precisely factoring in production time, you cannot accurately calculate total manufacturing costs. You have no way of measuring SKU profitability based on how fast each individual product type produces money per hour of production capacity.
Every manufacturer that makes a wide variety of products produces some items that have high unit margins but – because they take a long time to produce – only generate low (or even negative) profit per machine hour. We call these ‘False Profits.’ Conversely, the same manufacturer will also make some low unit margin SKUs with very fast production rates that yield extraordinarily high profit per machine hour. We call these ‘Hidden Winners.’ Unfortunately, manufacturers that don’t calculate total manufacturing costs with time-based profit analytics have no way of distinguishing their False Profits from their Hidden Winners.
How does the lack of time-based profit analytics in one’s total manufacturing cost formula impact real-world decision making? Ill-advised product line rationalizations are just one common example. Many executives feel trapped by their inability to raise capacity utilization by cutting prices to boost volume. Why? Because their unit margin numbers tell them they cannot match the aggressive pricing offered by competitors. And yet, if they only knew that some of their low unit margin products were actually highly profitable Hidden Winners, they could in fact trim prices on those SKUs to gain profitable volume and drive up utilization.
At Profit Velocity, we pioneered the development of time-based profit analytics for large, complex manufacturers. Typically, we enable manufacturers of parts and components – those who make products in hundreds or thousands of varieties – to see for the first time precisely how fast each of their SKUs generate returns from their assets. By properly factoring in production speed, our time-based manufacturing analytics allow decision makers to move beyond estimates when making their product line rationalizations. Instead, they zero in on the SKUs they should prioritize (Hidden Winners) and de-emphasize (False Profits).
When commercial teams don’t even know which SKUs are their highly profitable Hidden Winners and instead keep chasing after orders for their False Profits, the negative impact on the bottom line is devastating. Sadly, this is the common predicament for parts and component manufacturers that produce hundreds or thousands of SKUs.
At Profit Velocity, we’ve redefined manufacturing profitability analysis. Commercial and operations teams with access to our instant ‘what if’ planning platform are able to align on tactics that actually maximize total profit.
Figuring out which SKUs and customers yield the highest profit per time on the assets and which SKUs and customers suck up expensive capacity for little or no manufacturing profit margin should not be a guessing game. Just like Google Maps, Profit Velocity factors in real-world speeds and flows to help decision-makers choose the best path to their profit destination before they commit their capacity to products and customers that can’t get them to their goal on time.