Book Order Form | Table of Contents | Preface | Chapter 1 | Chapter 2 | Chapter 3 | Chapter 4 | | Chapter 5 | Chapter 6 | Chapter 7 | Chapter 8 | Appendix A | Appendix B | Glossary

    Not all Operations and Manufacturing managers are true blue, and the experienced ones have long ago learned that the appearance of good performance can be enhanced by playing the inventory game to their advantage. Unneeded and unwanted inventory can make a bottom line took better in any Accounting Report which includes labor, material and overhead in the inventory figures. Even while shipping commitments are being missed, products can be built and added to inventory. If a manipulative manager adds labor and overhead costs to the material costs of products not necessarily needed at that time, the operating expenses for that period are reduced. This makes him and the profit and loss statement look better in that period but grossly distorts the real picture.

    In my first ever role as a general manager, I was in charge of manufacturing ferrite memory cores. I discovered habitual distortion of true performance; a procedure that had been tolerated for years. Our division produced 20 to 30 different types of cores. They were all made on the same presses of the same basic material, but each had its own particular set of specifications and had to meet strict testing criteria before shipping. While the presses were running well, producing one type of core with high pass rates yielding 80-90%, the line supervisors would let the presses run on and on, churning out just that one core, sacrificing the other types and missing other customer’s deadlines. On paper the yield figures looked great, and by taking labor and manufacturing overhead costs into inventory, the financial performance seemed outstanding.

    So what was the problem?

    Just this: In a company which made 30 different components, keeping one component on continuous production tied up an entire department. This made the one customer who needed that component very happy, but irritated several other customers who each needed their own different components on time. To make matters even worse, we made hundreds of thousands of one type of component which were not really needed.

    But the figures looked great!

    Building unneeded inventories may make the profit line look good in the short run, but it also leads a company straight to disaster. Managers who have taken the easy way out, to make themselves look good on paper, will go to great lengths to hold on to these resources, overbuilding and impacting efficiency and yield figures as well as costing more than sales commitments will cover. This eventually creates cash shortages and distorts the true profitability of the company. It gets even worse when the manufacturing resources exceed the need.

    This situation sends the company into what I call, The Spiral to Oblivion.

    Growth is a very exciting way of life, but under certain circumstances it can mask problems. Many growth companies have taken wrong turns, or even disappeared along the road to success because Management was unable to respond properly when business leveled off or took a turn for the worse. Managers who are very good at growth often fail when a stall occurs. When faced with hard decisions, they freeze up at the worst possible moment. This impotence can kill the company if he or she is not able to respond in a timely manner.

    When a business experiences a slowdown in the market, the most difficult task for many managers is letting people go. There is an inherent resistance to reductions, and all kinds of rationale are created to delay the inevitable. The trouble starts when a manager does not want to recognize that a downturn is real, that manufacturing resources are exceeding the sales demand. This situation requires objective and timely actions to minimize its impact on profitability and company survival. Reducing expenses and, more importantly, reducing staffing levels are tasks most managers are uncomfortable with and find distasteful. However, every business will eventually see a slowdown or downturn, and the mature manager must take the necessary steps when they need to be taken or risk the Spiral To Oblivion.

    In a market downturn, the first thing the manager must do is recognize the change and understand its ultimate impact on profitability and cash flow. There is a normal lag in profitability drop-off which is often delayed even further by creative accounting.

    But why, oh, why does it take some managers so long to realize that without the bookings and revenue as projected and budgeted, any profit plan will fall apart?

    Most likely, the answer is that managers are reluctant to make any changes, particularly those changes that are not popular and require gut-wrenching decisions, such as staffing reductions.

    My Law of Management Physics # 27 states, "Revenue levels will eventually reach the level of bookings (new orders)."

    Whenever there is a down-turn in new orders it is essential that managers compare the level of organization and the resources which will be needed to support the lower level of bookings. Whenever a downturn in the booking level continues to affect revenue, quick adjustments are necessary. When current bookings fall lower than recent or past levels (adjusting for cyclical variations), the situation requires corrective action.

    The most obvious sign of trouble is a booking to billing ratio (book to bill ratio) which has fallen below one. This indicates that the level of new business coming in is less than the shipping and billing level. In this situation, you must act fast. If bookings are down, the organization must be restructured to reflect the lower booking level.

    Ignoring a book to bill ratio of less than one is usually justified by statements like, "This is a one-time thing, and it will pass," or "This is typical of our cyclic business."

