How to Increase Profit By Reducing Complexity
Growth is great, but…
Companies are great at adding new products. In fact, this is the most common strategy for growth. Hard-working engineers design, manufacture and launch new products to meet the changing needs of customers. Growing companies make acquisitions that add to the overall product line.
While these additions may add to the top-line sales figures, they don’t necessarily increase the overall profit. As the number of products increases, so does the cost of carrying, supporting and managing those products.
A great tool to “clean up” the product line is the process of production rationalization. The problem here is that less than 3% of companies have a product rationalization process.
Why is product rationalization important?
As the number of products increases and products move through their life cycles, the percentage of products that become low volume and/or low profit increases. So how does product rationalization work?
For one manufacturing company, we extracted volume, sales and cost data for all manufacturing parts. The total number of parts was in excess of 6000. When we analyzed the data, we segmented the parts into 4 groups according to volume and profit contribution.
We could quickly see that approximately one third of the parts were rarely used. Usage of these parts could not be forecast since their ordering patterns were highly sporadic. This was the first group of parts that were evaluated by a cross-functional team to see if their low volumes were justified, i.e., should they keep offering these low volume parts?
It is possible that low volume parts belong to products that were only recently introduced. It is also possible that in industries such as automotive, there is a requirement to carry parts for the duration of the warranty period.
The parts were also analyzed by category to see whether some of the offerings overlapped with existing offerings. This is sometimes the case when a product line grows through acquisition. Any low volume parts that could be moved to an existing offering were put on a phase-out list. While it would be optimal to discontinue these parts tomorrow, the reality of the business is that one needs to ensure that communications are sent to existing customers so they know which part number they can order instead which will still meet their needs.
High volume parts with good margins are considered the cream of the crop. For these parts, information on demand over time, the range of demand and supplier lead times makes forecasting easier than for the sporadic parts. Over time though, the demand needs to be monitored in order to assess ongoing trends due to product life cycle progression or economic changes.
The Benefits of Product Rationalization
The systematic process of product rationalization takes time but has several benefits.
The elimination of products with a negative profit.
The elimination of low volume, low profit offerings.
There are even more benefits once the rationalization takes place:
A reduction in inventory cost.
A reduction in the number of suppliers and the labour required to manage suppliers.
A reduction of inbound shipments and loading dock labour.
A reduction in the number of POs and invoices to process.
I know some people get nervous when I speak about a reduction in the labour, but think of it this way. Remember all of those projects you wanted your people to work on but they’re too busy to get started? The reduction in their labour can free up personnel to make those projects happen.
Knowing the profitability of what you sell and the overall contribution of your products to total profit will increase a business’ chance of long-term success. Don’t be in the 97% that never does product rationalization.