By Thomas R. Cutler
The cost of measuring manufacturing performance is a vital element to bottom-line profitability, yet too often secondary standards have mislead CFO’s and caused many wrong decisions. According to Michael D. Lundy P.E. and President of Blue Springs, Missouri-based, Optimation, “The most important standard is to know how each part produced contributes to the profitability of the company.”
All businesses make measurements which are intended to tell management about the performance and health of the business. Often these measurements are secondary standards such as square feet produced, tons shipped, contracts signed, or units shipped. CFO’s and Finance Managers use these measurements with a false sense of security that they are actually managing the company well. Too often one can hear a manager say, “I do not understand why profits are down…the measurement of ‘X’ indicated that we would have a good month.”
Confusion by what is being measured
The measurement in question was not designed to reflect the profitability of the company which is the reason for this confusion. One metric frequently measure is pieces-per-hour, a rate measurement designed to measure efficiency of a machine or group of machines. Lundy asserts, “There are many reasons why an increase in pieces-per-hour may not cause an increase in profit. The first is the sales price and therefore contribution may be lower for the product mix produced during the month. Another is that raw material may cost more.”
Indeed there are a number of costs that have nothing to do with productivity that may be out of control during the month.
Examples of Faulty Measurement Impacting Profitability
Consider a department that is staffed with six people. The department is charged with processing $1,000,000 of product made up of 100,000 pieces in a given month. The department works at the efficiently rate of 625 pieces per hour or 5,000 pieces per eight hour day. This would produce the $1,000,000 in a 20-day month. If the department could produce at 650 pieces per hour, the 100,000 pieces would be produced in 19.23 days, instead of twenty.
However, if the department continues to pay for six people for twenty days, there is no change in expense. If there is no change in expense, there is no change in profit. A worse scenario is for management to offer a bonus for the higher pieces per hour rate; in that case, expenses increase, and profits decrease.
Measuring Profitability Through Primary Standards
Optimation introduced Primary Standards to determine if production resources are performing in line with profit goals. “In order to manage a company well, manufacturers must know how the company creates profit and measure the components that determine the results to achieve profit,” insists Lundy.
The efficacy of Overall Equipment Effectiveness (OEE) is not negated with these new profitability quantifying tools, however the ability to look at a Contribution Chart (planned versus actual profitability) is essential. The need to examine customer profitability and order profitability has often been an elusive task. Delineating the exact percentage of labor and material costs are needed to determine the percentage of profitability contribution. The ability to assess percentage of scrap is integral to lean manufacturing initiatives and defines the system by which continued process improvement can be measured and profitability the result.