Finding Easy Money On the Target’s Shop Floor: Simple changes in manufacturing processes and inventory control can quickly start generating value.

Attractive targets that offer potential for true value are harder to come by these days. And even when you do find companies with real potential, it may take years to fully implement the changes needed to generate value. In leveraged transactions especially, a quick return on investment is an important consideration. Two areas of potential value worth checking out in acquisition candidates are areas where some of the largest and quickest returns are often realized in a deal improvement in manufacturing processes and inventory reduction. It often pays to make a quick and accurate assessment of a prospective target’s factory operations. Many times there is value laying right there on the shop floor. You just have to know where to look for it. Simple changes in manufacturing processes and inventory management can produce quick returns, and in a leveraged transaction, that means money in the partner’s pockets. This article offers several tips to help you quickly size up a company’s value-generating potential during your first factory walkthrough. These tips focus on changes that can be made in a matter of weeks or months and will quickly start generating value. Before taking your initial plant tour, you should ask the seller the following questions: What have been your annual improvements in labor productivity for each of the last three years? Six out of 10 sellers will give you a blank stare and tell you they don’t track it. That’s a good sign for a buyer looking for cash on the shop floor. What have been your annual improvements in inventory turns for each of the last three years? If the seller offers a blank stare to this question, put on your wading boots the cash will be waist deep. Using a shop floor diagram, how does the product flow as it goes through its manufacturing processes? If you got a blank stare from the previous two questions, don’t be surprised if this chart ends up resembling a plate of spaghetti. In preparing for your tour, remember to take off your suit jacket and tuck in your tie or scarf. In some shop environments this is required because machinery can catch loose objects (like ties) and pull them in. Also, roll up your sleeves. On the floor, pick up pieces in process. Get your hands greasy. And carry your own safety glasses. These small behaviors can go a long way in impressing the seller with your know-how on the shop floor. There are several things to look for once you’re on the factory floor. First, estimate how much of the floor, including store rooms and attached warehouses, is filled with inventory. If your percentage is 75% or more, you have a gold mine probably about 50% more inventory than a well-run company needs. If it’s 50% or more, the business may have about a third too much inventory. If it’s 25% or more, as a buyer, you have some opportunity for inventory reduction. Next, determine whether assembly operations are labor-paced or machine- or conveyor-paced; both processes hide their own wastes. If they are machine-paced, randomly ask 10 operators how much of their work time is spent “adjusting.” (Adjustment is a bad word in manufacturing.) Take the average of the 10 responses and figure that to be your first year’s potential labor productivity improvement. Expect to see numbers in the 10%-to-30% range. Labor-paced assembly environments typically present even more opportunity. Pick the operation’s highest-volume assembly area. Using your watch, measure the time it takes five operators in a line to do their assigned jobs. In many plants, the difference is more than 30% between the slowest and the fastest operator. In an “balanced” assembly flow, all times should be the same. Variation is waste. Take the percentage variation you found and multiply it by the business’ assembly labor cost. That is a quick estimate of your assembly labor cost out opportunity. In fabrication operations, check how many machines are running versus standing idle. Ask what percentage of total available machine time is spent in setup and unscheduled downtime. No metal-cutting or bending operation should have setup and downtime of more than 15% of total available machine time; however, 35% to 40% is more typical. The difference represents lost capacity and labor waste. Take the difference in percentages and multiply it by total fabrication labor cost. This is a quick cut at your fabrication cost out opportunity. Other items to look for include: One-piece flow in assembly. The goal for any manufacturer is single-piece flow of goods between workstations. Most operations batch inventory between workstations and hide waste in the process. Color-coded shop instructions. Shop instructions tell operators what to do at each workstation. The best ones are color-coded and use pictures rather than text. Visuals. Everything related to production should be displayed visually. This includes daily scheduling, output achieved versus targeted output, problem identification and resolution, inventory levels, supplier problems, etc. Operators are a shop’s most