MARKETING CEO JOURNAL MATTERS A More Nuanced View DAN MARCUS, TDC CONSULTING INC., AMHERST, WISCONSIN wo recent events have com-pelled me to revisit, in a more nuanced way, the well-worn subjects of cost absorption and volume’s inuence on protability. For those who follow CEO Journal, you’ll remember reading countless times that an absorption-driven view of prot making has been the bane of innumerable metalcasters and bottom lines, and that the account-ing and operations-oriented notion that more volume necessarily leads to more prot is just plain wrong. You’ll remember too my mentor Joel’s words: Higher volumes are all too often a recipe for running a company out of business at higher speeds. So what happened that moved me to write about absorption yet again? A week or so ago I received the latest income state-ments from one of my clients, and they revealed a strong improve-ment in protability over previous periods. In fact, the company’s typical pre-tax return on sales these days is nearly 18%, and in subsequent discussions the controller shared her interpreta-tion of the facts and her view that, despite my consistently anti-ab-sorption rhetoric, increased sales and volume-driven cost absorption are largely responsible for the company’s eye-popping prot jump. She’s right. As happens at virtually all of my clients, management at this one is ready to internalize a more nuanced view of cost absorption and its role in prot making. ey now possess the experience, perspective and wisdom needed to appreciate that volume does have the power to drive protabil-ity gains, but only when other, more powerful prot drivers are rmly under control. And this company absolutely does have all its prot drivers very well under control. As a result, volume is up and prots are soaring. But, not very long ago, management’s less enlight-ened and absorption-driven view of prot making was a dead weight on the company’s operational performance, T nancial and human resources, and bottom line. For metalcasters, by far the most potent drivers of protability are pric-ing and scrap, and the bottom-line impacts of poor pricing are crystal clear. As for scrap, part populations saddled with jobs that run at exces-sive scrap rates will without fail result in cost structures that are dispropor-tionately outsized, making supe-rior protability impossible to attain regardless of volume. It’s been said the true and largely hidden cost of poor quality is three times the sales value of scrap castings, and I have puzzled over For metalcasters, by far the most potent drivers of protability are pricing and scrap, and the bottom-line impacts of poor pricing are crystal clear. enough income statements to know something along that order of magni-tude is absolutely true and correct. Now consider the power of price and scrap in the context of an absorption-driven growth strategy. Management teams directed to seek growth almost always ignore compat-ibility and take on new work they shouldn’t—work that is priced too low and/or beyond the plant’s ability to produce at reasonable scrap levels. When this happens, costs inevitably rise faster and proportionally higher than revenues, causing protability to plummet. Yes, it is a fact that un-controlled growth invariably leads to prot declines that can, as Joel indi-cates, quickly move a company toward bankruptcy. is reality is contrary and confounding to the accounting and operations mindsets, and as such has been, and unfortunately continues to be, experienced at many metalcast-ing businesses. Other important prot drivers include patterns of routine cost-of-goods-sold and sales, general and administration spending, facilities and equipment ex-penditures, work-in-process and nished goods inventories, and plant labor hours. If management of these drivers is sub-stantially lacking, additional volume will not be enough to generate and sustain superior protability. Like pricing and scrap, these inuencers—when they are out of control and disproportionate to the revenue stream—can and routinely do negate absorption’s potential positive e ects. However, when the drivers are rmly in control, the door does open to substantial absorption-driven prot gains. e second event that pre-cipitated this column occurred just yesterday morning when a despondent phone call from another client informed me that one of its major custom-ers is pulling its business. To the CEO and other managers still enthralled by the accounting and absorption-driven view of prot making, this is devastatingly bad news. However, those who accept the more nuanced view presented here are able to correctly perceive this as a decidedly positive opportunity. You see, while this customer contributed a couple million dollars to the com-pany’s top line, its roughly 25% overall scrap rate, extremely complex and expensive manufacturing process and crushing quality support requirements larded huge amounts of cost onto the business’s bottom line—costs that ultimately far exceeded that top-line contribution. us, if management responds correctly to this opportunity (a big “if,” to be sure), the outcome will be a smaller top line and a bigger bot-tom line. We’ll see. Keep the conversation going. Reach the author at tdcmetal@wi-net.com to comment on this or any CEO Journal column or to suggest future topics. August 2014 MODERN CASTING | 55
Modern Casting August 2014: Page 55
