Reducing Cost and Increasing Profitability in a Down Economy

By: Yaron Lew

March 2009

These days, as the economy is rapidly slowing down, companies need to and are vigorously pursuing cost reduction. The question is whether the cost reductions adversely impact operational efficiency.  It is vitally important that while a company is carrying out cost reduction efforts, it simultaneously undertakes improvement efforts that will enable it to improve productivity from existing resources.  Productivity gains will enable companies to meet market demand while operating resources less, thus reducing cost, increasing asset utilization and improving profitability. 

Flow Management Technology (FMT) is a methodology that uses the power of flow physics, incorporates an understanding of the causes underlying the chaos theory and a deep knowledge of process management to make every operation leaner and more efficient with lower cost.  By focusing on creating fast, smooth and profitable flow, FMT can improve any operation.  The implementation of FMT will guide the efforts to methodically reduce costs in the short term, mid term and long term above and beyond any reductions already achieved by other improvement techniques.

In the past, companies embraced FMT interventions with the view that additional market share could be gained once capacity was increased and past due orders were eliminated.  Even though the interventions were successful and additional sales were, in fact, achieved, the business climate has changed. Increasing market share is not the driver for current FMT interventions. Further cost reduction and improving the bottom line are.

The Global Perspective

            Today, the worldwide manufacturing capacity is greater than demand. To stay afloat, companies must look to ongoing cost reduction.  There are numerous ways to reduce cost.  However, in today’s environment most companies are furiously rushing to cut costs, without a methodical way of going about it.  More often than not, the end result leads to a decline in customer service and satisfaction. During a down turn, companies need to put greater emphasis on achieving high customer service, to preserve the current customer base and gain additional market share. On time, lead-time and quality cannot suffer due to cost reduction activities or the down turn will be accompanied by a loss of customers. Cost reduction should be done with a global perspective along with global measurements.  If the measurements are local, the cost reductions may appear to be very good locally but may be hurting the business as a whole. If cost reductions negatively impact on time, lead-time, inventory, quality or even customer perception, less than desirable results could follow.  FMT provides both a philosophy and a methodology to continuously reduce costs while improving lead time and on time performance, reducing inventory and improving asset utilization.

The Basics of Flow Management Technology

Business Technology Management (BTM) has assisted numerous companies in improving their operations through the implementation of Flow Management Technology since its inception in 1987.  In every implementation, a cross-functional self directed team was created and trained by BTM in the principles of FMT.  The team then took a leadership role in the Analysis of the business and Design of a Business Flow Model.  The Flow Model design is the product of the analysis and defines how the Flow system should operate.  It includes:

· Process simplification and redesign

· Disruptions analysis by cause

· Capacity statements of key resources

· System capabilities and capacities

· Provisions for reserve capacity at every resource

· Locations and size of the time (Strategic) buffers

· Location of the Scheduling/Control points (Valves)

· Establishment of measurements, feedback loops and necessary reporting

· Flow Families definitions and their inter relationships

· Selection of a common denominator (equivalent unit) among Flow Families for defining capacity, loading, scheduling, and measuring throughput, inventory and lead-time.

· Loading and scheduling methodology

· The designed lead-time

· A comparison of Key Resources Actual Capacity to current or projected Demand

The Flow Model Design sets the framework and stage for implementing the five key principles of Flow Management Technology: Reserve Capacity, Valves, Strategic Buffers, Vacuuming and Feedback Loops.  Flow Management Technology introduces enhanced measurements to provide the basis for seeing individually and collectively, the absolute values and trends of overall system performance. 

A good improvement program will result in positive trends of On Time, Throughput, Schedule Adherence and Quality coupled with decreases in Lead-Time, Inventory and Cost.  It should be noted that the frequency of measurement is of vital importance.  In general, to have a good control of the system, each measurement needs to be monitored at intervals no greater than one quarter of the lead time.  High frequency of monitoring will enable triggering of corrective actions close to “real time” and ensure that the process does not diverge out of control.

One of the toughest challenges in a down turn economy is to insure that all processes are moving fast, keep reducing the lead time and keep improving on-time delivery.  It is human nature to “hoard” inventory during a slow-down.  Workers like to know that they will have something to work on tomorrow.  Nobody likes to run out of work and be seen idling while waiting for work to come to them from preceding operations.  Because of this natural human behavior, as demand is reduced, we see lead times start to extend and on-time performance slip.  This, of course, is exactly opposite to what one would like. 

 Anytime the system has capacity that is greater than demand, there is a capability to “vacuum” the work and inventory through, thus reducing in process inventory and overall lead time.  To improve process efficiency and fight the human tendency to slow down, local measurements are established to monitor each resource’s performance (again at high frequency of monitoring).  The local measurements are:

· Throughput Efficiency

· Vacuum efficiency

· Schedule adherence

· Strategic Buffer’s efficiency

Workers and management need to be trained in operating as a “vacuum.”  FMT helps operations use “vacuuming” as a driver for improving overall performance.

