I recently came off a project with a metal fabrication company that was in severe distress.
I was originally introduced to the company in October of 2020 by a mentor of the owner who thought they could use my help. At the time, the owner believed he had the situation under control; he did not.
I followed-up in January and, even though he had hired and dismissed the first person who attempted a turn-around and was on his second, he felt he had it under control this time; again, he did not.
When I followed-up again in March of 2021, he had just dismissed the second turn-around team and asked me to come down to do a week-long assessment.
At the conclusion of the assessment, my debrief started with my stating that the business was a gold-mine; no matter where you swung your pick, you were going to strike gold. The owner took this as a positive. But the reality was that the business was so broken that it didn’t matter where you started, there were opportunities for impactful improvements in every function (or dysfunction) of the business.
The company was a mess. It is a case study in a business spinning out of control (and will serve as article fodder for the next year). The real challenge was prioritization of efforts. Because, as we know, if everything is a priority, then nothing is a priority.
I told the owner that I was a pretty good “numbers guy” and could usually tell where the most serious challenges could be found by looking at the financials. He told me that my focus would be confined to production and production flow. Certainly, there was opportunity there. But a review of the financials might give me an idea of where to start looking. I was on a snipe hunt.
When I arrived for the start of my engagement, I was invited (rightfully so) to a leadership meeting. In attendance were the leaders of Accounting, Human Resources, Sales, Engineering, Information Technologies, and Production. They would share the health of what was in their purview and any challenges they faced.
The owner would also share the health of the company and its goals for the month.
Week on week, the same challenges would be shared. It seemed that nothing ever moved to the “done” pile. And that they rarely ever spoke of goals beyond the current and following month was telling. No vision. No strategy. They were living hand to mouth.
What was made abundantly clear was that the company’s losses were approximately 10% of revenue month on month for most of 2021. Their thinking was that the only way to become profitable was to increase the flow of production so they could increase fulfilled orders by 25-50%. With on-time delivery being 18%, they certainly had the book of business and backorders to increase their monthly shipments and revenue earnings.
I had my marching orders; increase production flow, eat through the backorders, and increase the monthly revenue earned.
So, I started to investigate the problems with flow. And there were a great many challenges (which I will detail in another article). But time was of the essence, and it was going to take more than a couple months to increase the production flow to meet the goals – months (and cash) that the company did not have. Time was not on their side.
But during the first few weeks there, I started to get an uneasy feeling about the products they were selling, what they were selling them at, and what their costs might be. A couple of the other members of the leadership team would also whisper in my ear that they thought the company was selling product at below their production costs.
My early mentor, Francis “Pogo” Paolangeli, once told me; “If you win all the projects, you are doing something wrong. And if you don’t win any projects you are doing something wrong.”
He was in the commercial construction business. And the day the bids were opened were always nerve-wracking; especially if he were to win by more than 5%. This usually meant he forgot something (thank God for change-orders when this happened).
I asked the head of sales at the company what percentage of quotes the company wins and his response was “about 50% of the quotes we give, we get.”
A basic (read “rough”) rule of thumb for sales in a metal fabrication job shop is that 25% of the prospects won’t buy anything from anyone. Of the remaining 75%, a good winning average (depending on the number of competitors) would be 10-15%. This company was winning 66% of the business; a sure sign that their costs estimates – and pricing – was too low.
One product in particular caught my attention. Its dimensions were approximately 7-feet tall, 2-feet wide, and 2-feet deep at the base (tapering to about half-that at the top). It was made from sheet steel which was powder coated. It had maybe 50-ish bends including flanged slots for ventilation. In addition to the normal hardware you would expect to be used in metal fabrication, the company had to install customer-provided electronics.
All this, plus free delivery, for a sell-price of $400 each.
It didn’t pass my “sniff-test”.
But remember, I was not allowed to see the financials (not that it would help, come to find out; but more on this in another article). I could only see information related to production (quantities, hours, scheduling, and so on).
So, I enlisted the help of one of the industrial engineers on staff and I asked him for a complete time (labor and machine) and materials breakdown; basically, a detailed costed routing including setups, inspections, movements, materials, and applied overheads.
He provided his report-out a couple of days later; and what it revealed was shocking.
The product they were selling for $400 each cost $750 each to make.
Seeing this, I asked him to do a similar cost analysis on another product that was higher volume. The results were not as dramatic as the first item, but the loss per item was approximately 10% of the sell price.
Combined, these two products alone consumed approximately 25% of the production capacity (based on a 40hrs of plant production per week).
I suspected I would find most (all?) of their products and pricing in similar distress.
The fastest way to go out of business is to sell your product below cost.
An additional challenge was that there was no possibility of obtaining actual time or materials consumed in the production process; we could only rely on what was supposed to happen based on the routings (methods) and bills-of-materials that were in the system.
- For materials: There was no way of tracking scrap, rework, or substitutions (and associating it with the build) in any reliable manner.
