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

    In the normal course of business the Engineering Department plays a crucial role in controlling and optimizing the inventory. It all starts with a good design. The more complete and tested the design, the less likely changes will be necessary. Finalizing a design before creating a Bill of Material and going all out on production minimizes the possibility of filling inventory with parts and components that will go unused and have to be written off at year end.

    I have seldom heard the words effectivity date coming from an engineer. The effectivity date of a component or part is the date by which the part or component can be used in manufacturing of the product. Mature companies establish formal guidelines defining the effectivity date in a way that ensures manufacturing will be prepared to make the change in their process.

    Too often the effectivity date is unilaterally set by an engineer sitting in front of his PC, completely oblivious to the outside world. For engineers the date of change is immediate and does not allow input from Manufacturing, Purchasing, Sales or Accounting. When such changes are made, a new part or component (or parts and components) are substituted for the old ones in inventory, and the resulting scramble to make the change is usually very costly. As Purchasing rushes to find the new parts before the Sales complains about delays, they inevitably incur expediting charges that send Accounting through the roof.

    Sure, at times there may be a defective or non-performing component that needs immediate replacement. Engineering is responsible for making changes to the product when dictated by performance quality, cost improvement or safety. However, there are shelves full of parts and components all over the world which are still usable and could have been phased out after depletion, except for that one design change.

    Don’t get me wrong, Engineering departments play an extremely important role in any manufacturing company. The engineering perspective provides crucial input to the Material Review Board (MRB) by helping make quick decisions on the disposition of products and components. However, it does no one any good when Engineering unilaterally makes decisions that delay getting designs into production and create pigeonholes that are classified "components to be disposed of" and "components for assemblies."

    Effectivity dates should be set by multi-departmental consensus which always takes into account the existing stock of usable parts. Otherwise you will end up stockpiling enough "obsolete parts" to sink your company’s profit margin faster than the Titanic.

    It is also Engineering’s job to select and qualify parts and rightly so. But it should stop there. Engineering should never be left to negotiate prices and availability with vendors and suppliers. Vendors love to have engineers make the first buy before Purchasing gets a chance to negotiate a fair price. And when engineers do buy, they buy too many parts, parts which have a high probability of being replaced in the near term. Parts like these live in limbo, like the unbaptized innocents, neither really in or out. They are counted as part of the inventory time and time again, but are never moved out or used.

    An interesting inventory report to run in a heavy engineering company is one which notes all components and parts listed "not used on a Bill of Material (BOM). If a component or part does not exist on a BOM, it will never be used by Manufacturing to build products. (See the example of Company E at the end of Chapter 2, page 42)

    In my experience engineers are notorious for taking material out of inventory without recording the transaction or even without telling anyone in charge. I have known engineers who would climb over walls or squeeze into cages like mountain climbers or amateur magicians, just to get that part they happened to need right now.

    A more subtle impact on inventory and finances is the delayed development program. The often used cliché is true: it takes Engineering 95% of the time to do the last 5% of the design. In order for a product release and launch plan to be successful, several related activities in sales, marketing, finance and manufacturing have to be planned and acted upon parallel to the engineering design effort. These are all keyed to the release date specified by engineering and any delay creates havoc in all areas, with a large negative impact on a company’s cash flow.

    In order to meet schedules, Manufacturing has to take a risk and commit to material purchases which make material available as it will be needed in the manufacturing process. The longer a design takes, the more likely parts will be changed or substituted, creating a pool of unneeded parts which will sit in inventory, and (no surprise now) will eventually be written off.

    Team members who are only concentrating on their piece of the pie, do not have the perspective to recognize the impact that delays have at the beginning of a program. Most programs build to a crescendo -- the date of product release -- and any delay in meeting that date is not only costly to the company financially but hurts the company’s image in the market place.

    What appears to be a modest slip in scheduling and milestone commitments at the beginning of a program can have a devastating effect on long term outcome. Windows of opportunity for new product introduction are often fragile, so a manager must be sensitive enough to catch them when they open and address them with the priority and level of commitment they require. I have heard too often the unabashed excuse, "We will only be a month late…"

    A one month slip is like that first drink on a first date, it has a tremendous impact on the big picture.

