Determining the Magnitude of the Profit Reductions

There is no line item on the income statement that measures how much profit is lost by ineffective decisions. By their very nature, the losses are invisible, almost defying management to do something about them. Addressing the issue requires that a more detailed analysis of profit be generated within the firm.

By using data for the typical WMIA member, it is possible to quantify the potential profit reductions. Based on the latest numbers available, the typical WMIA firm has the following key operating characteristics:

Net Sales Average Transaction Number of Transactions Average Line Value Number of Line Items

$5,000,000 $1,600 3,125 $400.00 12,500

The thought of simply processing 3,125 orders and 12,500 order lines is daunting enough. The thought of doing so with 100 percent accuracy in every aspect of the transaction moves beyond daunting to impossible. (See the sidebar, The Losses from Profit Slippages.)

Clearly, many of the mistakes that can be made in the transaction process are obvious, particularly in areas such as warehouse operations. For example, if the wrong item is picked and shipped to the customer, the customer complains. The wrong item has to be retrieved and the correct item delivered. Tracking such problems is relatively easy.

However, another category of errors is not quite so apparent: the loss of sales and gross margin when an individual transaction is not handled in an optimal manner.

Exhibit 1 looks at the nature of the unseen slippages by focusing on sales force activity. The first column simply reflects a typical order for a WMIA member. The numbers reflect the results identified above. To be able to analyze results, two important assumptions were made:

• Commissions. These represent 10 percent of gross margin. Commissions are frequently paid based on margin, but the exact rate depends on whether there is also a base salary and several other issues. The 10 percent figure is used simply for the ease of computation.
• Other variable expenses. These include the cost of financing the transaction, potential bad debts and incremental handling costs. For ease of calculation, variable expenses are set at 3 percent of sales.

As can be seen at the bottom of the first column, the typical transaction produces a meager profit of $6.40, which represents the profit margin for the typical WMIA member of 0.4 percent of sales.

The second column of numbers looks at what happens when the rep does not generate as many items on each order as possible. Specifically, it involves just one less line item per invoice. The impact on profitability of this action is often grossly underestimated. In fact, one less item produces a loss of $89.60 on the entire order.

The final column examines what happens when a 3 percent price reduction is granted to secure the order. This reflects the fact that price is continually under attack. Once again the impact on profit is devastating, with a loss of $35.36.

Both of these are real-world situations. With diligence, it is probably possible to pick up most of the major price reductions. However, the vast majority of the minor ones slip by unnoticed. In contrast, the failure to generate as large an order as possible is virtually impossible to control in any situation.

Eliminating Profit Erosion

It will never be possible to completely capture all of the potential profit on every order. There simply continue to be too many transactions to monitor closely. However, there are two significant steps that management can take to alleviate the problem.

• Profitability education. The vast majority of operating employees, as well as much of lower and middle management, have a very poor understanding of how profitability is generated or undermined in the firm. For example, when asked about the impact of one less line on an order, most employees would suggest that the transaction's profit will fall 5 percent to 10 percent, not that it will be destroyed. Such differences are critical. No firm wants to turn all of its employees into accountants. However, a more thorough understanding is essential to profit success.
• Better monitoring systems. Traditional accounting systems do little to help firms control the issues identified in exhibit 1. However, new database programs do provide a relatively easy means to make such comparisons. It is essential to begin to track key profit drivers, such as lines per order, by salesperson over time. Without measurement there is no basis for improvement.

Moving Forward

Most firms experience ongoing reductions in profitability without even being aware of it. Such slippages are not limited to the sales area: They occur throughout the business. To achieve truly high-profit performance, the typical WMIA member must begin to educate its employees on the nature of profit relationships. In addition, it needs to have a tight control system that regularly tracks each of the key profit drivers in the firm.

About the Author
Albert D. Bates, Ph.D., is founder and president of Profit Planning Group, a distribution research firm headquartered in Boulder, Colo.

©2004 Profit Planning Group. WMIA has unlimited duplication rights for this manuscript. Further, members may duplicate this report for their internal use in any way desired. Duplication by any other organization in any manner is strictly prohibited.

