Growing companies often grapple with capacity issues, as they seek growth in the face of static production or service capabilities. Think of a plastic part maker who has one press, but continues adding more and more parts for different customer projects that the press needs to produce. At some point, the one press will be overloaded, right?
From a service perspective, think of a salon owner with 1 stylist. As customer count increases, one stylist still has a limited number of hours per day to service customers. Overtime is an option to an extent, but work fatigue, quality issues, and unhappiness can creep in when people are stretched too thin.
What should companies like these do? Invest in another press, or hire another stylist? Increasing capacity is great, if it is done to sustain healthy growth. What if, in desperation to grow the business, the company takes on low-margin customers? Is it worthwhile to continue adding capacity at low margins? Or would resources be better spent working on improving margins?
Let’s look at the plastics press example. We’ll assume a press at capacity provides $500k in sales, with $50k in fixed costs, on top of $20k in fixed costs for the facility. Each press, given the current customer mix, will average 20% gross margin.
Then, let’s look at the two options: add an additional press of similar size & capability, or adjust sales mix to more profitable customers.
(Note: GM% = Gross Margin %; GM$ = Gross Margin $; FC = Fixed Costs; NI = Net Income)
|Press – current||$500k||20%||$100k||$70k||$30k|
|Press – add press||$1000k||20%||$200k||$120k||$80k|
|Press – improve mix||$500k||30%||$150k||$70k||$80k|
As you can see, the same net income is achieved through both methods! By adjusting the sales mix to more profitable customers and work, it’s not necessary in this case to purchase a new press.
Of course, there are a lot of underlying assumptions, and unspoken repercussions of each decision. Every company’s situation is different. When at a point of expansion, it’s critical to look at healthy growth versus growth at any cost, and develop a strategy based on data. Other important data metrics to use for a fixed asset purchase could include return on investment, internal rate of return, net present value of cash flows, and total utilization.
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