Eliminating waste isn t enough; you have to reduce inputs to save money. lean accounting. By Reginald Tomas Yu-Lee.

Transcription

1 Eliminating waste isn t enough; you have to reduce inputs to save money Proper lean accounting By Reginald Tomas Yu-Lee October

2 proper lean accounting rom its inception, lean has been about cost savings. The proof can be found by going to the founder of the concept. Lean has its roots in the Toyota Production System (TPS) or just-in-time manufacturing. Taiichi Ohno, the primary architect of the TPS, suggested that its goal was reducing costs. Ohno and his consultant, Shigeo Shingo, went so far as to restructure the profit and pricing equation so that its interpretation would be different to emphasize the concept of cost reduction. Often, the selling price is determined by adding profit to cost, or equation No. 1: cost + profit = selling price. For instance, the sales department always wants to know the cost so it can add a reasonable margin to get a proposed selling price. This, according to Shingo, was not a realistic perspective. He believed that the market determined the selling price. They thought that a more realistic way of looking at cost was to subtract cost from selling price to determine profit, or equation No. 2: selling price - cost = profit. With this approach, according to Ohno, At Toyota, as in all manufacturing industries, profit can be obtained only by reducing costs. Since lean was designed to focus on cost, the creators had to find places to look. The answer was to eliminate waste because, by eliminating waste, costs should go down. The next step was to categorize and define waste categories. Initially, Ohno and Shingo defined seven types of waste: 1. Overproduction 2. Inventory 3. Overprocessing 4. Defects 5. Motion 6. Waiting 7. Transport Considering these categories, you would think that eliminating these types of wastes definitely would lead to cost reductions, correct? Not necessarily. When you look through the lenses of explicit cost dynamics, the impact of some of these wastes on costs is fairly marginal at best. It isn t that the opportunity isn t there. It just means that eliminating the waste, itself, won t lead to cost reduction. Cost dynamics in real life Explicit cost dynamics is an extremely robust cost management methodology. Its robustness comes from two things. First, it s able to make cost dynamics simple. Second, it provides more realistic managerial information than other costing approaches, including activity-based costing and its latest version, time-driven activity-based costing. It does this first by defining costs as a flow rate of dollars out of the company. If the flow rate increases by doing something, it costs money. For instance, turning on a light consumes electricity, which costs the company money. Being energy efficient can lower the consumption of electricity, which lowers costs. For certain items, however, explicit cost dynamics predicts no change where other approaches will predict change. For example, a worker on a shop floor who is paid by the hour affects the cost dynamics based on how the employee is paid. Assume a shop floor worker can make 10 units per hour and is paid $10 per hour. If she increases her output to 12, the labor cost is still $10. Contrast this to someone paid by piecework. Someone paid $1 per part will cost $10 for 10 pieces. However, if this is increased to 12 pieces, the cost to the company changes when her pay increases to $12. The reason for this difference is found in the cost dynamics. When you pay by the hour, only two things will change the cost: either the number of hours you are paying or the amount you pay per hour. The pay is uncoupled or detached from the work. No matter what workers produce, zero or an infinite amount, the labor cost will be $10. When you re paying based on output, each bit of output will cost the company more. In this case, that more is $1 per unit. Explicit cost dynamics describes the difference in terms of two types of capacity: input and output. Input can be referred to as static capacity because the quantities purchased don t change. Output can be referred to as dynamic capacity because it can change. When a company buys an hour, an item, space or other type of capacity, it is buying input capacity. They are inputs to a company s operations and processes. For instance, an area (space) with a machine (equipment), materials (materials) and a person (labor) can begin building things. The resources are there first and are used to build, hence they are inputs. There are five types of input capacity: labor, space, materials, equipment and information technology. Inputs are purchased to be used in anticipation of demand, so the cost exists regardless of whether the demand materializes or not. This relationship between capacity and demand sets the stage for the resulting cost dynamics. As shown later in the relationship, the cost exists before work is done, so in that sense, it is independent of the work. It s important to understand the relationship between input capacity and cost for improvement purposes. Using input capacity efficiently will not lower its costs. The cost is determined by how much is purchased and the price at which it was purchased. That s it. Lower one s salary and the salary cost 40 Industrial Engineer

