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Outsourcing Profit

This post on Kevin Meyer’s Evolving Excellence blog brings up some good challenges to the traditional “avoid fixed costs” rationale for outsourcing. The post (and the comments) point out Wall Street’s obsession with achieving a total variable cost model.

There is certainly a lot of appeal. Traditional cost accounting works hard to “assign” fixed costs  to individual units of production so that they can then pretend to calculate unit costs and unit margins. But rather than going into a long rant on accounting, I will just refer you to the experts.

Instead, I want to go beyond the cost accounting rationale that is usually put together, and look at some of the other issues with outsourcing.

Here’s a question for you: Where is the value added in your value stream?

That means what stage of the value stream has the steepest difference in value between what is purchased and what is transferred to the next stage? Put another way, if all you do is final assembly, what is the difference between what you pay for the parts and what your customers pay for the finished product? Keep in mind that this number is the most money you could make. All of your expenses come off this delta. Given any particular level of costs, it makes sense to add as much value as possible.

What is the difference between the cost of components and what you pay for your outsourced sub-assemblies? That is the value your supplier adds.

If, for the sake of argument, your kaizen activities made space and labor available – space and labor that you are already paying for today – how much more profit would you make if you used those resources to bring some of those outsourced sub-assemblies under your own roof?

Remember, in this little exercise, your labor costs stay the same. Your production area stays the same. Your overhead stays the same. The only thing that changes is this: Instead of buying completed sub-assemblies from a supplier, you are buying the components that the supplier buys and assembling them yourself.

If you would pay less for the components than you do for that sub assembly, your total cost of goods sold goes down, and all of that difference goes straight to the bottom line. (I am sticking with assembly here because the capital requirements, in most cases, are modest here.)

This is a different answer than you would get in a traditional make-vs.-buy analysis which assumed that all of the burdened direct labor costs would be shed with the work. It isn’t that clean in reality.

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NUMMI (again)

Toyota to end Calif. joint venture with GM – Yahoo! News.

The joint venture was developed to have American workers learn Toyota’s production methods, which were much leaner and more efficient. [emphasis added]

Maybe that was GM’s intention – to “fix” the workforce. This fits in with the judgment I developed about GM’s leadership over the last decade, and especially the last year – that they see their problems as something other than them.

Toyota’s intention in the plant was to determine the best way to teach Toyota’s methods to the leadership. The test is to see how well the leadership teaches the line workers. To that end, Toyota pretty much succeeded. They learned how to open a plant outside of Japan.

Who didn’t learn as much as this opportunity presented them?

Aside from GM’s top leadership (a topic which has been pretty well dissected here and elsewhere on the web and in print), I think the other big missed opportunity here was for the UAW.  What if their stewards and business managers were experts in coaching and continuous improvement? Think about the possibilities for them.

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leanblog.org: Measuring for Improvement

Mark Grabon’s latest post hits the key difference between metrics that help improvement, vs. management-by-measurement that destroys trust and possibly drives unethical behavior. He quotes a U.K. hospital administrator as saying:

“We’re trying to shift from collecting data for judgment to data for improvement.”

I agree with Mark’s assessment: “Brilliant.”

Metrics are a “Check” in Plan-Do-Check-Act.

The purpose is not to determine if people are “doing their jobs” but to assess if the plan is working as predicted.

“As predicted” means that not only is there an objective, but there are discrete actions which everyone agrees will cause the objective to be reached.

Note the words “everyone agrees.”

For that to happen, not only are objectives handed down, but the plan to reach them is discussed. The boss is keenly interested in exactly how his people plan to accomplish their objectives, and he has bought in after he is satisfied they have done thorough work. Think about that for a second. The boss now has his own “skin in the game” on not only the objective, but the way to get there.

There isn’t any space, at this point, for judging people based solely on hitting the numbers, because the boss has already agreed that the plan should work. The question now comes down to how well the team did putting together a plan and gaining consensus, and how well they executed. If the numbers aren’t hit, everybody has to reflect on why the plan didn’t work, what they didn’t foresee, and what they need to do better next time.

Management-by-measurement, on the other hand, is an abdication of leadership. It becomes an adversiaral rather than collaborative exercise and becomes a contest of politics and blame-shifting. This is why, I think, Deming finds the merit system and individual performance bonuses so destructive.

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What Is The Customer Really Buying?

Background: Frank’s still-under-warranty freezer stopped working. The service tech decided it would be repaired, ordered a new compressor and said “See you when the part gets here next week.” Frank and his wife, about to lose a freezer full of food, are not happy with the with this level of service, call “Customer Care” and are basically told that the repair will run its course.

The question posed at the end of follow-up #1 was:

“What, exactly, did the customer want here?”

I asked that question because occasionally it is good to think about not only the product we make or service we deliver, but to reflect a bit on exactly what value the customer receives from that product or service. Sometimes we confuse the technology we apply to get something done with what we are really trying to do.

