Product Rationalization process looks at separating the winners from the also rans.
Products, features and options. How easy would the job of planning and controlling inventories and the manufacturing process be if you had fewer choices. Of course, excess product variation causes many problems as well as many opportunities that you see every day. The beauty of the product rationalization process is that you can use it if you manufacture products or offer services, the logic is the same.
While option and feature variations cause many problems, most companies never take an active role in reducing the number of options and features. This can be caused by a lack of facts about the profitability of specific features and options. If you ask the sales force what options make money, they are sure to reply that they all do!
Here is a product rationalization process that we have used successfully across many industries. Included are several tools and examples of how to collect the facts and how to make some simple common sense decisions about your products or services.
SET A PLAN OF ATTACK
First of all forget about solving all the world’s problems, at least for today. Set a limited amount of time and effort you can spend on this project. Our experience and the feedback from companies that have used this process is that it is simple and it works. The goal is to address those 20% of the items that will havethe 80% of the effect.
What this means is that you should only look at one product family at a time. If there are more options and features then twenty, pick only the top twenty. It is a pretty safe bet that the others can be included in the category of pesky and quickly reviewed later.
KNOW HOW TO LOOK AT YOUR CHOICES
In order to remove as many controversial or resistance issues as possible you need to convert raw data into easily presented information. One of the best methods for this is a simple Sales, Profit, Asset chart and the resulting Return on Asset calculation.
Determine the Sales Dollars that each option has contributed over the past 12 months. While you might be tempted to look back further 12 months is enough to take into account most trends.
Next the Assets
Assets can be broken down into three basic areas as described below:
The inventory required to support a commonly selected option compared to one sold three times yearly will obviously affect product profitability.
While, normally a constant, you might have to adapt this to your product based on space required for assembly and warehousing.
Often special equipment or tooling is required to produce certain options/features. If this occurs to low volume high variety options, we should take this into consideration when calculating the per option/feature equipment requirements.
CALCULATE YOUR SUPPORT COSTS
Support costs are all the other overhead items. Some examples are the price to process a sales order, or the engineering costs associated with option/feature selection.
Perhaps your company’s products do not require engineering intervention, but many companies require engineering approvals when selecting options. Some options require special care when being selected because they exclude or require the selection of other options/features to function properly.
When we look at transaction costs (the costs to process an order) it becomes evident that most options require the same transaction steps. This means it costs as much to process the $500,000 orders as it does the $4.00 ones.
When we now look at those low volume selections, we can see just how much these options really cost. The best thing about support costs is that all options suffer or prosper equally.
Total up the costs.
Now simply total up the plant, equipment and inventory totals for each option/feature. For our purposes we will also add the support costs to our asset total. Keep the support costs available for later.
Calculate the profit!
Profit for our purposes will be defined as:
Profit = (sales – assets – support costs)
Plot the results
As you can see in Figure 1 we can now plot our options on a simple bar graph.
In our example you will see that some options really do make a profit while some others are subsidized. Option ZZ shows no profit and in reality is a subsidized option, while Option J returns a healthy profit. Our final task is to convert this chart into a set of meaningful numbers.
Calculate the Return on Assets
One of the best measures we can use is Return on Assets (ROA). ROA is the ratio of profit to assets. In other words how much does it cost to make money. The calculation is simply:
In Table 1 we can see the result of our sample data.
|Opt J||Ftr O||Ftr R||Opt ZZ|
|ROA||4.5 %||1.20%||1.40%||-0.40 %|
This data shows us that Option “J” is truly a profit maker while Option “ZZ” costs us money every time we sell it!
A FEW WORDS OF CAUTION
While our example clearly illustrates which options/features are profit generators you need to keep a few thoughts in mind. While some options make little money they are necessary because they are required to make “system” type sales or are sold to a large otherwise profitable customer.
Product Life Cycle
New products will cost more to get to market then those established cash cows. If we were to judge based solely on ROA new products would never be developed!
Figures lie and liars figure
Traditional methods for figuring out costs are not accurate! In our examples I have stressed that we must use common sense when finding out costs such as support. Standard cost systems typically allocate overhead at fixed rates or as a percent of labor or machine time. There is no consideration for special machines or engineering support required for certain options/features.
In the product rationalization process data is most accurate when collected often. When managing configuration information we need to keep in mind that our market and products are always changing. This means that as we start to make changes we need to keep track of the effect that we are having. To collect this data once and assume it will not change is like assuming that there is money in the check book simply because you have checks in the book!
START MOVING on the PRODUCT RATIONALIZATION PROCESS!
Collecting the information necessary to make a good decision is not easy! There are several simple and highly accurate methods that you can use. Two examples of these are seen below.
Modified Delphi Method
In the Delphi method we simply quiz the experts. For example we would ask the people who do or schedule the work to tell us which items require all the capacity or effort.
The sampling method is simple. One such application is to have the order entry clerks or salespeople keep track of each time an option or feature is entered during a sample period i.e. day, week, month.
WHAT ARE YOUR CHOICES?
There are several choices that exist once you have the right information. Let’s briefly discuss each.
Bye, Bye Laggard!
You might simply decide not to sell the low ROA options. While we all want to sell only high ROA items few companies get to reach this Nirvana. Be sure that you check the Customer and Product Line issues before you delete.
Often overlooked is the fact we can confuse our Customers or Salespeople with complicated order sheets and order rules. It is even possible that we are selling competing options or features.
Raise your price
Perhaps you are giving your product away. While it’s a simple solution to raise price we need to keep in mind our place in the market. Will the desired selling price put you out of business? You need to look at the market not only from the brand level i.e. direct competition but, also the generic level. One example of a generic market would be the producers of potato chips. While they compete against other chip manufactures they also compete against the popcorn and cheese twist producers.
Reduce Support or Asset level
In 1926 Henry Ford published a book entitled “Today and Tomorrow” Mr. Ford discusses the merits of lowering the cost base so that you can reduce selling price. This tactic as applied at FORD virtually created our Middle Class in the United States of America and nearly eliminated Ford’s generic competitors. Think about it, when was the last time you rode a horse to work?
Build “Standard Options” into your Product
If you find that a majority or your orders contain the same basic options look at the cost impact of making these items standard. If it is not possible to build the options into the product can you build in a more plug and play style. Meaning can you create generic setups that allow options and features to be added with little effort. Keep in mind that you might increase your market appeal at the same time!
While this is an choice, be careful! Too many empty buildings stand as monuments to former businesses. There is no guarantee that simply because you have been in business for 100 years you will be here tomorrow.
WHAT HAVE YOU DONE?
You have developed a solid platform on which you can judge your options and features objectively. By simply collecting Sales, Profit and Asset information you can accurately see which options are winners and which are losers. Once we have good information you can look at the choices outlined to make better decisions.
Your task at hand is to start measuring the production rationalization steps! If you keep putting it off until you have “ALL” the information you will never make a change. Use the tools, adapt the tools as necessary, and start today!
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