The Budget Process Revealed
December 5, 2012
According to Quality’s 2012 Spending Survey, 68% of company budgets matched projections in 2011, while 21% were under budget and 16% came in over budget. Of those whom missed their budget projections, 20-25% were either under or over budget by 25%. This represents either a significant amount of money missing from company operations and profits or missed opportunities to further invest in those operations, particularly improvements in the quality control process.
Quality took the opportunity to ask industry experts—Louise O’Sullivan, CEO of Prime Advantage (Chicago), a buying group for manufacturers, and professionals at MBX Systems (Libertyville, IL), our 2012 Plant of the Year—some questions about budgeting and how to get the most out of the process and limit the mistakes that can lead to missed projections. Here’s what they had to say:
MBX: Budgets must be aligned with a company’s goals for growth and not compete with departmental objectives for improvement. For example, the sales team’s objective may be to increase revenues by 15%. However if the supply chain group’s objective is to hold inventory steady, it would be challenging to meet the company’s goals. Likewise the finance department must be involved to account for the funds for growth.
O’Sullivan: One of our members, a medium-sized Midwest-based manufacturer, told me that budgeting for new product test equipment and validation testing (used to qualify new products) are key to a successful launch. This company also said that calibration and maintenance costs of current test equipment have been major but are equally important.
MBX: To sustain the quality and supply of the components we need, we have to stay on top of domestic and international issues. Our industry was tested during the devastating flooding in Thailand last year that put severe constraints on hard drive supplies. Every technology hardware manufacturer, large to small, had to take a position on how they would deal with this crisis to fulfill customer orders.
Where quality assurance is concerned, during this crisis the MBX leadership team committed to two objectives: not sacrifice quality or performance by substituting less-robust hard drives, and do everything within our power to get customer orders out on time. We immediately scoured the channel – prices were increasing exponentially every day. We purchased inventories of hard drives above and beyond our customers’ forecasts, knowing it was going to diminish our margins. But this allowed us to stay ahead of demand until the crisis passed and hard drive manufacturers were running at full capacity again.
O’Sullivan: I just talked with one of our member company leaders about this. The manufacturing executive I spoke with told me that the one of the greatest impacts to her quality assurance budget was the issue of missed budget forecasts. She told me that when the forecast is too low, it is not unusual to find that unbudgeted costs for additional man-power and overtime, leading the quality department to exceed budget numbers. And if for instance the forecast is too high and volumes are not meeting the budgeted number, the department is over-staffed, creating a budgeted quality cost per unit excess. This impacts both yearly and quarterly.
It is clear that an economic downturn and lost sales are at the foundation of these missed units forecast. As more and more global “standards” for RoHS and energy consumption are implemented, the cost of quality goes up. We see our member companies needing to budget for agency testing, as well as component validation for adherence to the standards.
MBX: Our budget process is not complicated. We build budgets around training, follow up and review. Our CFO and accounting team continuously train MBX’s leadership team on recognizing which technology investments are providing the greatest ROI for each department.
In our manufacturing/QC department, we rely heavily on production software and the skill set of cross training workers at different work centers which provide a significant ROI. When assembly technicians are trained to step into different manufacturing disciplines, especially QC, they are aware of the importance of accuracy with every step of the build process. Technology has a place in our quality assurance budget through investments in tools to improve assembly and QC testing processes, which let us better track and correct defects to avoid recurrence.
O’Sullivan: The person establishing the quality budget is often at the mercy of the sales department forecast. Therefore, it becomes valuable for that department to be able to analyze market trends, anticipate new product launch volumes based on test trials, evaluate field issue impacts and project raw material cost increases.
MBX: This question is easy to answer but difficult to justify. It depends on less tangible measurements and relates more to our objectives regarding customer retention and the company’s values and culture.
The easy answer is to use ROI analysis, but measurement is the age-old challenge that every company battles. It is difficult to build a model to interpret the incremental benefits of the quality assurance investment, especially when your quality is high. This is where the culture is critical to fill the gaps when the folks on the front line aren’t really sure the model will produce the ROI.
