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Re-examining Performance Metrics

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We have traditionally striven for competitive and profitable stability and aimed for acceptable standards of performance.  Many of our techniques for planning, measuring and controlling performance such as budgetary control, standard costing, ratio analysis, throughput rate, project appraisal and reject/yield rates are aimed at defining acceptable standards against which to measure deviations.  These in turn influence actions, attitudes, priorities and behaviour in organisations by being implicit or explicit in reward systems.

Peoples’ thinking ability and behaviour, influenced as they are by these reward systems, are clearly the key determinants of the success or otherwise of an enterprise.  However, at the current rate of change we should be re-examining performance metrics and find metrics that will drive the required performance.

Change and Improvement must be the Norm

Rather differently than the relatively unchanging environment of the late 90’s and early 2000’s, we are faced now with a situation in which change is the norm.  Indeed, the rate of change is accelerating.

The nature of international trade and the demand to provide product and services quicker, better and higher quality as a way of doing business has changed the required standards of performance.

Projects have been used to bring about change and introduce improvements in performance in our traditional environment of stability. This is no longer good enough. Continual change and improvement must now infiltrate and, indeed, dominate every aspect of our organisational lives.

This is easy to contemplate; much more difficult to achieve, especially in large organisations.

We need to alter the Emphasis

The current use of integrated business planning and management (ERP) together with the use of Lean / Flow techniques is common. They must be used, however, within the context of a strategic plan formally committing the organisation to change and improvement.  Education and training must have a central place in the plans in order that the opportunities are really understood and harnessed.

The emphases we put to techniques need to alter:

  1. From direct labour to direct materials.

Direct labour represents 12% of SA manufacturing costs overall, yet research shows that some 63% of cost saving investment tries to reduce it.  Material atypically represents 48%. Companies should really aim to reduce waste of material as the first priority.

2.  From achievable standards to improvement standards.

3. Using a wider range of performance measures.

4. Replacing some performance measures that are now misleading. 

Which Measures are obsolete or undesirable?

 1.Plant Utilisation

Utilisation measures assume that the plant is doing well if equipment is operating almost all of the time.  The fallacy is that running equipment for long periods often means turning out material that is not needed immediately, thus creating waste (WIP) as well as limiting equipment care to ‘fix it when it breaks’.  Producing in long runs and large batches to drive up utilisation figures is the antithesis of, for example, the Lean philosophy of short runs, producing only what is immediately needed, no more and no less.

To maximise overall saleable throughput must be the aim and therefore utilisation is only important at the bottlenecks of the plant.  Elsewhere, in spite of ‘book values’, the machinery is bought or is being paid for and in cash terms does not increase costs to have it standing idle.  Clearly, if the equipment represents an opportunity cost, then that may be a different matter.  If not, however, there are two unhelpful consequences if the production manager is being measured on plant utilisation.

  1. Machines are consuming real money. Cash on material purchases (and labour, if you are in a situation where you can regard it as variable) being tied up in stock and work in progress is real and is a waste.
  1. Queuing theory will demonstrate that a plant that is being run to maximum utilisation throughout is likely to pay a heavy penalty in throughput terms due to the cumulative effects of random disruptive factors down the line.

For years, we have regarded stock as an asset.  Our balance sheets have confirmed it!  Our production, distribution and sales people have told us it is essential to cushion the effects of unpredictable but nevertheless inevitable problems.  We need all the stock to maintain our customer service level, they say.

By example, the Lean/Agile process was developed initially by Japanese vehicle manufacturer’s who had neither the space nor the currency for carrying stock and developed systems to eliminate problems not accommodate them.  Under LEAN, stock is waste.

A number of companies in RSA have adopted this philosophy.  Utilisation, as an important performance measure, is at best misleading and at worst totally expensive.

  1. Efficiency

Efficiency measures for direct labour accomplish the same results as utilisation measures for equipment.  Lean, for example, demands that direct labour workers spend part of their time on improvement activities, preventative maintenance and housekeeping.  These activities are inconsistent with traditional efficiency measurements.

Efficiency, together with utilisation, measures are short-sighted and detract from the preferable gaols of long-term improvements and maximising throughput with minimum lead time and inventory.  Furthermore, they create an incentive to defer maintenance, avoid set-ups and keep processes running that are of marginal quality.

The other misleading aspect of using efficiency as an important measure is that it can lead both management and technical resources to spend a disproportionate amount of time and money on reducing direct labour costs.  ‘Speeds and feeds’ the production engineers would call it.  We must focus our valuable time where the pickings are easiest – direct material and overheads.

