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Manufacturing Urgency

In this difficult economic environment, the producers who act with thoughtful speed will survive and thrive the longest.

By Conrad Winkler, Kaj Grichnik, and Arvind Kaushal

Troubled times like this one are always especially troubled for manufacturers. The makers of goods were already facing some of their toughest challenges in decades: shifting consumer demand, fierce competitiveness, and relatively high commodity and oil prices. The financial “meltdown” of October has brought with it severe cash shortages and the possibility of a long-term credit crunch.

However, the current situation also offers rare opportunities. It is during such times of discontinuity that industry structures are transformed, the competitive landscape is altered, and long-overdue changes are implemented. The key to surviving and thriving in these challenging times is to quickly take critical actions that save cash now but enable manufacturing leaders to come out the other side in the winning position.

Speed is of the essence—but so is thoughtfulness. All the critical measures involve judgment calls. They can’t be applied across the board. They may mean cutting back some inventory but maintaining or improving service levels for the most profitable customers, or outsourcing in some areas and bringing operations in-house elsewhere. In each case, rapidly assess your situation, diagnose your problem, and then move to a more frugal, adaptive, and resilient position.

1. Free up cash

The current crisis is, at heart, a crisis of liquidity. Save every penny of cash you can. Apply the discipline to use “real” cash costs, rather than “accounting-based” costs like depreciation and notional allocations, to guide your investment decisions.

One of the surest ways to free up cash is to reduce inventory. Even highly experienced manufacturers often have inventory costs that can be recovered. In these times, the demand for many products has suddenly decreased, which leaves excess inventory in the system. This is the first area to target. Next, eliminate obsolete stock stored in plants and warehouses. Establish new, stricter inventory targets, based on a “pull” supply model: Start with customer demand and work your way “market-back” to the shop floor and the component orders. In many cases, unwelcome low demand makes it possible to react more quickly to orders, and less finished inventory is required. Position inventory in the factory in a way that reduces production cycle time and enables further reduction in finished goods inventory. Move to this model for both your outbound finished goods and your incoming materials. Shift your inventory locations to more optimal positions in the supply chain.

This is also the time to cancel or defer nonessential investments until the financial path ahead is clearer. In addition to the fact that capital is tight, the lower demand may change the benefits of many investments. Among the investments that might be eliminated are those for extra capacity that is now less attractive. Deferments could also include nonessential capital expenditures for maintenance, and new investments in existing plants. The current economic climate might make it easier to recognize some investments as inherently unattractive; cancel them entirely. Defer the rest. Be ruthless about sunk costs; although resources may have already been invested in a project, you do not need to continue investing in it if it is no longer appealing.

2. Review product profitability

Companies do not always maintain a full view of the true profitability of their product lines. Profitability may be clouded by accounting methods such as average costing or outdated allocation categories. The economics of many products has suddenly gotten worse. Take a new look; you probably won’t have to work hard to find some established products that are losing money.

Stop serving unprofitable customers as well. Sometimes a product is profitable only when sold to certain customer groups; reaching others is too costly. For example, an aftermarket auto parts manufacturer may lose money on products sold at select big-box retailers but make money selling through the distribution channel or other retailers. In other words, match your product’s operating model more carefully to your target markets.

What unprofitable products, stock-keeping units (SKUs), and customer commitments can you safely eliminate? Not all of them. Some of them might be strategically critical to your portfolio. For example, while no automobile tire supplier makes money on tires sold through manufacturers, those sales are essential to selling in the highly profitable aftermarket. In some cases, you may be able to increase prices to allow for adequate margins.

Meanwhile, add new products that target underserved markets. Demand is currently increasing for fuel-efficient small cars, clothes that are trendy but inexpensive, and products that people can use at home instead of hiring others or going out: entry-level yard fertilizers, canned foods, and frozen entrees.

3. Reduce capacity

Dropping space and equipment can give you a step-change reduction in fixed costs. Look for areas where you are spending more on manufacturing capacity than your competitors are. Those products will be the first to become unprofitable if demand falls in this downturn.

Watch for chronic overcapacity. Have you been willing to operate below full capital recovery levels for long periods of time? Even relatively low-cost facilities can become unprofitable—especially when you have fixed costs and exit barriers (real or perceived).

Use the downturn as an opportunity to consolidate plants and close relatively disadvantaged or costly facilities. Shut down unused areas within plants. Reduce high-cost capacity; keep open facilities that are likely to be needed as higher-cost competitors back off or as demand rises. An analysis of your competitive position and the potential future market demand for your products will probably be required before you shut anything down.

4. Rationalize overhead costs

Reduce plant and supervisory staff by decreasing layers of management, increasing the span of control, matching staffing to the new workload, and adjusting the ratio of indirect to direct employees. Make better use of manufacturing support functions like engineering, maintenance, and quality by sharing them across plants; consider centralizing functions that do not need to be based locally. Determine whether maintenance work can be done internally.

Assess your fixed costs. Which costs can be made variable, so that they adjust along with changes in volume or product mix? Increase your use of temporary workers; many companies with a highly seasonal demand already do that well. Outsource services for which your need fluctuates, and outsource manufacturing of components.