Finding hidden opportunity through observation

What is your Profit Potential?

There are five areas that organizations need to address to realize their profit potential.

For most organizations, addressing these collectively can improve profits by 3‐4% of revenue.

Scratch the surface of any leading
organization and you will find
significant profit opportunities exist
with how they are delivering their
product or service to the market. For
every $100 million in revenue, a
company typically loses $3-$4 million
in recoverable profits. Addressing
common issues can help organizations
recover this profit potential.

Why do profit gaps exist?

There are several areas of opportunity with how companies execute that often result in profit dollars being left on the table:

  1. The company strategy is not clearly communicated to the organization
  2. Management systems do not provide relevant or timely feedback
  3. Resources are underutilized at the point of execution
  4. Management actions and decisions that are made on a daily basis are inconsistent with the strategy
  5. Leadership does not develop organizational experiences and belief system that are required to shift the organization to one that focuses on profit improvement

These issues are interrelated and it takes a holistic approach to addressing gaps within each to successfully recover untapped profits.

1. Clearly communicated strategy

To be understood, a strategy needs to be numeric, specific and it needs to be meaningful in relation to the outputs that each manager is responsible for delivering. On one side of the continuum, you can have overarching strategies that are defined in grandiose mission statements: “We want to be the world leader in providing online business solutions”. While this sounds great it would be difficult for any manager in that business to explain what this actually means to them on a day to day basis.

For every $100 million in revenue, a company typically loses $3-$4 million in recoverable profits.

At first glance, statements like “we need double digit growth” sound better but still communicate a subjective target that ranges between 10% and 99%.

A more helpful foundation for executing a strategy would be to communicate something like: “next year, we must grow product line A’s revenue by 8% at 40% gross margin through increasing our current market share in North America.”

A clear strategy must also be relevant to everyone in the organization. To be relevant, the financial requirements of the company must be translated into meaningful operational requirements.

As an example, the owner of a waste management business may want 10% net profit. Unfortunately that business requirement is completely meaningless to the truck driver picking up waste. A more tangible metric for the driver may be that he needs to have completed 30 pickups by 10AM. In order to effectively manage the business to the strategy (10% net profit), the manager must know if this schedule translates into the required profit. If this is true, the manager will know that if the driver is off schedule 2 hours into his day, the company will not be hitting its financial requirement.

2. Management systems

Only when the strategy is translated into meaningful operational indicators can an effective management system be developed. A management system is defined as a set of tools that the management team uses to plan, follow up and measure performance.

While basing a system on operational requirements that are tied to the strategy seems like an obvious statement, we have seen time and time again management systems where the parameters with which managers use to plan their operations are not at all tied to the profit, service or quality requirements of the business.

This can have a cascading effect. If the planning parameters are not tied to the strategy, then there is zero chance the management team will be following up or measuring their performance against the strategy. To be effective, planning, execution and measurement tools must all be numerically tied to the company strategy.

A quick way to check if this is the case in your organization is to ask the management team to pull all the reports and tools they use to measure their function. This does not mean to collect all the report tools that are available, but rather the ones they use on a daily, weekly or monthly basis. Count how many of these reports measure performanceagainst a key indicator that is tied to your strategic direction. Now count how many of those reports have the correct numeric requirements. You will likely be surprised at the quantity of reports that do not have anything to do with your strategy. Some may even contradict the direction you want to move the company in.

To be effective, planning execution and measurement tools must all be numerically tied to your strategy.

Another key requirement of an effective management system is that the information is timely. In many organizations, executive visibility to strategic performance comes from the monthly financials. The problem with this is that the financial statements are produced way too late. If, for example there was a variance to plan on the third day of the fiscal month, it may take up to 6 weeks to see that variance in the financials. Most managers will not recall the details around why the variance occurred let alone have any ability to resolve it weeks after the fact.

Timely feedback on performance is a requirement for timely decision making and variance resolution. In the example of the waste management company, it means knowing that the driver is behind plan and having the ability to resolve a potentially recurring variance at 10AM the day of as opposed to 6 weeks later.

3. Underutilized resources at the point of execution

Based on thousands of hours observing processes across a range of industries, we have found that on average approximately 40% of the activities within a process do not add value to the customer. This means that across 100 employees, there is roughly 80,000 hours per year that is lost due to various issues. In addition to increased hours, non-value added activities consume extra materials, capacity (potentially driving a requirement for increased capital), and order cycle time. They can also have an adverse effect on quality and service levels.

This means that across 100 employees, there are approximately 80,000 hours per year that is lost due to various issues.

There are many reasons for why non-value added activities consume such a large proportion of a company’s resources. Some are related to ineffective management systems mentioned above. A poor planning parameter can easily manifest itself into underutilized resources at the point of execution. For example, an inaccurate bill of material may be causing production to run out of an ingredient earlier than expected which in turns causes the production supervisor to make an unplanned changeover. Lost capacity due to a line shutdown, material loss due to washouts, and skilled labor waiting for the next product run to start are all outcomes of this planning issue. Service levels may also be impacted as there may not be enough inventory to ship to the customer as a result the shortened run.

Other reasons for lost utilization are related to the process itself. Often there are steps in the process that were necessary at one point in time or were added in reaction to working around an issue. Over time these activities become part of the defined process.

