An area in management where using BDM concepts should be front and center is with improvement activities. Whether reducing product, service, or activity costs, or going through a significant improvements or transformations enabled by lean, Six Sigma, or IT, the objective is to improve how much money we make. In fact, Taiichi Ohno, the architect of the Toyota Production System (TPS), the precursor to lean, argued the primary role of TPS was cost reduction with the hope of improving how much money Toyota made.1
Each year, executives around the world spend billions on improvements they feel will make their departments, divisions, or companies more money, and they walk away disappointed. I believe there are three key reasons this happens.
1. Cash is tied to input capacity
2. Improvements are tied to output capacity
3. Companies fail to convert the improvements in output capacity to reductions in input capacity
Let’s look at each.
Input and Cash
As mentioned throughout the book, we spend money to buy input capacity. The rate of spend affects cashOUT which, in turn, influences BCR. With the input capacity we buy, we establish the basis for being able to create output capacity. Buying office space enables us to establish offices where people can do their work.
Most improvements affect efficiency. For instance, simplifying or automating operations may allow for less capacity to be consumed when creating output. They may also help the same capacity create more output. Either way, the result is either more output with the same input or same output while consuming less input. However, if the input is a person whose time is being bought and where money is spent, the overall input is not affected. If someone reduces the time it takes you to do something, your salary isn’t adjusted.
Those designing these improvements often capture cost savings here. For instance, consuming one fewer hour of a $30 per hour resource will “save” $30. As we’ve seen, this value is costNC, so it is not cash. An extreme case involved a healthcare executive who, in a discussion, quoted a $7,000 cost for each day a patient stayed in their hospital. His thought was, by reducing the number of patient-days by 1,000, the hospital could save seven million dollars.
This is a major flaw with business cases and cash-benefit analyses developedthis way. The cost savings, in many cases, are costNC and not costC savings. Hence, the comparison and subsequent return on investment (ROI) is not valid from a cash perspective. The $5M promised by an IT consultant resulting from a software implementation may be a $5M reduction in capacity consumption value, but it quite frequently is not $5M in cash. The ROI analyses of company savings and spend in cases like these are no longer valid. You cannot calculate an ROI, for instance, by comparing $5M in non-cash dollars to $1M in cash dollars and believe you have a 4:1 ROI. The numerator, savings − investment, is mathematically invalid because they’re different values; pickups and trees.
The danger is, most do not realize this. They identify false cash savings and claim victory. These saving will not be realized in cash because they are not cash. Time and time again, I’ve been asked to review value propositions software companies and consultants promise only to find that the savings promised were oftentimes off by an order of magnitude or more from a cash savings perspective. In other words, the $10M in savings promised by the consultants may yield $1M in cash.
The objective should be to reduce costC not costNC when looking to improve your cash position. This means converting the efficiency improvement into cash savings by shifting to a different isocash curve. The way this happens is, the efficiency improvement will free input capacity. For instance, if, in eight hours, a worker can process or produce 56 widgets and a productivity improvement allows her to now do it in seven hours, she has one extra hour that is available. Leaving this situation alone means costC is still the same if she is paid for eight hours, and no money was saved. Only when you buy one less hour of her time has costC changed.
I’m not advocating for companies to start cutting staff, however. I am very much pro employment and look for ways to keep and hire people rather than cut them. In this case, I’m only the messenger. If you want to make money by reducing costs, you do so by buying less. Spending the same whether she takes seven or eight hours to make the widgets leads to no money savings. This is what many companies leave out of their analyses and implementation plans; converting efficiency savings into cash savings. Four steps will help make this happen:
1. Determine impact of improvement on output capacity
2. Identify steps necessary to achieve these savings
3. Determine how cashOUT will change as a result of the capacity savings
4. Create and execute an implementation plan
Impact on Capacity Levels
The first step in calculating the impact is documenting the improvement on output capacity consumption. Recall from Chapter 15, capacity consumption is the amount of capacity units output consumes. Any improvement should have projections of how operations and processes will be better, whether point projections or a range, that should be achieved from implementing the solution. For instance, with our worker, the improvement allowed her to create the same output, 56 widgets, in one less hour. If we do not know the improvement with that level of precision, we may project that she should be able to product somewhere between 54 and 58 widgets in seven hours, or to make 56 widgets somewhere between 6:45 and 7:15 hours. Ranges help immensely in the face of uncertainty.
Document the Steps Necessary
One of the most painful things I experience when helping companies is what I call if-then statements; if we have better data then costs go down or, if we implement this software, then inventory will be optimized. There is a presumption that improvements just happen. The question is, “How will they happen?” What actions, specifically, need to occur? In the case of our worker, what needs to happen before she can create 56 widgets in seven versus eight hours? Implement software alone? Training? Provide her with input faster? Eliminate nonvalue added steps? Eliminate mistakes? In many cases, improvements don’t just happen. They must be enabled.
Documenting what is required forces you to think about what you have to do to realize improvements and whether they are actually realizable. As you review these steps, you can do a validation check; if we do these things, will we get her to 56 widgets in seven hours? If not, refine the improvement or the steps necessary to achieve the target and then reassess. Once you agree the steps will achieve the benefit, you now have a checklist to work against.
Document Plan to Save Money
The way to reduce costC is to reduce cashOUT. The way to do this is to spend less on capacity, transactions, and or TF&R. Here, we’ll focus specifically on capacity.
As mentioned in the previous step, improvements should affect output capacity and consumption. If successfully completed, we should have an idea how much of a change to output capacity will occur and what is required to achieve it. The next is to convert that into costC savings by reducing cashOUT.
The idea with this step is to consider the nature of the improvements to see if you can position yourself to buy less capacity (Exhibit 17.1). For instance, if our worker can make 56 widgets and we are going to pay her for eight hours anyway, there won’t be any cash savings. However, if there are opportunities to buy less capacity, that is what should be documented as a part of your implementation plan. Consider space reduction. If you can consolidate space, you’ll need to figure out which offices or warehouses you will consolidated, when, who has to make the decisions, are they on board, will there be broken leases, if so, are there penalties, how much, and who makes the call? A detailed plan of how the savings in output can be converted into input capacity reduction opportunities which, in turn, need to be turned into a plan of action with steps, names, timing, and approvals identified.
Exhibit 17.1 Ultimately, you’d like to pay the lowest level of cash to meet demand, regardless of the source of demand. Paying $150 to sell $2000 worth of services is generally better than paying $240. The key is to ensure you are not overtaxing your company and its capacity to do so. That environment is not sustainable
Implementation Plan
These steps create your implementation plan. Once you execute your project, you check off the assumptions as you progress toward achieving the cashOUT improvements. Since you have a detailed description with steps, accountabilities, and anticipated improvements, you can compare reality with what you projected. Variances will inevitably occur. “We were off with our savings projections because we could not convince the leasing company to end the lease early, so we paid for two leases in one month” or “There were resource availability constraints, so we had to delay the start of the improvement.” However, instead of this being a negative situation, care should be taken to understand the source of the variance so that lessons learned can be considered to improve future performance.
1 Ohno, T. 1988. Toyota Production System: Beyond Large Scale Production, 8. Cambridge, MA: Productivity Press.