3 governmental transformation Interminable waits at the Department of Motor Vehicles or other government agencies often are the norm, but an Arizona court clerk is using lean Six Sigma to make operations more efficient. Chad Roche, Pinal County clerk of the Superior Court, told The Florence Reminder and Blade Tribune that the business practices have revamped his office. Roche saw firsthand the benefits of lean Six Sigma when he was a business development manager at Ecolab. Roche s initial kaizen event involved mapping processes for the Clerk of Superior Court. The five-day event exceeded expectations, he said. Because lean Six Sigma requires involvement and buy-in from top management, Roche is sending his core management team to get training from Villanova University. Dyane Ceal, director of court operations, told the newspaper that the bottom-up style of management of lean Six Sigma is not common in government. It s a cultural shift to be sure, Ceal said. Lean Six [Sigma] allows every employee to feel committed to being good trustees of taxpayers money. goes down. Pay someone for seven rather than eight hours, and the labor cost goes down. Make them more efficient? That has its benefits, but it will not affect costs. When someone does work, they create output. It is the product of one s work. The widgets that are created, the measurements that are taken and other facets of work are all tied to output. Notice that the work itself is a byproduct of what was purchased. The output from the shop floor workers who are paid by the hour does not affect the company s labor cost dynamics. Only their hourly rate and the number of hours purchased come into play. The units are the output, and the hour that they work and the $10 paid for each hour are the input. So what does this have to do with waste and cost reduction? Input and output capacity help explain practically everything you need to know about the cost dynamics of waste, especially these three things: 1. How the waste impacts operations through output capacity 2. How and why reducing waste will not impact costs 3. What is necessary to reduce costs Waste impacts operations through output capacity Waste in Ohno s context really means one of three things. You are doing things that don t need to be done (overproducing, transportation, overprocessing, motion, inventory), doing something wrong (defects) or not doing anything at all (waiting). In all cases, it is about what someone is doing, or their output. The impact was wide, ranging from excess space capacity being used to reduced operation and process throughput to monies being tied up buying materials that will go into inventory. All this points to output capacity and how efficiently capacity is being used, not how much capacity is being purchased. Figure 1 describes how the different types of waste affect the organization. The third column describes the general ways in which the waste will have a negative impact. These may be the organization s pain points. The last column documents how these pain points are translated into output capacity problems. Combining these two columns becomes the basis for understanding how the waste is impacting operations and where process improvements can occur. This step is important when trying to identify the impact the waste is having on the organization and where the impact occurs. By documenting specifically how output is affected, this creates an understanding of where eliminating waste will create the improvements in operations and, ultimately, lead to improvements that will reduce costs. Reducing waste isn t enough If the waste is eliminated, costs will not go down automatically, although the opportunity to improve output capacity is very clear. For instance, if you eliminate the excess inventory that is spread throughout the facility, there will be more ability to use that space for something more useful than idle inventory. If you eliminate the time people have to spend looking for tools, they can do their job rather than waste time looking for things they need. These are improvements to output, but costs are tied to inputs. Eliminating the inventory from being on the floor doesn t reduce the monthly lease cost on the warehouse or the factory. The worker looking for tooling might save 15 to 20 minutes of October

4 proper lean accounting waste effects Waste type Description Examples of how operations are affected How it influences output capacity Overproduction Creating product before demand exists Excess inventory Excess labor costs Longer lead-times Consumes equipment capacity Consumes equipment, labor, material capacity Time on hand waiting Waiting for work to occur Slows output Consumes labor and Transporting Moving products more than required for production Slows output Consumes labor capacity Might consume Consumes labor and Overprocessing More fabrication and assembly-type work than is necessary to meet customer expectations Slows output, excess wear on equipment Reducing can possibly increase output Unnecessary stock on hand (inventory) Having excess stock on hand a result of overproduction Uses space Forced to buy excess materials May increase lead-times Reduces space capacity Unnecessary motion Moving more than is required for production May slow output Reduces labor output Producing defective goods Creating products that don t meet quality specifications Slows output Forced to buy excess materials Consumes labor Reduces material output Reduces labor output Reduces process output Possibly reduces space output Figure 1. The third and fourth columns of the table help lean practitioners understand how waste affects operations and where to target process improvements. search time, but if he still works an eight-hour day, his labor cost for the eight hours is the same. The result is that waste impacts the amount and use of output capacity. But if the company wants to get the cost benefit of eliminating waste, steps must be made to convert the savings in output capacity to reducing the requirements of input capacity. Many readers might argue that in both cases, the increase in output means the cost per square foot, per maintenance call or per unit produced has gone down. Explicit cost dynamics considers this irrelevant; recall that it only measures money that leaves the company. Hence if an improvement is made that impacts output, but the inputs remain the same, the flow of dollars leaving the company has not changed. In the case of the warehouse, the cost dynamics for space are tied to the periodic lease payments and not what is in the warehouse. The only exception would be a leased warehouse space agreement where the more warehouse space you use, the more you pay. Otherwise, reducing the use of floor space will not impact the cost of the warehouse. In general, eliminating waste means that operational efficiency is increasing. Efficiency is a critical measure when considering how to assess the impact of eliminating waste. Efficiency can be described in equation No. 3: efficiency = output input. Efficiency is the mathematical opposite of the unit cost equation seen in equation No. 4: cost per unit = input (cost) 42 Industrial Engineer