- For time: Although people were supposed to track their time to an operation within a build, it was done in an inconsistent manner; so much so, that the information that was captured was worthless. People would forget to log into or out of a job (sometimes both) or they would log into the wrong job. In fact, the only real reason I could see for logging into a job at all was to track productive versus unproductive time (and even that was largely inaccurate) and how many of what was produced.
Basically, they were backflushing their costs based on the expected (estimated) costs in the bill-of-materials and routings (methods). Any variances were thrown into a bucket on the Profit and Loss Statement; impossible to analyze.
Another, and probably the most significant failure, was the company’s practice of not periodically reviewing their costs and update prices based on any changes. Operational improvements aside, and especially if the cost fluctuations are in the commodity prices of your raw materials; if costs go up, you need to increase your prices or lose money – and if costs go down, you need to decrease your prices or lose customers.
In this regard, the company demonstrated a level of incompetence that was hard to match.
Certainly, there has been wage and compensation inflation over the past year (2020-2021) as companies large and small from across all industries struggle to obtain and retain employees; you might have read about it, it’s been in all the papers.
But the biggest challenge facing the company – and one they failed to recognize – had been the dramatic increase in costs for sheet steel (up over 200% in the from August ‘20 to August ’21; with one-half of that increase coming in from March ’21 to July ’21, thankfully leveling off from July ’21 to August ‘21).
Coupled with a 70% increase in sheet aluminum from June 2020 to August 2021 (with no sign of abating as of yet).
The company’s practice (if not policy) was to not revisit prices once a quote was accepted and the order was placed by the customer. While this might work for a mass-producer or a job-shop taking an order that will be delivered in a few weeks, there is great peril in a job-shop that has repetitive orders or jobs that might span months.
In such instances, the agreement should allow for price changes based on the changes in material costs (both favorable and unfavorable) beyond some mutually agreed threshold.
Furthermore, the company was not always generating new quotes from scratch; but would replicate new quotes from old quotes (not always making sure to update costs).
Lastly, and investigating the company’s business practices involving pricing even further, I discovered another unsound business practice that involved changes made to a customer’s order after the customer had issued the purchase order and the company had accepted it.
Often (but not always) the customer would ask for changes to be made in the design specifications of the product they ordered. The company would perform the engineering services without charging the time to the customer (in effect, lending their engineering department to the customer for free).
Not only would the company not charge for the engineering time, but they would often not change the pricing of the product being sold or the production schedule; even if the job had already been released to the floor.
That there was no “toll” paid by the customer for these changes naturally led to the customer to continue their costly behavior to the detriment of the company. And the resultant hemorrhaging of cash for these practices was incalculable.
I presented the owner with these findings. Much to my surprise, he was not as concerned as I thought he should be; instead asking me to refocus my efforts on improving production flow (I actually got the sense from him that examining pricing was a waste of time).
But at the next leadership meeting, he enthusiastically reinforced his stance and strategy for turning around the company, that; “the only way we are going to eliminate the losses and return to profitability is to increase monthly shipments from $2m to $3m.”
At this point, I could no longer be politely passive and countered; “You are selling your product at a loss. The only result you will get by increasing your monthly sales from $2m to $3m is that your loss will increase from $200k to $300k.” And I shared my findings to the entire leadership team, telling them that the quickest way to keep them from crashing and burning was to increase prices to where they should be.
There was some protesting about the potential loss of customers, to which I responded; “Why don’t you just close down your shop and send your customers a check instead. Save yourself all that aggravation from running a business to the same end?”
Certainly, a justifiable 10% increase (at a minimum) would erase the company’s losses and could be easily defended to their customers on the cost increase in materials alone. I am sure it would not be a surprise to them. In fact, my guess would be the customers were surprised that there wasn’t already a price increase.
I also told them to not be too timid in amount they raised the price; but also not be too aggressive either. They would only have one chance to increase the pricing.
The best part was that this could be done immediately. And it would give them the runway necessary to start fixing the rest of their company; including production flow.
So here it was, the middle of May 2021, and the company’s owner (finally) realized that sales are really important; but so are monitoring and managing costs. And he gave the go-ahead to update the pricing of all their open orders, all their open quotes, and to revisit the costs used when issuing new quotes.
Certainly, there was a risk of losing customers. But losing customers who were buying products from you at less than your cost is no particular loss at all. Besides, they were more likely to lose customers from their 18% on-time delivery rate, not a price increase.
Revisiting their costs and repricing their products is an absolute necessity and will plug the most obvious holes almost immediately. And this will give them some additional runway so they can attack other areas of their business that were in desperate need of fixing.
Next up, production flow, scrap, rework, and on-time deliveries.
About the author
Joseph Paris is an international expert in the field of Operational Excellence, organizational design, strategy development and deployment, and helping companies become high-performance organizations. His vehicles for change include being the Founder of; the XONITEK Group of Companies; the Operational Excellence Society; and the Readiness Institute.