- January 18, 2022
- Posted by: Aurora Picco
- Category: Senza categoria
The companies that have embraced the lean manufacturing approach to cancel the “muda” and maximize the value of their business processes have also the task of creating a Lean Management System, different from the traditional reporting system, built in a proper version to measure and address improvements in order to guide the company towards financial and economic success.
The creation of value for the customer, at the basis of lean concepts, leads to a growth in turnover; the improvement of the resource’s productivity (technological, financial and human), leads to cost reduction. The combination for these two factors generates an increase in profits as the Lean System matures. It is therefore necessary to develop an adequate management system that is able to incentivize the creation and maintenance of flow, continuous improvement, problem solving and value creation.
The traditional management system
In many manufacturing companies, standard costs are still the main source of information tor analyze operational processes and take decisions. However this type of information is dangerous for lean companies because standard costs work well in the environment in which they are conceived, that is, mass production. For this reason, one of the first objectives of a lean management system is precisely to eliminate standard costs from all decision-making processes.
In lean systems we rely on performance measurement systems and visual signals to manage and control operational flows and little reliance is placed on ERP (Enterprise Resources Planning, that is corporate information system). In fact the ESP systems are typically designed for traditional production processes, including the need of several useless registrations which will generate useless information and reports, all of which can be classified as sources of waste. For example, think of the operational efficiency measurements (OEE, Overall Equipment Effectiveness) of each manufacturing process machine, based on the push concept that each of them must be on – i.e. they must produce – for as long as the company is open. In a value stream approach, however, we realize that is not necessary to measure this efficiency for each machine but only for the value stream bottleneck and, eventually, for the very few critical machines.
A traditional company measures the waste elimination in terms of manpower hours saved: multiplying the hourly cost of labor by the hours of labor saved, the savings generated by the improvement intervention are obtained. In this way, it is often claimed that savings have been made, even if, in fact, the manpower is not really reduced and the costs actually incurred by the company do not change because the relative fractional savings will turn into new forms of waste. What is missing in this vision is the “flow’s focus”, that is the main step to reach the real productivity improvements.
For most of traditional manufacturing companies the value of inventories is calculated though standard costs: they are in turn determined by keeping the rates updated, allocating all production costs to the product and constantly comparing the current cost with the standard one, then analyzing the unavoidable variances and trying to explain their causes and to set corrective actions to correct such differences. Sales prices are also determined on the basis of such standard costs.
In a traditional system, corporate economic-financial measurements are based on comparing the current trend with the budget: a monthly expenditure budget is created, current expenditure is measured against the budget and the differences are explained. This leads to think the factory as cost centers having the ultimate aim of reducing costs as much as possible.
The measurement of deviations respect to planning is based on the ability to absorb fixed costs and on the analysis of variances. In the production reporting system the operational standards of performance – which include bill of materials, work cycles, labor cost and fixed costs – are defined. The actual production and use of resources reporting generates a series of variances with respect to standards. In such a system the company aims to absorb fixed costs as much as possible while maintaining a rate of variance with respect to the standard as favorable as possible.
Investments opportunities are assessed on the basis of the single machine/operation efficiency and on the fixed costs absorption, also in this case without an overview of the whole process. Furthermore the process of hiring new staff is based on payroll and head counting. Therefore, the new hires are justified by reasons of increased efficiency or absorption of fixed costs: in this way, the company MRP (Material Requirement Planning) plays an important role because it is able to determine the total manpower requirements on the base of sales forecast and available production capacity.
The final result is a complex management system, with many cost and profit centers and a considerable difficulty in tracking the movements of material code from one individual cost center to the next one. The organization is therefore committed to maintain a complex management system which provides little or zero added value.
Value stream, the importance
The number one goal of a lean strategy is to provide value to customers and market. From an accounting point of view, therefore, it is of fundamental importance to be able to measure how each operation is effective in generating value for the customer, whenever the latter has interaction with the company.
Likewise it is important to work by value stream, i.e. the set of steps that make up the operational process that goes from the customer order reception until the supply of goods/services to the market. In this sense each value stream (or product/service line) is by itself the business profit center. This means that all financial/economic and operational metrics must be modified and focused on the value streams performance level, because they are those ones who really create and provide value to final customers.
Such type of approach is opposite to the traditional one for which each business function/operation is a cost center and, in certain cases, also a profit center, thus fragmenting the value chain into multiple parts and making you lose the overview of the flow (both of materials and information).
The number one goal of each value stream is to maximize the time spent in creating value to the costumers.
This is achieved by making the demand flow in the quickest possible way within it (minimization of the through-put time and of the lead-time to the market) and by ceaselessly eliminating sources of waste.
The value stream therefore includes both all the value-added activities necessary to transform the raw material into a finished product and all the other activities necessary to support such transformation. This means that the activities carried out by quality, maintenance, engineering, material flow, purchasing and logistics are part of the value stream. Therefore lean companies must incorporate these activities as much as possible into the product or service lines in order not to inhibit the flow. The old concept of company departments is itself a form of waste, entirely generated by a structure organized by functions, each of which is interpreted as a sealed compartment independent from the rest of the company.
Lean performance measures
The heart of a lean business performance measurement is the capability to identify the root causes of problems and take actions to eliminate them. The key point of the matter consists of the actions that company personnel is driven to take by performance measurements, not of the mere reporting for its own sake. After all, a lean management system is such if it allows stable annual productivity increases of order of magnitude of at least 10%, possibly around 20%. This is why lean metrics focus, for each value stream, on indicators of flow, productivity, quality, delivery times, cost and lead-time.
