It’s About Spending, Not Costs – Part 4

Continuing my discussion about what I call “Lean Cost Management:”  I’ve been making the case for a Lean Cost Management System vs. using  “traditional” cost management methods.  Management methods differ widely between the two approaches when it comes to keeping track and reducing spending  on labor and machines, as I covered in my last blog.

Now it’s time to think about some types of spending that may not directly contribute to customer value, but which are nevertheless crucial to delivering it.  I’m talking about activities your company has to do and do well. We have to do them so well in fact, that we keep our costs as low as necessary while making sure that production flows unimpeded.  All companies everywhere have to solve these issues.  But looking at these subjects  through the Lean Management lens can give you a fresh approach and perhaps help you make changes that move your lean efforts in the right direction.  We’ll start with quality.

Spending on Quality

Traditional companies make an attempt to calculate the Cost of Quality. The most popular method to do this is to use the standard costing system to track the total material cost scrapped or the total product cost scrapped (including the materials, labor & overhead.) Companies do this primarily to be able to report summary information to senior management and answer this question: How much is poor quality costing the company?

Lean companies go about this another way.

A colleague of mine related a story she heard at a meeting of lean accountants.  A CFO (from a very large lean company) was telling about how his company did not track scrap cost.   A bunch of hands shot up; a lively back-and-forth  followed about how you get scrap off the books, why report it, how you manage it etc.  The CFO laughed and answered patiently.  It turns out he did not care about the standard cost of scrap because tracking it and telling upper management about it (himself, in this case) did not help.  What he really cared about was that lots of scrap represented lots of waste, and it meant there was more lean work to do.

This CFO understood that fixing the real “Costs of Quality” from a lean viewpoint should focus on the waste:  the lost productivity, the possibility of poor quality products being shipped to customers and the hidden root causes of poor quality.  Notice, none of this information is directly financial.  And that’s the point!  Fixing scrap cost involves fixing the “who what where why and how.”  Fixing scrap cost comes from fixing  quality at the source.

Lean companies measure quality incidents at every production step (cell)  daily and overall in every value stream weekly. Performance measures such as First Time Through or First Pass Yield help identify the true root causes of quality failures.  Then the cell or value stream can put countermeasures in place promptly and new standard work will emerge. Such improvements  will  reduce spending on bad quality while maintaining production flow. Lean companies will work to eliminate quality inspection entirely  (as a separate department) and instead incorporate it directly into the value stream through a series of kaizen events.  Overall quality spending goes down.

Spending on Maintenance


Many times what I see regarding traditional ways of tracking and controlling maintenance costs goes something like this:   the company uses a work-order system to track the time and material spent by the maintenance department.  The department manager  knows down to the gnat’s eyebrow exactly what the financial impact of maintenance spending is.  This is all good information to have,  but it does little to focus on the root causes of maintenance issues and how they impact the pull of value to the customer.

As I discussed in my earlier blog  ( ) there’s a better Lean way to manage maintenance, namely finding a way to FLOW maintenance work

Flowing maintenance  work actually improves productivity in the long run and reduces spending for unplanned problems.  Plus, existing maintenance staff can handle more work.  Incorporating maintenance flow into the value stream produces better flow over all and saves money.

Spending on Material Management


LEI’s[i] Lean Lexicon[ii] makes the point nicely:  moving materials through a production facility is much more than just getting stuff to the line, “wrestling with dunnage, and finding parts.”  You still have to do it, but doing it well, and in a planned way that is integrated into the flow of production is the Lean way.

A lean company will establish pull systems throughout production as inventory management activity is absorbed into the value stream;  spending on it will be reduced overall and inventory levels will go down.  Implementing various lean ways of managing inventory visually, having  point-of-use stocking locations, etc. will not totally eliminate the costs, but they be reduced to the minimum necessary for maintenance of flow, and  (for the CFO best of all!)  they will render obsolete a bunch of spending on dragging materials around the production floor, cycle counting, and the like.

Spending on Receiving Inspection


Here is where a Lean approach can result in major savings.

