One of the most significant and enduring ways to increase business profitability is to continuously evaluate your cost structure and reduce costs where possible without sacrificing quality and customer satisfaction. You need to reduce both direct costs of producing your finished goods and business overhead.
Your profit improvement program should help you identify specific steps for cost reduction. These steps often include lowering total delivered costs with your suppliers and reviewing production processes and systems to eliminate waste.
Define material content
You want to start with an evaluation of each category of your cost of goods sold. This evaluation requires each category to be identified with the actual dollars spent and its percentage of sales.
The next step is to look at material content, which is usually your largest cost of sales category, both in actual dollars and as a percent of sales. It is not uncommon in industrial products for your material content to be between 40 and 60 percent of sales. Reducing material costs will immediately and directly benefit the bottom
line and does not require any working capital.
The next thing you need to do is define the specific material content of your products.
Work with suppliers to reduce cost
Companies should be sure to develop a global supply chain for procuring material and evaluate the suppliers for their ability to deliver on time with the required quality and lowest possible cost. Intensive Internet searches, referrals and supply chain conference seminars are all useful for finding and evaluating suppliers.
Displaying your products at supply chain open-house events can also be very effective for developing new sources of supply. Effective supply chain partners will constantly suggest product improvement and cost-reduction ideas.
Adopt an open-door policy for the supply base. You should always be willing to talk to anyone who has a potential way to help you reduce cost and improve quality.
Stratify material purchases
The ABC methodology stratifies all materials and parts purchased by a company into three groups. The A parts are the most expensive and critical to the company’s operations. They will make up 70 to 75 percent of your total material spend, but represent only 5 to 10 percent of the total number of part numbers you purchase.
B parts represent 20 percent of your material spend and about 20 percent of the total part numbers purchased. C parts represent 5 to 10 percent of your material spend but represent 70 to 75 percent of your total number of part numbers purchased. This stratification gives you and your supply base the focus to work on reducing the greatest costs.
Next you want to develop and analyze a purchase price variance report. Ask yourself what your actual spend is versus standard. What are the year-over-year changes? You should evaluate your supply chain’s delivery and quality by developing a scorecard to know how delivery and quality are influencing your total costs.
Another way to reduce material content and costs is product redesign or product simplification. Product simplification is the discipline of integrating the greatest performance functionality into the fewest number of parts using the most suitable and cost-effective materials and manufacturing processes.
Through product simplification, cross-functional product development teams have found that the rigorous combination of design and process innovation can significantly enhance market desirability and engineering efficiency.
Not only is it a team-building experience, but it is also a business opportunity that typically nets significant cost reduction and improved efficiency without sacrificing quality or product performance.
Make an effort to become a greener company by recycling. This can contribute to reduced total material content and increased profitability.
Matthew P. Figgie is chairman of Clark-Reliance, a global, multidivisional manufacturing company with sales in more than 80 countries, serving the power generation petroleum, refining and chemical processing industries. He is also chairman of Figgie Capital and the Figgie Foundation, a member of the University Hospitals Board of Directors, corporate co-chairman for the 2013 Five Star Sensation and chairman of the National Kidney Walk.
Rick Solon is president and CEO of Clark-Reliance and has more than 35 years of experience in manufacturing and operating companies. He is also the chairman of the National Kidney Foundation Golf Outing.