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Manufacturing Small Business

Manufacturing small businesses could focus on niche products or contract manufacture. The total demand for niche products could be too small or widely distributed to interest large businesses. Small businesses could find such products ideal.

Large businesses might often find it more profitable to sub-contract the manufacture of components to others instead of making these in-house. Some large businesses might even decide to focus on marketing and get all their manufacturing done by others.

And governments might not be interested in manufacturing all their requirements.

Sub-contracts from these sources could assure a ready market for manufacturing small businesses. On the other hand, your large customer might try to exploit its strong position to obtain an unfair advantage.

Economic Significance

It is manufactured products, and the products of agriculture, fishing and mining, that provide the merchandise you and I need. Without these hard goods, the scope for service businesses would be negligible.

Manufacturing small businesses are ideal for your innovative product ideas. Once you have proven their commercial viability, large businesses might take these over leaving you significantly richer.

Establishing A Manufacturing Small Business

Establishing manufacturing small businesses is usually a more complex process than setting up a retail store or a small service business. It involves the following special aspects:

  • Finding and using the right technology – one that will help you achieve competitive quality at economic costs
  • Hiring and managing skilled operators experienced in the manufacturing process and equipment
  • Ensuring that the production processes result in products of acceptable quality and minimum of rejections
  • Checking that scrap and wastage during the manufacturing process are kept within allowable limits
  • Seeing that adequate inventories of raw materials and supplies are maintained to avoid downtimes caused by lack of these. At the same time, the costs of inventory holding should be kept to the minimum.
  • Making sure that the inputs – materials, supplies, fuel, power, and any other – are procured on the best terms.

The above tasks involve considerable planning and organizing, and a systematic approach. If you are a creative ideas person, and not comfortable with systems, you should find a partner or employee who could attend to these.

Then there are the other essential traits for small business success:

  • An ability to analyze situations and take suitable decisions,
  • Learning from your mistakes and successes, and
  • Persistence against inevitable frustrations and adversities.

We now look at the standard steps for establishing a manufacturing small business.

Is There A Market You Can Tap?

When you set up a manufacturing small business, you are committing significant resources to a particular product or line of products. These resources might not be capable of being used to produce another product. Hence, the importance of assessing the market becomes even greater.

The market study should tell you two things:

  1. Is there a big enough market for your product or line of products? And is it a market that you can reach?
  2. Can you handle the competition in this market? Unless you can develop a compeitive strategy and have the resources to implement it, you might find yourself driven out of the market.

You do the market study by:

  • Referring to trade and industry publications: What is the total demand? Who are the competitors and what are their market shares? Is the industry growing, static or declining?
  • Identifying and interacting with customers: Who are the customers? Why do they buy the product? Are they satisfied with existing offers? If not, what more do they want? [Answers to the last two questions will help you develop a competitive strategy.]
  • Observing competitors: Are they prospering or getting out of the business? How do they promote their products? How do they get their products to the ultimate consumers? What are their strengths? And weaknesses?

Marketing Strategy

You should define clearly what business you are in. Your business is not just making a certain product. Instead, it should be seen as satisfying a certain customer need. Your product sells because it fulfils a need.

Identify that need. To do this, you have to identify your customer first, and note how that person uses your product. When you start observing customers, you might find that actually, there is not just one kind of customer for your product, but different types of customers who have slightly different needs.

Certain groups of customers might be dissatisfied because it lacks certain features that they would like to have. Features considered significant include:

  • A lower price for most goods, and higher price for premium products
  • Doing better what the product is expected to do
  • Doing it faster or more precisely
  • More compact in size or weight
  • More stylistic or attractive
  • Easier to use, or setup, or repair
  • Longer product life

Identify the particular needs that are not being met, and find how to satisfy those needs. You would then have the best kind of competitive advantage.

Arrange to incorporate specific features needed by different customers, and tell those particular customers why your product is better for them. You would have a winning market strategy. Extend this strategy to other groups, offering them products that meet their specific desires, and you would have an expanding market.

All marketing strategies involve making your offer more appealing to customers. You must have a Unique Selling Proposition – USP – i.e. a customer benefit that competitors do not yet offer.

