To illustrate this situation, we will discuss the actual story of a small automotive repair and towing business. The business had a regional towing contract with AAA Auto Club, which gave the business top priority on all service calls. For four or five months during the year, however, the business was operating six to seven days a week but not making any money. After a third-party review of costs, it was determined that the AAA business was costing on a cash basis several dollars per call more than the revenue being generated. The owner was reluctant to give up what represented 40% of his business, but he took professional advice and eliminated that contract. The result was a normal work week throughout the year, much higher profitability and time to focus on work that is more profitable.
Here are six steps your company can take to make sure that your revenue stream is the best one for your business.
1. Evaluate Your Production Equipment and Processes
You must determine the capabilities (repeatability) of your equipment and processes. If all the equipment cannot meet minimum performance standards, it should not be considered when selecting products to manufacture. You must also determine the size limitations imposed by each piece of equipment and select only those products that will fit within this envelope. Be willing to correct, replace or add equipment that might open new product possibilities in the future.
2. Evaluate Your Human Resources
People make a company. Document the knowledge, skills and talents of all the personnel involved in the production, engineering, quoting and quality aspects of your business. Knowing your strengths and weaknesses will guide your decision-making process for future business. Using third-party testing may provide greater insight into the fundamental characteristics of your employees (such as communication, problem solving, vocabulary, math skills, etc.) that might enhance or harm your processes.
3. Know Your Costs
Unfortunately, many companies do not really know the true costs of each of their products because they use a costing system that is too simplified to generate accurate information. Average costs are used rather than actual product costs. The problem with averages is that more costs are applied to simpler jobs that may not be won, while lower costs are assigned to difficult jobs that are awarded to your company and consume more resources.
Prepare a list of all your products by volume from highest to lowest, and then prepare a detailed cost report for each product showing its total cost and gross profit. Costs should include material, freight, direct labor with fringes and manufacturing overhead costs. Then add things that are not included in the overhead amount but that are unique to this product, such as special handling, special packaging, special product movement, additional quality requirements and warranty costs. Now regenerate the list of products by gross margin from the highest to the lowest. How do these compare to your sales list?
4. Decision Time
After following these steps, select the products that best fit your company and that make the highest contribution to profitability. You may also include volume products with lower margins if you can determine how to improve the margins. It is usually cheaper to fix and keep existing products than it is to add products and find customers for those products.
5. New Products
The best place to start to determine how to sell more products and add new products to your mix is to ask your existing customers what they see as your strengths and your weaknesses and what it would take to get more of their business. It is often not cost or quality but other things that the customer sees as imperative, such as customer service, on-time delivery or an understanding of their business needs.
Next, look for new products that best match your business footprint. For example, a manufacturer of a large product that required motors, electrical circuit boards, metal fabricating and powder-coat paints acquired a small product line in a niche market that used the same processes. He was able to add over $1 million in revenue at a lower cost than the prior manufacturer because of the skills and capabilities that his company already had.
6. Incremental Business
Many companies are often tempted to take on work at less than full price because they have excess capacity, and they believe that the additional business will contribute to their bottom line. Exercise caution. Make sure that the margins on this new business are sufficient to add to the bottom line and not take away. Remember to focus on the bottom line first, and you will discover that you can make more with less.