Let’s look at Frank’s case. If, instead of Bellevue, Washington in July the freezer had broken down in Grand Rapids, Minnesota last December, this would not have been an issue at all. Take the food out of the freezer and set it on the porch where it was actually colder than in the freezer.

What the customer is buying is not a freezer, but an environment that keeps food from spoiling. Any environment that accomplishes that purpose will work. With our current technology, freezing the food by placing it in an insulated box with a vapor-compression heat pump attached is the best way to do that. But it isn’t the only way.

What upset Frank, and his wife, was not so much that it would take a week to fix the freezer, but that their food would spoil in the meantime. Any solution that solved that problem would have worked for them.

What, exactly, does the customer find valuable?

You press the button, We do the rest.

Sometimes the product or service simply helps the customer create, or recreate, an emotion. George Eastman “got that” and grew an empire from that idea by making photography simple enough for anyone to do. Prior to that, amateur photographers had to mess with mixing their own chemicals, glass plates, their own processing, and persevering to actually get a photograph. The value came from the technical accomplishment as much as the image itself. But that didn’t work for families that just wanted to remember an occasion, and share it with their friends. Kodak changed all of that forever. But their way wasn’t the only way, and a few years ago, a better way emerged. It wasn’t about the technology, it was about sharing the memories.

I have spent a lot of time in the construction equipment business. I recall a senior manager making a pretty insightful comment. “The only part of the crane that the customer cares about is the hook. Everything else just makes it work.”

Most construction equipment is actually is capital equipment for the customer’s business. The owner-operator of an excavator is selling a service: The customer has dirt where he wants a hole. The excavator is a tool that can fix that problem. The owner-operator needs to be able to deliver the service at a price his customer is willing to pay and still be able to make a profit. That fact, in turn, sets the prices for the equipment.

But it is important for the seller of that equipment to remember that, to his customer, it isn’t an excavator so much as a business. The seller that thinks “How can I help my customer provide better service to his customers?” rather than “I sell decent hardware at a fair price” has an opportunity to think of things beyond the hardware itself.

Look at your own operation. What value do you provide to your customers? Not just the product itself. What is the problem the customer can solve, or what is the source of pleasure he gains from your product or service? How would (or could) the customer solve the same problem, or gain the same benefit, without your product or service?

What is your customer really buying?   What business are you really in?

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Design Innovation Example

This post on the Fastcompany.com blog shows a clever desktop manufacturing invention.

But what really got my attention was the development process that starts at 3:40 in the video. It shows the process of developing it. They may not call it “3P” but, by and large, this is what it looks like.

As they develop ideas, they try them out in simulation, learn, improve, try, learn, improve. As the design matures in stages, they are moving forward, step by step, with concepts that are solid. This process is fast, flushes out problems early, while they are cheap to fix, and fun.

Contrast this with what might be created by a traditional process with the assignment of making a “tabletop NC cutter for cardboard.”

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Is This a Problem – Part 2

Last week I posted a story of a failed freezer, ruined food, and a customer support experience that could be summed up as “That’s how we do it.” I invited comments and asked:

“Is this a problem?”

And when I say “problem” I mean, is this a “problem” from the standpoint of the company’s internal process?

There are some interesting comments, some about the internal culture of the company, others about the support process itself.

But I promised to offer my thoughts, so here they are.

The key question is “What did they intend to happen?” While we can speculate, unless we have the process documentation or are otherwise privy to that internal information, we really don’t know what they intended in this case.

Let’s assume, for the sake of argument, that Frank’s experience was exactly as the company intended it to be. Then, from the point of view of their internal process, there is no problem.

“Wait a minute!” I can hear, “Nobody wants  a customer to never buy the product again.”

And here is my point. We don’t know. This company may be perfectly willing to accept that consequence, i.e. “fire the customer” to preserve their warranty cost structure. They certainly would not be the first. Whether that is good business or not is a totally separate issue. The question is “Did they produce this result on purpose, as a logical, foreseeable outcome of the process as they designed it?.” If the answer is “Yes, they did” (and only they can know), then there is no problem. It might be bad business, but the process is working just fine. (I acknowledge that “bad business practices” can result in unintended results – like bankruptcy. But my point is the results are the outcome of a process, and the process is the result of a decision, even if that decision was to “not care.”)

The key point here is that only after there is clarity of what should happen, can the process itself even be addressed. Until the intended result is clear, then there is no way to see if the process works or not.

Was there a problem here? I don’t know. But this is what I would like people to take away from this little story.

Whenever something in your company seems “not right” ask this really powerful clarifying question:

“Did (or would) we do this on purpose?“
If the answer is anything other than an unqualified yes then it is likely you have a problem.

Here is a tougher position: If something was unpleasant for your customer, and you don’t intend to fix it, then embrace the truth that you did do it on purpose. Take responsibility for your decisions, look in the mirror, and say “We meant to do it exactly that way, and will do it the same way next time.” If you can’t stomach that, then go back the the first question.

Here is an extra credit question for this little case study in customer support.
What, exactly, did the customer want here?

