Measurements that drive operational results: use customer demand, not internal efficiency measures, to set priorities

Measurements that drive operational results: use customer demand, not internal efficiency measures, to set priorities

Charlie Allieri

While the U.S. industrial sector is currently operating at 76% capacity, most manufacturers are still shipping below 90% on time. How can this be?

The industrial sector in North America is working hard simply to maintain customers, never mind win new business. Delivering quality products at reduced prices, offshore competition isdriving profit margins down and leaving North America scrambling to adjust.

Advanced Tooling Specialists owner Jim Luebke recently categorized the situation well: “Quality and the best technology is a given to enter the market. Cost-effective, on-time deliveries are about the only advantages we have left to exploit.”

You might ask: If delivery performance is an imperative and there is 24% excess capacity on average across the U.S., why can’t companies ship on time?

The answer is based on antiquated measurements and the reporting systems that managing executives use to run their businesses. Two measurements driving poor decision-making and causing delays in the supply chain are efficiency measurements and pricing schemes based on unit cost.

Efficiency Measurements

What manager wants to see workers–or that multimillion-dollar machine–standing idle, especially when orders are late? Human nature and, unfortunately, most of the systems that drive operational decisions dictate the demand to “get to work.” That decision, however, is actually counterproductive to the goal of achieving 100% on-time deliveries.

Most companies already have too much inventory, and that causes workers to lose sight of important orders. What they see instead is a wall of inventory that they simply need to get through. Long setup times normally drive decisions to work through the inventory, even if half of it is not for a specific order. The truth is that the wall of inventory could have been created by the aforementioned manager, who saw that the work centers upstream were idle.

The measurements accountants use to judge managers’ performance and dictate bonuses often compel the managers to keep the labor force and equipment busy to maintain efficiency numbers.

Optimal measurements and systems actually gate the release of material into the supply chain and dictate priorities based on real customer demand. Too often, companies push materials into the process prematurely, and that increases the material needed to fulfill customer orders. The result is decisions that inevitably cause delays.

Contrary to conventional wisdom, by choking the release of materials until necessary, companies will quickly see inventories evaporate by as much as 50%, lead times drop by as much as 50%, and on-time deliveries increase into the high 90% category.

Unit Cost Pricing

Once companies are managing their excess capacity, they can capitalize on it by applying pricing schemes to capture new business. For instance, a company has a unit cost of $20 ($10 for material, $10 for labor and overhead). An opportunity for a 2,000-unit order arises, but at a price of $17.50. Most companies would walk away, calculating a loss of $5,000.

But would it really be a financial loss to your business? You have already paid for the overhead and your workforce and machines with excess capacity are in the building. Isn’t the only real cost to accepting this additional order the cost of the materials? Using metrics based on “throughput accounting,” the order would actually represent $15,000 in new revenue.

ThermoFab, a provider of high-quality plastic enclosures, has implemented this pricing scheme and as a result has identified a new revenue stream that represents a 10% increase in revenues.

In the state in which the North American industrial sector finds itself, companies owe it to themselves to investigate alternatives to their existing measurements and the processes dictated by those measurements. Let’s face it, who would not want to identify a 10% additional revenue stream?

Charlie Allieri is vice president for marketing at Lilly Software Associates Inc. in Hampton, N.H. You can reach him at

COPYRIGHT 2004 Advanstar Communications, Inc.

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