Pricing for $profit: metalcasters can only hope to break through to new levels of profitability by producing parts that are compatible with their operations and ditching the rest.
Strategic and Management Prerequisites
A business strategy rooted in compatibility and the relentless pursuit of an increasingly compatible part population is the central strategic prerequisite for profit maximization. Compatible castings are the parts which fit the plant best; they create focus and enable the company to achieve the best quality, lowest costs and highest levels of customer satisfaction. When marketing efforts successfully bring in compatible parts and manufacturing achieves high quality, low cost and strong productivity with these parts, profit maximization will occur.
Compatibility makes profit maximization possible, and an advanced management approach enables metalcasters to make good on that opportunity. Such an approach explicitly acknowledges the primacy of profitability, as well as the reality that metalcasters cannot produce or grow their way to profit maximization but must instead manage their way there. Specifically, the approach is rooted in advanced management strategies that include compatibility and focus, and utilizes advanced manufacturing, marketing and other tactics that are strongly synergistic with these strategic principles.
A robust business performance management system is at the heart of the advanced management approach. Many metalcasters have long attempted to exert some control over business performance through the use of ineffectual and often counterproductive budgets and variance analyses, but the advanced management approach demands more than these tools. Rather than trying to figure out what happened long after the month has closed, as budgeting does, the advanced approach includes a proactive, predictive, real time operational and financial target-setting system, which can impose the operational and financial control required to support large and sustainable improvements in plant performance and company profitability. In contrast to budgeting, such a system enables management to control business performance and frees it (to the greatest extent possible) from the vagaries of demand and the tyranny of the top line.
Profit-oriented leadership is another essential facet of the advanced management approach and dictates that CEOs can be neither production-oriented nor sales-oriented but absorbed full-time in directing and coordinating the business for profit making. The CEO should embrace the goal of profit maximization over time and understand that a strategy rooted in manufacturing and marketing focus, rather than capacity expansion and sales growth, is the right path forward. In other words, the profit-oriented leader fully appreciates that profitability only can be maximized in an environment of finite capacity and sets the direction for focus, compatibility, capital conservation and superior profitability.
Compatibility and focus at the strategic level, plus the tactics inherent in the advanced management approach, combine to create synergy throughout a business, especially between the manufacturing and marketing functions. That synergy results in a cascading series of positive effects on plant performance, cost, customer satisfaction and marketing success and ultimately creates a multiplier effect which can boost profitability from the industry norm (2-5% pre-tax when demand is up) to 10, 12 and even 15% pre-tax virtually all of the time. The interconnectedness of compatibility-driven strategies and advanced management tactics makes profit maximization possible and opens the door for profit-oriented pricing.
Tactics of Profit-Oriented Pricing
Profit-oriented pricing is a central tactical element within the advanced management approach, but a metal-caster's ability to use it to maximum effect depends on the prerequisites compatibility, focus, improved plant performance and customer satisfaction. These work together to drive manufacturing effectiveness, improve customer satisfaction, maximize pricing flexibility, open the door to profit-oriented pricing and enable the astute metalcaster to combine "best cost" with "best price."
Profit-oriented pricing begins with a clear definition of compatible castings. When considering compatibility, metalcasters should look at their existing part populations to develop a workable definition. The parts that flow smoothly, create few (if any) problems and earn solid profits--and the parts similar to them--are compatible. Compatibility is expressed in terms of the five attributes customers use to value castings, including:
* Casting complexity--the more complex the coring and/or casting geometry, the greater the perceived value; this is the strongest rule and accounts for the greatest value premium.
* Volume--the lower the volume, the higher the value.
* Alloy--the higher the alloy content, the greater the value.
* Order complexity--as the number of value-adding steps in the order increases, so does its value in the marketplace.
* Size--the larger the part, the greater the value; this is the weakest rule and accounts for the smallest value premium.
In considering the above, metalcasters must not confuse cost with value. While costs change as each of the attributes listed above increases, an additional and increasing increment of value beyond that increased cost is created at the same time. It is this extra value component, the value premium, which profit-oriented pricing is aimed at quantifying and capturing.
