An analysis of the top 200 <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/equipment-manufacturing/">equipment manufacturing</a> companies in India over the four years after the COVID-19 lockdown (2021-2024) reveals an interesting pattern. Of these, 146 companies showed consistent year-on-year sales growth, but only 31 achieved consistent year-on-year growth in net profit. Just 11 companies demonstrated a consistent ROCE (Return on Capital Employed) of over 25%! <figure class="image"><img style="aspect-ratio:4000/3903;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//get-more-out-of-less-image-1_1758037720.jpg" width="4000" height="3903"></figure>There are four types of companies in this sector:<ol><li>Ever-flourishing organisations that show consistent sales and profit growth, while maintaining a high ROCE.  </li><li>Asset inefficient organisations - which maintain sales and profit growth but are unable to maintain a healthy ROCE.  </li><li>Turnover-biased organisations, which have consistent top-line growth but are unable to maintain consistent profit growth.  </li><li>Starving organisations, which are unable to grow consistently because of a lack of orders.   </li></ol>Most organisations make annual business plans aiming to become ever-flourishing companies. However, most of them fail to achieve that state in execution. The reasons are: <ul><li>Uncertainty and the time lag between manufacturing capacity enhancements and additional demand.  </li><li>Disproportionately higher working capital is required to manage higher sales. </li><li> Increasing management strength (to improve coordination) without getting a corresponding increase in output.   </li></ul><h2>The recipe for being an ever-flourishing company</h2>The only way to be an ever-flourishing company is to be in a state where the growth rate of sales (and gross contribution) is always higher than the rate of growth of total fixed expenses and working capital requirements. This can happen only when the company has the: <ul><li>ability to get significantly more output than the ‘best achieved in full-load conditions’ from current capacity, cash, and management bandwidth.  </li><li>ability to maintain an adequate order backlog, without dropping prices.  </li><li>ability to always create disproportionately more capacity from small incremental investments.</li></ul> A company can get significantly more output than the ‘best ever achieved in full-load conditions’ only when there is <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/counterpoint/podcasts/find-the-hidden-capacity-in-manufacturing-plants/">‘hidden’ capacity</a>. At the same time, it can generate additional orders from the same market and products when there is ‘hidden’ unfulfilled demand in the current market. Any other strategy for expanding by adding new plant capacities or entering new markets with new products without first generating significant surplus cash (higher ROCE) cannot guarantee continued growth.  <h2>Revealing the ‘hidden’ capacity</h2>Most equipment manufacturing companies define capacity in terms of the best physical output, with a specific product mix, achieved in a month. But this does not reveal inherent potential. The correct way of looking at capacity is to measure the exact touch time on the constraint work centre (e.g., the actual time spent in metal removal on a drilling machine or in assembly when a complete components kit is available) and compare it with available calendar hours in a month. The ‘theoretical’ numbers arrived in most cases, using the suggested method, are at least twice the best output ever achieved by the plant. A large part of the enormous gap between the ‘theory’ and ‘actuals’ is usually explained by periods of starvation in which the critical work centre waits for either material or operators.  <h2>Capacity and cash guzzler: The monthly planning system</h2>Most equipment manufacturing organisations (except large equipment, where every component is engineered for each order) follow a monthly planning system. A snapshot of actual execution performance is taken at the end of the ‘current’ month, and a fresh plan for next month is made, considering orders completed closer to the ‘current’ month-end; vendors can react to it well into the start of next month. As different feeding components have varying lead times, it takes time to complete a full kit. As a result, capacity is lost in the first half of the month. WIP (work-in-progress) increases as initial work centres keep busy processing whatever components arrive. Pile-ups occur at assembly points, and WIP and raw material (RM) inventory balloon as the month progresses. The production of missing parts is expedited, which in turn affects the scheduling of other parts, creating a vicious loop of further desynchronisation in assembly and additional capacity losses (additional set-ups) in parts manufacturing. Consequently, even when WIP inventory piles up, desynchronisation leads to underutilisation at assembly. Capacity is lost not only when WIP is very low but also when it is excessive.  As the full kits start getting ready, the remaining time (capacity) available in the month to complete the entire plan falls short. A significant quantum of orders gets split over to the next month. By the month’s end, to show lower <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/from-inventory-turns-to-norm-turns/">inventory in management</a> reports, plant managers stop the inflow of parts, which cannot help in the current month’s billing. The practice forces vendors to wait for fresh plans to get the right picture. At the end, a snapshot is taken of pending orders and excessive WIP and RM, and a new plan is made after ‘netting’ off. The same cycle of starvation in the first half and piling up in the second half repeats every month. If the lead time for manufacturing the equipment exceeds a month, then such skewed output waves can also be observed towards the end of each quarter. <figure class="image"><img style="aspect-ratio:4000/2633;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//vcg-article-5-get-more-out-of-less-1_1757846017.jpg" width="4000" height="2633"></figure>The ‘wave-based’ movement of inventory requires high working capital due to peak WIP during the middle of the month and skewed dispatches (which cause a large volume of receivables to be due almost at the same time).  <h2>The solution, which isn’t!</h2>Organisations have tried to tame the wave by creating rolling plans – a one-month ‘firm’ (the immediate next month) and subsequent two months ‘tentative’ - to improve utilisation of the first week. (Companies with lower lead times create a tentative plan by around the 15th of the previous month, followed by a ‘fixed’ plan by the month-end.) However, a high level of expediting weakens the reliability of such projections. So, suppliers do not react to tentative plans; everyone waits for the end-of-the-month ‘firm’ plan.  <h2>Exploiting the hidden capacity</h2>The only sustainable way to improve the output of equipment manufacturing plants is to ensure synchronisation of parts (full kits) at assembly operations throughout the month. The prime reason for desynchronised parts supply is the visibility of the entire order backlog to the parts manufacturers. This visibility causes them to ‘cherry pick’ components for processing across the order backlog – for better efficiencies. Various part manufacturers have their own preferences for cherry-picking. As a result, parts arrive desynchronised for assembly.  Restricted visibility, with clear order-level priorities, forces focus on a few orders, which, in turn, dramatically improves synchronisation. The lead time for orders drops dramatically. Uniformity in inventory flow prevents the creation of ‘temporary constraints’, thereby revealing hidden capacity. With improved flow, the ‘real’ constraint is exposed. A few improvement projects on the constraint further increase the output. An ongoing improvement process can be launched to incrementally address each constraint as they are exposed at higher volumes.  As delivery reliability improves and order spillovers are negligible, there is no need to reschedule orders at the end of each month or on weekends. Monthly planning can be changed to daily, perpetual planning – where orders are scheduled based on available capacity as they arrive.  Lower lead times and uniformly staggered deliveries across the month dramatically reduce working capital requirements.  <h2>Revealing and exploiting the ‘hidden’ market</h2>With the implementation of such flow processes, the variance in lead time performance comes down dramatically. The result is very high reliability in deliveries. When most competitors are unreliable (i.e., commit and execute across a wide range of lead times), the capability of one player to commit and execute with shorter lead times and specific delivery dates can be disruptive in the market. The previously ‘unaddressed’ delivery-sensitive customer segment is likely to shift volumes to such suppliers en masse.  In almost every equipment category, there are two types of customers. Large institutions that buy customised products in significant volumes, and many small businesses or households that tend to buy in very small quantities with minimal customisation.  Typically, the gross contribution percentage of such small orders is much higher than that of large institution orders. But most organisations neglect the ‘small’ because of the following reasons: <ul><li>Large orders yield higher sales output than small orders for the same effort.  </li><li>There are many small customers and they are spread out; a larger sales team would be required to reach out to them.   </li><li>The plant prefers large orders to achieve higher efficiency.  </li><li>When the plant is loaded with large orders, the lead time of small orders becomes longer and less reliable - customers of ‘smalls’ shy away from placing orders with large companies.   </li></ul>With reliable delivery and customer preference, the sales team’s efforts are significantly reduced. The released capacity in the plant and the flow system enables the delivery of small orders in shorter lead times. With these enabling conditions, a company can reach out to geographically spread-out customers of ‘smalls’ by establishing a network of sales agents. Lower lead times enable agents to place confirmed orders rather than anticipated ones. Eliminating the risk of unconfirmed orders allows a company to sell ‘smalls’ with advance payment. The sales efforts become negligible as small orders can be managed on ‘autopilot’.    <h2>Risk-free expansion</h2>In an environment of skewed flow, temporary constraints emerge at many places in the supply chain. When managers plan for growth in such environments, they add capacity in many areas. However, in an organisation with a uniform inventory flow, the real constraints are always in a few places. This enables organisations to invest in small incremental lots. The released capacity is used to support sales growth. This incremental approach can continue until the available opportunity within the current capacity and markets is sufficiently addressed. The ROCE and operating surplus improve dramatically, creating a platform for adding new plants, serving new markets, or developing new products with much lower risk, thereby enabling an ever-flourishing organisation.

Key Takeaways

This article unveils the complexities faced by equipment manufacturing companies and proposes strategies to achieve enduring success, emphasising the need to uncover hidden capacities, synchronise operations, and tap into underserved markets.

