Can Lean Initiatives Move the Needle?

Simply stated – probably not, but maybe!

?Brian K. Higgins, Principal

Management Resource Technologies, Ltd.

[email protected]

Introduction

There are many LinkedIn postings and articles (notably in Industry Week) touting both the successes and failures of Lean and/or Lean Six-Sigma.?Of note, two articles “Why Do So Many Lean Efforts Fail?” by Phil Ledbetter (Industry Week, October 2020) and “Why Lean Programs Fails” by Jeffrey Liker and Mike Rother (Lean Enterprise Institute) both cite a 2007 Industry Week study which found that nearly 70% of all US plants used Lean, but only 2% of those companies achieved anticipated results.

There are numerous published articles on the reasons for Lean failures.?However, the majority of the reasons can be summarized into four major groups as compiled by goleansixsigma.com…

The purpose of this paper is not to rehash the numerous causes of Lean failure, but to present an alternative approach that achieves the failed promises of Lean and Lean Six Sigma (LSS) – an approach that will be demonstrated using a real-world case study showing actual study findings.

Lean’s Structural, Informational, Procedural, and Focus Deficiencies

The success of Lean and/or Lean Six-Sigma is dependent on additional factors associated with the structure of Lean: procedural failures; lack of information required to identify opportunities for financial performance; and narrow focus most often on the wrong or inappropriate improvement targets.?This paper will address these deficiencies one at a time…

Lean Structural Foundation

More often than not, Lean initiatives are relegated to mid- and lower-levels of the organization and are typically a “bottoms-up” approach, focusing on procedural improvements to processes and activities.

This bottoms-up perspective limits the attention of Lean teams to those processes and activities within the “vicinity” of the team, focusing on the removal of waste from processes – less material, less human effort, less time, less space, less energy, etc. As such, losing focus on those areas that are more strategically important to the organization.?Too often, Lean teams are improving processes that should not be performed in the first place, processes related to lines of business (LOBs) that are poorly designed and executed whereas even if all waste is removed, the LOB would still be financially “under water.”?This leads us to the next topic…

Informational Deficiency

Oftentimes, Lean teams depend on Finance to provide financial information in support of their efforts.?However, most organizations today – especially service organizations – have little, if any, reliable and useable cost information suitable for performance management.?Organizations simply do not know what their products and services cost nor the level of profitability they earn plus few insights necessary to validate the costs they believe are true and from which decisions are based.

Costing is more problematic in service organizations.?Unlike manufacturing, service organizations typically have not identified the factors necessary to assign overhead costs to their service offerings.?Since services are “manufactured” at the time of delivery they often require different levels of resource investment depending on the needs of the customer.?Kaplan and Cooper (Kaplan, R.S. & Cooper, R. (1998).?Cost and Effect – Using Integrated Cost Systems to Drive Profitability and Performance.?Harvard Business School Press. Boston, Massachusetts, pg. 17):

"Service companies, lacking tangible products, have no financial reporting requirements at all for allocating indirect and support expenses to the services they produce or the customers they serve.?Consequently, most service companies do not suffer from distorted cost numbers; they have no cost numbers at all since they do not measure the costs of producing their individual products, delivering their individual services, and serving their individual customers…nor do they know anything about the costs of the activities and processes they perform."

Oftentimes, the first place to seek understanding of the financial well-being of the organization is to examine the organization’s financial statements.

GAAP accounting, supported by General Ledger systems, is designed to capture costs at the functional/department level and although they can be structured for P&L data at a granular level (e.g., office or branch), they may not deal with indirect/overhead costs, overlap/duplication, value creation, or activity fragmentation.?Therefore, GAAP accounting provides little, if any, managerial insights that can be used to identify improvement opportunities.?That said, more detailed managerial cost accounting systems are required.?The most commonly applied cost-accounting systems are:

