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Burning fat: Improved shareholder value through true waste reduction

improved shareholder value

Executive Summary
Cost-cutting, that most infamous of management approaches, has often proved unsuccessful beyond the short term. In fact, research indicates that only 10% of cost reduction programs show sustained results three years later. Why then, is it that it is so poorly executed, and how can costs be taken out of a business for good, leaving behind a much healthier organization — one that is well positioned for growth, for generating new jobs and for deliverintg long-term returns for shareholders? At the center of this argument, contends John Vaughan-Jones, lies the difference between superficial short-term cost-cutting and true waste reduction or elimination. Getting true waste reduction right will ultimately help drive shareholder value through increased operational efficiency across your entire value chain.

 

It’s the metaphorical term “scalpel” and the approach it signifies which is the problem, because it’s all too easy to wield the scalpel and none too easy to permanently reduce waste and improve throughput by addressing the underlying problems with process. The challenge which brings the fallacy to the scalpel approach is that while the scalpel appears to yield dramatic short-term results and leaves the CEO-cum-surgeon feeling as though they’ve succeeded, the truth is that the fat returns very quickly indeed, while the muscle (removed inadvertently) takes a lot longer to regenerate. Such measures would thus effectively starve the organization from much-needed muscle to pull its weight in an increasing competitive marketplace, and can cause serious long-term problems.

improved shareholder valueFact is that the fat should never have been there in the first place, and a healthy system will reject the fatty deposits early on so they are iteratively removed in such small quantities that there is no trauma involved. For instance, what better way to serve shareholders than by making sure the existing assets they have already paid for, are operating at 95% and not 70% efficiency? This deferral of capital requests from shareholders creates immense value for them, because even if you have to invest capital in new plant and equipment, you’re still able to return funds to shareholders. Why? Because throughput goes up, operating costs go down and invested capital goes down or stays constant.

One large US-based multinational is producing around US$1 billion in bottom-line benefits each year, and accelerating.

Excessive deposits
It’s the progressive buildup of fat over lengthy periods that cause the problems, because over time the organization becomes obese with all this buildup, which is often not recognized for what it is. And the problem gets worse — becoming a vicious cycle of degradation — because as the people grow accustomed to the fat being there, they adapt to its presence, becoming less fit and progressively a little “lazier”. This applies to systems too, not necessarily only to people, and before long the fat isn’t seen as fat at all, but as  “the way we do things around here”. It becomes the new normal.

The problem is insidious, and the very arteries of organizational life, agility and vitality are clogged to the point where drastic measures are probably required. Approaching such a deeply rooted problem with a scalpel alone is bound to fail, precisely because the condition has become normal for all systems which constitute the organization and how it functions. The norm is a steady-state condition produced by the environment and systems, so any external intervention yields wonderful short-term superficial results, but nothing at all in the long term. The systems recreate the norm because the norm is a pure reflection of the systems. If the systems are not dealt with, the previous norm must return. It is as predictable as night following day.

Yet we continue to read about organizations going through massive cost-cutting drives, usually planned and orchestrated by a few people operating behind closed doors out of genuine respect for the people who will no doubt be affected, and accompanied by the conviction in senior circles that “this time we’re going to do it properly”. But “properly” has to involve those closest to the place where the work is done, because they know the systems, they know how the real work is done, and only they have the knowledge required to remove the fat permanently by working on the underlying systems.

improved shareholder valueWhether a company is fat or not is a result of how it lives. How it lives is defined by how leadership and management define their roles and what they spend their time on. Do they spend their time regularly inserting themselves into various parts of the organization and its systems to perform checks and thus to learn first-hand what is actually happening? Do they check to see whether things at that point are running to design? And whether people are focused on what needs to be done at that point? Are they solving the right problems, making progress with those problems and providing appropriate assistance — and if not, by coaching there and then to those adding value? Or do they spend their time in the office (believing that their computer monitor is providing them with “real time” information), rarely visiting any operating part of their organization, and then issuing directives on how to address the situation — thereby providing yesterday’s solutions to today’s problems? (This only reinforces a blindly compliant culture exactly when a questioning culture is required.) In doing this, they fail in their duty to teach the people to solve problems right at the place where the fat accumulates. Fact is managers with insufficient experience in true cost reduction, frequently end up adopting value-reducing measures. They are the direct result of an inappropriate view on the role of leaders in a business.

