What return should I expect?

What return should I expect?

Jan 23, 2017 | Governance, Management, Small business

This is a common question I get from the owners of businesses with whom I interact.

There is  no right answer, but when you consider that putting your money in a bank term deposit at no risk will currently generate you about 3%, and a diversified share portfolio held over the long term will earn 7-10%, you have to consider the risk/reward you are prepared to accept.

The question should really be expanded into two:

  • What is the financial return on the capital needed in the business
  • What is the personal return that might accrue.

Dealing with the financial return, it is a simple equation:

EBIT/Net Assets = Return on Capital employed (ROCE)

EBIT, or Earnings Before Interest and Tax  is a good measure as it reflects the true costs of running the business. Definitions do vary a bit, but usually it includes depreciation, a cost of replacing productive assets, but before the externally imposed Tax and interest which have little to do with the operations of the business.

Net assets is simply the result of subtracting Liabilities excluding equity, from the total assets of the business.

Businesses that have even moderately sophisticated financial management have usually reflected on the rates they see as acceptable, but as a rule of thumb, most manufacturing businesses  should have an explicit minimum hurdle rate not less than 15% before new investments can be approved.

A business that has very few fixed assets, such as a consulting practice, could reasonably expect a far greater return on the assets employed, simply because there needs to be so few of them, the key asset is knowledge. The calculation here is more about the return on time spent rather than fixed assets, way harder to measure, but directly related to revenue.

Clearly the type of business has a profound impact on the numbers, so commercial context is important.

Dealing with the second perspective, the risk/return of being your own boss is a highly personal equation, resistant of any useful quantification, so my advice is always to do what ‘feels right‘ to you.

 

 

 

Will this change finally compel you to build your own digital assets?

Will this change finally compel you to build your own digital assets?

Jan 20, 2017 | Change, Marketing

Back in June 2016 when Microsoft paid $US26 Billion for LinkedIn, we all expected there to be changes. You do not spend that sort of dosh, even when it is just change as it is for Microsoft, without a plan.

The advice from many, including myself was that it had just become even more important than ever to own your own digital real estate, a functional and attractive website, delivering your value proposition,  rather than relying on rented real estate, someone else’s platform like Facebook or LinkedIn.

All the platforms monetise by being wholesalers of eyeballs, they sell advertising by many names to those who want to reach you, and do not care much about how you feel, only that you are reachable, and they have found remarkably innovative ways to do so, and I suspect the pace of innovation is just accelerating.

Early in January, all LinkedIn members received an email from our friendly hosts at LinkedIn saying they were ‘retiring the notes and tags features’ our connections page for those using the free version. This is simply code for if you want it, you can pay for it.

As the platform is theirs, as with a rented house we live in, we have no control over the terms and conditions, we accept them or leave. Not too surprising I thought, but nevertheless, annoying as the tags feature particularly is (was at the end of March) very useful.

Now I opened up LinkedIn this morning and there is a whole new look, no doubt aimed at making my experience better, code for we are going to charge you for something else you have had for free to date.

Again, not surprising, but annoying, not just because it will start  to cost me,  but because I will have to adjust to a whole new layout. I am 65, change does not come as easily as it once did.

Never has the importance of having your own digital real estate been more important, and never has it been harder to build. No longer can you stick up a dodgy website and have people find you, there are millions of sites, and billions of posts daily, being found by chance is harder than finding a particular grain of sand on Bondi beach.

The best time to start building a digital platform you own was 10 years ago, the second best time is now.  It is a bit like the telephone in 1915, everyone had survived to date without one, it seemed that you could continue to do so, but by 1920, no business could survive without a phone.

Do not stuff around, but it is not free, there is a substantial investment of time, skill, and money involved, but like the phone 100 years ago, you cannot survive without one for long.

 

When the cheapest quote is not the best price.

When the cheapest quote is not the best price.

Jan 17, 2017 | Customers, Sales

A quote carries the implication of a low price, only price, little room for the value that may be delivered, and that your ‘nose’ is only just out of the water.

