building a business case for lean

Building a Business Case for

Dan Jones & John Darlington

Introductions

Observations about

Lean Implementations

both Operational and

Local efforts tackling isolated parts of the system to no overall beneficial effect

Poor understanding of demand and capacity; organisation not being run to maximise the flow of value through the constraint or pacemaker process

Naïve application of tools and techniques often in the wrong place at the wrong time

Inappropriate delegation of leadership

Much improvement activity does not hit

the bottom line why?

Why is it so hard to see the financial benefits

of Lean?

Here are just a few areas of contention and conflict with lean practices: -

Conventional accounting systems encourage overproduction by their clumsy interpretation of the “value adding” principle.

They do not recognise the importance of bottlenecks, constraints or pacemaker processes

They encourage local efficiency and consequently create “islands” of excellence

They have little or nothing to say about lead time

They promote the idea that the bigger the batch the lower the unit cost

They encourage cost reductions which often prove to be “mirages”

We are relying upon Accounting methods and conventions fundamentally designed nearly a century ago

So can we devise a different way of

looking at lean

In operations let’s play down the tools driven approach and look at the whole

In accounting let’s go back to basics (there’s already plenty of good practice around)

A combined common sense approach

We’re in good company

Taiichi OhnoFather of the Toyota Production System

• Taiichi Ohno, who developed the Toyota Production System, also took a down-to-earth approach.

• He called the Toyota system “profit-making industrial engineering”.

Financial Measures

NPNet Profit

ROIReturn on

Investment

CFCash Flow

UP UP UP

Simultaneously

Three Operational Measures

• Throughput– The rate that money is generated by the company through

sales • Inventory

– The money which is invested by the company to purchase things which it intends to sell

• Operating Expense– The money the company spends in order to turn inventory into

throughput

Boundary measures

T£

O.E £’s

£

I

Understand control at thePlant walls:- Real cash flow Real costs

Measures (Simultaneously)

NPNet Profit

UP CFCash Flow

UPROIReturn on

Investment

UP

TThroughput

UP IInventory D

OW

N OEOperatingExpense

DO

WN

?

Inventory and carrying charges. The traditional view

DELIVERY

OP EXP

PRODUCTQUALITY

SPECIFICATION

HIGHER MARGINS

LOWER INVESTMENT PER UNIT

DUE-DATE PERFORMANCE

SHORTER QUOTED LEAD TIMES

A Role For Reduced Inventory?

High Inventory Manufacturing

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

INVENTORY ORDER1,000UNITS

HOURS 1000 2000

ORDER1,000UNITS

1.5 weeks

INVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

Low Inventory Manufacturing

Quality Improvement Impact

Damage detected weeks after the fault occurred.What is the chance of locating the cause?

Damage is detected while the damaging process is still operating

DAMAGE DONE

DAMAGEDETECTED

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORY

Engineering Change Impact

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORYImproved product will be available several weeks after engineering make the change

Improved product will be available in less than two weeks

Engineering change

Margin Impact

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORY

The plant is forced into considerable overtime to meet the promised delivery

The production lead time is shorter than the lead time promised to the market no overtime will be needed

Investment Impact

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORY

The last operation is at peak load for longer, pressure to ship may force plant to invest in extra capacity which will be idle for long periods

The load is more uniform at the last operation no additional investment is required

Due Date Performance

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORYProduction starts based on a guess,Plant oscillates between excess Finished goods and poor due date performance

Production starts based on good forecast reliability Due date performance>95%

FORECAST VALIDITY

Finished Goods Impact

1.5 weeks

HOURS 1000 2000

INVENTORY

4 weeks

HOURS 1000 2000

AVERAGEINVENTORY

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

A0.5

HOURS/U

B0.1

HOURS/U

C1

HOURS/U

D.5

HOURS/U

B0.1

HOURS/U

INVENTORY

Production lead times are proportional to work in process inventory.

Finished goods inventories should be proportional to production lead times!

And what of Service applications?

And what of Service applications?

Sometimes Queues make us feel sooo baaad

Why the obsession with the inventory and

response or lead time?

Big Picture Financial Mapping

ControlCooled

Heat Treatment

Finish – North Line

Finish – South Line

Joy Mining Line

Die Shop

Cutting

Induction Heating

Forge

Shotblast

Shotblast

Con. Cooled £000’sSales 9263Material costs(4179)Throughput 5084

Heat Treated £000’sSales 2738Material costs(1023)Throughput 1715

RM30.8d

3.9d

1.5d

11.4d

19.2d

4.5d

9.6d

5.3d

5.2d

24.5d

Fgds1.8d

Fgds1.3d

Fgds15.7d

Overheads £3048k

£2255k

£366k

£628k

What about looking at the inventory lead times by the distinctive value streams (June results)

Raw material

28.07 days

Finished goods

11.01 days

Work in Progress

33.85 days

What does this tell us….. It is “screamingly” obvious where the biggest issue is at present

CC OTIF 90% by week

HT OTIF 72% by week

Key Drivers Sensitivity AnalysisSept YTD Profit and

Loss Actual 2006 $000’s

A 5% Change for better effects the bottom line by: -

Pareto does exist so use it!

September End Inventory of $211m

Working Capital Relationships: Current State

Finance days

111

Inventory Pipeline in Days

Raw WIP Fin Gds

24 100 7

Debtor days

30

Payables days

50

We don’t need a business case every

month, week or day so to keep us on

track and to encourage the right lean

behaviours we use the “flow cost”.

