10/1/2001
Higher Prices or Productivity Will Increase Pay
By Clarence Clark
During my seminars with machine shop owners across the country I hear over and over again two common themes: "I’m not making any money" and "I can’t afford any new equipment." From the employers’ point of view, these aren’t new problems; they’ve always been there. I will admit, they seem to be even bigger threats in the down-turned economy we’re in today, probably because we have more time to worry about them. I’d like to share with you some of my thoughts and opinions based on many years of owning a shop and talking with bankers, financial planners, other business owners and accountants.
The bottom line profit on most average machine shops is 3 to 4 cents on the dollar. A simple way to figure this is take the amount on which you pay taxes and divide it by the gross sales you have for the year. For instance, if you have $500,000 in gross sales and paid taxes on $32,000, then the math would be 6.4 cents on the dollar. I thought this sounded pretty bad, then I heard that the grocery business works on about 1 cent on the dollar.
If I’d have known the economics of the business when I started, I’d have probably thought twice about the engine rebuilding business, but like many of you, I was in way too far before I had figured it out. So what to do? You still need money for new equipment, raises for employees and to pay yourself. In my opinion, there are only two ways to give raises and buy new equipment. One is to increase productivity; the other is to raise your prices.
When you want to increase productivity, keep one thing in mind: productivity is linked to quality. To have one without the other is like having a peanut butter sandwich with no bread. A big pile of peanut butter with no bread is just as bad as a whole lot of bread and hardly any peanut butter. A whole lot of production with hardly any quality is just as bad as a whole lot of quality and no production. Obviously, we’d like a whole lot of both!
I’ve had numerous occasions over the years to talk about speed and accuracy, especially with new employees. Often a new employee just can’t wait to get a job done as fast as a veteran whose been doing the job for years. My motto was always "first you learn to do the job right, then you can start thinking about how to do it faster."
New equipment purchases often tie directly into increased productivity. I like to look around a shop when I visit, trying to locate the biggest bottleneck area because that’s where the improvement in productivity will often pay the most dividends.
For example, let’s say you mill an average of six heads a day and it takes 15 minutes to set each head up in the mill. That’s a total of 90 minutes a day of setup. Adding a quick-leveling table at a cost of $6,000 will save an hour a day. Your shop labor rate is $65 per hour times the 20 hours a month you save for a $1,300 total. At this rate, the table would pay for it self completely in the fifth month you own it, providing, of course, you have other work you could be doing in the 20 hours you save.
One of the things we have to watch in the shop is the old saying, "The job will expand to fill the time on hand." Employees have a way of filling the time they feel they have with the jobs at hand. This is very frustrating when you’re trying to increase productivity!
I’m often asked, "How much should an employee produce?" The rule of thumb I’ve used is three times the hourly rate you pay the employee. So if you’re paying $12 an hour, the employee should produce $36 an hour or $1,620 for a 45 hour work week, or $6,480 a month in labor. Try the math for your business and see how it works.
Bill McKnight, an instructor at the Dana/Clevite School also talks about shop layout as a way to increase productivity. He says that chances are, if it’s been more than a couple of years since you’ve rearranged your shop, it’s costing you money. How, you might ask?
Bill says look at the job mix you’re doing and how it has changed, the number of people you have in the shop, any new equipment you might have purchased and even job responsibilities that have changed between people. All that adds up to a need to change the shop layout. Bill says 10 extra steps between jobs can cost 10 percent in productivity! He believes that lots of planning and thinking and asking "What if" is the key before you move the first piece of equipment. Bill says the Dana motto is "nobody knows the job better than the person doing it every day" so be sure to include your employees in the planning stage.
I remember visiting a shop on the southwest side of Phoenix, AZ, a year or so ago. It was a beehive of activity. A steady stream of work and customers were passing through as the owner and I talked. Finally, after 15 or 20 minutes there was a break in the action and the owner told me how busy they were (that was obvious) and then that he wasn’t making any money (that wasn’t obvious). After a polite pause, I asked, "Have you thought about raising your prices"? "Oh no!" the owner replied, "my brother would take all my business at his shop down the street."
My response was to ask why do you have so many customers? The answer was: we’re priced very low, customers like us, we do good work, we treat customers very well. We talked a while and I brought up the price increase issue again and I mentioned a modest 5 percent price increase in labor. The owner’s reply was that amount wasn’t very much, so we did a little math. His labor was $25,000 per month and of course a 5 percent increase added $1,250 to the bottom line. "Would an additional $1,250 a month help?" I asked. "Oh yes!" was the response. We went on and talked about his fear of customer acceptance and the fact that on a modest job with $500 in billable labor, the increase to the customer was only $25. I reminded him again of all the good things he does for his customers, all the reasons they buy from him besides the really low price he’d been charging, and the fact that if he goes out of business, the customers lose.
After convincing the customer to give the increase a try, I broached the subject of another price increase a couple of months later. When you get way behind on your pricing, usually you have to spread the increases out over several months to make it more palatable to your customers. Remember that when you’re continually buried in work, month after month, it’s a real good indication you’re not charging enough.
Most businesses I visit could benefit from a combination of both raising prices and increasing productivity. It’s a hard thing for many shop owners who got in the business just like I did; they were good at fixing mechanical things. But no matter what our comfort level is with the management side of our business, it needs attention. You don’t need to take my word for this: Barry Soltz at AERA and Joe Polich at PERA will both tell you that their technical sessions are almost always better attended than management and financial sessions. It’s that comfort zone thing; we feel at home in those tech sessions, we can relate well to the speakers and enjoy the discussions.
Well, I’m telling you we’ve got to climb out of the comfort zone, challenge ourselves with new ideas and try new things. My favorite saying is "If you continue doing what you’ve always done, you won’t make it!" There’s a lot of truth in this statement. Look around you and notice the companies who used to be in our business and are no longer with us. Manufacturers, suppliers, competitors and friends, none was immune from business failure. Take charge of your future!