Chet Marchwinski: Why do so many senior leaders have such a hard time understanding lean’s financial benefits? Hi, I’m Chet Marchwinski, Communications Director for the Lean Enterprise Institute. And today I’m joined by a CFO who can give us some tips on how to explain those benefits to senior officials. Jean Cunningham was the CFO at Lantech, whose transformation was featured in Lean Thinking. Jean, thanks a lot for stopping by and helping us convince senior leaders that they should support a lean transformation.
So let me go back to the question I started with: why do senior leaders have such a hard time understanding or seeing lean’s financial benefits?
Jean Cunningham: I think one of the reasons is that lean is inappropriately assumed to be a cost-cutting activity. And of course it’s really not; it’s really about creating more value for customers. But one of the things we do with lean transformation is try to identify waste and eliminate it. And that by itself just frees up capacity, and unless that capacity is deployed to other activities, we don’t immediately see it on the income statement.
Marchwinski: That’s a good point, because it’s rare for lean’s cost savings to be realized instantly in the income statement, even though most leaders probably wish that they were. Are there some non-financial metrics people can use to make the case to senior management?
Cunningham: Absolutely, when we look at metrics that indicate how well a process is working, not just the outcome of the process. Most of our business metrics have been financial indicators, and those are really all outcomes. The first thing we’re doing with lean transformation is engaging people, working cross-functionally and within their own areas to change the processes. Those changes don’t always immediately show up.
So one of the early metrics we maybe want to look at is, are those processes working the way we thought? So let’s say we put in a process to work in smaller batches. We could track if the batches that we’re making are actually smaller or not. As a result of that, has that led to a reduction in finished goods? Has it led to a reduction in work and process inventory? These are all indicators that the process is working and changing the results of the business.
We can also look at metrics like people involvement with improvement, just tracking the number of improvements being made. It’s a really simple first way that lots of people can understand, not just the executives but the workers too. And convincing workers is also part of the challenge of lean transformation. It’s not only leadership; it’s really convincing everybody in the company that it’s worthwhile to work a new way.
Marchwinski: In your workshop I’ve heard you mention cost avoidance is a powerful way to explain lean’s financial benefits. In other words, “We didn’t have to rent that Air Force base to expand our operations; in fact, we don’t even need our current warehouse!” Can you tell us more about that?
Cunningham: Absolutely. Accounting measures things that do happen. How much scrap we actually created, how much in expediting fees we paid, how many customers we serve. When we change our processes to reduce the negative things that happen, we in accounting don’t have a good way of measuring that. So what we have to do instead is use some trends that indicate we have fewer bad things than we’ve had in the past. Sometimes it’s less waste compared to our volume, our sales dollars or other factors that help us to see that we’re going in the right direction and we’re not having as many of these bad things happen as we used to.
Marchwinski: I know you use a graphic called a profit model to help explain the financial impact of lean, regardless of the unique situation. Can you walk us through that?
Cunningham: I’d be glad to. You know, the profit model really isn’t about lean because it’s really just basic economics. The resources you have as an organization are at a certain level and management makes the decision about how many resources we have. And then we have the contribution to profitability, which represents the amount of revenue we have and the variable costs that go along with that revenue. Where the resources of the organization and the contribution from volume cross is our breakeven. Above that level is profit, and below that it’s a loss – and that’s not special to lean.
But what is special to lean is that since a lot of people think lean is only about reducing costs, they miss the fact that we’re creating capacity for future growth, improving the contribution of the products we have, and improving the underlying infrastructure of capital inventory, receivables, and fixed assets that we have. So we’re really hitting on all elements of profit and financial-benefit generation.