    Once when I was a division manager, we had a purchase order from a Fortune Ten company. We would not have been considered eligible if we had not been a division of a multi-billion dollar corporation. Believe me I got it from both sides. The customer wanted their deadlines met and the company wanted their reputation preserved. My staff was in complete disarray because of the pressure we all felt and their inexperience in dealing with companies of this magnitude.

    I received a visit from the customer’s representative, who wanted to make sure that we had the right attitude and were giving a high priority to their purchase orders and needs. After everyone was seated, the first thing he wanted to know was. "Why shouldn’t I worry about you meeting the schedules for the first article and the subsequent production buildup?"

    Surprising even myself, I remained very calm (I realized later I was able to remain calm because I was so underpaid I had very little to lose) and gave him my well thought out answer. "First off, if we miss the dates, every day we are late will cause cost over-runs, hurting our bottom line and cash availability. Also, if we miss dates, we tie up personnel resources that we need for other projects, hurting our chances for future success. Thirdly, if we fail, all hell will break loose at corporate headquarters. Finally, if we miss our revenue and profit forecasts it will affect our bonuses, and maybe even my job. So I assure you that I will be watching the program personally and as soon as I see a problem that could cause us to miss a major milestone, I will force my staff to find alternatives to make very sure our final schedule commitments are met."

    The man glared at me for what seemed like a lifetime, and I was certain that he had interpreted my remarks in the worst possible way. However, when he finally replied, he told me he was very impressed with all my reasons. But it was my last one that had really hit home. He then made it clear that they too were part of the team, and that if they could be part of any alternatives, I should call them.

    What happened? We got the order, and although we hit several bumps in the road, in the spirit of cooperation we smoothed them out and performed to everyone’s satisfaction.

    I have worked with this idea in mind over the years, and I try to get it across to everyone I work with: Missed schedules create extra costs and delay revenue streams. As a result they delay profit and most importantly risk losing the customer and the product’s market window. Because keeping schedule commitments is so important, the management team must always have viable alternatives ready to implement on short notice which will enable them to stay on schedule. It is like dominos: one bad program will knock down all the others.

    The way many companies tolerate missed commitments has always frustrated me. Unfortunately big company environments are often more tolerant of such slippage than smaller companies can afford to be.

    A while ago I worked in a $400 million electronics component group in a multi-billion dollar company. Sales were centralized at the group level for all divisions. The sales department started off the budgeting process for the coming year by presenting its sales forecasts to the various divisions in September. Division budgets were due in October, but the divisions got squeezed between the sales forecasts on one side and the corporate revenue and return on investment targets on the other, making it very difficult for the divisions to make ends meet. Not having direct control of sales forced the divisions to fit their plans for operating expenses between two walls, a sales forecast and corporate requirements. It was not just a squeeze in planning, but the corporate requirements restricted the manufacturing divisions and kept them from trying to do great things with their business.

    They were caught between inflexible corporate goals for performance which were not compatible with the revenue the centralized Sales group could deliver. Usually by the end of October, Group Sales would issue a revised forecast downward by as much as 17%. Of course, group level management would then hammer the divisions to reduce their budgeted expenses across the board, with some arbitrary percentage required to meet the consolidated corporate profit goal. The new sales forecast for the Electronics Group dropped over $60 million in sales and $5 million in profit. As you can imagine, this created severe morale problems since Group Sales was always let off the hook. I saw division managers break down in tears when told to cut their budgets again and again, after having wrestled with them for weeks trying to get the first pass accepted.

    The big company attitude toward the operating divisions, who had less control over the process, was, "It's their jobs to do what we tell them. We pay them enough to respond to the directions we give."

    You would think that management at the group level would have told sales to find alternatives that would enable them to stick to their original commitment. Even if it required investments above the original budget, the overall results might still be improved upon, and with far less pain and risk.

    From the very beginning, focus must be on setting goals and making commitments that will stick.

And then stick to them!

TABLE 1: Original Revenue Projections for NuPro

    Table 1 shows the monthly projected revenue for a new product, NuPro, during the first year. In this case, the revenue equals the per unit price of $25,000 times the number of units. The revenue starts out slowly, and after a slight dip in months 3 and 4, picks up steam in the second half of the year. The total revenue forecast for the first year is 166 units, or $4,150,000.

