A challenge facing owners and managers of all businesses is how to increase the profitability of the company. The focus almost always turns to increase sales revenue. The strategy is to increase sales to existing clients, finding new prospects, and/or adding new products/services.
Typically, each of these avenues of pursuit requires a lead time before the realization of the additional revenue. The identification and sale to a new prospect are conservatively less than a thirty to sixty-day effort. With more complex, larger volume, and more expensive sales, the elapsed time can easily be three to six months.
Even after the sale, there is a delay before revenue is recognized. The elapsed time required for delivery, installation, and billing can easily add another month. In the best of cases, companies recognize a 30 – 45 days sales outstanding on their receivables.
So, in a best-case world, we might be able to realize increases revenues in as little as 60 days, but more realistically, it can take more than two months before additional revenue appears on the bottom line.
What would be management’s reaction to a proposal to increase profitability in less than sixty days? Such a suggestion would excite almost anybody in the business. What if this could be accomplished without increasing sales volume? Sales volume could remain the same, and profits could improve!
How Is It Possible?
In most companies, the following operational inefficiencies represent between 10 to 20 percent of sales revenue. In less efficient companies, this “operational waste” may run as high as 30 – 50 percent.
Sources of “operational waste”:
- People – Inefficient staffing and scheduling, unnecessary work, overtime, lack of training
- Materials – Scrap, wrong supplies, excess inventory
- Machines – idle time, excess downtime
- Method – bottlenecks, inefficient process workflows
- Information – lack of communication, miscommunication, delayed communication
- Environment – unorganized work areas, poor or delayed staging of work
Let’s Take a Look
For illustrational purposes, let’s take a hypothetical company that has $10 million in sales. Assume the company earns $1 million in profit before taxes. Also, assume the cost of operational inefficiencies is a conservative 15 percent.
Translated, that means that the cost of “operational waste” costs the company $1.5 million per year.
With efficient operational management practices, assume that with a concerted effort, the cost of these inefficient processing practices could be driven down 5 percent to a 10 percent level.
The savings from improvements in operational efficiency are a cost avoidance or reduction in existing expenses and drop straight to the bottom line as the expenses associated with these inefficiencies have already been accounted for.
Let’s take a look at the profitability opportunity from a 5% reduction in “labor time waste.” Assume a company is realizing a 70% utilization/efficiency of paid hours. (2080 hours/year/staff * .7 efficiency = 1,456 productive hours). A five percent improvement to 75% is 1,560 productive hours or a gain of 104 hours per staff per year. With a labor force of 30 staff members and a labor burden of $25/hour, a 5% gain is $78,000 annually in eliminated “labor time waste”.
It is a rare instance when profitability improvement or elimination of “operational waste” is realized from a single source. The reality is the profitability improvement is the cumulation of waste reduction efforts across all the different lines of business.
The effort and cost to realize these improvements are already included in current expenses. The improvements are recognized by improving processes, increasing efficiency/utilization, and making changes in management culture, methodology and approach.
In a comparison of efforts, a reduction of operational inefficiency expenses from $1.5 million to $1 million per year would require 5 million dollars in additional sales, at a 10% profit margin, to generate an equivalent $500,000 in additional revenue.
In our hypothetical company eliminating 104 hours annually of wasted time per staff member appears to be a challenge. However, when broken down to a daily goal, a savings of 24 minutes per day is a lot less daunting.
To shave 24 minutes of wasted time a day does not require supervisors to implement Draconian controls on staff, but instead focus on the minimization of the small lapses in time control that have crept into the operation over time. An uptick in supervisory diligence of 24 minutes of “operational waste” over a day is feasible.
The following are possible opportunities for reduction of staff non-productive time creep:
- Personal cell phone calls or use during work hours. 5 – 10 minutes
- Extended or additional breaks. 10 – 15 minutes
- Extended lunches. 10 – 15 minutes
- Slow daily startup. Prep time before starting the day. 5 – 10 minutes
- Early quitting/end-of-day wrap-up/cleanup. 5 – 10 minutes
- Time spent waiting for work or changing tasks. 5 – 10 minutes
Improving labor efficiency by cutting half of the estimated 40 – 70 minutes daily non-productive time makes the 104-hour annual goal less daunting.
If the opportunity to eliminate “operational waste” in labor can be easily identified and corrected, how much additional opportunity exists in other areas of the business?
Reinforcing a change in operational mindsets and culture with an operational waste elimination-based incentive program (savings commission) can prove to be an easy and quick way to increase profitability.