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by Dr. David M. Anderson, P.E., CMC
Copyright © 2018 by David M. Anderson
Triple your profits
Just stop selling your highest-overhead "loser" products.
You will earn back that 20% sales when the rest of your products can sell for less and
when the resources that were wasted on fire-drill products can focus on designing low-cost products.
Product line rationalization is a powerful technique to improve profits, free valuable resources, and simplify operations and supply chains. It does this by rationalizing existing product lines to eliminate or outsource products and product variations that are problem prone, don’t "fit" into a flexible environment, have low sales, have excessive overhead demands, are not really appreciated by customers, have limited future potential, may really be losing money.1
The first step would be to segregate all product variations into families, according to the four criteria presented in the Product Family Article and then build the most promising families in flexible build-to-order operations with parts delivered by spontaneous supply chains . It may be necessary to design product families to be built in flexible BTO operations from standard parts and materials that are always available, as described in the Family Design article.
Products that do not fit into these families will need to be rationalized, as discussed in the product line rationalization procedure (next):
All companies experience some Pareto effect, typically with 80% of profits or sales coming from the best 20% of the products.
This happens because almost all companies keep adding products to the portfolio without every removing any. Further, sales incentives and emphases on growth and market share encourage the mantra "take all orders," thus overloading production operations and the supply chain with too many low-volume products that have unusual parts and manufacturing procedures. This causes excessive overhead costs, lowers plant capacity, dilutes manufacturing resources, and complicates supply chain management.
Few companies realize these problems because their cost systems allocate (average) overhead costs, which implies that all products have the same overhead costs.
Product line rationalization encourages companies to focus on their best products by eliminating or outsourcing the marginal products. The resources that were being wasted on the low-leverage products can then be focused on growing the "cash cows."
The following scenario shows the power of this methodology using the simple example illustrated on the cover. If a company kept the 20% of the product line that was making 80% of the profits, and dropped the other 80% of the product line, it would result in only a 20% drop in revenue.
However, dropping 80% of the worst products would eliminate 80% or more of overhead and distribution costs because those products are built infrequently with less common parts on older equipment using sketchy documentation by a workforce with little experience on those products. Further, those products may be less well designed for manufacturability and have much higher quality costs.
If overhead and distribution costs are half of total cost (as is quite common), eliminating 80% of those costs will cut total costs in half. If profits were originally 10%, dropping revenue by 20% and cutting costs in half would result in over three times the profit!
Case Study: An industrial products company had 30% price price disadvantage from "taking all orders." Neither the engineers or managers could not figure out why a competitor's product sold for thirty percent less until they realized that the competitor built only its newest, best product whereas this company was still “taking all orders” and selling all its legacy products.
The actual procedure divides the product line in to four zones: The least profitable products would be dropped. Products that need to be in the catalog would be outsourced, thus simplifying the supply chain and manufacturing operations.
The cash-cows would remain and the balance would be improved with a better focus in product development, operations, and marketing. Because these products no longer need to subsidize the "losers," they can now sell for less.
The combination of better focus and lower overhead changes will soon restore the "lost" revenue from the dropped products.
The Value of Product Line Rationalization. Eliminating or outsourcing low-leverage products will immediately:
C Increase profits by avoiding the manufacture of products that have low profit or are really losing money because of their (unreported) high overhead demands and inefficient manufacture/procurement
C Improve operational flexibility because, typically, low-leverage products are inherently different with unusual parts, materials, set-ups, and processing. Often, these are older products that are built infrequently with less common parts on older equipment using sketchy documentation by a workforce with little experience on those products.
C Simplify Supply Chain Management. Eliminating the products with unusual parts and materials will greatly simplify supply-chain management.
C Free up valuable resources to improve operations and quality, implement better product development practices, and introduce new capabilities like build-to-order & mass customization.
"Product line rationalization freed up a lot of people!"
- Jon Milliken, VP Engineering, Fisher Controls div., Emerson Electric
C Improve quality from eliminating older, infrequently-built products, which inherently have more quality problems than current, high-volume products that have benefited from continuous improvement and current quality programs and techniques.
C Focus on most profitable products in product development, manufacturing, quality improvement, and sales emphases. Focusing on the most profitable products can increase their growth and the growth of similarly profitable products. According to Richard Koch, writing in The 80/20 Principle,2
"If you focus on the most profitable segments, you can grow them surprisingly fast -- nearly always at 20 percent a year and sometimes even faster. Remember that the initial position and customer franchise are strong, so it’s a lot easier than growing the business overall."
C Protect most profitable products from "cherry picking" (launching a competitive attack on the most profitable products), which is becoming more common as "virtual," cyberspace enterprises skim off the most profitable products.3
C Stop cross-subsidizes. Remaining products will no longer have to subsidize the "dogs" and so they can generate more profit or offer a more competitive selling price.
Dr. Anderson is a California-based consultant specializing in training and consulting on build-to-order, mass customization, lean/flow production, design for manufacturability, and cost reduction. He is the author of "Design for Manufacturability & Concurrent Engineering; How to Design for Low Cost, Design in High Quality, Design for Lean Manufacture, and Design Quickly for Fast Production" (2008, 432 pages; CIM Press, 1-805-924-0200; www.design4manufacturability.com/books.htm) and Build-to-Order & Mass Customization, The Ultimate Supply Chain Management and Lean Manufacturing Strategy for Low-Cost On-Demand Production without Forecasts or Inventory" (2008, 520 pages; CIM Press, 1-805-924-0200, www.build-to-order-consulting.com/books.htm). He is currently writing the book, "Half Cost Products: How to Develop, Build, and Deliver Products at Half the Total Cost."
Dr. Anderson can be reached at (805) 924-0100 ore-mail: firstname.lastname@example.org
1. David M. Anderson, Build-to-Order & Mass Customization; The Ultimate Supply Chain Management and Lean Production Strategy for Low-Cost On-Demand Production without Forecasts or Inventory; (2004, 520 pages; CIM Press, 1-800-924-0200; www.build-to-order-consulting.com/books.htm). Chapter 3, " Product Line Rationalization"
2. Richard Koch, The 80/20 Principle; The Secret of Achieving More With Less, (New York, Currency/Doubleday, 1998), p. 90.
3. Larry Downes and Chunka Mui, Unleashing the Killer App, Digital Strategies for Market Dominance, (Boston, Harvard Business School Press, 1998), p. 140.
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