Share
Businesses may not have control over the economic environment, but they do have a tool that can help: improving efficiency.
In recent months, companies have seen their operating costs rise to varying degrees as wages have escalated, input prices have soared and financing costs have increased. If they want to curb profit margin erosion, their only alternative is to become more efficient.
While influencing the cost of resources (raw materials, equipment, labour, etc.) is not within a company’s power, measuring how it uses these resources and optimizing them is possible. Unfortunately, too few SMEs analyze their processes to identify potential waste. This makes it difficult for them to get an accurate picture of their operational performance and identify areas for improvement.
Identifying key optimization opportunities
You need to review all your processes to see where there is room for improvement. For example, here are some key questions to determine operational efficiency and understand the profit shortfall:
- Are employees maximizing their work time?
- Do they need to wait for raw materials or move around the plant unnecessarily?
- Is insufficient maintenance causing equipment stoppages?
- How much are you losing because of a quality problem?
Tracking performance indicators
Achieving your objectives means using relevant performance indicators and well-designed dashboards for both internal and external comparisons. Tracking should be done regularly. The frequency depends on the indicator, it can be daily, weekly, annually or even in real time. Checking indicators at the right time significantly increases the chances of correcting the situation.
Controlling production costs
Another essential factor in reaching your business objectives is to improve your production costs. A good costing model makes it possible to calculate all the direct or indirect expenses (production costs, supply costs, administrative costs, etc.) required to produce a product or service so that a profitable price can be determined.
This exercise must be repeated at least once a year and as the company changes. Furthermore, with significant inflation, part of the increase in input costs has to be passed on to products and services. The other part should be offset by improving efficiency.
Consider a factory that is unable to operate at full capacity because it does not have enough people. Instead of spreading its costs over 10,000 production hours, it must now amortize them over 9,000 hours, which necessarily increases its production cost.
To improve its results, it will have to make choices. It may have to increase its selling price, reduce or eliminate some expenses, optimize processes, or refocus its activities on certain products or services.
The company can also measure the profitability of its customers. In one study, researchers Cooper and Kaplan showed that, on average, 20% of customers generated 225% of a company’s profits, while 70% generated no profit. The remaining 10% were much more costly, accounting for 125% of losses.
Although this study was published in the 1990s, our experience shows that this calculation is still valid and that the gaps tend to become even wider in some sectors.
In tangible terms, this means that a company with a profit of $100,000 could potentially increase its profit to $225,000 if it had a better understanding of its costs and profitability.
Using such an analysis, the company can make more informed decisions, whether it be to work differently with certain customers or renew their customer base.
By taking action on specific aspects of their activities, managers can quickly adapt to the situation and improve their performance despite a less favourable context.