A Value Discipline for Small Businesses

by Merlin Hernandez

Consumers today want a more seamless delivery interface, a more personalized and simplified process, and a valued-customer experience but most of all they want it quickly. According to a Cisco Customer Experience Report, the most important attributes in the consumer interface are access/availability of the desired product or service, knowledge and competence in delivery, and efficiency in meeting their individual needs. In this mix what a business needs to survive the far-reaching changes in the contemporary consumer culture is a more specifically customer service orientation for a more satisfied and loyal customer.

Contemporary market leaders typically have narrowed their business focus to deliver superior customer value in one of the three value disciplines – cost leadership (best prices), product leadership (highest quality), customer intimacy (most responsive service culture) – while maintaining industry standards in the other two. Companies like FedEx and Home Depot that outstrip the competition in terms of profitability tend to excel in more than one value discipline. A firm’s relative position within an industry is given by the type(s) of value discipline chosen for competitive advantage e.g. cost leadership vs customer intimacy. Dual value disciplines as the strategic focus for a service business can become the basis of sustained market leadership. But for a small business especially a start up operating in the service sector, cost and product leadership within limited resource capabilities may not be possible. There can thus be no compromise on the customer focus.

What does this say about the business of service in the SME sector? In a nutshell, a service experience that is so remarkable that it stands out from the competition. But even more important, it is burned into the memory of the customer. The service business, by its very nature, is one of fulfilling customer expectation which intrinsically entails a value discipline of customer intimacy. The emphasis is on attention to customer detail and customer service, customization, CRM efficiencies, surpassing customer expectations, timely delivery, reliability, and lifetime value. But the same can be said for a consumer product. Companies like Apple and Nike have so surpassed industry standards as to have raised customer expectations with superior products that set a higher standard which competitors are not easily able to reach. This requires intimate and detailed customer knowledge with the kind of operational flexibility that allows fast response to changing customer needs and preferences.

Small businesses are at a distinct advantage for that kind of flexibility and intimate relationships. They are not structurally distant from the customer and bogged down by multi-tiered delivery systems and processes. In factoring customer needs into the strategic mix, businesses need to identify value-creating strategies that are most appropriate. The target market remains the most influential stakeholder around which to structure a business, and customers buy value. Market leaders are adept at understanding the value drivers that motivate their customer base. And small businesses remain closer to the ground. This does not mean that there is no need for rigorous market assessment before embarking on a small business venture. But shaping the service to more closely fit customer need brands the business as customer-focused and builds customer loyalty.

Assessment of the target market, however, should present a customer that would be more interested in a best total solution that meets their needs where quality delivery is the primary consideration. A business servicing this market segment needs to be immersed in continuous delivery process innovation and improvement to both satisfy and anticipate customer needs. This would reflect the value discipline of customer intimacy which places a stronger emphasis on more esoteric and long-lasting value e.g. organic food and good health, hypo-allergenic natural cosmetics, recycled gift paper and cards, customized cooking oils or jams – natural raw materials, locally grown, chemical-free, non-GMO product etc. Value here is described as relevancy and engagement in response to long term need and wider societal benefit. Strong value added strategies and deeper customer relationships might be critical for a new small business. It can bring the solid market differentiation that gives the new business the lead time for developing brand awareness and customer loyalty. This will consolidate the market presence and establish a customer base before the competition comes knocking.

Related Articles on this Blog

• Developing the Business Idea
• Focusing the Business
• Is SWOT Enough?
• Marketing Service
• Service as Commodity
• Surviving the Red Ocean

Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this and other topics, please send enquiries to businesssolutions1168@gmail.com

 

 

Why Job Analysis

I find that many employers do not have an up-to-date understanding of some of the real job requirements in their businesses. There is a strong reliance on the job description as the measure of productivity but an absence of the understanding that jobs are more organic that they used to be in a fast changing economic climate. Employees are more often than not required to think on their feet and do that little bit extra to ensure that the job gets done. Job execution is now more of a feature of on-going trouble-shooting, system adjustments, and even fire-fighting to remain ahead in the very dynamic competitive game.

Productive efficiencies and employee morale can be seriously eroded when employer expectations do not match the needs of job execution. This has implications for broad-based job analyses so that businesses have a real time appreciation of what it takes to remain competitive and what employees are actually being asked to do. New acquisitions, diversifying, attrition, or sometimes a simple move to a new space may warrant some re-structuring. This brings the possibility that the current situation may now require new inputs and methodologies. The job analysis bares gaps in expectations and resource allocation for early intervention to improve efficiencies.

