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Mike Micklewright

Quality Insider

At the Heart of Steroids is “ROI”

Short-term gains, long-term damage

Published: Tuesday, November 16, 2010 - 06:00

Just imagine for a moment that you are a major league baseball player in 1990. If you wish, you can even choose your name and position. Perhaps you would like to be a pitcher, let’s say, Dodger Lemens, or a hitter, perhaps Marcus McWired or Al Roidriguez. You want to improve your performance because you know that you don’t have that many years left to play ball and you’ve heard so many great things about how steroids can improve one’s performance. But you do the right thing. You ask the advice of a business consultant first. The business consultant performs a return on investment (ROI) analysis and determines that the payback is two years, which happens to be the same time that your next contract is up. A two-year payback is a no-brainer. You’ve done the responsible thing by hiring a business consultant to perform an ROI analysis and his advice is to take the performance-enhancing steroids (just what you wanted to do anyway). Two years later, after your career has been revived and you are setting records, you receive a nice big contract with the New York Yankees.

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You have another few great years but your performance starts to degrade with age. You take more steroids to avoid the onset of age. You bulk up. If you’re a woman, you look more like a man. If your man, you look more like a monster. You finally retire after setting several records. Your retirement is bittersweet though because the public now knows more about steroids and believes you cheated, and that it wasn’t really you who threw all those strikeouts or hit all those home runs—it was the “roids.” You can’t reproduce offspring. You burn through several relationships as you become more and more physically aggressive. You go to jail. You become jaundiced and you die of a heart attack at 45.

At the heart your unhappy final years and early death was not the steroids; it was an ROI.

It’s not the steroids that kill people, it’s the ROI.

If this is true with an individual, isn’t it then true for an organization? Over the past decades of the modern business era, we have grown used to completely relying on ROI analyses, and the entire toolbox of financial and accounting systems that are focused on short-term goals, a practice that is prevalent in many nonlean-oriented companies. But isn’t it only good for short-term performance and destructive to the long-term health of an organization? The answer to this question is a resounding, “Yes.”

In Rebirth of American Industry(PCS Press, 2005), authors William H. Waddell and Norman Bodek “identify Pierre DuPont’s return on investment (ROI) formulas, the critical factor that prevents U.S. manufacturing from becoming as lean as the Japanese.” What’s most important to a lean organization is cash flow. Henry Ford, the original lean pioneer, used to say that if there was more money in the bank at the end of the week than at the beginning of the week, it was a good week. This is how a lean organization makes its decisions, and this is how a small machine shop is run and how your own family household is run. Most families (and lean organizations) make purchasing decisions—whether it is a vacation, a vehicle, or a toy—based on cash flow and not based on balance sheets, income statements, and stockholder ROI analyses. So why doesn’t your organization do the same?

By the way, did you choose your spouse based on an ROI of three years, while ignoring the long-term interests and being together in “sickness and in health,” which would probably only happen after the three-year payback period anyway? I hope not. Perhaps that is why our divorce rate is so high anyway—we look for a three- to five-year payback (when our spouses are “hot” or “cool”), rather than the long-term qualities in a person.

“Lean all the Enterprise”

I recently provided a couple of keynote presentations at an American Society for Quality (ASQ) conference in Santa Clara, California. I also attended a number of the individual sessions to increase my own knowledge. One session that caught my attention was called “Lean all the Enterprise.” The presenter, a certified public accountant (CPA), spoke of the need to focus on waste reduction efforts on the second-biggest line item on the profit and loss statement—nondirect labor (after cost of goods sold). In and of itself, this is not bad advice since there is, generally speaking, so much waste in nondirect labor. However, being a CPA and having an accounting background, his approach was to use the analysis of ROI to justify the elimination of waste.

The presenter spoke of one example in which the wasted time and salaries of 20 office workers was used in an ROI analysis to justify buying 20 printers (at about $100 each), one per employee, instead of having one big centralized network printer that everyone used. The presenter then proudly exclaimed that the ROI was just 14 days.

If management needs to have an ROI done to justify a $2,000 expense with a payback of 14 days, then that management doesn’t know what it is doing and doesn’t understand the true essence of lean and process orientation. Management should be about seeing the waste, understanding the process, always making improvements based on process flow, without the need to perform a short-term ROI analysis.

