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Beyond Lean

Making Lean Improvements Count: Performance Issue #1 – Improvements Do Not Have Impact at the Enterprise Level

By Michael S. Jordan and Don Chappell, Time Wise Solutions, Inc.

Few would argue with the assertion that there is constant need to improve a business. In today's competitive marketplace, manufacturers are investing significant resources into a variety of improvement programs. Some companies have succeeded while others experience marginal impact at the enterprise level. These hard won gains can dissipate in a matter of months if not vigorously maintained. Given the risk inherent in any improvement effort, companies frequently focus their resources on immediate cost cutting initiatives. After all, the impact of cutting cost is evident. It improves the bottom line quickly. There is a demonstrable line of sight between operational improvements and financial impact – or is there?

Lean, like all improvement systems, is not fully effective unless a manufacturer can achieve real, sustainable impact. It is important for a business is to identify and discriminate "real" improvements from the "fool's gold" variety – operational impact that is marginally relevant to enterprise success. Real operational gains must be sustainable to ultimately contribute to enterprise financial performance.

Continuous improvement is the Holy Grail of all manufacturers. However, this is possible only to the extent that real and sustainable improvements can be consistently achieved. In Part 1 of this article, we define the concept of making real improvements. In Part 2 we will discuss how to sustain these performance gains.

The Enterprise Value Stream
For a Lean improvement to improve the enterprise, it must enhance value creation. Value is always defined from a customer's perspective. Specifically, value is any product or service attribute that a customer is willing to pay for. Thus, any activity that contributes to the creation of customer value is "value added." When value-added activities are improved, "real" impact is achieved because customer value has been enhanced. All value creating activities are linked to form the value stream.

The value stream is often viewed in the context of production-related operations. Traditionally, value stream mapping has focused on the logistical flows of information, materials, and factory processes. Such activities enable direct value creation via some tangible transformation. There are also activities that are indirectly involved in value creation. Supporting functions that add indirect value include sales, IT services, purchasing, marketing, product development, customer service, and research efforts. Even though these activities may not produce a tangible value that a customer will pay for if asked, they nonetheless play a critical role in the value stream. Thus, the "enterprise value stream" consists of all activities that are involved in sourcing, selling, making, delivering, and servicing that directly or indirectly add value to a final product.   

The enterprise value stream can be viewed along two dimensions: value stream scope and value stream focus. Value stream scope defines the strategic structure of the value stream which is shaped by market and resource constraints, growth opportunities, and stakeholder needs. Structural attributes include the formal description of processes and job functions, operating policies and parameters, and management infrastructure. The strategic value stream does not change much over time once established.

Chaos vs Synergy
Value stream focus has to do with how activities work to produce final outputs that are sold to external customers. This tactical dimension of value stream is dynamic in that change can be very fast and is subject to significant variability. Value stream focus requires constant attention as it has a natural tendency towards chaos and chaos is the enemy of improvement sustainability.

The idea that an organization can take steps to improve and then become satisfied with interim gains is not realistic. The moment an enterprise stops improving, the risk increases of seeing hard won performance gains unravel. Either an enterprise is moving into chaos or it is moving in the opposite direction – synergy. So, continuous improvement is a necessary condition for sustainability. However, not all improvements are equal opportunity investments. Ultimately, operational improvements that fall outside of the enterprise value stream make no contribution to financial returns. Thus, the irony is making an impact but not an improvement.

Time Wise® Return on Value Model
To illustrate this point, we introduce the Return-on-Value (ROV) model (Figure 1). The ROV model assumes that the primary mission of a manufacturing enterprise is to perpetually create value that customers are willing to purchase at a price higher than the cost to produce that value. Further, the value-added activities that are performed today result in financial returns tomorrow. Simply put, a resource used to improve the value stream is an investment in future financial return. However, because financial return is a sum total of all enterprise activities and, as a result, is delayed in time, there is no line of sight between the value drivers and the financial results. Thus, it is not clear how or what specific activities contribute to financial results.

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Conventional reasoning says that if a positive impact is made on some intermediate financial or operational measure, it will eventually have impact at the enterprise level. This is not necessarily true. It is certainly possible to show a positive impact on certain productivity or cost performance measures, for example, that will never actually contribute in any way to enterprise returns – an artificial impact. If there is no clear line of sight between activities and financial returns, then how can we draw this conclusion?

An artificial impact improves some aspect of operations that targets a result which has nothing to do with the enterprise value stream. The impact is artificial because value creation has not been directly or indirectly enhanced. Thus, resources invested in the impact will not yield financial returns – a case of winning the battle but not the war. The illusion is that progress is being made, but in reality, time, resources, and energy are spent improving something irrelevant to the customer and therefore ultimately irrelevant to enterprise success.

Value creation must be both effective and efficient to produce financial returns. Effective value means that the "voice of the customer" has been captured in the product design process. A product is effective to the extent that it enables a customer to achieve a desired outcome. Further, the total quality of a product must be at or above other competitive products. Total quality in this context refers to product functional features, aesthetic attributes, durability, and usability. Of course the total quality mix will depend on the nature of the product relative to the enterprise strategy.

