A Small Family-Owned Manufacturing Company
American Fittings was a $20 million, family-owned manufacturing company that produced products for the energy industry. For many years, the majority of its products were patent-protected, which enabled the company to establish prices that guaranteed profit levels far above those of similar firms in the industry. As those patents began to expire, however, profits began to fall to levels management felt were unacceptable.
To reverse the downward trend, the company’s management took two steps: It began adopting lean principles in manufacturing and developed a descriptive and predictive, causality-based cost model. The development of a new cost model was deemed necessary because the direct labor-based cost model that had been in use indicated that–contrary to management’s intuition and lean thinking’s precepts–most of the lean initiatives being considered were counterproductive.
Armed with a cost model that clearly reflected causality, the company moved forward with its lean program and totally reengineered its manufacturing process. The model’s predictive ability accurately measured the impact each lean initiative would have on cost as well as the overall cost impact of the package of lean initiatives under consideration. In several cases, the model highlighted the cost savings that would be realized by bringing low-volume outsourced processes in-house–moves that management had always assumed to be uneconomical due to low volumes.
The model’s descriptive ability enabled the company to accurately measure the cost of each of its products as well as the cost of serving individual customers. Armed with this information, the company was able to identify its “profit zones”–product categories where market prices provided the greatest margins–and identify customer behavior characteristics that ate into those margins.
By managing its portfolio of business to emphasize products with the most profit potential and addressing the costs driven by customer behavior, the company was able to raise its profitability to levels even higher than in its patent-protected years. The first few months of the process were “scary” as profits appeared to plummet while “the toxins” that were part of its pre-lean operations began to flush themselves out of the system, but the company stayed the course and reaped the benefits.
After several years of record profits, a large international organization made the family an offer to purchase the company at a substantial premium. The family accepted and American Fittings became a division of the purchaser. Almost immediately, the new owner sent in its finance team to evaluate the company’s accounting and reporting systems. The large organization’s financial representatives didn’t understand the unique costing process used by their new operation and decided it would have to switch to the new owner’s company-wide, direct labor-based standard costing system.
Armed with decision support information from the new standard cost system, profits slowly declined, and within a year, were back around industry average, where they remain to this day.