Does a dollar saved by efficiency improvement of a process have the same value to the organization as another dollar saved elsewhere say in labor, marketing, or accounting? The answer to this question is: it depends. It depends on many factors and the reasons are not only unique to the organization but also to the current situation. The value of the savings achieved at one part of the business is different depending on where it was saved, when it was saved, and what other consequences result from it. Consequently, more of the same cost savings, which benefited the company bottom-line once, may not have the same effect ever again.
The value of one dollar in cost savings changes as it bubbles through the organization. It may either increase or decrease. Rarely will it maintain its one dollar value on the financial statements of the strategic business unit. The change in its value depends on the various interactions among the different business functions and their current status. For example, savings by off-loading work to increase efficiency are either reduced or lost by an increase in the overhead. One can not add the savings in individual components for the overall gain.
A business is not a random bag of individual functions put together. It is more than a collection of operations, accounting, marketing, sales, and so on. All functions connect with each other to create an ongoing business. Unless all perform collectively for the good of the organization, the business can not flourish; in fact, it would deteriorate. A business is a living dynamic system.
Improving a dynamic system
A system is a connected network of various entities, not a mere collection of individual components. It has built-in influencers that either amplify or attenuate, but surely manipulate, the response of an individual component to any stimulus. The stimulus may result from external factors such as changes in market demand, or from internal decisions to improve financial performance, meet regulatory compliance, and the like.
Any stimulus or cause to one of the components creates an effect, which in turn becomes the cause to other components, and so on. The chain continues to build resulting in a cascade of effects. Unfortunately, just because a component has already been influenced by another cause does not exclude it from being stimulated again, resulting in feedback and stimulating that component repeatedly.
Let’s consider an example. The objective is to reduce cost by $1 million. This could be achieved by one of many ways. The company could implement continuous improvement (such as lean, six sigma, flexible processing, etc) to enhance process efficiency, move operations to a low labor cost region, force suppliers to reduce their prices, reduce sales and marketing efforts, reduce IT infrastructure, eliminate new product development projects, and so on. As evident from this list, all are possible options but none are confined enough to be isolated from other parts of the business. Each has multiple consequences and affects the overall business in complex ways.
Another characteristic of the above options is that their payoff and influences on other parts of business are not at the same time. Each component reacts differently over its own time frame. Before the dynamics of an effect die out, a new cause may, and it often does, arise further complicating the dynamic response of the system. For example, eliminating new product development projects would bring cost savings right now but would adversely affect the business in the future for a lack of new products.
Need for a systematic approach
Efficiency enhancements by continuous improvement approaches generally do not result in long term financial or other benefits unless the operational influences are permanently modified. For example, reduction in inventory brings about a one time benefit unless the role of inventory is changed in the business. Unless the system that caused the bloated inventory in the first place is changed, the reduction in the holding cost would be short lived. Only when it would no longer be possible to let the inventory to increase again without affecting the rest of the operations, the cost savings would become sustainable. This is one of the most significant deficiencies of continuous improvement efficiency initiatives. A change that produces a one time, non-repeatable gain does not contribute to sustainable improvement.
Each component of the system reacts to any stimulus in its own characteristic way. Responses to distinct causes, generally, are not the same. In fact, systems exhibit different responses to the same cause depending on their current situation. The magnitude and the type of the cause along with the current state of the component define the response. If the finished goods inventory is high and the management decides to suspend production of some products due to a lack of raw material availability, the business may not suffer the consequences. Conversely, the business would suffer loss in sales with a lean inventory situation – different response for the same cause depending on the current situation.
Many proponents of continuous improvement methodologies, such as lean, take an enthusiastic approach of doing the right things, yet not allowing any financial levers to guide their thinking. They argue that financials are the result and should not factor into the means. This argument assumes a direct and linear relationship between efficiency improvement and financial gains. Experience shows otherwise. The interconnectedness of the overall system moderates this relationship. Cost savings bubble through the organization in different and constantly changing ways. Consequently, efficiency improvements, although noble things to do, achieve mostly short term gains and fail in the longer run for a lack of a clear financial insight.
Managing a business – a dynamic living system – is to device a moderate path between two extremes: being overly bloated or too lean. Arriving at the right balance requires a clear acknowledgement of risks, and an intimate knowledge of how various stimuli affect the individual components of the business and the resulting cascading effects on the strategic business unit.
Without a systematic approach to ascertain the current status of the system and then to change it, which is to redesign the activities requirement to execute the necessary processes, long term sustainable gains are impossible. In other words, the interconnected influences among the various components of the system have to be reorganized to attain lasting benefits. It is not sufficient to identify the interconnections. It is imperative to also understand the magnitudes of responses in order to meet specific business objectives. Good managers instinctively understand this reality.