A Guide to Unlocking Profit Margin in Manufacturing
In the changing landscape of modern manufacturing, navigating challenges like the pandemic, supply chain headwinds, cost pressures and inflation can be daunting. To stay ahead, businesses must uncover the hidden potential within their profit margins. Majority of businesses have felt the impact of global uncertainties on price management. Understanding what constitutes a robust profit margin and evaluating effective strategies to bolster profit margins will help businesses optimise profitability and foster sustainable growth.
Understanding Profit Margins in Manufacturing
There are different types of profit margins and each provides unique insights that enable you to make informed business decisions. We’ll look at two types of profit margins, gross profit and net profit margins.
Gross Profit Margin is an important metric for businesses to track and enables you to evaluate the health, efficiency and competitiveness of your business. It is the profit that remains after accounting for costs of goods sold (COGS) and includes costs necessary to and directly related to produce or manufacture your products. COGS includes costs such as raw materials, labour costs and factory overhead expenses.
Gross Profit = Revenue – COGS
Gross Profit Margin = [(Gross Profit ÷ Revenue) x 100]
Example:
Revenue £500,000
COGS (£345,000)
-------------
Gross Profit £155,000
Gross Profit Margin = [(£155,000 ÷ £500,000) x 100]
= 31%
This metric enables you to compare how much more or less efficiently your business operates compared to your competitors. Comparisons year-on-year provide insights as to whether your gross profit margin is increasing or decreasing. It is also very helpful in assessing individual products.
Net Profit Margin measures the ability to turn income into profit. It reflects the percentage of revenue retained as profit after accounting for all production costs (COGS) plus operating expenses such as rent, wages, administrative and sales expenses (OPEX) necessary to run the day-to-day business plus payments for interest, taxes and other expenses. It's a crucial metric that measures a company's ability to generate profits from its manufacturing operations.
Net Profit = Revenue – (COGS + OPEX + Interest + Taxes)
Net Profit Margin = [(Net Profit ÷ Revenue) x 100]
This is a great indicator of your company’s profitability because it takes into account all direct and indirect costs. Your Net Profit Margin will be lower than your Gross Profit Margin, for example 7%.
Strategies to Boost Profit Margins in Manufacturing
Profit margins in manufacturing can increase or decrease due to various internal and external factors, including production costs, operational efficiency, changes in competitive landscape, market volatility and level of innovation in the industry. Manufacturers can increase profitability in a number of ways such as increasing revenues and reducing costs.
Here are some strategies for manufacturing companies to consider:
1. Customer-Centric Approach and Value Creation
A customer centric approach involves placing your customers’ needs at the heart of all your decision-making and prioritising delivering maximum value to them. Often businesses are focused on processes, systems and products that are designed and implemented with their own business in mind. Decisions are then based on what is best for their business rather than what is best for their customers. By placing your customers at the heart of all your decisions and through a deep understanding of your customers’ needs, businesses can then deliver solutions that add value to their customers.
Customer centricity is essential for building strong customer relationships, increasing customer loyalty and driving business growth. It is particularly important in today's competitive business environment, where customer expectations are constantly evolving, and companies that prioritise their customers are more likely to succeed.
2. Innovation and New Product Development
Companies that foster a culture of innovation, invest in research and development and continually seek ways to improve and evolve their products and services significantly increase their profits. To stay at the forefront of innovation companies must explore and implement cutting-edge technologies and processes, invest in research and development to ensure innovation in product design, manufacturing processes and supply chain optimisation and embrace sustainability initiatives.
3. Investing in your Workforce
Developing a skilled and motivated workforce is a strategic investment that can significantly impact profitability. Employee training and development programmes are essential for fostering staff loyalty and continuous improvement. By investing in these programmes, you can enhance the technical skills of your employees, boost process efficiency and nurture a culture of perpetual improvement.
Empowering your workforce to actively participate in identifying value-added opportunities and contributing to your journey toward operational excellence can yield substantial benefits. Employees who feel valued and equipped with the right skills are more likely to drive efficiency, innovate, and contribute to the overall profitability of your organisation. Investing in your workforce is not just an expense but a pathway to long-term financial success and sustainability.
