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Ask Art: What Do You Focus on When Assessing the Potential Gains From Converting to Lean?

by Art Byrne
April 16, 2020

Ask Art: What Do You Focus on When Assessing the Potential Gains From Converting to Lean?

by Art Byrne
April 16, 2020 | Comments (2)

This is a great question and a very natural one for any company thinking about converting to lean. After all, the traditional management approach and lean are almost the exact opposite of each other. As a result, you have to assume that the changes needed will be very big and disruptive to the way things have traditionally been done. You are not just making a few management shifts here and there; you are going to be changing the company's entire culture. As a result it is totally appropriate to ask what kind of results you should expect from implementing a lean turnaround.

Whenever I talk to the senior management teams of fairly large companies I point out how much money they are leaving on the table by not doing lean. Most of the time the opportunities I identify are quite large, and, as a result, most management teams dismiss them out of hand. After all, if there is really that much to be gained, what does it say about them as a management team? They think they are already doing great and don’t want to hear me telling them how much better they could be. You can hear them thinking, “This is nuts, no way is this possible.”

And yet. Most traditionally run manufacturing companies (many service companies as well) are organized into functional departments, based on the type of equipment they have (or, if a service company, by narrowly defined specialties). This causes everything to move through processes in batches, traveling long distances, spending lots of time waiting, resulting in long lead times. For example, a simple loan application with six minutes of touch time labor ends up taking a bank three weeks to process. Most companies organized in this fashion have 25% to 40% excess labor, but they can’t see it, and would strongly disagree that this is the case.

I always begin by looking at the balance sheet. Many people take this for granted, but the reality is that the things that you do to improve your balance sheet are the things that will drive your earnings.

I like to start with inventory turns, which usually represents a big opportunity for most companies. A typical traditionally managed manufacturing company will turn its inventory from 3x to 6x. A good lean company, on the other hand, will push for 20x or more. At Jake Brake, one of my Group companies when I was a Group Executive at the Danaher Corporation, we went from 2x to 25x inventory turns over 10 years; when I was the CEO of The Wiremold Company we went from 3x to 18x over about nine and a half years; and as an Operating Partner in a private equity firm one of my portfolio companies, where I was Chairman, we took about 12 factories in Europe from 3x to 5x turns to 17x to 25x with most of them over 20x. So just do the math. Look at your company’s inventory turns now and calculate how much cash you could free up at 10x turns, at 15x turns and at 20x turns.

These results might sound far-fetched, but you would only be scratching the surface on the gains. For example, going from 5x inventory turns to 15x turns will free up about 50% of your floor space (all that inventory had to be stored someplace). Consider the overhead reduction you could get from getting rid of that space. Consider also that in order to sustain 15x to 20x inventory turns, many other things have to fall in place. You have to remove a lot of waste so your costs will be a lot lower. Moving to a one piece flow as lean requires also will have a major impact on your quality. In my experience a 10x improvement in quality goes hand in hand with converting to flow operations and away from the traditional batch approach. But wait, we’re not done yet the biggest gain from increasing inventory turns into the 15x to 20x category comes from the much shorter lead times that this will allow. At Wiremold we went from 4-6 week lead times to 1-2 day lead times as our inventory turns got into this category. This gave us tremendous competitive advantages over our competitors who were still at 4-6 weeks. It allowed us to grow and gain market share.

While still on the balance sheet, we need to look at accounts receivable as well. If your sales terms are net 30 days and your receivable days are 56 days, then you should ask what’s wrong and how do you fix it. At Wiremold, we got our customers to pay us twice per month thus freeing up a lot of cash from accounts receivable.

Switching to the P&L, you can focus on margin growth—and I don’t mean improving by 0.5% or 1%. At Wiremold, we gained 13 points of gross margin; and at Jake Brake, operating income went from 4% to >30%. Again, do the math comparing where you are to gains like these. What if you got 5 points of improvement or 10 points? You still wouldn’t get to Jake Brake or Wiremold levels but you would see significant gains.

And, while all of this is very nice, it doesn’t compare to what you get from a time-based growth strategy. As I mentioned above, Wiremold reduced its lead time from 4-6 weeks to 1-2 days. Jake Brake blew this away, going from 85 days to 2 days. The resulting sales growth in both cases was tremendous. Wiremold doubled in size in four years, and then doubled again in the next four years. Jake Brake grew from $65 million in 1988 to $220 million in 1999 with no addition to floor space, and only a 4.5% increase in headcount. Wiremold gained 13.4x increase in operating income and just under a 2,500% increase in enterprise value.

Summary

While there are no set gains that a company can expect to get from converting to lean we can use as guidelines the gains that others have gotten to set goals as to what is possible. Focus on sales growth as the result of shorter lead times (lean is a time-based growth strategy), margin growth, inventory turns, doubling sales per employee and freeing up 50% or so of your floor space. No two companies will get the same results. What is important is knowing what is possible: the type of gains of companies like Wiremold and Jake Brake are repeatable. For a more detailed analysis of all of this I refer you to my book The Lean Turnaround Action Guide which is not only a step by step implementation of lean but more importantly shows the detailed financial results of a company before and after lean.

 

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2 Comments | Post a Comment
Bob Emiliani April 16, 2020
2 People AGREE with this comment

"...if there is really that much to be gained, what does it say about them as a management team? They think they are already doing great..." What their dismissiveness shows is that while business has the appearance of being all about money, what is even more inportant to senior managers is status and maintaining (or increasing) one's status. Lean management, as we all know, humbles people who think they know a lot. For most senior leaders, being humbled and the associated reduction in status in full view of one's peers is much worse than losing money. The role of status in the non-adoption of Lean needs to be better understood by the Lean community. I have described all this in my book, The Triumph of Classical Management.



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art byrne April 16, 2020
1 Person AGREES with this reply

Bob, as always thanks for your comments and nice addition to the post. I agree with your basic premis that loosing status or loosing face is a big barrier to lean. No one wants to admit "gee we have been doing it wrong all these years". I also think personality plays a big role in blocking lean. For example CEO's who are very insecure or those with a "command and control" management style are so afraid of being wrong they will never be willing to take the "leaps of faith" required to implement lean. They always need someone to blame so nothing will come back on them. This of course creates a culture of fear where no one is willing to take a risk. The fact that these personality types probably make up 50% or so of all CEOs starts to narrow the number of companies who can ever become lean.



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