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Quantifying Lean Benefits: 5 Steps to Better Process-Cost Understanding

May 5, 2014
A financial activity analysis is a powerful adjunct to the technical analysis of lean manufacturing. It answers the question: How much are we saving if we make changes?

It is imperative to predict or at least know the quantified financial benefit of the Lean Journey.  

Often, firms can show improvement in terms of cycle times and setup times, but the expression and visibility of these improvements in real and precise financial terms is often missing.

In a manufacturing firm, revenue is generated and costs incurred through the performance of activities.   An activity is the fundamental unit of production within an enterprise because resources are being consumed to carry out necessary processes.  Activities are the discrete operations and tasks that make up processes. They are the necessary work operations that result in products and other process outputs.  

Given this, it should be possible to conduct an activity-based analysis of value-stream processes that shows how costs are being incurred.

This analysis has the objective of tracing costs to specific activities in the value stream. In addition, by identifying the cost drivers at the activity level, it is possible to determine how costs are being incurred. Under this approach, it is then possible to express process activities in both technical and financial terms. 

Most importantly, we are able to fully understand what financial benefit will result when a specific activity is improved or eliminated.

While there are many approaches to implementing activity analyses, a method that complements the Lean Journey is made up of the following key steps:

1. Identify the value stream.

If it is a mixed-production environment, where a mix of different products is flowing, a product-line analysis is performed to identify the main product families, their process flows and their demand attributes.

2. The value-stream of each product family is mapped.

All key processes are mapped and process data (such as demand rates, takt time, process-cycle times, setup times, defect rates and inventory data) are added to the map.

3. Once the value-stream map is completed, analyze each activity for every process.

 This involves identifying all relevant process costs to establish a capacity-cost rate (the cost incurred to supply the process capacity per unit of time).  We should also include an activity tear down of the process to identify and quantify the key activities which are performed to produce the process outputs.  Costs are then traced to specific activities using the process capacity-cost rate.

4. From the process activity analysis, a fully costed activity model of the process is built. 

This will show the dollar value of the non-value adding activities. Unused capacity is also identified and dollarized.   This will result in a “Cost of Waste” for each process, showing how lean the process is in dollar terms and highlighting the potential for cost reduction.

5. The opportunities for improvement are identified, prioritized and planned based on the activity analysis model.

Typically, the non-value adding activities are ranked in terms of their cost contribution, from highest to lowest. The non-value adding activities with the highest cost burden or contribution are then selected for kaizen, assigned to a process improvement project team, and moved through successive plan-do-check-act cycles. At the conclusion of each cycle, the process is re-measured and the financial savings predicted by the activity analysis are confirmed.  

Activity analyses are extremely useful for highlighting the financial costs of excess process capacity or cases where there is insufficient capacity. In cases of excess capacity, the cost of the supplied, but unused, capacity is highlighted. This shows management where costs are being incurred to supply a capacity that is being underutilized and thus not contributing to profit.

 In those cases where insufficient capacity exists, an activity analysis can show how much process costs will increase as decisions are made to supply extra capacity.

Too Skinny, Lacks Robustness

It is important to note that a process can be made too lean. That is, a process may be made too skinny where it lacks the necessary robustness, responsiveness and flexibility. Activity-based analysis holds to the same basic principle -- that it is impossible to reduce all process costs to zero.

The objective is to remove all the costs associated with non-value added work and reduce the process, as near as possible, to pure value added process activities.

A financial activity analysis is a powerful adjunct to the technical analysis of lean. It answers the question: How much are we saving if we make changes? This is a key question that is difficult to answer without the financial information it reveals. The financial activity analysis also provides power and punch to the lean effort by targeting improvement efforts where they will have the greatest cost benefit.

Jason Piatt is president of Praestar Technology Corp., a provider of consulting and training services to manufacturers in the Mid-Atlantic region specializing in lean, Six Sigma & strategy formation.

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