The Missing Metric in Manufacturing
How a new profit performance metric, Profit Velocity,
is being used to drive more revenue to the bottom line
in complex, capital-intensive manufacturing businesses
Michael Rothschild
Founder & Chairman
2013
Introduction
Investors naturally seek the highest rate of return on their investments. Making money faster
from the money tied up in a business has always been the name of the game. When investing
in complex, capital-intensive manufacturing businesses, this means finding ways to generate
profit as fast as possible from expensive production facilities despite the many challenges that
complexity breeds.
Given investors’ intense focus on the speed of money---how fast dollars are being produced by
the assets they own---it would be reasonable to assume that every manufacturer measures and
manages in great detail exactly how fast (in dollars per machine hour) profits are being
produced by their production equipment. However, virtually none have the tools to precisely
measure this metric. This incorrect assumption has tremendous implications for shareholder’s
return on assets.
Rather than running their business by focusing on profit per machine hour, manufacturers
worldwide instead pay closest attention to the profit per product unit of the products they sell. In
fact, very few manufacturers are even able to measure the profit per hour generated by their
equipment. Most have never even tried. This is why we refer to “profit per hour,” or Profit
Velocity, as the “Missing Metric.” Speed of money-making may
be paramount to investors, but with few exceptions,
The performance measure
manufacturers do not even attempt to measure---and therefore
that investors care about
cannot manage---the result that matters most to their investors.
On the surface, it would seem rather simple to calculate profit per
machine hour to learn which product items, customer orders,
market segments, etc. yield more money from the precious time
they use passing through production equipment. But until
recently, measuring and managing profit per hour in enough
detail to make the Profit Velocity metric useful in decision-making
has been too difficult to put into management practice.
most is ROIC, but very few
companies have systems
that inform decisionmaking on the basis of
profit per minute, per hour,
per day or per week.
Without ready access to precise and reliable profit per hour data, manufacturing executives and
managers do the best they can by setting improvement priorities based upon the only detailed
profit metric they have access to---the profit or margin per unit as reported by their accounting
system. But, unfortunately for their investors, when manufacturing management teams rely on
profit per unit rankings to set policy on customer priority, product mix, market focus, pricing
strategy, new capacity investments, and the like, those policies are inherently biased in ways
that actually slow the enterprise’s overall flow rate of profit per hour. Consequently, a lower
average profit per hour leads to lower profits per quarter and per year, and lower returns to
investors overall.
This problem is especially harmful to the thousands of “High Mix” manufacturers worldwide who
produce extremely broad product lines with thousands of distinct part numbers from plants
requiring significant capital investments. Their inability to measure and manage Profit Velocity
leads to a pattern of decision-making that unintentionally drives investor returns down well
below the results those businesses can otherwise deliver.
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
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With the development of the PV AcceleratorTM software, this is beginning to change. It is now
practical to measure and manage profit per asset hour regardless of the size and complexity of
a manufacturing enterprise. In short, the “Missing Metric” of Profit Velocity is no longer missing.
3+ percentage points
of revenue may be
added to the bottom
line once the Profit
Velocity metric is
used by management
to help guide
decisions.
Recognizing a rare opportunity to deliver a major increase in
investor returns, leading manufacturers in High Mix, asset-intensive
industries are increasingly taking advantage of the new insights
revealed by the Profit Velocity metric. Using the formerly “Missing
Metric” to help guide decisions on how they market, sell, and
produce their products, these manufacturers have measurably
accelerated the flow of cash and profits from their assets and
significantly increased return on their investors’ capital.
Why High Mix Manufacturers With Complex Product Lines
Make Far Less Profit Than They Should
All manufacturers everywhere use the profit per unit metric to understand which of their
products contribute more to overall profit. For example, a product sold for $10 that costs $4 to
manufacture is naturally considered more profitable with its $6 per unit margin than a product
priced at $20 that costs $15 to make and yields just $5 per unit.
But what if the machinery cranks out the lower margin product
at the rate of 50 units per hour ($5 per unit x 50 units per hour =
$250 per hour), while the high margin product moves through
that machinery at 30 units per hour ($6 per unit x 30 units per
hour = $180 per hour). Surprisingly, the low margin product
actually yields more money per asset hour at $250 than the high
margin product at $180.