The true meaning of Lean
The healthiest organizational systems that truly unlock shareholder value are those that are Lean in the proper sense of the word — as defined by Jim Womack and Dan Jones in their seminal book, The Machine that Changed the World. Unfortunately much of the popular press and even some academic books by well-known authors have yet to grasp the depth of the true meaning of Lean. The press often uses the word Lean to imply a simple, “cost-out” approach or “lean and mean” without the deep thinking, philosophy, style, approach and enabling systems that characterize truly Lean organizations in the way best exemplified by Toyota.

Operational excellence is when each employee can see the flow of value to the customer — and fix that flow when it breaks down.
– Kevin Duggan, faculty member, Lean Enterprise Institute

 

improved shareholder valueIn an organization in which Lean is deeply embedded, a constant focus on waste would mean that pre-existing fat has been permanently removed through addressing its underlying cause/s (to the extent that current process conditions allow). When fat is present, it is present for a reason — something much deeper and more important than the fat itself is badly out of alignment and needs to be addressed.

Best practice cost-reduction strategies require a targeted approach. By focusing on the underlying process health, Lean is able to iteratively and progressively remove the fat and keep it off. In the organizational context, this could rather be seen as cost reduction as opposed to cost-cutting. For instance, say your organization has US$10 billion worth of fixed assets. Our experience and those of our clients would suggest that there should be an approximate 20% release of productive capacity in, say, the first three years or so from a structured, formal and disciplined best practice initiative. Now if that’s true, what we’re talking about is a two billion dollar capital saving — presumably deferred capital, because if your market is growing then you’re going to have to spend that two billion to serve this market. Secondly, if you were going to spend the two billion, you as the CEO wouldn’t spend it expecting zero return. You’ll spend it because you’re expecting about an 18% return on investment, which adds US$360 million per annum additional EBIT to the bottomline year on year.

Costs are therefore being systemically reduced, enabling the whole system to function better at lower cost. And the fat stays off because the organization stays fit, by continually being in training — training which is made up of continually identifying and resolving problems. This approach is diametrically opposed to the cost-cutting practiced by the scalpel-wielding CEO. The gradual stripping of fat layers comprises not only removing fat but first exposing it by improving a process and uncovering some new waste, then carefully removing just that which is no longer needed within the newly improved process. This care is applied not only to the process itself, but to the supporting systems and most importantly to the people. In fact, it is done by the people closest to the process, not by people external to it. Effectively, they are performing self-surgery and because they themselves live with the consequences, they do it with greater care.

The results are spectacularly different when contrasted with the scalpel wielded from on high. One large US-based multinational is producing around US$1 billion in bottom-line benefits each year, and accelerating. A small operation in New Zealand has more than doubled their output, acquired a new business, won the New Zealand International Business Award and, in the process of their transformation, reversed the offshoring trend by bringing component manufacture back from China to New Zealand. These are BIG results, and they are results that will stick because they come from inherently better methods rather than from superficial and damaging cost-cutting exercises.

improved shareholder valueCurrent practice
Looking at organizations in transition, it is useful to think about “current practice”. The current way of doing things contains items/tasks/processes of value (which are necessary and which the customer is willing to pay for) and items of waste (everything else). Some of this waste is true fat and can immediately be removed, but some of the waste is necessary due to imperfections in the present way of doing the work. For example, there may be buffer inventory feeding a critical machine because an upstream process is unreliable. The inventory is a waste, but cannot be removed immediately without ill effect until the upstream process is made more reliable. That same business may well have inventory alongside other noncritical machines or processes, i.e. the whole process won’t stop if those processes stop for a short while. This inventory is pure fat and should be immediately removed, but always with care.

It is further useful to distinguish between value-adding work, non-value-adding but necessary work, and waste. Fat is pure waste, not required for the process as it is currently designed and working, and can be removed immediately with no ill effect.

The metaphorical scalpel, wielded with care by people close to the process, can be used to remove it immediately. The problem arising from this surgical approach to cutting costs, however, is that often those wielding the scalpel do not have the intimate knowledge or experience in the process required to distinguish pure fat from the waste currently needed to insulate against existing system inadequacies. Removing this waste can bring the entire system to a grinding halt. Often the impact is more subtle than this — and more insidious — in that the impact is not felt immediately, but progressively over a period of time.

As a direct result of the way in which Lean is practiced, where those closest to a process are the ones who identify the improvements and the ones who execute them, the organizational muscle remains strong and fit through continual structured and disciplined problem-solving. This process of ongoing reflection and learning is focused on relentlessly and continuously identifying waste within processes, and removing it. It is the only sure way to success, and the only sure way to put money back into your shareholders’ pockets.

 

Disclaimer
This resource has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained herein without obtaining specific professional advice. Competitive Capabilities International (CCi) does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this resource or for any decision based on it.

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