To improve resource utilization, one must first understand how the function is currently performing against what level they could be performing at. This principle holds true whether you are measuring efficiency, material usage, service, quality, or cycle time. The challenge is that most management systems only measure performance against the planning standard. Since the planning standards include ‘lost time’ or the workarounds that have been built into the process, there is little visibility to the fact that opportunity even exists.

We ran across this when we worked with a food packaging company that was experiencing leakers in their packaging process. Supervisors believed the issue was due to how the product fell unevenly into the case at the end of the packaging line. The workaround was to add an employee at the end of the line to help guide the product into the case. Over time, the additional position was built into the crewing standard and visibility to the labor variance (and the root cause of the leaker issue itself) was thereafter hidden.

4. Management actions

Another reason that profit is left on the table is due to the actions that management takes to execute the process. In fact, a common pitfall with many improvement initiatives is the belief that making changes to one or both the process or management system will bring improved results. This could not be further from the truth. Even the best change ideas can be completely ineffective without addressing management actions and decision making.

Front line managers are the key resource a company has to ensure that the strategic plan is achieved at the point of execution. Given this, it is interesting that over the hundreds of hours we have spent directly with front line management, less than 5% of their time is spent proactively communicating, following up and problem solving at the point of execution. Most of the other 95% of their time is consumed reacting to issues, planning, attending meetings or reviewing past performance.

There are a couple of reasons for this. The first is tied to the management system. As discussed earlier, schedules are often not tied to the performance requirements of the business. Rather, people will work from ‘to do lists’ without a clear expectation of when activities need to be completed by, with what amount of materials, equipment or capital. Without a proper schedule, follow up by managers is typically reduced to something like “How’s it going?” or “Are you having any issues?” The employee will usually respond “Not bad – we had some issues but things are smooth now” to which the response by the manager is often, “OK, let me know if you need help with anything else”. This interaction does not tell the manager anything about whether they are on plan. It also does not get to the root cause of what the issues were that the employee experienced. Having not addressed the issues, they are sure to reappear in the future.

The second reason that proactive communication and follow up does not occur as often as you may expect, is that front line management is never asked or trained to do it. Emphasis is usually placed on making sure front line managers are ‘on the floor’, but there is little training or tools available to them to proactively manage the operation while they are out there. As a result, being on the floor usually entails touring, ad hoc follow up with staff or reacting to issues on the spot. While this may be valuable at times, it does not provide the visibility required to know if the business is performing at its required level.

Most of the other 95% of front line management’s time is consumed reacting to issues, planning, attending meetings or reviewing past performance.

5. Building experiences

Maximizing the recovery of profits takes a concerted effort from the leadership team. Modifying front line management actions and decision making is not enough to provide a sustainable model for profit improvement. A structured approach is required by the leadership team to ensure that the organization’s culture aligns to the changes that are being implemented.

Organizational culture is defined as the way people act and think. Everyday leaders are creating experiences that shape organizational culture. These experiences foster a belief system within the organization about how things get done. This belief system in turn drives how managers make decisions and it drives the actions they take on a daily basis. If you want to change how management acts, you must create experiences that are aligned to the cultural changes that are required to achieve your improved results.

The reality is that most employees would want managers to follow up with them if that meant they could fix their issues.

Let’s take the example of trying to get front line management to move from being in reactive, fire-fighting mode to one where they are proactively communicating performance expectations and following up throughout the day. This is a major change and will take people out of their comfort zones. There will likely be a perception that this approach is too intrusive and it will be demotivating to staff to have a manager ‘policing’ their performance.

The reality is that most employees would want managers to follow up with them if that meant they could fix their issues. Nobody likes having hurdles thrown at them that prevent them from getting their work done. The challenge is that the way in which this proactive management style is conducted is critically important and often falls short-reinforcing the perception that management “doesn’t get it and they are now trying to police every action we take”. Ironically, the intent of the follow up is to reward performance, uncover variances, and solve issues that the employees are facing in their day to day activities.

If the past experience of the organization is that poor performance is reprimanded, then installing a proactive management approach will likely be met with strong resistance. People will naturally be worried that this exercise is intended to call out and punish poor performance regardless of how it is communicated by the executives. In this case, leadership must create new experiences that support how this approach is intended to resolve issues.

While this sounds easy, what is often missing is the deliberate and planned support of the leadership team to build experiences and foster a belief system that drives management actions and decisions. When starting an improvement initiative, most leaders will do all the right things such as kick off
communications, facilitating feedback, coaching sessions and celebration of wins. However, if employees see any actions that reinforce their past experiences they will discount these efforts and continue with the current belief system.

Leaders and managers in the company must deliberately plan what experiences they are going to create to reinforce the belief system that proactively managing is not a method of reprimand but a method to make people’s work lives more enjoyable.

What is Your Profit Potential?

By addressing the 5 areas outlined in this article, organizations can recover $3-$4 million in profit for every $100 million of revenue.

Mensana takes a structured approach to understand the profit potential of your operation. This approach is rooted in the concept that to generate continuous profit improvement, you must recognize that the strategy, systems, processes, actions and experiences of the organization are interrelated. Addressing one or more without the others will leave profit on the table.