Sometimes Good Costing Information is Not Enough

Aug 21, 2015

I recently learned that one of my long-time manufacturing clients just closed their doors. This client was in a very mature manufacturing environment where his specialty was not subject to radical technological changes. And in fact his equipment and many of his products were similar to what was being done 25 or 30 years ago. His sales volumes were highly dependent on finding and keeping new work in a highly competitive selling price environment.

From my experience, mature industries that are not subject to radical technological changes both in products and in processes, must constantly strive to improve every phase of their operation with whatever subtle technological advances there are to remain competitive. This is especially true in an industry that has a relatively low entrance costs, and one that may include operations that will actually take jobs at a loss without realizing the long-term effects to their company. The end result is that the competitors in that industry may be pricing their products so low that it is not possible to compete profitably because they don’t understand their cost.

I have seen some examples in this industry that a competitors selling price was below the raw material cost of my client without including any of the labor or overhead necessary to convert the raw material to a finished product. In effect, the competitor won the job at a price that was below the raw material cost.

This client had done a very good job of finding and holding on to profitable work and although the volumes fluctuated year to year, in good years they made significant profits and in bad years he was able to manage the losses to be minimal.

However, in the last 18 months volumes were very soft and this client was unwilling to let his very experienced staff go by layoff because he was receiving assurances from one of his major customers that substantial new volume was soon to be developed. He made his way by using capital that was expensive and with significant limits in the amount that was available. The end result was that the new volume was never delivered and he exceeded the capital available which made it impossible to continue operations.

For all the years we were together, he had a very precise view of his product cost and spent the time and money it took to keep his costing information current and relevant to his market. I believe he is one of the relatively small number of managers/owners that we work with who truly understood his costing structure and how it could be managed to improve his competitiveness in the marketplace.

I believe in this case he relied on assurances from customers and friends who were unable to deliver as was expected and therefore forced this otherwise successful company out of business and cause the unemployment of a significant number of hourly and management people.

It simply points out the complexities of today’s business environment where many factors have to be managed, considered and effectively dealt with to maintain a long-term successful company.

Categories: Cost Accounting