Newsletter Sample

Cutting 'Costs' or Cutting 'Waste':  Who Will Be the Leaders in the Next Decade?

Last month (December 2009) FoxBusiness News reported, "By most accounts, the just completed third-quarter earnings season was generally a bright spot for both Wall Street and corporate America…"  Based on the most recent figures from Thomson Reuters, 77% of the S&P 500 companies that reported have beaten analysts' earnings forecasts, while only 15.8% missed earnings estimates.  It was the largest percentage of corporations beating consensus earnings estimates in more than two decades!

However, the general impression is that companies met the numbers neither because sales are surging nor because business is much better.  The story line at Fox News continued to say that most companies beat expectations through massive cost-cutting measures, to include major job cuts.  According to Thomas Reuters, only 56.4% of the S&P 500 companies beat expectations on Sales, while more than 42% of companies missed on Revenues.

How do we define 'productivity?'

Bob Doll, chief investment officer of global equities for Black Rock, recently stated, "Corporate America beat expectations this season because it was more vigilant on its cost structure than growing its business."  And this trend of slashing jobs to gain "productivity" will continue into 2010, according to Mr. Doll.  Then Marc Pado, chief investment strategist with Cantor Fitzgerald, stated, "You always see cost cutting in a recession, but what you don't see is the permanent restructuring of major corporations."  Both Doll and Pado said that cost cutting will remain the dominant theme going into the final months of 2009 and into 2010.

As Lean practitioners and Lean accountants, I believe we would all agree that "cost cutting" is not 'productivity,' and is not going to bring good things to our businesses in the next decade.  We Lean accountants have always proposed that we measure those things which we want to improve – not just whatever is easy to measure.  But what is it that we want to improve?  I believe we need to begin by examining our businesses in light of Toyota's four (4) True North metrics:

• Q – Quality Improvement
• C – Cost / Productivity Improvement
• D – Delivery / Lead Time / Flow Improvement
• H – Human Development

True North Metric #1: Quality

Let's look at Quality first.  Having worked with the late Mr. Ito during my employment at Pratt & Whitney and Otis Elevator (both UTC companies), I know that Mr. Ito places Quality first in the QCD (Quality, Cost, Delivery) triad of metrics.  However, when one places heavy emphasis on Quality, costs generally increase as the number of inspections and number of inspectors increase.  George David, retired CEO of UTC, once stated that he had more inspectors in his Pratt & Whitney business than he had workers!  The truth is that increasing Quality does not necessarily imply increasing costs, but we do need a COQ (Cost of Quality) Program, and I do not see many companies with a COQ Program.  As a Lean accountant, I also have seen that most significant quality-related costs are NOT captured by most accounting systems.  So perhaps you and I, as Lean accountants, can help with this Quality metrics issue.

COQ (Cost of Quality) is composed of costs due to internal failure, external failure, appraisal failure, and prevention failures.  Let's look at a brief description of each of these Quality failures:

• Internal failures – scrap and rework.
• External failures – warranty costs, cost of complaints and returns.
• Appraisal failures – cost of inspection and quality audits.
• Prevention failures – "process" control and training.

Why is COQ so difficult to measure?  The answer to this question is probably because scrap and rework are the only "visible" signs of poor Quality.  Another internal failure would be increases in cycle time, which makes for higher Inventory.  The only way this becomes "visible" is if we use a VSM (Value Stream Map) to guide our continuous improvement and vision for our business.  How many companies in that S&P 500 do you suppose are utilizing VS Maps?  And then how do we financially measure COQ?  I believe it is time for Lean accountants to step up to the plate in the New Year, and add "Value" to the business (beyond the traditional financial statements) by helping to build a COQ model.

True North Metric #2: Delivery

Another Toyota True North metric is Delivery / Lead Time / Flow.  How do we measure and improve this?  Once again, the measurement is contained in our VS Map.  To help us improve this metric, let us look at Little's Law.  Little's Law tells us that LEAD TIME = WIP / AVERAGE COMPLETION RATE.  For example, if you know how many "things" you have in the "pipeline" (WIP) and you know your completion rate, you can calculate Lead Time.  Thus, two ways to control Lead Time are either to limit WIP or increase your average completion rate.  Michael George, in his book "Lean Six Sigma for Service," gives an example of a marketing group quoting on jobs.  If you currently have 48 requests for quotes in the system, and your average completion rate is 20 quotes per day, then your Lead Time is 48/20 or 2.4 days.  If you want to reduce that Lead Time, reduce your WIP or increase your rate of completion.  Do not allow one more quote to enter the system until at least one quote is released!  (Lean tells us "don't make one until the customer takes one.")  Perhaps we Lean accountants should challenge ourselves to work with our Product Family or Value Stream Team to investigate the relationship between Lead Time (which is Cycle Time plus "wait time") and Quality.

True North Metric #3: Productivity

A third Toyota True North metric is Cost / Productivity.  Hopefully, we Lean accountants understand and can communicate the difference between "cutting costs" to SAVE cash, and "cutting waste" to CREATE cash.  Cost cutting will not get us to a leadership position in 2010 or the next decade.  We need something better!  We can only "cut costs" (lay-off people, close plants) for so long.  Then we no longer have a business!  This is only a short-term strategy.  The long-term strategy is to "cut waste" (eg, Inventory) to create Cash, then use that Cash to buy a supplier or another similar business, and drop that new business into the capacity created by the reduction in Lead Time.  Toyota measures Productivity as Revenues / number of Employees.  So we can either increase Revenues, or decrease number of employees, to better Productivity.  We do not want to decrease number of employees (that is demoralizing), so we must increase revenues.  But will we increase revenues by raising prices __ or growing the business?  Again, we as Lean accountants have an obligation to assist top management with these choices.

True North Metric #4: Human Development

The fourth True North is Human Development.  In my Lean Beans seminar, I talk about NOT using Myers Briggs but rather using Toyota's "Systems Values" model for improving Human Development.  We do not want to fire people for not genuflecting in front of our Lean leaders.  Instead, we want to empower people!  Listen to the voice of the workers who know best how "the work" works.  Then work with those Associates to get them from their current "plateau," on Toyota's mountainside of seven plateaus, to the next level.  Human Development also involves communication and training.  Our universities (and this is my opinion as I have taught there) do not help with this.  Our universities train accountants on transactions and variance analysis.  And our MBA Programs teach students how to "play the game."  The "game" is that, if we produce more than the customer wants, we are allowed to "defer" the costs of those products we do not sell to the Balance Sheet as assets – full- up cost! – making ourselves look really good this month.  We, as Lean accountants, need to communicate so that we truly contribute to the "right behavior" and accomplish a true culture change.  A true culture change, which involves a permanent restructuring of a business, is the road to leadership in the next decade!

Characteristics of Business Leaders in 2010

In the next decade, the leaders will be those companies cutting waste (not cost cutting.)  The leaders will be those companies increasing productivity by increasing revenues (and not laying off people.)  The leaders will be those companies increasing revenues by growing the business, and not just raising prices.  The leaders will be those businesses with a COQ program and a Lean Sigma program.  The leaders will be those utilizing both Lean, for speed to market, and Six Sigma, for defect reduction and quality.  The leading companies will be those with Value Stream maps to guide their Vision for the future.  The leading companies will be those who are engaging in a permanent culture change, which means changing the management system, which implies targeting the Lean leaders' behaviors. 

We, the Lean Accountants, can be and should be, leading this culture change which will make our business a successful, true leader in the next decade.  You and I, as Lean Accountants, CAN make a difference!  That is real Lean Beans!

To learn more, please do register today for a seminar / workshop in Lean and Lean Accounting in your area today!