Think twice before adding fabrication capacity to your sheet metal shop
You can’t have it both ways.
Either consciously or subconsciously, your sheet metal products business makes many decisions that preclude certain activities. If you focus on one geographic area, you lose opportunities in others. If you focus on sheet metal forming, you lose opportunities in other mechanical areas. If you focus on your own employees, you forego the use of subcontractors. If you focus on manufacturing, you lose the opportunity to outsource material acquisition.
There are pros and cons to every decision you make. You need to ensure you get the big decisions right. Doing research is critical. This is especially true when it comes to purchasing sheet metal machinery.
If you borrowed $100,000 at a 6 percent interest rate to finance an equipment purchase, you would be adding almost $2,000 a month to your fixed cost for the machine alone for a period of 60 months.
The $100,000 you spend should include the cost of setting up and commissioning the equipment. Will you need additional equipment for materials handling — a crane, forklifts or storage racks? Add to this the cost of the space for these items and this is your fixed cost. Your variable costs are:
- Cost of carrying inventory
- Labor to run the machine
- Materials handling costs
- Finished goods storage
- Shipping to site
For every dollar of fixed cost you incur, you need to reduce your operating expenses by that amount just to break even or increase your sales by about eight times the fixed cost to get a return for the risk you are taking.
In addition, you will need more operating cash to finance the working capital. Don’t forget that when you buy from a supplier you can get 30 to 45 days credit, while with the additional labor of in-house fabrication you have to meet regular payroll. Cash flow is king.
Compare all this cost to ordering from a supplier who will deliver directly to the job site. Do an analysis based on the previous six months to get a sense of what it would have cost you to make the materials using the machine and compare it to what you are paying.
Another benchmark that some contractors use is the number of hours of work per week they believe they can schedule use of the machine. While your equipment supplier may be able to help you with this, remember the company wants the sale. Talk to noncompeting contractors who have gone through this process, visit their plants and get some hands-on understanding of the issues.
Remember in the 1980s when every sheet metal contractor seemed like it had to have a plasma machine? No one was doing any number crunching, and many contractors were lucky if these machines worked two hours per day. So, don’t get lulled into buying a piece of equipment because your competitor has one. Be smart and, where possible, use someone else’s fixed cost. They will be glad to give you a price break as they get the extra machine hours.
The main reason sheet metal contractors say they they want to own their own equipment is because of the lack of control when they subcontract out ductwork fabrication. Before purchasing any machinery, analyze any problems you are having with outsourcing and determine if they can be corrected without buying the equipment. Investing in an efficient procurement process is a lot less expensive than investing in a large fabrication shop full of sheet metal machinery — and keeps your options open.
Because you will lack control over the production process when you subcontract, you need to develop better control. Some of the activities that will improve this process include:
- Regularly visiting the fabricator to ensure they are processing your orders in a timely manner. This can be done by the company regularly sending you video or photographs, so you don’t have to make the physical trip.
- Offer the ductwork fabrication contractor a financial incentive if it can go six months without a mistake or time delay.
- Use at least two fabricators to ensure you get competitive pricing and reliable service.
A fabrication shop can offset 2 to 4 percent lower prices by increasing production, while a contractor will often lose another 2 to 4 percent by doing additional work because of a lack of control.
There are many fabrication shops that would love to do more work, so look seriously at outsourcing your fabrication until you are sure you can justify the investment and risk of a fabrication shop.
The development of technology in recent years in ordering materials has improved reliability and streamlined the purchasing process significantly. Turnaround time has improved dramatically. Part of the reason is the creation of software that allows web-based ordering of duct from anywhere.
A sheet metal contractor in British Columbia started Webduct Systems Inc., which the company says “is the world’s first and only completely cloud-based ordering, pricing and sales platform for sheet metal HVAC contractors. … Webduct allows users to log in from anywhere using a computer or smartphone with internet access and price, or order ducting components and their accessories instantly.”
So ordering duct from outside sources is not as inconvenient or as difficult as it was even five years ago.
The use of tablets and smartphones makes the process of ordering, pricing and delivery of materials faster and more accurate than ever before. As more fabricators introduce this type of process and offer their services to sheet metal contractors, the need for fabrication shops will decrease and there will be increased competition among those left. That will give contractors that outsource even more opportunities to reduce material costs. Whether they pass on those savings to the customers or retain them as profits is another trade-off decision they can make.
If you are focused on adding equipment, start by really analyzing the pros and cons of outsourcing ductwork fabrication. This is your trade-off decision. Outsourcing work should give you better control over your costs, as you can switch from one fabricator to another and when business slows down you won’t have to feed the “beast” of fixed cost. Any production mistakes are at the fabricator’s expense. The price you put in your bid is the actual cost you will pay, not an estimate. You will have a fixed-price contract for fabrication.
Here are some questions and suggested actions when deciding whether to fabricate or outsource.
- What are the real difficulties in outsourcing?
- What could I do to limit the risk of each difficulty?
- How much would I save by not having the in-house equipment?
- What are the risk factors involved with in-house fabrication?
- What else would I do with that money?
- Ask potential fabricators for the names of other contractors the company works for. Meet them and explore the problems they are having.
- Can I give my fabricator sufficient lead time to make and deliver in a timely manner?
- Will the relationship be a win/win for both parties?
When it comes to selling a sheet metal works business, it can be difficult to find a buyer who can afford to pay for the shop. Because of the investment in equipment and inventory, it precludes many potential buyers, particularly if you are looking at selling to employees. A sheet metal business with limited fabrication facilities would be more attractive to a competitor that wants to add some production capabilities without buying capacity it doesn’t need.
The real trade-off decision is do you want to have variable costs that you can control or fixed costs that you have to feed?
Ronald Coleman is a Vancouver, British Columbia-based professional accountant, author, certified management consultant and professional speaker who specializes in working with construction contractors. Contact him at Ronald@ronaldcoleman.ca or see www.ronaldcoleman.ca on the internet.