5 output. The cost per unit equation is deceptive because it causes one to believe that increasing output reduces costs. The problem is that one can show a cost reduction even when the explicit cost, the one that hits the income statement and is in the numerator, remains the same. So when eliminating waste improves output, the perception is that costs are going down when mathematically and in fact they could be, and often are, exactly the same. What is needed to reduce costs? Equation No. 3 tells us two things in terms of where cost improvements will come from. First, the only way to reduce capacity cost is to reduce the amount purchased or the price of the amount purchased. Second, if you increase your output for the same input, then it must follow that less input is required to meet the previous output level. For instance, assume someone makes 10 phone calls in an eight-hour shift. Technology is implemented to increase output to 20 over the same period. Then 10 calls must require less input now than before. It is this opportunity to reduce input that reduces your costs. Efficiency alone only creates the need for less input. You must act on the excess input to reduce the input costs. To provide guidance, examine each type of waste for opportunities to reduce costs. Overproduction. When reducing overproduction waste, you are reducing the use of labor and material capacity. The labor cost improvement opportunity comes from paying less for labor. This may mean asking them to work less time. It might also mean employing them in activities such as 5S or maintenance that will lower the need for excess staff elsewhere. The cost improvement opportunity comes by reducing the amount of materials purchased by attempting to create better alignment with demand. Inventory. The input capacity created when reducing inventory is primarily through space availability. If a substantial amount of inventory is reduced, whole spaces can be freed, which would eliminate the cost of the space capacity. Overprocessing. Overprocessing is tricky in terms of how it is defined. For instance, there is the actual fabrication part of doing too much to a product being made. There also are activities such as wasteful labeling and packaging. In the case of machining, reducing overprocessing can impact the purchase of tooling and machinery. Shorter term, look for ways where overprocessing consumes labor and equipment (tooling) capacity. Also, look for ways where defects are occurring during the overprocessing. Longer term there may be issues associated with buying parts for equipment that is used up prematurely and for buying replacement equipment. Defects. Defects can have a substantial impact on input capacity. Areas to look at are how much labor capacity is being used to fix defects, to address the defects in some other way, or to reproduce product. Accounting systems often hide this information or keep it in very different accounts, so finding the whole picture is sometimes hard. Additional areas to consider are material reductions and premature equipment wear, as is the case with overprocessing. There often are a lot of opportunities associated with defect creation that go hidden. This area can be ripe for companies with marginal production capabilities. Motion. The question with motion is how much excess motion is there and how much time does it take up? If someone scratches her nose before picking up a part, there likely will not be much opportunity for improvement. If someone has to walk to the other side of a factory between production lots, the opportunity to save time could be large. Primarily, the issue here is looking for freed labor time that can be reduced. Waiting. Waiting is another tough one. The source of cost savings is likely labor capacity. It might indicate excess output capacity from an unbalanced line. For instance, maybe you have an operation that has output capacity of four units per hour feeding a process that can handle 12 units per hour. The second operation often has to wait to be fed work. Other causes include poor production activity control or large batch processing. Such causes may not indicate excess labor capacity at the waiting station. There will be times that the worker will be inundated with work, as work comes in waves in poorly planned facilities. Where excess input capacity exists and how much there is will have to be addressed as part of fixing the problem that creates the waiting. Transporting. Transporting inside the plant typically will be a labor play, especially if a culture exists where an excessive number of expeditors or material handlers exist. There also might be an opportunity to reduce material capacity if overproduction exists to hide inefficient material movement. Eliminating waste is a great thing because it ultimately leads to reduced capacity requirements. What lean forgot to share is that eliminating waste by itself isn t enough. So focus on taking the improvements in efficiency to design work with fewer resources. That will allow IEs to reduce input capacity costs and, therefore, create true cost reductions. d Reginald Tomas Yu-Lee is a coach with Blitz Cincinnati. Yu-Lee has a Ph.D. in engineering from the University of Dayton. He previously worked with GM, IBM, Oracle, Sapient and Ernst & Young. Yu-Lee is the author of Explicit Cost Dynamics and Essentials of Capacity Management. October