 A job analysis documents the requirements of a job and the work to be performed. It is a developmental instrument that encompasses the job definition and description, measures for performance appraisals, selection systems, promotion criteria, training needs, and compensation plans. Job analyses should be revisited every few years to remain relevant. Keeping the job requirements current would require an employer to actively seek employee input that will inform the systems and practices adopted. This makes the practice an important feature in risk reduction.

My preferred method of information gathering for analysis is the worker interview in a standardized format, which would provide subjective information from workers about standard and non-standard aspects of the job, as well as a range of regular worker inputs that may be outside of the standard but perhaps need be included. The requirements of a job are constantly evolving in a dynamic economic environment, and very often these activities are not legitimized. This can play havoc with established management structures and lead to conflicts and employee dissatisfaction.

Because the information provided will be subjective, and interviewer’s questions could be misunderstood, there is the possibility of distortion to the analysis. Selecting experienced and knowledgeable workers and trained interviewers could mitigate some of the potential bias. But sometimes new employees see things with fresh eyes and have much to offer. Unskilled workers who operate at the tail-end of productive processes can also bring some meaningful insights to bear on improving those processes. I find this aspect of the job analysis crucial so that systems remain grounded in the reality of the job both ideal and actual. Interviewing several workers engaged in the same activities will allow the analysis to abstract and categorize the information based on similarity of responses. This cumulative dimension will give greater stability to the results.

To further insert objectivity into the analysis, I often combine interviews with a web-based structured questionnaire. This would tend to remove possible interview ambiguities, and allow for a wider coverage of participants at a lower marginal cost, with less work disruption. It would also facilitate quicker analysis and feedback. Using company intranets for web-based analyses would afford easy access to the final product across the board. But for small businesses without intranet facilities, an e-mail questionnaire will suffice.

The face-to-face process of the interview will lend credibility to the information which could then be used as a baseline measure in the structuring of the questionnaire. The disadvantage of questionnaires is that they are time consuming and expensive to develop, and the impersonal approach may be a demotivating factor for respondents. But the utility and reach of questionnaires, their long term application, and cost savings in administering them would outweigh such concerns.

Related Articles on this Blog

• Strategic Staffing
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• Performance Metrics

Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this and other topics, please send enquiries to businesssolutions1168@gmail.com

Financing Working Capital

by Merlin Hernandez

 

Businesses need to keep current with capital markets since they remain a major source of investment funds for capital formation and working capital and have some of the highest returns on investments. Larger businesses use the funds generated from issuing stock in an IPO to finance long term capital expenditures like new equipment, projects, acquisitions or new technology. For companies that are not publicly traded, as well as small businesses, the use of marketable securities is important in building collateral for business loans from financial intermediaries. Choosing the right securities in which to invest, and determining the best risk-return trade-off in order to support the goals of the company is part of the measure of effective management.

Managers also need to be mindful that the share price on the stock exchange is directly related to demonstrated operational efficiencies as evidenced by annual corporate financial statements. This also supports consumer and credit market confidence – an appreciating stock is an indication of a healthy prognosis and worth consideration in decisions about where to place the investment dollar. For smaller businesses, CDs and Treasuries are also extremely liquid though they may yield lower returns. The advantage is that they remain low risk.  Bond markets are particularly useful for short term financing like working capital – meeting inventory needs and receivables within the next year. 

Commercial paper has been a cheap way to raise capital by corporations with strong credit. With slightly higher return rates than T-Bills, and minimum credit risk, commercial paper has been regarded as a safe asset. The mortgage crisis of 2007 where mortgage-backed securities fell significantly in value changed the perception of commercial paper as low risk. The lesson might be that heavy reliance on commercial paper as an investment/financing instrument can flip the portfolio risk from low to high. A good strategy when investing in commercial paper might be that investors should spread their risk with a diversified portfolio, and perhaps restrict investment to blue chip issues. Short term T-Bills can form part of a contingency plan.

 In terms of short term loans in the current economic climate, the maturity matching approach can leverage a firm’s risk of default on a loan portfolio by using T-Bills that mature at the same time as the loan term. This offers protection from default but if receivables can cover the loan as expected, returns from the T-Bills can become part of the company’s liquidity cushion. What I am saying is that when loans are cheap as they currently are, firms can aggressively take advantage of the climate to access working capital while using asset reserves for investment and liquidity cushion. This would be a combination of aggressive and maturity matching approaches to working capital financing.