Let’s look at the VS Map again and make some more observations about what we want from a “costing system”

Flow Costing

Capacity, Lead Time and Unit CostConventional Unit Costing

80 per

hour

75 per

hour

60 per

hour

85 per

hour

Customer Orders

Raw Material

CUT TURN MILL GRIND

RateHours per week Rate

Hours per week Rate

Hours per week Rate

Hours per week

80 37 75 37 60 37 85 37

Quan6ty to Recover 2960 Quan6ty to Recover 2775 Quan6ty to Recover 2220 Quan6ty to Recover 3145

Demonstrated Efficiency 87.0%Demonstrated

Efficiency 85.0%Demonstrated

Efficiency 98.0%Demonstrated

Efficiency 91.0%

Costed Quan6ty 2575.2 Costed Quan6ty 2358.8 Costed Quan6ty 2176 Costed Quan6ty 2862 Total

Process costs

Process costs £1,805 Process costs £2,495 Process costs £1,915 Process costs £2,563 £8,778

Target Cost Recovery Rate £0.70




Unit Cost £3.53

Batch 13

Batch 12 Batch 11

Cutting 1

Batch 10 Batch 9

Turning 2

Batch 8

Batch 7

Batch 6

Batch 5 Batch 4

Milling 3

Batch 2 Batch 1

Grinding 4

Batch 3

Batch Size 500

• 13 Batches in work in process.

• Cycle time per part 45 secs 48 secs 60 secs and 42 secs

• Processing 18.75 hrs + 12.5 hrs + 41.7 hrs + 17.5 hrs = 90.45 hrs

• Total manufacturing lead time 2.4 weeks

Capacity, Lead Time and Flow CostDemand 1740/wk

80 per hour

75 per hour

60 per hour

85 per hour

Customer Orders

Raw Material

CUT TURN MILL GRIND

Capacity, Lead Time and Flow Cost

Value Added minutes = 195 seconds

Lead time 2.4 weeks or 12 days

Flow Cost Calculation

This means that the product is having value added to it or in the process of conversion much less than 1% of the time or

Another way of thinking is that it is not having anything done to it for 99.99…% of the time!


Batch 13

Batch 12 Batch 11

Cutting 1

Batch 10 Batch 9

Turning 2

Batch 8

Batch 7

Batch 6

Batch 5 Batch 4

Milling 3

Batch 2 Batch 1

Grinding 4

Batch 3

Batch Size 500 Demand 1740/wk

• Operating Expense of the System £8778 per week

• Product exposed to the money it takes to run the system for 2.4 weeks or 12 days

• 2.4 weeks x £8778 = £21067.2

• Divide the Total System Cost by the demand (sold) 1740 = Flow Cost of £12.11

Typical Lean Interventions

Introduce a “pull system” to cap work in progress and buffer in relation to variation and vulnerabilityApply 5 “s” including standard work in progress; zero wip at a non pacemaker is okSet up reduction to modify batch sizes…so how do they impact the “cost calculations?”

Typical Lean Interventions

Lean Intervention

Pull system

Real 5 “s”

SMED

80 per hour

75 per hour

60 per hour

85 per hour

Customer Orders

Raw Material

CUT TURN MILL GRIND

Impact on Unit CostProfit down + One off cash increaseProfit down + One off cash increaseIncreases unit cost

Conventional Unit Costing





Unit Cost £3.53


Batch 13

Batch 12 Batch 11

Cutting 1

Batch 10 Batch 9

Turning 2

Batch 8

Batch 7

Batch 6

Batch 5 Batch 4

Milling 3

Batch 2 Batch 1

Grinding 4

Batch 3


Lean InterventionPull systemReal 5 “s” SMED

Impact on Flow Cost


Batch 7 Batch 6

Cutting 1

Batch 5

Turning 2

Batch 4

Batch 3 Batch 2

Milling 3

Batch 1

Grinding 4



Impact on Flow CostCash + Flow Cost down by £5.59


Batch 6

Cutting 1

Batch 5

Turning 2

Batch 4

Batch 3 Batch 2

Milling 3

Batch 1

Grinding 4



Impact on Flow CostCash + Flow cost down by £5.59 Cash + Flow cost down by £0.94


Batch 6

Cutting 1

Batch 5

Turning 2

Batch 4

Batch 3 Batch 2

Milling 3

Batch 1

Grinding 4



Impact on Flow CostCash + Flow cost down by £5.59 Cash + Flow cost down by £0.94 Cash + Flow cost down by £2.79

Competitive Edge

Flow Cost Benefits

The whole focus of the methodology is to keep product or information flow moving. The system has been labelled “Inactivity based costing” because it penalises delay.

Typical Unit Cost Interventions

Unit Cost Interventions

Speed up non constraints

Invest in non constraints

Increase batch sizes with no corresponding increase in “Throughput”

80 per hour

75 per hour

60 per hour

85 per hour

Customer Orders

Raw Material

CUT TURN MILL GRIND

Impact on Flow CostConsumes cash + increases the Flow CostConsumes cash + increases the Flow CostConsumes Cash + increases the Flow Cost

Conventional Unit Costing





Unit Cost £3.53

The purpose of Flow Costing

In an effort to handle the complexity of a modern organisation we break down “the whole” into smaller “chunks”.

These chunks can be departments but also we have devised ways of breaking overall money spent into “product costs” and we appoint people known as managers to head up these artificial “constructs”.

The dilemma we create in doing this is that the local manager tries to optimise what they can control, her or his local part of the overall system.

The problem this creates can be summed up by the question “are the sum of the local optima the same as the optima of the whole?”

Most people see that trying to optimise parts of the whole is NOT the same as trying to optimise the whole.

building a business case for lean

Education