Mar 11 2014
Lean Handbags and Micro Failures | Mark Graban
See on Scoop.it – lean manufacturing
Blog post from Mark Graban at Lean Blog :
“I enjoy reading the magazine Inc. for my interests in startups and entrepreneurship. There are often examples and case studies that directly reference Lean thinking or just sound like Lean and Kaizen with another label…”
Well run businesses are always good reading, even if their stories are usually embellished. Starting the design of fashion accessories from a market price or organizing to allow chefs in a restaurant chain to experiment with new dishes, however, just sounds like good management, not examples of “Lean Thinking.”
I have never found much depth in the contrasting of “Margin = Price – Cost” with “Price = Cost + Margin,” maybe because I have never worked in a cost-plus business. Commercial manufacturers usually do not have the power to set prices this way. Perhaps, the Big Three US automakers did have that power in the 1950s, and Toyota didn’t.
In Tracy Kidder’s 1985 documentary book House, a Boston lawyer hired a local contractor named to build a house in the suburbs. The contractor rigorously calculated the costs of the materials and labor, tacked on a 10% profit, and presented a bid with no wiggle room. It was not intended for negotiation, but the lawyer just had to wrangle some concession out of the contractor. The culture clash between the two makes great reading, but also throws light on how “cost-plus” works in practice.
The equation “Margin = Price – Cost” is based on the assumption that Price and Cost are characteristics of the same nature, both attached to each unit of product. It is true of Price: whenever a unit is sold — in whatever form and however it is financed — it has a unit price, and it is not ambiguous.
Unit cost, on the other hand, is the result of allocations among products and over time done in a myriad different ways, with different results. By shifting overhead around, managers make the products they like appear cheap, and the ones they want to kill appear expensive. Once the “expensive” products are terminated, the same overhead is spread among fewer survivors, thus making new ones unprofitable, and the death spiral ends only with closure of the factory.
Instead of the simplistic “Margin = Price – Cost” for each unit, a sound economic analysis of manufacturing considers the flows of revenues and expenses associated with making a product in given volumes over its life cycle, and sometimes a product family rather than an individual products with, for example, some products given away as free samples to promote the sale of other products.
See on www.leanblog.org
March 11, 2014 @ 4:00 pm
I think the “cost plus” mindset is still VERY prevalent, even though most companies do not really have this pricing power. People THINK they do.
For example, how many news stories do you see about companies saying they “have to raise prices” or are “forced to raise prices” because their raw material costs are up, gasoline prices are up, etc.
I think the handbag company looking at the market and working backward from a market price is brilliant — it’s simple, but very RARE thinking.
March 12, 2014 @ 10:29 am
Cost Plus mentality is EVERYWHERE.
Defense and Public Sector. Anything contracted by the US government takes on a cost plus mentality (regardless of how they classify the contract…) because of accounting laws created to eliminate price gouging. In order to win a major competitive “fixed price” defense contract you have to bid on the price by giving them a complete breakdown of all of the costs and demonstrating that the margin is not above a fixed number (usually 10%). Once you have the contract, you have to open up your books and prove that the costs proposed were real. This is often for products that are also sold commercial with market driven prices readily available. The market driven price is pretty much always lower than the accounting mandated prices.
Suppliers to major manufacturers. Major manufacturers often act pretty much exactly like the government with their supply chain. They ask their suppliers to open up their books and then they make sure the supplier isn’t making too much money on them by regularly auditing. With preferred supplier relationships, this is often done in the absence of market surveys or cost comparisons.
Healthcare. This is the biggest and most important cost plus fiasco in all of finance. Healthcare is a strictly cost plus paradigm and I think it is the root cause of almost everything wrong with the healthcare system (the US system anyway…). The way we pay for healthcare should mean that the only way that a hospital can ever lose money is if they do their job too well. The better job a hospital does, the less money they make. They are paid strictly on the amount of time and activity that is spent on patients. More time and activity spent on patients is pretty much the opposite of the patients wants.