• Conventional Absorption Cost Accounting (ACA) – Having its roots going back to over a century, conventional absorption costing remains the dominant method that is used for costing products and services.?As the name implies, ACA is the method by which Overhead and Indirect (O&I) expenses are commonly “allocated” to, or “absorbed” by, the Lines of Business (LOB) or outputs of the organization.??O&I costs are allocated to the LOBs typically using metrics associated with each LOB.?Such metrics include direct labor costs, machine hours, number of employees, floor space, and revenues.?For example, LOBs having proportionately greater revenues often subsidize LOBs having smaller revenues that may, in fact, carry greater O&I expense – as typical of new and immature product and service offerings.?O&I costs, sometimes exceeding 50% of all spending, are typically aggregated then allocated to the LOBs using one or more LOB-identified metrics.?The major drawback is that resulting LOB costs may be grossly inaccurate as LOBs will be assigned costs unassociated with the creation, selling, and delivery of the specific product or service.?Also, changes in the metric’s volume may not necessarily be accompanied by a change in O&I spending.

Cited in the January, 2017 McKinsey white paper “Who Should Pay for Support Functions” – “…one of the basic problems with allocation practices: they often result in business units [LOBs] paying for costs that they cannot control [costs not incurred by the LOBs]” and “…what [leaders] want most from an allocation system is actionable information.”

Conventional Driver-Based Activity Based Costing (ABC) – ABC utilizes a two-stage process for costing LOBs.?First, resource costs are allocated to activities, then subsequently, activity costs are allocated to products and services which creates the potential for significant errors.

Stage 1, the first source of error.?Resource costs are allocated to the activities using resource drivers.?A commonly used resource driver is the distribution of total effort expressed as a percentage of time or Full-Time Equivalency (FTE) effort – “wages coming the GL system will be allocated to activities according to the distribution of total FTEs associated with those activities.”?A critical assumption is that the distribution of costs within a department is the same as the distribution of effort expended on the activities – this is most often not the case and as such activity costs can become significantly distorted.

Stage 2, the second source of error.?The manner in which activity costs are allocated to cost objects (e.g., LOBs, channels, customers, etc.).?A single principal Activity Cost Driver (ACD) is identified for each activity and an average cost per ACD is computed which is used to assign activity costs to objects (LOBs) based on the consumption of the number of drivers consumed by each object.?The two main issues associated with this approach are: 1) the selection of a single driver that represents the cost behavior of the activity when the activity may be influenced by a multitude of drivers, and 2) the use of an average ACD rate.?The ACD rate may be comprised of a wide dispersion of costs for which the average rate often is not representative of any individual product or service.?As a result, LOBs receiving the activity costs in this manner will be over- or under-costed (sometimes significantly) and as such making it challenging to identify targets for performance improvement.

Time-Driven Activity Based Costing (TDABC) – TDABC is a costing method that uses the time required to complete each step in a process to produce a product or deliver a service.?The cost of a product or service is determined by multiplying the total time required to complete a series of process steps by the capacity cost rate, whereas the capacity cost rate (expressed as a cost per unit of time) is determined by the total cost of capacity supplied (such as personnel; benefits; management; occupancy; utilities; equipment costs; and allocated indirect and overhead spending) divided by the practical capacity of resources (expressed using a unit of time) within a given time period.?Similar to ACA, indirect and overhead costs are “allocated” (in many cases in an arbitrary manner) such that they represent an overhead cost to the department that is performing the prescribed process.?Since managerial and O&I costs are blended into the total cost of capacity supplied, the activities associated with these O&I costs cannot be determined so the value resulting from such costs cannot be established.?Since many tasks that, at best, can be identified as “knowledge work” or variable in time consumption, such activities cannot be described in terms of specific process-step time and therefore, they cannot be adequately costed and yet may represent a significant portion of total spending.?To refer to TDABC as activity-based costing may be a misnomer as it does not follow the tenets associated with conventional ABC and more closely resemble Industrial Engineering process-based costing and ACA.

It is oftentimes believed that errors (over and under costing) associated with conventional driver-based ABC and TDABC tend to cancel each other, and any residual errors are insignificant and immaterial. On the contrary, such errors compound – profound errors in object costs resulting from inaccurate activity costs which, in turn, result from errors in resource-to-activity allocations are magnified and as such, resulting LOB costs that cannot be relied upon to make informed management decisions regarding areas targeted for Lean improvement.