Value is efficient to the extent that it can be produced at a lower cost than what customers are willing to pay. This means that a product is offered at a competitive price and there is an adequate financial return. Most operational improvement efforts have traditionally focused on minimizing the cost of value by reducing the cost of inputs and increasing the efficiency of resource usage. From a Lean perspective, the cost of value is a function of value stream efficiency which is improved by eliminating all forms of waste. Waste in this context includes all resources and activities that do not contribute to value creation as well as the under-utilization of information and human abilities.

Real Impact of Value Stream Improvement
Value stream effectiveness and efficiency ultimately contribute in different ways to the cost of the capital tied up in the enterprise. Value stream effectiveness drives total quality while value stream efficiency drives total productivity. Both of these intermediate performance measures uniquely impact net operating profit and both uniquely determine how capital assets are used to generate an operating surplus. Thus, the interplay between effectiveness and efficiency ultimately drives the enterprise financial result – return on capital employed (ROCE).

Financial return on investment (ROI) can be measured in many ways. The ROV model uses return on capital employed because it is perhaps the most widely used ROI measure today.  Also, if the cost of capital is taken into account, then ROCE can be further refined into value-based return measures like Economic Value Added (EVA) and Total Shareholder Return (TSR).

To be sure, financial return is the result of both net operating profit and asset utilization – the whole business. The emphasis is on enterprise-level return because intermediate measures like productivity, quality, profitability, and asset utilization, for example, reflect different aspects of enterprise performance. Only financial return reflects the performance of the whole enterprise.

Without this perspective, too much emphasis can be placed on driving specific intermediate performance measures (the parts) to improve enterprise performance (the whole). But it doesn't always add up this way. The common assumption is that any amount of operational improvement is good. However, the enterprise is a complex business system. As such, the different aspects of operating performance must be balanced or optimized to maximize enterprise returns. Counter to conventional reasoning, performance gains in specific areas can cease to make any contribution to enterprise return after a certain point in time or effort.

Prioritizing Improvement Opportunities
There are countless ways to improve operations. The key is being able to discriminate which improvements will matter from the ones that will have marginal impact on enterprise success. The challenge is finding a simple and reliable way to identify and prioritize improvements that will maximize enterprise return. If you had such a crystal ball, you would be half way there!

Return on investment criteria are commonly used to identify and prioritize operational improvements. Because financial measures are aggregated in nature and delayed in time, ROI methods are a less than an ideal roadmap. Selecting improvement initiatives based on financial payback projections can be like driving a car while looking through the rear view mirror. Feedback comes only after the results. The connection between strategy and tactics can be lost, and with it the ability to learn and to be proactive with strategic intent. This leads to a de facto strategy of firefighting where time, energy, and resources are spent trying to "fix" undesirable performance measures by improving the symptoms!

A more effective method is to identify and prioritize an improvement opportunity based on how it will enhance value stream effectiveness and efficiency. This simplifies things quite a bit. There is no need to calculate projected risks and payback and then wait to see if you are correct. There is no need to "fix" a poor performance result after the fact. Using value stream criterion makes it easy to identify and implement operational improvements for everyone. It takes the guess work and risk of failure out of the picture. When everyone understands their contribution to the enterprise value stream, it becomes clear and actionable what must be improved at all levels to ultimately drive enterprise success.

Continuous Improvement Drives Returns
In summary, the mission of any manufacturing enterprise is to perpetually enhance value creation and to maximize financial returns. Continuous improvements are the stair steps that move the enterprise forward. However, forward momentum is possible only to the extent that the enterprise is able to achieve both real and sustainable improvements. An improvement has real impact only if it enhances the enterprise value stream. Otherwise, it is possible to consume resources to achieve impact that is irrelevant to success. We conclude that frequent and continuous improvements to the enterprise value stream ultimately drive sustainable financial returns.

In today's relentless global economy, continuous improvement is not an option. Everyday, competitors are finding new ways to create value at a lower cost. Some manufacturers experience more pressure than others. But one thing is for certain, there is no future in the status quo. It is not enough to work hard; manufacturers must also work smart. The ability to select and prioritize operational improvements that maximize value creation and financial returns is critical to success. To use a metaphor, improvements are the rungs of a ladder that enable an enterprise to reach a desired future state. But in order to make forward progress, improvements must be sustainable and continuous – like climbing a ladder.

Michael Jordan and Don Chappell are consultants with Time Wise Solutions, Inc., a performance improvement consulting organization that offers manufacturers an integrated suite of products and services to achieve world class Lean Enterprise operations and supplier networks. The enterprise toolset is integrated around the Time Wise® Management System, an approach based on sustainability and continuous improvement.  You can reach Don Chappell at 207-837-9147 or visit www.timewisesolutions.net

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