December 6, 2013
Columnist Gerald Davis explains how the process of estimating can be evaluated in terms of what the business needs.
This edition of Precision Matters continues our detailed examination of estimating as a business process. The previous edition discussed the importance of reviewing the estimating system’s performance in preparing price quotations.
Throughout that review process, we compared the estimator’s results with the job shop’s expectations. A slightly different comparison between results and business needs leads to a process we’re calling optimization.
For the sake of discussion, we’ve dissected the estimator’s job into a dozen tasks. In reality, these tasks may overlap or evolve in different sequences. As a review, here is a brief outline of how we’ve dissected an estimator’s job:
The estimates a job shop presents in response to requests for quotation from prospective customers filter the kind of work that makes its way into the shop. For example, consider a shop that consistently uses high labor rates and high markups for materials. That practice will eliminate all but those customers who are willing to pay premium prices for the service they demand. Those demands might include audit trails for all chemicals and materials used in the fabrication of their product, or perhaps they require challenging levels of precision, beauty, or speed.
Consider all of the fabricating facilities you know. Some shops are “high price” while others are “low price.” At the same time, they might enjoy low- or high-volume work. In Figure 1, we’re using an acronym—HPLV—to designate high-price, low-volume shops. Similar acronyms are used for the other three types of job shop business strategies: high price, high volume (HPHV); low price, low volume (LPLV); and low price, high volume (LPHV).
In our example “high-price” shop enjoys relatively high gross margins. By gross margin, we are referring to income before general overhead expenses are taken into account. The nuisance and expense of recordkeeping, special packaging, or special delivery eat up that high initial margin. The final profit depends on the shop’s efficiency in satisfying the customer’s requirements.
In general, high margins lead to low volume in sales. On the other hand, low margins typically lead to high volume in sales. Consider the HPHV situation, which happens to be the goal of every job shopper I’ve met. At just about the moment you figure it out, a competitor does too. A price war ensues, and it becomes LPHV pretty soon.
In the fabrication trade, a low-volume and high-margin shop is typically involved early in the product development and discovery stage. As the product line evolves from new release to established production, the type of fabrication required changes. One shop’s agility and flexibility—the result of very skilled craftsmen—might be a curse if stability and repeatability are of paramount concern. High rates of production generally benefit from dedicated production lines with specialized tooling and probably a significant investment in automation.
Each fabricating organization has its own tolerance for pain. Customers in the product development cycle have behaviors that can be easily stereotyped: no ability to schedule, great ability to change the design, and need for small quantities immediately. Mature product designs come with different demands: rigid delivery schedules and methods, no tolerance for flaws or disruption, and constant pressure for price reduction.
I once owned and operated a precision sheet metal job shop. Part of my early business plan was to grow with my customers. All prototype projects were evaluated for the opportunity to transform them into repeat production work. The theory was to help our customers grow from start-ups to big-time operations, and we would expand to service everything from prototypes through high-volume production.
I enjoyed the excitement of the product development crowd. I felt wounded every time one of our growing customers announced that they had to go out for competitive bids because they didn’t want to have a single source for their critical components. I resented having to lower my prices just to keep the work in the shop.
Guess what happened to my job shop over time? We specialized in product development because that was what pleased me as the owner. One of the important consequences of targeting a specific type of ideal customer was that our estimating strategy needed to change. It originally was designed to be full-spectrum. We’d quote anything.
To be successful as a small-batch/high-margin shop, I needed to optimize my estimating system. Additionally, the shop floor plan, the shop machinery, tooling, and crew all needed to be transformed from generalists to specialists.
Don’t be like me. I was slow to make the connection between the kind of work I wanted and the way I went about prospecting. By prospecting, I mean begging for work—soliciting bids, generating price estimates, and then delivering bids. If we were to categorize the kinds of customers associated with each of the four markets that mesh with the four types of business strategies, we might end up with something like Figure 2.
In my specific case, I needed to learn how to interact with customers that needed the service I wanted to offer. When I mixed with the big consumers of sheet metal in my local area, I found companies with well-established product lines that were in the business of cost reduction. I was unhappy with the customers I was getting, mostly because I was operating at close to break-even profit levels. I did not intend to operate a not-for-profit sheet metal shop.
