Well, this is a fun question for me because over the past thirty years I have vetted many companies as possible acquisitions. While I was CEO of The Wiremold Company we completed 21 acquisitions, and reviewed almost as many more that we didn’t buy. After Wiremold, as an operating partner at the private equity firm J. W. Childs Associates, I was constantly looking at companies to add to our portfolio. And I always did this with a set of “lean eyes,” or, a lean management perspective. Let me share with you the key elements to focus on.
Spring Spotlight: Creating the Purposeful Enterprise
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Then take a deep dive into the latest thinking on the topic by joining LEI and leading lean executives at the next Virtual Lean Learning Experience, June 21.When you evaluate a traditional (i.e. non-lean) company through a lean lens you can’t help but approach it from the perspective of how much better they could be doing if they would convert to lean. Only someone with real lean expertise can make this type of assessment. Traditional managers will never be able to see the real opportunity. They sum up opportunities only through the lens of what they recognize in their own company. These companies will appear pretty normal by these metrics, and so for the most part they will miss the big opportunities staring them in the face. They will concentrate only on traditional cost-cutting ideas. They will think about the potential cost savings from eliminating the need for two CEOs or two CFOs from the new venture. They calculate the savings from eliminating a plant or two, and forecast that with more volume, you can buy certain raw materials cheaper or can push more volume through the combined sales channels.
While the lean manager sees the promise of all this, they will focus on the deeper, broader gains made possible with a new approach. They would never allow the company to remain operating as a traditional batch company. They will convert it to flow as quickly as possible. All future gains will spin off of this conversion. The lean manager understands the tangible results that can occur over time, while the traditional manager does not. The opportunities extend far beyond any short-term cost rationalizations. I’m talking about the gains in cash from inventory reduction, productivity gains, reduced floor space, quality gains, lead time reductions and the ability to grow and gain market share.
What Should I Focus On?
Typically, when you are pursuing an acquisition, the first thing that you will see is not the physical company, but its financial reports (as well as a presentation on how wonderful the company is). Most people, both traditional and lean, will initially look at the sales and earning history on the P&L to get an estimate of what kind of purchase price multiple might be justified to buy this company. And that’s where most buyers will pretty much end their analysis.
The lean thinker, on the other hand, will spend more time on the balance sheet, vetting it deeper to understand what opportunities exist and reading between the lines to get a pretty good idea of how the company is being run and what they can expect to see when they finally get to see the physical company.
Lean leaders will focus on the deeper, broader gains made possible with a new approach. One of the first opportunities for improvement I look at is inventory turns. Many traditional companies only turn inventory about 3X. Yum, yum: what a goldmine for the lean manager! Many of the companies we bought at Wiremold had turns of about 3X. We knew we could double these turns to 6X by the end of the first year and boost them to 10X by at least the end of the third year. This freed up cash and greatly reduced the risk of the acquisition. It also freed up floor space that would give us room to grow the business or consolidate it into one of our existing facilities. One of the companies we bought had 50,000 square feet of space, and after some kaizens we were eventually able to consolidate it into just 4,000 square feet at one of our existing facilities. Think of the savings that generated!
But that only scratched the surface. Low inventory turns are caused by the functional structure employed by most traditional manufacturers. They are just a symptom of a bigger opportunity. These weak numbers are usually accompanied by long lead times due to all the batching required to move product through all the functional departments. Chances are high that setup times will also be long, forcing them to build things in big batches. This in turn forces them to build to a forecast. When the forecast is wrong, as it almost always is, this can give rise to a great deal of obsolete inventory. This also creates numerous recurring quality problems, which, along with long lead times, leads to unhappy customers and sluggish sales due to these problems. Correcting this is an even bigger opportunity than the cash and space freed up from increasing inventory turns. I have seen many cases where a company with flat-to-declining sales growth starts to grow at 10% per year after a lean implementation shortens its lead time and improves its quality.
