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Posts Tagged ‘production cost’
What is the Cost of Your Bottleneck to Your Business?
You are in your car and suddenly you find the two-lane highway narrowing to one lane. Traffic flow slows to the pace at which two lanes of traffic can merge into one. Your speed of 60 slows to perhaps 20 and can even be a stop and go to move ahead one car length. This is a bottleneck.
Bottlenecks are occurring everywhere in the business world. Bottleneck in business happen in the processes employed in every business. They happen in production, distribution, fulfillment, billing, filing, etc. They happen in manufacturing companies, distribution, retail, construction, real estate, consulting, financial services, and service businesses of all kinds. Bottlenecks are rampant in non-profits, and in government and the bureaucracies they employ.
I believe the primary culprits that cause bottlenecks are these:
- Inadequate infrastructure—capacity has topped out
- Inefficient processes—the quantity of raw material (or data) processed in a given time, known as ‘throughput’ has topped out
- Poorly trained workers—individual production has topped out
Capacity constraints affect a company’s ability to grow. Firms that find themselves bumping up against their system’s capacity constraints soon find that growth has stopped; profits begin to decline unless expenses are cut accordingly.
Any part of your business that has a capacity bottleneck will find the production and efficiency of everyone reduced to the speed of throughput at the bottleneck. The operation will slow to the lowest common denominator—the productivity at the slowest part of the process.
For example, if a bottleneck is reducing throughput by 30%, and your customers are unwilling to wait in line, your sales levels could be 30% lower than what they should be. How much margin are you losing at the bottleneck? If your normal throughput is $1,000,000 annually and the bottleneck reduces it by 30%, you have a new sales level of $700,000. At a gross margin of 60% applied to the lost sales of $300,000, the lost profits amount to $180,000! And this is just a one million dollar organization!
Worse yet, are you paying for “stand around” time while the under performing parts of your process “catch up” to the rest of your production?
What could you do with the money that you are leaving on the table?
As for the government bottlenecks, they just seem to throw more people and money at it without addressing the three culprits. And you and I are paying for this bad practice as government and bureaucracies have become the largest employer of record throughout our entire economy!
If you are concerned that your business is leaving money on the table due to bottlenecks, and want to quantify the expense and explore alternative solutions, please contact me directly at jlafferty@cfo-pro.com or 630.269.7646. I’m available to discuss options to unlock the revenue and increase cash flow.
The Importance of Pricing Business Services Profitably
Some businesses operate under the assumption that Cash Flow will solve most problems. The thought process continues that if the business generates enough volume, profitability will eventually take care of itself. The end of the free flowing credit markets has challenged that belief. Lack of profitability creates a cycle that will eventually destruct and ultimately dissolve the business.
A competent pricing model will include:
A thoughtful competitive analysis: Really understand your competition. What are their expenses? Overhead? Business Philosophy? Are they profitable? Do they have a sound business model? Will they still be a competitor to you in 5 years? Don’t assume that if their prices are lower, that they are doing something right. They may very well be giving the business away and there’s no need to match pricing under that circumstance. Understand your value and use this information to your competitive selling advantage.
Understand Your Value: The value of the business service is based largely on market perception. What value does the market place on your service? Business purchasers and consumers are very educated now on costs and the value of products and services. You will have to make a strong case for your pricing model and understand what they value to procure the prices that you want.
Know Your Costs: The U.S. Small Business Administration advises that the cost of producing any service includes materials, direct labor (direct and supervisory) and overhead. Overhead costs include all other salaries and wages incurred to run the business, plus rent, utilities, office supplies, insurance, depreciation, advertising, etc. The SBA states a reasonable amount of these overhead costs should be billed to each service performed—whether in an hourly rate or a percentage. You need to charge rates that cover current costs (not last year), including wage increases and inflation.
Determining Your Pricing: In today’s economic environment you will find fall out of competitors. Those that were operating on the assumption that volume will take care of profitability are trying to survive and are no longer formidable competitors. This is a perfect time to assess your business’ profitability and pricing model. It’s also time to re-evaluate. What has worked in the past may not work in this environment.
Three common methods of pricing are hourly rates, flat fees, and variable pricing, where negotiating helps set the price for each customer.
If your pricing model has not been profitable for each transaction in the past, now is the time to evaluate it. CFO-Pro can conduct an analysis of your current model, assess the costs you are allocating to each transaction, determine if there are areas to increase efficiencies and create a model that will help your business compete and win in today’s market. Contact us at 630-269-7646 or email me at jlafferty@cfo-pro.com to learn how to build a sustainable, profitable pricing model.