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Congratulations, you’ve implemented LEAN across your entire organization. Your team is finally on board with all of the changes, and you’ve been plowing ahead. There’s only one problem: your bottom line hasn’t changed. Where is all of extra net profit that was supposed to come from your lean implementation?

It’s your CFO’s Fault

It seems logical that this would be a great question for your CFO or the accounting department, right?

Unfortunately, your accounting system has been designed for a very specific legal/compliance purpose and NOT for doing the type of business analysis needed to produce tactical insight.

By allocating the fixed costs across your business, and your variable costs across the products/services that consume them, the resulting information is useless for making sound business decisions.

Oh, you can, and probably do use this information to make such decisions, just not likely good decisions.

These allocations muddy the water and result in the very logical conclusion that you need to improve everything, everywhere.

And so, we do LEAN everywhere, and we do Six Sigma projects willy nilly. Why not? It’s logical! Yet the impact of these efforts rarely shows up in the bottom line, and we don’t understand why.

This is logical. This is extremely common. And this is completely and utterly wrong.

So, it’s your COO’s Fault

It also seems logical that your COO should be able to tell you why there isn’t more money dropping to the bottom line. After all, this very capable individual has been showing increased efficiencies in almost every department.

Unfortunately, your operational efficiency metrics have been designed for a very specific purpose: to ensure that everyone is working all of the time. While these metrics do keep everyone’s productivity up, they don’t produce any real insight into profitability.

Logically, the whole is equal to the sum of the parts, and your COO has been running each department at their lowest or optimal cost. This should ensure that the system as a whole will be running at the lowest cost.

Your operational efficiency numbers are at their best ever, but these metrics are useless for making sound business decisions. (Oh, you can, and you probably do use this information to make such decisions, just not likely good decisions.)

These efficiencies and their place as the primary driver in the executive bonus structure muddy the water. They result in the very logical conclusion that if you want more money on the bottom line you need to cut costs and move faster. The belief is that if you can improve these efficiencies even more then that will trickle down to the bottom line.

And so, we look for cheaper labor, and we threaten our teams with the choice of “move faster or move out.” Why not? It’s logical! Yet the impact of these efforts rarely shows up on the bottom line, and we don’t understand why.

Again: logical, common, and dead wrong.

The Common Conclusion

You know intuitively that the strength of a chain is equal to the strength of its weakest link. Like a chain, there is one process in your business that is the weakest. That weak link determines your company’s capacity to deliver value to the entire business.

All processes are not created equal.

One weak link impacts your business the most and improving it will reap huge rewards. Improving the others will NOT impact the bottom line.

ONE department should run at its optimal cost, and every other department should run in the manner that PROTECTS that one – even at the expense of its own local costs.

The key question for business leaders is, “What weak link could you strengthen to increase net profit on the bottom line?”

The first step is to get better information out of your accounting system. It is not difficult to leverage the accounting data you already have to provide the information needed to identify the weak links, but you can’t use the default financial statements that your accounting software spits out. Those reports have been designed for compliance reporting, not management accounting.

You need to know how to pull the data that results in real tactical insights.

Once you’ve identified the weakest link, the second step is to implement productivity metrics based on protecting the weakest link rather than on local optimums. This may require a major change to your company’s bonus structure. Managers who are used to being measured on local performance over company performance may express concern, but the benefits to the organization as a whole far outweigh some initial hand-holding.

These steps are fairly simple, but they are not easy because they will go against the engrained (but faulty) logic that we’ve demonstrated above.

These simple changes can produce radically different results, and rolling them out takes real leadership!

The Quiz

In order to demonstrate how difficult it can be to go against the engrained (but faulty) logic, it’s time for a quick quiz.

Here is the scenario. Your business is losing money every month. You are going to use the last of your resources to market ONE of your three products to bring the business back to profitability.

Fail and you run out of cash and go bankrupt. (No pressure!)

Your CFO pulled the following financial data to guide you to a decision.

Now sit down with your actual accountant and determine which product you are going to promote. Good luck!

ProductRevenueC.O.G.S.Gross ProfitGross Margin
A$20,000$10,000$10,00050%
B$10,000$2,000$8,00080%
C$30,000$10,000$20,00067%

After you have your answer, check our next blog to see how you did!