A multi-purpose revolving line of credit is one of the most useful resources for businesses of any size and can serve both short and long term needs. It is a valuable source of working capital that can be applied to receivables, payroll and marketing expenses, and occasional cash flow shortages. Many times a bank will extend a line of credit to a firm based on receivables as the only collateral. They may look at AR and cash flows only in making the decision. This might however be specific to industries like fashion, toys, school supplies, the gift trade etc. – with their high seasonal demand and cash flow spikes. The bank would hedge its risk by only extending such a facility to clients in good standing or those with a cash flow history that demonstrates a high probability of meeting their payments.

For small businesses, trade credit is perhaps the most obvious and flexible form of short term financing. On the demand side, trade credit remains one of the most common modes of short term financing for businesses with working capital or credit challenges seeking better cash flow management. It can be seen as an interest-free line of credit.  The terms of trade credit are supposed to benefit a supplier as well through an increase in short term sales, moving inventory that would soon be out-of-date, or to reward valuable customers – credit terms function as a form of sales promotion.

The value of trade credit can be analyzed in terms of opportunity cost. The Time Value of Money increases an amount of money as a result of interest earned and is an opportunity cost attached to the deferment of a payment obligation. Small firms may not have an in-depth understanding of APR/APY terms or true rates of return. They tend to measure the benefits of credit terms by the length of the collection period. Payables are often prioritized by due dates and cash availability and a longer payment period is seen as an advantage. Perhaps there should be no difference but in practicality, there might be, especially as the opportunity costs attached to a small payable may be almost negligible in relation to the convenience of the longer term.

The fact that there are no interest penalties attached to a trade credit arrangement is motivation for the customer to defer payment in favor of immediate liquidity needs, which may include a short term investment, the gains of which could give an amount greater than the trade credit payment. The longer the collection term, the more attractive the arrangement might be. An added advantage is that deferment, even beyond the collection term, lowers the financing costs due to an extended period at no additional cost.

Related articles on this blog

• Financing a Small Business
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Developing the Business Idea

 

by Merlin Hernandez

 

If only I had a dollar for every time I’ve heard someone sing the praises of some great widget and how much money there is to be made if the creator should go into business. Without trying to diminish the value of innovation, by itself it may not provide the most solid foundation required to make a success of a business venture. There is an old adage that a superior product has a good chance of doing well in the marketplace but a mediocre product with a well-defined strategy will perform far better. Many brilliant and talented innovators never make it in business because they do not have a full appreciation of the business dimension to their work. This is to emphasize that regardless of how good the product is, it is the application of sound business strategies that will bring success.

In developing the business idea, it is necessary to first determine the core benefit to be provided to the consumer. This would come from market research that identifies a basic need. Too often in the small business sector, product development is a feature of the notion that a good product will create its own market – the idea of selling what is made rather that making what the market needs. But businesses need to be market-driven with customer satisfaction as the primary focus. A viable product is a result of information on marketplace trends, customer needs, wants and preferences, customer consumption patterns, and the activities of competitors so that the right marketing mix can be developed. The product idea will therefore be defined by the targeted market segment and the client profile.

To screen and select the idea that has the greatest potential for market success, the idea is also measured against resource capabilities to be applied to production and marketing. The ability to successfully develop, produce, and market a product depends on having the right mix of available resources. The business must be sufficiently capitalized to support key research, the right personnel, the most suitable raw materials, manufacturing equipment, processes, and marketing strategies that would bring desired returns. These elements need to operate in a delicate balance – I have seen a great marketing strategy realize sales volumes that could not be fulfilled on time because of inadequate production capacity leading to cancelled orders and low profitability. The other side of the coin is strong manufacturing capabilities and a weak marketing budget which can result in poor sales, high inventory, lower prices, and financial loss.

The process of developing the full product concept will be more meaningful through consultations with potential customers to better understand the benefits they value and the necessary product attributes for market viability. This kind of partnership culture opens up a first level commitment to the idea from the customer. It is also useful at this stage to engage professional advisors, potential partners, suppliers and other stakeholders in the process for feasibility and logistic input. The concept development phase is probably the most important exercise as it introduces the product idea to the potential market as well as explores the company’s ability to make the product available. Any negatives emerging from this phase would be a clear indication that the product does not have the potential for success.

Before any commitment to the idea, an analysis of the costs of bringing the product to market should be measured against the potential contribution to sales and profits. Furthermore, an in-depth market analysis should explore the competitive environment and other environmental factors – like the climate of innovation which might put an investment into the new product at risk. For existing businesses, possible new marketing strategies should be integrated into existing marketing objectives using channels and tactics that have demonstrated success. The rationale is to diffuse the cost and structure of marketing the new product throughout the marketing system in order to achieve cost efficiencies. R&D can now be charged with developing a prototype based on product attributes identified in the market intelligence and resource capabilities, with special attention to consumer contributions obtained at the concept development phase.