ABC and TDABC have been used exclusively as tools for furthering the understanding of costs and profitability of products and services even though both produce unreliable information.?ABC/TDABC are NOT performance-improvement systems.?Using costs exclusively, without consideration of value, as the basis for management decisions regarding performance improvement will create a situation whereby “the wrong conclusions lead to the wrong solutions.”?Similar to conventional cost accounting and a primary tenet of Lean thinking, ABC/TDABC are often void of customer and employee experiential input necessary to determine value.

Focus Deficiency

The first step of the Kaizen/Lean process is problem identification which is often problematic.?Most often, especially without the benefit of financial or operational data, problem areas are often selected using brainstorming techniques based on “intuition” or noise (the squeaky wheel) and may not be the most opportune areas.?The most urgent, important, and significant areas that require attention should be based on the linkages between costs; profitability; and stakeholder satisfaction and loyalty – all of which provide the underpinnings of Lean and Kaizen.?As a result, oftentimes improvements are made to processes that should not be performed in the first place.?Because Lean is implemented in a bottoms-up manner, efforts are mostly directed towards operations or peripheral areas rather than more tactical targets such as strategic pricing; financial performance of products/services; addition or divestitures of LOBs; resource utilization; activity fragmentation; overlap/duplication; compensation; organizational structure; etc. - areas that are often off limits to most Lean efforts but are the matters that matter most to management - and a sure way to achieve and sustain management support and commitment.

Some prominent Lean advocates have stated that the identification of target problems or opportunities by the Lean team should only take 5-10 hours – hardly enough time to validate financials and obtain internal/external customer qualitative experiential input necessary to identify issues that may have been institutionalized over decades.?If the Lean team only spends 5-10 hours to identify target issues and rely on cost information from Finance that employs conventional managerial cost accounting systems such as absorption cost accounting (ACA), ABC, or TDABC which often generates false and misleading information, the Lean team may be basing their assessment on bad data and miss important opportunities that impact financial and operational performance.

A Solution – Value-Based Lean

A Unique Perspective of Lean Diagnostic Performance Assessment – Activity Value Management

Activity Value Management (AVM) – AVM is a new way of thinking about cost and the ultimate use of financial and non-financial information to identify opportunities for both performance improvement as well as targeting areas for expansion and divestiture (areas that most often are off limits to Lean teams).?AVM has its roots, not in accounting or quality, but in the integration of process/activity analysis following the tenets of Value Engineering.?As such, AVM extends beyond simply costing, but focuses on value creation necessary to improve performance while enhancing customer loyalty and employee engagement.?The focus of AVM…

More specifically, having the following objectives:

• Diagnose performance in terms of costs, profitability, customer loyalty, employee commitment, processes, and activities – identifying improvement opportunities that have the greatest potential to enhance the desired strategic direction of the organization – such a diagnostic assessment should be performed prior to launching, or revitalizing an existing, improvement initiative;
• Improve LOB costing and profitability measurement by eliminating the types of errors found in more conventional managerial cost accounting systems, necessary to assess the potential financial benefits (if any) of Lean initiatives;
• Identify specific personnel and non-personnel resources engaged in each process and activity necessary to identify non-mission-related effort and expense ;
• Focus on value creation and cost optimization rather than cost reduction;
• Improve customer loyalty while improving employee engagement and satisfaction – identifying specific changes that drive customer/employee value;
• Enhance resource utilization and productivity associated with the redeployment of resources towards mission-critical activities;
• Identify and develop the information that will garner management support and commitment by providing a compelling reason for change that dislodges the status quo, all necessary to counter any resistance to change.?Since management will not support changes they don’t believe in, the system must be both comprehensive and comprehensible with regards to the data necessary to inspire change.

These objectives are achieved by…

1. Using a revolutionary costing approach that directly assigns all organizational cost and effort simultaneously to activities, products, and services without any intermediate cost aggregation, averaging, or indirect allocations characteristic of more outmoded techniques.?All costs (including O&I costs) are treated as direct to improve accuracy and precision of costing and profitability assessment while preserving a bi-directional audit trail between all resource costs, activities, and cost targets.?Since all unbundled costs, gleaned directly from both the GL and HR systems are directly assigned, the outcomes match GL costs and, as such, may be considered as closely GAAP compliant.
2. Delivering a business assessment system that improves financial and operational performance by seamlessly linking qualitative experiential stakeholder input with activities, costs, and cost targets, then applying a unique set of prescriptive analytical tools to identify breakthrough opportunities for both performance improvement and/or divestiture.

