This post opens up original ways of thinking for those looking for a new way to steer their business in the current unstable economic climate. With the topic of business (un)stability, we want to create an insight into an alternative way to steer both the manufacturing industry and trade and services according to techniques that no longer hang in the last century.
How can you make an unstable business manageable?
It is no longer news that almost every company is affected by the changing economic situation that causes a lot of instability. Returning to the past is not possible, sticking to outdated control systems is also not sensible, but what is? We must dare to ask ourselves whether the ‘classic’ cost-accounting systems, which support management decisions, are still adapted to this new situation. Prof. Marc Lambrechts (KUL) stated at a conference: “Eli Goldatt’s greatest merit may be that he has developed methods to control instability”.
Example 1: Cost price
Cost price. The classic way of calculating cost prices in the manufacturing industry has its origins in the industrial accounting of the last century. You calculate the raw materials and parts you need, you add to this the cost of the work done by the people and the machines and you have a reliable figure. For this we use a ‘standard cost’ for an hour’s work of a worker (e.g. 82.66 €) and/or a machine (bc 167.32 €) . So-far-so-good everyone does so. Some go even further and want to allocate the ‘indirect’ costs as well, as these are sometimes very important. Acitivity Based Costing is a well-known method for this.
There is a double problem:
A. These calculations create the idea that the hourly cost of €82.66 (direct cost) corresponds to a proportional expenditure of the company… and that road is very long and certainly not one to one. After all, if that worker does not work, he must also be paid! And if the machine is not running, depreciation continues… Yes, models have been made that take into account the degree of utilisation of the machine and make a correction to the hourly cost, with the result that a machine that is little used becomes ‘more expensive’ than a busy machine, etc…
B. All very well and good, but these ‘adjustments’ are made on the basis of analyses, which are done afterwards, on the assumption that future calculations will then be ‘more accurate’… There have certainly been attempts to calculate these surcharges à priori on the basis of the planned use of resources. Needless to say, such models become hopelessly complicated and still do not correspond to the reality of the outturn account at the end of the period because the much-needed stability no longer exists.
Instead of looking for an even better model, perhaps it would be better to ask ourselves what decisions we take on the basis of this type of calculation. Determining sales prices: The conscious ‘standard cost’ is the basis for any cost price calculation. The hourly cost is an average for a certain period of time, usually one year. From the addition of the price of raw materials and the times per work step, the cost price is calculated. Provided there is a surcharge for the ‘fixed costs’, a sales price is then calculated.
The problems are clear:
1. Labour costs are perceived as variable, whereas in reality they are much less variable than we would like them to be. After all, you cannot just pay a worker for the hours he works and it will get even worse with the unitary status for blue-collar and white-collar workers.
2. The standard cost is blind to bottlenecks. We know that a bottleneck in the flow creates a potential loss with enormous impact. Here the rule applies: “One hour lost on the bottleneck is one hour lost for the entire factory” and that effect is not visibly denounced in a standard cost system.
3. The standard cost is blind to opportunities. After all, in the case of unused capacity, the use of resources must be calculated as marginal. This is traditionally considered “very dangerous”, even if one does not have adapted systems, but it is a small gold mine if it is managed correctly.
4. The real selling price is determined by the market price. This leads to endless discussions between sales and production as to whether or not one will work ‘with a little loss’ for certain products.
Example 2: Outsourcing
Outsourcing takes place under pressure of some very well known strategies such as: We should not make what we can buy cheaper ourselves. The more proportional the expenditure, the less risk. These half-truths have led to a very large exodus of our manufacturing industry in previous years and still do so today. In a number of cases – generalisations are out of the question here! – are decided on the basis of: standard cost systems! In addition to the earlier remarks about cost price, there is also the fact that with every major outsourcing a part of the fixed cost is ‘stuck’, which is then spread out again on the remaining products or ‘cost carriers’ in the next accounting period. Even structurally, this picture is not without additional costs because managing a supply-supply chain requires different skills and systems.
Example 3: Delocalisation
Delocalisation is always based on the consideration that labour costs will be a fraction of the current costs. This is undeniably true, but this does not mean that every delocalisation has led to much more profit… In addition to the effects of the 2 previous examples, the delocalised factory, in order to work efficiently, is not always nicely synchronised with demand. The consequences are manifold: shortages and/or too many stocks.
The validity of the control model depends on the way in which this model corresponds to reality and that reality changes. The figures we use to make both tactical and strategic decisions are generated from systems designed for factories of the last century. The standard costs and ditto ‘factory accounts’ are based on the assumption of stability. The pure link between the analytical accounts and the actual court: the profit and loss account at the end of the period is becoming increasingly difficult for the same reason. Our experience shows that the use of Throughput Accounting does not suffer from the effects mentioned because it is one-to-one with the profit and loss account. Moreover, all local decisions are brought in line with the overall results.