How to improve business capacity without increasing overheads using Lean Transformation
What if I said there is a way to improve the capacity in your business by up to 30%, without increasing your overheads?
You would say I’m wrong, not even possible. There must be a catch; I need to pay for an expensive machine, or software to get a return on investment (ROI) of that magnitude, and that’s if I get it right; I won’t see the money until my investment is paid off over 4 years.
The reality is that it is possible through a concept called “Employee Driven Continuous Improvement”, which we commonly term a Lean Value Stream Transformation.
Businesses who have come to realise that this solution (although harder to conceptualise), is much more cost-effective, come to us at a point in their life cycle when they are hurting. That hurt is a culmination of a struggle to retain and engage people, a struggle to get an ROI from large capital investment, or a struggle to know how to grow their business, without just adding more expenses and people.
Growth in capacity should not be at the expense of quality
We see many businesses that have done fantastically well on tribal knowledge – highly skilled people have grown a business and they have a great reputation – but as they have added equally capable people from outside, the quality seems to have dropped. There’s confusion about why hand-picking so many great people has not led to the improvement expected.
This is the same story when new software, large capital intensive machinery or facilities are purchased. Often they all happen at the same time. Moral and turnover get worse. This is not what we want! Why are these logical things not working? Employees old and new are becoming rather jaded.
The answer is, they are missing a system that provides the common thinking and language that all employees and leaders can rely on to translate different perspectives on how to improve and get better. There is not a standard approach to how they work, a common approach to continuous improvement, a way to visualise and discuss performance nor a clear and orderly structure to how teams work and interrelate, making it easy for new and old employees to work together.
Unfortunately, nearly all businesses have this issue at some level, and worse, they have seen new capital acquisition in machines, infrastructure or software as the way to solve it. And, it’s easier to look at ways to spend money on things that don’t deal with people’s feelings, mindsets and behaviours – it seems easier not to address any underlying culture.
Most of the time, dealing with culture is seen as difficult to assign value to. Therefore, it’s hard to develop the business case given you don’t know if the ROI is real. It feels easier to create an ROI on something more concrete, like a $250,000 machine or a million-dollar software implementation. But, ironically, the culture prevents these investments from working to their maximum capability, and they often flounder for years.
So change the culture with Employee Driven Continuous Improvement.
The numbers for rapid value stream transformation and continuous improvement add up
If a system, a way of thinking and working improved your capacity by up to 30%, and all you had to do was invest in people’s learning and behaviours by giving them a structure to work to, would this not be worthwhile and make other capital intensive investments more worthwhile? What if I said it would cost you less than $40,000 per leader, and its return on investment is in months, not years?
Let me give you an example to break this down. We use a technique called Value Stream Mapping and can often find a 30% improvement in capacity. We can apply a technique, outlined in “The Goal” by Eli Rogratt, whereby the newfound capacity can be marketed at the same price, but with a shorter lead time (very attractive in some markets), or it can be priced at up to 20% below the market because your fixed overheads are covered by the existing work, which you are now doing in 70% of the available time. Let’s work with that second example in a business with revenues of around $30M a year. This business might be a manufacturing or services based business, it does not matter and has a fairly standard breakdown of the cost of goods sold (COGS) and overheads.
Revenue: $30M – all sales of goods and services
COGS: $18M (60% of Revenue) – all labour, materials and costs directly associated with producing a product or service
Overheads: $6M (20% of Revenue) – fixed costs that are the same regardless of the revenue, such as management and administration salaries, financing costs, leasing buildings and so on.
Net Profit: $6M (20% of Revenue) – before tax, what is considered a healthy net profit in a small to medium business. This is an ideal state, but many businesses fail to see profits like this.
Take a moment. Many small to medium businesses fail to make 20% net profit. Many large businesses fail to make 8-12% net profit. What are the percentage breakdowns for your business? Go on, write them down. I’ll wait 🙂
Now we apply a rapid value stream transformation and coach leaders on how to identify and eliminate several inefficiencies in their business. We call this the elimination of wasteful activity. We also coach them on how to get their teams to find and eliminate the waste – many hands make light work! Typically we identify up to a 30% increase in capacity!
