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28 December 2005

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I like that. The same thing is true of government except the upper level managers are political and driven by results over the short term - often little related to the goals of the unit - without any consideration for longer term needs and so investment in efficiency and effectiveness is minimized.

Hey "Dad" that isn't really different. Upper level public company managers are forced into the same short-term results mentality by our archane regulatory and financial reporting environment. Private companies have it a little easier since they don't have to report to the Street but since their senior managers often came from public companies, the mentality is still there. Efficiency and effectiveness really doesn't take much "investment" (I especially hate that term when used with the word "government"). We aren't talking about new computers or electronics or support people. Quite the opposite. Taking a step back and redesigning the process often eliminates computers, frees up people, etc. Companies that implement lean often simply get rid of their production control computers. I think it was a Rand study that showed that a typical company can reduce costs by 35% by eliminating wasteful processes, but the government operates at about a 50% waste level (non-profits were 25% as well). Some government orgs like the city of Mesa, AZ and several military orgs especially the repair depots have been very successful with lean. That is why waste reduction, by using highly trained employees, can yield far more savings than simply freezing wages or eliminating Ohno's dreaded "headcount".
-George

As a "big 3" auditor, I've commonly run into this valuation problem. We see massive training commitments, almost always required to simply run the business, but no corresponding balance sheet value. It is as if you accounted for all the platinum used in catalytic converters as "sand" and assumed you had an unlimited supply of a cheap material.

The other really big issue, and where the new lean accounting needs to take a forceful stand, is with the concept of waste. Ask almost any CFO and they will tell you that cost is material, labor, and overhead... and they will almost invariably say they know every number down to a knat's ass. And they will almost always say they "just report the true numbers". What BS. Their rules and methods force wrong-headed decisions.

Cost is made up of labor, overhead (which less-capable organizations still link to labor), material... and WASTE. Waste due to methods, quality, scheduling, etc that drives material usage, labor usage, etc higher. In every organization I've audited, and I'ved audited over 100 companies, the probable value of waste is ALWAYS greater than the value of value-added labor. That's the key. Take your people, train them, and have them focus on waste reduction and continuous improvement... you'll get FAR FAR MORE SAVINGS than you ever would by simply focusing on labor cost. As your methods improve and you legitimately don't need all the extra manpower, then manage it by attrition... or if you're really smart like Toyota, Danaher, Wiremold, and others you will grow your sales (helped by reduced cost and radically reduced lead times) which will then require those "extra" people.

People really ARE your most important asset. Too bad they are treated like commodity crap. GREAT GREAT POST!!!!!

Michael-
Great comment. I would be very interested in knowing more about how the "big 3" are approaching this problem, particularly from an audit/control/analysis standpoint.
-Kevin

Potential new audit structures and analysis methods have been discussed quite a bit, as waste ties directly into valuation models. More and more we're being asked to assess "waste" and "lean methods" from a valuation standpoint while working with companies on potential acquisitions.

I'm lucky in that I come from a manufacturing background, so I can see waste when walking the shop floor, and afterwards poke at it more. Invariably, and I truly mean invariably, waste is a larger cost component than direct labor. This is true in industries with low labor content... but even true when there's high labor content. With high labor content products there are many more opportunities for "method waste". Nailing method waste reduction is how high-labor New Balance continues to produce profitably in the U.S.. I'm trying to round up some folks to hit your Lean Accounting Conference later this year. It is REALLY needed. CFO's that get on board can drive huge improvements in company profitability.

Great blog, Kevin. I can tell you that it is widely read by the ops-related folks here.

I completely agree and I fight this battle every day. Waste is a far larger component than labor, and sometimes even approaches total material cost. The problem is that it is difficult to quantify, and therefore gets divvied up between labor and material (and thereby overhead in less sophisticated companies). So without being able to easily quantify it, our accounting staffs simply go after the easy labor/mat/OH dollars without digging deeper to quantify the waste... which makes me bang my head against the walls. I've now been in two profitable businesses that went down the tubes because of trying to cut labor cost, which destroyed and even reversed all Lean momentum. Accounting philosophy is now one of the major discussions I have with potential new companies.

Michael,

The folks at Price Waterhouse really need to read my book in its entirety, in addition to getting involved in the Lean Accounting Summit. I'll get 'em for you at cost - just read it. The lean area is crying out for the kind of financial leadership PWC can provide.

We have had considerable success capitalizing training and recruitment costs. Some of it has to be "book 2" as it isn't traditional GAAP, but it is still looked at by our executives. Easier to do in a private company. There is considerable pain, including a financial writeoff, when a highly trained employee leaves. It also lets us make good decisions of wage increase and salary vs the cost of someone potentially leaving. Converting direct labor to fixed cost is difficult and we haven't completely done it yet, but we can see the benefits and the light at the end of the tunnel. In reality senior managers should be the ones most at risk when sales go south... they obviously haven't planned very well.

I'm not as confident that a PWC will jump fully on board as they are too firmly entrenched with some Sloan companies. Kudos to Michael for trying to push the rope up the hill though.

I believe that the growth of temporary labor and temporary labor companies (Manpower) have gone a long way toward contributing to this problem. I believe that the balance of power between employees and employers has swung too far toward the employers and this will result serious problems for the employers. My beliefs are based on the following issues:

1) Managers have no ownership over new hires. They have simply picked up the phone and asked a temp service to supply people. The managers did not go through the exercise of hiring the person. You need to read the applications, interview the best options and then choose the individual that will best fit the company’s need. After all that work on hiring the individual, you want to make sure that they are the right person and they receive the necessary training to succeed. There is nothing more frustrating than spending all the time and effort to hire someone and then they do not work out. All this work and ownership is eliminated by the temp agencies. In industries effort to “outsource” all non-critical tasks, using temp agencies has essentially outsourced the most critical task a manager has – have the right people in the right place.

2) Employees’ start working at a company with the wrong objective. In the temp agency world, a new hire starts at a job and their objective is to become a full-time employee. With that objective, the temporary person works hard to impress the managers and hopes that through hard work they will be offered the full-time position. After they are hired what is their objective? I think that from the moment employment starts the objective of the new hires should be to accomplish the company’s goals. That could be continuous improvement, total customer satisfaction, six sigma quality or some other goal.

We all have fixed expenses (mortgages, college tuition, electricity, oil) and we depend on a regular income to pay for these things. Employers need to respect that and not play the headcount game without dire need. At the same time many employees have become more interested in their own compensation than the health of the company. Employees need to work with management to achieve the continuous improvement necessary to keep the companies healthy and, in turn, insure a steady wage for all employees.

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