Upon hearing this story, I raised my hand and when called upon I said, “Some people would claim that quantifying financial improvements is nonvalue-added itself.”

“It is necessary to speak the language of ROI in U.S. companies,” he replied defensively.

“But, should it be?” I retorted.

He did not answer.

The shame of it is that he is unfortunately right, but I would personally try to fight the issue instead of placing a Band-Aid on the problem. In other words, performing an ROI analysis in U.S. companies is a Band-Aid and a nonvalue-added lame exercise in which one makes up numbers to justify eliminating waste. It is a bandage to top management’s lack of understanding of the true essence of lean and the need to constantly improve the process for the long-term, not just in the next three years.

Lame exercise?

Why do I use such harsh words when referring to an analysis process that has existed as an institution in U.S. business for many decades? Because as anyone who has participated in performing an ROI can attest, an ROI is an assortment of made-up data based on extremely subjective assumptions and exaggerations for which the true results are truly unknowable, only to find the set of numbers that best works to justify what one wants to obtain in the first place. It is lame.

It is wise to remember the words of the late great W. Edwards Deming when discussing the value of ROI, “But he that would run his company on visible figures alone will in time have neither company nor figures.”

In other words, get out of the conference room or office and “see” the value in making process improvements and the waste in not doing so. The important figures are not knowable.

Deming also said, “Actually, the most important figures that one needs for management are unknown or unknowable, but successful management must take account of them.”

In other words, unsuccessful managers think the most important figures are knowable and can be quantified in an ROI analysis.

Deming also said, “He should know before he starts [process and quality improvement] that he will be able to quantify a trivial part of the gain.”

In other words, no matter what the payback is calculated to be for process and quality improvement, it will be far greater than anyone can calculate it to be, if it improves process flow and quality.

So then why do an ROI analysis? Or as a more specific singular example, how does one really calculate or put a value on improved morale resulting from working in an environment of which one can be proud? It is impossible.

The first principles of The Toyota Way and Deming

The very first of 14 principles from Jeffrey Liker’s book, The Toyota Way (McGraw-Hill: 2003),  is: “Base your management decisions on a long-term philosophy, even at the expense of short-term financial goals.”

It is perhaps the most important of all 14 principles and yet is the easiest to veer away from, because of the natural short-term human instincts to be greedy and arrogant. It is the principle that Toyota itself lost sight of in recent years as arrogance set in and it stopped listening to its customers’ problems, and as greed set in and the goal of becoming the biggest producer of automobiles overrode the principles that once made the company successful.

At the risk of being obvious, an ROI analysis doesn’t even come close to supporting this principle. In fact, one could say that it does exactly the opposite.

Toyota had learned a great deal from Deming. Deming’s first principle of his famous 14 Points for Management is: “Create constancy of purpose toward improvement of product and service, with the aim to become competitive and to stay in business, and to provide jobs.”

The constancy of purpose is not to increase short-term shareholder ROI. It is toward improvement (which would actually increase shareholder value far more in the long-term than by focusing on short-term shareholder ROI first). ROI and traditional accounting methodologies are more concerned with increasing the present day value of the company (including increasing inventory), as if the company would be sold today, rather than being competitive, staying in business, and providing jobs for the future.

A couple of examples

Case study 1
An engineer within a company where I recently worked as a consultant received approval to buy a computer numerical controlled (CNC) vertical machining center after many months of submitting purchase requests. The requests were rejected because the machining center was believed to not offer a payback. This company—a good one—but a typical U.S. company in that it relies on ROI analysis for decision making, manufactures widgets and also builds the equipment that makes the widgets. Needless to say, it’s a vertically-oriented organization. The CNC center would be used for machining the parts to build the equipment. This would free two of the builders from observing a lathe or mill, and allow them to assemble, test, and debug the equipment (their core competency) while the necessary parts are being machined. The engineer showed that in just seven months—based only on the time saved by enabling two machine builders to assemble and test the equipment instead of machining—the CNC center would be paid off.

