SADDLE BROOK, N.J. — A sales rep comes into the plant and excitedly exclaims, “I have a chance to sign a great new account, but … we will have to add a new item.”
This scenario is one that is all too familiar with most laundry managers.
Adding a stock keeping unit (SKU) can be an expensive proposition (and a slippery slope) for many reasons. Due to this fact, we need to determine if the new item represents a value-added proposition in the eyes of our customers, specifically by asking, “Do our customers want it and are they willing to pay for it?” It is not until we identify the hidden costs that we can properly price a new item and then determine if our customers are willing to pay a premium.
Custom items are expensive to process because they introduce variability into the production system, and this drives up costs. This is frequently seen in mixed plants with many SKUs, compared to specialized plants with limited SKUs. Specialized plants almost always operate more efficiently with greater pounds produced per operator hour.
Demand for a new item can be difficult to predict. If we add an item for a specific customer, we hope to be able to sell it to other customers as well, but there are no guarantees here. Additionally, we should consider the possibility of replacing existing items with the new one in order to level demand.
One strategy to reduce this variability is to add inventory to compensate for fluctuating demand, but this is expensive. To account for expected shrinkage due to loss, damage and even overstocking, it is not uncommon to require a circulating inventory level of 50% more than what is actually required.
Additionally, textile manufacturers often have minimum order quantities. It may be necessary to purchase and warehouse significantly more product than is actually needed.
We should also consider the customer when evaluating the need to add a new SKU. Is this for a new opening or for a business that has been operating for a number of years? New openings typically require greater inventories immediately after opening, but demand can quickly subside. And adding an item for a new customer, which ceases operation after a short time period, can result in that inventory sitting on a shelf.
Finally, this process variability creates operating inefficiencies. Processing smaller wash batches to accommodate limited demand wastes water, energy and chemicals. Mixing a new item with other items to assure a full wash load increases labor in the form of post-sorting. A new item can also create waste by increasing processing changeovers on the plant floor.
A second common scenario prompting laundry managers to introduce a new item into the product mix is to upgrade an existing item. Upgrading an existing SKU offers potential competitive differentiation and can garner customer goodwill, but it can also be expensive.
Be sure to consider the impact of an upgraded item on revenue per pound. This is particularly important in healthcare laundries, where piece pricing is prevalent.
Additionally, upgraded products are typically more expensive to purchase. A higher-thread-count sheet will prompt better patient satisfaction ratings, but it will be more expensive to purchase. The higher installation cost may be compensated by longer product life and increased turns, but, if not, a price increase will be in order.
Finally, we need to consider if the new product is more expensive to process than the item it is replacing. Microfiber products are becoming more and more popular with commercial laundries for a number of reasons; however, they do typically require additional chemistry to properly launder. If the customer is willing to pay a premium and recognizes the value of an upgraded item, the change should be made.
Before adding an SKU to your product mix, be sure to consider all of the costs and determine the real price necessary to profitably supply that item. If the customer recognizes the value and is willing to pay for it, the item can be safely added and will provide years of income.
Just as adding SKUs can generally be classified within one of two scenarios, so can capital equipment purchases.
First, we should consider if new equipment will reduce the cost of doing business. Under this scenario, return on investment (ROI) drives the decision. Considering that banks typically finance capital equipment over terms of five to seven years and equipment life expectancy should be at least twice the financing term, a target ROI of three years is appropriate.
It is, however, worth noting that considering today’s difficult labor market, many operators are willing to accept a much longer ROI if the new equipment reduces the need for full-time employees (FTE).
The second scenario when considering an equipment purchase is to replace existing equipment that has reached the end of its productive life with a like item. Here, we should look to finance over as long a term as possible or roll into a longer-term business loan.
These decisions are typically more price-driven. Of course, value and various options offered by competing manufacturers should be considered as well.
Finally, depreciation should be considered when making capital purchases. Identifying a target depreciation is often a matter of individual company strategy and profitability; however, 8-10% depreciation relative to total sales is common. If your company is operating above profit goals, more depreciation may be in order.
Whether product or equipment, laundry managers need to take similar factors into account, such as buying new, upgrading old, and enhancing value. Above all, the customer’s needs and wants, and what they are willing to pay for, must be considered.
Check back Thursday for another article on product evaluation with a “view from the plant floor.”