Insight, opinion and commentary for the leaders of Lean Enterprise Transformation from some of the world's leading experts.Are You Struggling to Improve 4%?
August 2nd, 2006 - by Mark EdmondsonReading Seth Godin’s article “The Mediocre Emergency” reminded me of a meeting I had awhile ago with the CFO of a privately held $1 billion company. I asked her about their financial goals, and she replied that they had an aggressive target to improve profits by 4% this year.
I felt their “aggressive target” was limiting, so I shared with her two facts that I hoped would shift her thinking:
1. Over 95% of her body mass consists of water.
2. Over 95% of her company’s activities consist of waste.
She was gracious and accepted fact #1 as a truth, yet balked over fact #2, and didn’t understand my overall meaning.
So I explained: “Pervasive waste in business is a fact, just like pervasive water in your body is a fact. Neither is particularly flattering, but does it make sense to deny they’re true?”
“Acknowledging that waste is pervasive in your company is critical for breakthrough thinking. For example, you have a value stream with a 5% profit margin. Let’s say that you reduce the waste in this value stream from 95% to 65%. What’s the bottom-line impact?” The CFO haltingly replied: “From a financial perspective, it would be huge. You just decreased my costs up to 30%, and increased profits by a factor of 6 or 7.”
“That’s breakthrough thinking.” I acknowledged. “But to succeed, we need your commitment and involvement as the CFO. Are you in?”
At first, she couldn’t decide if I was a lunatic or a godsend. But after spending some time with her discussing Lean thinking principles, and encouraging their executive team to talk with some of our clients, they began to see the potential. And after the first few weeks of working with us, they shifted their thinking.
Instead of struggling to increase earnings 4%, they now conservatively estimate reducing costs 30% and increasing earnings 40%.
So, are your company’s goals encouraging breakthrough thinking? Or are you still struggling with that 4%?
August 2nd, 2006 at 1:57 pm
What’s particularly alarming about this story is that many companies struggle to get a 4% net margin. Yet by taking really simple steps in each of the three primary lines of their P&L, they could easily shift this:
SALES $100
Cost of Sales (’Doing the Work’) -$60
Gross Profit $40
Overheads (’Cost of having a Co’.) -$36
Net Margin (What’s left!) $4
Now if they apply a simple 1% rule to the Sales (’Get 1% more money for the same work’), Cost of Sales (Spend 1% less in doing the work’), and Overhead (’Save 1% on overheads’) lines, these figures become:
SALES $101
Cost of Sales (’Doing the Work’) -$59
Gross Profit $42
Overheads (’Cost of having a Co’.) -$35
Net Margin (What’s left!) $7
A 75% improvement just by looking for SMALL changes!
The problem is that many CFOs (FDs in the UK) think that this is some sort of scary advanced math, probably driven by black magic . . . so when you start pointing out that actually there’s probably a 40% improvement just waiting to be had in the Cost of Sales line alone, it’s little wonder that they’re sceptical!
The fact is that the long history of many firms is to organise around hierarchical [command and control] structures, which encourage people to believe that the way things have always been done is the best way there is. This is why finance people struggle to get changes made, and why with any Lean project, its essential to get the middle managers in line as soon as the senior management have given the green light. Middle managers are the guardians of the status quo, and convincing them with some good early wins (low hanging fruit etc) is in my experience, one of the keys to success.
Karl.
August 3rd, 2006 at 7:17 am
This reminds me of Juran’s comments about sporadic and chronic quality issues. We jump all over the special causes of variation in a process, but the chronic problems just seem to go on forever.
Ben