Know and grow
However, many small to medium-sized "lean" businesses lack the infrastructure to develop this understanding. Rare are finance departments strong enough in cost accounting to develop an accurate profit-and-loss statement at the product-line level. Equally rare are sales/marketing departments that understand their customers' product roadmap, the competitive threats of substitutive technologies, or alternate markets and the optimal channels through which to sell products.
As a result to the extent that these companies do any strategic planning at all plans are often based on information that is inaccurate, outdated, or both. But for a company to maximize its investment in people, technology, and capital, it must make long-term decisions based on current and accurate information from both internal and external sources.
A growth-oriented company should build profitable product lines and develop turnaround or exit strategies for underperforming ones. To know if a product line is profitable, get a handle on direct costs associated with the line and eliminate as many "allocated" expenses as possible. Most companies use a flat manufacturing-overhead rate and apply it to direct-labor hours. This made sense years ago when direct labor dominated and overhead costs were minor. Today, overhead may represent three to four times the cost of direct labor because of a high degree of automation and expanding support functions such as quality and purchasing.
In addition, not every product line uses the same overhead. For example, one line may use an inexpensive semiautomated machine, while another requires an expensive fully automated machine. Allocating the depreciation, supplies, and other costs of both machines in the same overhead pool would overallocate the semiautomated product line with depreciation and underallocate the fully automated one. Companies should make every effort to identify costs that are unique to a product line and apply those costs directly to it. This includes traditional manufacturing overhead and depreciation as well as costs associated with engineering and sales, where applicable. Separate other expenses based on appropriate allocation metrics. For example, facilities charges such as rent and insurance may be allocated based on manufacturing space used, while purchasing could key on the value of purchased materials.
Next, look outside your business for clues to future direction. Unfortunately, manufacturers often limit conversations to those with customer purchasing departments on subjects of pricing, quantity, and timing of new or existing orders. Talk with your customers' marketing and engineering people as well. Here you can get a sense of market size, growth rate, their competitive situation, and potential new applications.
And don't forget competitors because they can be an excellent source of information about the business. Find out what trade shows they attend, even in markets you don't compete in. See what products they are exhibiting and identify potential customers. Look at competitor sales channels. Do they use independent sales reps that might want to represent you instead? Do competitors mention customers on their Web site? Are you aware of these customers and the markets in which they compete?
Armed with the above knowledge, management can begin to make educated decisions on pricing strategies, new product development, and product-line dispositions that optimize profitability and growth.
Synxronos LLC is a strategic planning and corporate development consulting firm (synxronos.com).