One change we made was to spend more time interacting with people in the product development discipline—inventors, holders of patents, designers, and graphic artists. Those folks had customers that we wanted to work with. We also changed the way we went about estimating.
One guiding principle of our early estimating process was that bigger batches are good. My theory at the time: There are efficiencies of scale that really boost the gross margin.
For example, purchasing a 10-ton coil of sheet stock resulted in a better price per pound than buying it one sheet at a time. Another example: A press brake operator will cycle the machine much faster after having repeated the same bend 100 times as compared to when he bent the first few parts during setup. More efficiency meant better profits as well as better prices for the customer. Obviously, big batches are good batches, right?
However, the mentality of my operation was not suited to big-batch production. I demanded that the shop have the ability to produce prototypes as well as big batches. That prevented us from being very good at either. For instance, when we succeeded with a big-batch order, we didn’t leave the production line much time to set up and produce the entire batch. We’d build enough to keep from getting into delivery trouble, tear down the line, build a few prototypes because the boss promised them an unrealistic delivery date, then tear down the prototype line, and set up again to finish the big batch. I mention this not as an example that you should follow, but as an example of a business strategy and estimating system that lacked discipline.
Our early estimating strategy was to emphasize to the customer that the price per part would be lower if they bought bigger quantities. We’d always quote three or four quantities, no matter what the customer asked for. Naturally, we forced our customers to change from the sweet darlings we wanted into price-conscious demons that had crazy problems managing their own in-house inventory and reordering schedule with us.
When we started emphasizing the things that please product developers, we ended up with more customers that needed the services we enjoyed providing. In our example, product developers don’t like to spend a lot of time preparing documentation. If they could get their parts built without making a drawing, they’d be happier. When we started offering the service of building from a 3-D CAD model, our customer base changed dramatically. We emphasized speed of delivery, a flexible schedule, and rapid response to revisions. The well-established folks were not interested in those services, but the start-ups and little companies warmly responded.
To be clear about this, I exchanged one form of pain for another. Instead of price warriors for customers, I had dreamers and flaky scatterbrains to deal with every day. We traded in our stable and predictable customers for greater volatility in sales. We also enjoyed a greater variety of products to work on and incredibly grateful customers. On the whole, the sense of accomplishment and competence went up in the shop when we disciplined ourselves to focus on the kind of manufacturing we were good at.
Here are the three simple steps to optimizing your estimating system in order to realize success with your business vision:
Hang on, you say. Those steps say nothing about the estimating process. Throughout this series of articles we’ve made a point of evaluating the estimating process and then making changes to codify successes and avoid the repetition of mistakes. Those evaluations are made by comparing what we expected the estimate to achieve and what was realized. In the realm of estimating, we’ve considered labor, machine time, material utilization, setup, fixtures, tooling, and schedule. The review of the estimator compared predictions to results. The better the predictions, the better we feel about our estimating process.
owever, if the business vision is to work with customers with steady and significant production requirements, then the estimating system needs to be precise in the elements that matter most to that type of customer. For example, the depreciation of tooling and fixtures might be an important cost consideration for your customer. Your estimating system will want to emphasize one-time expenses and nonrecurring charges as separate line items for the benefit of your customer’s financial department. Your estimates might include information or highlight methods that will be used to ensure the consistent and reliable delivery of perfect parts over a long period of time.
The review process will help you identify problems with the estimating system. Some of those problems are simply procedural—rules that need to change or be adopted. Other problems are built into the system, such as forcing customers to accept large quantities when that doesn’t really help their efficiency. The optimization process will go more smoothly when you have good feedback from your customers, as well as from your accountants. Screaming customers are good, but only for a short time, and they are good only for recognizing that you’re really a HPLV shop at heart and are wasting time on the LPLV estimates.
Gerald would love to have you send him your comments and questions. You are not alone, and the problems you face often are shared by others. Share the grief, and perhaps we will all share in the joy of finding answers. Please send your questions and comments to firstname.lastname@example.org.
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