What would happen if you  called it an offer for service?

Perhaps it is just a semantic difference, but it may also bring into better focus the value being offered irrespective of price.

Many companies I work with operate on the basis of quoting for jobs, and those seeking quotes are often doing so in the expectation of taking the lowest price.

This is good if you are buying paper, or some basic commodity, but buying something of value, that is mixed up with some expected level of expertise and service, is an absolute shocker.

One of my clients provides a specialised engineering service that has stringent regulatory requirements covering safety and engineering integrity. One of their biggest long term customers, the local arm of a multinational,  has recently moved their procurement function away from the domestic business unit to  a centralised offshore global procurement system based almost entirely on price.

The choice facing them was to compete on an uneven global playing field on price, and have their existing thin margins further eroded, or walk away and utilise the capacity and skills elsewhere.

A difficult choice, particularly against a background of uneven and difficult to forecast cash inflow was made, but after 6 months, they are  way better off, and their former customer is struggling with trying to manage a complicated plant with offshore contractors who quoted the lowest price to get the jobs and are intent on doing as little as possible to get the money.

The lowest quote is rarely the best total  price, and it is easy to drown when there is no room for error.

 

How do you set your prices

How do you set your prices

Jan 16, 2017 | Marketing, Small business

Most times people set prices as a function of three things:

  • What their costs are,
  • What margin the budget demands,
  • What the competition is charging.

All are the wrong way to go about it.

Prices should be absolutely dependent on what customers are willing to pay.

This bears no relationship whatsoever to your costs, or what the boss wants by way of margin, but has a lot to do with what the competitors are charging, assuming your product is substitutable.

The challenge therefore is to ensure that there are no substitutes for your product.

In many categories, perhaps most, this is a real challenge, one that makes marketing all that much more important, as marketing should be focussed on the delivery of value.

Most businesses set out to deliver all the bells and whistles, and the reasoning is that they are trying to help customers by giving them as much as possible, and some choice. However, looking at a product feature by feature and figuring out which ones customers are willing to  pay for, and which are just in the way, makes more sense.

The better you know your customers, it follows, the better you will be able to determine which features they are prepared to pay for, and how much they are worth to them. It also follows that the more specific the niche you are in, the easier it becomes to understand their purchase motivations. Nobody can be all things to all people, choices simply have to be made.

There is an electrician in my local area with a strong proposition.

In an environment where we do not expect tradies to come on time, and when they do turn up, they tramp through your home, and leave a mess behind them. This bloke makes several promises:

He will be there at the nominated time, + or – 15 minutes, or you do not pay him,

He leaves the work area at least as clean as he found it, or you do not pay him.

He will give you the price before he starts the job, and it is a fixed price, it will not change.

He charges a premium rate, and the biggest problem for a potential customer is the waiting list. If you cannot wait, or do not like the hourly rate, he does have the numbers of others he will give you, without any guarantee of performance.

Many people in the area would not use him, as he ‘charges too much’. They are the ones who see little value in the propositions that make him different, and he is fine with that. In fact, he seems to enjoy directing potential customers elsewhere, as it highlights the fact that he is really busy, and has become a price setter, not a price taker.

Back to the challenge of price setting.

When the cost of provision of something that adds value is less than the value customers see, then it makes sense to provide it. In my electricians case, he leaves himself some spare time to ensure he can make good on his promises, and he charges for the privilege, simply because the certainty offers great value to his client base.

Simplicity is a key, the simpler the better.

Simple to explain, deliver and understand.

 

 

 

 

The differences between Takt and cycle time, and why they are important.

The differences between Takt and cycle time, and why they are important.

Jan 11, 2017 | Lean, Operations

 

‘Job shops’ have particular challenges in production planning and capacity utilisation.

No two jobs are exactly the same, so the sequencing of jobs to optimise factory utilisation takes on even more importance.