The result is great, we can now shorten our lead time to your customer without all the necessary inefficiency. But there is a problem. You don’t think you can find 30% more work! This is where realising that the fixed overheads (that are part of the existing revenue model) can be ignored when pricing the additional 30% capacity, and you can undercut your current pricing by up to 20%.
30% Additional Capacity now available:
Additional Capacity Revenue: $9M less 20% discount (the value of the overheads) = $7.2M in revenue from the additional capacity
COGS: $5.4M (60% of the value of the revenue before discount, remember your labour and materials still cost full price)
Overheads: $Nil (the overheads are covered in the original work you already do)
Net Profit: $1.8M (25% net profit on your discounted price with fully priced materials and labour)
OK, you are not misreading that. Get the calculator out. Check my math. Apply it to your own business. Your cost breakdowns will be different, but you’ll see the potential. I’ll wait 🙂
So this business now has a strong case to enter new markets with an aggressive pricing strategy for its extra capacity. Let’s total the existing and extra capacity up:
New business opportunity:
Revenue: $30M + 7.2M = $37.2M (remember we are considering the extra capacity revenue is discounted by 20%)
COGS: $18M + 5.4M = $23.4M (62.9%, because even though we can discount the additional capacity we still pay full price for our materials and direct labour)
Overheads: $6M + $Nil = $6M (16.1%, because the overheads are consistent, the extra work to do the additional 30% capacity is in the direct costs)
Net Profit: $6M + 1.8M = $7.8M (20.97% net profit, still strong, and we gave a discount as well!)
Even if you take the undercutting approach, and spend 6 months on implementing the quick wins and building up the new revenue, your ROI will occur in under 8 months, and the additional $1.8M profit could then be used to:
- Train people and leaders to improve mindset and behaviours in the company
- Invest in researching R&D projects to further improve offerings to the market
- Invest in new machines and software now that the wasteful activities are gone
Yes, this was actually a real company!
This is a real company, by the way. Except we found their process was 90% inefficient. We easily doubled their capacity.
What did they do with the extra profits every month? They used it to:
- Value stream map their future approach to direct their future improvements
- Acted quickly and put changes to the process in place that could not be undone (layout and visual changes)
- Used spare time to train 15 key team members in Lean Leadership practices and how to change behaviours to inspire “employee-driven continuous improvement”
- Improved their lead time on customer orders from 20 days to 2 days, wowing existing clients
- Sold new capacity at 20% below market, shocking their competitors on large tenders, and winning every major tender in their region
- Maintain a healthy net profit and double volume, with a revenue of $54M per annum (taking into account their heavy undercutting on the new work)
- ROI achieved in less than 12 months
Could you expect an ROI in less than 12 months from a software deployment or new piece of machinery or infrastructure? No, more than likely, just a further cost over a number of years, as you put good people, good software and good equipment in a broken process.
The truth is, changing people and process is hard
There is a reason why businesses choose technology and capital intensive spending over changing the culture in their business – it’s plain hard to do the people stuff. No one likes to talk about feelings or deal with conflict. Building a Lean and Continuous Improvement capability in your business puts structure around the intangible stuff. Makes conversations more objective. Drives loyalty and employee retention.
Makoto is your partner on taking the harder, but the more sustainable and cost-effective road to an efficient business – one that is investing in its people to innovate and improve every day to drive customer value, employee value and company profits. Our programs use a unique blend of online content, group webinars, 1-on-1 coaching with industry experts, and collaborative workshops focused on results, not boring slide shows.
Commencing a program of capability building with us can start from as little as $99 per person per month* for a simple program with an exclusive premium newsletter to kick off your Lean transformation, through to premium all-inclusive membership with collaborative workshop days with peers from all sorts of industries for $2,990 per month*.
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|About the author|
|Daniel Giles is the director of Makoto Asia Pacific, a lean consulting firm, renowned globally for a people-focused approach to sustainable Lean training, consulting and implementations.
Dan’s passion is seeing leaders and teams develop a Lean and Kaizen culture mindset, allowing them to drive waste out of their business and engage in ongoing continuous improvement.
*Minimum commitment 12 months
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