The True Test of Managers
© John L. Mariotti 2000
Often what we need is already inside us.
A manager must learn many things on his/her way to a significant position in any business. A wide variety of these are taught in colleges and universities. One that is ultimately taught in the world of responsible work is the one that I always felt showed that a manager had truly passed a milestone.
That step is to understand the economic implication of his/her decisions and actions-before making the decision or taking action. So often, managers seem surprised when the monthly financial statements come out and show major variances in spending, shortfalls in profit margins, large unfavorable variances in price, freight, overtime and many other areas.
Yet each of these deviations from plans or budgets were the result of conscious (or unconscious in some cases) actions or decisions on the part of one or more managers, When the pressure is on, decisions must be made rapidly. That is when the ability to quickly compute-just approximately-what the costs and risks of those decisions are.
The orders have to go out and capacity is strained. Let's work over the weekend. That is a simple step to create additional capacity. But what does it cost? If the company involved has 100 employees, and each employee makes $10 per hour, then the cost of working over the weekend is easy to estimate. 100 people times $10 per hour, times (let's say) 10 hours per day is $10,000 for each weekend day-at "straight time". Then there is the 1 1/2 times overtime factor for Saturday and two times for Sunday. One half premium on $10,000 is $5,000 that will go into the Overtime Premium expense account for Saturday's efforts. Sunday is another story. Two times regular pay means Sunday's premium is $10,000-double the normal labor cost for "getting out the orders".
Altogether, the decision incurs a direct wage premium of $15,000. And this is based on a one-shift operation. Such costs can double or triple if two or three shifts are involved. There are other costs, if vacation pay is based on average earnings or if bonuses are tied to W-2 earning, but for now, just knowing the direct costs are enough.
But whoops, purchasing says there are not enough materials to work the extra 20 hours. We will have to airfreight the key components to make the production worthwhile. The airfreight cost (does anyone ever ask?) is about $5,000 more. Now the premium tab is $20,000.
Let's step back and reconsider. If this is a typical durable product, labor (direct plus indirect) might amount to 15-20% of total cost. Profit margin might be 20-30% of the selling price. Since we have effectively doubled the labor cost for the weekend to produce and ship this order, we have probably wiped out most of the profit-maybe all of it, if this was a low margin product. (After all, aren't those the ones that usually create the crises?)
The premium was $15,000 overtime-premium pay and $5,000 airfreight costs on a regular labor cost of $20,000 for the two days in our example. If the gross profit margin (which is calculated based on the selling price, not the cost.) was not much over 17%, then the final bottom line will be about zero. Of course there is the customer service aspect. If the customer really needed the product right then, there was no choice but to scramble and run it.
But on the other hand, if there was a 5% late shipment penalty, and no other serious repercussions, such heroic efforts just cost the company money. Wise, professional managers, learn how to run the calculations quickly as they are making these decisions. The not-so-wise ones spend a lot of time in budget review meetings explaining why a crisis cost them the variances-if they even can relate it to a specific situation at all-because there are usually more than one in the course of a month and the total expense variances are an amalgam of all of them.
I could have used many more examples involving premium airfares to send service people out to fix something that could have been easily corrected in the shop-if it was done when it should have been. Warranty costs arise because no one calculates the cost of good designs that work and don't break against the cost of returns, repairs, and loss of customer goodwill.
Become a professional, and make decisions based on outcomes and the facts you can know or estimate closely. And do it before you make that "split-second decision", or that may be your last "split-second decision" in that job.