Profit-oriented pricing is also market pricing, which means metalcasters must abandon cost-plus pricing and reconsider their costs and cost systems if they hope to stay on the path to profit maximization over time. Part families, which are the heart of the market pricing process, are sub-sets of the larger universe of compatible castings and groups of "like parts," such as housings, valve bodies, couplers, impellers and so on. Look first to key manufacturing characteristics, including production design, risk profile and cost structure, and then to how and where the market assigns value, when defining part families.
Once part families have been identified, pricing databases--one for each part family--can be constructed. Prices then are established by pricing up or down from a new part's closest family relative. Each database line item (i.e. part number) must show the part's key characteristics (e.g. size, volume, alloy, etc.), as well as the critical information needed to pinpoint the part's value as the market does. Once the part family databases are usable, market pricing can commence, cost-plus pricing can end, the cost estimator can be redeployed, and pricing becomes a simple, straightforward and highly efficient process where every quote can be submitted in 24 hours or less. Pricing then can become far more effective, as market pricing maximizes price realization over time; cost-plus pricing is a race to the bottom.
Negotiating Price Increases
If not to establish prices for potential new work, what is the proper role of cost within the advanced, profit-oriented management approach? It is to support replacement and/or re-pricing of parts already in production via another important advanced management tactic--mix and margin enhancement.
The number one mix and margin enhancement priority is to replace non-compatible parts with compatible ones. Foremost here is to rid the company of "losers"--those handful of parts which generate the lion's share of waste within the casting facility, cause the most problems with customers, are shown by the job cost system to generate zero net margin (or worse), and (despite what some may say about absorbing fixed costs) represent the most serious threat to the business's financial health. If these parts are compatible, they should be re-priced. If they are not compatible, they should be removed and the business downsized accordingly. While such actions may sound extreme, they are the best thing metalcasters can do to immediately improve their bottom lines and set themselves up for profit maximization over time.
Beyond eliminating the "losers," mix and margin enhancement means systematically and relentlessly replacing non-compatible parts with compatible ones and, once that primary goal is accomplished, replacing average compatible castings with compatible parts that possess even higher profit potential. In this way, the questionable portions of the part population are continuously and proactively turned over, thus helping to protect the company from product obsolescence and competitive encroachment while driving profit improvement.
Mix and margin enhancement also means re-pricing all those parts which were brought into the business at below market prices. This process should commence on an account-by-account basis, beginning with the accounts that are costing the business the most in terms of lost profits, manufacturing problems (e.g. scrap, flow disruptions, etc.), late deliveries, customer complaints and so on. For each of these accounts, detailed margin and re-pricing analyses should be completed and the non-confidential aspects shared with the customer as the kick-off to formal price renegotiations.
Customers obviously do not want prices to go up and will do almost anything to avoid that happening. They also tend to act in predictable ways throughout the negotiating process, beginning with a resounding "no" right off the bat. But customers cannot dictate what prices suppliers charge, and metalcasters should not relent or make unilateral concessions early on. When customers next attempt avoidance by way of delay tactics, metalcasters should set and adhere to milestone dates. Starting the clock and sticking to an early implementation date is the best way to convince customers you are serious. Those customers who still refuse to negotiate often will threaten legal action or to pull the work to deter price increases. Again, persevere, knowing that legal threats are all but empty and customers want to move work about as much as they want a big price increase.
When the tactics of deny, delay and deter all fail to dissuade the determined metalcaster, customers will move beyond avoidance and become serious about negotiating acceptable prices. The amount of the increase (or decrease) should be unique to each individual part number and achieve market-based margin targets for each part within its family and for the part family as a whole. Large increases should not be split up to be implemented over time, but rather negotiated and put into place all at once.
While not great, there is some risk that customers will refuse to negotiate in good faith and pull the work. But failure of this type is often for the best, as metalcasters are almost always better off without those intractable customers and their underpriced work. Metalcasters need to embrace this kind of turnover in the customer base and become more selective about who they do business with, which parts they produce, and what levels of profitability they are willing to accept. Such an attitude is the first sign of profit-oriented leadership, the foundation of the profit-oriented management approach, a first step towards real marketing and manufacturing success, and a jumping-off point for profit maximization over time.
About the Author
Dan Marcus is the owner and principal consultant in the firm TDC Consulting Inc., Amherst, Wis., which for more than 20 years has specialized in management consulting, turnaround management and executive development for the metalcasting industry.
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|Date:||Jan 1, 2011|
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