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Lean: Next Steps

Connecting the Dots: Aligning Lean Operational and Financial Metrics

By Larry Robinson. Project Manager, Maine MEP

Lean typically originates within the operations side of a business. After initial successes with foundational lean tools such as 5S, Standardized Work, and the Visual Workplace, attention turns to accelerating the flow of materials and information. When this occurs it begins to impact the Cost Accounting and Financial Reports of the company, sometimes in ways that are counter to the operational Lean initiative. 

To ensure this doesn’t happen in your organization, you need to be aware of the pitfalls and what to do in order to avoid them.

It’s About the Wastes
After embarking on the Lean journey, many organizations become disillusioned when they don’t see the bottom line results originally promised. This is especially true for the accounting and/or finance functions within the organization. When this occurs, Lean efforts are often abandoned, while the organization comforts itself with the notion Lean was not applicable to its business. Why does this occur and how can it be avoided?  The answer can be traced to the original impetus for the Lean initiative and its advertised benefits.

First and foremost, the Lean strategy is about eliminating wastes. Lean is not simply about pull systems, Kaizen events, quick changeovers, etc. These are the tools utilized to simplify, reduce, integrate, or eliminate wastes.  Per Shoichiro Toyoda, the former president of Toyota, waste is defined as "anything other than the minimum amount of equipment, materials, parts, space, and worker’s time, which are absolutely essential for adding value to the product."  Lean principles identify eight different wastes.  They are:

  • Overproduction of work in process
  • Waiting
  • Transportation of parts/materials/tooling
  • Nonvalue-added processing
  • Excess finished inventory
  • Defects
  • Excess people motion
  • Underutilized people

In the Lean strategy there is a tacit acceptance that the eight wastes are symptoms and that recognizing waste leads to identifying the root cause of problems. Furthermore, it is assumed that underlying any waste is a systemic flaw involving people, materials, machines, and/or information.

If waste elimination is the first pillar of Lean then the second is continuous improvement. By definition, continuous improvement implies that an organization will never completely eliminate all wastes; it will always be a work in progress. In this regard the Lean strategy is akin to a build-it-they-will-come, leap-of-faith mindset. In other words, if an organization tenaciously pursues waste elimination with a continuous improvement mindset, operational improvements will follow by default.

It is interesting to note in the waste-elimination, continuous-improvement definition that there is no overt discussion of quantifiable cost savings. This inability to translate the benefits of a Lean initiative into financial metrics forms the basis for why the initiative fails in many organizations. From the outset, expectations are not articulated for the organization to be able to measure success.

Maximizing the Effectiveness of the Lean Tool Box
Lean-focused organizations are identifying wastes through the application of a methodology called Value Stream Mapping (VSM) and are then applying stand-alone or combined Lean tools to eliminate wastes. VSM is a methodology for evaluating all the activities required to transform a product or service from their combined inputs to its finished state.

The key outcome of a VSM is a comparison of the sum of all the cycle times for each activity compared to the overall lead time for the product or service being evaluated. For example, if four sequential activities are required to transform a product or service and each requires one hour to perform, then the sum of the cycle time would be four hours. Compare this to overall lead time for the product or service, which not only includes the cycle time of the activities but also the time required for rework, waiting in queue, etc. 

Typically the lead time for a product or service is an order of magnitude greater than the sum of cycle times. In this way VSM is a gap analysis used to quantify what the difference is and why. Answering the why question for the gap leads to the identification and employment of the lean tool(s) required to close the gap. Taken to the extreme, VSM drives the organization to a one-piece flow model—where the sum of activity cycle times equals that of the product or services lead time.

