The No. 1 reason manufacturing managers fail is that they don’t know how financial managers keep score. A business incurs costs that can’t be tracked directly to production or products. These include taxes, administrative costs, depreciation and a host of others. These costs are dumped into overhead and allocated against direct labor hours or dollars, or floor space or something else that appears to have something to do with making products.
Costs that have nothing to do with actual production still have to be allocated. Things go awry when the allocation constant is too small, resulting in unabsorbed overhead. That’s when the manufacturing manager wants to generate more hours in the plant to cover the overhead. Dead wrong! The problem isn’t the size of the labor pool or the hours worked. There’s just too much overhead to support the level of business! The right answer is to shrink the costs going into the overhead pool.