In a previous blog,
Previously we covered reviewing formula loss and inventory shrinkage to increase profits. The next thing you can do to increase profits is to manage material costs.
In changing economic conditions, it is one thing to know your current production costs, and it is another to anticipate changes before they happen. Most formula manufacturers do not have insight into future production costs until it is too late.
NOT HAVING INSIGHT INTO FUTURE PRODUCTIONS COSTS IS MUCH LIKE TRYING TO DRIVE YOUR CAR BY LOOKING IN YOUR REARVIEW MIRROR.
Imagine being able to monitor your production costs with an eye to changes coming in the future. In today's ever-changing marketplace and with insight into your company’s materials costs, you can:
- Begin to look for alternative sources of materials
- Work with R&D to identify replacement materials in your formulations
- Brace your customers for a potential price increase
Any and all of these options are valid, and each can add profits to your bottom line. How can you do it? The key is in knowing what material costs are changing in the future as well as what effect these changes have on the production cost of the finished goods.
WHAT STEPS CAN YOU TAKE TO MANAGE MATERIAL COSTS?
IDENTIFY INGREDIENTS (HIGH VOLUME/HIGH COST).
- Knowing that material costs are changing – is the easier part of the challenge. If you can work with your vendors to get a better idea of when they anticipate price changes, or if your material is traded on the commodities market, you are most of the way there.
- Spend some time looking at your most used materials in production. Specifically, target those with relatively high costs per unit. Price changes in these products will have the greatest impact on your production cost.
- Review the price fluctuations over the past couple of years of this ingredient.
- Talk to some providers in the market. What are they seeing with this ingredient? Without much effort, you can identify the key ingredients to monitor and gain some insight into the anticipated cost changes in the future.
NOW THAT YOU HAVE KEY ITEMS TO MONITOR, THE NEXT STEP IS TO CALCULATE THE EFFECT THESE CHANGES WOULD HAVE ON YOUR PRODUCTION COSTS.
- Identify all formulas in which these ingredients appear. This should be a pretty basic ‘where-used’ function in your manufacturing system.
- Once you know these formulas, replace the existing cost with the proposed cost. The result is your new production cost for this formula. How does this compare with the existing formulation cost? Is it enough for you to absorb or do you need to take corrective action?
Some formula manufacturing systems such as Vicinity Software have functionality that will virtually automate the analysis step. The user can select components (ingredients) and manually enter proposed costs or alter the costs by a percentage of current costs. The Cost Rollup functionality is used to identify the formulas affected and calculate the new cost.
You can perform these steps using an automated tool like Vicinity Software, or manually with your existing system. The overall goal is to find out what items impact the production costs, research and identify the proposed material costs and finally, calculate the effect this change will have on your formulation costs. This knowledge will go a long way to provide corrective action that will increase profits without making significant changes to your production process. To learn more about how