Increase Profit by Eliminating Waste
Most companies would agree that the formula to calculate price for your products or service is Price = Cost + Profit. I challenge you to reconsider as I think this formula only holds true for new products.
The formula companies should live by is Profit = Price – Cost. Some will be quick to point out that this is the same formula. I don’t agree, let me explain.
Price = Cost + Profit implies that you can set your price by determining the cost and some percentage of desired profit and establish the selling price. This way of thinking unfairly gives too much of the burden (and blame) to your sales and marketing team. The only long-term plan when competition comes, are margins will naturally come down unless the marketing team can continue to differentiate and protect the margin.
Profit = Price – Cost helps to focus people on establishing the right price less the cost to establish the profit. In order to increase profit, you are now more focused on eliminating waste in the value chain in order to continually reduce the cost of the product or service.
This is even more important during a slow economy.
Waste comes in many forms depending on your product or services. In Taiichi Ohno’s book, Toyota Production System, he includes the following areas for waste:
- Waste of overproduction
- Waste of time on hand (wait times)
- Waste in transportation
- Waste of processing itself
- Waste of stock on hand (inventory)
- Waste of movement
- Waste of making defective products
Software development also has the same areas of waste:
- Waste of overproduction – More functionality that is needed (complex systems)
- Waste of time on hand (wait times) – People waiting for work
- Waste in transportation – Not having resources readily available
- Waste of processing itself – Poor automated testing and bad code
- Waste of stock on hand (inventory) – backlog of design documents
- Waste of movement – Poor office layout
- Waste of making defective products – buggy software
The long-term solution to higher profit is to build good products and eliminating waste. A key to doing this is to have the entire company understand that Profit = Price – Cost and to continually look for ways to remove waste in your company.
Recommended Reading:
Toyota Production System, Beyond Large-Scale Production, by Taiichi Ohno
The Gold Mine, by Fredy Balle and Michael Balle
Additional Websites
http://www.poppendieck.com
http://www.agilealliance.org
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