The Losses from Profit Slippages

Many of the factors that erode profits, such as fewer lines per order, are hidden. As a result, they cannot be measured with absolute accuracy. However, some estimates of their impact on the firm can be made based on a few wide-ranging assumptions.

For the typical WMIA member with $5 million in sales and 3,125 transactions, the impact of not generating a complete transaction would depend on the frequency with which this event occurs. The following suggests that for most firms it is probably a significant factor and that the lost profit dollars could equal anywhere between 15 percent to 60 percent of current profits.

Frequency	Dollar Profit Loss	Percentage Profit Loss
One in 100 Transactions One in 50 Transactions One in 25 Transactions	$3,000 $6,000 $12,000	15.0% 30.0% 60.0%

The impact of price cutting is much the same:

Frequency	Dollar Profit Loss	Percentage Profit Loss
One in 100 Transactions One in 50 Transactions One in 25 Transactions	$1,305 $2,610 $5,220	6.5% 13.1% 26.1%

These analyses are based on one less line per order and a 3 percent price reduction. Larger reductions in performance would have a much greater impact on the bottom line.

Weinig Group America to Host Open House April 2-3

The Weinig Group America, the North American subsidiary of Michael Weinig AG, Germany, will hold its fifth open house at its Mooresville, N.C., headquarters April 2-3.

All members of the Weinig Group will be exhibiting their latest equipment: Weinig moulders and grinders; Waco high-speed moulders and planers, resaws; Grecon fingerjointers, rough mills, and material handling equipment; Raimann gang and moving-blade rip saws; Dimter optimizing crosscut saws and edge-gluing presses; Control Logic rip scanning/optimizing equipment for rough mills; and LuxScan cross-cut scanners with vision and X-ray.

For details, call Weinig at (704) 799-0100.

Industry Suppliers Look to Rebound

Participants are encouraged by improving U.S. economy

by Rich Christianson

Source: Wood & Wood Products

Editor's note: Wood & Wood Products published the results of its online woodworker poll last month. As promised, here's a summary of responses from U.S. suppliers to the industry. Counted among them are manufacturers and distributors of machinery, cutting tools, lumber, hardware and other products, plus consultants.

2003 was a year to forget for at least one-quarter of the 168 U.S. suppliers to the woodworking industry who took part in Wood & Wood Products' exclusive online survey. Six percent of the participating suppliers dubbed last year terrible and an additional 19.6 percent called it poor.

Collectively, the suppliers expect better deals to come in 2004. Two-thirds of them predict good or excellent years. The number of respondents predicting a terrible or poor 2004 for their company plummets to 4.8 percent.

"2003 has been a terrible year to date," said a woodworking machinery distributor. "Customers are, however, starting to make purchases they have delayed for one to three years. 2004 looks promising but one of the biggest challenges the industry will face is the rising cost of imported machinery as a result of the falling dollar."

Another machinery salesman noted, "This period in our history is a cleansing time to weed out the negativity, riff-raff and opportunists. It gives those with a sound foundation [an opportunity] to become creative and innovative and set the future of the industry."

Imports Take Their Toll

As imported wood products have claimed an increasingly bigger share of the U.S. market, the domestic sales prospects for suppliers have diminished. Nearly 42 percent of suppliers said their company lost significant business over the last five years because of imported wood products. In addition, 35.7 percent of respondents think the impact of imported wood products on their businesses will be greater in 2004.

It comes as little surprise that the largest number of suppliers, 32.1 percent, believe the one thing that government could best do to help businesses is to curb imports. Action to rein in health care costs, number one on most wish lists of woodworkers, was second at 25.3 percent, followed by offering tax incentives for capital investment, at 22.8 percent.

"Chinese imports are still growing at a staggering rate," said a software sales representative. "If something isn't done to balance the fairness of trade, many more companies will fail along with jobs."

A lumber distributor added, "Although I'm a firm believer in a 'world market' and free enterprise system, the government needs to investigate the percentage of imported furniture now making its way into the U.S. A lot of this furniture is being produced by slave labor, and domestic manufacturers cannot compete."

