Oct 20, 2023 | Innovation, Management
Investing in dead horses sounds like a pretty dumb idea, but it happens all the time.
Projects, ideas, products, people, that have little or no probability of returning revenue and margin from the continuing investment should be stopped. Not only do you save the money and management distraction, but you have the opportunity to leverage the freed-up capacity against the opportunities otherwise passed over.
Opportunity Cost flipped to be just Opportunity.
Over the years I have seen many projects that have persisted long past any reasonable time, never seeming to move forward, but never getting the chop.
When resources have been invested in a project, particularly when it has a favoured place in the psyche of some manager, killing it is often hard, resources just get budgeted, absorbed, and ultimately wasted.
Voltaire observed that: ‘Perfect is the enemy of good’ This leads to the idea of Minimum Viable Product (MVP), getting an idea out to the market in some form to test if it really has sufficient traction to deserve the allocation of resources over alternative uses. ‘Ship and Iterate’ should be the cry, assuming that each time you iterate, you learn from the outcomes, and better understand the commercial reality you confront.
Prudent investors and managers take a ‘portfolio approach’.
They know that not all initiatives are equal. Differences abound in the resources they consume, the opportunity offered, and the odds that the opportunity as visualised will become reality.
Daniel Kahneman established quantitatively that we value what we stand to lose much more than what we stand to gain. This is the magic power of continuing to invest to avoid accepting a sunk cost. Flogging a dead horse by another name.
Stop investing in dead horses, they will not come back to life no matter how hard you wish it were different.
Aug 21, 2023 | Analytics, Management
Volume, flow, and capacity utilisation are drivers of each other, a symbiotic relationship articulated by Wrights Law.
A product with significant volume that is easy to schedule through a factory, and because of those volumes, has ‘well-oiled’ and efficient operational processes, generally delivers profit.
Years ago, I did a product profitability exercise on a range of products that were marketed by the company for which I worked at the time, Dairy Farmers Ltd. The parameters I used were based on the gross contribution to fixed overhead after promotional costs. These I calculated from the standard costing model being used at the time. Also weighted into the calculations were the complexity of the operational scheduling imposed by the products, and the ratio of gross contribution to the calculated capacity of the individual production lines, including downtime measures like machine availability.
The most profitable product in the range in both dollars and percentage was 300gm sour cream in cartons. It was a product that had significant and easily forecast volumes, so raw material procurement was simplified, predictable, the operational processes were ‘well-oiled’, and we had some pricing power in the supermarkets. There was very little wasted capacity or product failure in the manufacturing processes. Wrights law at work, and after a bit of thought, it made absolute sense that it would be the most profitable.
The second most profitable product in the range in percentage terms was a surprise to everyone, including me. A relatively small volume product, ‘Buttermilk’ in 600ml cartons. At the time there was no competitive product, so we had considerable pricing power, the volumes were highly predictable albeit modest, the ingredients simple and always available, and we could run the product immediately after sour cream with just a change in carton size which we could do ‘on the run’, the first few cartons acting as the ‘clean-up’ after the sour cream. There was effectively no downtime, no ‘start-up waste’ product, no added labour, few inventory costs, and no promotional costs. The capacity utilisation of buttermilk was virtually 100% of the capacity allocated by the arithmetic that combined volumes required and theoretical throughput rate and delivered margin.
Sadly for Dairy Farmers profitability, the supermarkets realised there was a profit pool they were not accessing. They introduced house brand products manufactured by a competitor who had idle capacity and took a marginal cost approach to the price at which they were prepared to sell the product to use that capacity. The volumes of both sour cream and buttermilk products fell quite quickly, while the operational costs per unit increased markedly.
Wright’s Law works in reverse as well.
The header is of Theodore Paul Wright 1895 – 1970
Jun 13, 2023 | Management, Operations
There is a simple answer, but the money is just a bit harder to find.
It is tied up in your current operations, consumed by all manner of things that do not add value to a customer.
Machine down time, rework, waste, on line inventory, double handling, and a host of other things that get in the way of a steady, predictable and continuous flow through a factory.
Progress to completion through a production process can only go as fast as the slowest point in the process. Working around these choke points entails either building WIP inventory, or slowing the faster parts down to the speed of the slowest part of the process. There is no third internal option, but ‘outsourcing’ the slow bits is sometimes a productive choice.
Progressive removal of any impediment to a predictable even ‘flow’ and you will save money. However, even more importantly, you will free up capacity that will give you the opportunity to sell more from the same fixed cost base.
That is where the gold hides: Money for nothing.
Do you want it?
May 17, 2023 | Analytics, Management
The ‘Long tail’ is a graphic recognition of the Pareto principle, the 80/20 rule. It holds true in every situation I have ever seen. Rarely exactly 80/20, but always somewhere in the region.
We tend to accept it as a reflection of revenue and profit: ‘20% of our customers generate 80% of our revenue’.
Often, we manage our businesses, particularly the sales effort, as if this is the only place the principle works.
It applies equally to transaction costs, long term potential, management attention, geography, product class, customer type, and many other useful to know indicators.
Take for example, those customers that in 5 years’ time will be amongst your most profitable. Chances are, they are currently hiding somewhere in your long tail, denied the focus and assistance they might value that will assist them to grow in importance, simply because they are not seen. I call them ‘Strategically Important Customers.’ Unimportant now by most measures, but critically important in the long term.
Ignore these customers at your peril.
So, how do you find them?
- They meet the parameters of your ‘ideal customer.’
- They have a problem to which you have or are developing the ideal solution.
- Your share of their ‘wallet‘ is low when they meet other ‘ideal customer’ parameters.