The market testing phase is aimed at collating customer responses to prototypes. It provides information for product modification and refinement, as well as full development of the marketing plan. Market testing could also determine whether the product should be abandoned due to poor consumer interest. Once results of testing are favorable, the business idea has been effectively developed and the product may now be ready for commercialization and the introduction to the market. Commercialization is the action plan for introducing the product to the market. It includes timing, pricing, distribution, budget, advertising and promotion, launch impact, and adoption by the target market, along with strategies to incrementally increase sales volumes and build the brand. The process is meant to leverage the effects of marketing strategies on ROI and optimize market spend in relation to competition.

Market success does not begin with a product but with the way it delivers value and benefit to the end user. Many businesses are incorporating the customer as a partner to their product development initiatives as a way of building strong external partnerships, demonstrating the value of the customer to the organization, ensuring delivery efficiencies based on articulated customer need, while availing themselves of a ready market down the line. In developing the product idea it is also important to differentiate the product by finding new ways to extend product value beyond expectations through the addition of new layers of customer satisfaction to the development matrix.

Related articles on this blog
• Marketing Service

•The Budget

• Resource Planning and Costing Systems

• Strategic Capacity Planning

• Focusing the Business

 

 

Marketing Service

by Merlin Hernandez

Many entrepreneurs looking to start a small business look to the service industry because of the potential to translate a knowledge base into income without a large capital outlay as well as the ease of need identification. Services, however, pose unique challenges to marketers because the dominant factor is people not product and each interaction with the service is important to maintaining delivery levels and building the brand. Customer expectations regarding managing and maintaining service quality are critical defining factors. But regardless of the size of the business, the role of employee satisfaction in the quality of delivery can make or break the business if not given serious attention.

Employees are the face of a business and charged with the responsibility for a high level of customer satisfaction. They need to have strong buy-in to the organization to preserve its interests in service quality in order to maintain cost efficiencies and perhaps a pricing edge. High job satisfaction equates with positive representation of company interests. Tying business goals into the employee’s personal interests maintains a high level of employee engagement for sustained commitment. An employee who believes in the organization and its products builds trust and fosters customer loyalty.

Marketing a service product is challenged by the unique characteristics of services which are influenced by four basic considerations to the service marketing mix. It is important for marketers to have a grasp of these factors and see them as advantages rather than stumbling blocks. Services are intangible i.e. there is no physical deliverable that changes hands. Pricing is difficult due to the elusive nature of component costing and marketers often determine prices by comparison with other providers in a similar field. This inherently juxtaposes competitors, and throws the quality of the service more sharply into focus making price a key point of differentiation. But price is often of secondary importance to the quality of the personal interaction consumers have with service personnel.

The service product only exists within the provider/consumer relationship – it has no shelf life and cannot be inventoried. This makes the customer relationship the sole engine that drives the business. The service provider is therefore inseparable from the service itself but so is the consumer. For marketing, the fact that producer, product, and client are so closely intertwined would be an advantage to building product quality according to client need, making customer satisfaction an integral component of the service. Employees form part of the service product e.g. great food poorly served is a bad dining experience – a law office with an unprofessional assistant influences expectations about the quality of advocacy – the pest control service person who does not observe the basic courtesies ensures that his company does not receive a call back.

Each client brings a new dynamic with different expectations and satisfaction index that will not necessarily transfer to another client which makes the service heterogeneous. There may be needs that fit into the basic service offering but with some preference differentials. Furthermore each experience of the service will be different. Understanding this dimension of heterogeneity brings the opportunity to make the service unique each time, add to the quality of delivery, and appeal to a wider customer base.

Marketers need close monitoring of individual customer interests in the planning phase to maintain a high level of delivery and remain competitive. Standardization in services marketing would be necessary to establish rigorous procedures for some measure of uniformity to the customer experience and brand identity. But this needs to be done with the recognition that the heterogeneity factor would demand constant adjustments and varying of methods to accommodate changing customer tastes, customer preferences, and new trends. Employees are better able to provide the level of feedback necessary for sustained customer satisfaction.

Like many tangible goods, services can also be described as perishable since each design and delivery is unique unto itself, finite, and cannot be sold again. This provides the opportunity to market a “new” product each time the service is offered whether a CPA provides annual financial statements, a nutritionist creates a new diet plan or a consultant does the feasibility for a new venture. Customer need will define the service, with past experience feeding into innovation, modification and improvement. It does mean that the service provider often has one chance to get it right.

