26th Dec Determine ways to reduce costs for an organization - Economics

2010 Assignment

EMBA

Submission of Economics Assignment

For the Batch 2010-2012

Paper on:

Determine ways to reduce costs for an organization

By

Uma Ganesan

Rajeev Valunjkar

Pritpal Singh

Sarvesh Prajapati

Ajay Kabra

26th Dec 2010

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Seven issues in manufacturing industries, which impacts, the cash flow and bottom
line of any organization:

1. Over Production and early production – producing over customer

requirements, producing unnecessary materials / products
2. Waiting – time delays, idle time (time during which value is not added
to the product)
3. Transportation – multiple handling, delay in materials handling,
unnecessary handling
4. Inventory – holding or purchasing unnecessary raw materials, work in
process, and finished goods
5. Motion – actions of people or equipment that do not add value to the
product
6. Over-processing – unnecessary steps or work elements / procedures
(non added value work)
7. Defective units – production of a part that is scrapped or requires
rework...

This is a place where concepts of Lean can be applied.

Lean manufacturing concepts were developed over the last five to six decades,
primarily in Japan, particularly for the Toyota production system. These concepts
met various tests for many many years and passed the test of time very easily.

Lean manufacturing revolutionaries the manufacturing process. It was not a fine

tuning of the existing manufacturing processes. These manufacturing techniques are
conceptually different from the traditional process. For an example, traditional
manufacturing works based on inventory. But lean manufacturing questions the role
of inventory and defines as a waste itself and also as the reflector of the
imperfections a system has. This example, itself shows the conceptual deference
between the traditional manufacturing system and lean manufacturing system.

Sometimes it is very hard to believe that a system like lean manufacturing was born
with a simple set of concepts. But it is true. Principle on which lean manufacturing

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

operates is very simple. For an example it identifies the fact that “customer will not
pay for the mistakes, but only for the value of the product or the service they
receive”. The impact on this thinking is huge on the manufacturing process. It
changed the way people looked at the manufacturing process. It made people to
define value of the product from the customer’s point of view, not from the internal
manufacturing point of view.

To successfully implement lean manufacturing, it is necessary to understand the

differences between the lean manufacturing concepts to the conventional
manufacturing. Failing to do this, will eventually kill your success.

Prime objective of waste elimination from the system is achieved with lean
manufacturing technique and all tools. Based on this requirement, Just In Time (JIT)
techniques, Total Quality Management (TQM), Total Productive Maintenance (TPM),
Flow charts, Workplace Redesigning techniques are used.

Basically, lean manufacturing technique consists of four steps. First step is to realize
that there are wastes in the system to be removed. Although this seems like a crazy
idea, this is the step which creates the requirement for the movement towards lean
manufacturing. Many organizations do not realize that they have tons of hidden
wastes with them. Therefore they do not have the requirement to remove them from
the system. So they will have their problems forever and they will try to find solutions
for these problems forever.

Once you realize that there are wastes to be removed from the system, in the
second step, you will identify the different forms of that waste. Further, in this step
you will identify the causes for these wastes. This is very important step in the
process. Lean manufacturing never promotes treating the symptoms. Rather it
believes treating the causes and cures the problems permanently. In this step tools
like Ishikawa diagrams or cause and effect diagrams can be used for good effect.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

In the third step, comes the solution finding for the identified root causes. One golden
rule to be followed in this step is adhering to the basic lean manufacturing principle
of seeing the total picture. Do not find solutions by only looking at causes on their
surface. It is very important to identify the solution. It is even more important to
identify the effect of the solution to the entire system. For an example if you are
trying to reduce the line down time, it is very important to make sure the solution is
not going to increase the lot sizes heavily and make the net effect on the
organization a negative.

Final step is the implementation process and making sure things are going in the
intended way. Here the solutions will be tested and implemented. Then these
solutions will be tweaked to accommodate practical difficulties occur in the
implementation process. User training and follow-up are among the most important
things in this step of lean manufacturing technique. This step generally takes long
time.

In each and every step mentioned above, many tools will be used to achieve the
goals of each step. Make sure to look at the entirety, not a part of the problem.
Solution you find must have a positive effect on the entire system.

Lean manufacturing, also known as Just-In-Time manufacturing, is a process where

manufacturing companies attempt to become more profitable by eliminating waste
from the manufacturing procedure. The time it takes to process and ship and order is
Determine ways to reduce costs for an organization - ECONMICS Assignment -
EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

greatly reduced, and companies only order the minimum amount of materials
needed and keep little or no inventory. While lean manufacturing offers many
benefits, it can be difficult and costly to implement, and disaster can occur if
something goes wrong.

Need for Full Support

In order for a lean manufacturing process to be successful, it must have the

complete support of the entire operation, especially its leaders. The implementation
of lean manufacturing may be a radical departure from the previous methods, and
workers may be resistant to change. Without proper support, lean manufacturing will
not be embraced and is doomed to fail.

