Day 95 - Variance Schmariance

          We took Bud back to the vet today for another round of x-rays. We were clinging to the hope that what looked like osteosarcoma on his shoulder would actually turn out to be an infection. To this end we had him on some really strong anti-biotics and anti-inflammatory drugs. If our hope turned out to be true the shadow on Bud’s x-rays should have been markedly diminished. It was not. This is as close as we can get to absolute certainty without getting a biopsy. We don’t see the need to put him through the additional pain just to be certain of what is by now obvious to us. Bud has bone cancer, and he is rapidly failing. Still he offers no complaint. He continues to eat well and seems to enjoy his walks as much as ever, although he is noticeably slower.

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The new president at Albatross, let’s call him Jed Boome, went about the business of stacking the local executive management posts with his buds and cronies from past companies. Notably, we got a new CFO and a new supply chain manager. Then it was back to business as usual with the new guys in charge. Just because they were new didn’t mean they were any smarter or any more qualified to run the company as they soon proved.

Several new initiatives were started that accomplished, in the final analysis, not much more than stirring the pot. That may have been their sole purpose all along because nothing makes a cook look more like he or she is doing something useful than stirring the pot, but as any cook will tell you the main thing it does is keep things in motion so they don’t stick to the bottom and burn up.

To keep anything from sticking to the bottom and burning we started a huge strategic sourcing project, an outsourcing project, and an option optimization project. These were all touted to streamline operations, save buckets of money, and return us to profitability. Instead they paved the way to our next major reorganization.

The first of these initiatives to get off the ground was the outsourcing project. The new vice president in charge of supply chain management, let’s call him James Ringcomme, decided, probably because he’d read somewhere that this was a good idea, to start having all the parts that we had been fabricating in-house manufactured and delivered to us by outside vendors instead.

No studies were done, no detailed cost analysis undertaken to determine whether or not this made any sense in our particular situation. It was just done. Not only was it done, it was done as quickly as humanly possible, and accompanied by a great deal of yelling and threats when it still didn’t happen fast enough to suit Ringcomme.

Yes, Ringcomme was yet another of those over-energized, take-no-prisoners managers who substitute hysteria and abuse for good sense and reasonable attempts at communicating ideas. Ringcomme burned through a rapid succession of competent lieutenants by such antics as calling them at two o’clock in the morning to give them unreasonable assignments and then taking them to task in front of the rest of the staff the following day for not having accomplished the job he gave them to his satisfaction.

The purpose of outsourcing is to save total costs. You expect to get some uptick in productivity, in this case reduced labor cost by the amount of labor normally input into the fabrication of the parts now being outsourced. This savings would be offset by the increased cost of materials now purchased from the outsource vendors. The labor that would have been applied to the parts fabrication process may then be applied to assembly instead, hopefully earning a better return.

The better return is essential because there is not a direct trade off between the labor saved and the additional materials costs. The additional materials costs, all other things being equal between Albatross and its parts vendor, will now include the profits of the vendor. In other words if Albatross doesn’t earn more efficiently on its re-directed labor, there is no savings and no reason to outsource. This is not rocket science, but it is complicated and difficult to measure. It requires some sophisticated analysis and intelligence to do properly.

Unfortunately, at Albatross and many other places I have been associated with, managers do not do the kind of sophisticated analysis that is required to make these kinds of decisions. What they do instead is skim through popular business literature to get an idea what the current buzzwords are, and then attempt to manage to those buzzwords.

We even had one manager who made it his business to learn what the president was reading at the time so he could pepper his conversation with appropriate buzzwords from the same book. He never actually read the books himself just skimmed the chapter headings to pick out the buzzwords and get some inkling as to what they meant.

In our case the buzzword Ringcomme was most enamored of at the time was outsourcing. Outsourcing had been touted by several large auto makers, and Ringcomme figured what was good for them would be good for us, so outsource we did. Because we did it without sufficient forethought and analysis and because we did it quickly, it failed miserably.

Our total costs did not go down. They went up. We did not post gains in the efficiency of our assembly operations. Instead we had operators standing around waiting for parts that our vendors couldn’t deliver because, among other things, we had done nothing to ensure that our outsource vendors had the capacity to meet our demands. The materials cost of a 45’ boat increased by nearly $20,000 within several months. The labor cost on the assembly side remained virtually the same.

When it became obvious that something was seriously wrong with our new cost structure, Ringcomme began trying to manipulate the accounting numbers to deflect the blame. He had taken a savings number to the board to get them to approve his outsourcing scheme. He came up with this number by getting the vendors to commit to advantageous pricing at a given (aggressively estimated) volume. We never reached those volumes so the vendors were under no obligation to meet the advantageous pricing that Ringcomme had in effect taken to the bank.

When the smoke cleared the new and advantageous prices were established in the system as the standard cost for the associated outsourced items. Whenever we were invoiced for an amount greater than the standard, the situation that usually attained because our volumes were too low to get the standard prices, the system would spin off an unfavorable purchase price variance for the difference.

The purchase price variance account is meant to allow a company to track the performance of its purchasing department. If they can negotiate better prices than the standard they get a favorable variance, and that reflects well on their performance. If they secure prices that are greater than the standard they get an unfavorable variance that reflects poorly on their performance. Since the purchasing department belonged to the supply chain manager, Ringcomme, these unfavorable variances reflected badly on him. His solution to his problem was to direct the purchasing agents to go into the system and increase the standard costs in order to make the unfavorable variances disappear.

Standard prices are usually only changed once a year and under the direction and control of the accounting department. Standards that are fixed over time allow you to get meaningful data out of your variance accounts. Changing the standards changes the total standard product costs and therefore the standard margins. What Ringcomme was doing was shifting the margin erosion caused by the ill-concieved outsourcing project into the standard cost structure at the same time he was claiming that he had saved the company a ton of money.

When we caught him at it, and called him on it he put on an innocent act that was worthy of an academy award. He promised not to do it any more. Not only did he continue to do it, when one of the purchasing managers refused to bump up a standard cost for some critical hull fittings, Ringcomme had him fired for not being a team player. Naturally he had to give him a big severance package to keep us out of a wrongful termination suit, but we did after all have all those substantial outsourcing savings so we could well afford the severance.

Of course it didn’t matter to the company whether the extra costs were in the variance accounts or the standard cost accounts. Either way we had the same additional costs to deal with. You’d think if Ringcomme was serious about doing a good job, serious about making the company more competitive, he would have been attacking those costs with dogged energy. Such was not Ringcomme’s bent however. He was all about smoke and mirrors. All his energy went to making himself look as good as possible. There was none left over for actually doing the right thing.