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 ( https://maskell.com/?p=418 ) 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:
- Supplier certification (where you establish relationships with your key suppliers in terms of price, delivery, quality and lead-time)
- 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.
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.