Having a receiving inspection department or designated function usually exists because traditional approaches don’t focus specifically on ensuring that your suppliers consistently deliver quality where and when you need it and are rewarded for doing this well.

Similarly to material management functions, the ultimate goal in the Lean company is to incorporate the receiving function into the value stream flow. Lean companies do this by setting into place such practices as:

  1. Supplier certification  (where you establish relationships with your key suppliers in terms of price, delivery, quality and lead-time)
  2. Kanban pull between value streams & certified suppliers, who deliver directly to the point-of-use.

Using Lean methods may render the receiving inspection function obsolete, thus saving money, and freeing up that resource for value-added work.

Wrap Up

Spending money involves making business operating decisions or taking some other type of action.  If the decisions and actions can be changed, spending can be changed. This is the foundation of a Lean Cost Management System.  As a Lean CFO your first priority is to help focus the efforts of your value streams on controlling spending, understanding how and why it fluctuates, period-to-period and how it ties directly revenue

A weekly value stream income statement will do this.  You can then give  the value stream manager what he/she needs to understand root causes that affect spending.  Waiting ‘til after month end and trying to tease information out of financial variances does not help.

With this focus, your company can begin using kaizen events specifically targeted  to reduce spending.

I strongly recommend that you  create and use a weekly value stream income statement. Make the Value Stream Income Statement the only income statement your managers us to analyze the business.   This is how you “put everyone on the same page.”   You will soon see the conversation shift from “what happened?” to “what do we do about it?”

Also start using weekly value stream cost reports with income statements.  Use them along with your box scores when doing kaizen events.   Your company will grow many more “financial analysts” who are in the gemba taking a proactive role in controlling spending.

Here’s a sample cost report for a lean value stream that breaks out information in an actionable way.  [iii]

This sure beats having people analyzing a complex standard cost report that no one understands or believes.

[i] LEI – Lean Enterprise Institute,  Cambridge MA

[ii] Lean Lexicon : A Graphical Glossary for Lean Thinkers published by LEI,  is now in its 4th edition.  Read their definition of Material Handling.

[iii] Adapted from: Brian Maskell, Bruce Baggaley, Larry Grasso, Practical Lean Accounting. A Proven System for Measuring a Managing the Lean Enterprise, Second Edition.  ( New York, NY CRC Press, 2011), Chapter 4.

It’s About Spending, Not Costs – Part 3

Continuing my discussion about Lean Cost Management: last blog, I made the case for a Lean Cost Management System vs. using “traditional” cost management methods, focusing on Materials Spending.

Today, I’ll tackle two more topics: Labor and Machines.

Labor Spending


The CFO’s traditional approach to managing labor costs is deceptively simple – try to keep reducing it. When you look at it from a “total labor cost perspective,” you naturally get into measuring headcount and overtime hours.  And, because traditional costing methods are always focused on standard product cost, reducing direct labor cost becomes important to reducing the cost of your products; typically, you will do this by examining your variances and making sure that production resources are used as efficiently as possible.

From our discussion last time, about materials spending, we saw that this leads to big batches and more waste. [i] The same goes for labor resources.  Seems sensible, right? Having people standing around idle is bad; having them making something is good.  But Lean teaches us that making too much, making the wrong stuff, or making poor quality is a bad way to keep busy.

By now, we should be able to guess the traditional approach to labor cost will not be effective because it doesn’t address the real root causes of how much a company spends on labor.

We have to change the discussion from “How much did we spend?” to “How well did we spend?” on labor.

The Lean CFO will look at labor as an operating expense, not as a component of product cost.  We see labor is a resource; labor provides the capacity to create the value your customers will buy from you.  The Lean CFO will be very interested in how well our labor spending met customer demand.

This leads us to a discussion of root causes.  I believe the two primary drivers of your labor cost are 1) the total amount of labor required to make the all products your customer buys and 2) how productively our labor resource was used.

By this approach, the total amount of labor is the aggregate cost of all the people that are assigned to your value streams.  The Lean value stream is the “engine” that produces our revenue, and maximizing FLOW within the value stream is how Lean companies make more money.