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An analysis of the top 200 <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/industries/equipment-manufacturing/">equipment manufacturing</a> companies in India over the four years after the COVID-19 lockdown (2021-2024) reveals an interesting pattern. Of these, 146 companies showed consistent year-on-year sales growth, but only 31 achieved consistent year-on-year growth in net profit. Just 11 companies demonstrated a consistent ROCE (Return on Capital Employed) of over 25%! <figure class="image"><img style="aspect-ratio:4000/3903;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//get-more-out-of-less-image-1_1758037705.jpg" width="4000" height="3903"></figure>There are four types of companies in this sector:<ol><li>Ever-flourishing organisations that show consistent sales and profit growth, while maintaining a high ROCE.   </li><li>Asset inefficient organisations - which maintain sales and profit growth but are unable to maintain a healthy ROCE.   </li><li>Turnover-biased organisations, which have consistent top-line growth but are unable to maintain consistent profit growth.   </li><li>Starving organisations, which are unable to grow consistently because of a lack of orders.   </li></ol>Most organisations make annual business plans aiming to become ever-flourishing companies. However, most of them fail to achieve that state in execution. The reasons are: <ul><li>Uncertainty and the time lag between manufacturing capacity enhancements and additional demand.   </li><li>Disproportionately higher working capital is required to manage higher sales.  </li><li> Increasing management strength (to improve coordination) without getting a corresponding increase in output.   </li></ul><h2>The recipe for being an ever-flourishing company</h2>The only way to be an ever-flourishing company is to be in a state where the growth rate of sales (and gross contribution) is always higher than the rate of growth of total fixed expenses and working capital requirements. This can happen only when the company has the: <ul><li>ability to get significantly more output than the ‘best achieved in full-load conditions’ from current capacity, cash, and management bandwidth.   </li><li>ability to maintain an adequate order backlog, without dropping prices.   </li><li>ability to always create disproportionately more capacity from small incremental investments.</li></ul> A company can get significantly more output than the ‘best ever achieved in full-load conditions’ only when there is <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/counterpoint/podcasts/find-the-hidden-capacity-in-manufacturing-plants/">‘hidden’ capacity</a>. At the same time, it can generate additional orders from the same market and products when there is ‘hidden’ unfulfilled demand in the current market. Any other strategy for expanding by adding new plant capacities or entering new markets with new products without first generating significant surplus cash (higher ROCE) cannot guarantee continued growth.  <h2>Revealing the ‘hidden’ capacity</h2>Most equipment manufacturing companies define capacity in terms of the best physical output, with a specific product mix, achieved in a month. But this does not reveal inherent potential. The correct way of looking at capacity is to measure the exact touch time on the constraint work centre (e.g., the actual time spent in metal removal on a drilling machine or in assembly when a complete components kit is available) and compare it with available calendar hours in a month. The ‘theoretical’ numbers arrived in most cases, using the suggested method, are at least twice the best output ever achieved by the plant. A large part of the enormous gap between the ‘theory’ and ‘actuals’ is usually explained by periods of starvation in which the critical work centre waits for either material or operators.  <h2>Capacity and cash guzzler: The monthly planning system</h2>Most equipment manufacturing organisations (except large equipment, where every component is engineered for each order) follow a monthly planning system. A snapshot of actual execution performance is taken at the end of the ‘current’ month, and a fresh plan for next month is made, considering orders completed closer to the ‘current’ month-end; vendors can react to it well into the start of next month. As different feeding components have varying lead times, it takes time to complete a full kit. As a result, capacity is lost in the first half of the month. WIP (work-in-progress) increases as initial work centres keep busy processing whatever components arrive. Pile-ups occur at assembly points, and WIP and raw material (RM) inventory balloon as the month progresses. The production of missing parts is expedited, which in turn affects the scheduling of other parts, creating a vicious loop of further desynchronisation in assembly and additional capacity losses (additional set-ups) in parts manufacturing. Consequently, even when WIP inventory piles up, desynchronisation leads to underutilisation at assembly. Capacity is lost not only when WIP is very low but also when it is excessive.  