4. Cross-Functional Collaboration and Breaking Down Silos
Cross-functional collaboration and the dismantling of organisational silos are pivotal strategies in achieving shared margin-boosting objectives. Traditionally, where finance, sales, marketing and production teams have operated within their respective domains, an holistic approach to profitability is required. Encouraging the different departments to harmonise their efforts and work towards a shared vision and common goals has become a strategic imperative.
5. Pricing Strategy
A pricing strategy is the foundation for sustainable, long-term profitable growth within your business. It supports your business in achieving its corporate and marketing objectives and it has a significant impact on your financial results. Pricing is the most powerful profit and growth lever that a business has. It aims to increase both sales and profits by setting prices that reflect the true value of your products and services.
Additionally it involves recognising that your business cannot be everything to everyone and therefore you must be selective about which customers you choose to serve. The objective ultimately is to maximise profits by understanding, creating, communicating and capturing value within the constraints of your competitive environment, company costs and organisational capabilities.
6. Customer Profitability and Cost-to-Serve
Customer profitability analysis reveals the financial performance of individual customers or customer segments, highlighting which customers contribute significantly to your bottom line and which may present challenges. It empowers businesses to identify high-profit customers, optimise their strategies and make tough decisions regarding less profitable or even loss making accounts.
Cost-to-serve analysis delves into the expenses incurred to serve different customer segments. It goes beyond the surface, evaluating elements such as price discounts, payment terms and the technical support provided to ascertain the true cost of servicing each customer segment.
Both these analytical tools provide invaluable insights that enable data-driven decisions to enhance margin. By distinguishing between profit-generating and loss-incurring customers and comprehending the real costs of serving each, organisations can make informed decisions such as strategically reallocating resources, refining business strategies that will improve their bottom line.
7. Efficient Cost Management
Efficient cost management is a cornerstone of profitability. To bolster your bottom line, it's essential to delve deeper into cost structures and identify avenues for improvement. Initiatives such as identifying and eliminating unnecessary costs, optimising procurement processes, reviewing terms with suppliers, exploring bulk purchase discounts and establishing long-term relationships to secure cost-effective sourcing options can lead to substantial cost savings. Lean manufacturing practices and waste reduction initiatives can yield significant savings too. Cost management is an ongoing process that requires vigilance and adaptability to ensure long-term financial health.
8. Operational Efficiency
Achieving operational efficiency will increase margins. This can be realised by streamlining your manufacturing operations, minimising downtime and maximising equipment effectiveness. Embracing advanced technologies, such as automation and robotics can significantly enhance productivity by reducing manual labour, minimising errors and optimising production processes. Additionally, continuous monitoring of key performance indicators (KPIs) and data analytics can provide valuable insights into operational efficiency. Fostering a culture of continuous improvement among your employees can drive operational excellence, resulting in increased profits and sustained growth.
9. Supply Chain Optimisation & Supplier Collaboration
Efficient supply chain management is a key driver of profitability. Collaborating closely with your suppliers is essential to secure cost-effective sourcing options. Forging strong partnerships with suppliers will result in cost efficiencies and joint cost-saving initiatives. This collaboration also enhances the reliability and flexibility of your supply chain. By working closely with suppliers, you can identify opportunities for mutual growth and develop strategies to increase profitability across the supply chain.
10. Process Optimisation, Technology and Automation
Continuous evaluation and optimisation of production processes are essential for maximising profitability. Encourage a culture of continuous improvement among employees, empowering them to identify and implement process enhancements. Invest in advanced manufacturing technologies and robotics to optimise production processes. Embracing innovative technologies not only increases productivity but also positions your organisation for long-term profitability and competitiveness in the ever-evolving manufacturing landscape.
What Constitutes a Good Profit Margin?
A "good" profit margin in manufacturing is of course context-dependent, varying with industry, company size, market conditions and company strategy. As a rule of thumb, Net Profit Margin of 5% is low, 10% is healthy and 20% is high. These margins can vary widely depending on manufacturing sectors and business models. Benchmarking against industry standards and competitors is essential for assessing the health of your profit margins.
Conclusion
These are only a few of the strategies available to manufacturing companies to increase their profit margins. The important point is to review and evaluate your business performance, competitive landscape, industry trends and customer needs and then decide on which strategies are most appropriate to achieve your goals. By implementing these strategies, manufacturing companies can unlock profit potential hidden within their margins, ensuring resilience and growth even in challenging times.