3 Reasons why (certain) US Companies are Struggling

Ignorance and/or Lipservice to Lean & 6Sigma

When I'm out of sugar, I take the pack in the pantry, and put 'sugar' on the shopping list. Minimal inventory, never out of sugar.
When my son was 3 he helped me wash car wheels in the drive way. When the water bucket was too far away and he had to keep running back and forth to wet his sponge, he didn't ask for a bigger sponge so he didn't have to run as much. He moved the bucket closer. What a concept. And here we are in 2010 asking for bigger sponges in so many US companies.

The same companies will claim "yes, we're a lean company". This can mean that they are running scarce resources (typically manpower) or they may actually be trying to apply some lean ideas, but don't really get it.

6Sigma is taking on a whole new twist. Seems like everyone is pursuing or already a notorious Black Belt. I think belts are what holds your pants up. It's what's between your ears that matters. For what it's worth, we will at least have a belt-wearing army that speaks the language of lean and six sigma. Now all they need is the authority to really change things around, instead of tweaking process a little here and cutting waste a little there.

Bill Waddell makes a similar point on his blog http://www.evolvingexcellence.com/blog/2009/12/global-ignorance.html based on a study in The Economist.


Reliance on Standard Cost Systems

Unlike the lean perspective on inventory, inventory is better than gold for many finance and accounting departments and their respective heads of organizations. When you produce something, it becomes an asset. Assets are good. You can borrow against them. And as long as the ROA is decent nobody pays too much attention.
When you reduce inventory (with stable processes and other lean benefits), your balance sheet shrinks. Although cash flow is great, your 'profitability' actually suffers.
This is just one obstacle.

Another would be the stubborn focus on overhead absorption and variances. Besides bashing operations upside the head with every month's variance analysis, is there ever an endeavour into root cause analysis? Or do we just adjust overhead and labor rates for next year to minimize our variances?
The desire for overhead absorption leads to undesired activities, namely period end rushes to build something, ANYTHING, to make sure the accountants are happy. It's the sales department's job to sell it right?

I assume the most obvious use of standard cost would be to figure out what something costs. There's just a slight problem. Although any cost accountant can accurately determine a widgets cost to 4 digits after the decimal, it is rarely the true cost. Widely known as 'peanut-butter spread', the assignment of overhead arbitrary. And what does direct labor have to do with assigning activities such as material handling??
Incomprehensible to many, a widget's unit cost varies from week to week, if not daily.
The problem is that standard cost cannot even get close to the true cost.

And try to make decisions based on a cost structure consisting of material cost, direct labor cost, and an overhead portion. I guess you pressure purchasing to get better deals, you can't really do much about overhead in the short term, so you're left with increasing productivity and/or letting people go.

What about the rate of flow through all processes? What about capacity levels? What about the stability of your processes?


Outdated Leadership 'Styles'

Command and control. Don't let people think on their own. And God forbid they make a mistake. The intimidation of workers or managers is so great that they do as they're told and never step outside the box. Successful companies foster an environment that let's people experiment, and do not punish them if something does not work out, but make sure that the organization learns from the mistake.

Again, just one aspect, but in its entirety, Leadership is misunderstood, misapplied, and misguided by way too many people.

Dan Pink made a point on TED about it.


Some more thoughts added on Feb 1, 2010 - I found this in John P. Kotter's "What Leaders Really Do" (emphasis mine):

"A close examination of the day-in, day-out actions and responsibilities of a "manager" or "leader" will produce a picture that doesn't resemble anything like the "able manager" or "visionary leader" of our dreams. In "real life", effective executives spend a lot of time just talking to other people, including people who are not their subordinates. They deal in a broad sweep of topics rather than just their functional specialty, are much more likely to ask questions than give orders, and actually make "big" policy decisions only rarely."

Nice highlights of real leadership vs. the command-and-control still prevalent in too many organizations.

Best Practices in Strategic Cost Management

Under construction is a collection of Best Practices in Strategic Cost Management.

But first off, anyone who still believes that standard cost systems are adequate for today's management decisions need not read on, but first see the Strategic Costing quotes on Words to Lead By or the example on The Leadership Chronicles.

Everyone else can follow the link to Best Practices in Strategic Cost Management at http://strategiccostmanagement.blogspot.com/

"Overhead"

Strategic Management requires a shift in perspective when viewing "overhead".

The traditional view is based on a financial tradition of:

"CONTRIBUTING to Overhead (Absorption)"
Here we are trying to 'spread' the cost, to get as much 'out of it' as possible.
This leads to cost averages mixed into cost structures. The necessary detail of the cost structure is lost.

The perspective for strategic decisions needs to be:

"Overhead CONSUMPTION"
The key difference is the detailed link of what is actually consuming which overhead and by how much. Many items considered 'overhead' can truly be attributed to certain processes, products, customers, and channels. All of a sudden 'overhead' is not 'overhead' anymore.

