PRICE, COST, and VALUE
Recently, on the NWLEAN listserv (http://finance.groups.yahoo.com/group/NWLEAN/), Paul VanderKley asked what seemed like an innocuous question:
“Has anyone attempted to analyze the "Cost of Poor Lean", similar to "Cost of Poor Quality?”
There were some very insightful answers, which you should check out. My own spin is a bit out-of-the-box. The cost of ‘poor lean practices’ (or no continuous improvement at all) is in risk, the risk that the company is completely at the mercy of the economy.
To be sure, every company is at the mercy of the economy. The economy dictates commodity prices, labor prices, and how much money is available for our customers to spend. But we need to control what happens inside – labor hours, materials and resources used, lead times, inventory. Remember, it’s not
Cost + Profit = Selling Price,
Selling Price – Cost = Profit1
The first equation (which has become known as the Cost Plus model) assumes we can pass all costs on to our customers. The second equation (known as the “non-cost” principle) assumes that profit is derived from meeting customer expectations (as demonstrated when they actually purchase our product) and controlling the cost of production.
So what does this have to do with risk? Risk exists everywhere, whether we recognize it or not. In our production systems, we find risk through our quality systems. In our service systems, we find risk through our feedback systems. In the marketplace, we find risk in the alternatives our customers have to purchasing our products. In many cases, we have been trained to translate risk into costs. By reducing risk, we can reduce costs. Our customers tend to do the same, albeit somewhat in reverse. When costs increase (or competitor costs decrease), our customers have an opportunity to re-evaluate our product on their perception of value.
So I considered calling my insurance company, to discuss why my rates had been raised. But since it was early Saturday morning (AND because we have this wonderful system known as the internet), I decided to do some poking around instead. Besides, can you imagine the conversation?
(After minutes of dialing through menus, several requests for my policy number, and finally being routed to Customer service…)
“Can I help you?”, the representative asks.
“Yes. I’m wondering why my rates have gone up, although the risk I pose as a driver have gone down.”
“How is that, sir?”
"My car is a year older, therefore the replacement costs are lower. I’m a year older, therefore statistically a better and more cautious driver. AND, due to my travel schedule, I only put a couple of hundred miles on my car each month. I assumed my rate would decrease!”
“I’m sorry, sir. Let me take a moment to look at the specifics of your policy. Can I have your policy number?” Of course, we then go into the ‘up-sell’ algorithm. Not only do I not get my price reduction, but she’s probably sold me another product which actually increases my premium. No thanks!
After surfing for a few minutes, I convince myself that I still have a pretty good rate. Remember, I do this every year, so unless something has happened in the insurance industry, or my carrier has somehow tanked, I know my rates are competitive. But that doesn’t mean I’m giving up.
Most insurance companies allow access to your policy online. I decide that I’ll have to get into the individual elements of coverage, to determine if my policy is still right for my needs. I evaluate the types of coverage, as well as the coverage levels. Then it hits me: Rental car coverage? Do I need it? Is it worth it? As it turns out, I bought a small truck this year, to do some hauling. In an emergency, I could certainly drive that, instead of hassling with a rental. Perhaps there is something else here as well. I’ll keep looking…
VARIATION AS RISK
Too often, we accept the status quo. If our operational and financial metrics are within expected parameters, we thank the production gods, and wait for the next reporting period. If the metrics are ‘out of whack’, we dig into it. The adage, “The squeaky wheel gets the grease”, is very prevalent.
We tend to rely on static metrics. Once our budget is set for the year, we track to it. Quarter by quarter, month by month. But a lot of things can happen in a year. Energy prices spike and fall. The economy in general is all over the place, nothing close to predictable. If we hit budget this month, the biggest factor may actually be luck! (You’ll see it in the budget. Scroll down to the lines that say, “Miscellaneous…”.) If we don’t make it, we can usually blame something. Some event, something we couldn’t have predicted. Sure, we’ll make it up, we’ll cut somewhere. On to the next reporting period (and hope my promotion comes through, so I don’t have to worry about this!).
Risk comes in many forms. The statisticians among us will tell us that we can usually spot it if we’re looking for variation. Reducing variation lowers risk. We really reduce variation in commodities by partnering with our vendors and hedging certain costs. We can reduce variation to the economy by recognizing where our exposure is, and reducing that exposure. We can reduce variation in consumer demand by increasing both intrinsic and extrinsic value of the product itself. And we can control variation in our companies by measuring in small increments (as close to real-time as possible), and continually expecting improved results.
Lest anyone think I’m talking heresy, I’m not talking about six sigma measuring systems, and all the overhead that may come with that. Those of you who know me understand that I’m not a big ‘tool guy’ (with all respect to Tim “The Tool Man” Taylor). I advocate finding and eliminating waste, period. If you get too fancy, you get too complicated, and you’ll experience diminishing returns. And I’m not bashing six sigma, either. I’m a big advocate of any method, as long as it makes sense for the problems at hand. But if a company hasn’t embraced a high level of standardization (the real foundation of lean), they can’t be ready for anything else.
Last year, I noticed that my auto insurance included an “Emergency Roadside Service” feature. I’ve had AAA for many years (I even use it!), and I saved some money by eliminating the redundant coverage. This year, my 15 minutes of effort on a Saturday morning have saved me $12.50. Not really a huge win, but a pattern that I follow in everything I do. I’m in the habit of questioning the status quo, and seeing variation for the waste it reveals.
All of our victories don’t have to be measured as BIFs (Big Improvements Fast). I believe small victories are much more powerful, in that they can be achieved with far less resources, and they build the habit of continual change. Both are a required for effective continuous improvement, and for real culture change in an organization.
I really like my insurance company. I’ve looked around, and for my situation, they provide a great value. But I don’t buy that they are going to push all of their cost inefficiencies down to me. I push back, and that creates a real business relationship. So the frog isn’t getting boiled today, boys, I’ve turned the temperature down by $10.30!
ABOUT THE AUTHOR
Bill Kluck is the Founder and Director of Operations for The Northwest Lean Networks, a professional society which connects the lean community worldwide. Bill has over 20 years of experience implementing lean in a wide variety of industries, both public and private. He has trained thousands of team members in various lean strategies and techniques, and has overseen financial impact in the hundreds of millions of dollars. Much of Bill’s time is spent internationally, building transformational change by evolving business culture.
Bill earned his Bachelor of Science in Industrial Engineering from the University of Washington, an MBA from Seattle University, and holds several continuous improvement certifications, including a Six Sigma Black Belt, and a Master’s Certification in Lean Methods.
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1Shigeo Shingo, A Study of the Toyota Production System From an Industrial Engineering Viewpoint, English re-translation (Portland: Productivity Press, 1989), pg. 75.