| Background | A privately held X-ray equipment manufacturer and distributor headquartered in the United States was experiencing persistent negative gross margins. The company sold both equipment and support agreements globally, utilizing an internal direct salesforce as well as a distribution agreement with McKesson, a major healthcare equipment distributor. The company’s manufacturing facility was located in Switzerland, and it used Navision (ERP) with an integrated manufacturing module to track inventory, production, and financial reporting. |
| Challenge | Month-over-month gross margins were negative, and the company was unable to determine the root cause. The disconnect between inventory costing and financial reporting prevented leadership from gaining clear insights into profitability. |
| Analysis & Key Findings | To diagnose the issue, we conducted a detailed review of the company’s ERP setup and costing methodology. Step 1: System Analysis – Identifying the Breakdown • We examined how inventory costs (raw materials) were tracked, how finished goods were valued, and how cost of goods sold (COGS) was recorded. • We discovered that the inventory tracking module and the manufacturing module were not connected to the financial system in Navision. • A system setting had prevented inventory and manufacturing transactions from posting to the general ledger, leading to manual financial calculations for inventory valuation. Step 2: Uncovering the Root Cause of Negative Margins • The accounting team performed complex manual computations to estimate inventory value, work-in-progress (WIP), and finished goods costs. This process raised red flags, as it was prone to errors and inconsistencies. • Since the company only produced six different X-ray models, we manually calculated their actual costs using FIFO (First-In, First-Out) inventory valuation, ensuring accuracy. • Our cost breakdown included: • Material costs based on bill of materials (BOM), with minimal fluctuations. • Standard labor costs, applied based on production hours provided by the COO. • Overhead allocation, determined in consultation with the COO. Step 3: Identifying the Pricing Issue with McKesson • Once we recalculated COGS for the past six months, the primary cause of negative margins became clear. • The contract with McKesson provided steep discounts on the company’s most popular X-ray model. • Our cost analysis revealed that the price McKesson was paying was lower than the company’s production costs—in some cases, it didn’t even cover the cost of raw materials. |
| Solution & Outcome | ✅ SOLUTION 1: Renegotiating the McKesson Contract • The direct salesforce was successfully selling the same X-ray model at significantly higher prices, proving that the market could sustain a higher price point. • The original contract with McKesson was based on preliminary cost estimates before the product was available. However, the contract language allowed for price renegotiation based on actual cost data. • The company met with McKesson and renegotiated the contract, securing sustainable pricing that ensured profitability. ✅ SOLUTION 2: Enabling ERP-Driven Costing & Financial Integration • We enabled inventory and manufacturing transactions to post to the general ledger, eliminating the need for manual cost calculations. • Implemented standard costing for finished goods, ensuring accurate and real-time financial reporting. • Established an annual review policy for costing assumptions, preventing future mispricing issues. 📈 OUTCOME: • Once the new McKesson pricing took effect, the company’s gross margins turned positive, restoring financial health. • Accurate, system-driven inventory and costing processes improved operational efficiency and financial reporting accuracy. • The company eliminated manual financial calculations, reducing the risk of errors and inefficiencies in cost tracking and reporting. |
| Conclusion | By integrating manufacturing data with financial reporting and leveraging data-driven pricing strategies, the company was able to reverse negative margins and restore profitability. This case study demonstrates the critical role of accurate cost tracking, ERP optimization, and strategic contract negotiations in sustaining long-term financial success. |
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