This leads to profitability insights that can then allow proper strategic decisions about the respective 'overhead'.

Why Strategic Cost Management?

CEOs, Presidents, Owners, etc. always need to be examining, tweaking, and/or reinventing their business models towards maximum profitability. In order to do this, they need information about the cost structure and profitability of their products, processes, customers and channels.

It is crucial to know which parts (customers, channels, products, etc.) of the business are more profitable than others. Some parts may actually be removing profit from the bottom line. If all parts are considered to be adding to the bottom line, which parts add less profit than others? Because resources for these parts are underutilized and could be applied to more profitable parts.

Unless the company has a highly sophisticated ERP system with dedicated IT and analytical resources, this information is not readily available. Some companies have to rely on what they can get out of their standard cost systems, but these systems are typically designed for financial reporting, not strategic management decisions.

So, do you have the necessary detail, to confidently make these decisions?

• If you are sophisticated enough to have the information to make these decisions:
  - Is the information based on standard cost?
  Would you mind sharing your tweaks on the standard cost system to avoid averaging and cost distortion, and how you achieved the necessary level of detail?
  - If it is not based on standard cost, what types of analyses did you perform to arrive at the information?


• Your sophistication level is top of the line:
  - What actions has your team taken in the last 90 days based on the information you gather around customers, channels, products, and processes?
  - What other types of decisions do your team members make based on the data and information you have?
  - Are you able to attribute an increase in profitability to these actions and decisions? How would you quantify this?
  - If you decided not to make a certain change, what were your reasons for that decision?
  (for instance, why did company x NOT discontinue product line 5?)
  - How do you manage/incentivise/direct your sales force to go after the most profitable business?
  - How do you monitor changes in product mix and/or profitability? And how do you change your organization's behavior in light of any shifts?
  

Would you buy a Can of Coke (or Pepsi) for $1 Million?

Say there's a bottling/canning factory with $1,000,000 overhead or fixed cost. It has a capacity of 10,000,000 cans per year. Obviously the cost of one can is 10 cents (plus any variable cost, or we can assume here that it is 'fully automated').

What if (for whatever reason and just to prove a point) all year long, the factory just ran ONE coke can through the factory?
What is the cost of that can? Most people would answer $1,000,000. That's what cost accounting has drilled us to believe.

Well good luck selling that one can to consumers at a price that covers the 'cost'.

Shouldn't it still be 10 cents and there is a cost of $999,999.90 in unutilized capacity?
Standard cost systems do not capture such important considerations. This is especially critical in times of changing product mixes and volumes.

Yes, this example is drastic, but it proves the point. Relying on standard cost for pricing decisions can lead to devastating consequences:
The company starts inching up the sales price because "cost has gone up" --> customers are lost --> volume goes down further --> standard cost goes up more --> time to increase prices again --> the company has entered a death spiral.

This is happening as I type. Not as drastic as in the example, but across all company sizes, types, and industries. I am seeing it over and over again.
The batch of MBAs and ACC graduates that understand the threat are not in positions yet to impact a shift in senior executive awareness.

Click here to read Strategic Cost Management articles.

When Worlds Collide: Operations vs. Accounting

…in 2007 I witnessed a classic debate between operations and accounting:

Ops: Why is this standard unit cost so high [$1.25]? It used to cost 50 cents and we used to sell this for a buck!
Acc: The material price went up and the labor/overhead rate went up.
Ops: But that doesn’t make sense! What overhead rate?
Acc: $80 per hour of direct labor
Ops: What? What’s in there??
Acc: It’s labor + the overhead derived from spreading it over total labor hours
Ops: Is it $80 everywhere?
Acc: No, this is for the molding department. Every department has a different rate.
Ops: Molding? But this product isn’t molded!! There’s only a little glue sprayer that they use to apply the Velcro to the foam.
Acc: But the people in the molding department produce it so that’s the rate we use in the routing and it went up from last year’s $45 because you didn't utilize the equipment well enough.
Ops: But that doesn’t make sense! This product doesn’t USE molding equipment!!!

I hear and see this kind of interchange quite a bit. The numbers, products, and processes change, but the underlying disconnect is the same. Standard cost is inadequate for today's management and operations strategies. Hence the importance of Activity-Based Costing and other Strategic Costing methods. Standard cost is fine for the finance/accounting side of things. It is necessary to value inventory (until lean thinking can reduce it) and create monthly financials.

Finance and accounting folks are entrenched with standard cost methodologies, which is good for regulatory requirements sake. There are only a few who possess the right lens to see things different. But it is very important for management to see true costs, and make their strategic and operational decisions based on that.

"Traditional managerial accounting is at best useless, and at worst dysfunctional and misleading.“

John K. Shank

Noble Professor of Managerial Accounting and Management Control

Tuck School of Business - Dartmouth College

“[Traditional standard cost systems] are inadequate for managers and employees in today’s competitive environment.”

Robert S. Kaplan

Baker Foundation Professor at Harvard Business School