Inaccurate labour costings could kill your profits

Most manufacturing businesses have a strong handle on overall company profitability, but some – especially those making multiple products with high labour content – struggle to set product pricing that is both competitive and profitable.

According to the Office for National Statistics (ONS) [1], profits are on the up for UK manufacturing companies. The average net rate of return in Q1 2015 was 11.9%, up from 10.9% in 2014 and 8.2% in 2013. What’s behind this improvement? According to the ONS, one factor is the direct link between manufacturing firms’ investment in IT and their productivity [2]

Certainly, productivity plays a big part in determining profit and your competitiveness, but there is another critical issue that many manufacturers struggle with, which is how to determine the right price for a product. Ultimately, it is pricing that determines the difference between a profit- and loss-making product.

Accurate costings can have an accumulated impact on profits

Typically, a minimum price will be determined by materials costs, plus direct labour, indirect labour and overheads. Most businesses will be able to track materials costs with high accuracy. For those businesses that have it, properly configured enterprise resource planning (ERP) software can do a good job of keeping track of material costs even when prices change frequently.

However, tracking labour costs with a high degree of accuracy is far more challenging. And when the labour contribution outweighs materials cost, as if often the case in the labour-intensive operations that characterise UK manufacturing (Figure 1), it becomes even more important that labour costs are calculated accurately.

Where manufacturers have multiple product variants with high labour input, even small inaccuracies in standard times can combine to dramatically affect overall profit.

Actual vs standard labour times

Historically, manufacturers have used ‘standard’ labour times to help inform their pricing strategies. They typically derive these by comparing production times and labour costs for similar products that they have made in the past, or by conducting ‘time and motion’ studies. Unfortunately, both of these approaches can give inaccurate data. ‘Similar products’ can have very different labour requirements, and conducting trial runs under measurement conditions don’t account for all of the variables that can affect labour times, such as the use of different operators, shifts, equipment and so on.

Producing accurate time studies depends on repeatedly observing and recording the production of the same part by different workers, accounting for all of the possible variations in efficiency. This approach takes time and will typically divert an experienced worker, such as a line supervisor, from their normal day job.

Mitigating the risks of unprofitable labour and production

One way to mitigate the risk of underestimating standard times is to simply overestimate them. This approach however creates another risk – uncompetitive pricing and loss of market share.

Some manufacturers who deal with short production runs face yet another challenge – that they don’t have time to build experience to be able to estimate standard production times, cost and labour content before the job changes.

While predicting direct labour costs is difficult, understanding how indirect labour affects labour utilisation can be even more of a challenge where staff can work on both direct and indirect tasks in a single shift.  A line supervisor might dramatically vary the time they spend on indirect tasks such as training and administration from one shift to the next. These indirect activities are difficult to account for in the labour costs.

Evolving products, static labour costs

As product designs evolve over time, because accurately determining standard times is a slow and costly process, sometimes the set standard times aren’t updated alongside the product development, and so a business’s product or process engineering can get out of synch with product pricing. Legacy inaccuracies are perpetuated, yet go unnoticed as they are buffered by the business’s overall profitability figures.

These are just some of the complexities and deficiencies associated with deriving figures for standard labour costs. Without accurate ways of measuring direct and indirect labour costs, setting a product price can involve guesswork that ultimately risks company profits. So what can manufacturers do to quickly and accurately derive actual labour costs?

IT investment: manufacturing management software

The ONS’s analysis of the profitability of UK manufacturing companies suggests that IT investment has a significant part to play. The use of manufacturing management software can help manufacturers to close the gap between estimated standard labour time and actual labour time. The only way to track actual labour time without spending a lot of time and effort is to automatically measure – both direct and indirect labour – as work is in progress on the factory floor.

One of the features of MESTEC’s manufacturing management software is its ability to accurately and automatically measure the time that all operators spend on different tasks. Manufacturers using our software and touch screens can quickly identify unprofitable products by enabling them to identify discrepancies in actual and standard labour times.

We provide manufacturers operating discrete and batch processes and/or a high mix of products with an easier and more accurate way of gaining full visibility of labour hours and product cost.

Case study: GTK

GTK manufactures cable assemblies for a wide range of applications. One of the challenges they faced was not being able to accurately estimate standard labour times in their Basingstoke facility which specialises in low-to mid-volume production runs of a wide range of custom products.

Within a matter of weeks, MESTEC’s manufacturing software enabled GTK to pinpoint jobs that had a large variance between actual and standard times, and address future product pricing appropriately. Read the full case study.

Pricing for profit

Manufacturers with batch-based and discrete assembly operations typically depend on high levels of labour to produce their goods. MESTEC’s manufacturing management software makes it easy for manufacturers to quickly and accurately measure direct and indirect labour times for operators, line supervisors – in fact anyone who contributes to the cost of the product by incurring labour time. This rich set of data enables the management team to generate accurate analyses that can point to discrepancies in labour hours and incorrect – and unprofitable – product pricing.

To discuss how we can help you to simply and quickly analyse your production times and labour hours to identify unprofitable products and increase your overall productivity, contact us today.

References

1: Profitability of UK Companies, Q1 2015

http://www.ons.gov.uk/ons/rel/pnfc2/profitability-of-uk-companies/q4-2014/stb-profitability-of-uk-companies-q4-2014.html

2: UK manufacturing firms more productive thanks to IT say ONS

http://www.computerworlduk.com/news/it-business/3582254/uk-manufacturing-firms-more-productive-thanks-to-it-say-ons/