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Looking at the wrong stuff: America’s Best Hospitals: The 2009-10 Honor Roll

This news piece, America’s Best Hospitals: The 2009-10 Honor Roll, originally got my attention because I hoped someone might be actually be paying attention to the things that make a real difference in our national debate about health care.

Unfortunately, it looks like more of the same.

This survey looks at things like technical capability – what kinds of specialty procedures these hospitals can perform, and their general reputation  and then ranks them accordingly.

But where are we asking about the basics?

Which hospitals kill or injure the fewest of their patients? What is the rate of post-operative or other opportunistic infection? How about medication errors? These are the things that all hospitals should be “getting right” and yet the evidence is overwhelming that most don’t. Further, nobody seems to be paying attention to it except tort lawyers.

Now take a look at this post on Steven Spear’s blog, and especially the Paul O’Neal commentary that he links to.

Tell me what makes a “good” hospital?

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Is this a “problem?”

This morning I got an email from a friend that recounts a (still ongoing) story of a failed freezer.

We arrived home Tuesday from a week away to find the “extra” freezer in the garage totally kaput…..much of the stuff inside already ruined but some still partially frozen. It’s only 4 years old and within warranty, so [we] go on line and schedule an appointment with GE service for the next day, and spend hours sorting what [food] might be savable, getting bags of ice to try and bridge the time until (you would assume) they will exchange this unit with a new one. Tech comes out the next day, announces that the compressor is fried, and that he’ll order the part and see you in a week to install.

Needless to say, the customer is not exactly happy here. What could be saved now cannot. When they elevate the problem to “Customer Care” on the phone, the answer is basically holding the line to the warranty terms which give the company the option of replacing or repairing the unit.

Aside from speculation that the response would be different if this had been a commercial unit for a large corporate customer, this story brings up some interesting issues.

Clearly the company here is well within their agreement with the customer. That is (apparently) spelled out in black and white in the warranty, all approved by the legal department. And repair of the unit is the logical economic choice for the company.

But equally clearly, the customer here is not happy with the response.

All of my protestations about how an exchange unit shipped from their warehouse in Kent today would allow my wife to save her food falls on deaf ears. Not even a transfer to a “supervisor” for exception resolution could be arranged. If you don’t like it, tough luck..not buy another GE product? “hey, your choice” hard to believe!

And a customer with a technical problem has likely been turned into a customer for the competition.

So here is the question.

“Is this a problem?”

And when I say “problem” I mean, is this a “problem” from the standpoint of the company’s internal process?

I have my thoughts, and I’ll share them in a day or so. But I’d like to hear what you think.

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Thinking About Improvement

Although it caters to the I.T. community, Tech Republic sometimes publishes pieces could have that have a wider application. Here are two of them.

In Five ways of thinking that can fell I.T. leaders, author Ilya Bogorad lists some limiting beliefs that can result in the I.T. folks being marginalized in the company. She says:

I often encounter situations where I can’t help but feel that an IT department could be a runaway success within its organization if it weren’t for the beliefs that their leader seems to hold. I want to share with you a small collection of such limiting beliefs. There are five in this list but I could have just as easily added another twenty.

Reading those five things, my feeling is that I could easily substitute the term “Continuous Improvement” where ever “I.T.” appears, and maybe a couple of other very simple edits, and most of the article really strikes home.

Read it, tell me what you think.

That article, in turn, links back to another called Costs and benefits of projects: Looking beyond the dollar sign. Same point. In this world of seemingly having to put up a positive short-term ROI for every idea, we deprive ourselves of so much innovation it isn’t funny. Just what is the ROI of “getting it right every time?” It’s pretty hard to calculate, but I’m pretty sure the opposite is more expensive.

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Toyota’s Dilemma over NUMMI

Toyota says it may shut Fremont’s NUMMI auto plant – San Jose Mercury News

Part of the aftermath of GM’s implosion is that Toyota is left holding the bag on the NUMMI joint venture. The plant primarily built vehicles for GM (the Pontiac Vibe), but was essentially managed by Toyota as a Toyota operation. A lot has been written about GM’s failure to truly learn from this opportunity, but that is now in the past.

What is in the present, and the future, is the fate of the plant itself. Toyota does not need this factory. And if Toyota were being run the way U.S. automakers are, there wouldn’t have been a decision. As soon as GM backed out, the layoff notices would have been issued, and the gates locked. Period. Politically, that probably would have been the best move for Toyota. Let GM make the decision, and reluctantly go along. They had a great opportunity to do that last week when the press was preoccupied with the death of a high-profile celebrity.

But they didn’t do that. Enough time has passed that the plant is now 100% associated with Toyota. (Remember, in our 24/7 news cycle, a week or two is an eternity.)

So now they are stuck. The fate of this plant is Toyota’s and Toyota’s alone.

Here is a thought.

GM is not the only auto manufacturer with something to learn from Toyota, and almost anyone could (if they set about doing it right) learn more than GM ever did. Maybe someone can step up and seize what is, in my mind, a golden opportunity.