Turn 'little innovations’ into big cost reductions
One of the clarion calls in all businesses is to innovate – that is, they must develop or access the latest advance in technology, products or processes in order to gain a competitive advantage. Yet many companies are managing this process with only mediocre results. How can you achieve advances through innovation in a climate of mediocrity? In manufacturing companies, working to create i...
One of the clarion calls in all businesses is to innovate %%MDASSML%% that is, they must develop or access the latest advance in technology, products or processes in order to gain a competitive advantage. Yet many companies are managing this process with only mediocre results. How can you achieve advances through innovation in a climate of mediocrity? In manufacturing companies, working to create innovative products without having your basic practices in order is problematic at best %%MDASSML%% and nearly impossible at worst.
Innovation and the attitude and culture that goes with an innovative company must permeate the organization from the CEO to the shop floor. It’s quite difficult to create an innovative environment in an organization when only one small group (e.g., research and development) is perceived to be responsible for innovation.
Market price depends on economic conditions, competitive pressures, substitute products and so on. Over time, for most products, market price tends to decline when adjusted for inflation. Over time, we must lower our costs to remain reasonably profitable, or we must create new products for which we can charge a higher price relative to older products. Even these new products will eventually become old and have diminished margins. So it’s important in creating a future for the business that we constantly work to reduce our costs, allowing for adequate gross profits to finance future innovations for new products and markets.
Why do prices tend to decline over time? A simplistic answer is that when two equivalent products for purchase are in front of us, we naturally tend to buy the cheaper one. We’re trying to maximize our personal benefit with our limited resources. Manufacturers know this and, like Wal-Mart, they constantly work to put the cheapest products in front of us so we’ll buy them, while they still make a profit.
As noted, the gap between unit cost of production and market price represents gross profit. How do we spend our gross profit? The gross profit finances R&D and new product/process development, marketing and sales and the development of our distribution channels, general and administrative expenses and, of course, operating profits. These profits in turn finance additional capital investment and ultimately growth.
Gross profit represents the future of the company. Without gross profit for investing in the innovative efforts associated with marketing, R&D and new product/process development, or what I’ll call 'big innovation,’ the company has little future.
Financing big innovation
How do we increasingly improve our gross profit and finance our 'big innovation’ in an intensely competitive world where price tends to trend downward? We must reduce our production unit costs, particularly when market price is declining with time, as they always do over the long term.
How do we do that? By cost cutting? By process improvement? Both? As we’ve seen, cost cutting has a low probability for success. It’s through 'little innovation’ at the plant or operating level, constantly seeking to improve our processes so that the costs are constantly driven lower, and so that we can finance our 'big innovation,’ perhaps allowing higher prices because of higher value in the product, allowing higher margins and creating a virtuous circle for improvement.
Clearly, if things aren’t 'falling over’ because the processes are reliable and capable, the company will also have lower costs, not just because of potential volume, but also because costs just aren’t being incurred unnecessarily. A word of caution: products are not made under the misguided guise of keeping unit costs down, thereby creating waste in the form of excess inventory and lower return on capital.
Indeed, they are much more capable of running a lean manufacturing operation; their assets are reliable and capable of running when needed to meet market demand. They don’t carry extra inventory, just in case, because they don’t need to. Their assets don’t fail when they’re needed, and all their costs are lower as a consequence of their business system design and capability.
Cost cutting has a low probability of success in improving business performance. We may have to literally cut costs in the short term, just to survive, but it should not be our long-term strategy. Cost reduction is essential. Cost reduction is differentiated from cost cutting in that it results from improving your processes to improve productivity; or eliminating defects to reduce failures; or applying a new technology to improve yields. Costs decline as a consequence. Costs cutting is simply reducing budgets, headcount or other resources, and hoping that costs will decrease and overall performance will improve.
Production costs must be driven down to finance 'big innovation,’ or step changes in technology or processes. The most effective approach for financing this is through 'little innovation’ at the plant and shop-floor level, improving your processes so that costs are not incurred and eliminating defects that cause failures. Innovation here is about everyone constantly seeking to do the work a little better every day.
An atmosphere of innovation
Put the right processes in place; get your people engaged with a sense of ownership; create an environment for pride, enjoyment and trust; and costs will decline as a consequence. Operating your assets in an optimal way will provide for minimum costs. This also creates an environment wherein the company is innovative from the CEO to the shop-floor level, in all its key functions, and is constantly seeking to improve its performance in all areas.
There are lots of strategies for achieving 'little innovation’ so you can effectively finance 'big innovation,’ and so that you can create an environment for this 'little innovation.’
Capturing those opportunities, however minute they are, is essential if we are to sustain the improvement process and align and leverage the entire organization for superior results. This requires a more innovative approach to management, driving the responsibility for improvement to the shop floor. Not doing so ignores huge opportunity and results in small problems eventually becoming much bigger ones, both of which are to the detriment of the organization.
A key message here is that there are the two broad categories of improvement opportunities, each with a major business impact. But, they require fundamentally different approaches for problem solving and implementation.
Unfortunately, many in management do not appear to sufficiently appreciate this phenomenon. It’s essential to understand that a well-managed process for surfacing the many small-scale opportunities and rapidly implementing them has a far greater impact on building and sustaining a continuous improvement culture in an organization than do a few large projects.
Finally, each innovation, large or small, must be standardized so that the benefit is maintained within the organization. Hence, we need procedures, checklists and so on, and people need to be trained in these and to practice these with great discipline. However, once the standard is set, we must be constantly looking for the next improvement.
Excerpted from the new book, “Selecting the Right Manufacturing Improvement Tools %%MDASSML%% What Tool? When?” by Ron Moore, published by Elsevier Books, Butterworth-Heinemann Imprint. Ron Moore is the managing partner of The RM Group, Inc. He can be reached at (865) 675-7647 or by email at RonsRMGp@aol.com .