Additional Training

The implementation of lean manufacturing will require much additional training.

Employees may be required to work overtime to learn the process, which will create
additional expense. Production may also slow considerably during the learning
curve, which may result in a loss of business and unhappy customers.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Need for Team Leaders

In addition to the support of management, strong front-line leaders must emerge on

the floor. Employees will likely experience high levels of frustration, especially those
who were content with the "old way" of doing things. Appointed team leaders must
be on board with the new process and have the respect of both the workers and
management. It's possible that such individuals may not be eager to accept the
challenge.

Supplier Issues

Since lean manufacturing requires the keeping of minimal inventory and supplies, a
problem with a supplier can be monumental. If a shipment of defective goods or
parts is received, the result could be that a customer receives a low-quality product
or no product at all. Thus, one of the most important components of lean
manufacturing is to find reliable suppliers and develop strong relationships.

Cost of Failure

At worst, it is possible that lean manufacturing will not prove successful, resulting in
permanent damage to the company. Customers may be lost due to poor service and
relationships with suppliers may deteriorate. It may not be feasible to return to the
old way of doing business. The result might be the ultimate failure of the business.

Five areas drive lean manufacturing/production:

1. cost
2. quality
3. delivery
4. safety, and
5. morale.

Just as mass production is recognized as the production system of the 20th century,
lean production is viewed as the production system of the 21st century.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Benefits of Lean Production

Establishment and mastering of a lean production system would allow you to

achieve the following benefits:

• Waste reduction by 80%

• Production cost reduction by 50%
• Manufacturing cycle times decreased by 50%
• Labor reduction by 50% while maintaining or increasing throughput
• Inventory reduction by 80% while increasing customer service levels
• Capacity in current facilities increase by 50%
• Higher quality
• Higher profits
• Higher system flexibility in reacting to changes in requirements improved
• More strategic focus
• Improved cash flow through increasing shipping and billing frequencies

However, by continually focusing on waste reduction, there are truly no end to the
benefits that can be achieved.

Applications of Lean Techniques

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Lean techniques are applicable not only in manufacturing, but also in service-
oriented industry and service environment. Every system contains waste, i.e.
something that does not provide value to your customer. Whether you are producing
a product, processing a material, or providing a service, there are elements which
are considered 'waste'. The techniques for analyzing systems, identifying and
reducing waste, and focusing on the customer are applicable in any system, and in
any industry.

Lean thinking may also be applied for getting rid of bureaucracy in your home office.
To run your home office more effectively and faster you may need just as little as
10% of its current staff. Only executives who have a direct involvement with finding,
keeping, or growing customers as well as key support staff - accountants, tax, legal
and human resources people – should stay. Others can be rehabilitated by sending
to an operating unit.

Financial Impact of using Lean

CEOs want to know the return on investment of Lean and CFOs want to compare
the real financial results to "PowerPoint dollars." A rigorous approach to calculating
an improvement project's impact is important to every organization.

The benefit to an organization deploying Lean is not limited to immediate financial

gain from improvement projects. In fact, the cultural change generated by a fully
accepted initiative is probably the best long-term pay back that a company can
obtain. Having said this, however, it does not justify a lack of rigor in calculating the
financial impact of Lean projects. That rigor is an imperative for the coherence of a
data-oriented approach.

Additionally, a rigorous approach in defining how to calculate a project's impact can

be helpful for the project selection process since the potential financial impact should
be a key criteria to select and launch a project.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

To properly calculate the business impact of a project in a Lean Six Sigma

deployment, it is important to have guidelines. These guidelines must be agreed to
by the finance department and applied in the same way across the entire business.

Technical rules on how to calculate the financial impact can vary depending on the
business, however, the main areas to be analyzed and measured are common to
almost all businesses. They are:

1. Revenues
2. Costs
3. Risk
4. Customer satisfaction

Revenues

Lean projects are not only related to cost reductions and productivity increases. They
also can be aimed a boosting the revenue side of the business. Revenue can be
increased through increased sales volumes as well as the launch of new products or
services.

Increased volume: Higher volume of an existing product/service sold due to

increased customer satisfaction, better offer proposition, improved distribution
(geographic coverage, number of shops, higher productivity of existing channels,
etc.). The general rule to calculate the increased revenues at the time of successful
project closure (N+1) compared to the time before the project starts (N) is simple:

Revenues N+1 - Revenues N = Increased Revenues

This rule can be easily applied in a situation of constant price and constant cost.

If revenue increase is obtained as a result of lower price (volume increase caused by

price reduction), it is recommended to measure the impact at margin level.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

If the result of the project is a cost reduction of the product/service that results in a
price reduction, calculate this impact in the revenue line only for the volume increase
(if any).

