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Brian Maskell

Lean

The Best Performance Measure for the Manufacturing CEO

It’s in the flow of how you pull

Published: Wednesday, October 24, 2018 - 11:01

If you are a CEO of a manufacturing company with many value streams, it’s impractical to think that you have the time to review all the performance measures of every value stream in your company. Yet you need to know the operational impact of lean on your entire organization.

The traditional solution to this issue is to roll up or aggregate measures so the CEO sees just a few numbers to get a pulse of performance. However, rolling up value-stream measures doesn’t work because the aggregation of value stream measures really doesn’t mean anything. Each value stream is really a separate business unit with different products, customers, and operational issues. Because each value stream is an independent business unit, performance should be measured against future-state targets, which may be different for each value stream.

What I tell manufacturing CEOs and executive management teams is to focus on one measure: flow, as measured by inventory days or inventory turns. I believe this is the best indicator to let the CEO see the effectiveness of deploying and using lean practices, tools, and methods.

When a company commits to a lean business strategy, it means that pull systems will be used to manage inventory from suppliers, through production to the customer. Traditional companies employ many methods to “manage” inventory. Lean companies employ pull systems to minimize inventory throughout the business. If your company does replace traditional inventory management methods with pull systems, inventory days will go down significantly.

What I’ve seen in many companies is that they are selective in how they apply pull systems in their business. The initial focus is usually reducing work-in-process inventory in production. From a lean viewpoint, this is not too difficult to do. But many companies stop here and claim “victory” over inventory. But you as the CEO see that total inventory days for your company are not going down.

The real inventory problems in many larger companies are raw materials and finished goods. And I think the primary root cause of these problems is functional silo thinking in companies. Let me explain.

Purchasing or supply chain typically controls raw materials inventory. In a functional environment, supply chain leaders may focus their performance measures solely on their function. This is why many larger companies still use purchase-price variance as a performance measure. The focus on purchase-price variance is simple: The job of supply chain is to reduce material cost. The result is a supply chain function that is disconnected from operations. In a lean company, operations is the customer, and supply chain is the supplier. Supply chain’s job in a lean company is to create pull systems from suppliers to operations and minimize raw materials inventories.

Marketing and sales typically control finished-goods warehouses. In many larger companies, these warehouses are regional distribution centers that are supplied finished goods by many factories (which, in fact, may be very lean). In a functional environment, marketing and sales employees are concerned about availability of finished goods, so they plan finished-goods levels based on sales forecasts. These sales forecasts end up driving production in the lean factories because the distribution center places orders to factories. The result is high levels of finished goods.

There is not one solution to reduce finished goods in warehouses controlled by sales and marketing. Creating a pull system from finished-goods warehouses back to operations is one step. As orders are filled from a warehouse, it should send a signal back to operations to replenish the warehouse. Orders should not be placed based on forecasts.

Another step in reducing finished goods is changing the way sales and marketing plan finished-good levels. Finished-good requirements should not be based on a sales forecast because that is simply an estimate of what the company wants sales to be. Lean companies plan finished-goods inventory levels based on a combination of forecasts, lead times, and safety stock.

The final step to reducing finished goods is what I mentioned a few paragraphs earlier: Create effective pull systems from your suppliers through operations to your warehouses. The faster you flow materials, the less inventory you will need.

If you are a CEO of a lean manufacturing company, you should see significant reduction in inventory days. Figure it takes about one year to introduce lean to a small company, or a division of a larger company. In the first year, there is focus on training, education, and getting pull systems in place. After the first year, you should start to see reductions in inventory days of 20 percent or more per year. This means by year three or four, your inventory should be about 50-percent less than what it was when you began the lean journey. If you are not seeing this, your company is not employing lean practices the way it was meant to.

First published on the BMA blog.

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About The Author

Brian Maskell’s picture

Brian Maskell

Brian Maskell is president of BMA Inc., providing consulting on the accounting and management system changes needed for companies pursuing lean manufacturing and other lean methods. These changes include lean performance measurements, value-stream accounting, “plain English” financial statements, and lean-approach decision making to sales, production, procurement, supply chain, product development, and administrative processes. Maskell is an author, speaker, and trainer, presenting in videos and at venues worldwide. He’s authored many articles published in business journals and eight books including Practical Lean Accounting (Productivity Press, 2011), Making the Numbers Count (Productivity Press, 2009), and The Lean Business Management System (BMA Press, 2007).