Uncommon Sense: Barriers to Success

In what seems like 600 years in manufacturing, I’ve worked with some pretty sharp manufacturing managers. Many were successful, as measured by career growth, income, and their employers’ success. Others were not, and the reasons for success or failure are fairly consistent. Everyone knows energy, compassion, enthusiasm, and considerable technical and managerial ability are essential to success. No argument there, so let’s look at the three most common reasons for failure, with a view toward eliminating them as barriers to success.

The No. 1 reason manufacturing managers fail is that they don’t know how financial managers keep score. A business incurs costs that can’t be tracked directly to production or products. These include taxes, administrative costs, depreciation and a host of others. These costs are dumped into overhead and allocated against direct labor hours or dollars, or floor space or something else that appears to have something to do with making products.

Costs that have nothing to do with actual production still have to be allocated. Things go awry when the allocation constant is too small, resulting in unabsorbed overhead. That’s when the manufacturing manager wants to generate more hours in the plant to cover the overhead. Dead wrong! The problem isn’t the size of the labor pool or the hours worked. There’s just too much overhead to support the level of business! The right answer is to shrink the costs going into the overhead pool.

The No. 2 reason for failure is trying to manage with the income statement alone, ignoring the balance sheet. Financial reports come in two forms, income statements and balance sheets. The income statement records period results over one segment of the accounting period. It measures the dynamics of the business: how much money it spent and what for, and what money came in and from whom.

The balance sheet is a snapshot of the business at one point in time. It shows a static image of the business: how much cash it owns, the value of its fixed assets and working capital, and the amount it has borrowed. Anything left over goes to shareholder equity. Nothing wrong so far. If you want to see the trend of the business, you just compare sequential balance sheets.

Things go awry when managers try to manage based on period results alone, without considering the trends in the business. That often leads to some goofy initiatives and may truncate a manager’s career!

The No. 3 reason for failure is responding to economic conditions that existed 20 years ago. During the halcyon days of the Carter administration, the prime rate went to 21 percent. Because the cost of borrowing is a balance sheet item, many manufacturing folks paid little attention to inventories. The stigma of having products on the shelf was more than offset by being able to ship on demand and avoid criticism from top management for not being able to ship.

Then someone saw the exorbitant cost of borrowing and of carrying inventory, and the drive to eliminate inventory began. But firms still had to respond to customer demands, so the solution switched from inventory to capacitythe ability to make it just in time. But what do you do with that capacity when demand softens? Here’s what is really wrong: Manufacturing managers are still responding to a 21 percent prime rate, even though the prime rate now is at 6 percent and the whole capacity vs. inventory algorithm has changed.