Michael Rothschild explains profit velocity for manufacturers: a tiny fraction of production hours generates most cash. He shows how sales, operations, and finance silos hide which products actually make money per hour, and argues companies should measure and optimize dollars-per-hour at the SKU level.
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And just to be real clear, these kinds of companies that we work with, they generally start off with a couple different raw materials, and depending upon what tooling they use, they make all these different shapes and sizes and widths and colors and thises and thats. So they wind up with thousands of different product types, which is completely different than an assembly company, like where you're assembling a car, like a Tesla, or assembling an iPhone, where you're taking all these parts that have been made by guys like this, and these parts come in the front door in your raw materials, and then you assemble them into finished goods that consumers like us buy. We don't work with the assemblers, we only work with the converters. Now this graph is pretty new. We only came up with it, unfortunately, or started using it in the last 2, 3 months, but it's something we found. I'll show you a bunch of examples That is a problem that all of these converter companies seem to have. What this graph shows is the percent of total cash, this is the percent of all the money a factory or a business produces, so from 0 to 100%, and this is the number of production hours. This is not the idle time, this is when they're actually working and stuff is coming off the lines. People are in there, they're crunching away, machines are running, product is flowing. And what you see is, let's say the first, the best 10%, first 10% of the time, they're making 35% of their money. Each dot represents a different SKU. SKU means stock keeping unit. It's like a product identifier, a product code, individual item. Okay. So some products make a lot of money for relatively little bit of time. You with me? Mm-hm. And then of course diminishing returns set in and kind of the next group is making money, but not quite as fast. And then the curve, by the time you get to about 60% of the active working time, the companies we see make all the money they're gonna make. The last 40% of their time, they might make a little bit more, And then it starts to go negative because it's hard to believe, but most companies actually have, of these kind of complex companies, have a bunch of products that actually they sell below even their material costs. You say, how stupid could they be? And the answer is when you have 10,000 products and you have page after page after page of printout and everything's changing and some customers buy at this price and some customers buy at that price, some customers place an order of 100 units a shipment, some order 10,000 units a shipment. It's basically data chaos. It's a cloud of complexity. These guys cannot see what's really going on. But what we found is that people are making all their money in 60% of their active production time. Now active production time, it turns out, if you go to most factories around the world, I've done this a lot, hundreds of times, if you take 24/7 as the amount of theoretical capacity they have, they generally run around 50 to 60%. They're not even attempting to use half to 40% of their time. They're just shut down. So that means that they're only making money on 60% of the 60% that they're working. So all these factories out there are only making money, 60 times 60 is 36%, so roughly a third of the time, They're making money, and 2/3 of the time they're either making no money, treading water, or they're just idle. Is that efficiency? Is that a problem? I think it's a problem. I think it's an incredible waste of resources to have that. And just to go through very quickly, we've done a lot of different industries. Extruded rubber parts, well, not so bad. The last 40% made 22% of cash. Wood products, 18% of cash. Building products, 17%. This is a metals processor, a big steel company. The last 40% of their working time made them 8% of their total cash. Now it's not going to be perfect. You're not gonna have a situation where everything's on a neat line. There's always gonna be a curve to it. But is that good? No. make very sophisticated synthetic cables, well they're really ropes, very sophisticated ropes for maritime use, et cetera. The first few hours really of what they're working makes all their money. They only make 4% of their total cash out of the last 40% of their working effort. Now how could this be? I mean how could these companies who work day and night, people are very vigilant, they work very hard, How could it be that they don't know this? Whenever we show one of these graphs, they're, believe me, it's shock and awe. They're blown away, they're very disturbed, it can't be so, but we have the data. How could it be that these companies that are so disciplined don't know how they're misallocating their time? And how does it show up in day-to-day life? In these kinds of companies, I'll just do this quickly for you, they've never seen that graph before. They don't know that. But what the people who actually work in the bowels of these companies, the middle management, upper management, these are the things they've told us over the years are problems in their lives. The sales and marketing people, they chase 2 metrics basically, revenue, If I'm a sales guy, if I'm gonna get my commission, I need to hit a revenue number or I don't get my commission. So all they think about is revenue, revenue, revenue, revenue. And maybe it's factored by what was the average gross margin, what you get. The operations, meaning production people, it's how many units per hour are they producing, what utilization rate of the factory, what's the cost per unit, what's our quality rating. They don't know revenue, they don't even know how many dollars are involved, they don't see reports on that. And the people over in finance, they care about, and I assume you know the term EBITDA, earnings before interest, taxes, depreciation, and amortization. Think of it as cash flow. Return on sales, return on investment, return on assets, lots of different mumbo jumbo alphabet soup measures for profitability. So you've got 3 stovepipes in these organizations, 3 completely different families who pay attention to 3 completely different sets of goals or metrics. And kind of like the old Bible story of the Tower of Babel, they're speaking 3 different languages, and it's amazing anything happens at all in these companies. And the problems they deal with Our sales and marketing, you know, we're never really sure whether, we're selling so hard to these guys, but we don't know whether we make any money on these guys. We got so many products, which ones should we be emphasizing, which ones should we drop? And you can read this for yourselves, but these are the kinds of problems, we didn't make these up, these are the symptoms that the customers have told us about over years of talking to them. So we want to go, well, what is the root cause underneath these symptoms? And so in one slide, I put it this way. This is the way accounting works. Are any of you recovering accountants? Recovering accountant? Good, good. Accountants look at, okay, I'm trying to pick between product A and product B. We know the price, we know the material cost. I'm keeping this simple, not overheads and all this. Hmm, we make more money on product B. Everybody can see that. Margins are better. Let's tell the sales guys to sell more B. All right? The entire world out there, believe me, it works like this. So what's the problem? Seems right, as far as it goes. Well, you just saw our little video. We said, well, wait a second. What about factoring in the speed at which these products are moving through the machinery? The investor doesn't give a rip about the margin on a given unit. That's like taking a snapshot and saying, oh, this one's good and this one's not so good. What the investor cares about is, How much money is produced per period of time from the assets that I, investor, was nice enough to buy for you, the management team, to use? Unfortunately, in the real world, in all the reports out there, in all the columns and all the data that all these guys see of thousands of reports, that's as far as the reports go. There is no column that shows these numbers, dollars per hour, or dollars per second, or dollars per minute. It's not done. And that's what we do. We figured, hey, if you just made people aware of how fast they were making money, add a microscopic level of detail for each and every one of those 10,000 products, for each and every shipment, to each and every customer for each and every order, then you have enough detail to actually be able to, on the margin, move things a bit and make things change.
