How do you achieve a 140% improvement in net profit for no extra cost?
I spent an enjoyable day at a client site* recently working with a team to help develop their plans for improvement in the next year. We explored various options including their plans to implement 5S in the workshop. All of the ideas were good in their own ways but we decided a walkthrough of the process would be helpful to visualise the impact on the core process and to the company as a whole.
The company offers an engineering service to its clients, refurbishing equipment necessary for their clients business. How they go about doing this is not really the point of this blog so I’ll skip the detail and get straight to the really interesting part.
It was a blisteringly cold English winters day but the sky was cloudless and vividly blue. I shivered as we toured the plant (I'm usually cold), and I asked my client one of my standard questions,
'Which part of the process most often has the biggest queue?'
After a short debate, they all agreed that it was the paint plant. This was the resource most often under pressure and therefore had the biggest queue of work waiting in front of it. This might change under certain circumstances and the most under pressure work centre would be elsewhere, according to mix of work - this could be the subject of a separate blog post explaining why capacity often isn’t the issue in this instance and it’s the decisions we make that create wandering bottlenecks (as they’re known) - but most often the paint plant was the capacity-constrained resource (CCR).
After a reconvening inside with a warming cup of tea - we were all British after all! - we discussed a variety of simple ways in which you could increase output at a CCR. After some thought, the team estimated that the CCR could easily be idle for 20 hours during the week (they operate 24 hours per day, five days per week) and eliminating unnecessary downtime at the CCR could give them roughly an extra day worth of production each week!
’So let’s understand the benefit of addressing the lost capacity at the bottleneck,'
Currently, the CCR has 120 hours available per week but only 100 of those hours are being used. Therefore, 100 hours of production per week sums up over the year to £10M in sales. Adding an extra 20 hours per week annualises to an extra £2M in sales (assuming they can get extra work and there’s no reason to doubt that at present).
Raw material costs are an estimated 30% of sales, or £3M annually. These costs must increase with the volume of production.
However, provided they don’t take on extra people to the man the CCR for the additional 20 hours of production possible in the week, there are no other costs.
And here’s the really cool thing - there is absolutely no need to take on more people.
We’re talking about lost throughput due to things like waiting for a forklift truck to be available, or someone being available to help load the line. A simple reorganisation of working priorities alone will suffice to increase throughput at the CCR, along with an appreciation from the staff of how important it is that the paint plant is kept busy at all times. If the paint plant borrows someone from another part of the plant for 20mins, they’re taking capacity from a non-constraint which by definition will catch up.
Creating and following a simple schedule will also help ensure that the CCR is not only always working, but also always working on the right thing at the right time, which is unlikely to always be the case right now.
Therefore, the change in the company’s financial performance looks like this...
Sales increase (more product can be completed within the period and there is a backlog), as does the spending on the raw materials necessary to support production. Throughput (= sales minus raw materials) increases in absolute terms but stays at the same 70% level. Operating expenses do not change. There are no extra people required (almost always the biggest costs for companies I visit in the West), no extra sales costs, no extra R&D, no extra CEO’s, CFO’s, COO’,s HR, IT, Finance, etc etc etc.
That being the case Net Profit increases from £1M to £2.4M - a staggering 140% improvement from making relatively simple changes to working practice.
5S-ing a work centre is definitely helpful and improvement and may even increase throughput. But if it isn’t the constraint, it is highly unlikely to impact the company’s bottom-line**
Productivity = Throughput / Operating Expense
Throughput = Sales - Totally Variable Costs
Or, in other words,
‘How many £s of Throughput do we generate for every £ of Operating Expense?'***
An improvement in productivity moves us closer to the organisation's goal. If the goal is to make money now and in the future, a change to the company can only be classified as a productivity improvement if it results in us moving closer to our goal. This must mean that the organisation:
- Generates more throughput for the same amount of operating expenses spent, or,
- Generates the same amount throughput for less operating expense, or,
- Generates more throughput and spends less operating expense.
And here we are definitely not playing the usual numbers game - e.g. man-hours, direct labour, overhead allocated or recovered, etc. - played by corporate managers taken in by cost accounting approaches, like Activity Based Costing. These are fundamentally flawed and will get you into serious trouble if you’re not careful.
But a significant, measurable, bottom-line improvement to net profit.
In short, this is what a REAL improvement in productivity looks like.
*Specific details have been anonymised to protect client confidentiality but all proportions and percentages are correct or to scale.
** There are a limited number of situations where it will help on a non-constraint but it will be by nowhere near the delta you achieve by addressing the constraint, and I’m trying to keep this one simple.
*** I'm British. We use £GBP. Just replace this with your own currency symbol if it's different.