With an ROI of just seven months, it seems obvious that the decision to approve the purchase would be made without wasting months haggling and politicking within the highest levels of the company and developing multiple ROI analyses. If the costs of not politicking and the needless justifications had been factored into the ROI, the payback probably would have been more like four months.

The engineer pointed out that the additional benefits of purchasing the CNC center include higher quality of parts, fewer rejects and rework, producing machines faster to further improve the efficiencies, effectiveness, and quality for internal customers (huge financial benefits), and fewer administrative and transportation costs than when parts are made by a sister company. It is impossible to calculate benefits if they are unknown, yet wise management takes unknowable benefits into consideration. In Deming’s words, the engineer only “quantified a trivial part of the gain,” and even that was huge. So why is it necessary? This is what management needs to answer.

Case Study 2
In my book Out of Another @#&*% Crisis, (ASQ, 2010) I describe how years ago, when I worked as a manufacturing engineer, I worked for a company that lived by the ROI analysis. At this particular location, we were assembling aerosol valves on high-speed assembly equipment. For a particular product line, there were four subassembly machines that assembled two internal plastic parts to a spring. These subassemblies were fed into boxes and stored as a part number. The boxes of the subassembled parts would then be brought to the main assembly machine and dumped into a feeder bowl to be assembled into the valve itself on the much larger continuous motion assembly machine.

I had initiated a project to eliminate the four subassembly machines by incorporating their functions into the main assembly machine, thus getting rid of machines, inventory, nonvalue-added transportation, mixed parts, waiting for components if planning was not accurate, and freeing up a lot of floor space.

It was a lean project before the term lean manufacturing existed. It just made sense. And yet, my boss made me perform a very painstaking ROI analysis. He not only made me perform studies to back up my claims, but he rejected my ROI analyses at least four times. Each time, I had to go back to the drawing board to redo my ROI analysis. After about three months, the project was approved and it turned out to be successful.

Still, most of the numbers were made up or projected. The entire project just made sense for the sake of the process and the elimination of a lot of waste. I think my boss also believed the whole project made sense, but he wanted me to learn the world of the corporate ROI analysis and how to justify a project. I learned it, but I also learned that it was a complete waste of time and delayed the project for months.

The invisible figures—those difficult to quantify—including the cost of inventory, the cost of money, the cost of lead times, the cost of mixed and obsolete parts, the cost of storage and space, the cost of packing the parts in boxes, the cost of boxes, the cost of transporting the parts to and from the warehouse, the cost of parts spilling, the cost of handling, the cost of maintaining part numbers in the system, the cost of human frustration working within a difficult system, were huge. This alone should have justified the project without having to perform a costly ROI analysis.

Conclusion

Many lean-minded companies will do whatever it takes to improve the process without justifying the return. What’s good for process flow is what’s good for the company, they unrelentlessly believe. This belief needs to occur more in U.S. business. Management needs to understand the focus of continuously improving the process and material flow and they can help to do so by eliminating the need to perform many short-term ROI analyses—a very difficult task indeed. This task is a huge part of management’s job— to lead the transformation away from a short-term focus on ROI, a typical short-term steROIds approach—to a long-term focus of continuously improving the process, improving quality, and thus improving throughput, and driving out waste (and politics).

Discuss

About The Author

Mike Micklewright’s picture

Mike Micklewright

Mike Micklewright has been teaching and facilitating quality and lean principles worldwide for more than 25 years. He specializes in creating lean and continuous improvement cultures, and has implemented continuous improvement systems and facilitated kaizen/Six Sigma events in hundreds of organizations in the aerospace, automotive, entertainment, manufacturing, food, healthcare, and warehousing industries. Micklewright is the U.S. director and senior consultant for Kaizen Institute. He has an engineering degree from the University of Illinois, and he is ASQ-certified as a Six Sigma Black Belt, quality auditor, quality engineer, manager of quality/operational excellence, and supply chain analyst.

Micklewright hosts a video training series by Kaizen Institute on integrating lean and quality management systems in order to reduce waste.

Comments

How do you prioritize?

Mike,

I agree with the premise that too much value is placed on ROI as a toll gate for projects; however what would you suggest a company use to prioritize improvement efforts. There are always a limited amount of resources and not all projects can be the highest priority, would not ROI or a similar tool be appropriate to identify the most bang for the buck?