In the middle of an operational improvement project in a job shop environment with multiple possible routes for a given job, I found myself having a regular conversation with the factory management and machine operators about creating a sense of ‘flow’ through the factory, and how that related to machine cycle time, total process time,  and Takt time.

There were multiple definitions of cycle, depending on who I was talking to, but none had any idea of what Takt time was.

Therefore I followed my own advice to ensure that as a first step, the language in any factory was absolutely common. This ensures that the meaning meant to be conveyed by specific words were exactly the way they were received.

Cycle time.

Cycle time has many definitions depending on circumstances. In effect it is the time taken to do one cycle of a specified task. The cycle time of production of a Boeing 747 is many months, whereas the cycle time for production of a specific part may be hours. Both are valid definitions, so ensuring that the definitions being used in your context are exactly the same is essential.

In my job shop, there are many routes for a completed job via a range of different machinery, each with its own limitations.

A job may be done on a machine that produces  5/minute, a cycle time of 12 seconds, or a machine that does 60/minute, a cycle time of 1 second. Make sure you are talking of the same machine when discussing the routing.

The cycle time of a particular completed job may have a number of separate processes that require both a specific order and potentially variable routing, so knowing the cycle times of each machine option, and other limitations, such as manning, that may apply is essential.

Takt time.  (derived from the German ‘Taktzeit’ referring to a musical beat measured by a metronome)

Takt time is similarly subject to differing interpretations, but less so than cycle time.

The classic definition of Takt time is:

Available time for production/Required units for production. In other words, the time required to meet demand.

This is exactly right, but the confusion usually occurs in the definition of ‘available time’

Assuming a normal 8 hour day, we start with 8 hours X 60 minutes = 480 minutes.

However, there will also be standard times during the day when the machine is not available. For example, it may take 15 minutes to be set up in the morning, then there are 2 x 10 minute ‘smoko’ breaks during the day, a 30 minute lunch break, and a 40 minute wash up at the end of the day.

The available time then becomes: 480 – 15 – (2 x 10)-30-40 = 375 minutes/day.

This ‘down time’ might be managed by having split times for lunch and start-up/wash up, and would change the Takt time calculation, but essentially to be simple there are 375 minutes available in the day. This becomes the base for the Takt time calculations.

Let’s assume that the customer demand was for 50 units. You then have 375 minutes to produce 50 completed products, or an available time/unit of 7.5 minutes.

Let’s further assume that the product takes  8 minutes /unit to produce, you are therefore  30 seconds short per unit, or 25 minutes over the course of a normal day. This is typically made up with overtime used to produce the 50th unit, or producing only 49 units, which annoys the customer of the 50th who are short or late delivered.

The additional problem is the backlog of back orders builds up, resulting in customers cancelling, going elsewhere, or just losing confidence in you.

None are outcomes you would wish for.

In addition, there are always unexpected things that happen, a machine goes down, a well-meaning manager walks through talking to operators and slows down the speed, a productivity improvement meeting is called, and so on. All this impacts on the available time, but the customer demand does not vary from 50 units/day.

The operational improvement task, often referred to as ‘Lean Thinking’ is to apply continuous improvement to both the available machine time, and time required to produce the unit, so that it eventually matches the Takt time of demand.

Most factories I have seen have no idea of takt time, and many see no need for it, but it has several benefits.

  • It makes capacity calculations relatively easier, even through a complex set of sub processes. By calculating the capacity and cycle time of each process, and the alternative routes that may be available, the best fit to the demand is exposed.
  • It enables the calculation of the best batch sizes to be done.
  • It gives team members an idea of what ‘well done’ looks like for every bit of production, an enormously valuable outcome.
  • It acts as an early warning system of an emerging problem.

Understanding the two times, Cycle and Takt enables a clear sense of priority that can be applied to planning the sequences of jobs, and an understanding the total and local (individual process) capacity utilisation necessary  to be of maximum service to customers.

When you have that clarity, you can address the opportunities for improvement, leading to a greater sense of ‘flow’ through the factory.