The tools that are used to reduce the gap between sum of the required activities cycle time and the product or service lead time are:

  • Standardized Work. Developing and implementing a standard way to accomplish work.
  • 5S System. Bringing orderliness and consistency to the work place.
  • Visual Controls. Communicating information so that it readily understood and available.
  • Plant Layout. Organizing the physical layout of the facility to optimize movement of people, material, and information.
  • Organizational Culture. Developing people to expose waste and empowering them to eliminate it.
  • Quick Changeover.  Quickly changing over processes to create the capacity for smaller runs.
  • Batch Reduction. Making smaller runs more often.
  • Quality at Source.  Ensuring an activity is done correctly when it is done.
  • Point of Use. Storing materials and information where they are used/required.
  • Total Productive Maintenance. Reducing the incidence of unplanned machine downtime.
  • Pull/Kanban. Achieving flow of materials when one-piece flow is unattainable. (This should always be considered a temporary fix until one-piece-flow end state is achieved.)
  • Cellular Flow. Arrangement of processes to enable one-piece flow.

If the inability to translate the benefits of a Lean initiative into financial metrics is the first point of failure in a Lean initiative, the second is adoption of the above tool(s) without an understanding of how it closes the cycle-time/lead-time gap. Many organizations have implemented some of the tools listed above without the means and methods to measure their impact, often prompting management to question the wisdom of allocating capacity (people’s time) in implementing these tools when there is no discernable benefit, and leading to the demise of the Lean initiative. The bottom line is that the employment of the above tools has to be tied to how it will reduce the gap between the sum of cycle times for activities and the product or service lead time.

Behind the Scenes
The relentless focus on closing the cycle-time/lead-time gap results in the squeezing out of nonvalue-added work. Lean is a strategy that focuses on eliminating all of the non-value-added work, resulting in an increase in productivity. Productivity is defined as the ability to increase output without a matching increase in input. This creates capacity to grow and the opportunity for market-share growth without the need for greater resources, thereby accelerating cash flow growth. 1

In some organizations, this has been referred to as "Soft Cost Savings." In reality, because the increase in capacity is not actualized, "Soft Cost Savings" is actually nonactualized capacity.

In order to gain the financial benefits of the Lean strategy, increases in capacity as gained through increases in productivity need to be actualized in one of, or in a combination of four ways:

  • Increase Revenue (unit sales) without a commiserate increase in resources.  (Highest Impact)
  • Decrease Overtime, if currently being used.
  • Insource Items that are currently being made by suppliers, if your organization has the capability.
  • Hold Attrition

Notably missing in the above is a reduction in head count and/or squeezing of the supply chain for unsustainable price concessions. The reason: the Lean strategy is waste identification and elimination. Implicit in this is that the people best positioned are the owners of the process. Conversely, if people in the organization believe the end state of a Lean strategy is the elimination of their jobs, then they are apt to be unwilling participants at best.

The third point of failure in the implementation of the Lean strategy has to do with how it is viewed within the organization. To achieve success, Lean needs to be seen less as a manufacturing tactic and more as an organizational strategy to increase capacity with the same relative resources so that each new unit increase costs less.

The role, and challenge, for senior management is to develop and implement the strategy to actualize the increase in capacity derived from productivity gains so that it results in profit. By default this results in existing units costing less. In many instances it is approached as just another quick-fix, cost-reduction program, which it is not.  Instead, it should be thought of in terms of traditional absorption cost accounting where cost reduction for existing units is a beneficial by-product. In order to realize such savings, though, the gain in capacity needs to be actualized. 

Aligning the Metrics
Modern management accounting essentials and tools were established by 1930, having been developed by Alfred P. Sloan when he was at DuPont and later at General Motors. While there haven’t been any substantial changes since then, the basic cost structure for most products has changed substantially since these tools were originally developed and implemented. For example, 70 years ago direct labor was approximately 50 percent of total costs; today that percentage is approximately 12 -15 percent in the United States.

For most manufactures today, the majority of their costs are driven by their suppliers; yet many of the management accounting tools still in use today focus upon the direct-labor component. Furthermore, these tools tend to be lagging indicators that provide little real- time, actionable management information. Compounding the problem is Lean’s focus on accelerating the velocity of materials through the company without adding commensurate resources. For example, below is a table of widely used performance metrics used today that are focused on minimizing the direct-labor cost component; yet they have a negative impact in a Lean environment.




