Commentary: Running the Numbers on Value-Added

Lead Author: Dr. Jeff Howe

Publish date: 09.01.2005

 

What a Caveman Would Tell Today's Wood Industry

 

One of the greatest threats to the environment, and one of the most contentious areas of discussion, is the continued commoditization of our natural resources. This is true in farming, where corn, corn and corn are the primary products and it is true in forestry where the continued search for “jump-back” trees dominates large segments of the industry. (Note: a jump-back tree is one where you plant the seed and “jump back” out of the way because it grows so quickly). At its heart, the positive goal of commoditization is to provide economic access to products to the widest audience possible. At its depth, the negative aspect of commoditization is that the ideal input scenario is for zero labor dollars and zero material costs. So for farms and forests, the theoretical ideal value of food and fiber is zero. The commoditization model doesn't leave much room for profits, or the environment.

 

Yet many really good people work for commodity companies, and there is still a growing need for vast quantities of “stuff.” The question is: Is it possible to shift a commodity company to more value-added activities, have a major positive impact on the profitability of the company, and begin to change that more-faster-better mindset without starting over? The short answer is – yes!

 

Let's look at a very challenging example, dimensional lumber, to illustrate the potential.

 

Let's say you have a lumber manufacturer that, for the sake of nice round numbers, does $10 million in annual sales with a pre-tax net profit of four percent. The goal is to increase the profitability by 25 percent or more. So, let's explore a series of what-if scenarios.

 

What if - the company identified a major developer (either single family or multi-family residential housing) in a nearby (within 500 miles) urban area, and met with that developer and their general contractor?

 

What if - the lumber manufacturer then offered to provide to the contractor lumber that is:

  • Pre-cut to the exact lengths and in the exact quantities for each housing unit
  • Sorted any way the contractor needed (e.g. by room, by unit, by length), and color coded if desired
  • Pre-bored for all wiring
  • Pre-surface treated for mold, mildew and similar air quality issues
  • Delivered on a day defined by the contractor with modifications allowed with 48 hours notice.

 

Savings to the contractor would include:

  • Labor to cut the parts during framing
  • Labor to clean up and dispose of the waste
  • Labor to drill for the wiring
  • Labor to clean up again
  • Costs of disposal of the waste

 

Additional benefits include the ability for the developer/contractor to promote the fact that materials have been treated to avoid mold/mildew, time for the framing crew to spend doing accurate assembly, fewer cutting errors, and the availability of parts cut with a higher level of precision and consistency than is possible in the field.Would the contractor be interested in this special treatment and a direct relationship with the manufacturer? From our initial inquiries with developers, the answer is – yes!

 

So what's in it for the manufacturer?

 

First, it requires a relatively low level of technology to provide the services described above, and all the necessary equipment is relatively low cost and available off the shelf or even used.

 

Second, today the price the contractor pays for his framing generally includes a number of intermediary markups, such that it is reasonable to expect that the contractor is already paying about 50 percent above the manufacturer's selling price for framing. For discussion's sake we'll use this current contractor price as the new manufacturer's price, although it could be easily argued that there are enough benefits that the contractor could afford to pay even more.

 

So, the manufacturer gets 50 percent more for his wood by supplying a large number of additional services. But what does it cost the manufacturer, and is it worth it?

 

Let's say the manufacturer sells five percent ($500,000) of his product in this new manner. In general, without being specific to a particular species or dimension, the addition of these processes will add about 10 percent in labor and additional materials (e.g. coating) to provide those services. However, at the same time, about 15 percent of exterior wall framing and five percent of interior wall framing can come from lumber that is significantly shorter than eight feet, with some as short as 16 inches. IF integrated into the companies overall yield program, much of this could come from what is now considered to be either waste or is grade stamped at a lower grade currently.

 

Thus a program like this has the potential to measurably improve lumber yields (that should strike near the heart of any commodity producer!). IF this new processing was well operated and integrated into existing practices, it is not unreasonable to assume that about half of the additional labor costs could be made up by improvements in yield. (Imagine if the manufacturer provided ALL lumber cut exactly to customer specifications, it would no longer be necessary to produce grade lumber in two-foot increments, eight feet and longer!! They could produce grade lumber at ANY length!! And then optimize it to customer specifications! This has HUGE yield implications!!

 

Getting back to our example, assume that the additional cost, net of yield improvements, to produce these services is about five percent. So the difference for the contractor sales segment can be described as below:

 

Original Value-added

Sales $500,000 $750,000 (50% more)

Base costs $480,000 $460,000 (5% savings)

Value-added costs $0 $48,000 (10% of base value-added)

Pretax Profit on VA segment $20,000 $242,000

Total Corp Pretax Profit $400,000 $622,000

 

So adding a little value added to a small percentage of a commodity companies business can have a huge impact on the profitability of that organization!

 

Now, are there likely to be issues that need to be resolved, like what if the contractor needs to change things at the last minute, or “who calculates the number of parts,” or “we need this housing unit produced next not that one?” Of course there are, but those are real issues with a real customer, and the discussion is no longer about price and productivity. Seems like the right discussion to be having to me.

 

Of course you can't have this discussion without extrapolating, “what if all the lumber companies started serving contractors in this manner?” Who knows, but IF we started linking the manufacturer more closely with the user, we might do a better job of making what customers really want, and manufacturers might not all have to focus on how much volume they make, but instead on implementing the flexibility to make a wide variety of products from the forests to meet the wide variety of needs of the customer.

 

The old saying is “if all you have is a hammer, everything looks like a nail.” Perhaps if all you produce is studs, everything looks like wall. Today, if you would show a 2x4 to a caveman and ask him what it is, he would probably reply “a stick.” He's not far wrong. In the future, the long-term success of forestry may rely on the industry manufacturing fewer sticks.

 

Dr. Jeff Howe