  1. Individual Incentive Schemes

Where people are measured individually, especially with incentive pay systems, an atmosphere of ‘every worker for himself’ results.  The Lean emphasis on teamwork and flow production does not lend itself to individual incentives.

Incentive systems also undermine efforts to cultivate flexible practices because workers strive to do work that pays the most, and where they can adopt a rhythm, whereas today our plants have to be much more responsive and flexible.

The Lean emphasis is to only produce what is demanded, yet these schemes encourage operatives to keep on pushing material into work in progress rather than allowing it to be ‘pulled’ by the next operation.

Another disadvantage of these schemes is that they tend to deny the company the opportunity to take advantage of the enormous amount of latent ideas and goodwill that, if harnessed, can save so much money without needing as many expensive specialists, or worse, overpaid consultants.

  1. Absorption costing

‘Fixed’ costs (are there any when it comes down to it?) are incurred on behalf of customers and they have to pay for them.  The actual contribution that each customer makes, however, is a matter of policy for the company and is largely governed by the market place.  This may or may not be consistent with a cost structure that apportions these fixed overheads to direct labour and/or machine groups and therefore such costs are misleading if used for pricing, profitability analysis or investment planning purposes.

Certainly it cannot be said that fixed costs are incurred in a way that relates much to direct labour.  To apportion in this way is a policy of expenditure apportionment and bears little relation for reality.  Fortunately, most enlightened companies use variable costing and contribution analysis now and are making full use of activity based costing techniques.

Absorbing overheads on direct labour can inhibit the drive for continuous improvement in performance.  A move that reduces waste can appear to increase cost due simply to the way the measurement system works.

Again, too, this system singles out direct labour for our attention when looking for cost savings since we not only save the payroll cost but also the overheads!

The last misleading aspect of this practice is that it encourages the adding of ‘value’ to work in progress by pushing it through the processes of the factory.  If this production is not required yet, then all we have achieved is an increase in expenditure, an increase in waste and an opportunity cost.  Little of value.

What new Measures do we need? 

We need performance measures that are simple to understand, have visual impact such as simple graphs and are visible to all.

We must avoid monitoring too many facets since most will have importance for only a short period whilst we focus our attention on improving them.  Once achieved, we should turn our attention to a different facet so that we are working on a small number at any one time.

We should concentrate on throughput (contribution from saleable products), cash consumed (inventory and debtors mainly) and operating expense.  Lead time performance, delivery performance, defect and returns ratios and machine reliability rates are key measures in manufacturing.

Most important of all, however, is the method of measurement.  Rather than calculating variances to a ‘standard’, we should measure improvements.  Not only the amount of improvement in this period compared to last, but the percentage improvement and, even more important, the rate of improvement in the percentage improvement.  This can in some cases be achieved by taking a different approach to setting standards and zero base budgeting may be suitable.

We need new measures such as:

  1. Total improvement projects in progress and complete per employee.
  2. Trends in costs where effort is being focused.
  3. Improvement in defect rates.
  4. Improvement in quality procedures.
  5. Speed of material flow in departments and overall.
  6. Staying within expense budget.
  7. Inventory record accuracy through perpetual inventory procedures.
  8. Operatives trained to be accountable for quality.
  9. Inspection operations eliminated.
  10. The number and percentage of reductions in planned batch sizes.
  11. Customer service 100% of committed and production equals demand.
  12. Single digit set-ups established (less than 10 minutes).
  13. Reduction in the number of active suppliers.
  14. New Profit Based Ratio systems reward team contribution compared to target.

 

About the contributor:

Jeff Hollingdale trained and qualified as an Industrial Engineer. He received internationally certified training in APICS (CPIM) Lean Manufacturing, TPM, TQM, SPC. Lean /Six Sigma and ISO 9000, ISO 14001, ISO 31000, ISO 50001, ISO 55000 implementation and audit requirements.

Jeff has worked within primarily the manufacturing sector assisting clients with coaching and implementation of Lean / Agile and ISO standards implementation, i.e. ISO 9001, ISO 14001, Energy and Asset management.

His current activity is in assisting the growth of SME’s which can sustainably generate growth and job creation in South Africa.

Jeff is a contributor to a wide range of industry focused journals ranging from commentary on current certification issues affecting industry to newsletters and focused articles on the impact of ISO standards.

 

 

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