Employees tend to have heightened knowledge of customer preferences and are central to managing service quality and customer satisfaction. Employee engagement can be facilitated through a combination of base pay and long-term incentives which enhances an employee’s equity and is a measure of the level of ownership and satisfaction an employee experiences in a job. Training and tangible benefits and rewards like bonuses tied to the attainment of strategic objectives, skills enhancement, mentoring, and opportunities for promotions and increasing autonomy go a long way to keep morale and staff commitment high. With reduced turnover, there would be long term benefits like deeper customer relationships and a stronger feedback loop for greater service refinement and targeted delivery.

Related articles on this blog

• Strategic Staffing

• Service as Commodity

• Training as Strategic

 Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this topic, please send enquiries to businesssolutions1168@gmail.com

Unionizing

by Merlin Hernandez

The question of whether a company can legally prohibit employees from attempts to organize the workplace comes up quite often in small businesses. Labor laws fall under the National Labor Relations Act of 1935 and grant employees the right to form, join and assist labor organization and to engage in efforts to promote these rights. It is a body of law that is meant to equalize the relationships and bargaining power between employers and employees. While employers may not prohibit employees from attempts to unionize, they do have the power to control union solicitation by minimizing opportunities for professional organizers to operate in the workplace or by having a written and posted no-solicitation/no-distribution rule that governs the disbursement of any type of literature on the premises as part of an overall risk management strategy at the outset of operations.

But the question of employee organizers poses a different challenge. Employees must be permitted to talk about a union on breaks, lunches, and personal time. But employers have the right, under the Labor Management Relations Act of 1947, to engage in free-speech against labor unions as part of a campaign prior to a union election. Employers are also allowed to contest union elections for which a simple majority (50%) will create a winner. They must, however, be careful not to engage in Unfair Labor Practices for which there are serious penalties, if found guilty. These practices include:
– Threats against union activity
– Asking about union activities
– Offering incentives not to unionize
– Spying on union activity.
Under the Fair Labor Standards Act (FLSA), there are certain categories of employees who may not unionize – executives, security guards, and other classes of exempt employees who are usually salaried workers, professional staff, outside sales personnel, or employees earning more than $100,000.00 annually. It may not be possible to prevent the local union from speaking to any or all employees at a company but an employer may advise employees of the regulations, and direct a union organizer to the relevant statute that would preclude the union from approaching those categories of employees.

Having only one union with which to bargain may have the advantage of a single collective bargaining unit that affords ease of management of the company’s industrial relations. But there can be some advantages to having more than one. Under the NLRA, a bargaining unit can comprise the employees of a single company or a group within a single company. This means that there may be several groups within a company, fitting into several bargaining units that may be represented by different unions e.g. maintenance workers and clerical workers may elect to have different representation based on their different characteristics and needs. In this scenario, should one bargaining unit go out on strike, operations may not be as adversely affected as in the case of a single union. The company may very well be able to re-deploy the workers on hand efficiently enough not to be compelled to hire ‘scabs’ (replacement workers).

The Budget

by Merlin Hernandez

A budget is a financial plan that is based on an estimate of future income and expenses. Developing a budget begins with an estimate of future sales (sales forecast) in order to calculate the expenditure necessary to achieve those revenues. Sales forecasts predict sales volume for a particular period by comparing estimated future sales with the actual sales of the prior period. This would make the forecasted ending balance sheet for the prior budget period essential to developing the sales forecast as it brings important insights about trends and seasonal fluctuations, and can be a reminder of unexpected environmental determinants like rising unemployment levels, changing interest rates or credit market challenges.

The sales budget clarifies required product volumes, defines cost driver budgets, and helps to determine the best price at which to sell. The sales forecast responds to some basic questions:
– The number of different products the company plans to sell.
– The number of units of each product to be sold.
– The selling price of each unit.
The Sales Budget uses this information to determine the level of production required and at what intervals, the costs of bringing the product to market, and expected revenues for the period. Costs are broken down into an Operating Budget for variable costs and selling/administrative expenses, and a Financial Budget for fixed and capital costs as well as cash requirements. The sales forecast, therefore, drives the master budget in that it gives form to the sales budget and other cost driver budgets that lead to the development of operating and financial budgets.

