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Considering machining.

A client of mine, who thinks he's really clever, recently gave me some seemingly counterintuitive advice. "Do the math," he said, "and you'll see that machining is a lousy business." Is he right? Is machining a lousy business? Here's his rationale.

First, a typical machine tool runs 12 hours per day (that's 80% uptime on a two-shift operation) and can usually be billed out at a rate between $50 and $100 per hour, depending on the nature of the product mix. That means our hypothetical machine tool can generate something like $225,000 in revenue per year. As typical net machining margins are in the range of 10 to 15%, that equates to roughly $30,000 in profit contributed per machine tool per year. So far, my client's right; such a pittance of a contribution is evidence that machining is probably a lousy business.

Second, given that machine tools typically cost upwards of $500,000 and (as we've now seen) will generate only a few dollars of profit each year, the strong implication is that neither the return on an investment in machine tools, nor the resulting cash flows, will be very impressive. So far, he's still right: no sensible CEO is going to get behind a serious investment in machining capabilities for financial reasons.

Not ready to say "uncle" yet? Well, perhaps you're skeptical because you're thinking that there's got to be another side of this story, a "soft" side. Certainly in my world there is always a soft side to every management story, a side that is either customer-oriented or strategic in a non-financial sense.

From the customer perspective, metal-casting facilities that can provide a finished part are a mixed blessing. On the one hand, buyers love the idea of single sourcing. It makes their lives much easier, so score one for the machining option. On the other hand, the executives that buyers report to understand that their company's business strategy trumps the purchasing agent's need for ease. If the company outsources machining, then a single source is an ideal solution; if not, then it's castings and castings only. So, a metalcaster that can provide a machined part is only attractive to a small, but growing, portion of the marketplace that has divested itself of its machining capabilities. On the third hand (I told you this was a mixed up situation), a significant number of castings required by those OEMs that no longer machine parts in-house are sourced through machine shops, and metalcasters must weigh the pros and cons of competing against potential customers. All things considered, the machining option gets no real help from the customer perspective.

Consider also the practical aspects of a metalcasting company entering the machining business. Machining is a completely different business than metalcasting. So much so that virtually nothing your organization knows about metalcasting operations will help it understand how to machine a casting, and virtually nothing your organization knows about competing in the metalcasting business will prepare it for competing in the machining business. It's so different, in fact, that the sensible CEO soon will realize that support systems (e.g., sales, accounting, information technology, customer service, purchasing, etc.) will be stretched to the breaking point by the addition of machining capabilities, and such strains will cause serious disruptions within the organization. Moreover, the sensible CEO will conclude that genuine and expensive machining talent will be required to manage the new machine shop.

At the strategic level, the strongest--and likely the only--argument in favor of machining is that it could (if managed properly, of course) protect the company's casting business from competitors both foreign and domestic. And that's supremely important because, as we've already proven, machining is not going to be a cash cow. The metalcasting facility must play that role. Since we most certainly want to protect our cash cow, we erect barriers to competition. While the costs of moving patterns is high, the switching costs associated with changing casting and machining sources is considerably higher.

After all is said and done, the sensible CEO must conclude that my clever client was indeed right-machining is a lousy business. It's a lousy business unless, of course, you have a cash cow metalcasting business that is so lucrative you'll invest in a marginal business to protect it. Machining, like other value-adding services, is an excellent way to accomplish this prudent and strategically sensible objective.

So, should your company invest in machining? Will entering the machining business allow it to achieve strong revenue growth, rack up brilliant ROIs, or save a flagging metalcasting business? No. Instead, the machining option only makes sense when the metalcasting operation is generating what most in our industry would consider huge profits and cash flows and is worth millions to protect.

Dan Marcus, TDC Consulting Inc., Amherst, Wisconsin
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Title Annotation:CEO JOURNAL
Author:Marcus, Dan
Publication:Modern Casting
Date:Feb 1, 2007
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