In less than two years, an
electronic components
manufacturer’s operating
profit per hour increased
from $1,400 to $4,400,
adding $8 million in profits
on annual revenues of $80
million.
To be sure, for a great many manufacturers the margin per unit
metric has been and remains perfectly adequate to support
good decision-making. In labor-intensive manufacturing that is not machine intensive, the
speed at which the various products produce profits while moving through equipment doesn’t
matter very much, because the production process does not require investment in expensive
capital assets.
And in some capital-intensive industries, such as mining or bulk chemicals, producers tend to
make just one or a few product varieties, giving them very little room to alter their product mix or
refocus on certain customers or market segments. Getting good financial results for these
narrow product line/capital intensive firms is mostly a matter of keeping the plants operationally
efficient and fully utilized.
But across a wide swath of High Mix industries including electronic components, specialty
chemicals, packaging, semiconductors, textiles, fabricated metal and plastic parts, steel,
contract pharmaceuticals, etc., a single manufacturer will typically produce several thousand
product varieties (shape, size, capacity, strength, etc.) for hundreds of industrial customers from
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
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many production lines and plants. For these High Mix, capital-intensive manufacturers, ranking
products solely by unit margin without considering Profit Velocity undermines management’s
ability to fine-tune the business to maximize the profit yielded by their product, customer, and
asset portfolios. For these High Mix manufacturers, the evidence shows that 3+ percentage
points of revenue will be added to the bottom line once the Profit Velocity metric is used by
management to help guide their decisions.
Example: Accelerating Profits with the Missing Metric
To be able to see their previously invisible profit gain opportunities, manufacturers need to
measure the profit generated per hour for every product as it moves through production. By
aggregating this information, especially by customer and product group, to understand how
much profit per hour each order, each product variety, each customer contract, and each
production line contributes, managers will see a much clearer picture of the true sources of
profitability in their business than that revealed by relying solely on margin per unit.
Figure 1: In complex manufacturing environments, there is a wide range of speeds at which
various products generate profit per machine hour
In Figure 1, representing actual data, we show the conventional picture of profitability, unit
margin, on the vertical axis. By this measure, both Product 1 and Product 3 are more attractive
to manufacture than Product 2, because they both produce a higher profit per unit. However,
although Product 2 has a lower unit margin, it can be produced at a faster speed. As a result,
Product 2 generates profits more quickly than Product 1 and Product 3. The low margin/high
Profit Velocity Product 2 actually generates more cash per machine hour, and as such
contributes more to the number investors care most about at year-end.
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
Page 4 of 8
Proprietary & Confidential
Being able to see a product portfolio from both the unit margin and Profit Velocity perspectives
at the same time reveals new options for pricing, promotion, market development, deal
negotiation, product definition, capacity planning, and operations. Manufacturers who have
exploited the enhanced visibility that the Profit Velocity metric provides have shown significant
increases in their bottom line.
For example, by measuring the Profit Velocity of its 4000+ product varieties and then steadily
cultivating the sales of its higher Profit Velocity products, a leading global packaging
manufacturer drove pretax margins in its $2.0 Billion annual revenue North American business
from 11% to 16% from 2007 to 2009. Annual operating profits rose by $88 million, an amount
equal to 4% of revenue.
Figure 2: Analyzing by profit per unit and profit per hour reveals both “Hidden Winners”
and “False Profits” in the product line
Among several profitable initiatives, managers at the packaging manufacturer refocused scarce
sales resources on those customers whose purchases tended to generate higher Profit Velocity.
In one case, management discovered its business with one high-volume customer that was
believed to be among its most profitable customers, barely made money on a profit per machine
hour basis. Huge volumes consumed vast amounts of time on
the facilities, but precious little money was produced by all the
Between 2007 and 2009, a
effort. With information revealed by the PV Accelerator
consumer products
software, management was able to see exactly how fast each of
container manufacturer
the dozens of product varieties sold to that customer (from each
drove its pretax margins in
plant and to every shipping destination) made money. When the
its North American
customer’s annual contract came up for renewal, management
operations from 11% to
renegotiated the deal in light of this Profit Velocity information,
16%. It increased annual
pretax profits by $88 million
and soon made this key account highly profitable.
over the period, equal to 4%
of revenue.
