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Volume II Issue 11
"Be Careful What You Ask For"
by Jack Miller
Be careful what you ask for, you might get it. You get what you measure, so
be careful what you measure.
Improving productivity is a good thing, and so is improving margin, but if the
marketing manager is measured on margin per hour, while the mill manager
is measured on tons per hour, you have a problem.
The paper industry has done a good job measuring tons. Tons produced.
Tons sold. Record production in tons per day on a paper machine. And tons
is what they got. Yes, they measure profits, but day to day, the discussion
centers on tons, and as I discussed in The Tonnage Disease, profit
performance has suffered as a result. And for my printer friends, please stay
with me, because you might be susceptible to a similar disease.
I recently attended a conference in Wisconsin on specialty papers that
featured a discussion about metrics, and the importance of measuring the
right things. The discussion addressed some of the problems with The
Tonnage Disease, and most agreed that margin is a better metric than
volume, and that margin per hour is a better measure than margin per ton.
All true. But I would argue that this only begins to scratch the surface.
Someone said, “In the paper business we sell machine time, so we need to
optimize margin per hour.” Someone else said, “In the paper business we
sell pulp plus machine time.” And I would also say, “Printers are selling ink
and paper, plus press time.”
I would go further and make the case that we are also selling service and
technical know how, especially for specialty papers. To this point, printers
are selling even more, and are finding some of the best growth and profit
opportunities in services such as data base management, fulfillment and
logistics. I was reminded of this by a billboard at the airport in Appleton, WI
for Banta: “a technology leader in printing and supply chain management.”
Keep in mind, too, that the customer is not buying paper machine time, or
press time, or ink. That’s a subject for another day, but keep it in mind,
because it's always good to remember how the customer thinks. Meanwhile,
back to our metrics.
I recall a segmentation exercise where we were debating which customer
was more important: the low margin high volume customer, or the high
margin low volume customer? The answer is: it depends. This too, is a
subject for another day, but the point is that you need the right tool for the
job, i.e. the right metric for the decision at hand. Are you trying to
determine which products or customers are profitable and which are targets
for replacement? Are you trying to determine whether to meet a particularly
aggressive competitive price? Are you trying to determine whether to shut
a mill for a week? Permanently?
Indeed, these major decisions require deep study, but day to day, you need
metrics that are practical, i.e. reasonably available, and readily understood,
and as the discussion confirmed, margin per hour is generally considered to
be one of the key metrics.
So then, what’s wrong with margin per hour? It is a good tool, and the
problems are subtle.
First, there is a tonnage bias: margin per hour equals tons per hour times
margin per ton. And there is an implicit assumption that machine hours are
limited, i.e. the mill is “sold out,” but this is often not the case.
Second, it is not a useful tool for comparing profitability on different paper
machines. Almost anything run on a bigger machine will have higher margin
per hour than most items run on a smaller machine, because the bigger
machine produces more tons per hour.
Third, it doesn’t properly account for fixed cost. A grade that makes more
tons per day uses more pulp and should bear more of the pulp mill fixed
cost. A specialty grade that requires more R&D or more marketing should
bear a higher cost for those items.
Fourth, and this is related to the previous item, it subtly reinforces the
dangerous idea that anything with positive margin is good. Put another way,
it fails to highlight those items that are actually losing money. Papermakers
and printers have lost a lot of money with business that has margin, but not
profit, i.e. business that covers some of the fixed cost but not all of it.
All of this gives a bias toward volume. One way to reconcile this is a metric I
have seen used only rarely: profit per ton. A grade that has higher price and
higher margin per ton, but uses more machine time, will have higher fixed
cost per ton and this will reduce profit per ton. It will benefit from the higher
price and suffer from the lower run rate, and as long fixed costs are
accurately allocated, the net will accurately reflect the true profitability.
Measuring margin is better than measuring tons, and measuring profit is
better still, but the main thing is to avoid The Tonnage Disease. And just as
important, don’t succumb to the related disease: The Machine Time Disease.
In the next issue, we’ll talk about The Machine Time Disease, but meanwhile,
if you need help figuring out what metrics you need for the decisions you
face, call Jack Miller at 203 925 0326 or email firstname.lastname@example.org
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Copyright 2006, Jack Miller
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