The 411 on managing manufacturing overhead cost

Rarely has U.S. manufacturing been touted so often at the highest levels of government than it has been in 2017. However, the industry still faces an unpredictable future. To be best equipped for whatever the coming years and decades may bring, it is incumbent upon companies to prioritize optimizing efficiency and reducing costs.

When the Solution Becomes the Problem

Manufacturing companies have long since jumped on bandwagons pulling lean, Six Sigma, process excellence (PEX), design for manufacturing and assembly (DFMA), kaizen, target costing, the Taguchi method, total quality management, and value engineering.

Sure, some of these efficiency-boosting and cost-savings methods go back decades, and some even include a focus on innovating and maintaining or improving quality. But they all have one thing in common: Each involves a process of execution, and none of them really works to identify the tasks to be performed or the processes that guide the performance of the tasks. Each one-size-fits-all approach omits sometimes crucial details that affect the entire production process.

Enterprise resource planning (ERP) eclipses the other methods by focusing attention on the product or service under study, and then determining the best way to accomplish it through the most efficient use of human, capital, and equipment resources. The analysis ERP demands brings into focus those overhead costs that other methods miss.

No Overhead, No Operation

Efforts to control and minimize overhead costs cannot result in their elimination. Indirect costs keep the business running. Every manufacturing plant requires utilities, such as electricity, water, sewer, and communications.

Try to imagine running a factory without functional toilets. A factory or office that cannot accommodate basic human and equipment needs won’t have employees at all.

While engineers and factory workers often enjoy disparaging company salespeople, they rely upon one another. If the factory workers cannot build the products to suit, then the salesforce has nothing to sell. If the company eliminates its salesforce, the client list disappears. If the engineers cannot design to client needs, dissatisfied customers will find other vendors who can fulfill their needs.

The interdependence of indirect costs and direct costs cannot be understated, nor dismissed; therefore, they must be integrated into the pricing of services and products.

Identifying Overhead Costs

The cost of manufacturing extends far beyond the cost of factory labor, raw materials, and production equipment. It includes indirect costs, from production floor space (rental, depreciation, taxes) and utilities to insurance, maintenance, and material handling.

It’s no secret that labor comprises a high percentage of manufacturing overhead costs and is the most difficult to control. But nonmanufacturing overhead costs still must be factored into pricing calculations along with direct manufacturing costs to determine the real cost of a company’s products.

ERP integrates time into its analysis of resources and processes, disclosing the best places for benchmarking progress. Employees can and should be entrusted with the decisions to proceed to the next step without the costly and often frustrating delay of approving signatures.

Finding Your Company’s Core

A diverse product or service portfolio often serves as a business asset. Diversity enables the company to serve a varied range of customers so that when one clientele niche fades in profitability, another picks up the slack.

But diversity becomes its own problem if the variety of products and services expands beyond a company’s ability to provide them efficiently and to their clients’ satisfaction. “When your production facility is tied up with noncore products, you bog down your company’s ability to provide up-to-date products that your customers expect in a timely manner,” said Craig Zoberis in his article “Know Your Indirect Costs before Outsourcing Your Manufacturing.”

In other words, a product or service in a company’s portfolio may be better provided by a subcontractor, or eliminated from the portfolio altogether.

Managing Indirect Costs

There are two types of overhead employees in the manufacturing labor force: those who are responsible only for administrative tasks, and those who actively support the production process. When you are calculating the manufacturing overhead cost for each staff member, consider a few key points:What category of work does the employee fit into? Direct labor, production support, or administration?

Note the difference between billable hours – the time that can be directly attributed to a specific job or project – and nonbillable hours, such as staff meetings and training. The cost of equipment, supplies, or software purchased for the support of a specific product or service should be assigned to that product or service.

Paying the Real Cost of Business

The goal always should be to allocate all direct and indirect costs to the cost of the finished product. Doing so provides a realistic picture of estimated product costs. With this information, plus the analysis of resources, management can then assign the appropriate personnel, equipment, software, time, and budget.

Analysis of this information also indicates when and where it may be appropriate to authorize overtime, hire and train additional staff, and outsource elements of the production and assembly process. You may even be able to bring already outsourced elements back in-house.

As important as it is to diligently and accurately allocate costs to understand the real cost of business, it’s equally important to control them. That means outsourcing where prudent, allowing meetings only as necessary, and regulating meetings for productivity. With meetings being notorious time wasters, it’s best to keep them to a minimum. You need only enough of them to ensure progress is on track and that employees feel included and valued.

Breaking Patterns

A U.S. consulting firm, AlixPartners LLC, recommends proactive management of indirect costs by adopting a long-term perspective that accommodates future fluctuations. This will essentially make the difference between being reactive and proactive. Doing so can have permanent effects on a company’s cost competitiveness in the market.

Proactive planning is the only way to effectively manage overhead costs, and it’s the best path to more profits too.