Once the packaging manufacturer saw exactly how it could use
Profit Velocity to squeeze more total profit from less total unit
volume, it was able to shut down four plants, significantly reducing overhead, and further
boosting profits. At the same time, it kept reallocating more capacity to its high Profit Velocity
products and customers. Within 7 quarters, this refocusing of the product mix and customer mix
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
Page 5 of 8
Proprietary & Confidential
drove the formerly “Missing Metric” of Profit Velocity to rise nearly 50%, from $1031 to $1,509
per hour---from the same machinery.
Figure 3: From 2007 to 2009 speeds at which the packaging manufacturer generated gross
and net profit steadily increased
Typically, manufacturers using the Profit Velocity metric to rethink trade-offs and complex,
interrelated choices drive 3+ points of revenue to the bottom line as they find new ways to
squeeze more cash from the same assets, products, people, and cost structure.
New Capabilities in the Planning and Control of Profitability
PV Accelerator has been used to improve the profitability of many High Mix, asset-intensive
manufacturers in industries including specialty chemicals, electronic components, packaging,
industrial parts, plastics, pharmaceuticals, textiles and metals. It enables these high-productvariety manufacturers to increase cash contribution by gaining precise control over their
complex mix of customers, products and assets. Profit Velocity provides manufacturers with
entirely new capabilities in the planning and control of profitability. By enabling manufacturers
to maximize ROA by prioritizing incoming customer orders, executives are able to focus on the
opportunities that make money faster from existing assets.
•
Improves cash contribution by zeroing in on high Profit Velocity orders for more aggressive
competitive pricing.
•
Ranks products, customers, and markets by Profit Velocity to prioritize resources,
marketing initiatives, sales programs, and capital investments.
•
Maximizes cash contribution and profit impact of changes in mix, pricing, volumes and
asset configurations by running ‘What If’ scenarios.
•
Optimizes sales and operations planning (S&OP) with a common metric (Profit Velocity).
•
Increases ROA by refining asset utilization and capital investment planning.
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
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Conclusion
Time is money. And in the world of High Mix, asset-intensive manufacturing this old adage
takes on new meaning.
Executives who run complex manufacturing businesses know that significantly higher profits are
buried in small pockets here and there within their broad product and customer portfolios. But
they have never been able to see precisely where those extra bottom line dollars are hiding or
exactly what action steps they can take to start harvesting those elusive profit dollars.
Thanks to many recent advances in information technology and the development of the PV
Accelerator, there is a solution to this dilemma. By analyzing Profit Velocity, profit per time
along with margin per unit, decision-makers in marketing, sales, production, operations, and
finance can make more profitable choices from the complex options they face.
Manufacturers committed to improving their performance have embraced the Missing Metric of
Profit Velocity and have delivered bottom line gains to their shareholders consistently worth
3+% of revenues.
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
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Proprietary & Confidential
Contact:
San Francisco
New York
Based in San Francisco, with offices in key manufacturing
centers worldwide, Profit Velocity Solutions offers
PV Accelerator, a breakthrough in the power and
sophistication of business analysis and planning tools for
manufacturers.
One Market Street
245 Park Avenue
th
th
36 Floor
24 Floor
San Francisco, CA 94105
New York, NY 10167
+1.415.456.1000
[email protected]
Chicago
Singapore
Available exclusively through its global network of
consulting firm alliance partners, PV Accelerator reveals
new profit improvement insights to drive continuous profit
improvement. By supplementing traditional profit-perproduct-unit margin analysis with the previously unavailable
“missing metric” of profit-per-machine-hour, High Mix
manufacturers can tap previously hidden opportunities to
accelerate cash flow and achieve major gains in annual
profit and ROA.
One South Dearborn Street
Suite 2100
Chicago, IL 60603
One Raffles Place
Level 24
Singapore 048616
Shanghai
Taiwan
9/F Eco City
1788 Nanjing West Rd
Jing’an District
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14F, Section 5, No. 8
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110 Taipei, Taiwan
For more information, visit us at
http://www.profitvelocitysolutions.com.
© 2013 Profit Velocity Solutions
Missing Metric White Paper (WPM-13A02)
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Proprietary & Confidential