Presidential Approval is Mixed

Asked to weigh in on President Bush's overall performance to date, 50 percent of suppliers rated him good or excellent and 30.5 percent rated him terrible or poor. One of the nearly 20 percent who gave the president an OK rating said, "President Bush needed to go to war; he had no choice. Now he needs to take care of the American workers before it is too late. He needs to stop imported products or at least slow them down."

Other comments were more indicative of the love-him-or-hate-him feelings respondents have for the U.S. commander in chief. "President Bush has taken a bad rap over the U.S. economic condition, but much of the problem with trade policies occurred during the Clinton administration, especially our current trade problems with China," said a software supplier. "We have the largest economy in the world. It didn't break overnight and it won't likely be fixed overnight."

Several suppliers critical of President Bush labeled him the worst president ever. A machinery dealer said, "Reacting rather than acting! President Bush's fate will probably be settled by the voters - the same way as his father's!"

Working the Web

Nearly three out of every four suppliers agree that their firm's web site is at least somewhat important for generating new business. Yet even as the Internet becomes a more common marketing tool, 26.4 percent of suppliers said it is not important to help drum up new business.

"Our web site has been a great sales tool for customers to get to know us better," said a wholesale lumber representative. Several respondents observed that their web sites could stand improvement. "I would like to see our web site be more product oriented as compared to telling the history of our company. We need it to get to the meat and potatoes that customers are looking for," said another respondent.

Competitive Differential - Automation Technology

Reduce costs by eliminating nonvalue-added activities

by Don Shultz

Source: Wood Digest

Recently, the frustrated owner of a medium-size furniture company asked me, "What is the purpose of my business?" Not really wanting me to answer, he continued. "I mean, we're working harder and harder, and putting less and less to the bottom line. Our customers are demanding lower prices, higher quality, faster deliveries. All the while, my costs continue to rise. It's become impossibly hard for me to compete."

In different words, the question of competition is becoming an increasingly worrisome and complex pressure that many North American manufacturers are talking about. Over the past three years, manufacturers have addressed the issue of competitive pressure in various ways.

From investing in capital equipment and implementing continuous improvement initiatives to staff reductions and offshore manufacturing, North American producers have worked aggressively to reduce labor costs.

According to the U.S. Bureau of Labor Statistics, Economic Policy Institute, the U.S manufacturing sector lost 2.4 million jobs between March 2001 and October 2003. The wood industry has been particularly hard hit relative to employment, but in spite of labor cost reductions, profitability has continued to decline, driving many manufacturers either to seek offshore sources or to close down operations entirely.

The current reality, according to the U.S. Census Bureau, Economic Census, and the Bureau of Economic Analysis, is that the U.S. furniture industry lags behind other manufacturing sectors when considering net income: 6.2 percent compared to 7.7 percent average for all manufacturing sectors combined. Of greater concern is that only about 60 percent of woodworking companies report they are profitable. All this on top of a profit picture for the manufacturing sector that, as of the end of the third quarter, is off 29 percent from the same period in 2000.

For many producers like the frustrated owner, the question remains: How does the industry respond to this growing pressure? One observer, Ivan Saul Cutler of the Business Journal, suggested the industry "should have been investing in technology to establish efficient, flexible short-cycle production methods to eradicate nonvalue-added costs for increased profitability." Clearly, this is sound advice.

The advice is very specific, too: Eliminate all nonvalue-added costs. The suggestion here is not about reducing the cost of labor but rather the content of labor - direct and indirect. Further, reduce cost through the elimination of nonvalue-added activities that occur both on the plant floor and in the office.

There are many ways in which nonvalue-added activities chip away at profitability, but generally they relate to work process design. Inefficient and wasteful processes typically exist, to varying degrees, in all functional areas of the business including sales, operations, and finance and administrative activities. They are manifest in product design, engineering, planning and scheduling, production, material handling and expediting, and, more often than not, in the functionality of information technology systems.

Automation

For many woodworking companies, automation is one approach to improve work process, quality and accuracy; reduce labor content; and positively impact the financial performance of the organization. Simply stated, automation is the management of redundant tasks, processes or systems that have common attributes and occur with regular or high frequency - automatically. Automation can involve replacing a manual with a mechanical or technical solution, combining manual or separate tasks into a process, or combining separate processes into an integrated system.

