The right way to Suppose About Digital Printer Investments

It has been almost 100 years since the essayist HL Mencken wrote: “There is always a known solution to every human problem – orderly, plausible and false”. Some of the problems printers face today include being able to compete in new capital investments, especially digital devices, that are required to enter new markets. I will suggest that the popular spreadsheets often used to analyze the return on investment (ROI) of digital printing equipment are neat, plausible, and potentially misleading. (Elsewhere I’ve suggested a manufacturing simulator that shows an animated workflow and incorporates some statistical variation in orders and productivity into an ROI analysis.) However, in this article I want to take a step back from the detailed analysis and suggest a broad one View of productivity investments that differs from the standardized approach.

The first problem that needs to be addressed is conventional job costing. Many printers rely on a software-based estimation system to generate quotes and provide budgeted hourly rates (BHR) that are used to analyze potential investments in new machines. While these estimation systems are not necessarily wrong, they can provide a misleading view of how jobs are valued and investments assessed, as they allocate costs to jobs and press hours. A cost accountant will argue that mapping labor costs and overhead costs to cost centers is a good thing as it ensures that jobs can be quoted at prices to ensure that all of the company’s costs are covered and that managers are accountable for metrics such as department profitability, set-up times and machine utilization can be drawn.

Goldratt’s Theory of Constraints (TOC) teaches a different approach – one that takes a holistic view of the company’s ability to achieve “The Goal” – namely, increasing “throughput.” Goldratt believes that the allocation of costs within an organization can be misleading, and how trying to maximize the utilization of individual machines results in less than optimal decision making. There are many resources online that describe the table of contents and related “throughput accounting” methods. Therefore, I will not describe them in detail here, except to define the basic concepts: throughput (‘T’) equals sales (‘R’) minus total variable costs (‘TVC’) like direct materials; Operating costs (‘OE’) include the non-varying costs for creating the throughput – the direct work is also decisive, as this does not vary with the production volume in the short term. and investment (‘I’), including inventories and other assets. The most important equations in throughput calculation are:

  • Throughput (‘T’) = R-TVC
  • Net Profit (‘NP’) = T-OE and
  • Return on Investment (‘ROI’) = NP / I.

Using these definitions, let’s consider a simple situation of a company that uses a linear process to manufacture products and graphs profit over a set period of time versus volume of production. For a conventional printer, these can be cost centers such as For example: prepress, plate making, printing, finishing and packing / shipping.

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Here we can see that with zero production, the company is losing an amount equal to its operating costs, i.e. its fixed costs. As the production volume increases, the throughput (R-TVC) increases until it exceeds the breakeven point (‘BE’) and continues to increase until the system can no longer produce in the specified period and hits a wall, making the maximum profit is by P.

How can we increase this profit?

  • We can reduce our operating costs, OE (moving the beginning of the line along the y-axis) or
  • We can increase the throughput T by
    • Increase in sales or
    • Reduction in TVC (e.g. direct materials or sales commissions) or
    • Remove the restriction shown by the wall in Figure 1.

Let’s take a look at these one by one and start reducing the OE:

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It is pretty obvious that by moving the line on OE ‘and keeping the line inclined, we will reduce the volume at which the company breaks even and increase the profit we can make when we “hit the wall”. “What else can we do? We can find out The slope of the line corresponds to the throughput per volume unit or conventionally the contribution margin to the product (without direct work).

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By increasing the turnover per order or reducing the completely variable costs, the list is tilted steeper – the break-even point is lowered and the maximum profit is increased. If you do the opposite, the line will be swung down, making break even more difficult and reducing the maximum profit that can be achieved. These effects are shown in Figure 3.

