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Find the Real Opportunity

By Kevin Meyer

Published: 15 October 2009

Mark Graban, our friend over at the Lean Blog and expert on the lean health care side of things, tweeted an interesting link showing the detailed breakdown of U.S. health care costs.  Take a look at the following pie chart:

Screen shot 2009-10-13 at 1.35.08 PM
I know better than to dive into this political minefield too deeply, but I'm intrigued that many people focus purely on the 7% that goes to administration.  Sure it's probably larger than it needs to be, but if you want to reduce (or contain) costs by double digits, where should you look?  Shaving a couple percent off of admin doesn't cut it.  As Mark often points out, improving efficiency in delivering care, reducing mistakes, and reducing the cost of care resulting from mistakes are the real opportunities.  And there's the CYA component of hospital care and clinic services created by unnecessary tests to create a shield against lawsuits. 

Of course if we allow the dollar fall in value any further we won't have the argument that we spend more than our friends to the north and across the pond.  But our exports will become a better deal.  Amazing how all that works.  Ok, end of diatribe before I get into trouble.

What struck me was how similar this is to how traditional manufacturers look at costs.  Consider the following scenario:

Screen shot 2009-10-13 at 2.08.39 PM

A little simplified, but that's intentional, and it assumes there is some profit.  So what does the traditional manufacturer do if they want to create or increase profit?  They take a whack at "variable costs" which is usually considered to be labor.  Cut that back by 10%, drive those remaining folks hard, and hope they don't commit karoshi.  10% more profit!  Woo hoo!  Or maybe they'll chase cheap labor to some obscure factory thousands of miles across an ocean or two but ignore the impact on overhead and material.

I know what some of you are saying... there's labor in overhead.  Aha!  The traditional accounting demon has reared his ugly head.  You're in for even more of a surprise if you love absorption-based cost accounting, as Bill pointed out a few days ago.  For the sake of this exercise assume all brains are in "labor" and "overhead" is plant, equipment, and administrative processes.  A true lean accounting guy would make it a tad more complex, but correct, by having direct value-adding (hopefully) "conversion processes."  But let's keep it simple.

But what's really going on in the original scenario?  Typically it's something like the following:

Screen shot 2009-10-13 at 2.09.03 PM

There's waste in every component, every activity.  So sure, there's some labor "waste"... and I put it in quotes as the brains are never waste if they are actually used effectively.  I'm lumping in waste of movement and such.  There's obvious material waste in scrap, setup, quality, etc.  And of course often a boatload of waste in overhead... perhaps including the result of a bunch of inexperienced MBA's who want to simply whack labor.  Overhead includes such things as requiring a bunch of rubber-stamp signatures instead of trusting the brains of your people and managing unnecessarily complex supply chains and material flows.

I'll say it again: The primary cost in business is not material, labor, or overhead.  It's unnecessary complexity.

The reality is that the real opportunities lie primarily outside of direct labor.  Look at what happens if you somehow root out all of that waste:

Screen shot 2009-10-13 at 2.21.42 PM

That's just a tad better than adding 10% profit by chopping brains.  Especially when that traditional 10% becomes temporary due to burning out remaining team members.  Ok, "team members" isn't the right term in that kind of environment.  "Poor souls" is more like it.

But I'll take this one step further.  What would happen if you give up some of that profit and did the following:

Screen shot 2009-10-13 at 2.23.04 PM

"Huh" you're asking?  Take away profit?  Add 10% labor instead of reducing the 10%?  That's yet another way how traditional accounting has warped common sense.  Labor is not a pair of hands; it's a pair of hands attached to a brain.  If you use that brain, invest in more brains, what happens in two years instead of satisfying greedy "investors" for the next month or quarter? 

That's how you grow the pie itself. 


Now who's making the money?  As in cold, hard cash.  Real dollars, not percentages.  Yes, unfortunately I find I often have to remind some traditional business people what "money" really is.