Written by Jeffrey T. Luftig, Ph.D.
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Originally Published in Measuring Business Excellence Number 1 Volume 3
An Overview of a Productivity Metric for Profitability Enhancement and Focused Cost Reduction
BackgroundIn the United States today, many companies are faced with the daunting prospect of responding to three concurrent and inter-related challenges :
- continuous demands from their customers to reduce the price of their products and/or services; while
- managing and reducing their costs in order to maintain profitability; and
- maintaining an adequate return on equity or assets to meet or exceed the expectations of stock market analysts and stockholders.
This pressure has been particularly acute on primary (e.g. steel and aluminum) and component manufacturing firms producing a complex product mix as first and second tier suppliers; and, most especially, in mature industries producing commodities. As these companies have struggled with meeting these externally-driven demands, the result of their efforts have been decidedly mixed. Re-engineering, often simply a not-so-subtle ‘code word’ for downsizing, and forced mergers have, in many cases, led to the sub-optimization of Key Performance Indicators (KPIs) in all three domains. Still other firms have attacked the problem through company-wide cost or quality initiatives which start with great fanfare, yet die slowly (and in some cases, excruciatingly), ultimately ending without adequate financial benefit.
A good deal of the failure of all of these approaches is that the effort to reduce cost and subsequently price, and ultimately control profitability, is that the attempts tend to take place with vertically rather than horizontally-integrated strategies. The quality department is assigned the responsibility for reducing scrap and loss; the sales and marketing department is assigned the task of increasing sales and hopefully margin; the finance personnel dedicate themselves to uncovering opportunities to reduce costs; and the process engineering and operations groups commit their time to increase productivity and efficiency. Unfortunately, each of the individual division or department efforts often tend to generate sub-optimal responses and solutions, so that the ultimate gain in profitability tends to be less than the sum of the individual parts.