I get lots of questions about metrics. We seem to be a culture obsessed with measuring things, and the idiotic notion that we can't manage anything we can't measure seems to be a hard one to shake. Far better would be to embrace the wisdom in the adage that hung on Einstein's wall: "Not everything that counts can be counted; and not everything that can be counted counts."
Nevertheless, there is one number – a percentage really – that goes a long way toward quantifying whether the business is getting leaner or not. It is the measure of value added expenses to total expenses. If the business spent $20,000, for instance, and $12,000 of it was on value adding things while the rest was on management, supervision, material handling, inspection and generally pushing paper around, the Lean Ratio would be 60%; or it could be expressed as 3:2 if you like looking at numbers that way better.
I like the percentage approach better because it is easy to graph and track month to month and year to year to see if the business is actually making progress toward the elimination of waste. Note that it is a useless benchmarking tool. The fact that one company may have a 60% ratio while another has a 45% is meaningless. All that matters is that the 60% company become a 61% company then a 62% and so forth.
It seems pretty straightforward. The objective is to continually improve the percentage of money spent on useful endeavors - making sure more of it is gong to things customers perceive to be of value and worth paying for, and less of it to waste. The rub is that very few companies really know what adds value and what does not, as important as it is to know. One of the most important, interesting, and probably contentious discussions you and your management team can have is the one needed to build consensus on defining value adding.
The big problem with defining value adding versus non-value adding seems to be psychological, rather tha intellectual. The CFO of a big publicly traded manufacturer recently told me they had defined all payroll expenses as 'value adding' because they did not want anyone to be upset with the implication that they were not valuable. An admirable sentiment, perhaps, but it utterly destroys the purpose. That seems to the common theme that everyone runs into. Everyone in every department is convinced that they are the ones really adding value. If you are going to have any chance of getting it right, everyone needs to know that all people are valuable, but much of the work is not in the eyes of the customers.
I can't tell you any universal rules for identifying what creates value in your company. Each organization needs to decide that for itself. I can tell you, however, that nothing in the SG&A category is likely to create value. Sales and marketing and logistics/shipping are generally not value adding. Materials handling, quality inspection and fixing broken machines is not of much value. Much of the money spent on packaging is not really adding value beyond the minimum necessary to protect the product and communicate what's inside the box. But again, you have to figure it out for yourselves and it requires really knowing your customers and what they want.
Optimizing any other financial measure doesn't count for much if you are not tracking this one; and if you want to know whether you are really getting leaner or not, tracking the Lean Ration over time is about the only sure-fire way to tell.