Managers – continuous improvement delivers more than you think
How many companies really just do “Continuous Improvement” for the savings. They may refer in external and internal communications to “listening to the voice of the customer” or “improving the process capability of all of our key processes”.
When I was training to be a Black Belt in 1997 the expectation was “All projects must save at least US$100K”. Another mantra was “Management can expect four completed projects per practitioner in the first year”. You can do the arithmetic. By 2000 the consultants’ mantra of $100K per project had risen to “$250K per project”. That’s some inflation!
Then reality set in. Not everyone completed their projects and so lower savings arose. Management asked why the profits hadn’t gone up. Some individual practitioners and their Champions then became somewhat ‘inventive’ in their savings calculations. For a while everyone was happy until someone suggested auditing the savings calculation process and discovered large variation and occasionally more than a little “smoke and mirrors”. The new rule became finance must sign off all benefits calculations. Is this a good idea or non-value added waste based on interdepartmental mistrust?
This resulted in a return to reporting the easy savings anyone can spot i.e. direct labour time and material reductions that hit the P&L. This ignores the potential opportunities that other ‘harder to measure’ benefits would achieve.
Different people have different expectations about savings
Different stakeholders have different expectations from improvement savings. If the CEO personally authorised an improvement deployment, then they typically expect large savings so they can vindicate their own judgement. The improvement practitioner also seeks large savings, so they can vindicate their own value to the organisation.
Finance expect to see effort translating directly to the P&L account and certainly feel uncomfortable about the concept of spending money up front to achieve savings.
As a finance guy myself I know how easy it is apparently just to save money. Just say No, every time someone suggests spending money. Give me the return on investment. Trouble is people don’t know how to calculate soft savings. They are hard (to determine), so maybe that is why they are called soft, like fake news that might actually be real and big.
What does life in a finance department consist of?
Accountants use a series of costing methodologies, including marginal costing, standard costing, absorption costing and activity based costing. According to an EFQM European Quality award winning submission, best practice comprises:
- 33% of time spent reporting and budgeting
- 33% of time collecting and paying money and
- 34% of time providing value added management information.
There is a danger that the percentage of time spent on the first two activities can crowd out time for the third (admittedly data collection and analysis is technically a non-value-added activity).
Historical cost accounting doesn’t identify real losses
Historical cost accounting is simply not set up to identify real losses. For example:
- Purchase price variance motivates the buyer to increase order quantities to get the best price; compromising quality, delivery and inventory & inspection costs.
- Machine utilisation variance can motivate the worker in a cell to produce more parts than required, creating excess inventories, increasing risks of obsolescence, handling damage, hiding defects.
- Unreported in-process rework. Accounting systems can only see the effect, so the root cause can be overlooked leading to no or misplaced so-called corrective action.
Juran’s categories of quality cost
Dr. Juran took a different view in identifying and reporting cost categories, focusing on “quality costs”
In other words, all costs incurred in keeping failure and appraisal costs to a minimum.
In summary, Juran defined Cost of Poor Quality as:
Internal failure cost + External failure cost.
He then defined Cost of Quality as:
Internal failure cost + External failure cost + Appraisal cost + Prevention cost.
We should also consider the costs associated with ‘Ohno’s’ 7 Lean wastes.
Have you got an account for…?
We don’t often encounter accounting for the likes of the…
- “Sales director’s flight, car hire & hotel to explain late delivery”
- “Temporary workers not hired following rolled throughput yield improvement”
There will almost certainly not be an
- “Advertisement for new workers, no longer needed, not placed following process improvement (Defects per million opportunities reduction)”
And Lean practitioners will be hard pushed to find a
- “Space saved following 12th consecutive successful rapid improvement kaizen workshop in this area but not quite enough to get rid of the lease on that warehouse yet”
Costs will never decrease unless improvement projects are given some encouragement in the form of reportable monetary credit and then tracked along with all other improvement projects. Whilst cost cutting is an important discipline it is not the only discipline. Successful businesses now place great stock in measuring the effect of Customer Experience on building profitable revenue growth.
Hard savings are easy, soft savings are hard
There is often considerable debate about what constitutes improvement project savings.
Hard savings are subject to the least debate, they refer to the absolute removal of expenditure and positively impact the profit and loss account.
- Scrap reductions as a result of eliminating defects.
More efficient use of raw materials can be a major contributor to hard savings.
- Rework costs reduced as a result of eliminating defects, which can directly reduce the cost of paid hours.
Soft savings are harder to quantify and are open to much more debate. They are, therefore, often ignored. But they do create realistic possibilities for future hard savings, so they should be tracked and acted upon.
To facilitate the management decision making process, soft savings can be categorised into three types:
- When space requirements for an activity are reduced, but the building is not vacated or sublet.
If buildings are rented, they can often be partitioned off, resulting in tangible hard savings of rent reductions, together with proportionate reductions in heating and lighting costs.
- Capturing the cost of saving 30% of a person here, 25% of a person there, will add up to significant FTE (full time equivalent) savings. When managed correctly, these can be turned into hard savings, by reassigning staff instead of hiring new employees, reducing temporary staffing costs or reducing the payroll burden generally.
Cost avoidance savings
These types of costs can be very large. For example the avoidance of regulatory fines in previously non-compliant processes in food, drug or financial services industries. A major pharmaceutical manufacturer was so paranoid about incurring complaints from its lucrative Japanese market that perfectly good product was routinely scrapped by “inspectors” who by definition believed that their job was to find rejects. It was, but not if they could not properly tell good from bad. A little measurement systems analysis, tiny investment in detection equipment and good training and standard operating procedures saved many hundreds of thousands of dollars per year.
Many organisations invest in capital equipment at great cost. However, the utilisation of such equipment, which dictates an efficient return on that investment, is often overlooked. Underutilised equipment is a drain on effective use of capital and should be monitored and addressed before decisions are made to invest in new capital equipment. So, there are great ‘opportunities’ to exploit in utilising existing equipment effectively. Total productive maintenance and use of OEE (overall equipment effectiveness) techniques can help RoI enormously.
Soft benefits do not become hard savings on their own. They must be tracked, quantified, and monitored. This gives management the ‘opportunities’ they need to convert them into benefits hitting the P&L account.
Despite the fact business is based on having paying customers (and therefore managing customer experience is essential), the bottom line is literally just that – growth, profitability and return on investment. Thankfully, sites like https://thesoutherninstitute.com/cbd-merchant-account/ give us hope with new technology that promises to help oversee finances. When management are able to use performance indicators that enable the realization of the hidden costs of poor quality and performance and measure the opportunities it’s then just a case of ‘managing’ these opportunities through to realization in a structured manner before the competition get there first.