Low inventory turns also indicate a big productivity opportunity. Most traditionally managed companies organized by functional department have between 25% to 40% too many people. For example, in a batch process with say 26 steps, it is not uncommon to find that only 5-7 of those steps are value-adding, while the rest are just waste. These excess steps, plus all the inventory lying around, can create significant safety hazards which are not only unfair to your workforce but very expensive.
Inventory turns aren’t of course the only thing to look for on the balance sheet. Accounts receivable days outstanding can often tell you what kind of relationship a company has with its customers. For example, if the company’s sales terms are net 30 days but AR days are running at 65 days, what does that say? Are the customers just pushing the company around or does this result from late, partial or low quality shipments that cause disputes? And don’t forget Accounts Payable. How is the company managing these and what do they tell you about its relationships with its suppliers? Yes the balance sheet can tell the lean manager a lot.
Dive Even Deeper at the Company
Eventually you will get to dive even deeper when you visit the company. With inventory turns of only 3x, you can expect to see inventory everywhere, not to mention an excess of people and fork lift trucks doing nothing but moving it around. Then, look beyond this by focusing on housekeeping—items that lean covers under 5S. Before you can even get started with lean, you will have to resolve your dirty shop floor. A messy shop floor represents tremendous opportunity that you will recognize after applying the 5S that is fundamental to lean. Focus also on setup times: reducing them will enable flow, which is essential. Has any effort been put into this? Is management convinced that nothing further can be done? At Wiremold we were able to average about a 90% reduction in setup times on almost any type of equipment after a one-week kaizen. More opportunity for the lean manager. What about visual controls? Do you see any? How do they control what happens on the shop floor? Set up reduction, 5S and visual control are foundational items for a lean conversion. If you see no evidence of these then you will know there is a big opportunity for improvement.
Look beyond immediate tangible results; your opportunities extend far beyond any short-term cost rationalizations. Because the key to improvement will be to move from batch to flow, get a sense of what needs to physically be done to achieve this. The existing equipment will give you a good feel for how difficult it will be to create flow cells from the current functional departments. This holds true for other value streams in service or other settings. Look into how the current production scheduling is done. How accurate is the forecast? Do they have an expediting function? How does order entry handle customer requests? Do they block out inventory for future shipments causing stock outs for current orders?
And of course, beyond these physical aspects, investigate what management believes is possible. Are they set in their ways or open to change? Are there areas where they are very rigid in their thinking? If so, that change will be difficult.
Launch Lean on Day One
Once you have bought the new traditionally run company, now what? Get started. Most traditional companies spend six months to a year analyzing the new company before they make any changes. They want to be careful and avoid mistakes. What could go wrong? The lean manager on the other hand knows that the faster the new company can be converted to lean, the lower the risk of the acquisition and the greater the benefits. Your lean conversion should start right away. At Wiremold, for example, we created standard work for this.
At Wiremold we would visit the company as soon as possible once the acquisition closed (generally no more than a week). We pulled the employees together to 1) introduce them to Wiremold and tell them they were now part of our profit-sharing plan, 2) give them all a 3-hour training session on lean conducted by their new CEO (me), and 3) form a couple of teams right after lunch and start the first kaizens that would run for the rest of the week. Bam! What a shock. We moved a lot of equipment right away and created the first flow cells. We freed up extensive space, cleaned up the area and introduced visual controls. We left homework for the new management team and scheduled the kaizens for the next year on frequent intervals. No one at the new company had to wonder what was in store going forward. They saw the benefits from the first two kaizens right away and participated in creating these results. We gave them Wiremold’s operational excellence targets so they knew right away what we expected and where we wanted them to focus. The speed of change in every case was rapid, supported by our in-house lean experts along with some outside sensei.
But don’t think this mindset is only for acquisitions. While we have talked about what to focus on when looking at a new company, there is nothing to stop you from applying this same approach to your own company. You could try it yourself but I wouldn’t recommend going it alone. You need an experienced lean expert to help you assess your current state and get started. This expense will certainly be worth it. The gains are so big you won’t regret it. At Wiremold, we increased our enterprise value by nearly 2,500% in a little under ten years. Why wouldn’t you want to do that as well? And please don’t tell me “you are too busy to get better.”