valuable resource, and visuals are the most effective way to share information with them. Physical kanbans. A kanban is a piece of paper or a square on the floor. It serves as a signal to an upstream operation to make and move a part. Better operations use kanbans rather than material resource planning (MRP) systems computer-driven production scheduling and materials release programs to manage day-to-day shop operations. Good housekeeping. There should be a place for everything, and everything should be in its place. The value of this discipline cannot be understated in manufacturing. Computer-generated preventative maintenance systems. Preventative maintenance (PM) is the most often overlooked freebie in U.S. manufacturing. Off-the-shelf software is now available to refine and schedule PM for most factories. Absence of any of these items in the business you’re reviewing probably costs the company at least 10% of its total labor cost. By adding any missing items, you will save at least that same 10%. Another area that presents opportunities for savings in an acquisition is inventory management, which can yield substantial cash to an acquiring group. Consider the following example. Company X has $20 million of inventory on $100 million costs of sales, or five inventory turns. The company makes 10% operating income and was purchased for $66 million. At 20 inventory turns, the inventory balance becomes $5 million. The difference of $15 million effectively reduces the company’s purchase price from $66 million to $51 million. That difference adds 10 points to a partnership’s annual internal rate of return for Company X. Inventory improvements such as this are readily achievable over a typical ownership period. In fact, regardless of where your plants stand on inventory management, set their target at 30% to 50% annual improvement in turns. Inventory management boils down to a simple maxim: Buy only what you need, when you need it, and then use it right away. In business terms, this translates to: Optimize your “days-on-hand” versus usage cycle times, then drive cycle times down. Inventory management focuses on tightening disciplines, which are illustrated in the accompanying Inventory Worksheet on page 37. Your company’s manufacturing manager should review these items quarterly with plant managers, and plant managers should perform weekly checks to determine their staff’s inventory improvement activities. Here are some rules of thumb in using the Worksheet: * Allow no vendor an order lead time of more than 10 days. * Work to eliminate stockrooms. They hide inventory. * Drive down internal shop cycle times. Add up labor content for a representative part in the shop where you want to drive down cycles. Compare labor content with elapsed time from when production on a part starts to when it’s finished. Many plants still have numbers around 3%. That means that a part is being worked on only 3% of the time that it is in an area; the rest of the time it sits idle. Once you start identifying idle time, reaching at least 20% is easy. It only takes focus and discipline. Just remember, time is waste. * Physically segregate slow-moving inventory, mobilize the organization to reapply it to other uses, and never let it show up again. The example illustrated in the Inventory Worksheet shows that Company X has $6 million of sheet steel in inventory. It buys steel from a distributor that requires only a five-day order lead time. Company X uses only $3 million worth of steel each month, so that leaves it with 60 days’ worth of inventory on hand. The company can reduce its sheet steel inventory to five days’ on hand (or 10 to be safe). With only 10 days’ worth on hand, its inventory drops from $6 million to $1 million. If you think this is an extreme example, then apply the Worksheet to your own situation and see for yourself. When this tool was introduced recently at one of my plants, its employees found enough opportunities to improve their inventory turns from six to nine in just eight months. And that’s only the beginning. In any deal, the ability to reap large, swift returns is highly desirable. Improvement in manufacturing processes and inventory reduction are two areas that can generate that kind of value, so it is well worth your time to investigate the shop-floor operations of prospec-tive targets. Quick and easy changes in those often-overlooked areas can lead to a swifter realization of value in your deal. Quickie PaybacksTargets with value-creating potential are harder tofind these days. Even when you do find companies with real potential, it may take years to fully implement the changes needed to generate value. Getting a quick return oninvestment is especially important in a leveragedtransaction. Some of the quickest returns often realized in adeal come from quick and easy changes made ina target’s shop-floor operations manufacturing processes and inventory management. Changes inthose often-overlooked areas can lead to a swifter realization of value in your deal. It is well worthyour time to get a quick and accurate assessment of shop-floor operations while on a plant tour at a prospective target.