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Understanding the Monetary $$$ Reasons for Improvement in Business Operations

The common reason for companies that do not want to adopt changes, Technologies and  Information Technologies is their high cost.  We can analyze the current business trend and see whether companies can survive without making any change.

Business Trends

 The following trends are apparent in today’s business environment. They will affect the bottom line of companies:

    Shortage of Labor

The growth in economy has caused the shortage of labor in many sectors.  The shortages of skilled labor are especially critical.

    Rising Labor Cost

The shortage of labor causes the rising labor cost.  This increases operating costs of the business.

    High Turnover of Employees

The rapid change of business environment couples with the shortage of labor lead to the higher turnover of employees.

    Higher Cost of Operations (Rental, Equipment)

Costs such as rental, equipment, labor and utilities have been increasing and will continue to increase.

    Customers are Less Willing to Keep Stock

The realization of the problem and costs of keeping inventory has drive companies to keep their inventory level low.  The larger companies practice Just-In-Time operations and dictate their suppliers to keep stock on their behalf.  The suppliers will have to improve their inventory management skill to handle the new requirement.

    Increasing Global Competition

Competitors are no longer just the shops next door.  In the New Economy, the breaking down of national boundaries introduces new competitors that local businesses have never encountered before.  They are often better managed, financially stronger and pose serious threats to the local businesses.

Effects of Business Trends

How do these trends affect the bottom line? Let us use the basic profit formula to illustrate the effect:

Profit = (Price – Direct Cost) x Sale Volume – Indirect Cost

Profit of a company is the function of Selling Price of the Product/Services, the Sale Volume and the Indirect Cost of operations.  So what will be effect be?

1.      Price - The price of existing products and services will go down due to increased competition.

  1. Costs - The direct and indirect costs will increase due to shortage of labor and increase in operations costs.

If we take an example of a Small and Medium Size Manufacturer (SME/SMI) that has a yearly sales turnover of $10,000,000, a healthy 40% gross margin and 10% net margin (which is unusually high nowadays).  The profit formula can be:

Profit    =            (Price – Direct Cost) x Sale Volume – Indirect Cost

=            ($100 - $60) x 100,000 units - $3,000,000

=            $1,000,000 (10% margin)

What happen if the costs are increased 10% and the Price is reduced by 10%? When this happened, the profit will be:

Profit    =            ($90-$66) x 100,000 - $3,300,000

            =            -$900,000 (-9% margin)

The changes in price and costs drive the company to a loss of –9%.  So how can the problem be rectified?  There are generally three common strategies available:

  1. Develop new products/services that will command higher price
  2. Shift the operations to a lower costs location
  3. Sell more units of the product to obtain economy of scales

The first two strategies involve investment and higher risk.  Furthermore, it may not be suitable for all companies.  The third strategy is the more common approach to increasing the profitability.  We can find out how much the company needs to produce and sell to achieve breakeven.

Breakeven = (90-66) x 137,500 - 3,300,000

The calculation shows that the company needs to Increase 37.5% output just to Breakeven.  To achieve the same profit as before, the company needs to increase its output by 80%.  This is a tall call for any company.

How to Achieve Increase in Sale Volume?

There are two areas that the company must achieve to increase its sale volume:

    Increase Supply

The company must build up its capability to increase production.  This means doing more things and doing them faster without corresponding increase in operations costs.

    Increase Demand

After increasing the production volume, the marketing department must increase the sale of the company.  This can be achieved by capturing a larger market share or entering new markets.  It has to do it with better services and better response to customers’ needs.

The Need for Change

The conclusion is that companies that do not make any appropriate changes will not survive in the fast change business environment.  There is a need to improve the management of the company and adopt appropriate technologies in the correct manner to stay competitive.

 

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