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Bottom line white elephant.

Editor's Note:

This column launches a new regular feature about the art and science of manufacturing management. It will be written by Itzik Kostika, president, Business Technology Management Inc.

The conversation at the dinner meeting was becoming quite emotional. A group of executives was exchanging ideas on how to deal with the growing pressure their OEM customers were putting on them to reduce the price of their products. Over the past few years, most OEM's claim to have moved toward a "partnership" relationship with their vendors. The executives were questioning the true value behind the claims.

One president said he had been observing big OEM companies for many years and was puzzled by what he saw. "On the one hand, they demand price reduction of my goods year after year; it's even part of my contract with them. On the other hand, they raise their selling price well above the inflation rate. Their total dollar sales are growing. If, as I believe, they implement their purchasing cost-reduction program to all vendors and yet increase their selling price, they must be making a lot of money! However, they are not! If anything, when you look at their financial performance, they are losing money. So where does the money go?"

This is a serious question and not easy to answer. There are many parameters. There is one, however that has a substantial impact on the bottom line: the way we invest money in automation.

The stated goals prompting investment in equipment range from achieving the leading edge of competitiveness, to improving quality, to reducing cost and improving profitability.

More often than not, the main reason is cost reduction and productivity improvement, especially in a world where excess capacity vs market demand exists almost everywhere. It is almost impossible to pass the test of the cost accounting system unless you can justify it through the above mentioned gains.

Therein lies a basic fallacy. To better understand this process, let's look at the following example: A company has invested $2 million in a current production line modernization. The investment was justified through the elimination of 25 line worker jobs, plus some additional cost savings due to setup reduction and increased output. The investment recovery period was estimated at 18 months.

Three years later, not only did the company fail to see any gains, its total cost had increased. The company executives, faced with a reality far from the original expectation, could not explain what went wrong.

A year later, I met the company's management and posed this question: When you look at the total company, have you really reduced your direct labor workforce by 25? In reality, only a few workers had left the company (through attrition); the rest were simply relocated.

The next question took the management totally by surprise--What happened to the maintenance, programming, and engineering department? It turned out that to support the new sophisticated equipment, new skills had to be hired, including some highly paid engineers, programmers, and technicians. Their average wage was more than twice that paid to the hourly employees.

What about the capital cost? The company has increased its liabilities and still pays the cost of the investment without realizing any operating cost reduction. Even in cases where companies were really able to reduce the projected amount of labor, they still did not see the whole picture and fully appreciate the true impact on total business cost. Another factor: what about the message we are sending to employees? In effect, we are signaling that their future is in jeopardy, which discourages participation in process improvement.

Does all this mean we should stop investing in automation and modernization? Absolutely not! What we need is to change our decision making processes. We must look at the investment's impact on our total business and on resources that at a first glance do not seem to be related to the suggested change. The manufacturing flow may be affected, creating bottlenecks in other machines and resources. We have to understand the implication on delivery and customer's lead time. We have to calculate impact on inventories and cash flow.

We cannot use cost accounting and other cost analysis techniques as our only guideline for investment decision making.

If what is supposed to have reduced total cost really does not, what we have is just another "white elephant." And haven't we seen too many of these already?

Itzik Kostika, president of Business Technology Management Inc, is a graduate engineer with experience in a broad cross section of industries. Mr. Kostika has developed a unique method of plant analysis based on the physics of flow and its chaotic nature in manufacturing organizations called Flow Management Technology. He is the author of Flow Management Technology--Breaking Out of the Box.
COPYRIGHT 1993 Nelson Publishing
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Management Memos
Publication:Tooling & Production
Article Type:Editorial
Date:Sep 1, 1993
Words:793
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