Investigate other means of improving your bottom line before you take the action of raising prices and potentially losing loyal customers.
The owner of a millwork company recently asked me, “How can I raise prices?” On the surface, that seems like a silly question, but it is a serious query. I answered with a question of my own: “Why do you want to raise prices?”
There are many reasons he could have given. The first is the obvious: he was not making a satisfactory profit in his operation and knew that a price increase would immediately plump his margins. Perhaps competitive products were priced higher and he felt he could demand a higher price without hurting volume. Maybe he wanted to shift his market position to a higher-end product, although he likely would have to re-engineer his product in order to offer a better value. Or, he could have wanted to reduce demand for a certain product by raising prices. It could have been a combination of many reasons, but in this case, it was simply a lack of profitability.
Rising Costs Don’t Justify Rising Prices
Too often, when company profits are disappointing, management first thinks of raising prices. Maybe the costs of your finishing materials or raw materials, like lumber or polyurethane foam, have risen and eroded profit margins. Maybe you raised wages significantly and a surge in business necessitated labor overtime that resulted in total payroll costs eating into profits this year.
The easy solution is to pass these higher costs on to your customers. The problem is that somewhere down the road you will discover you have lost customers, or that you have priced yourself out of business altogether. During the past 20 years, a lot of companies have disappeared from the wood products landscape because of this strategy. Whatever the reasons that profits slip, raising prices is the last resort!
Of course, everyone does not simply take the easy way out. World-class competitors will figure out how to cut costs for an amount at least equal to or greater than costs have risen. Imagine, cutting costs to become more competitive.
Productivity Is the Real Issue
Productivity in a wood products company is a simple, but often misunderstood, term. It is the rate at which your company produces products in relation to the amount of resources (especially materials and labor) consumed during the process.
Your company may gauge productivity as the year’s total sales volume divided by the average number of employees. While there is nothing intrinsically wrong with that, let’s get back to basics and take a broader look instead at productivity improvement this month, and in more detail in January.
This is a timely subject, as many wood products manufacturers will end their fiscal year this month and look at profitability as they enter 2007. Thus, let’s walk through six simple steps to cut costs, improve productivity and avoid unnecessary price increases.
1. Identify Rising Costs
Analyzing your operating costs during the year is critical to effectively manage a company. In fact, every company should be constantly looking at monthly and quarterly results in order to identify trends — especially rising costs. This may seem obvious to larger companies, but many small companies do not go through a thorough or systematic approach like this to prevent the erosion of profits.
If your company currently does not keep good records of raw material costs and operating expenses, start next month. This will give you a way to monitor costs next year and a base with which to compare 2008 to 2007. However, before the new year rings in, take the time to look for possible rising costs in your 2007 operation — no matter what the size of your
company or its financial status. Your review should include materials, labor and overhead costs, all of which have records to be analyzed. If you have income statements that are broken down by category, review each for an upward creep in your expenses, or unexplained spikes. Otherwise, dig into the records you have.
2. Analyze Causes
The next step in improving your quest to cut costs is to find out why they are rising. This can be a daunting process and thus is often overlooked or just ignored due to a “lack of time.” A simple example would be that an upholstered furniture manufacturer saw its material costs rising during the first step above. The cause was determined to be polyurethane foam costs that had spiked dramatically, contributing more than half of the cost increase. It was also discovered that chemical costs for the foam producers had risen due to the increased petroleum prices.
Maybe your company has seen labor costs rise. Did your plant output increase in proportion? Why not? How about your electrical power bill? How do your energy costs compare with your output? Have rates risen, or is there another reason this measure of productivity is slipping?
The point is that there are hundreds of areas of inquiry that are essential if you want to adequately analyze your costs and determine the root causes of increases. These same areas of inquiry will offer you opportunities to cut what you consider stable or normal costs of doing business.
3. Investigate Opportunities
In the process of cutting costs and improving profitability, the next step is to separate those issues that you have some control over from those that you do not. The three areas of materials, labor and operating costs will offer the best opportunities for improving productivity and reducing costs. As each cause for rising costs is micro-analyzed, opportunities for eliminating future increases or actually lowering these costs will become apparent.
Following our upholstered furniture example, there are substitutions for polyurethane foam in some applications. Thus, the opportunity should exist to substitute some materials after a bit of product re-engineering. (Other examples applicable to your company will be explored next month.) There are always opportunities to do almost anything better, and often at a lower cost. This is what Continuous Improvement is all about. The key is to investigate all opportunities and determine which offer you an attractive return.
4. Determine Corrective Action
The next obvious step is to determine what corrective action should be taken to stop or reverse the erosion of profits due to rising costs or diminished productivity. Knowing that a problem exists within the throughput of your cabinet line is not enough. Once identifying that as an issue and an obvious opportunity for improvement, you have to make a decision as to how you are going to correct the problem.
As I have mentioned in previous 2006 columns, employee empowerment is a much
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