Although, for the woodworking industry, automation is still in its relative infancy, the word automation first came into use around 1950. The use of CNC machine tools, technology and system advancements to support material handling, on-machine tool management, and now even part programming and its benefit to manufacturers is becoming increasingly apparent.

Automated material handling devices have evolved from simple pick-and-place machines to sophisticated robotic assembly cells. Devices for loading and off-stacking from panel saws, edgebanders and drilling machines have been in use since the mid-'80s,but were applied to applications where part volume was high and variability low. These systems reduced labor requirements within the work cell by two to four workers. Moreover, they allowed the lines to run at higher speeds and improved worker safety.

For many manufacturers, a beneficial application of automation is in the combination of multiple work process steps. In this instance, work processes normally performed on separate machines are performed on one machine tool or process line. Combining manufacturing processes reduces material handling and work in process, and accelerates the speed of throughput. In some cases, the processes can be combined in a standard machine. In others, the solution requires a specialized, engineered solution.

One Midwestern company, Creative Automation Inc., manufactures custom materials handling equipment and specialty machinery for the woodworking industry. According to company president Thomas E. Streckert, "because we understand that your manufacturing strategy is unique within your market, we offer engineering solutions that are custom designed to improve your work flow."

Process Combination

Process combination can occur in line, such as with countertop fabrication, where scoring and forming of the backsplash is combined with end trimming. In panel processing operations, edgebanding can be combined with drilling by linking through-feed machines in a single processing, or the process elements of sizing, banding and drilling are incorporated in a single machine such as a CNC contour edgebanders and machining center.

The result in either case is that the nonvalue-added cost content of the part is reduced. Time spent loading and unloading the machines is reduced to a single event for the combined operations. Intermediate material handling is eliminated, thus reducing indirect labor content. In the case of the CNC, the nonvalue-added content is even less due to minimal setup and changeover time requirements.

Similarly, individual operations for finishing, assembly or packaging can be combined into automated processes. Consider for instance, an automated assembly cell for case goods where a robot is integrated into the process. The work cell is designed to assemble case goods on a batch-size basis. Each cabinet in the customer order can be of a differing size. The work cell is composed of a through-feed CNC case clamp where the pre-positioning of the horizontal members and the backs is accomplished by a CNC robot. The attachment of the back is achieved through a quick-change screw insertion head that is manipulated by the robot.

Such an automated cell results from integrating market strategy, product design, process design, plant and process engineering, and manufacturing IT systems. Such high levels of automation require highly integrated systems to prepare and manage the data within the cell and to coordinate the work and information to the cell. Clearly, the data required to run this cell extends far beyond the programming of the robot.

When this high level of automation is realized, extremely fast internal lead times can be achieved, nonvalue-added is minimized, and operational flexibility and responsiveness to customer demand is maximized. When front-office operations - order configuration and entry, planning and scheduling, engineering and programming - are automated and business processes are integrated, the operational performance is even further improved.

As a business attains a higher level of process mastery, the greater is its ability to reduce direct and indirect labor content. Automation can help manufacturers create new processes that optimize the use of labor and consequently reduce the overall labor content in a product. Automation improves flexibility, agility and responsiveness to customers' needs and expectations.

"There are plenty of opportunities for the mid- to small manufacturer to take advantage of automation," says Marty Simpson, president of Technical Services Inc. in Ames, Iowa. "If one looks at the nonvalue-added labor content on a percentage of man-hours worked, the problem is much larger for the smaller operations. I think the smaller guy needs to be made aware that there are many affordable options to solve the cost and quality problems that they have identified."

For businesses large or small whose leaders are looking to improve quality and manage growth in a tight labor market, or for the frustrated owner looking for the new competitive edge, automation may be just the strategic advantage they seek. Whether it's a standard return conveyor or an integrated work cell, automation can help you meet customer demand - better, faster and at a lower cost than your competitor.

Firing a Customer

Sad to say, but most of us have customers who pay slowly, order infrequently or make unreasonable demands. As a last resort, you may just have to fire them. DETAILS