Wednesday, February 22, 2012

A Problem with Lean and Six Sigma

Any operational improvement program suffers from the same problem: a narrow definition of value. Lean's main premise is to improve the ratio of value-added activities to total activities. The proponents of Lean define value as that which the customer is willing to pay you to do. To increase this value, you are reducing expenses, sort of. (The 'sort of' is a different paradigm on fixed and variable costs and what really is saved through process reduction time, and what is not saved.)

Many proponents complain that the support from the executive suite is anemic. That's because operationally the definition of value doesn't match the definition of value used in the executive suite. The value that the executive suite focuses on is the enterprise value. This is increased when 'discounted cash flow' is improved, or income capitalization is improved. They want increased Return on Net Assets or Economic Value Added (EVA)--the latter which is the difference between net operating profit after taxes and a portion of the capital investment. Value is that which increases the share prices. Some of it's earnings, but more is related to how much cash can be generated in the future, and not consumed by inventory, accounts receivables, fixed assets and operational and administrative expenses.

Saving a minute on one part of the process doesn't increase value because the person doing the work is still getting paid. Cash is still being spent.

Speeding up the rate at which customers pay you does increase value. Less company worth (asset and equity) is tied up in unpaid bills sitting on someone else's desk.

For Lean and Six Sigma to get the executive suite's attention, it has to be tied into the enterprise value a big way, not in a small way only concerned with operational waste.

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