Clients of our forest industry marketing research firm from time to time set, as a target, increasing their ‘profit’ by some fixed percentage each year and ask LGA how we would recommend going about it. Many of our suggestions are what NOT to do, such as poor decisions which often lead to serious, negative, unforeseen consequences. These observations are based on our firm’s experience over four decades.
We see a profitable forest industry as essential to the desired goal of sustainable forests. That sustainable forestry depends on a continuous stream of: financing for thinning; protection against fungal and insect infestation; removal of weed species which interfere with the natural forest; and protection from fire, among other hazards.
This funding can come from a number of sources: government, which relies on taxation; private support based on charitable motives; or income generated from the forest itself, such as selling timber.
The only reliable purchasers of timber, at least in the long run, are profitable private enterprises which convert timber into lumber, plywood, composite wood products and other materials required for construction, furniture, cabinetry and other aspects of our economy.
First, of course, we must define ‘profit’, which in this context is usually accepted as the amount remaining after net sales are reduced by the cost of goods sold and operating expenses such as sales, research and development (R&D), and general overhead. Also referred to as operating earnings, or ebit, this figure represents the amount the company has available to service debt, pay taxes and pay out to shareholders.
How can forest products companies, or any company (but I concentrate on the forest products industries), increase profit by a predetermined amount, or by any amount, and still avoid the serious errors which too often accompany such efforts? In other words, what is within a company’s control and what is not?
This discussion excludes companies in dire straits, where the struggle for survival may require decisions not normally made. We are concerned with forest products businesses in the normal course of effective management.
Profit from ongoing operations Taking into consideration what each company makes and sells, and how it sells it, there are only two broad categories to influence, although there are many options within each: These are income and expenses.
We will consider expenses first, since that is the simpler of the two, and more directly within the control of a company’s employees.
Expenses are often comprised (in no particular order) of salaries and wages (including benefits); raw materials such as logs (bucked or not) or semi-finished products (lumber, veneer) or residues; R&D; utilities such as power (electricity, water, gas) and light. Other manufacturing costs include: depreciation of equipment; quality control; supplies; packaging; storage; shipping; communications (phone, fax, mail, courier); office expenses (including depreciation of new office equipment, maintenance and selling expenses).
It is always possible to reduce expenses. The trick is to do so without raising costs in another, unforeseen, area, or eroding sales, thereby reducing income.
These negative outcomes are almost always the result of the ‘meat-cutter’ approach to reducing expenses. For example, mandating a 10% reduction across the board. Income once lost by such slicing is either gone forever or hard to retrieve.
I have found that the most practicable way is to assign this task to an independent person or group within the organisation, led by a respected manager who knows and understands all aspects of the business. This includes detailed knowledge of mill operations from log, lumber or chip input, through processing, to finishing and storage. Tapping into this expertise generally avoids reckless and ignorant recommendations. Asking a department or division head to cut his/her own expenses raises immediate objections that everything is necessary because to admit otherwise is to confess to previous waste.
One cannot ask such a head to do a ‘Sophie’s Choice’ from the sad movie of the same name (look it up if you haven’t seen it). But the team leader must be sensitive to the realities of the business and not dismiss the input of these department heads just because they may be biased!
Nor can you assign a junior to the task who will be ignored, browbeaten or overwhelmed by the defences of the boss. It goes almost without saying that this task must be supported by the ceo, like any other attempt at fundamental change. If it is not, there will be so much general resistance to the project, and so many leaks in the sieve of expense reduction, as to render the task meaningless.
One other important aspect: the task should NOT include specific personnel actions. That is, comments targeted at an individual. This path leads to discord and internal lack of cohesiveness.
Now let’s take the cost line items one at a time.
Salaries – This is often (too often) the first thing that comes to mind in a programme of cost reduction. Certainly there is a tendency in good times to add, even bloat, staff, but the correction too frequently involves firing junior staff and older executives. I know the latter is illegal but so what? It is done under a thousand disguises. There are five caveats to watch for: 1. Losing the corporate memory. So many times, important facts, procedures or experiences remain only in the memories of older, long-term employees. Many companies have found to their sorrow that when they said goodbye to old Sam, with a party and a gold watch (or gold-plated in these days of US$1650+/oz gold!) they said goodbye to a solution that was critical for productivity but undocumented. So many things are NOT in the files, and even if they are, where is forgotten. 2. Reducing the ‘bench’, those who will follow the present supervisors and grow into effective management. The selection of those to go must be reviewed by a still more senior person, just to ensure, as far as possible, that favouritism does not override promise. 3. Who will do the work? Removing the people does not remove the function, if it was necessary in the first place. The concern is not so much ‘overloading’ the people who inherit the job; it’s their lack of experience and skill. This is a cost which offsets the ostensible saving. This seems to occur frequently in two areas: quality control and maintenance. In the case of quality control, the temptation is to relax standards by widening the grade, including defect or wane that would otherwise be removed, ignoring some measurements (MOR, MOE, IB) that are a little below standard, scrimping on the more expensive raw materials (resin, scavengers, waxes, etc). These are all actions that put the company on the slippery slope to hell, or at least, failure. In the case of maintenance, the temptation is deferral – easy to implement, costly in its effects: loss of products, loss of equipment and, worst of all, avoidable worker injury. 4. Wages are often bound by union contracts, as well as many other aspects of the job; there may be little that management can do, especially without alienating its work force. There are two possibilities that come to mind if these restrictions are not present: Outsourcing – some manufacturing or maintenance operations can be outsourced, as can many overhead functions (payroll and IT are two examples). The danger of course is lacking a ‘fix’ if the need is immediate. I have always said that a local outsource is better than a distant one, even if the latter is cheaper!
