What is your Limiting Factor?
Back To Main Page
Determine Your Profit per Limiting Factor from Operations

(reprinted here article from U.S. manufacturing magazine- graph not reproduced)

Using a new time-based profitability metric, steel company managers can optimize product mix and pricing to   
maximize profit.

Instead of looking for yet more ways to cut costs, it is imperative that managers in the U.S. steel industry find 
new ways of improving performance on key investor measures like Earnings per Share (EPS) and Return on Net   Assets (RONA). The steel industry today has a different cost structure than it did half a century ago, due to 
production efficiencies gained over the past 25 years. It now embraces a smaller ratio of direct costs (i.e.,
materials and labor) that rise with increases in production volume.

Fixed assets such as plant facilities now represent a larger ratio of direct costs than ever before. In other words,
rather than direct costs, per-product cost and profit is most affected by the amount of time that plant facilities
are tied up for production. Performance is linked to time Measuring time is critical because the measures of
profitability at the corporate level and the investor’s critical financial metrics– earnings, RONA, and cash
flow–are all linked to specific periods of time. Simply put, measures of corporate financial performance are
denominated by time.

Moving a company from the traditional “profit per ton” view to a time-based view of profitability–dollars per
minute–requires more than just a spreadsheet.
“The secret to maximizing the profitable throughput of a
steelmaking operation lies in identifying those products that make the greatest profit contribution per hour (or
minute) of capacity on the constraining equipment,”
explains David Jardini, director of Hatch Beddows in
Pittsburgh. This means taking into account both the margin per ton that is earned on a product and the amount
of time required on the bottleneck asset to produce that product.

A typical mill produces thousands of different types of steel that vary by gauge, width, finish, grade, form, and
end customer or market segment. Raw material costs, finished product prices, and processing time changes
need to be captured and incorporated as they occur so the profitability analysis can be reliable and accurate. Cost   models that are updated yearly, or even quarterly, simply do not deliver the accuracy required for success in
today’s fast moving markets.

This problem is even more acute when companies are participating in online exchanges and reverse auctions. As
bidders in e-markets, steel producers need to understand the  characteristics of their own business to know
which opportunities to pursue.

They need to know the “sweet spot” price where they have an advantage over the competition. They need to
figure out which price will meet the RONA target for the enterprise. And they need to understand which
customers and markets provide the highest overall returns.

Profit per Limiting Factor analysis –based on the the principles of through-put accounting- enables the integration   of the finance, marketing, operations, and sales departments- to align daily decision-making with corporate
profitability metrics like Return on Net Assets.


Armed with Profit per Limiting Factor analysis, managers across the enterprise can see exactly how much each
product, customer, market segment, production line, and plant is contributing to earnings and return on assets.

In the steel industry, a steel company’s most profitable products typically generate cash, on a per-minute basis,
at least 10 times faster than its least profitable products, sometimes up to 20 times faster. In other words, there
is at least a 10:1 range in profit per minute by product. By understanding in detail the variations in profitability per   minute, a steel producer can focus sales and marketing on those highly profitable products to increase
profitability.

Using Profit per Limiting Factor analysis, a huge range in profitability by product type becomes obvious. In the
example illustrated, each bubble represents a specific product. Standard profit per unit is plotted on the vertical
axis. The horizontal axis shows how fast each product contributes cash-cash contribution per minute, or cc/min.   This chart compares the standard per-unit view of profitability (the way industry views product profitability
today) with time-based analysis. The time-based analysis focuses decision-makers on cash contribution per
minute, because this cash contribution velocity is the fundamental driver of earnings per quarter and return on
assets.

To illustrate where production time is employed, the bubble size scales to the time consumed by each of the
products over this twelve-month period. Two products are highlighted. Both are good cash contributors,
generating approximately $10M. But, the product LTRO took 10 days of productive time to generate $10M in
cash, while the other product, LTRE, used only 5 days to generate the same amount of cash. Viewed from the
conventional standard profit per unit perspective, this difference in rate of cash contribution is not visible. Profit
per minute analysis makes this hidden profit opportunity visible.

With this hidden profit opportunity now visible, what can be done to capitalize on this powerful information? 
Let’s look at the profit impact when a sales organization adjusts the mix of products to the more profitable ones.
If just 5% of production minutes are shifted from the slowest to the fastest profit per minute product types, the
overall average cash contribution per minute increases 16%, resulting in a plant-wide profit improvement of
$21.8 million. That’s $21.8 million added directly to the bottom line without adding equipment or labor.

What makes Profit per Limiting Factor important is that instead of calculating profitability on a per-unit basis,
based on allocating labor costs and material costs to products, it focuses on profit per minute. Profit per minute 
is a profit metric that focuses on the rate of profit flow in terms of time, as opposed to units. The minute time-
increment permits a micro-level perspective on profitability, and serves as a common denominator for comparing   product, machine, and customer profitability.


The reason this is such a powerful lever for improving profitability is that profit per minute analysis reveals a
very different picture from the traditional profit per ton view. As shown in the previous example, products that
make a large profit per ton may require a long processing time through the critical manufacturing assets. As a
result, these products actually deliver a very low profit per minute and a low or negative return on assets.
Manufacturers who understand which products they make well–products with a high profit per minute–can
focus their sales and marketing efforts on these products and improve the overall profit per minute of their
product mix-not to mention the profitability of the corporation.

With a profit-per-minute view of operations, the dollar value of improvement possibilities becomes very clear.
Sales managers can tell at a glance which products, market segments, or customers generate the highest return
to the company. By focusing sales activities toward products with a higher profit per minute, steel producers can   make significant continuing improvements in a company’s overall profitability. Production managers can
investigate the various reasons for factory downtime and prioritize them based on profit impact. Improvement
initiatives can be focused on those with the highest return to the corporation.

This may mean the mill will choose to forego business that appears profitable from a gross margin perspective
but actually delivers a low or negative return on assets. Conversely, sales managers can now pursue high-return
business with aggressive pricing that may show a low standard margin but delivers a high return thanks to the
short cycle time or high yield in production.

“It is imperative that we find new ways of increasing profitability in today’s market,” says Paul Kadlic, executive   vice president of sheet products for U. S. Steel. “Profitability per Limiting Factor minute analysis helps us shift
our product mix towards products with a higher profit per minute so we can make significant improvements in
cash flow and overall profitability.”

“Standard profit per unit numbers may not be sufficient for aligning daily decisions with corporate profitability 
goals if time is not taken into account,”
says Gretchen Haggerty, vice president of accounting and finance for
U. S. Steel.
“Profitability per minute analysis gives managers the information required to assist them in making the  most profitable decisions in setting prices, analyzing utilization, allocating plant resources, managing production 
flow and product mix, and much more.”
Back To Top of Page
Back To Main Page