O’Sullivan: I talked with another Prime Advantage member about this. She told me that a quality department budget differs from other departments in that because it is indirect labor and cost, it does not add value to the product. So, any budget request should then be presented as an indirect cost reduction benefit. This can mean an improved perceived quality of product, service cost reduction, or even reduced scrap due to increased inspection. Budgeted direct costs are a fixed cost per unit.
MBX: The effects of technology and automation are immeasurable. With technology comes training – and we invest 15-30% of our overall staffing costs to train our skilled workers on technology and departmental cross training. We have workers trained in QC who don’t work in QC unless they’re needed, whether to scale up for demand or avoid bottlenecks downstream. It also keeps workers fresh by rotating them around.
Investing in technology and automation has improved efficiency and allowed us to scale for growth, but it doesn’t happen without challenges. While it empowers users to function at much higher levels, the biggest challenge we face is finding skilled manufacturing/QC candidates that are accustomed to working in a high-tech factory. The technology in our Super Cell workstations is immense to allow workers to remotely connect to many systems simultaneously and view several monitors at a time to verify the quality of the builds.
Our customized production software was developed by our IT department for our manufacturing/QC processes. Extensive training is required even for skilled workers and is handled by the employees most familiar with the processes. It reduces our capacity and increases the labor burden during the training timeframe, but provides ROI in the long run.
O’Sullivan: One of our member company leaders told me that the more the end product becomes technologically advanced, the more sophisticated the test equipment required to assure a quality product. Automated assembly processes reduce labor, but also require more statistical process controls to assure the equipment is capable of producing good product 100% of the time.
MBX: Poor planning and supply chain issues can influence whether the budget is met or not. Over the past couple of years we’ve improved at forecasting and, as a result, gotten better at effectively planning labor and inventory. It has helped keep our staffing workload on target rather than wasting labor. It also guides our purchasing department to procure the components we need when it’s time to fulfill orders and avoid bringing in too little or too much inventory.
O’Sullivan: As far as quality is concerned, one member company told me that missed budgets are generally due to two factors: 1] unanticipated validation testing, due to field issues, until controls can be put in place; and 2] missing the forecasted sales volumes.
MBX: Not aligning the budget with the goals of the company. If the management team sets goals to grow revenues by 15% and decrease inventory by 30%, it can put a squeeze on the supply chain and you will likely pay a premium on parts and expediting them to meet order promise dates.
O’Sullivan: Underestimating necessary test equipment costs for new product start-ups is a budget issue. Underestimating the cost of quality and price of non-conformance, per unit, is an issue also.
MBX: One year we had a customer that unexpectedly became a larger portion of our business, which sounds like a good problem to have, except that their rapid growth was not forecasted. We ran into challenges trying to budget and procure for inventory and skilled labor. We took on a couple of initiatives to resolve this so in the future we could easily scale for rapid growth. We improved the ratio of managers to employees so that they were no longer supervising more employees than they should manage. We also cross trained workers so they were skilled to rotate into several different workstations. Our production software could predict potential bottlenecks and we could move these workers where they were most needed.
O’Sullivan: One member company told me that, for her mid-tier manufacturing company, the ability to establish a cost for 2014 Energy Guideline testing and validation was tricky. If the engineering changes to meet the goal were successful, the testing would be minimal. But if the engineering changes were only partially successful and need modification, additional testing and test units would need to be made and performed. This company avoided the risk by using “model” development in its engineering lab prior to actual test validation on numerous units.
MBX: MBX moved into the OEM server appliance business in 2000, so we don’t have a long legacy of budgeting for manufacturing/QC. But in the past five years we implemented a policy to focus on run-rate customers because it’s more cost-effective to prepare a production line and maintain quality for larger orders than constantly switching gears after just a few systems.
O’Sullivan: Quality budgets have changed as industry requirements have changed to meet global environmental and safety standards. At one time, test equipment and tooling could only be purchased here in the states and be cost effective. For instance, one foodservice equipment maker told me that it has molds made in Brazil that must be validated there before shipping to the U.S.