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Stories From The Field

Stories From the Field # 2 - March, 2004

Quoting Decision Without Standard Costs
by Brian H. Maskell, President BMA Inc.

Our client manufactures automation equipment. They received a request-for-quote from a major retail pharmacy chain. The pharmacy is developing prescription dispensing "robots". The law in most states requires a retail pharmacy to have 2 qualified pharmacists working at all times; one to dispense and one to check the other's work. This is seen by the law-makers as a way of protecting the public from dangerous errors in dispensing medicines. But these days pharmacists are difficult to recruit.

 
#1: Using Target Costing to Increase Customer Value.
#2: Quoting Decision Without Standard Costs
#3: Value Streams for a Retail Products Manufacturer
#4: Value Streams for Plants With Many Product Families
#5: Make-Buy Decision Using Value Stream Costing
#6: Making Money from Lean Improvement
#7: Making Pricing Decisions based on Lean Accounting
#8: Value Stream Costing & Decision-Making Lead To Significant Business Growth
#9: One Company Learns About Quoting & Sourcing
#10 Making an Accounts Payable Service Center a Little More Lean

 

There is a shortage of pharmacists; plus many do not want to work in retail and see it as not sufficiently stretching their professional skills. The answer - according to this retail pharmacy chain - is one qualified pharmacist and robot to do the grunt-work and the paper work.The pharmacy chain approached our client (through a third-party design & manufacturing company) for a quotation to supply the automation equipment within the pill-dispensing robot and they quoted a target price of $6,000. Our client did as the always did; they checked their standard cost for the assemblies and systems required and they came to $7,200. The customer's required price was less than the standard cost. The President of the company said "Oh darn. Here we go again. Either we will decide not to quote. Or we will quote too high and lose the business. Or we will sharpen our pencils, bring down some of the material costs, work on the production costs and scrape into the deal with a price that does not make us money." They had just come out of a similar situation with a package handling company where they had been pushed out of the deal by an aggressive small company. This was becoming an unhappy pattern of their business.

Diagram 1

It was at this time that BMA Inc. facilitated a Lean Accounting kaizen event at the company. As a part of the kaizen we helped develop value stream costs and value stream income statements. The company was making money but the value stream where the pill-dispensing robot would be made was in trouble. The last thing the value stream manager needed was another loss-making order. But when we got to the part of the kaizen where we look at how to make decisions of this sort using the full value stream profit ability, they discovered that this project was in fact highly profitable business. Taking the value stream as a whole, they worked out the incremental costs required to fill this order. The sales quantities started off slowly - just one a month for the first 6 months, but growing to 30 per month in the third year. The products are mainstream to the business and would - over time - more than double the revenue of the value stream. But what was the point of additional revenue that was unprofitable?
If you look at the diagram below (Diagram 2) you will see that - far from being unprofitable - this order is highly profitable despite the low price of $6000 per unit. The value stream had enough capacity to complete the order for the next 12 months. After that additional resources would be required. They studied the process and determined that 5 more operators and 3 more machines would be required to meet the quantities after 18 months. Additional manpower and machines would be required in the third year. The overall profitability of this order came to around 34%. Not bad for a quote that showed negative margin!!

Diagram 2

We find this to be very common across our customers. When they use standard costs to make decisions on the profitability of an order or a quote, they make the wrong decision; one way or the other. In the recent economic downturn we worked with many companies that were turning down highly profitable potential orders because they were shown to have negative margin. It is the standard costs that are wrong. Lean value stream managers should never make decisions using a standard cost. They should always look at how the new order effects the profitability of the value stream. as a whole. This requires value stream costing and a good understanding of the flow & capacity of the value stream. The full Box Score for this decision is shown below. Not only does the new order bring the value stream into profitability, but increases the return-on-sales to 15% or 20%.

Diagram 3

 


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