If you're looking at the gross margins on your production costs — the percentage you earn after deducting the expenses associated with making your product — you might be wondering how you can give them a boost. Gross margins don't include other business costs like marketing, so it's crucial to maintain a high percentage. Of course, raising prices isn't always an option if consumers aren't willing to pay for it. In those cases, the only way to increase profits is to cut production costs.
How can you do that? Here are four steps you can take:
1. Work Backward From Your Market Value
A useful tactic to find areas to cut costs is to start with your product's market value. Your production costs need to be a fraction of the product's retail value for your business to profit. Many companies set prices based on the manufacturing cost when they should be doing the opposite.
Imagine you own a furniture company that sells wooden chairs. If market research shows consumers are willing to pay $150 for similar products, that is the price you have to start with. The average gross profit margin for furniture is about 32.2%. So, your cost to produce the chair needs to stay under $102 to maintain a 32% gross profit margin.
You now have a specific goal to shoot for as you're cutting production costs. From there, you can substitute cheaper materials and simplify the production process until you achieve a product that costs $102 or less to manufacture.
2. Take a Just-In-Time Approach
Overproduction and excess inventory are some of the most significant sources of waste in the manufacturing sector. The just-in-time (JIT) approach, pioneered in the 1970s by Japanese manufacturers, aims to cut those cost centers in the production process. Products are only manufactured in the amount needed, and only enough raw materials to support current production needs are shipped to the facility.
This method significantly limits unused inventory and the storage costs associated with it. It can also reduce wasted labor hours and product defects.
3. Think Local and Negotiate
Although you can achieve lower rates by outsourcing suppliers, you can gain stability and reliability by working with local vendors. Suppliers situated close to your manufacturing plant or retail location lower the transportation costs associated with getting your products to their final destinations. You can also avoid supply chain disruptions by sourcing locally, which can have a substantial fiscal impact. In 2018, 62% of organizations suffered a financial loss due to a supply chain disruption.
Once you migrate your supply chain to your own backyard, the next step is to negotiate with your suppliers. Many are willing to go to great lengths to keep a customer or make a sale, and you can use that to your advantage.
Some negotiation tactics you can try include:
- Offer to pay sooner in exchange for a discount.
- Strike a long-term agreement to receive volume discounts.
- Take advantage of lower rates when suppliers run into overstocks.
- Ask for discounts and other freebies every time you place an order.
4. Optimize Technology and Equipment Costs
Efficient technology can boost productivity and make operations run more efficiently. For example, automation in manufacturing can help you predict quality defects before they become high costs. Technology can also help you predict when preventive maintenance is needed to reduce unscheduled downtime.
In manufacturing, your equipment's energy and maintenance costs represent a massive expense. Finding ways to reduce these costs, such as using energy-efficient equipment, can lower your overhead. Reducing your air compressor costs is a particularly smart solution since it can represent up to 30% of your plant's total electricity bill.
5. Optimize your day-to-day
The saying “time is money” is true in any sort of production scenario. Take a deep look at your routines and procedures and see how you can do them quicker and more efficiently. Are you typing out emails that could be a template? Are you doing accounting by hand when it could easily be automated? Do you leave random notes all over the place, or do you have a easy-to-use calendar that notifies you of dud-dates and meetings? It can take a small amount of time to set up these things, but will save you a lot of time and money in the future.
Cut Costs and See Your Profits Soar
Production expenses are an inevitable part of doing business. Keeping them in check is crucial to remaining competitive and profitable in any market. While the price customers are willing to pay will always fluctuate, low production costs can help you earn a steady profit margin in any economic climate.
Filed under: Uncategorized