TABLE 2: Original Cash Flow Projections for NuPro ($000)

    Table 2 shows a cash flow projection based on the monthly revenue forecast through the first year. The cash flow (column 9) turns positive in the eighth month, and the cumulative cash flow (column 10) reaches the break-even point in the twelfth month. Development expenses (column 2) drop each quarter as the product moves into production so technical resources can be available for other projects, which translates in to future revenue, possibly even in the same fiscal year. Cash is required to cover inventory (column 3) starting in the first month as the bills for material needed for the first month’s shipment come due. Finally, manufacturing must anticipate the time when they need to take over and sustain product support, so there are sustaining engineering expenses (column 4) beginning in the first month of shipments.

 TABLE 3: Gross Margin Contribution (60%) from Sales

   Table 3 shows the gross margin contribution from the sale of NuPro. These figures justified the investment. With a Cost of Goods at 40% of revenue, the contribution after one year will be $2,490,000 (Revenue - COGS = Gross Margin). The company funding the program was willing to make the investment and take the risk because of the significant potential for an additional gross margin.

    At a progress meeting, Ed Loosely, Vice President of Engineering, casually announces that there will be a slight slip in the schedule and NuPro will not be released on schedule.

    Sam Action, Vice President of Sales and Marketing, raises a fuss because they will miss the marketing window. Sam has been fighting for years to get management to commit to the product and is fearful that with a slip in schedule their competition will move out ahead and kill their own market impact.

    Paul Wimple, President, says. "Come on, Sam. This is the same old dialogue. I’m sure a little slip can be overcome by the team."

    Sam is about to bring up other examples of programs that have been hurt by the company being late, but he figures he had better stick to the issue at hand. Besides, his neck is already out pretty far, over his last revisions to the sale’s forecasts. He also has payments on that BMW to keep up. "Well, how long?" He asks.

    "Only one to two months," Ed Loosely replies.

    Now Mike Response, Vice President of Manufacturing, starts complaining that he has been spending money according to the original budget, and now he has inventory coming in, and this is going to make him look bad.

    At that point, Paul, who cannot stand division in the ranks, jumps in and says, "Let’s go with Ed’s schedule. It really shouldn’t hurt that much, being only one or two months late." Paul is even thinking to himself that he might not even mention it to the board, since it’s such an insignificant change.

    Fred Numbers, Vice President of Finance, comforts Paul further saying, "I could find ways to cover the potential impact on cash and profit." He has a golf date with Paul for Friday afternoon.

    Sam does not give up easily. Back in his office he begins to consider the impact on the original schedule. He calls up his friend in accounting, Andy Ledger, to do an analysis for him. The next day Andy comes back with some results that don’t surprise Sam, but sure will be news to Paul. The changes to the original schedule are shown in Tables 4, 5, and 6, which compare the first-year numbers of the slipped schedule with the original projections.

TABLE 4: Effect of a One Month Slip on Revenue

    Table 4: The units shipped the first year drop from 166 to 118. This 48 unit drop lowers the revenue projections from $4,150,000 to $2,950,000. A revenue reduction of $1,200,000!

TABLE 5: Effect on Cash Flow with a One Month Slip ($000)

   Table 5: The net cash for the year drops $675,000, from a positive $75,000 to a negative $600,000. Most of the impact comes from the fall off in the last month’s shipments, which represents 29% of the shipments for the year.

TABLE 6: Gross Margin - One Month Slip

    Table 6: Finally, Sam and Andy’s analysis reveal that the gross margin would drop from $2,490,000 to $1,770,000. Nearly three quarters of a million dollars ($740,000)!

    Out of curiosity, Sam asks Andy to carry the analysis further with a look at a two-month slip. After all, when has Ed ever made revised deadlines’?

    Tables 7, 8 and 9 show the impact of a two-month slip, which would extend the initial start-up schedule two months.

TABLE 7: Revenue - Two Month Slip

    Table 7: In the first year of a two month slip, shipments drop by 84 units, from 166 to 82, and revenue drops by $2,100,000, from $4,150,000 to $2,050,000.

TABLE 8: Cash Flow - Two Month Slip ($000)

    Table 8: Net cash for the year drops $1,150,000, from a positive $75,000 to a whopping negative ($1,075,000).

TABLE 9: Gross Margin - Two Month Slip

   Table 9: The drop in Gross Margin tells the story in very dramatic terms—a decline of $1,260,000, from $2,490.000 to $1,230,000.