Conversely, set your sales team to dig them out of your competitor’s long tail, deliver value to them, and convert.
An equally important task is to identify those customers who cost more to service than their current or potential profitability. The best thing you can do is send them to your competitor, so they can be saddled with the usually hidden transaction costs and low margins.
The profit and Loss statement is, or can be, a remarkably efficient way of capturing the information required to focus resources in the most optimised manner, dictated by your strategy. A P&L by customer, product, geography, market, and any other driver can be generated using readily available and relatively simple tools. The challenge is in overcoming the institutional definitions of how the data for the statements is collected, collated, and presented.
For example, what is an overhead, and how is it allocated?
In a factory, is the cost of supervisory staff allocated to individual product lines based on the actual costs, some rough ‘standard’ cost, or not allocated at all? Are those costs seen as overhead? Is the total overhead spread across total production by some magical formula devised by the accountants, or treated as a cost centre and managed proactively? What about those directly on the production line? Are their costs allocated in proportion to production volumes, customer offtake, or some mythical ‘absorption’ rate?
Take the time to ‘slice and dice’ your Profit and Loss statement. After having tackled the greater challenge of having the costs as they are actually incurred reflected in the customer P&L statement, you will be in a great position to take decisions that will have a significant impact on your overall profitability.
May 5, 2023 | Leadership, Management
Amongst all the blather about remote work, there is an aspect that has received little attention, but in a couple of my clients is beginning to make itself known.
The ‘remote work’ idea is not applicable to everyone.
Office workers of all types are able to some extent, work remotely. They are saving commute time and money, childcare is more flexible, ‘family friendly’ and potentially delivering savings to their employers and to themselves.
However, those in factories, on building sites, driving trucks, are not able to work remotely, and find these benefits.
This is starting to cause friction. Those still punching a time clock, and subjected to the disciplines of shifts are starting to resent the freedom accorded to white collar workers.
During the covid lockdowns, it was OK, they understood. However, now the lockdowns are over, and the whiteys are still workingfrom home, or are they really working at all, or just logging in from the local café or pub?.
Why are they the lucky lot?
The benefit they are getting, dropping the kids to school, lunch with friends, and all the rest being denied to the blue collars.
They are getting pissed, and management needs to start considering the impact and implications of a differing set of expectations across the breadth of their workforce.
Apr 3, 2023 | Innovation, Lean, Management
The double entry bookkeeping system we are familiar with, or should be, has been around for millennia. In the form we now know it, double entry bookkeeping was codified by Franciscan monk Luca Pacioli, a collaborator of Leonardo da Vinci in a mathematics text published in 1494.
It remained largely unchanged, just increasingly complex until the 1920’s when Alfred Sloan, the king of General Motors for 50 years developed the system of management accounts we still use, with standard product costs as a foundation.
As the ‘lean manufacturing’ movement, pioneered by Toyota, extended throughout the western world from the late 70’s onwards, the system of standard costs became increasingly problematic.
It tends to set in stone the assumptions that are built into the standard product costs, rather than using them as a basis for continuous improvement. Even worse, management KPI’s tend to be centered around functional silos that have little to do with the overall productivity of assets in delivering value to customers.
I have been subjected to ‘stalking’ variances, those that seem never to go away, but persist in defiance of management edict many times. The easiest way to get rid of them is to adjust the standard. Not very smart, but accepted practice and often the only way to achieve KPI’s in a corporate environment. It also has the effect of hiding opportunities for improvement, and ensuring reliable data is not available in real time. In parallel, we have increasingly digitised operational processes by multimillion dollar installations of MRP (Manufacturing Resource Planning) and its more expensive sibling ERP (Enterprise Resource Planning) systems. These tend to set in stone standard costs and variances down to the micro transaction level contained in work orders, which complicates and adds cost to the reporting and management processes without adding value for customers.
One of the core ideas of Lean is ‘Flow’ which is at odds with standard costing systems. Standard costing gives precedent to operational efficiency at individual stages in a process, rather than flow through a whole system, ignoring varying capacity and efficiency constraints. This results in several usually uncomfortable conflicts.
Two examples:
- Lean seeks to reduce inventory of all types, raw material, work in progress and finished goods, seeing it as a cost, tying up working capital. Traditional accounting treats inventory as an asset, and when a Lean project reduces inventory, it reduces the current assets in the balance sheet, giving a misleading perception of financial performance.
- Lean focusses on capacity utilisation and ‘Flow’ through the processes necessary to create a product. Capacity is the key operational constraint, but does not appear anywhere in the general ledger other than by inference, as a function of capital invested, the calculated value of inventory, and unit sales. Delivering capacity is only of value when that capacity is used to add value in some way, usually by producing more product from the same fixed cost base. Standard costing ignores this reality of operational management.
There are no easily GAAP (Generally Accepted Accounting Practice) conforming measures for calculating immediate capacity utilisation, and flow, and no sensible calculation of actual product costs on a short term basis that conforms to the standard cost model. A second set of measures, which use the same data base as GAAP accounting, but in different ways is necessary.
While it will take work to set up these alternative measures, once deployed they will reduce the reporting workload and error rates inherent in the highly transaction based standard cost models, delivering both utility and accuracy to operational reporting and analysis. Deployment is however not like installing an ERP system, it is a process of continuous improvement.
Setting out to implement a Lean accounting environment in the absence of collaboration and mutual understanding at the senior executive level, is akin to climbing Everest in a t-shirt. Success requires a complete change of mindset from that taught by most accounting institutions where the concentration is on financial and reporting compliance, rather than gathering and critically analysing the information that enables better management decision making and continuous improvement.
Header credit: Nick Katco from ‘The Lean Accounting CFO’
