As companies grow from small to medium-sized, they inevitably reach a point where systematic cost analysis— a routine, automated process for assessing all costs — is critical to their survival and continued growth. Small businesses with only a small number of services or products can do manual accounting to ensure they have a good understanding of their costs in order to price a product or service and realize profits. When material and labor costs are stable and predictable (as they have been for much of the past decade), pricing and cost estimation is not a huge challenge.
However, as happens when businesses grow and grow, when products and services proliferate, medium-sized companies often start losing money on some of them and profiting on others, a situation that is exacerbated in unpredictable market environments. This produces a suboptimal average profit. Worse still, if these profitable services and products are overpriced, the company will slowly lose sales, further worsening its total revenue situation.
At that point, manual accounting will no longer be sufficient to trace high-volume costs to a single product or service. Then, growing companies need erp (enterprise resource planning), MRP (material requirements planning) and other technologies and project management software to keep the right (and profitable) track by identifying what is creating value at what cost, tracking the flow of manpower and materials in the value generation process, and minimizing the cost of excess assets such as inventory or underutilized human assets. This is a critical turning point in the digital transformation of midsize enterprises. It is not enough to have a basic, accounting-focused ERP, as it makes many activities impossible to measure and manage, while others still use paper-based processes and, at best, slow periodic reporting.
Analytics and tracking techniques like this aren't just for manufacturing businesses. As the workload of any growing midsize business—from plumbing companies, retailers and distributors to consultancies to law firms—increases, the complexity of tracking the true cost of products and services grows exponentially. Here's how a mid-sized business is committed to digital transformation and successfully implementing technology upgrades.
Grow from small to medium-sized
Founded in 1967, San Jose, California-based Elcon Precision manufactures precision parts and assembly components for the aerospace, defense, and medical industries. The company specializes in photochemical etching, brazing assembly and ceramic metallization. Decades ago, it grew into a medium-sized business with a total workforce of between 50-100 for years. In 2015, while upgrading its ERP software, Elcon learned that its products were less profitable than expected. The product's profits are so low that the ceramics division looks like it's losing money and should probably be closed. Tim Dyer, who has been Elcon's president since 2017, said: "We may be out of business now, it was so bad. ”
Elcon's manufacturing process is very complex. The approximately 5,000 finished parts it sells are made of 10,000 parts and sub-accessories. Elcon has significant direct labor costs and ever-changing part costs, including rare precious metals such as gold and molybdenum. As the sole supplier of many products, the company cannot rely on market pricing, and its relatively small team cannot effectively use spreadsheets to analyze the total cost of production to set prices. The company's products and cost components are so numerous that Elcon cannot collect the labor costs of each product one by one.
"Without an MRP-capable, enterprise-wide ERP," Dell says, "we wouldn't have been able to remain profitable because we sold a wide variety of parts and assemblies." I don't think it's possible for anyone to be profitable without this technology. ”
Digital transformation for midsize enterprises
Medium-sized businesses almost never start from scratch. They have a complete IT system that works for them from the very beginning of their business. Elcon, like many other smaller businesses, initially used QuickBooks. By 2011, the system was clearly no longer up to the company's pace. The company wanted to better capture the costs of its ceramics division, so it upgraded to MAS 90, a Sage accounting package. By 2015, however, the software was no longer supported, forcing the company to upgrade to Sage 100. At this point, Elcon understood that it needed to consolidate all its operations into one connected system. This is commonly referred to as "digital transformation.".
The digital transformation of a medium-sized enterprise can take years. It should be that long. Attempts to compress digital transformation into too tight a time frame are often counterproductive, either taking longer than planned, thereby demoralizing, or the implementation of the transformation ending in complete failure. After the core technologies of ERP are up and running, companies must create a roadmap that outlines the issues to be addressed in implementing the transformation and determines which are the important elements in subsequent IT projects. Dell recalled: "The gross margin of the ceramics division is questionable. We started integrating using handwritten time on a flow card [a paper form that comes with the product as it moves around the assembly line], and entering it into Sage to calculate gross margin. We were accounting for the profitability of the ceramics division, but we always thought the metals division was profitable, so no one paid attention to it. As it turns out, the metals sector also has a lot to learn; it's not always profitable. ”
Elcon completed the upgrade to Sage 100 in late 2015, integrated its quality management system in early 2016, and introduced a work order scanning system towards the end of that year. In 2016, Elcon acquired a company, and in 2018, it acquired a division of Jennings Radio, consolidating it into ERP/MRP and enabling a SQL database. All of this lays the foundation for 2020: a new Customer Relationship Management System (CRM) for sales flexibility, which comes with a special quoting module that makes it possible to create mobile cards with barcodes. They also took a step to improve efficiency: a barcode inventory module that eliminated the year-end inventory scavenger hunt. The Inventory Count in December 2020 took one person a day to complete, compared to five days in previous years.