Unlike most financially-based quantitative methods described earlier which are void of qualitative stakeholder input, AVM provides the connections between customer/employee commitment and organizational performance.

The AVM initiative follows a comprehensive and straight-forward project plan that is time and resource efficient…

Phase I – this phase represents the diagnostic performance assessment that is missing from most Lean initiatives, designed to identify the matters that matter most to management, consisting of…

• Step 1: Planning.?During this step, organizational information is captured; processes and activities defined; the data-collection schedule is developed; and the project is introduced to all management personnel.
• Step 2: Data Collection.?Quantitative data collection is performed whereby a profile for each resource component is established, defining the cost and/or effort attributed to the unique activities performed for each product/service target.?Note, for employees both the cost and a measure of effort are used, permitting measurements such as staffing by activity or activity fragmentation (defined as the number of employees engaged in an activity as compared to the FTE equivalent).???Qualitative experiential data is captured from stakeholders (e.g. employees, customers, customers of competitors, vendors, etc.) representing issues, concerns, roadblocks, and performance opportunities for which the information is also assigned to processes, activities, and product/service targets, providing a complete picture of financial and operational performance.
• Step 3: Synthesis.?Various diagnostic reports are defined, produced, reviewed, and updated if necessary.?Major opportunities, or themes, are identified in support of business strategies, goals, and objectives.

Phase II – this phase represents the prescriptive efforts to develop solutions for issues identified in Phase I, consisting of…

• Step 4: Data Analysis.?Diagnostic information is analyzed necessary to identify the most opportune areas either requiring corrective and/or improvement actions that would address the objectives of the Lean initiative.?Normally, the most important 5 to 7 target areas are selected for specific solutions which are closely managed by the AVM Implementation team.?The remaining opportunities are addressed on an on-going basis.
• Step 5: Solutions.?Specific solutions are developed including, but not limited to, financial analysis, resource requirements/responsibilities, milestone metrics, progress reporting, etc.

AVM Structural Foundation

The structural foundation of AVM is “tops-down,” focusing on the strategic performance of the organization rather than “bottoms-up” for which opportunities are somewhat limited to those areas in the “proximity” of the Lean team.

The Lean-AVM initiative reports directly to a “C-level” Management Oversight Committee (MOC) having the authority and responsibility for the entire performance-improvement initiative.?Reporting directly to the MOC is the Lean-AVM Project Manager and the Lean-AVM Diagnostic Team responsible for conducting the diagnostic performance assessment for which the assessment findings are reviewed, approved, and selected for implementation by the MOC.?In addition to Lean-AVM Diagnostic Team, the improvement targets are assigned to Specialist Staff, Lean, CI and Six Sigma teams for implementation – each implementation team also reports directly to the MOC – members of the MOC might also take a direct role in improvement target implementation.?The Lean-AVM Internal Facilitator supports all team efforts and reports to the MOC.?Another responsibility of the Lean-AVM Facilitator is for knowledge transfer of the Lean-AVM system necessary for expansion while eliminating the reliance on any external resources that may have been required for the initial Lean-AVM effort.

The Lean-AVM structure is tops-down, from which implementation of the target areas for improvement tends to be bottoms-up in the hands of those closest to, and most knowledgeable of, the areas targeted for corrective action.

A Real-World Case Study

Background

Prior to the Lean-AVM study, a financial services organization developed a new service offering designed to replace a Legacy system that had been the flagship of the business for several decades.?The decision to replace the Legacy system was based on the belief, supported by their ACA system, that this offering had both low and declining profitability.?Resulting from management’s perceptions, customers were in the process of being migrated (at the same transaction price) from the Legacy system to the Replacement offering which was believed to be, again using ACA, highly profitable.

