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If you have the right objectives selected, you can now focus on enrolling everyone into achieving the objectives. The next step is to identify business metrics.
The process diagram to the right depicts the three functions to transforming objectives into results.
First, business objectives should unite the business under a common purpose. Second, business metrics should be identified to communicate the focus and the progress being made towards achieving the objectives. And finally, various business situations should be analyzed and ranked based on their contribution to the metrics and business objectives.
Last week we saw that, although cutting costs and increasing sales have a common purpose, they are not going to get us there communicated like that. Profits and costs are financial measures that executives use to communicate performance to people external to the company such as shareholders, banks, or the government (IRS).
What we need to do is translate the executive’s “value language” (profits) into the language managers use to make decisions – business metrics. Then we need to translate the manager’s language into a language that empowers employees to achieve the objectives – action plans. Let’s see how this is done.
Reducing Variation Objective
Reducing variation — our primary objective — is about eliminating process waste. One often misunderstood example of process waste is inventory. Inventory provides a buffer against all the various unknowns you run into in your business.
Inventory is composed of three parts:
raw materials + work-in-process + finished goods
Each one represents an inefficiency:
- Raw materials inventory represent the inefficiency of your suppliers and purchasing cycle. For example, the longer it takes your supplier to deliver your raw materials, the more safety stock (buffer) you need to manufacture your own products.
- Work-in-process inventory represents the inefficiency of your manufacturing cycle. For example, the longer it takes to make a customer’s order (typically due to large batch sizes), the more work-in-process (buffer) you need to keep the line moving.
- Finished goods inventory represent the inefficiency of your customer demand, sales forecasting, or order-to-delivery cycle. For example, the longer it takes to restock or deliver a customer’s order (lead time), the more finished goods inventory (buffer) you need to get the order.
When combined, you get the sum total of your suppliers, customers, and your own manufacturing inefficiencies. The inventory metric here is inventory turns.
Let’s say your company is at 7 turns and your competition is at 15 turns. Then the competition has a significant competitive advantage over you. Higher turns translates into more efficient use of cash because less money is tied up in inventory. So, to create a competitive advantage for your own company, you will need to be twice as good. Therefore your target for inventory turns should be 30 to be twice as good. So you have to improve your turns from 7 to 30.
Diagnosing Business Situation Outcomes
Now that you have the Inventory Turns metric identified, you are ready to review the business situations that are influenced by the metric. There are a number of ways we can reduce inventory. Let’s start with the most obvious:
- Reducing batch size drives inventory down.
- Setting cycle time to lead time drives inventory down.
- Reducing scrap drives inventory and costs down.
- Decreasing cycle time drives inventory down.
- Reducing lot size and increasing frequency drives inventory down.
- Setting purchasing cycle time to supplier lead time drives inventory down.
- Reducing purchasing errors drives inventory and costs down.
- Decreasing purchasing cycle time drives inventory down.
- Increasing order frequency drives inventory down.
- Setting sales cycle time to customer lead time drives inventory down.
- Reducing sales forecasting errors drives inventory and costs down.
- Decreasing lead time drives inventory down.
In each of these examples you will notice a familiar pattern. Each one is a cycle or process and each one is contributing to the inventory problem in the same way. Therefore, the solutions look very similar. You just have to identify the source of the inventory problem and eliminate it.
Optimum Inventory Turns
In fact, we will have to do all of these to reach an optimum inventory turns ratio. If we can turn inventory every day and there are 250 business days in a year then the highest inventory turns we could possibly achieve is around 250 (once a day). So an upper limit to inventory turns might be 250. But in reality, a more practical goal might be 52 turns or once a week.
Most companies think 12 turns (once a month) is pretty good. But 12 is a far cry from 250. If you really want to have a competitive advantage in an industry then a target of 24 (twice a month), twice as good as the average, would be a good goal, but really you should be thinking in terms of 52 (once a week) turns to be great! Why settle for good when you can be great.
We have discussed how to identify business metrics and diagnose business situation outcomes needed to drive results. But there is another important metric, time. Next week we will discuss how long it should take to achieve our target and what other resources we will need to build our action plan. Then you will be ready to set your objectives for real process improvement.
Learn more on process design, implementation and continuous improvement with a How to Create Well-Defined Processes Class .