The final element of your marketing strategy is concerned with getting the product to the ultimate consumers. If your publicity is effective, these consumers would be looking for the product. If they can’t find it where they look, your publicity efforts would have been a waste.

The distribution could be done through your own sales force, through intermediaries like wholesalers or commission agents, or online through an e-commerce Web site. Which would be the best channels of distribution for you?

Technology for Your Manufacturing Small Business

Technology is significant in two important ways. Firstly, it could reduce cost of manufacture. Secondly, it could impart a better quality. Both these could provide you with a competitive advantage. Hence, you should try to get the most appropriate technology for your manufacturing small business venture.

You could do this in different ways:

  • Visit the Patent Office Web site and look for relevant patents. If you find a suitable technology there, you could license it and improve upon it
  • Meet experts at a research lab dealing with the relevant technology and discuss the possibilities
  • If you are a technician, try to get a government grant for doing research and development
  • Engage a competent technical consultant to help you select and implement the most appropriate technology for your manufacturing small business. Inquire around about the dependability of the consultant first, however
  • Consult your local government small business support agency. They might be able to guide you in all the alternatives, including those not mentioned above

We have used the word appropriate technology because the best and latest might not be suitable for the kind of manufacturing small business you plan. Highly automated technologies might be useful only for larger enterprises able to market the resulting large volumes of output, for example.

Planning Your Manufacturing Small Business

Now that the essential preliminaries of market study and technology selection are over, you have to start business planning in detail.

The first thing you have to estimate is your sales. How much will you sell in the first month, second month and so on? Estimate monthly sales for the first twelve months, and yearly sales for the next two years.

Physical Requirements

Next, list the production facilities and equipment you need to produce on that scale. These would depend on the technology you have selected, and would involve:

  • Listing the production operations – cutting, welding, punching, assembling, packing or any other.
  • Listing the equipments needed to perform these operations, and estimating the numbers for achieving your planned level of output.
  • Listing the inputs you would need – raw materials, components, supplies.
  • Estimating the quantities you would need each month, considering the sales and stocking requirements as also expected wastage in process.
  • Listing the tools and other incidentials (like power and fuel) that would be required for production operations, and estimated quantities.
  • Listing the labor skills you would need to run the equipment, and the indirect labor to keep operations running – like material handlers, janitors and storekeepers. Also estimate the number of people required under each category.
  • Estimating the space you would need to accommodate each of these – equipments (and safety devices), stocks of raw materials and finished products, personnel including rest rooms, transportation (internal and external) – and also to comply with any government regulations.

Costs Estimating

With the physical requirements estimated, you would now have to estimate the costs involved. Against each of the items in your list, indicate the source, price and other relevant information.

Now estimate the other expenses – office help, telephone, taxes, salaries of key persons like managers and foremen, travel, and any other.

Checking Profitability

Segregate the costs you have estimated above into two categories –

(i) the one time costs that you incur to create your manufacturing small business facility and

(ii)the recurring operational costs including direct manufacturing costs and the indirect overheads like rent.

The first of these is known as ‘capital’ costs and the second as ‘revenue’ costs i.e. costs incurred to earn the sales or other revenue.

Now compare your month by month revenues (sales and/or other income) with the month by month revenue costs. The difference would be your profit or loss. You might find that until sales reach a certain level, you would continue to incur a net loss.

This happens because several revenue costs are ‘fixed’ in nature. For example, you would have to incur rent, salaries of managers and foremen and such costs even if the production levels are quite low. These fixed costs can be recovered only from the margins you receive on sales. And the sales must reach sufficiently high levels for the total margin to equal the fixed costs.

A technique called break-even analysis estimates the level of sales at which the fixed costs are fully recovered. See the Break-even Analysis article for fuller details of this technique.

If you find that you could expect to achieve profitability within a reasonable time (say, in six months), you might decide to go ahead with the project. Otherwise, you would either have to rework the project to set up higher capacities, or abandon it and look for another. Assuming that you have decided to go ahead, your next task is to estimate the cash flows.

