Time for Leadership – How Standard Costs Impact Company Behavior

There are many things wrong with using standard costing in an Lean company, but perhaps the most dangerous is when standard costing actually drives a company’s behavior in a way that makes Lean unworkable.  Here is an example:

Recently, I was working with a company on implementing Lean Accounting. The company manufactures products at one location, and sells those products in its stores. The stores also provide service on the products.  Manufacturing operations has been practicing Lean for about 3 years. They all work internally was on a Pull System and they were performing regular kaizen events. The company currently uses a standard costing system.

pushmiI was reminded of Dr. Doolittle’s pushmi-pullyu, a strange animal that had two heads at opposite ends of its body. When it tried to move at all it was stuck; both heads tried to go in opposite directions.

In this company’s case, both ends of the company seemed to be at cross- purposes.  The stores view themselves as the “profit centers” of the business and they see manufacturing as a cost center.  The stores need a standard cost for every product so each store can calculate its profitability. The conversation between stores and manufacturing typically revolves around manufacturing lowering its costs to improve store (and company) profitability.

After further discussion, I discovered that the store managers and the sales force are being compensated based on store gross margin (revenue less standard cost of goods sold) – no wonder lowering  manufacturing costs was such an important issue!   Because of this compensation policy, there was strong resistance on the part of the stores to defining the true value streams of the company. Doing so would have to include manufacturing and would involve calculating value stream profitability (rather than store profitability.)

As of the writing of this blog, this issue is still under discussion within this company. It has delayed the roll out of lean accounting.

What can you learn from this story?

It’s essential to understand why people within a company are pulling in a given direction. You have to keep asking “Why?”   In this company’s case they were using a standard costing system to determine people’s pay. This is what has stymied their Lean Accounting roll out.

In order to get everyone pulling together, management had to take the lead. They had to create an action plan to move the company off using standard costing for compensation.  Seems simple, but the key was understanding the impact of standard costing, so they could work through the related issues and clear the way forward.