Training – it may seem odd to recommend a cost in the name of cost reduction, but good training is never wasted. There are many workshops, seminars and some trade shows which offer real worth to your employees. Send them. They will learn, you will benefit from their learning through increased productivity and their enhanced self-regard. 5. Raw materials – since this is a topic under the constant eye of management there seems little that can be done to save cost without changing the nature of the output. But there is often something more that can be done with the residue: scrap, fall-down, and sawdust. There are product possibilities in each that are worth exploring, but often burning for power and steam is the most effective.
This leads us to utilities and the obvious potential in co-generation. It is always worthwhile to review all electric consumption in lighting, office equipment, air conditioning, and to consider alternative sources of power, including solar.
One cost worth treating separately, and in greater depth, is selling, which generally includes distribution, media advertising, claims and technical support, trade shows, credit management.
By now you get the idea. Cost analysis is a detailed exercise, with close consideration of every line (and its components) in the income statement, financial factors and customer analysis. This subject is worthy of a paper on its own, but I will confine myself to a few observations: Sales & Marketing. Media advertising without some form of measurement is throwing money down a rat hole
– Claims should be responded to immediately and favour the customer as far as possible
– Trade shows are expensive and participation should be considered minutely. Too often they are simply recreational opportunities for sales staff.
– Customer analysis often supports the 80/20 rule, in that 80% of your volume comes from 20% of your customers. There is nothing wrong with thinning out your customer list, referring smaller orders to distribution.
– Conversely, substituting human contact with phone and email often leads to psychological distance and eventual shrinkage of a relationship. Senior people, as well as sales people, must go to the field periodically to ‘press the flesh’ and show appreciation to their customers. Again, there are some things where spending leads to savings.
Conversely, the practice of inviting customers ‘to the shop’ is a good one and helps build and solidify relationships. It should be extended, if feasible, especially if there is some unique event possible at home (fishing, a golf tournament, whatever).
Increasing income The revenue side of the equation is trickier than the cost side. Costs can be reduced by decree, but revenue is often beyond the company’s direct control. Generally speaking, there are just four ways to increase income.
Volume – in a commodity business like lumber, plywood, standard OSB and others, making more of the same increases profit, provided the prices are sufficiently above cost to generate incremental margin. Otherwise, of course, the converse is true: more equals less. Unfortunately, the more of a commodity one produces, the lower the price obtained.
Speciality modification of the basic product – this is usually easiest for a commodity producer, since it does not require whole new ways of doing business. This may be an OSB rim board, a lumber pre-drilled stud, a plywood/aluminium combo; if it is a good modification it will command a higher price, hopefully above the costs of production and marketing.
New products – ventures into new forest industry products should be carefully reviewed but often provide an excellent opportunity for extension of the basic industry. However, by definition, these are not likely to be commodities and this should be recognised. Adding a structural engineered wood product is a natural extension of the company’s product line, especially if it uses what the company already makes: lumber for glulam, veneer for LVL, residue for composites, etc.
Once again, profit is delayed by the capital and people investment that is required, the effort to organise a different distribution system, technical support which is needed for a speciality product, marketing support to introduce the product and company to new markets and other efforts: the old cliché – one has to spend money to make money.
In the forest products industries, unfortunately, ventures into new products that are not forest products are often failures. Why? Because they require a different mindset for a different business. If the product is related to the current business, adaptation to the new line, while challenging, is not difficult.
If it is quite different, failure is frequent unless the company itself is one of those which historically has been a conglomeration of different products, usually technical, often advanced – not true of most forest products companies.
Before proceeding, a thorough vetting is required. Can it be made in the same place on the same equipment by the same people? Can it be managed by the same people? Is the distribution different (Lord help us if it requires retail experience!). How about the accounting systems? IT? Are they compatible? They almost never are.
If it is a fast-moving industry, can the company keep up? This is not an idle question; forest products firms are usually more contemplative – used to longer product life cycles and slower to respond. Recognise that the addition of a new product adds much cost before it adds profit.
Acquisition of a company – acquiring a company in the same line of business is often catastrophic enough; examples abound. How often do we see in the business press a photo of the two company leaders, smiling, shaking hands, congratulating themselves on their joining forces?
Six months later, on the back page, is a notice that the acquired leader has left: to pursue other options, for health, to spend more time with his family.
Melding all the issues cited above, in spades, is a real challenge. Sure it can be done: carefully, well planned, well thought-out. Acquiring a company in a different line of business?…..well, see the above comments. In summary, the paths to profit-increase are strewn with many obstacles, but every one of them can be overcome with due diligence and rational expectations.