The analysis so far may perceive you as what a colleague of mine has called the “blinding flash of apparent bleeding”. But keep this in mind when we are considering an investment: the sales rep at your favorite digital printer manufacturer has just suggested an upgrade for your old device that can run it 50% faster than your current device. The (totally variable) ink and paper costs per unit and your direct labor costs (which we imagine as part of OE) do not change. In fact, your lease payments and maintenance contract are higher than they are now, increasing the OU. But the printer itself will be faster – as fast (as the employee didn’t tell you slow …) as the device he just sold to your competitor. Let’s graph the effect:

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Some points are immediately apparent: The line has moved down from OE ‘due to the increased fixed costs. So the break-even point (BE ‘) is shifted to the right, which increases your business risk. Since the revenue and the variable cost per unit have not changed, the slope of the line remains the same. The only good news is that the higher productivity of the new printer has “moved the wall” to the right so you can – possibly – make more profit.

But here’s the key point – this only applies if your old printer was the limitation (or bottleneck) in the system. The “system” is defined as anything that converts raw materials into cash. If the real limitation is your prepress or finishing department, or your inefficient order processing, or the market itselfAll your new investment is going to do is reduce the likelihood that you will be profitable. You’ve spent money without increasing throughput because “the wall” isn’t where you thought it would be. For this reason, the “five steps of focusing” in the table of contents begin by identifying the system limitation and then taking full advantage of it.

Let’s look at the potential investment in a less bleak way and assume that it actually addresses a production constraint. Additionally, you can potentially retire old analog equipment or reduce the space required for production or inventory, or save manpower or overtime – potentially leading to a network reduction in OE. More importantly, you may be able to enter a new market or cater to the needs of a less price-conscious group of customers. How does that change the picture?

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The investment is unlikely to reduce direct material costs (unless you have a problem with waste that will fix), but in the new market you may be able to charge higher prices. This means more throughput, so the line of productivity becomes steeper – good! As Figure 5 shows, the combination of a small decrease in OE, a steeper slope to the throughput line, and a higher maximum achievable volume has resulted in a lower break-even point and much greater profit potential. On this basis, the new investment seems easy to justify.

The real world is unfortunately more complicated than this idealized picture. Printers don’t produce identical widgets at constant prices. They accept orders at different prices with different editions and print them on machines with different setup times and running speeds. However, this does not mean that TOC thinking has no value. This leads to the realization that doing positive throughput (R> TVC) work is valuable as long as you have production capacity – even if it may seem unprofitable based on the assigned costs. (In his books, Goldratt calls this “making a mafia offer” – one the customer cannot refuse because the price or delivery terms are so attractive. He points out that this tactic must be used with caution to ensure that this is not the case, putting a new low price in a core market.)

The key point is that any positive throughput adds to the fixed costs. For example, with a short-term order option, but with a digital printer already fully loaded, creating plates and setting up an offset printing machine may make sense – even if the estimation software uses your standard costs.The model tells you that the job will be on this machine is unprofitable.

Too many printers rely on a cost-plus model that BHR uses to determine prices. Throughput accounting is moving away from a “cost plus” model of pricing to doing the hard work of figuring out the true value of your service to the customer and pricing accordingly. (Industry financial analysts, New Direction Partners, cite an even more damaging result of using “cost-plus” pricing: you inadvertently give away the benefits of your investment in new technology by basing prices on the newly lowered costs result from the investment!)

Many years ago, new to the prepress and printing industry, I asked the owner of a small print shop what management metrics he had used to keep track of his business. “Well, I think if the overtime is up and the overdrafts are down, I’ll be fine,” he said.

If your metrics for managing your printing business are your company’s overdrafts and overtime, you’re “driving past the rearview mirror” and chances are you’re not in control of your business. When you rely on traditional accounting systems to know whether to start new jobs or enter new markets, maintaining competitiveness and profitability in today’s dynamic business climate is an issue. We need more differentiated business measures, better methods of pricing by market segment, and better methods of evaluating potential investments. Relying on traditional cost accounting methods can be misleading – the table of contents and throughput accounting offer a different and valuable perspective.

About the author

Chris Lynn is a process improvement consultant specializing in digital technologies for printing and packaging. A 33-year veteran of the digital prepress and inkjet printing market, he is a Principal of Hillam Technology Partners, LLC based in Atlanta, Georgia. He can be contacted at chris@hillamtech.com.