The Best Performance Measure for the Manufacturing CEO

If you are a CEO of a manufacturing company with many value streams, it’s impractical to think that you have the time to review all the performance measures of every value stream in your company. Yet you need to know the operational impact of Lean on your entire organization.

The traditional solution to this issue is to roll-up or aggregate measures so the CEO sees just a few numbers to get a pulse of performance. However, rolling up value stream measures doesn’t work because the aggregation of value stream measures really doesn’t mean anything. Each value stream is really a separate business unit with different products, customers and operational issues. Because each value stream is an independent business unit, performance should be measured against future state targets, which may be different for each value stream.

What I tell manufacturing CEO’s and executive a management team is to focus one measure – Flow, as measured by inventory days or inventory turns. I believe this is the best indicator to let the CEO the effectiveness of deploying and using lean practices, tools and methods.

When a company commits to a lean business strategy, it means that Pull Systems will be used to manage inventory from suppliers, through production to the customer. Traditional companies employ many methods to “manage” inventory. Lean companies employ Pull Systems to minimize inventory throughout the business. If your company does replace traditional inventory management methods with Pull Systems, Inventory Days will go down significantly.

What I’ve seen in many companies is that they are selective in how they apply Pull Systems in their business. The initial focus is usually reducing work-in-process inventory in production. From a lean viewpoint, this is not too difficult to do. But many companies stop here and claim “victory” over inventory. But you as the CEO see that total inventory days for your company is not going down.

The real inventory problems in many larger companies are raw materials and finished goods. And I think the primary root cause of these problems is functional silo thinking in companies. Let me explain.

Purchasing or Supply Chain typically controls Raw Materials inventory. In a functional environment, Supply Chain leadership may focus their performance measures solely on their function. This is why many larger companies still use Purchase Price Variance as a performance measure. The focus on PPV is simple – the job of Supply Chain is to reduce material cost. The result is a Supply Chain function that is disconnected from Operations. In a Lean company, Operations is the customer and Supply Chain is the supplier. Supply Chain’s job in a Lean company is to create Pull Systems from suppliers to operations and minimize raw materials inventories.

Marketing and/or Sales typically control finished goods warehouses. In many larger companies, these warehouses are regional distribution centers that are supplied finished goods by many factories (which in fact may be very Lean). In a functional environment, Marketing/Sales is concerned about availability of finished goods, so it plans finished goods levels based on sales forecasts. These sales forecasts end up driving production in the Lean factories because the distribution center places orders to factories. The result is high levels of finished goods.

There is not one solution to reducing finished goods in warehouses controlled by Sales & Marketing. Creating a Pull System from finished goods warehouses back to Operations one step. As orders are filled from a warehouse, it should send a signal back to operations to replenish the warehouse. Orders should not be placed based in forecasts.

 

Another step in reducing finished goods is changing the way Sales & Marketing plan finished good levels. Finished good requirements should not simply be based on a sales forecast, because that is simply an estimate of what the company wants sales to be. Lean companies plan finished goods inventory levels based on a combination of forecasts, lead times and safety stock.

 

The final step to reducing finished goods is what I mentioned a few paragraphs earlier – create effective Pull Systems from your suppliers through Operations to your warehouses. The faster you flow materials, the less inventory you will need.

 

If you are a CEO of a Lean manufacturing company, you should see significant reduction in Inventory Days. Figure it takes about one year to introduce Lean to a small company, or a division of a larger company. In first year, there is focus on training, education and getting Pull Systems in place. After the first year, you should start to see reductions in Inventory Days of 20% or more per year. This means by year 3 or 4 your inventory should be about 50% less than what it was when you began the Lean journey. If you are not seeing this, your company is not employing lean practices they way they were meant to.

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2 Responses to The Best Performance Measure for the Manufacturing CEO

  1. Carl says:

    Nick – excellent article! Inventory days or turns is definitely the main indicator for a company to monitor and pull is definitely the way forward. Another indicator worth monitoring is inventory aging, which will help to demonstrate problem areas in the upstream processes leading to many inventory problems we experience.

  2. Dave Spann says:

    Mr. Katko,
    Many thanks for the blog post and I agree with you 100%. One of the beauties of the “PULL” system is the simplicity in which it can implemented. An effective Kanban board (process) can have the same impact with modest effort. The Pull System can be used in other areas such operating supplies and materials which is a plus plus.
    Have a great day.

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