Process innovation: Reduce ‘cycle time’ and pump up profits
Wednesday, August 29, 2012/
Business is tough. The tightening of credit markets has made running prosperous enterprises even more difficult, and while some wring their hands and lament the good old days of plentiful credit, how many people are looking at their business cycle time as an alternative to extended credit or increased overdrafts?
What is “cycle time”?
Cycle time is best defined as the total time in business it takes from receipt of an order until payment is received and banked©. In many businesses the cycle time is typically 90 days. In some cases it is much longer. For complex projects, payment can be staggered over many years and final payments are often withheld for a guarantee period, extending even further the total cycle time.
Negative cycle time
Some businesses have a negative cycle time; that is the money is received and banked even before the goods or services are delivered. Airline tickets or pre-paid phone cards are typically negative cycle time businesses, so too are online sellers such as Amazon. In the latter case there is not even a need to have expensive infrastructure, such as in the case of a telco or an airline. Amazon as a business needed nothing more than a PC and a website as its investments to get started and create a highly successful negative cycle time business.
The difference between success and failure
It is important to understand the influence cycle time can have on success, or perhaps failure. There are many stories of businesses that have failed because they grew too fast and were unable to provide the finance to support that growth.
In simplistic terms, if a business is shipping $100K per month and is operating on a three-month cycle time, a minimum of $300k is needed to finance the business. Banks, especially these days, are loath to finance businesses against orders, but rather look for bricks and mortar assets as collateral. If suddenly the business starts shipping $200k per month with the same cycle time, now $600k is needed as working capital, and if that is not available, then foreclosure may be staring you in the face.
However, if the same business can reduce its cycle time to just 1.5 months, then sales of $200k can be supported with the same initial equity base. That’s how important cycle time is, but unfortunately, this is often overlooked.
Customers are slow to pay
Doubtless the greater part of cycle time is the delay in customers paying their debts.
While we can push for deposits, short-term financing or even early payment incentives, we should not ignore the delays inherent in our own internal processes. If these can be identified and rectified, any reduction in cycle time will be immediately seen on the bottom line as pure profit.
So what’s the solution?
Some businesses look to “factoring” their debts. This essentially means taking a short-term loan for the period of financial stress, but in many cases the interest charged is sufficient to wipe out any potential profits. Thus, while factoring does have a place, look closely at the costs before seeing this as a panacea. Yet another means is to offer discounts for early payment.
Unfortunately, while both of the above may improve cash flow somewhat, they come at a cost.
A better solution to gaining a partial reduction in cycle time is to take immediate deposits on a customer’s placement of an order. Deposits from customers are seldom seen as your ploy to gain some payment a little earlier, but more likely embraced by many as a means to secure their place in your delivery queue, and thus they are not viewed negatively.
The best solution is to analyse your entire business cycle time. This is best done by dissecting the business into its serial components from receipt of an order, to shipment, and debt collection and to look for ways cycle time can be reduced.
Process innovation is one way of investigating cycle time in a systematic manner. It is quite amazing what effect small changes to processes can have in delivering real cycle-time reductions, and any gains made here go straight to the bottom line as profit, pure and simple.
What’s the message?
Process innovation applied to the cycle time reduction should be seen as a means to reap hidden profits from transactions that may otherwise cost real money. Dissect and analyse your business: there is always room for improvement.