Alternative Selection – More Efficient Processes Can Increase Costs

StrategyDriven Alternative Selection ArticleThere is a common misperception that being more efficient necessarily equates to being more cost effective. However, that relationship does not necessarily exist. While seemingly desirable to be more efficient, the benefits may not necessarily be cost reductions. In fact, depending on where the efficiencies are gained within a given process, higher costs may be incurred. Consequently, leaders must articulate their goals as a specific outcome to be achieved, cost reductions being one, and not simply as a desire to be more efficient.[wcm_restrict plans=”40837, 25542, 25653″]

Example 1 – Efficiency Gains Begetting Employee Goodwill at a Cost

Background: An organization with 20 salaried engineers oversees the operating performance of a facility’s physical assets. Included as part of their weekly tasking is the development and updating of preventive maintenance plans. Each engineer is responsible for a unique system or set of systems and the creation and updating of the system(s)’s associated preventive maintenance plans. These activities consume 10 percent of each engineer’s 50 hour work week.

Initiative: An effort is undertaken to heighten the efficiency of the preventive maintenance plan development and updating process. Efficiency improvements made through streamlining the process yields a 5 percent efficiency gain resulting in an average savings of approximately 2.5 hours per engineer per week. Initiative owners claim success because the 50 hours of engineering time saved per week (20 engineers each working 2.5 hours less per week = 50 engineering hours saved per week) reduces the organization’s staffing need by 1 engineer… or does it?

Reality: Because each engineer is responsible for a uniquely different system or set of systems and no one engineer performs all of the preventive maintenance plan development and updating tasks, the gains from this efficiency improvement reduces the workload of each engineer by 2.5 hours per week from 50 to 47.5 hours per week. While this is a net improvement in the quality of life for each engineer, they are salaried and already working more than 40 hours per week, therefore, there is no opportunity for a headcount reduction and little possibility that additional work will be done. Consequently, there is no cost savings and likely no increase in output.

Net Result: The initiative itself cost the company resources (time and money) and yielded a quality of life improvement for its engineers.

Example 2 – Efficiency Gains Begetting Higher Inventory Carrying and Spoilage Costs

Background: In a five step manufacturing process, Steps 1 and 2 have a throughput of 15 units per hour and Steps 3, 4, and 5 have a throughput of 10 units per hour. Consequently, there exists a buildup of in-process inventory at Step 3, a visible bottleneck, which has become the target of an efficiency improvement initiative.

Note that Steps 4 and 5 represent the same bottleneck but because they have an equivalent throughput as Step 3 there is no visible in-process inventory buildup ahead of these steps and so they are not targeted for improvement.

Initiative: Step 3 in the process realizes a 50 percent efficiency gain and now has a throughput of 15 units per hour. Initiative leaders claim success and feel that the efficiency gain will now reduce costs… but will it?

Reality: Step 4 being no more efficient than Step 3 was originally, the bottleneck simply moves one step further along in the process. There is now a quantity in-process inventory stored before Step 4 equivalent to that stored ahead of Step 3 prior to completion of the efficiency initiative. However, the in-process inventory at Step 4 is of higher value because of Step 3’s value adding activities. Consequently, overall in-process inventory value and, subsequently, its carrying costs went up. All other conditions being equal, the number of units of in-process spoilage remains the same but because of the higher per unit value, spoilage costs also increase.

Net Result: The initiative itself cost the company resources (time and money) and yielded higher in-process inventory carrying and spoilage costs.

Seek Cost Reductions (or other specific outcome), Not Efficiency Gains

In principle, leaders seeking to reduce costs should express their goals in these terms and focus on achieving this outcome. While such a focus may yield initiatives to improve efficiency in some areas, it is more likely to reveal many other more valuable improvement opportunities that represent little or no efficiency gain. If it is a cost reduction that is desired, then initiative evaluation and selection criteria should be set on that basis and not the efficiency gains to be achieved.[/wcm_restrict][wcm_nonmember plans=”40837, 25542, 25653″]

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Additional Information

Additional information on determining the overall value, including cost reduction potential, of initiatives can be found in the following StrategyDriven articles:

About the Author

Nathan Ives, StrategyDriven Principal is a StrategyDriven Principal and Host of the StrategyDriven Podcast. For over twenty years, he has served as trusted advisor to executives and managers at dozens of Fortune 500 and smaller companies in the areas of management effectiveness, organizational development, and process improvement. To read Nathan’s complete biography, click here.

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