By William (Bill) Fetterman
Written for Forefront magazine April 2018
Business owners should do all they can now to counter the pending effects of inflation on their cost structures and subsequent enterprise values.
Inflationary pressures can be relentless on businesses and can make owners and operators feel powerless. Preparation for inflationary periods can be thought of as similar to preparing for any kind of significant volatility. To weather an inflationary storm, owners should commit to a business strategy that includes operational excellence as a competitive advantage – including three important pillars: flexibility, scalability, and reliability.
Flexibility
In this context, the concept of flexibility means the capability to adjust to changes in mix with almost no change to the cost structure, and with minimal extra costs of changeover. Many businesses are excellent at execution once the production mix is established, but changing the mix late in the game is often catastrophic to the variable cost structure and subsequently to margins.
Flexibility can be established as a competitive advantage by focusing on the design of the production process(es) and asking key questions during the design phase (or looking at in-place processes critically and making adjustments where necessary). If production processes are equipment-intensive, ensuring that the equipment and setup/changeover practices are world-class can help toward these goals. Maximizing inventory turns (and thereby minimizing on-hand inventories) contributes toward the ability to pivot production when necessary. If processes are more labor-intensive, many world-class options are available for process design that will minimize costs and maximize flexibility.
Scalability
The concept of scalability means the capability to adjust to changes in volume with minimal change to the cost structure. On its face this may sound simple, but adding significantly more volume into a production system usually exacerbates existing flow and process defect issues and will almost always cause other unexpected costs, from additional processing steps for quality assurance to buffer stocks to added labor necessary to move more product through the plant. Production process design with a goal of scalability (for both higher AND lower volumes) is key to achieving this goal, whether for existing production processes or for new processes. There are many world-class options available to address these goals, such as replicable cellular layouts, cross-training of production personnel, and movement toward one-piece flow.
Reliability
The concept of reliability in the context of a business operation simply means freedom from error in a manner whereby quality does not rely on detecting but rather preventing problems through process design. It stems from the philosophy of systems thinking and systems design, with an emphasis on designing production systems with error-prevention as a goal. There have been remarkable advances in this sub-science in the past few decades, and the science of reliability engineering itself continues to evolve. Generally, the idea is that simple is better and defect and waste prevention (waste in all of its forms – transport, inventory, motion, waiting, overproduction, over-processing, and scrap) is a primary system design objective.
Capital Expenditures and Uncovering Hidden Capacity
Capital expenditure decisions can impact your cost structures and may also impose constraints that work against the three goals of flexibility, scalability, and reliability. When facing decisions about adding additional capacity, whether it’s equipment or people or space or all of these, the primary objective of any owner must be to uncover the hidden capacity in their current systems first. Most production systems have significant amounts of hidden capacity – that is, capacity that can be had simply by executing differently, using different production flows or practices, or scheduling production differently. Typically this hidden capacity is free – it’s already there but needs to be unleashed. And often it’s 20% or more of current capacity but cannot be seen because people often can only see what they are used to seeing.
Business Owners Win Either Way
These operating strategies are powerful ways to prepare your company for volatility, including inflationary cycles. And whether significant inflation materializes in the near future or not, owners and their businesses win through these approaches. These strategies are some of the best techniques for building sustainability in your business through any period of volatility and adopting operational excellence as a major organizational goal.
William (Bill) Fetterman
CPIM, CQE, CMA, leads the operational and engineering practice of Advanced Manufacturing Group, LLC. Bill and the AMG team specialize in working with under-performing operating companies and also healthy companies that are seeking operational excellence as a competitive advantage.
UNFAMILIAR TERRITORY – THE PROSPECTS FOR INFLATION
By William (Bill) Fetterman
Written for Forefront magazine April 2018
The drivers of higher inflation appear to be gathering momentum and largely in place as we enter the second quarter of 2018.
The U.S. economy continues its slow but steady expansion, which started in June 2009 and, as of this writing, is the third-longest stretch (currently 103 months) of economic growth in American history. After April 2018 this recovery will be the second-longest ever. Some economists are predicting, and some early data trends are supporting, that as the expansion continues GDP growth will accelerate in 2018 above 2.5%, thanks largely to stimulus from recent tax legislation. Consumer spending, which makes up roughly 70% of the U.S. economy, also continues to be strong and is showing signs of accelerating. A recent survey of 52 economists by Wolters Kluwer Blue Chip Economic Indicators showed an expectation that consumer spending would rise 2.5% in 2018, and that survey was taken before the recent tax legislation was passed.[1] Business investment expectations were also strong in this survey, with business investment growth expected to be 4.7% for 2018 but could be as high as 6.0%. These expectations, when coupled with the U.S. facing virtually full employment, factory utilization at 77% heading toward inflationary-pressure levels of 80-85%, and potential for protectionist tariffs in the steel and aluminum industries, show that the drivers for an inflationary period are largely in place.
The low unemployment rate and the shortage of skilled labor will place pressure on wage rates, which is often one of the main contributing factors to inflationary cycles. Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch, was recently quoted on this topic.
“We have to think that we are near the boundary of the nonaccelerating inflation rate of employment,” she stated.[2]
Similarly, David Kelly, chief global strategist for JP Morgan Funds, stated, “It’s going to be an interesting year for economists. We have never tried massive fiscal stimulus in a period of full employment.”[3]
Inflation risks are seemingly easy to ignore since periods of high inflation are unfamiliar territory for many Americans – it has been more than a generation since the U.S. has experienced dangerous levels of price increases. The U.S. Bureau of Labor Statistics (BLS) collects and publishes the leading data on inflation. BLS’s Consumer Price Index (CPI), which discounts energy and food costs from its monthly CPI calculation because of their volatility, has shown annual levels of inflation since the 2009 recovery ranging from 0.6% to 2.3% – hardly concerning. One has to go back to 1990 to see inflation above the very palpable 5.0% level, and 1980-81 to see levels above 10%. Today’s factors, however, seem to point to an inflationary period in the not too distant future. Business owners and managers should plan now to counter the effects of inflation on their cost structures and long term value of their businesses.
William (Bill) Fetterman
CPIM, CQE, CMA, leads the operational and engineering practice of Advanced Manufacturing Group, LLC. Bill and the AMG team specialize in working with under-performing operating companies and also healthy companies that are seeking operational excellence as a competitive advantage.
[1] Wolters Kluwer Blue Chip Economic Indicators, as summarized in USA Today on-line edition, Jan. 1, 2018.
[2] Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch, as quoted in Investment News online edition, Jan. 2018.
[3] David Kelly, chief global strategist for JP Morgan Funds, as quoted in Investment News online edition, Jan. 2018.
[1] Wolters Kluwer Blue Chip Economic Indicators, as summarized in USA Today on-line edition, Jan. 1, 2018.
[1] Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch, as quoted in Investment News online edition, Jan. 2018.
[1] David Kelly, chief global strategist for JP Morgan Funds, as quoted in Investment News online edition, Jan. 2018.