Turn
As the sole supplier of many products, Elcon shares its cost data to justify price increases. Systematic cost analysis drives this process. Elcon Ceramics is the sole U.S. supplier of strategic military components. Their customers asked Elcon to name the price needed to sustain production. Elcon used its new system to prove that it needed to triple the price of the component. To Elcon's surprise, its customers agreed, and instead of shutting down, the ceramics division is now profitable.
With its systematic cost analysis technology, "we can now accurately calculate and verify the gross margin for every product we sell," Dell says, "and with this in mind, we can make informed decisions about where to spend capital expenditures to improve efficiency and yield." ”
Elcon's investments in technology have paid off. After the slow sales in 2017, 2018 began to show the fruits of their labor. Both gross and net profit margins are growing, as reflected in the books of companies.
One of them, the ceramic metallized product group, accounted for 20% of Elcon's sales, and its gross margin grew by 50% from 2017 to 2020. This growth was driven by negotiating supply chain price reductions, replacing two employees with assembly robots, not accepting low gross margin orders, increasing yields, reducing quality control (QC) costs, introducing more efficient furnaces, and implementing other Six Sigma process improvements. One of the two employees replaced retired and the other was retrained to work in different departments.
Price increases have played an important role in Elcon's steady annual revenue growth – a 40% increase in 2020 compared to 2016. Since 2018, net profit has been growing every year. By 2020, net profit had jumped 2.56 times from unacceptably low levels in 2016.
For a medium-sized company, becoming a data-driven business can be a daunting task. It's easy for senior leaders to assume that the current system is good enough to be acceptable, especially when the company is achieving strong overall performance through existing systems. However, profits, whether earned or lost, are accumulated bit by bit. Modernizing IT systems and being fully equipped to manage costs is at the heart of maintaining competitiveness and profitability. Continuous improvement is the right thing to do.
Elcon has a long way to go. The next few steps in 2021 include finding a maintenance module that talks to Sage 100 and a custom CRM/sales module for space component assembly. The company has begun preparations to launch a requirements planning system during 2022.
How to implement digital transformation in a midsize enterprise
When lost productivity during licensing, implementation, training and change is taken into account, the cost of changing the underlying accounting system can range from hundreds of thousands of dollars to millions of dollars. Choosing the right ERP is critical because too many processes and systems will pile up on top of that, and changing or replacing the ERP system later is risky and costly. Elcon's success highlights, and in our experience, key considerations when choosing an ERP include:
• The ability of ERP software to evolve with the business. When your company is twice or triple the size it is today, how will your needs be different?
• The long-term viability of the company that created the ERP. Small software companies can serve niche industries well, but software vendors should remain viable and responsive for more than the next 15 years. Make sure they will upgrade their software regularly and that your upgrade path is smooth.
• Manage the funding of erp. Big businesses like SAP will be around for a long time, will consider scaling up, and will be very versatile. However, the cost of managing and maintaining such systems is often high, which may be a cattle knife for many medium-sized enterprises.
• Availability of pre-built modules for your business. There's no doubt that you'll need a CRM, project management programs, barcodes, MRP, and more.
• Easy integration with external software. These systems can be vendor or customer systems, or other software systems that you choose to use internally.
• The strength of your Value Added Reseller (VAR). This is the company responsible for selling, installing, and customizing software. VARs make a lot of promises; make sure they deliver on those promises.
• Contracts with VAR. The contract should include incentives to encourage the VAR to act as planned.
At a higher level, the transformation roadmap should look forward for at least five years, as software choices are often influenced by the capabilities that businesses need to move along the path. However, a short-term roadmap with a detailed plan a year or two in advance is critical to implementing the transformation.
The incremental method is crucial because:
• Midsize companies need to reap the rewards of the costs they pay to implement IT changes. Small steps to improve efficiency or effectiveness in an area of the enterprise can yield results quickly and help justify further investment in IT. Most businesses can't afford a seismic transformation.
• Even small IT system changes are complex, and solving them little by little can reduce the risk of failure.
• IT staff, whether in-house or outsourced, are often resource-constrained. A series of smaller projects can make smaller teams more agile and make steady progress.
• Business needs often change with digital transformation. Without experiencing some of the changes that the new system brings, most midsize businesses won't be able to see exactly what they need. Learning from a data-driven system and designing the interaction between the next system is critical.
• Employees who will be working with new technologies have limited time to learn how to use them. They have full-time jobs. Too many changes that are too fast can affect service levels and revenue-generating activities. More importantly, change in any form is troubling and must be managed, which is time-consuming and resource-intensive. Technological change must go hand in hand with all other types of change, such as new products, acquisitions, new services, new employees, geographic expansion, changing market trends, and more.
Building the capacity to support systematic cost analysis is not easy for midsize enterprises. But once done, it can be the basis for managing gross margins for product and service companies.
Robert Sher | wen
Robert Schell is the head of CEO to CEO, a consulting firm of former CEOs focused on improving the leadership infrastructure of midsize companies seeking speed-up performance. His latest book is Mighty Midsized Companies: How Leaders Overcome 7 Silent Growth Killers.
Shi Qingjing | edit
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