Truly Lean companies quickly understand that traditional departments create barriers.  Barriers separating front-line production operations and traditional manufacturing support functions (such as quality, maintenance and engineering) are especially harmful; they actually impede flow and make it harder to improve it.   This is exactly why Lean companies work to destroy these impediments by assigning as many people to work full-time in value streams as possible.  Value stream costing recognizes this as labor expense on the value stream income statement.

Lean CFO’s understand labor spending best in the context of the Value Stream and how the labor cost is being spent. They are not as concerned with the total amount of labor spending, as long as productivity continues to increase. This is the reason why lean CFO’s simply charge the actual cost of labor to value streams. They want value stream managers to focus more on measuring and improving productivity while meeting customer demand.

In this context, productivity is the ratio of output to input of the entire value stream. Lean companies define output as demand or shipments, not production volume. Input is the total labor, such as hours worked. If productivity is improving, then output (demand/shipments) is increasing at a greater rate than input (hours worked). This means that the rate of spending on labor is increasing at a lower rate than the rate of revenue growth, which means profits are increasing.

What matters most is consistently improving productivity by 10-20% annually.

What will keep people from these productivity gains?   If the processes they work in, which have been designed by the company, are not Lean they will not see improvements in productivity.  Low productivity is generally not the fault of the people doing the work.   It’s caused by poorly-designed or poorly -performing processes.

Using traditional measurements like labor efficiency or total headcount sends the non-lean message that poor productivity is the workers’ own fault.   But the Lean CFO knows that productivity will only increase when waste is eliminated from the value stream and the people are focused on delivering value.

In a Lean environment, productivity in increased by perfecting the process; adding more people means that demand is increasing. As long as productivity improvement is maintained when people are hired, it doesn’t matter how large your headcount. You will be making money.

Machine Spending


The traditional approach to managing machine costs focuses on maximizing utilization.  It seems sensible, right?  You make maximum use of an expensive resource to get maximum pay back. This usually means long production runs with fewer change-overs.  This typically results in large batch sizes and too much inventory.

The Lean CFO thinks about machines pretty much like labor:  they are a component your capacity.  The focus should be on improving productivity, not maximizing the use of the machine.  This means thinking about root causes.   To improve machine productivity, lean companies focus on identifying the drivers that cause machine-related problems that impede flow.   The question becomes: “Why can’t the machine run if customer demand is present?”

One area of focus is downtime. Lean companies want to minimize unplanned downtime, as that disrupts flow. Total Preventative Maintenance (TPM) practices will minimize unplanned downtime and because PM is planned, flow will not be disrupted.

Other drivers of poor productivity will focus on quality problems related to making the product and the rate of production of the machine. If a machine is producing poor quality, costs go up. If the machine is producing at a lower rate than customer demand, then costs go up as well.

Changeover is another driver that the Lean CFO will address. To improve machine productivity, changeover must first be stabilized and standardized, then reduced.  Continuous improvement activities will address on-going changeover time.  If changeover cannot be avoided, then it must be managed using level scheduling techniques.

In summary:  Lean managers will use an analysis that shows the “How Well” they are spending their resources.  The following illustration shows one way to analyze this in a manner that us really useful and supportive of lean improvement. [ii] The data that underlies a report like this comes right out of the value stream map coupled with aggregated monthly costs of employees and machines, broken out by the cells and processes that belong to the value stream. A report such as this does not have to include money.  It could also be done in time units,  In either case, it is useful.  [iii]

Click to enlarge.

Next time: spending on Quality.

[i] Think about going to a big box store like Costco to buy duct tape.  Wow!  You can get 24 rolls for half the price of buying them one at a time.  But, is it really a bargain if you only need 10 feet of tape and it takes you the rest of your life to use all the rest?

[ii] From Practical Lean Accounting.  A Proven System for Measuring and Managing the Lean Enterprise.  Second Edition.  Brian Maskell et. al.  CRC Press, 2012 p. 89.

[iii] There’s a lot more detail about this in the book Practical Lean Accounting. It follows an extended example of how a company tracks its improvements and how these relate to their finances, using Lean Accounting methods.