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The OAG Default
Improvement Explained
The OAG Default
Improvement Explained
The OAG Default
Improvement Explained

An OAG assessment sets strategic aspirations and establishes the current state for the 7 key components shown in the OAG Operations model. It identifies the available improvement to operational performance gained by closing the gap between aspiration and current state. Each component influences the gross margin improvement process and thereby, gross profit improvement.

Establishing a Standard

The two main costs associated with gross margin performance are direct materials and labour.

The OAG default CoS is 60%, made up of 40% materials and 20% labour.

Defaults are adjustable to reflect your business parameters.

The effectiveness and efficiency of the operation directly influences the consumption of materials and labour productivity. The OAG performance criterion predicts gross margin improvement by establishing a highline for achieving maximum performance and a baseline for achieving minimum performance. When applied to both materials and labour, the potential improvement is revealed.

Material Usage
Highline for maximum achievement

The ultimate target for material usage is 100% yield. However, even in the very best operations, material is lost during manufacturing (process waste) and as a result of set up scrap and destructive testing (process scrap).

The material usage highline is based upon the following for achieving maximum performance:

Baseline for minimum achievement

Where an operation has achieved the minimum standard, processes will be neffective and inefficient thereby consuming more materials for the same yield.

Actual process waste will include additional material costs sustained using alternative materials, increased setup losses and increased purchasing costs.

Actual Scrap will include increased scrap from process and equipment failures, lack of operator skills and/or attitude and commitment.

Based on experience, the following baseline has been used as a default for minimum achievement.

The impact of material usage on gross margin

The difference between the baseline and highline is a decrease in material usage of 9% for the same output i.e. ((97%-89%)/89%) = 9%. This is the improvement potential for materials.

Labour Productivity
Highline for maximum achievement

The ultimate target for labour productivity is 100% performance, i.e. one hour of income earned for every hour paid. However, even in the very best operations there are still statutory breaks and paid holidays plus lost time i.e. illness and comfort breaks.

Based on experience, the following highline has been used as a default for maximum achievement.

Baseline for minimum achievement

Where an operation has achieved the minimum standard, processes will be less effective and inefficient thereby consuming more hours for the same yield (decreasing productivity).
Our turnaround experience has seen factories that initially operate at circa 60% productivity and we have reflected this by adjusting the losses accordingly:

Breaks – In the UK, for example, employees are entitled to a statutory 20-minute paid break when working over 6 hours i.e. 1.65-hrs/week. Often this is not well managed, so a 20% drift increasing breaks to 1.98-hrs/week has been set as a default.

Downtime – The same applies to comfort breaks, these will become more frequent and take longer to conclude. We have increased downtime from 3%, 1.13-hrs/week to 5%, 1.88-hrs/week. Unauthorised absence – We have increased unauthorised absence levels from 1%, 0.38-hrs/week to 4%, 1.52-hours/week.

Demotivated workforce – Ineffective leadership and inefficient processes will act as a demotivator reducing productivity performance by 6%, 2.25-hrs. High labour turnover, lateness and absence are indicators.

Lost time – No work being available, equipment shortages, breakdowns and skill shortages all contribute to reducing productivity performance. The absence of effective and efficient processes will act as a demotivator reducing productivity performance by 8%, 3-hrs.

Impact of productivity on gross margin

The difference between the baseline and highline is an increase in labour costs of 33% for the same output i.e. ((80%-60%)/60%) = 33%. This is the improvement potential for Labour.

The effect on gross margin performance

The following example shows the effect of operational performance on gross margin and gross profit. In this example, the business has a highline expectation for net annual sales of £10,000,000 with annual material costs of £4,000,000 (40%) and annual labour costs of £2,000,000 (20%).

The baseline expectation for net annual sales of £10,000,000 is:

Materials (40%x9%) + 40% = 43.6% = £360k increased cost.

Labour (20%x33%) + 20% = 26.6% = £660k increased cost.

Summary

This example shows the impact on gross margin is (40%-30%)/30% = 33%. This is used as the default percentage for calculating gross margin improvement.

Improving gross margin
Linking the assessment result to gross margin improvement

An OAG assessment identifies the available improvement to operational performance for closing the gap between the strategic aspiration of the business and its current state for each of the 7 key components shown in the OAG model.

Annual net sales and CoS, established during the assessment process, are used to calculate the current gross margin of the business and the potential for improvement.

The report generated, forecasts the potential gross margin improvement and provides detailed guidance to achieve it.

OAG default improvement percentages

OAG has based its calculation on CoS of 60%. Improving from a baseline minimum to highline maximum gives a gross margin improvement of 33%. This has been distributed between the 7 key components with a weighting based on their contribution to gross margin.

CoS is not a standard and will vary from business to business, higher or lower than 60%. The ‘Enter Improvement Values’ table, above, is a section of the assessment process. It enables the assessor to adjust the improvement value for each component to reflect the CoS or their view of available improvement.

Table headings
1. Default Improvement

Standard component improvement.

2. Remaining Improvement

This is the Default Improvement net of the assessment score e.g. aspiration of 5 and a current score of 2 means there is only 60% of the default improvement remaining.

3. Client Improvement Adjustment

Supersedes Remaining Improvement to reflect the assessors reasoning on available improvement.

4. Gross margin improvement

These numbers are used to calculate the financial benefits for achieving aspirational goals.

NB: The Remaining Improvement percentage is only used where no Client Improvement Adjustment percentage is entered.

5. Benefit Forecast

Is the gross profit improvement for achieving the forecast gross margin improvement. This is achieved by multiplying the gross margin improvement percentage by the current gross profit (£4M).

Gross margin definition

Gross margin is defined as Net Sales minus Cost of Sales (CoS) i.e. the amount of money a company retains after incurring the direct costs associated with producing the goods and services it provides.

Net sales = gross revenue, less the returns, allowances and discounts.

CoS = the direct costs associated with producing goods and services (typically around 60%+ of the total costs incurred by the business).

Calculating gross margin: (Net Sales – COS) / Net sales = Gross Margin %.

Pioneer is a self-assessment for single-site operations where aspiration and current state data is entered consecutively producing a report in under 90 minutes.