Note: It is not always easy to attribute the revenue increase clearly to a Lean project.
Maybe there were other unknown factors or parallel activities that also influenced the
increase.

New product/service: Revenue generated by a completely (or significantly) new

product or service.

Costs

The is the area in which most Lean Six Sigma projects are concentrated. Under this
saving line, are identify several different types of financial impacts - reduced material
costs, productivity increases (labor cost saving), and reduction of the cost of poor
quality.

Reduced cost: Any cost saving achieved; a reduction of a recurred P&L cost (a
certain cost already incurred in the past) can be calculated in this category. The
general rule is:

Cost N+1 - Cost N = Cost Saving

If direct cost, the following rule is applicable:

(Cost N+1 x Number of Items) - (Cost N x Number of Items) = Cost Saving

The "number of items" is the count of the items that the cost is related to (i.e.,
products, invoices, calls, etc).

Any reduction in capital used (assets), interest paid, working capital and stocks can
be calculated as a reduced cost.

Note: Cost avoidance (costs not in P&L and not incurred in the past) cannot be
included in this category. In financial businesses it needs to be clearly defined how to
calculate the cost of capital.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Productivity saving: Refers to the increased amount of output per unit (minutes,
hours, days, etc) of labor and is usually calculated in terms of time saved to perform
a specific action or to obtain a specific output. It can be achieved as a result of
simplification, automation or elimination of tasks (e.g., non-value-added activities).

To properly calculate a financial impact from productivity saving one of the following
conditions has to be applicable:

• Headcount reduction: If the productivity saving leads to headcount reduction,

the amount saved can be included in the financial impact. Redundancy cost, cost
related to headcount reduction, also can be considered. The general rule is:

Cost of Labour x Headcount Unit x Period - Redundancy Cost = Productivity

Saving

• Increased volume: If the business is growing and the time saved (units of labor)
is utilized to increase the production, the amount of time saved can be included in
the financial impact (up to the effective production increase).

Cost of Labor x Time x Number of Units = Productivity Saving

• No headcount reduction and stable volume: In this case, saving can be

calculated only if it can be demonstrated that the time saved will be used in
value-added activities not performed before.

Cost of Labor x Time x Activity = Productivity Saving

The cost of labor has to be clearly defined, i.e., Standard cost or actual cost? Does it
include overhead? Etc.

Cost of poor quality: Internal and external failure costs, prevention costs, appraisal
costs and others. Many of these costs are hidden and difficult to identify by
measurement systems. In order to properly calculate the financial impact it is critical
to capture the right measures.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

Risk

Risk-related projects are becoming more and more critical, mainly in financial
businesses. Types of risk-related savings include operational risk reduction and risk
provision reduction.

Operational risk reduction: Basel Committee on Banking Supervision defines

operational risk as "the risk of direct or indirect loss resulting from inadequate or
failed internal processes, people and systems or from external events." Operational
risk can result in increased write-offs, additional expenses or loss of revenue. One of
the best ways to capture operational risk reductions is the project's failure mode and
effects analysis in the Control phase.

Risk provision reduction: Any reduction in risk provisions allowed as the result of a
project (i.e., stable process, higher performances, etc.) must be reflected in risk
policies - in other words, better credit collection performances leading to lower
provision for unpaid invoices, or higher residual value of assets leading to lower
depreciation.

Note: Attention needs to be paid to double counting operational risk reduction and
cost reduction (i.e., cost savings for reduced invoice errors counted as cost reduction
and risk reduction).

Customer Satisfaction

Customer satisfaction is the declared goal of any Lean initiative. The customer
satisfaction index is probably the best leading indicator for a business. Customer
retention, customer penetration and customer winning rates are the business-related
indicators that reflect customer satisfaction.

It is not easy - if not sometimes impossible - to link the impact of a single project to a
customer satisfaction indicator or to customer retention, penetration and winning
rates.

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS
26th Dec Determine ways to reduce costs for an organization - Economics
2010 Assignment

While it is not possible or efficient to capture the one-to-one relationship

project/improvement, a cost-effective option is to identify projects and initiatives with
impacts in those areas and measure projects overall impact on satisfaction,
retention, penetration and winning rate in a defined period.

Note: Customer satisfaction index, customer retention, penetration and winning

rates - as they are key business indicators - have to be clearly defined at business
level (operational definitions).

Timing and Financial Impact

All project savings mentioned are calculated for a defined time period. This period is
usually 12 months following the project go-live (when improvements are
implemented).

Based on the type of the business or the amount of investment (such as the launch
of a wide Lean initiative), periods of two to three years (or more) can be used.

In any case, it is critical to demonstrate that a process management activity is in

place with stable process performances to calculate the savings.

Any further improvement has to be calculated starting from a clear baseline (in terms
of performance and timing).

Determine ways to reduce costs for an organization - ECONMICS Assignment -

EMBA GNMIS