When Lean Improvements Fail to Show Up on the Bottom-Line
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When Lean Improvements Fail to Show Up on the Bottom-Line

Lean improvement initiatives that focus on cost savings are destined to come unstuck. Why? Because it is extremely difficult to justify that these improvements have had a real effect on business financial performance. There is a growing trend for senior managers to question that lean is delivering the hard-line bottom-line results they anticipated. Some are asking why they should bother continuing with lean, they are not convinced the results are worth it.

There are two main reasons:

The first is that while most lean implementation initiatives are well-intentioned they are naïve applications of tools and techniques that do nothing to fundamentally alter the capability of the business to sell more with less inventory and less operating cost. This, after all, is the only way to make more money.

The second is more serious and harder to address. Many lean implementations falter when a major contradiction arises. The system is performing better: on-time delivery is higher, quality has improved, productivity is better and manufacturing lead-time has fallen with a consequent reduction in delivery. But profit looks worse. How can that be?

Standard cost based accounting systems interpret the value adding principle as ‘each time I make something I add value to the business’. This manifests as double entry book-keeping through an addition or debit to inflate the value of inventory and a corresponding credit to the profit and loss account. The effect is that reduced inventory can show as a loss. We could and should do away with all this silliness and complexity by simply changing the value adding principle to ‘each time I sell something I add value to the business’.

  1. Traditional accounting systems, based on standard costing principles, will often provide misleading information leading to poor decision making. Here are some common examples:
  2. Producing in smaller batches to match production with demand and reduce lead-time to the customer will make the product cost appear to go up.
  3. The need to changeover a non-bottleneck machine more often in order to better match the mix required by the customer will reduce its utilisation and appear to increase production cost.

Reduction of operating losses will often be focussed on a machine where we find the biggest losses even if this is a non-bottleneck machine despite the fact that targeting a smaller loss on the bottleneck will have a greater effect on the whole system.

So beware lean initiatives which claim that the purpose of lean is the elimination of waste in the belief that this will equate to cost reduction. Successful businesses focus on protecting and increasing real sales to the customer. Improvement activities should be determined by a pursuit of value.
At S A partners we refer to this as realising the profit potential of lean through x and 2x. Many lean implementations stop at creating capacity. However for profit to be realised that capacity must be filled.

graph showing profit over time

In summary, it is important to be aware that ‘doing all the right things’ may not manifest in a better bottom-line. The best antidote is to take your Finance Director on your lean journey with you. Make him your ally. He/she will see the good work you are doing and help you with cost justification – even if it mean keeping two sets of accounts!

 

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