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materials handling. Managers were also able to reduce the quantity of inventories
received (and produced) too early and the amount of space required for
manufacturing. As it later turned out, they were creating space for additional
production.
Caterpillar had a similar experience. During the 1980s, Caterpillar s managers
concluded that the company s cost structure was significantly higher than that of its
principal competitor Komatsu, a Japanese firm. Caterpillar was moving parts and
partially finished products from one production area to another, whereas Komatsu
was using more of a flow process. Caterpillar s managers undertook a significant
plant rearrangement initiative called PWAF (Plant With a Future). This led to their
own flow process, with a marked reduction in distances between operations,
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material handling expenses, inventory levels and cycle time to produce products. In
some cases, cycle time was reduced as much as 80%.
Improving profitability
Some of the most useful practical techniques to improve profitability are
as follows:
Focus decision-making on the most profitable areas.
Concentrating on products and services with the best margin will
protect or enhance profitability. This may involve redirecting
sales and advertising activities.
Decide how to deal with the least profitable products. These often
drift, with dwindling profitability. Decisive action is needed to
turn around a poor performer. You can reduce costs, raise prices,
alter discounts or change the product; or you can abandon it
altogether to prevent a drain on resources and reputation.
Ensure that new products enhance overall profitability. New
product development often focuses on market need or the
production process, with insufficient regard to the financial issues
of cost, price, sales volume and overall profitability, which are
inextricably linked. Interestingly, for certain products in certain
markets, lower prices may reduce demand.
Manage development and production decisions. The amount
spent on research and the priorities and methods used affect
profitability. Too little expenditure may result in larger costs in
the long term. The shelf-life and appeal of a product should be
considered when deciding whether to continue production or not.
The number and quality of suppliers are also important. Decide
what the buying policy should be (for example, will you have a
small number of preferred suppliers or a bidding system among a
larger number of potential suppliers). Consider techniques for
controlling delivery charges, monitoring exchange rates,
improving quality control, reducing stockholding and improving
production lead times.
Ensure that customer decisions improve profitability. Stepping
back from routine decisions and considering how to derive
greater value from existing customers and products may enhance
profitability. Questions to consider include:
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How can customer loyalty (and repeat purchasing) be
enhanced?
How can the sales proposition be made more competitive?
(Simply improving it may not be enough; this improvement
needs to be made relative to the opposition.)
How can existing markets, sales channels, products, brand
reputation and other resources be adapted to exploit new
markets and new opportunities?
How can sales expenses be reduced?
How can the overall effectiveness of marketing activities be
increased?
Consider how to increase profitability by managing people.
Active, successful leadership is a prerequisite to profitability.
People need to be motivated and supported. This implies
rewarding them fairly for their work, training and developing
them, providing a clear sense of direction and focusing on the
needs of the team, task and individual.
There are numerous techniques for improving profitability; below
are some of the most significant. The most effective approach is the one
that best suits the needs of the business, combining entrepreneurship
with good leadership and constant financial awareness.
Discounted cash flow and investment appraisal decisions2
Discounted cash flow is based on one key principle: that the value of
money changes, effectively reducing with time. In other words, cash
today is worth more than cash promised in the future. For example, it is
not worth investing $100,000 today for the promise of the same
amount returned next year; more usefully, discounted cash flow can
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