Continuous Budget
The continuous budget is a valuable tool for better planning and performance measurements by factoring the changes that could affect sales projections in order to take preemptive or corrective action. A continuous budget strategizes by drawing from past performance within the period to adjust strategies for the future. But it applies the most recent information like economic factors, new technological applications or market changes for a new starting point to forecasting revenues. For example, a new competitive product on the market could determine a need to increase the advertising budget, offer new volume discounts to customers, or increase sales efforts, which would alter budget allocations and/ or revenue expectations, all of which are designed to mitigate possible revenue contraction.

Continuous budgeting does however, present moving targets that dictate a constant need to re-strategize ways to achieve them. But failure to accommodate environmental changes or changes in resource availability will mean that the budget remains in a vacuum and devoid of the up-to-date and realistic input that would inform corrective action and budgetary adjustment.

Control Management
A company that manufactures and sells a product may experience fluctuations in sales from month to month. A static budget would aggregate monthly production needs based on previous sales data and allocate a monthly production budget to reflect one twelfth of the overall allocation. This does not take into consideration months of high or low activity and would present a distorted view of production efficiencies or shortfalls – high-activity months would reflect cost overruns, and months of reduced activity would mean lower variable costs and not the ability of
the business to generate cost savings.

A flexible budget would link the observed revenue patterns of the previous budget to anticipated expenses for the new period and factor cost variances that reflect variable cost differentials for each month or quarter. Flexible budgeting is a useful feature in contingency planning for uneven levels of activity and is best used in the variable expense sub-section of the Operating Budget. It is the kind of budgeting that adjusts for changes in the volume of activity and is driven by expected cost behavior. It would be of greater benefit to a company than a traditional single value static budget which assumes a world of certainty and only factors one budgeted amount regardless of the volume of activity. A flexible budget is a more comprehensive accounting of the static budget’s cost variance and should be used in conjunction with continuous budgeting for enhanced tracking of variances and more effective control management.

There is need for greater flexibility in contemporary business environments which are characterized by the market volatility and technological changes that would favor continuous budgeting. Small businesses are particularly vulnerable but any type of business, small or large, can benefit from flexible budgets once there is a profit imperative with the need for cost controls. This would include companies engaged in manufacturing, service delivery or even non-profits that would still need to show their ability to generate a small profit as a mark of efficient management in order to maintain their funding.

But flexible budgeting can present control challenges as we target specific financial objectives that do not necessarily change because of threats in the environment. It comes down to the management of systems and processes for contingencies and short falls. The flexible budget is the practice of management by exception i.e. giving more attention to areas of significant variances for more efficient resource allocation and strategic implementation to achieve financial goals. The combination of continuous and flexible budgeting enables more intense contingency planning and adaptability as well as short term performance variance analysis that feed into better cost controls and profit projections.

Related articles on this blog
• Managing Small Business Financing
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• Resource Planning and Costing Systems

Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this topic, please send enquiries to businesssolutions1168@gmail.com

Resource Planning and Costing Systems

by Merlin Hernandez

 

Computerized planning systems and automation have resulted in a greater visibility of cost drivers and reduction in direct labor. This allows more efficient manipulation of the costs of resources consumed by a particular activity involved in producing an item in order to reduce costs. The way costs are assigned to a product has an impact on the measurement of its profitability. The anomaly has been the separation of direct labor (used to compute both direct and indirect costs), and overhead – a relationship which has thus become skewed by the use of a predetermined overhead as a percentage of overall costs. With the use of more complex manufacturing processes, multiple allocation bases have become necessary in the computation of more accurate product costs.

Activity Based Accounting (ABC) is a costing model for allocating overhead costs that identifies a company’s range of activities and allocates the full costs to each, rolling overheads into direct costs but in a way that facilitates more efficient cost allocations. Cost drivers are expanded to include the full activity pool with overhead as a factor of each activity pool e.g. material ordering is assigned to material costs or equipment set up and maintenance assigned to the equipment cost driver. This represents a more logical and accurate allocation of costs than a single overhead rate, determined by a percentage of direct labor costs and applied across the board, in determining the exact cost of a product or service. Some activities demand more overhead input than others and cost rationalization will need more careful identification of potential areas of savings. This will enable the business to more effectively analyze and strategize for profitability way before scorched earth “cost cutting measures” need to be adopted.