    In the case of a two-month slip, the first year projections for units, revenue, and gross margin would drop more than half, and the net cash would go from a small positive number to a negative $1 million!

    These substantial losses happen because the main revenue gains would have come at the end. In this case, the last two months represent 51% of the original revenue. In the new revenue forecast the same period would only be 49% of the original projections, way down from the plan that was used to convince the board to make the investment in the first place. The impact on profit will be substantial because of costs already in place. The projections assume that development engineering stays with the program until it is complete, while sustaining engineering stays poised to take over and inventory build-up follows the original plan. Sam knows that his sales department can’t accelerate sales orders because the whole program relies on NuPro being available for immediate delivery.

    Based on the analysis both Andy and Sam realize that the two-month slip will kill the current year profits. Sam knows Paul will have a fit if he has to tell the board this. Andy is so concerned that he asks Sam if he can take these results to his boss, Fred Numbers. Of course Sam agrees, because this is exactly what he wants.

    After Fred reviews the analysis, he gets Paul to call an immediate staff meeting so he can present the results. After everyone is seated, Fred gets their attention by hitting them right across the face with the proverbial flounder. Showing them the numbers from Andy’s analysis, he summarizes the difficulties as follows:

    "Revenue Down: This kills any growth plans we had for the year."

    "Gross Margin Down: This falls so low that it will force a staff reduction."

    "Profit Down: Kiss your bonus good-bye, and feel for Paul when he has to tell the board."

    "Increased Manufacturing and Engineering Expenses: "Expenses will exceed budget and require actions that may end up hurting the company even more by draining people and resources away from other projects."

    "Development: New program development will be delayed, hurting future company performance. And worse yet, Remember that initial public stock offer the Board had planned to do at the end of the year?"

    "Delayed indefinitely."

    "Why? Negative Cash flow. Cash will fall far short of plan, which could force a private equity offering at give-away prices, diluting the value of the stock for the present stockholders."

    "All of this because engineering is going to be only one to two months late!"

    Of course Ed Loosely from engineering is the first to respond. "I don’t see why revenue schedules have to slip once the product is released, and anyway, why can’t such a cracker-jack organization as Sam’s make up the revenue in the following months?"

    Paul nods in, support and calls on Sam to define actions and programs that will enable the company to catch-up once the product is available.

    Sam is annoyed at Paul for not coming down on Ed hard enough. Instead of answering the question directly he voices his frustration. "First off Ed, why did you wait so long to tell us the program would slip. You are the one who encouraged us to put costs and resources in place because you were so confident you could make the schedules, which were, by the way, your estimated dates, not mine. We’ve all busted our butts trying to make this thing a go based on your timetable. We are too far into this now. Any delay will give our competitors a big jump on us, and the majority of sales depend upon my people not only having the NuPro in their hands, but into the customer’s hands without delay. How can we sell something we can’t deliver?"

    "And it’s not just about sales. Look at the figures. With all the other pieces in place we can’t easily redirect them to overcome the problem you created. Your slip will cause a tremendous negative impact on the year, the year we were to shine both in the market and to the investment community. And I wouldn’t bet on just a one or two month slip; so expect it to get worse. It will be difficult to shift our employees and energy to overcome the slip unless we can help Ed find a way to recover his part before it is too late."

    At this point, Sam begins to pick up support from the rest of the staff, and Paul swings toward the consensus. Soon Ed is asked to come back in 24 hours with alternative plans for avoiding the schedule slip. The staff will then evaluate costs and risks as a group, and look at ways to help engineering meet their original commitment.

So what was the problem?

    Ed’s technical mind needed to see the problem graphically. The big gap between shipments (graph 1) made an impression on him, but the cash flow curves (graph 2) heading in opposite directions cemented his support.

Graph 1

Graph 2

    In a situation like this, you can be sure that whatever extra things the engineering department may need to do to make schedule commitments will be far more cost effective in the long run than running the risk of losing all that revenue, profit and cash at the back end.

    Growth requires intensity and a firm commitment to meeting goals, no matter how impossible they may seem. Certainly management cannot permit casual schedule changes. Letting engineering off, the way Paul tried to do, would have violated the principles that encourage rapid growth and set off a chain reaction of devastating losses and problems that would most likely have ruined the company.

Remember, it’s the first drink that kills you!