In the midst of the customer migration, the company was also facing a $25M profit shortfall.?To mitigate this challenge, they embarked on several initiatives:

• Implemented Lean Six-Sigma – after spending nearly $1 million in training and about 1 year in implementation, they struggled with a slow start and little bottom-line impact which, in the words of the CFO, this effort did not “move the needle.”
• Hired a “Big-5” consulting firm – failed to quantify a perceived “revenue leak.”
• Unsuccessfully initiated an Activity Based Costing (ABC) study.

In addition to the financial shortfall, management expressed additional concerns regarding the:

• ?Lack of understanding of the true cost and profitability for their 15 lines of business (LOB).
• Flat revenue growth over the previous 4-5 years.
• High number of customer complaints and defections.

Following the Lean-AVM Job Plan…

Management formed both a Management Oversite Committee (MOC) and a cross-functional Lean-AVM Diagnostic Team for the purpose of identifying the most urgent and important target areas requiring corrective action.

The first task of the Diagnostic Team was to identify all organizational processes and activities across all functional areas, forming the foundation for capturing and categorizing all data that will be used in the diagnostic and prescriptive evaluation.?During the first two weeks of the Planning step, the Diagnostic team defined nearly 500 cross-functional processes, activities, and activity definitions using a Value Analysis technique that defines the sequence and relationships of processes and activities that will be shared throughout the organization:

The AVM Diagnostic team engaged the entire workforce through of series of managerial interviews and walk-throughs (Gemba) which directly assigned the cost and effort of nearly 2,400 employees and 7,000 non-personnel expenses to the activities supporting all 15 LOBs – costing was performed without using any pooling, aggregation, or allocations as used in conventional managerial cost accounting.?Captured 2,592 performance-related commentaries from employees, existing customers, and from customers that defected - commentaries related to issues, concerns, roadblocks, and opportunities all of which were assigned to the costed processes and activities.?The breakdown of the commentaries are as follows:

• 2,471 employee verbatims (captured from nearly 300 workplace interviews).
• 121 customer verbatims.

Each commentary verbatim was assigned one of several severity ratings, whereby the breakdown of the most serious rating was:

• 28 from customers (25 from defectors).
• 263 from employees.
• The majority of severely rated verbatims referred negatively towards customer support which pinpointed a major source of dissatisfaction and defection.

In Lean-AVM, target projects are based on a number criteria developed through the diagnostic and prescriptive assessment…

The Lean-AVM Diagnostic Team synthesized the information necessary to identify over three dozen opportunities related to improving financial/operational performance as well as customer loyalty and employee satisfaction.

The team presented their findings to the Oversight Committee to distill the opportunities down to the top 5-7 opportunities from which the MOC identified four major areas in which to concentrate…

The following summarizes the findings that corrects the misunderstandings of the current-state of Line of Business performance:

• Of their 15 LOBs, 4 LOBs (26%) accounted for 84% of the revenues.
• ?Of those 4 LOBs, the top-two accounted for 68% of the revenues.
• ?The LOB having the largest revenues was attributed to the Legacy system from which customers were being migrated to the Replacement offering – the Legacy system accounted for $185,037,221 in annual revenues (51% of the total) while the Replacement offering contributed $59,371,518 in annual revenues (17% of the total).

The First of Many “Ah-Ha” Moments – LOB Profitability…

Immediately after the quantitative and qualitative data was entered into the AVM system, the Profitability Analysis report was produced.

Of note, each cell within the following spreadsheet (referencing a specific activity and LOB) maintains a linkage to every individual resource cost, effort, and qualitative input permitting a bi-directional audit trail necessary to validate, understand, and assess the cost and value of each process/activity associated with each Line of Business.

Graphically depicting the profitability results, expressed as a “whale” curve, drew the attention of executive management…

Almost immediately, the above reports that provided the true cost and profitability of the LOBs solved the puzzle of the $25 million profit gap.?The decision to migrate customers from the Legacy system to the Replacement offering was based on a previous outcome from their Absorption Cost Accounting (ACA) system that pooled and allocated indirect and overhead (I&O) costs on the basis of revenues.?As such, since the Legacy system accounted for 51% of the revenues, it received a majority of the I&O costs – much of which, as this study identified, was not related to the Legacy system at all.?In essence, the Legacy system was subsidizing all the other LOBs, including the Replacement offering that had significant I&O costs which were not attributed to the Replacement offering.?Therefore, using the ACA costing system…

• Legacy system – over-costed & subsidizing less profitable LOBs.
• Replacement offering – under costed and was subsidized by other revenue-generating LOBs.

