March 21, 2017
This is a great question with many implications. Most people need some way to define success numerically; but what are the right metrics to look at? The ultimate goal for anyone running a business is to increase enterprise value. This still leaves you with the question of “as compared to what?”, and even then, the question remains: is it good enough? Or, should the result have been even higher if I did a better job on my companies’ lean turnaround?
I recently spoke with a lean thought leader and a business school professor who are creating a mathematical formula that can tell CEO’s what to expect from their companies if they make the switch from batch to lean. The thrust of this effort is finding a tangible way to answer the number one hurdle to getting more companies on the lean journey, which is: “How do you get the CEO’s interested in doing this?” I applaud their effort but it scares me a bit, as I don’t think you can reduce this important work to a mathematical formula with any precision. And in fact, this could backfire if it leads companies to expect a certain result that they don’t achieve. Above all, guaranteeing results is not merely an impossible task, but a misleading one. At the end of the day how you go about becoming lean is most important.
I met with the management team of a very successful industrial company that wants to take their lean efforts to the next level after 8 years of practice. So far, they have followed the (unfortunately) traditional path of thinking that lean is mostly a cost reduction program. They say all the right words, but then they showcase the annual cost savings from their “operating system” year by year, which only highlights the cost reduction mentality. I told them that the numbers look impressive in the annual report, but the ability of any company to collect this type of savings numbers with any accuracy is suspect. Not only the numbers themselves, but where did they come from? Was it from lean efforts, or from traditional tricks like closing plants or big capital spending? Whatever the case, and even if by some wild chance the numbers are accurate, the focus on cost reduction is still the wrong emphasis in my opinion.
The better approach is to focus on a few key operational excellence goals that, if they are achieved, will drive the future results and ultimate enterprise value of the company. The ones we used at Wiremold were:
100% On Time Customer Service
50% reduction in defects - - each year
20% productivity gain - - each year
20x inventory turns [we started at 3x]
Visual Control and the 5S’s everywhere
Yes, these were all stretch targets but that was the whole point. We wanted/needed to change the conversation. We needed everyone to start to think and act a different way. We wanted everyone to focus on the customer and create a learning environment. We ran the company on these five key targets. We met every week to discuss progress by every value stream leader against these goals. We never tried to track our cost savings. We never did an ROI analysis before making rearrangements in the plant. We just focused on progress on these five goals.
After 9 years we more than quadrupled sales, increased operating profits by 13.4 times and increased enterprise value by 2,467%. That was nice. But are these the right measurements to focus on? I would say no; they are just results. Our focus was on the customer. To serve the customer better we reduced our lead times from 6 weeks to 1-2 days. That let us provide better customer service and gave us a significant strategic advantage over our competitors, who still had 6-8 week lead times. We did this by focusing on setup reduction. Machines that used to changeover 3 times per week were being changed 20-30 times per day. Customer service went from 50% to 98+%. Inventory turns, a major focus for us, went from 3x to 18x, freeing up lots of cash and space and taking working capital/sales from 22% to 6.7%. Gross profit increased by 13 points. All driven by our focus on the five operational excellence targets shown above.
In my recent book The Lean Turnaround Action Guide, I shared comparisons of what a company would look like in key financial areas such as sales, margin, inventory turns, productivity and enterprise value, over five years, if they stayed as a traditional batch company instead of making the switch to lean. I used a very healthy batch company as the base line. We then take it step by step through a lean conversion and show the results after five years. I was quite conservative in the lean case, as we did much better at Wiremold, not to mention many other lean companies that have done better as well. Even so the comparison after five years is strikingly better for the lean company. These impressive results indicate what you should expect to achieve with lean in most key financial areas. And yet, even the best recorded set of results still won’t reveal to you what is truly possible with lean. That’s because there is no “ultimate”; there is only continuous improvement.
That’s why no equation will ever fully capture the value of lean, and why you should never rely too heavily on one. Try to get away from the traditional approach of focusing on results. Focus instead on stretch targets that you can measure and that if achieved will drive your future results to levels that you would never even dare dream of in your batch state.
The views expressed in this post do not necessarily represent the views or policies of The Lean Enterprise Institute.