by Marek Szwejczewski and Malcolm Jones
In our book, ‘Learning From World Class Manufacturers‘, we describe the approaches used by World Class Manufacturers to remain successful and competitive in highly challenging markets. While manufacturers must be competitive on Quality and Delivery Lead-times, these tend to be ‘qualifiers’, performance characteristics that are necessary but not sufficient for success.
Success increasingly depends on innovation in both product and processes, and process innovation increasingly focuses on finding ways to reduce production costs. There are however several issues faced by manufacturers when trying to determine cost reduction strategies. Some of these are accounting issues, with the best companies moving towards activity based value stream costing, which raises two basic questions:
What is the appropriate method for apportioning overhead to products?
What is the appropriate treatment of the value of inventory?
These two questions are linked, but let us start by considering inventory. One key principle of Lean Manufacturing is JIT – make what the customer wants, when they want it, and this applies to internal as well as external customers. A Lean factory is one with the minimum amount of inventory, however conventional accounting tends to see inventory production as beneficial to absorb overhead.
One case study we report shows inventory turns increasing by a factor of 6 – from ten to sixty in some cases, meaning we carry less than a week’s inventory, compared to more than a month previously. The same case study however shows equipment utilisation, and consequently overhead recovery, declining by 15%, from between 85% and 95% to only 70% to 80%.
Another case study showed a reduction in average inventory value of €20 million over a four year period. This equates to a cost saving of €6 million per annum assuming the annual carrying cost of inventory at 30% of inventory value, which is quite conservative (inventory carrying cost includes cost of capital, physical storage and logistics costs and obsolescence and damage).
The late Dr Shigeo Shingo, one of our Japanese Sensei, told a story of being shown an automated high bay warehouse system in California in the late eighties and, following a demonstration of the system’s efficiency in retrieving stored items, was challenged “I don’t expect any of your Japanese clients have this technology”. Shingo’s withering put-down was “none of my Japanese clients store so much inventory to need it!”
So how do our World Class Factories plan for cost reduction? We see evidence of two major approaches, Policy Deployment and Cost Deployment.
Policy Deployment uses an X-Type Matrix to link improvement strategies with financial gains. A typical matrix will have strategies on the left hand axis, linked to improvement projects on the top of the matrix. Each improvement project will have financial or non-financial targets on the right hand axis and these targets are linked to financial results on the bottom axis, linking back to the strategies, so we read around the X in the centre of the matrix by looking from strategies to projects to targets to financial results.
In our studies of engineering and electronics companies the X-Type Matrix is almost ubiquitous as a means of making the connections between strategy, improvement projects, targets and results. It is also an iterative process, like so much continuous improvement so that the relationships between the axes are refined as the process is used.
Cost Deployment is derived from the TPM (Total Productive Maintenance) philosophy of eliminating equipment related losses and is used more in highly automated FMCG industries where equipment utilization is an issue, although the approach can be applied to any industry. Many companies follow the definition and approach developed by Professor Hajime Yamashina during Japan’s ‘lost decade’ of the 1990’s. According to Professor Yamashina:
“Cost deployment is the method that establishes a cost reduction program, scientifically and systematically with the cooperation between the financial department and the production department:
(1) By investigating the relationship among the cost factors, process generating costs and various kinds of wastes and losses,
(2) By finding connections among waste, loss reduction and cost reduction
(3) By clarifying the know-how on waste and loss reduction is available and by obtaining the know how needed
(4) By ranking the items for waste and loss reduction according to priority based on cost and benefit analysis and then by establishing a cost reduction program for meaningful cost reduction.”
During this process a number of matrices are produced to identify losses, quantify their effects and then cost the negative effects. For example, the production group might classify their equipment losses and identify breakdowns on a particular machine as a major concern. The effect of these breakdowns on other parts of the process would then be quantified in terms of lost output, wasted energy, idle personnel, maintenance hours etc. and then working with the finance team the group would establish the consequential financial loss per hour of breakdown. A project to reduce breakdowns could then be properly costed in terms of cost benefit analysis based on current failure hours and planned future performance. The concept of causal and resultant losses is fundamental to this analysis – we are asked to calculate the overall effects of the failure of a specific machine, not just its own downtime cost.
As a final note, in our studies of innovation practices we have come across target costing strategies which use design for assembly approaches to reduce manufacturing cost at the design stage through simplification – reduce the number of parts in the product itself, and even reduce the number of parts in the equipment which will assemble it – design for maintainability and operability.
World Class Manufacturing approaches throw up challenges to conventional cost accounting and in our World Class Factories the finance department is responsible for assisting in strategic decision making by identifying which costs can be reduced through the use of the World Class Manufacturing toolkit.
Malcolm Jones is Co-founder, Productivity Europe
Marek Szwejczewski is Reader in Innovation and Operations Management and Director of the Best Factory Awards at Cranfield School of Management, Cranfield University.