ABC is best used over a long period of time to gather sufficient data for meaningful analysis. It also facilitates planning and budget development and helps to identify and devise HR programs increased efficiency and productivity. It is used in costing and cost controls, process improvement, product profitability, and customer profitability in manufacturing firms, communication firms, financial services, and the public sector. The method might be challenging for the construction industry due to wide cost variability among jobs. Critics of ABC have long argued that the system does not provide day-to-day guidance on process quality nor effectively measure short-term costs the way an ERP system can. But ABC remains viable as the system has expanded its scope beyond accounting to include supply chain and logistics, among other applications, and still emerge less expensive to acquire and maintain than ERP systems. It is ideal for the small business.

ERP systems integrate transactions but may not give an indication of which products to sell or which customers to cultivate. ABC is more adept at addressing these omissions. An integration of ABC with other data sources through business intelligence systems or ABC’s ETL (extract, transfer, load) technology can also address the problem of error or real time information usage. Some large organizations use a combination of ERP for full integration of transactions within the supply chain in addition to ABC for better product and customer analytics in order to drive performance improvements. The ERP becomes a real time data source for the ABC system to allow better day-to-day analyses.

Related articles on this blog

• Controlling Manufacturing Processes
• ERP Systems and Fashion Production
• Managing Small Business Finance 

• Supply Chain Management

Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this and other topics, please send enquiries to businesssolutions1168@gmail.com

 

Strategic Capacity Planning

by Merlin Hernandez

Capacity is the volume of output a production system can achieve over a specific period, and is the relationship between input and output e.g. how many labor hours it takes to produce an amount of item units like cars or dolls within a system (labor capacity).  It is measured as the aggregate capacity of all areas of production necessary for meeting productivity needs.  This includes financial and human resources. The objective of capacity planning is to determine an optimum level that best supports the company’s competitive strategy.

Capacity planning is concerned with lean and value-creating manufacturing processes. This involves accurate forecasting, a continuous flow for reduced cycle times and costs, collaborative customer and supplier relationships, line balancing for efficient resource allocation, and stock control for JIT production and delivery. Inadequate capacity can lose customers through failed or late delivery which would allow competitor entry to capture some of the company’s market share. Excessive capacity can result in larger inventories, price reductions to stimulate demand that would erode profit margins, and the costs of an underutilized workforce.

Contemporary competitive challenges for smaller manufacturers dictate the need to develop operational strategies to transform manufacturing processes from one of building inventory to JIT production in ways that give greater capacity utilization at reduced costs with minimal need for safety stock. This may require a shift to mass customization techniques that would provide a stable process for cost efficiencies, but with built-in flexibility for value creation. Mass customization means that a basic product can later be customized with several optional features that would be developed in collaboration with the client base. This enhances the customer relationship, and is a value creating strategy that provides a desired customized product, for faster customer re-supply that is more responsive to market pull signals.

Planning would then integrate the various stakeholders into the value chain – consumer, retailer, supplier, and manufacturer. And Production will be a feature of a synchronous manufacturing process that emphasizes total system performance not on localized measures such as labor or machine utilization. In terms of capacity planning, the combination of JIT production and mass customization would allow for larger lot sizes of the basic product to create the continuous flow needed for lean manufacturing. This will also facilitate production at near capacity, with a narrow capacity cushion, for optimum utilization of facilities, labor, raw material, and operational expenses.

Service Industry

While capacity planning for both manufacturing and service facilities has many similarities, the service industry presents some important differences. In a manufacturing context, the measure is the amount of items produced over a given period. In a service setting, the capacity measure might be the number of customers processed by the system within a certain time-frame. Manufacturing may be more concerned with batch quantities, line balancing, and stock control. These areas are of reduced importance to service delivery which is more involved with availability time, location proximity and access, and volatility of demand – different needs and expectations.

Service thus demands wide variability to process times and capacity needs that might be based on time of day, seasonal demand, weather conditions etc.  There is a shift from more internally- focused, product-based efficiency to a strategic need to derive efficiencies from more external variables like customer needs and the direct and immediate influence of environmental and seasonal factors (weather, holidays, disasters). There is then a day-to-day balance between capacity utilization rate and service quality, and planning often becomes more a feature of contingency.

Even short term capacity planning in manufacturing offers at least weekly or monthly process adjustments and may produce at near capacity with a small capacity cushion. Service industries require a much wider capacity cushion to accommodate wide demand fluctuations and individual service needs. A service business needs to factor optimum operating points e.g. lunch hour at a restaurant, pay days at retail stores, or high pollen days at an urgent care facility.

A manufacturing process may seek to maintain system balance to influence value creation. The service industry works at optimizing quality delivery to maximize customer satisfaction. These are not mutually exclusive goals. But accurate demand forecasts and meticulous calculation of equipment and labor requirements are necessary for effective capacity planning.  It should be noted, however, that strategic capacity planning needs to be resource-based. This will plot the strengths and weaknesses of financial, human resource, knowledge base, information and communication systems, as well as other assets against strategic goals. The point is to ensure  alignment of goals and resources so that the business can support sustained competitive advantage.

