For many years, and before my move back to being a full time Lean Six Sigma consultant again, I operated as a Director in the food manufacturing industry.
I’m a firm believer that those who perform some of the hardest and most taken for granted roles deserve great pay (and we are definitely not there yet), the 1st of April was always a stressful day.
This wasn’t just about the April Fool’s jokes. It was the date the new UK Living Wage increases kicked in.
The exposure was real. Often, renegotiations with customers weren’t complete, but the cost increase on one of the largest lines of our profit and loss, labour, was happening today.
The Vicious Cycle
The issue isn’t the wage increase itself, it’s the correlation with the broader inflationary landscape. Wages are one of the largest cost of sales element in many environments, and particularly in food manufacturing.
This creates a vicious cycle:
This cycle was massively exacerbated by the notable step changes brought by Covid, the war in Ukraine, the practical cost realities of Brexit, and now the recent conflicts.
The Invisible Enemy: Why Averages Kill Cash Flow
I’m a numbers guy. I love statistics. In the land of stats, this entire cycle can create significant increases in standard deviation.
Standard deviation is the enemy of stability, control, and inevitably, profits.
If we work in an industry that relies on manual labour and faces notable variations in raw materials, the standard deviation of our labour costs is naturally larger than some other industries. If the base hourly labour rate increases significantly, we also tend to see increases in that standard deviation.
Here is the personal observation that kept me up at night: I saw my standard deviation on labour costs move from ~25p to ~£1.
You might say, “It’s only the average that matters.” But standard deviation affects cash.
The Pop
You might plan your overall year on the average, but in a specific month, if you have a labour standard deviation of £1, this means (based on the bell curve principle) you could sometimes be costing £2 or even £3 more than the average.
If your business has 200,000 hours of labour going on in a month:
That is an extra £600k of cash flying out the door that the average cash planning model completely missed.
Yes, next month might be better than the average, and you might get that cash back quickly, butt it’s too late if that sudden, unexpected cash strain caused the business to go pop.
The Real Message for Finance Teams
This is the message I never see discussed in the boardroom: I never see standard deviation, process stability, control charts (SPC), or even medians being used as part of the budget process or monthly cash management process.
If you ignore the reality of how processes actually operate, you are ignoring the risks in your business.
If you accept that variation is always present and understand what that variation is, you can:
Conclusion:
If your financial modelling is missing the statistics, please reach out. We can look at how standard deviation is impacting your cash flow.
And if you are finding it difficult to discuss the reality of cost increases and variability with your own customers, why not make it visible to them? When you back your necessary price increases with clear stats and graphs, the conversation might change.