Throughput Increases Lower Costs

All Flow Management Technology implementations/interventions netted increases in throughput, reductions in inventory, reductions in customer order back log and past due plus creating opportunities for additional sales and avoiding or delaying capital expenditures. Significant throughput increases were achieved even in organizations that had already improved and were considered world class.  In today’s economic climate, the challenge is to use increases in throughput to lower cost.

One of the outcomes of the Analysis Phase in every intervention is identification of immediate opportunities to increase the system throughput.  These increases are the result of process simplifications and the reduction of the causes of disruptions that impede the overall flow.  Short term improvements will show in a matter of 2-3 months, with cash flow improvement and an acceleration in inventory turns. This translates to savings in inventory carrying costs: the cost of money, taxes, insurance, physical handling, warehousing expense, etc.  Lower scrap/rework results from inventory reductions and with it, a savings of their costs. Furthermore, inventory reduction reduces the manufacturing lead-time. With a shorter manufacturing lead-time, less replenishment inventory is needed in Distribution Centers or finished goods inventory which in turn further lowers inventory carrying costs.  In addition, initial throughput increases also reduce or eliminate the need to work overtime, further reducing costs.

Once the short term cost reductions are realized, the mid term improvements should be in the range of 3 to 6 months from the start of the Intervention. These savings will come from further increases in throughput while maintaining the overall cost of the operation.  This will translate to lower throughput cost and therefore lower product cost. From a macro perspective, we can look at operating costs as basically fixed.  We can look at any company as a “black box” (or Input/Output device).  Instead of detailed cost allocations of process steps per product (plus overhead allocation), we need to take a macro view.  With a macro view of the fixed “black box” cost, it will become apparent that increases in overall throughput will result in reduced throughput cost.  In addition, with fixed operating costs, each additional new product will increase bottom line profitability by an amount equal to the difference between its purchasing cost and selling price.  With this view, flow based accounting principles may be employed to aggressively price products and further increase profitability. 

The ability to reduce throughput cost is the key leverage for increasing competitive edge and market share.  The next step is to reduce operating cost while maintaining the high level of throughput and efficiency which will result in even lower throughput cost and better competitiveness.

Reducing Actual Capacity Lowers Cost

Elimination of excess capacity is a significant way to achieve cost reduction but it should be done in a methodical way to avoid jeopardizing overall performance. All resource’s Actual Capacity is quantified in the analysis and Flow Model design phase of a FMT intervention. Practical Capacity is the core capacity of each resource plus a reservation of capacity to protect the system from frequent disruptions. Actual Capacity is the amount of time a resource is actually running at Practical Capacity level.  Each resource whose Actual Capacity is higher than demand has excess capacity. The delta difference quantifies how much is excess for each resource. The actions to reduce excess capacity need to be orchestrated to insure they do not adversely affect inventory levels and on time performance.

             The following questions will direct cost reduction activities and bring Actual Capacity in line with projected demand:

· Can the number of shifts a resource operates be reduced?

· How many hours should a resource be staffed for Actual Capacity to equal demand?

· Can equipment be taken out of service?

· What cross training is needed to provide the skills necessary for an operator to work in multiple areas within the same shift?

· Can energy costs be reduced by periodically shutting down equipment without negatively impacting quality?

· Can surplus workers be transferred?

· What training must be done to ensure that after transferring workers, all resources will have adequate coverage on every shift?

The actions associated with the answers to these questions will yield cost reductions.  However, before any actions are taken, FMT global measurements must be instituted to ensure that these actions yield global improvements.

Eliminating Disruptions Lowers Cost

Long term cost reductions will come from prioritized, focused, continuous improvement activities identified during the analysis phase of the Flow Management Technology Intervention. The analysis and quantification of the causes of disruptions provide the focus for additional opportunities for cost reduction. 

Tracking the reason and length of each disruption for each key resource provides the data to be able to rank the time for each key resource’s disruptions from the highest to the lowest.  Assigning cost benefit, effort and length of time for eliminating the disruption provides a good way to prioritize the sequence in eliminating the causes.

Eliminating the causes of a disruption may result in a cost reduction on its own i.e. eliminating the cause of scrap will eliminate scrap and its cost. Regardless, eliminating disruptions will reduce the time needed for reserve capacity at that resource and may also reduce the time needed for strategic buffering. Reducing reserved capacities will increase excess capacity.  This process will raise the same questions of what can be done to reduce the costs of excess capacity.  It provides a road map for continuous improvement based on measurable data.

Summary

A Flow Management Technology Intervention will provide the basis and focus for a coordinated, orchestrated cost reduction program by reducing inventory, over time, scrap/rework and the cost of excess capacity. Throughput increases are the key for further reducing lead time while simultaneously improving overall profitability.  The key for achieving success in a down economy is viewing the operation as a total flow system, achieving fast and smooth process flow, adjusting Actual Capacity to meet demand, monitoring performance at high frequency and gaining additional market share as a result of superior customer service and aggressive pricing.