Cash Flow Estimates

Cash flows are different from profit estimates. Firstly, cash flows include capital expenditure also. You have to pay cash to acquire premises and equipments. Secondly, the practice of receiving and giving credit makes the actual cash outflows and inflows different from the date of incurrence of the expense or income.

Against each item of cost or sales in the statements you had prepared earlier, you show the credit period and estimate when the actual cash payment or receipt would occur.

Based on this data, you prepare a statement of cash outflows and inflows, month by month for the first year and yearly thereafter.

This statement would start with the cash balance in hand at the beginning of the month or year. Add cash inflows for the month (year) to this amount and deduct cash outflows. You end up with the closing balance of cash in hand (or cash deficit).

Any deficits would have to be met through bringing in more of your own funds or by borrowing from banks or other sources like venture capital funds.

The cash flow statement would also indicate when you would be in a position to repay the borrowings (and also to draw funds from the business for your personal necessities).

Financing Alternatives

The broad alternatives for financing the startup and initial operations of your business would be your own funds, borrowings, government grants (if any are available) and venture capital or angel funds.

Note that you would have to provide funds for “initial” operations (that might last several months or even years). As explained above, you might not start making profit until your sales reach a certain level.

Borrowings could be short term borrowings for seasonal needs like a Christmas peak, or long term borrowings to meet long term commitments like setting up your manufacturing small business facilities. The long term borrowing would be repaid in instalments from the profits you earn.

Government grants might be available to encourage investments in backward regions or to help weaker sections of the society.

Venture capitalists and angel financiers look for projects with unusualy high profit and growth potential. They would invest in such projects and sell off their investments at a premium once the business has grown. If yours is such a high potential business, you could look for such investment funds.

You would need to prepare a complete business plan, incorporating the following, to seek outside financing:

  • Company details – Names and addresses of Owners and contact persons, backgrounds of the owners and key managers, location of the business, progress already achieved.
  • The proposed project – The products planned to be manufactured and the estimated total project cost and finance needed.
  • Markets and marketing – The findings of your market study and details of your marketing strategy.
  • Profitability – The month by month and yearly profit estimates and the break-even statement you have prepared.
  • Project costs – The startup and initial operating costs until cash inflows begin to equal outflows.
  • Cash flow statement – Showing the funds that owners would bring in and the outside finance they expect.
  • Balance Sheet – This is a statement of the assets, liabilities and owners’ capital as at the end of a month, year or other period. It gives an overview of the business’ financial position.
  • The financing proposal – How it is proposed to finance the project costs and how the borrowings would be repaid.

Monitoring and Control

Monitoring and control are needed at both the project implementation stage and subsequent manufacturing operations. Control is exercised by comparing actual performance against the plans and taking any remedial actions (or plan revisions) where necessary.

Project implementation involves setting specific date milestones, such as acquiring premises, placing orders for equiments, receiving the equipments and all the other key results involved. Control is exercised by monitoring the actual dates of each result against the milestone dates.

Operations control is exercised by monitoring all critical results against planned levels. These key results include:

  • Monthly production and sales achieved
  • Rejections and returns resulting from quality problems
  • Percentages of direct cost elements to sales
  • Levels of indirect overhead costs
  • Collections against credit sales
  • Levels of raw materials and finished goods inventories

Note the mention about inventory levels. A certain level of inventory needs to be maintained to ensure that production schedules are not interrupted for want of inputs. However, inventories cost money in terms of funds blocked up, storage and spoilage costs and so on. So, a balance needs to be maintained between the needs of production and the burden of costs.

Accumulation of finished goods inventory could indicate unsatisfactory sales efforts or changing market trends. This is a critical sign and needs to be investigated in detail.

Conclusion

Your manufacturing small business enterprise would stand every chance of success if you attend to the key aspects:

  • Assess your own suitability and situation to run the venture. Arrange to remedy any weaknesses found.
  • Assess the market conditions – demand and competition – and develop a competitive marketing strategy to meet an unfilled need.
  • Locate the most appropriate technology for your manufacturing small business operations to achieve lower costs and better quality.
  • Develop a detailed business plan that could provide benchmark standards and also convince prospective lenders and investors.
  • Install and operate good monitoring and control systems.

About Andre Hospidales

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