Such excuses can be fatal!

    Perhaps no action should be taken in the first month when the less-than-one ratio first appears, but it is a warning signal that should not be ignored.

    Even when an organization appears balanced, with man-power meeting the current shipping level, adjustments should be considered if the booking level is consistently less than the shipping level. In order to maintain a financially viable company, actions must eventually be taken to balance the organization and resources to the new level of business as dictated by the booking level.

   No one likes laying people off, especially when an operation has taken so long to achieve good results. The best solution is vigilance. It is helpful to plot the book to bill ratio on a monthly, rolling average. This can help smooth out the one-time glitches and prevent overreaction.

    Example: AJAX widget company has been shipping widgets at a rate of $1,000,000 per month. New bookings are coming in at a rate of $400,000 per month.

$400,000 (bookings) ÷ $1,000,000 (billing) = .4

    Anyone who does the math must recognize and accept that AJAX is no longer a $12,000,000 company. Management must make adjustments and fast. It is obvious that the future revenue will not be there to support the higher level of production. Even so, many managers rationalize their inaction and fight making the needed corrections, and if they continue to ignore the signs and resists making changes in a downturn, the spiral is underway.

Excuse #1: "Staffing levels must stay high to meet backlog requirements."

   The backlog is the total figure of product in inventory that is committed to customer orders. The total figure may be high, but the schedules for delivery have most likely been spread out over several months. Managers who do not want to make necessary staffing adjustments often turn to backlog aging—pulling-in and speeding up customer delivery schedules. Then they argue that people must be kept in place for an extended period to meet near-term backlog schedules. By pulling in backlog requirements, the overall backlog deteriorates even faster, and the eventual reduction in personnel will have to be far more dramatic, falling below the critical mass needed for reasonably efficient production schedules. Another danger of pulling in delivery dates is that customers may not accept them, hence will not pay for the product until the proper delivery date.

Excuse #2: "Personnel are needed to fill past due orders."

    It is strange how, after living with past due shipments for years, things suddenly become urgent and must he resolved immediately. Again, it is just delaying the need to reduce personnel.

Excuse #3: "Opportunity is just around the corner."

    Managers will argue that they must keep staff in place to fill that big order that has been pending for several months.

    "If people are let go, the customer will become very unhappy, and take their business to a competitor."

    Of course it is also true that the potential customer will not pay to keep these people in place until the job is sprung loose.

Excuse #4: "We should begin building inventory in order to keep people busy."

    This action is more subtle, and not always quickly detected by upper management. Manufacturing managers, in an effort to look good and retain personnel, keeps the input pump running full bore. However, production can be like a dragon, gobbling up any and all free material and labor hours laying around. Not only is there a risk in building inventory on the come (without even potential customers), the absorption of overhead and manufacturing labor hours will yield inaccurate profitability figures.

    Excess labor and overhead should be treated as a period building expense and deducted from the current profit performance. By overbuilding a product, the labor and overhead are capitalized (assigned to the product value in inventory) and later written off as unneeded, obsolete or surplus.

    There goes the profit line!

    Building unneeded inventory is probably the most obvious warning flag for upper management to look for. A company is over building when it is producing inventory that is not covered by orders. At first, if inside forces (department managers or supervisors) are perpetuating the Spiral and their activities have not been detected, inventory might not show the pulling ahead of production and lagging of orders or billing.

    Ironically, while inventory builds up, the profit and loss figures look much better. However, excess labor costs and overhead are being absorbed into the inventory, giving a false impression of profitability. Even under normal circumstances, a Manufacturing manager can play havoc with the profit performance by over building inventory, but in a down-turn this can be devastating because the company will never be able to pay for the excess inventory.

    Lower billing levels will never support higher-than-needed operating costs. People spend money. Material costs, telephone expenses, supplies and services are proportional to the number of people in place. Besides direct costs, excess personnel add inefficiencies, spend too much money, and create more scrap, all of which plays havoc with the bottom line.

    The longer it takes to make corrections, reduce staffing levels, cutting back on overhead and excess expenditures, the worse the financial picture gets. Pressure continues to build on the manager in charge as he resists making the necessary changes. By maintaining excess staff and not addressing imbalances in the inventory, the problem gets worse. More scrap is created with each shift and the inventory balloons with more raw material and unsold product.

    At this point, with the company now completely out of control, upper management finds that it has been relegated to OBLIVION. The entire downward process, brought about and perpetuated by inaction, is visible in deteriorating cash flow and expanding inventory. The cash flow problem becomes clear when receipts (collections) are not sufficient to cover expenditures.

