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Cost Savings: "You want how much for your product?"

April 03, 2020

Industrial engineer analyzes cost through a magnifying glass

by Stephen Gibson

"You want how much for your product?"

This was my reaction to the presenter after being told the price of their product. A cringe-worthy response for any salesperson and one which can typically be avoided.

There is typically a reason why an object costs a certain price. Price is typically dictated by two things the inputs (including profit margin) and what the market is willing to pay. A business cannot control what the market is willing to pay. Cost of inputs (i.e. profit margin, materials, labor, etc.) can be controlled. A second look by a professional Industrial Systems Engineer (ISE) can deliver a tremendous benefit; 25%+ cost reductions are not uncommon. This is why large companies like FedEx, UPS, the automotive “Big 3”, etc. employ teams of ISEs.

So, what are the choices a business faces when the market is unwilling to pay the price being asked?

(A) Cut the profit margin

In order to survive, a business must satisfy three key stakeholders: The Customer, The Investor, and The Employee. Cutting the profit margin is good for the customer. If the volumes are high enough, the total returns may be such the profit margin as a percentage can be reduced and still make payroll, pay dividends, make the loan payments, et cetera. This is a high stakes gamble. At some point, volumes will most likely drop. When this occurs, the price will have to increase thus becoming a dissatisfier for the customer. This presents further risk by lowering the return hurting the investor. Eventually, this can be the demise of the company thus the employee.

(B) Stop Making the Product

Edwards Deming once wrote, "Survival is not compulsory. Improvement is not compulsory. But improvement is necessary for survival." A business can always choose to kill a product or let it die a slow, albeit painful, death. Companies have chosen this way for centuries. Look at any industry and there are examples of companies who refused to change. In this scenario, all key stakeholders get hurt.  The investors stop seeing a return and typically lose a portion, if not all, of their investment.  Employees are left without jobs. And, customers are forced to find alternatives or do without.

(C) Reduce Costs

Most people believe reducing costs requires lower quality and/or loss of customer value. Businesses often try to create extra value by adding features which customers may not even really care about to hold their price. The business may simply decide to use lower quality inputs. Neither of these are of value to customers. The result: see option (B). There is another more challenging but successful way.  Instead of cutting value, what about looking at alternative inputs including processes. This is where an Industrial Systems Engineer can be of value.

The presentation mentioned earlier was for a new product to assist project managers in scheduling a project. It was a physical tool that integrated into a computer program. The concept was great; the price was not. I waited until the presentation was over and looked at the parts. The guy asked, “What did you think?” I responded, “The concept is great; the price is too high.” With a puzzled look, the guy starts explaining his costs. As a consumer, I do not care about your costs. The guy was obviously very intelligent but did not know manufacturing. Having spent years in a college classroom studying manufacturing and decades in the industry, I quickly knew the material, the process, and guessed where it was being made. I was able to give him a price range of $0.15 to $0.20 each; he was near the top of it and maybe higher plus shipping cost and tooling costs. In a 15-minute conversation, I was able to explain to him how to source the product locally - virtually eliminating shipping costs. By changing the process from injection mold to extrusion, reduce scrap (trim from the injection molding process), and increase the recycled content (use scrap from others’ processes). The cost of his product would be reduced by as much as 75% along with reducing plastic headed for the landfill. He could: pass the savings to the customer exceeding their expectations; increase the profit margin to exceed investor expectations; and by sourcing it locally, he could create jobs in the local market to meet employee expectations. The other components which were driving the sales price had a much larger opportunity. He now has the opportunity to develop a patentable new design to replace an existing product in the marketplace at a much lower cost.

“There is more than one way to skin a cat, but only one way is the best.”

It’s true that “there is more than one way to skin a cat,” but it’s often overlooked that “only one way is the best.” There are many ways to make any product. Plastic parts, like in this scenario, can be made by multiple processes: machined, blow-molded, thermoformed, injection-molded, extruded, printed...  All are unique and have a reason to exist. Good Industrial Systems Engineers (ISE) are experts at processes and can quickly and efficiently identify better ways to deliver products and services. Businesses are processes. They convert a good or service for customers by means of employees and resources into a profit for investors. A good ISE understands not only the engineering of the process but also the economics of business. They should understand what each key stakeholder demands and how to best satisfy those needs. An ISE can design a new or improve an existing process to maintain or improve work for employees, increase customer value, and drive bottom-line profitability. Even a small start-up business like the one mentioned earlier can benefit from a professional reviewing their product and process for significant returns.