This discovery totally reversed management’s previous understanding of LOB profitability. That said, customers were being migrated from the LOB having a 45% operating margin (87% of total margin $) to one having a negative 13% (negative 8% of total margin $).?It was noted that if the revenues from the Replacement offering were generated using the Legacy system, profitability would have increased by approximately $25 million – the source of the profit gap!?THE WRONG CONCLUSIONS LED TO THE WRONG SOLUTIONS!

The solution was simple, curtail the migration of customers at the same transaction price, reprice the Replacement offering to produce a targeted margin then market this offering as a premium upgrade from the Legacy system reflecting the additional value of the features and benefits over that of the Legacy system.

Still Another “Ah-Ha” Moment – Customer Dissatisfaction & Churn…

Customer churn was a major concern of management, knowing that it represented a loss of revenues and a high cost associated with responding to the issues expressed by customers.??The process of “Supporting Customers” was costing nearly $24M annually (nearly 10% of total spend) yet garnered close to 500 experiential stakeholder comments which were cited as a major cause of customer defection as the following excerpt depicts.

The Diagnostic Team wanted to validate the perception that customer defections were running at a 17% churn rate.?What the team discovered was much more troubling than what was perceived.?This company provided financial services to retail establishments from which they derived their revenues from each client location.

What the churn rate signified was that 34% of the locations churned within 1 year while 58% churned within 2 years.?It was later discovered by the Diagnostic Team that a reason that previous-years’ revenue growth remained flat was because Sales was simply replacing churned revenues.

A cross-functional analysis found that “Support Customer” costs nearly $24M annually (about twice what was believed to be the cost of Customer Support) from which Sales contributed $13.6M while $8.7M came from Operations.

From Sales input, this effort represented nearly 200 FTEs, but the primary group responsible for customer service was not in Sales but resided in Operations – the cost and effort within Sales related to supporting customers was identified as being non-mission related and performed because of the lack of trust in Operations to resolve customer issues based on feedback from customers regarding issues that were not resolved by Operations.?Sales expended this effort to salvage discontented customers necessary to preserve revenues.?Unfortunately, customer dissatisfaction continued.?Also cited was the dissatisfaction on the part of Sales personnel associated with the loss of commissions from new sales due to the diversion of effort to customer support.?This non-mission diversion of Sales effort was eventually determined as a source of lost revenues of $45M annually.

The cost per FTE can be computed and used as an indicator to identify work activities that could be performed by lesser-compensated employees while freeing higher-compensated and more experienced employees to concentrate on more mission-critical activities.?In this case, the cost per FTE in Sales is nearly twice that of Operations who were primarily responsible for customer support.?Not only was customer support considered non-mission-related and duplicative in Sales, but it consumed significantly more cost per FTE.

Of the nearly 500 stakeholder experiential comments captured that related to customer support, many of which were negative as well as offering possible opportunities.?From a cost perspective, only about 11% of the cost in Sales was associated with supporting customers and end users as compared with 27% of the effort.

A 50% improvement in mission-related activities was achieved by shifting non-mission-related effort expended on supporting customers to their mission of generating revenues which resulted in an additional $45M production of higher-profit annual revenues – a remarkable achievement given that revenue growth had been flat for the previous 4-5 years.