    This is not a sophisticated concept to understand. According to my first Law of Management Physics, "The goes-innas must equal the goes-outtas."

    The sure sign a company is headed for oblivion is when the expenditures, services and payroll, exceed the levels needed to support the bookings and shipping commitments. Eventually expenditures will outpace collections, and the company will go bust.

    Personnel reductions are difficult, and it is natural for department managers to feel that other departments should take the hit. But when you are caught in a market downturn, democracy cannot prevail in the running of your company. Top management must make these reduction decisions. Every manager must reassess the roles and numbers of personnel that will be required to support the anticipated amount of business.

    In an effort to be fair and avoid accusations of favoritism, it helps to develop reduction criteria. For example, "We will cut out project X and those jobs associated with it." or "We will forego our European activity for now." Following that, management must target a dollar amount of savings from this reduction. This helps ensure that it is not just lower salaried people who are let go, which might happen if the target was only in numbers of employees.

    An alert department manager can prevent this spiral from beginning by focusing on staffing levels and controlling the inflow of materials. Payroll is clearly and easily measured against both the company’s need to fill orders and what it can afford.

    Most importantly, once the decision to reduce staffing has been made, it should be implemented immediately (as soon as the paperwork is completed). There is never a good time for people to be let go. Don’t wait until next Friday afternoon.

    If an organization is really determined to fight cutbacks, strategies such as getting new business at any price must be avoided. If not, the company will find itself taking on low-margin business, including those jobs no competitor wants. Such pricing pressures definitely lead to forced staffing reductions.

    Because the need for staffing reductions is so apparent, much energy goes into wrestling with these reductions and the resulting shock waves. However, it is also important to make sure that other forces are not spending money unnecessarily. In a Spiral, expenditures must be controlled across the board, or better yet, stopped altogether.

    Many items require careful monitoring: projected Cost of Goods Sold within the product that is shipped, material already available in inventory which can still be used, the purchase orders with planned receipts aged, and material received. Keeping an eagle eye on them is the only way to insure that more material than necessary will not creep into the system.

    In almost every turn-around situation, cash-out versus cash-in is the first problem that must be resolved. Although controls may be set up to reduce cash flow specifically related to the payroll and generally to all expenditures for indirect material and outside services, off in a corner somewhere someone continues to buy direct material for shipping products.

    It continues to amaze me that in many companies there are extensive signature controls for capital items, but manufacturing can commit hundreds of thousands of dollars for anything classified as "direct materials." That is another leak that needs to be patched before oblivion looms.

    Besides payroll, material is next in line for stringent control efforts. Basing material expenditures on a forecast of sales at the new, lower level of business is imperative. Once this forecast is scrutinized and approved, a benchmark must be set for purchasing material to meet near-term shipping commitments.

    The efficient manager must track the commitments and movement of material throughout the system. The trick is to make sure the commitments to buy are consistent with what is already in inventory and projected requirements for upcoming shipments. He or she must keep also know the nature and culture of purchasing personnel: to buy material at the lowest price, to overbuy in order to gain that lower price, to always make sure that materials are available and to force deliveries ahead of time if needed.

    Ordering more material than needed or receiving it ahead of time is dangerous in a downturn. The practice should be halted before commitments to pay for are made.

    By enforcing manufacturing limits linked to shipping forecasts, you can prevent extra labor and material expenditures and keep the business running during the downturn. Cash becomes even more important here. The company going through a downturn must have the cash available to weather the storms ahead. As sales decline the accounts receivable, which are still high from previous sales, can yield extra cash if the operating levels are reduced quickly enough.

    This strategy can prevent the Spiral or at least slow it down while preventative steps are taken.

    For example if a company was operating at a $10 million revenue level, but recent orders would only support $5 million, the sooner operating expenses were cut to match current trends, the better off the company’s prospects for weathering the rough financial weather. I have helped turn companies around by adjusting the cost base to the actual level of business. Because we reduced the goes-outtas almost immediately, the accounts receivable were enough to sustain the lower operating expenses until new business could be found.

    Time is of the essence in spotting a downturn. A good manager must have the maturity to respond properly when the warning signs come: book to bill ratios under 1.0, poor cash flow, excess inventory, material flow, and profitability problems. Responding promptly in these situations will not only prevent a further slide down the Spiral To Oblivion, but they will also prepare the organization to react quickly to an upturn, the fun part of running a business.