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Controlling Manufacturing Processes

 

by Merlin Hernandez     

         As small businesses seek to become more effective, they might take a page from the playbook of larger organizations and use business statistics as a vital key to competitive manufacturing processes. Process controls can influence cost savings, product quality, and customer satisfaction by establishing upper and lower limits to defects so that production and delivery schedules work as anticipated.  A Statistical Process Control (SPC) system uses process data to describe optimal manufacturing process to execute a prototype within the context of its environment – the goal is to identify defect points and levels in order to intervene before tolerance violators occur.

The system uses random sampling to detect whether process output is within the pre-selected range for quality. It is meant to optimize the entire process and allow for better control and documentation of processes, and faster interventions. Identifying the relationship between control needs and process capability would invite process improvement to maintain small tolerances and mean variations. Using control charts to calculate the overall fraction defective will offer better cost and revenue projections. Process flow and resource allocation will be more efficient and also allow savings. Standards and specifications will drive better processes for improved quality to have greater process integration, reduce margins of error, and increase customer satisfaction. These can positively impact brand equity, market share objectives, market expansion, and overall profitability.

SPC has been gaining attention in the last few years because of the increasing popularity of more comprehensive quality systems like ISO, QS9000, MSA, and Six Sigma. Manufacturers and service providers in both small and large enterprises are under pressure to improve quality and customer satisfaction, reduce response times, increase productivity, and reduce costs in order to remain competitive. Two major impediments to bringing quality improvement to many companies are cost and time. In terms of cost effectiveness and implementation time, relatively simple techniques like SPC and EPC can achieve great quality improvement and system cost reduction at a fraction of the cost of more comprehensive systems like Six Sigma or ISO. Lower cost SPC systems have proven to be effective in process improvement and can bring adequate data analysis for managerial/technical corrective actions where financial resources are limited. 

While the Six Sigma system is expensive to implement, a cost-benefit analysis might reveal that these costs, when amortized across the long term benefits of the strategies, can be offset by the sustained level of savings. Six Sigma efficiencies will smooth process problems like bottlenecks, starving, and blocking to eliminate production delays and reduce throughput times thus saving on costs and improve quality. Statistical analysis will identify areas of system vulnerability to defects in order to minimize waste and facilitate savings. But while smaller companies need such a system, they may not have the resources to afford the initial investment and might consider the SPC route to inject better process control. 

The complexity of the Six Sigma system and the method for gathering and analyzing data makes the steps to DMAIC time consuming and tedious, and training is also time-consuming as the system requires an organizational culture that supports implementation which may translate into major structural change. Six Sigma, however, has proven beneficial to large manufacturers like Motorola and Lockheed Martin resulting in across the board savings, streamlined operations, and improved quality. But implementation tended to begin in smaller pockets around these large organizations before incorporation throughout the entire organization. It is a strategy that requires deep pockets and a long term vision where the time to implementation is an asset to the process of organizational change. Many smaller organizations have found it difficult to create employee buy-in as early implementation adjustments can be disorienting and dislocating and bring questions as to the system’s value.

This is compounded by the fact that Six Sigma is more specifically grounded in objective analysis, and application to the unique characteristics of smaller businesses may prove difficult as the knowledge base and experience of employees are not factored. Cost savings are also difficult to determine in the short term and there are questions about the high cost of implementation. The method can also inhibit the creative process as statistical systems and standardization favor quantitative approaches to problem-solving as opposed to the more qualitative requirements of the creative process or a new small business still trying to map its way.

Meanwhile, companies like Toyota, John Deere and Raytheon have been using the Japanese Shingo system which places emphasis on integrating only value-added activities into the production process as they pursue lean manufacturing.  SQC methods like Six Sigma are not structured to prevent defects or eliminate them, they tell us the probability of a defect occurring. The Shingo system seeks to prevent defects from emerging at the end of a process by embedding controls within the process through feedback and corrective action immediately following detection of an error. Feedback is provided through different levels of inspections that facilitate detection. Source Inspections identify errors that can cause defects before the defects occur while Successive and Self-Checks are done for defects themselves. The supporting practice of Poka Yoke requires the stopping of a process as soon as a defect occurs, identifying the source of the defect, and taking proactive measures to prevent recurrence. Smaller  operations may find it advantageous to adopt this method.

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