In practice, lean manufacturing is an operating philosophy that yields a number of long-term benefits that aren’t always obvious to those who are considering adopting it. The first thing most manufacturing entrepreneurs think when they hear the term, lean manufacturing, is “cost cutting.” This is especially true when a private equity investor is the first to raise the idea. But it’s just one of many misperceptions about “lean,” an approach that provides efficiencies to help a company grow and make it more investable.
Based on research of high performance companies at the Center for Strategy, Execution and Valuation in the Driehaus College of Business at DePaul University (Center for SEV), there are at least three major unrecognized advantages of instituting lean principles:
- The lean manufacturing process provides a simple framework for defining a company’s purpose and decision-making to reflect the needs of all stakeholders. The lean framework of engaging stakeholders in the co-creation of the company’s product-service strategy takes the guesswork out of strategic planning because it exposes ownership to other viewpoints that ultimately determine the company’s success. This is consistent with Return Driven Strategy, a framework for analyzing a business and prioritizing its plans so they are more executable and drive growth and profitability. A key tenet of this strategy is Map and Redesign Processes, a methodology for engaging all stakeholders—both internal and external—in clarifying, defining and achieving the organization’s purpose. This is particularly beneficial for small- to medium-size manufacturers (SMEs). Many SMEs are led by founders who make operating decisions based on their personal knowledge of customers, suppliers, employees and the market. There are many challenges to this approach, as illustrated by Terry Groff, chairman of Reading Bakery Systems. In a presentation for the Center for SEV, Mr. Groff candidly described how his company badly missed projections on each of its core business segments using a management-only strategic planning process—before adopting Return Driven Strategy lean principles.
- “Lean” results in a highly engaged employee culture. A lot of SMEs understand the need to engage employees to enhance productivity, recruitment and retention—all contribute significantly to financial performance. Yet many may not have the resources, beyond a human resources leader, for a sophisticated employee engagement program. “Lean” provides that because employees become stakeholders as they’re invited to participate in the Map and Redesign Processes. There is a fundamental shift in employee attitudes from fearing problems to celebrating and embracing them. That’s because employees engaged in the lean philosophy become frontline problem-solvers—a sustainable asset. Said Ken Iverson, CEO of Nucor (a “Good to Great” company): “I recall that we started a crew on a straightener machine…at a production bonus baseline of eight tons per hour. The rated capacity of the machine was 10 tons per hour. Well, that crew kept tinkering and experimenting. Within a year, their production was up to 20 tons an hour, twice that machine’s rated capacity.”
- Lean manufacturers can better navigate the competitive life cycle. Part of the “lean” process can include conducting a Competitive Life Cycle Analysis, which evaluates company performance to determine what strategies are needed during different phases of its life cycle. That means not getting comfortable with today’s success and having a roadmap for adapting to changing circumstances. This is vital for many SMEs because it mitigates the chances of getting caught off-guard and hurt significantly by a sudden downturn in the business. More so, it provides time for planning so you can ride a competitive wave rather than be thrown off course by it.
A great example of this adaptability is Danaher Business Systems, an unheralded high performance company that integrates lean thinking and continuous improvement to create sustainable competitive advantage. Danaher acquires smaller companies and improves them with its lean approach, called DBS: The Danaher Business System. Danaher began implementing “lean” in the mid-1980s, and has expanded its model as the company has grown. In a recent investor presentation, Danaher showed how integrating and evolving DBS helped grow the company from $90 million in revenue and a 20 percent gross margin in 1984 to $18 billion and a 55 percent gross margin today.
From the investor perspective, the benefits of SMEs embracing lean principles are substantial and include increased profits, decreased costs, efficiency gains and long-term growth and value creation capabilities.
According to the Lean Enterprise Institute, the core idea behind “lean” is: “To maximize customer value while minimizing waste.” The business benefits of “lean” are achieved because there’s less process waste, reduced lead time, less rework, reduced inventories, increased process understanding, improved knowledge management and lower costs.
These benefits are music to the ears of VC and PE firms, who are tasked by their investors to make the most efficient use of capital. But for PE firms in particular, there are less obvious advantages to investing in companies that use, or are willing to integrate, lean thinking. The most important is how it clarifies, defines and gives structure to the company-investor relationship.
Many SME owners need private equity to grow, but are concerned about losing control or inviting the PE firm into the company’s operations. The smart PE firm will use its own form of the Return Driven Strategy framework to evaluate the potential of prospective investments and as a tool to bond with ownership and management on an agreed-upon strategy that reflects the best interests of all stakeholders. Everyone operates from the same strategic framework, so the resources needed and expectations for performance are based in consensus—and not the capricious will of one party or the other. This helps reduce the SME owner’s concerns over what happens the day after a PE deal is signed.
Particularly for SMEs, adopting lean manufacturing principles can help make the most of limited resources, primarily by expanding ownership and leadership’s view of how to engage key stakeholders to focus on what’s needed and how to best deliver it. It’s a relatively simple process that often evolves into an operating philosophy with proven benefits, including engaged and active stakeholders who become central to delivering enhanced financial performance—and therefore opportunities for growth and value creation.
Eli Boufis is co-founder and executive principal of Driehaus Private Equity, LLC. Dr. Mark L. Frigo is Ezerski Endowed Chair and director, the Center for Strategy, Execution and Valuation in the Driehaus College of Business at DePaul University.