It has long been a theory of mine that companies that operate their businesses based on the philosophy of “If I run my plants flat out, I’ll make the most money” are not only leaving money on the table, but also precipitating industry problems. Recently, I’ve had conversations with several customers and prospects that have validated my theory.
In chemicals, the cyclic nature of the industry has long been a problem. As profits grow, more people enter the industry, and the economical large chunks of capacity that come online with new plants drive a supply glut, sinking price and profitability.
In the paper industry, one of our customers made the choice to partially idle plants. This had the dual benefit of keeping SOME (but not all) jobs and keeping prices up on the now-scarcer supply. Using this strategy, our customer returned to marginal profitability in a sinking industry.
Finally, a manufacturing company with whom I was recently consulting was facing marginal profitability in one business unit. They made the decision to be a “good industry leader” – they held firm on price, anchored in the value they delivered to their customers. They also reduced capacity utilization to avoid a supply gut, which also enables their pricing strategy. Counter to the prevailing wisdom at this company, profitability shot up.
What does this mean for you? First, reconsider the prevailing wisdom of “maximum capacity utilization” that is prevalent at your company. Next, in the upcoming weeks, we will explore several tactics you can use to better inform your business on the effect that a sound pricing strategy can have on profitability:
- Improve communication between supply and demand groups
- Estimate demand based on data, rather than roll-ups of sales forecasts
- Consider total costs of your supply chain, including moving output to higher-demand areas
- Using software to optimize your business’ profitability
See you next week.