Such a measurement system must deal with the natural instability of market demand (to be faced with production system based on the pull logic) and of the cycle times of internal processes (with their impact on the real company manufacturing capacity). It is for this reason that processes must be designed in order to have self-leveling systems in their DNA, which automatically – and with very short reactions times – tend to adapt the internal flow to that one of external demand. This is possible by assigning only 80% of the theoretical capacity of the value stream to the average market demand, leaving the remaining 20% to be used to cover the natural variations (peaks) of the market as well as the variation of the internal processes.
In a lean management system, all indicators based on an organizational structure by functions will have to be abandoned. The reference key performance indicators are those that are able to measure the effectiveness of the value stream in its whole:
- Flow: the best measure of flow is linked to the process speed (e.g. inventories coverage in days, process through-put times from raw material to the final product); constantly improving the value flow raises the ability to accept increases in demand without having to increase costs;
- Quality: realizing and measuring the reduction of the defects along the process helps the flow to have less interruptions and unexpected events, leading to an improvement of the productivity and on-time deliveries;
- Delivery: measuring the punctuality of deliveries with respect to the date requested by the costumer (instead of with respect to the confirmed one) is an excellent indicator to collect important information on how to improve the flow of the value stream;
- Lead-time: it is an excellent performance measure because it requires looking at the product or service line performance as a whole, rather than focusing on the individual phases that make it up: if customers know that the company’s lead time is short, they might reduce their stock levels so generating cash and so they will reduce delivery times to their own customers;
- Productivity: defined as the ratio between the output of a process (for example, the production or turnover of the value stream, the number of shipments to customers) and the input (for example the labor hours), the indicators of this family are probably the most important of a lean management system: achieving constant and substantial improvement of these indicators is the best guarantee of the effectiveness of the lean business processes.
Lean metrics must be simple, both because they must be measured frequently (on an hourly, daily or weekly basis) and because they must focus on identifying the causes of a low level of performance.
In addition to that, the other fundamental aspect is to report – visibly displayed in a performance scoreboard – each measurement of the individual value stream and of the company as a whole. In a lean company there are no secrets: therefore the scoreboard shows the trend of the measurements with respect to the objectives, a Pareto’s diagram to identify the main root causes of the failure to achieve the targets, the status of each one of the improvement actions undertaken to achieve objective and a list on the main undertaken Kaizen events.
Accounting for value stream
The focus of value stream accounting must be shifted to understand the economic and financial impact on one’s decision on two fundamental issues:
- How customer demand changes thanks to greater value creation;
- How the spending profile changes based on the improvements achieved in operational and information flows and in the use of production capacity.
Every Value Stream is a center of profit. This involves a unique attribution of each product code to the individual product line, with the consequent allocation on it of the turnover of all products codes.
At the same time, the costs allocation process is done directly on the value stream itself: all costs are attributed to the process points in which the expense occurs. Simple cost sharing rules will be defined only for the operations and functions that are shared between multiple value streams. This allows to have an income statement for each value stream, therefore to have clear indications on the profitability of each value chain, on the opportunities for improvement and on the commercial actions to be undertaken.
If the direct materials, direct labor, dedicated value stream machines and all related expenses (for example maintenance, scraps, non-quality, etc.) are simply charged to the specific value stream, the costs that cannot be directly assigned (e.g. the development of new products, sales, marketing, administration, shared machines and plants, etc.) must be managed by defining appropriate sharing parameters for the different types of costs, based on one or more predefined indicators.
The activities of creating new production capacity of the value stream by intervening on the bottleneck and any critical operation will turn into the ability to satisfy a higher market demand (or to satisfy the same demand with the use of fewer resources or to assign part of the capacity in excess to another value stream), thus determining that contribution margin of demand that a traditional approach based on standard costs is unable to grasp.
Investments in a lean management system are evaluated in an overall view, taking into account the total flow of materials and information, considering the reduction of delivery times and/or the improvement of the quality of the entire production cycle: never in a punctual view of the efficiency of the single operation seen as a stand-alone one.
Regarding the human resources, then, a lean management system perceives the company personnel not as a cost center but as a resource that generates value for the customers. The decision to hire new people is based on the same considerations made for investments: a structural increase in production capacity and/or value for the customer.
The final result achieved by the adoption of such a lean management system will be to have a certain number of financial analysts who – instead of being engaged in the office to analyze a complex cost reporting system based on standard costs or other typical mass production practices – will move in gemba in search of performance improvement opportunities, using weekly value stream income statements and measuring the effectiveness of kaizen events launched by the organization and by themselves. In addition, the entire company organization will be able to see the contribution of its own line of products or services to corporate profitability and to grasp the priorities of invention, both operational and strategic, on the way to improvement.
ICT srl (www.ict-advisorydivision.com) has a professional’s team able to support the client companies to re-engineer their own processes and management system with a lean perspective, in the aim of improving business performance by Lean Thinking and simplification of the administrative system.
Here are some examples of activities that ICT is able to deal with in these areas:
- Critical review of the value chain through the Value Stream Mapping methodology, within a Gap Analysis activity aimed at identifying areas of improvement, defining a hierarchy of recommended interventions and the related actions plan;
- Reorganization of flows and optimization of the same in a value stream perspective, also by means of enabling technologies as well as through the lean review of ERP and MES systems;
- Re-engineering of the administrative and internal reporting system;
- Creation of a lean system of KPI (Key Performance Indicators) focused to the optimization of the flow and to the creation of value for the customer;
- Staff training in lean techniques, with courses and practical application exercises on real problems. Among the courses offered the following ones are included:
- Basic principles of Lean Thinking
- Lean Supply Chain
- Value Stream Mapping
- Kanban, Pull System and Continuous Flow
- Lean ERP & MES
In case of interest or to receive more information on these topics,
please get in touch with ICT writing at email@example.com or calling +39 (0)121 376811.