Three Conditions for Smarter Margin Application to Make Healthier Profits

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Issue #12251 - June 2020 | Page #24
By Todd Drummond

Establishing a proper margin to maximize profits for your roof truss component sales is not as easy as most people think. Most do not have a clear understanding of how small changes make a significant impact on the company’s profitability. Making the most profits possible, no matter what the markets may be doing, should always be the main focus. During these uncertain times, perhaps it is wise to take a few moments and review some key points to reevaluate how your company is positioning itself within your sales market.

The ironclad golden rule about margin and profitability:
It is not the percentage of sales of margin that determines profitability but the total accumulative margins dollars that lead to a profit or loss.

For an understanding of common terminology, the margin is defined as the total sales minus direct cost of manufacturing (material and labor). Any indirect cost (anything that is not material or shop labor cost) being applied as a direct cost is not considered as being margin for this article.

Case #1Markets collapse, and your company has spare production capacity. This very scenario happened during the ’08 building crisis.

Example:

  • Sales average 35% margin at 100k, which is 35k per month.
  • Sales are only producing 50% of production capacity.
  • Problem – Break-even to cover the indirect cost is greater than $35k per month.

Question for your company – What is your company’s break-even to cover the indirect costs? If you do not know, you certainly should.

In the spreadsheet [See PDF or View in Full Issue], the breakdown for half of the sales is at a 35% margin rate, and the other “Added Sales” listed in the left column shows an estimated gain based on a reduced margin rate. Notice each line shows the combined sales with a total margin for each month. The worst-case scenario is that, in order to reach 90% capacity, half of the sales are only at a 20% margin rate. However, combined with the normal 35% margin, the results are a 27.89% margin rate. Granted, this is an unlikely scenario because, once margins start dropping in a market, every company within the given market sales are negatively affected, and nobody wants to lose a sale. Too often, it can become a race to the bottom, and no one should want that for their market. However, this exercise does clearly show that, when your capacity is less than full capacity, your company could be making more profits by dropping the margin for some sales. Once the overall market sales fall below the combined market manufacturing capacity, everyone will be dropping their pricing in an attempt to fill their spare capacity to maintain their total monthly margins to cover their indirect expenses. When the overall market collapses, it becomes an endurance race to be among the last ones standing of who remains in business.

Case #2When your company is at full capacity, are you raising your margin rates to maximize monthly total margin dollars? When I speak to clients about how they define what is considered full capacity, they normally respond by stating they have a schedule that is anywhere from four to six weeks. For orders with higher margins, they will make room to do them a little quicker. I will then state to them that, if your production never needs to be reduced for output for say a week, meaning the schedule never drops below five days of work for the shop employees, and no one’s hours need to be reduced below a normal forty-hour workweek, how are you not at full capacity? Why are so many of a mindset that you need to be out four weeks to be considered at full capacity? In the early 2000s, I witnessed a company in Alberta, Canada with a schedule of greater than sixteen weeks go bankrupt in a market where all they had to do was raise their margins and deliver the orders quicker. The market would have easily allowed higher pricing if only they would provide the orders quicker. If your competition is out four weeks for new orders and yet you are only out one week but are making higher margins because you are higher priced, why would you lower your margins to be scheduled out for four weeks? Every company should ask themselves how dynamic your margin practices during the year are, and are you maximizing your accumulative monthly margin dollars each month, or is it a static rate? Most companies have a fixed markup rate and are not maximizing their monthly total margin dollars.

Case #3Margin percentage of sales can lead your company to lower net profits. Let us look at a simplified example to explain what is meant by this statement.

A. One large order requires total production capacity for a single day and produces $2,500 margin dollars.

B. Three small orders require total production capacity for a single day, and the combined orders produce $3,500 margin dollars.

In this example, a single day’s capacity is defined, but it can be an entire month’s capacity to demonstrate the same points. I hope you have noticed something in these two examples of total capacity. The cost of material, board foot (BF), number of pieces, total sales dollars, or even the percentage of sales were not given to illustrate the total margin per day. The only defined term that was stated was the total capacity for a given days’ worth of production that could be produced, which could only be correctly expressed in man-hours, not BF or number of pieces, because only man-hours correctly define the capacity. An example is ten people on the assembly tables for eight hours means there are eighty man-hours of capacity (minus break times and other non-work time) not BF, number of pieces, or some other unit of measurement that has nothing to do with actual capacity. One could also use R.E. and S.U., which are actually man-hours expressed in units of 100. An assembly crew can have an outstanding day assembling AG trusses as defined by material cost, BF, or piece count compared to 1-1-1 orders being produced, yet they worked just as hard and put in the same number of man-hours. Why do so many still insist that BF or piece count is good enough for roof truss manufacturing?

Material + Labor Cost + (Dollar Rate * Expected Hours) = Sales Price
Drummond’s pricing method for proper margin rate based on time.

Any company which is still using BF, piece count, or a cost multiplier for establishing the pricing (margin) of their manufactured components is losing money compared to those who base their pricing on a properly defined margin rate per properly calculated man-hour. Once you start using this formula, your margin percent of sales will vary. This formula creates a baseline for which to adjust your margins to maximize total net profits per given time period.

 

When you want more than hype, TDC is your best source for learning about the very best and latest practices to keep your company competitive. Change that usually takes months and years can be accomplished in weeks and months with TDC’s assistance. The implementation of the suggestions produces an average gain of three to six points in net profits. TDC has proven real-world expertise that goes far beyond what many expect and has provided consulting services for well over one hundred clients—using proven and practical lean manufacturing best practices combined with industrial engineering principles that include refined time standard man-minutes for truss manufacturing. So, before you buy equipment, get TDC’s advice! TDC does not receive referral fees from any equipment or plate vendors, and you can trust TDC for unbiased vendor and equipment recommendations shaped only by customer experiences. Please don’t take my word about TDC’s services, though. Read the public testimonials many current and past clients with decades of expertise and experience have been willing to give: https://todd-drummond.com/testimonials/.

Website: www.todd-drummond.com – Phone (USA): 603-748-1051
E-mail: todd@todd-drummond.com – Copyright © 2020

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