To demonstrate the importance of capturing activity effort in terms of FTEs in addition to costs, is that activity fragmentation (e.g., the comparison between the actual number of employees engaged in an activity and the FTE equivalent) will identify excessively fragmented activities which negatively impacts productivity.?The following represents the fragmentation analysis of the activity “Determine Pricing & Profitability…

Using fragmentation, the Diagnostic Team discovered a policy issue as all pricing was to be determined by the Pricing Team (4 employees) to ensure that all contracts were profitable, unless the price was used as a loss leader necessary to gain additional business.?Another discovery made by the Diagnostic Team was that Sales staff was compensated based on a percentage of revenues for which the percentage was significantly increased after a threshold number of contracts were sold during a month.?This pricing “freedom,” as discovered in the fragmentation analysis, allowed Sales personnel to set lower contract prices until the threshold number of contracts were sold that would qualify for greater commissions based on a higher percentage of revenues.?A secondary study was performed on the contracts sold below the threshold number – a significant portion of these contracts were either sold at a loss or only contributed a modest margin.?In essence, the Sales staff was being compensated for the wrong behavior.?The Diagnostic Team continued to review the fragmentation of all organizational activities to discover additional improvement opportunities.

Another interesting outcome from the analysis of effort (FTE) between the Legacy system and the Replacement offering in terms of the revenues per FTE…

• Legacy system – revenues of $185,037,221 ÷ 748.37 FTE = $247,254/FTE.
• Replacement offering – revenues of $59,371,518/522.84 FTE = $113,556/FTE.
• Legacy revenues/FTE are 3.12 times greater than the Replacement offering.
• The difference in the Revenues/FTE between the two LOBs provides additional support regarding the unprofitable migration of customers from the Legacy system to the Replacement offering.

Getting Management’s Attention

A method emanating from the days of Total Quality Management (TQM) is the computation of the Cost of Quality (COQ), defined as…

Cost of Assurance – the cost of ensuring that quality is achieved, consisting of:

• Prevention – as the name implies, steps taken to prevent quality issues from occurring.
• Appraisal – checking and/or appraising to ensure that quality objectives have been achieved.

Cost of Failure – the cost incurred when quality issues occur, consisting of:

• Internal Failure – the cost incurred to fix quality issues before the customer receives the product and/or service.
• External Failure – the cost associated with correcting issues after the customer receives the product and/or service.?This cost is considered the most troubling, not just because of the costs involved but the reputational impact undermining customers’ confidence.

Unfortunately, it is an arduous task taking perhaps months to developing a system to capture COQ costs.?As typically the first step in launching a quality-improvement initiative, many such initiatives have failed before they really got off the ground due to the time required to develop the COQ.

With the Lean-AVM system, once the process/activity costs and efforts have been captured, it only takes hours, not months, to arrive at a highly-directional Cost of Quality.?The AVM Diagnostic Team mapped activity costs/efforts to the COQ categories for which the results opened the eyes of management to the need for supporting a performance-improvement initiative.

Real World Case Study Summary

The examples described previously only represent a fraction of the opportunities identified by the AVM Diagnostic Team and implemented by Lean teams.?The AVM Diagnostic team and Lean teams, working with other functional areas, took responsibility for re-pricing service offerings (both higher and lower) to improve profitability, re-designed the Sales compensation plan, identified LOBs that should be sunset, and restructured the number and location of Sales offices – all of which would have been traditionally considered “off-limits” to most Lean Six-Sigma teams.

Due to the discoveries attributed from a thorough diagnosis of total operational performance, the organization refocused their Lean Six Sigma initiative, and working in partnership Finance, “moved the needle” with regard to implementing over $30M (>11% of total spending) in repeatable financial improvements while achieving additional revenue growth of $45M (12.5% growth), both of which were accompanied by a significant reduction in customer churn achieved by enhanced customer satisfaction/loyalty – all accomplished without any negative impact on staffing.

A footnote: Given that the Replacement offering was developed in IT, it had no organizational “owner” that had overall responsibility for the offering’s performance.?The ownership of this service offering was assigned to a cross-functional Lean team that had total responsibility of all aspects of the service – pricing, marketing, etc.?Within a year or so, the Replacement offering had the highest margin as a percentage of revenues among all the LOBs.?A great example of an agile organization before agile became popular.

Summary

Why repeatedly implement Lean over and over in the same manner and expect different results??If Lean is to survive and flourish, it must be implemented in a manner that addresses the matters that matter most to the strategic direction and well-being of the organization and that a diagnostic financial and operational assessment is essential to guarantee that Lean and/or Lean Six Sigma will MOVE THE NEEDLE!