Purchase Price variance

Negotiate based on price & "quantity breaks"

Excess inventory and carrying costs; supplier with best quality and cost may be overlooked

Machine Utilization

Run in excess of current requirements to maximize utilization ratio

Excess inventory
Wrong inventory

Setup in Standards

Encourages high run quantities

Excess inventory

Scrap factor built into standard

No action if no standard variance

Inflated standard; Scrap allowed to exist

Direct/Indirect Labor Ratio

Encourages inaccurate labor reporting to maintain "acceptable" ratio

Total costs not in control
Lack of integrity

Direct Labor Efficiency

Encourages standards that are easy to achieve

Improvement opportunities overlooked

Earned Labor Dollars

Maximize earned labor-keep workers busy

Excess inventory; Wrong inventory

Overhead Rates

Focus on manipulating allocation methods.

Move work to lower overhead work centers to "reduce costs"

The majority of the above measurements have a negative impact upon materials because they are trying to optimize direct labor. This provides our first insight into developing metrics that support a Lean strategy. The metrics used in Lean organizations need to be tied to waste reduction. For example, a key metric in a Lean organization is inventory turns. The quicker the inventory is turning the less Lead time for a product or service. All else being equal, the faster the inventory is moving—or flowing—then the less waiting waste there is in the process. 

Another common measure used in Lean organizations is productivity growth. If management is effectively actualizing the growth in capacity that a Lean strategy affords then there will be strong year over year growth in productivity.  Next is the tracking of the cost of quality by measuring the decrease in defects year over year. This puts the emphasis on the wastes generated by defects and the resulting rework and over production.

When identifying the metrics that will support the Lean strategies for your organization, develop measures across the shop floor, plant level, and business level.

On the floor for each work area, develop and post measures for 5S, TPM, Standardized change over, etc. The test to ensure that you have developed effective metrics for the shop floor is if shop floor personnel can impact them.

At the plant level define and post TAKT time requirements for each value stream as defined by a product/process matrix. TAKT time is a measure of customer demand during the work period. Many organizations have operations and support personnel with no insight into what the actual customer demand is. Rather, they are scheduled by discrete work orders generated by a Material Requirements Program (MRP). Scheduling in this way insulates the organization from the ability to measure if they are being successful in meeting customer demand.

Below is an example of metrics used at the plant level at one facility to support the organization’s Lean initiative.




Inventory Turns

Keeps the organization focused on material flow

The quicker the turns the great the liquidity.  Less chance for excess and obsolesce.

Productivity Gains

Creates the capacity to be actualized.

Overall lower unit costs.

On Time Delivery

Drives organization to continuously look for wastes to eliminate

Competitive advantage vis-à-vis competition, especially for customized products

Reduction in Defects

Focuses organization on wastes associated with process quality

Contributes to a reduction in lead time and the creation of capacity.

The above metrics tie into business or corporate level goals and objectives that affect marketing, sales, financials, engineering, and operations.

Whatever metrics are best for your organization, above all else they must support your relentless emphasis on Waste Reduction and be supported by an overall business strategy with cascading measures for success from the shop floor to the boardroom. 

Below is a recommended reading list to help shape your thinking on identifying and implementing metrics within your organization.

  • Real Numbers: Management Accounting in a Lean Organization. Cunningham and Fiume (2003), Managing Times Press.
  • Who’s Counting? A Lean Accounting Business Novel. Solomon (2003), WCM Associates
  • Practical Lean Accounting: A Proven System for Measuring and Managing the Lean Enterprise. Maskell and Baggaley, (2003) Productivity Press.

About the author
Larry Robinson is a project manager with the Maine Manufacturing Extension Partnership, www.mainemep.org. His article is an edited version of a paper that was presented at the 22nd Annual International Forum of Design for Manufacture and Assembly (DFMA) held in Providence, R.I. in June.

1. Orest Fiume
Real Numbers

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