As the full kits start getting ready, the remaining time (capacity) available in the month to complete the entire plan falls short. A significant quantum of orders gets split over to the next month. By the month’s end, to show lower <a target="_blank" rel="noopener noreferrer" href="https://www.vectorconsulting.in/en/research-and-publication/articles/from-inventory-turns-to-norm-turns/">inventory in management</a> reports, plant managers stop the inflow of parts, which cannot help in the current month’s billing. The practice forces vendors to wait for fresh plans to get the right picture. At the end, a snapshot is taken of pending orders and excessive WIP and RM, and a new plan is made after ‘netting’ off. The same cycle of starvation in the first half and piling up in the second half repeats every month. If the lead time for manufacturing the equipment exceeds a month, then such skewed output waves can also be observed towards the end of each quarter. <figure class="image"><img style="aspect-ratio:4000/2633;" src="https://web-assets.vectorconsulting.in/storage/editor_uploads//vcg-article-5-get-more-out-of-less-1_1757846004.jpg" width="4000" height="2633"></figure>The ‘wave-based’ movement of inventory requires high working capital due to peak WIP during the middle of the month and skewed dispatches (which cause a large volume of receivables to be due almost at the same time).  <h2>The solution, which isn’t!</h2>Organisations have tried to tame the wave by creating rolling plans – a one-month ‘firm’ (the immediate next month) and subsequent two months ‘tentative’ - to improve utilisation of the first week. (Companies with lower lead times create a tentative plan by around the 15th of the previous month, followed by a ‘fixed’ plan by the month-end.) However, a high level of expediting weakens the reliability of such projections. So, suppliers do not react to tentative plans; everyone waits for the end-of-the-month ‘firm’ plan.  <h2>Exploiting the hidden capacity</h2>The only sustainable way to improve the output of equipment manufacturing plants is to ensure synchronisation of parts (full kits) at assembly operations throughout the month. The prime reason for desynchronised parts supply is the visibility of the entire order backlog to the parts manufacturers. This visibility causes them to ‘cherry pick’ components for processing across the order backlog – for better efficiencies. Various part manufacturers have their own preferences for cherry-picking. As a result, parts arrive desynchronised for assembly.  Restricted visibility, with clear order-level priorities, forces focus on a few orders, which, in turn, dramatically improves synchronisation. The lead time for orders drops dramatically. Uniformity in inventory flow prevents the creation of ‘temporary constraints’, thereby revealing hidden capacity. With improved flow, the ‘real’ constraint is exposed. A few improvement projects on the constraint further increase the output. An ongoing improvement process can be launched to incrementally address each constraint as they are exposed at higher volumes.  As delivery reliability improves and order spillovers are negligible, there is no need to reschedule orders at the end of each month or on weekends. Monthly planning can be changed to daily, perpetual planning – where orders are scheduled based on available capacity as they arrive.  Lower lead times and uniformly staggered deliveries across the month dramatically reduce working capital requirements.  <h2>Revealing and exploiting the ‘hidden’ market</h2>With the implementation of such flow processes, the variance in lead time performance comes down dramatically. The result is very high reliability in deliveries. When most competitors are unreliable (i.e., commit and execute across a wide range of lead times), the capability of one player to commit and execute with shorter lead times and specific delivery dates can be disruptive in the market. The previously ‘unaddressed’ delivery-sensitive customer segment is likely to shift volumes to such suppliers en masse.  In almost every equipment category, there are two types of customers. Large institutions that buy customised products in significant volumes, and many small businesses or households that tend to buy in very small quantities with minimal customisation.  Typically, the gross contribution percentage of such small orders is much higher than that of large institution orders. But most organisations neglect the ‘small’ because of the following reasons: <ul><li>Large orders yield higher sales output than small orders for the same effort.   </li><li>There are many small customers and they are spread out; a larger sales team would be required to reach out to them.    </li><li>The plant prefers large orders to achieve higher efficiency.   </li><li>When the plant is loaded with large orders, the lead time of small orders becomes longer and less reliable - customers of ‘smalls’ shy away from placing orders with large companies.   </li></ul>With reliable delivery and customer preference, the sales team’s efforts are significantly reduced. The released capacity in the plant and the flow system enables the delivery of small orders in shorter lead times. With these enabling conditions, a company can reach out to geographically spread-out customers of ‘smalls’ by establishing a network of sales agents. Lower lead times enable agents to place confirmed orders rather than anticipated ones. Eliminating the risk of unconfirmed orders allows a company to sell ‘smalls’ with advance payment. The sales efforts become negligible as small orders can be managed on ‘autopilot’.    <h2>Risk-free expansion</h2>In an environment of skewed flow, temporary constraints emerge at many places in the supply chain. When managers plan for growth in such environments, they add capacity in many areas. However, in an organisation with a uniform inventory flow, the real constraints are always in a few places. This enables organisations to invest in small incremental lots. The released capacity is used to support sales growth. This incremental approach can continue until the available opportunity within the current capacity and markets is sufficiently addressed. The ROCE and operating surplus improve dramatically, creating a platform for adding new plants, serving new markets, or developing new products with much lower risk, thereby enabling an ever-flourishing organisation.

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