After years of trashing Return On Investment – the DuPont ROI model, in particular – as a measure of manufacturing success, or as the decision making criteria for manufacturing analyses and investments of any stripe – I received an email from a reader the other day asking, if not ROI then how would a potential investor look at a manufacturing company? What are the measures of the business to gage their 'leanness'? I thought I'd share my answer here with everyone, and see what the rest of the lean community thinks.
The biggest problem with the ROI logic – other than the blatant violation of Einstein's not everything that can be counted counts and vise versa adage, is that it treats inventory and cash as equals – it doesn't matter whether you have a thousand dollars in cash or a thousand dollars in inventory … therefore cycle times don't matter … therefore lean manufacturing has no economic advantage.
The financial record I would look for includes:
Consistent, positive cash flow from operations, and a strong cash position. I would expect a lean manufacturer to be self-funded for just about everything except, perhaps, for huge outlays such as acquisitions or building new plants.
I would expect significantly better inventory turns than the industry average, and would expect a track record of continually improving inventory turns as cycle times continuously shrink. Of course what constitutes lean inventory turns depends on the industry and the structure of the business. A company constantly expanding into other countries and exporting to those subsidiary companies is going to have an ever growing pipeline, which will be a constant pull against inventory reduction. The point is that I would look for high inventory turns, or a very good, short term explanation for the lack of them. Long cycle times (manifested by low inventory turnover) is fundamentally incompatible with excellent manufacturing.
I would look for lower GSA (General, Selling & Administrative) expenses than the industry average. If available, I would look for the operating overheads in general, to be lower than the competition. The lean company is focused on eliminating non-value adding expenses, and should have a very high percentage of value adding expenses to their total expenses. While the non-lean company bludgeons direct labor and the suppliers, low GSA is an indicator of a company that truly understands the concept of value adding.
On the non-financial side, I would expect the company in which I I invest to:
Be quite vertically integrated. No one can outsource their way to excellence – having someone else provide the janitorial service, shovel the snow and cut the grass and the like are OK – but the core manufacturing should be done in house.
I would expect a long track record of stable employment – no layoffs. I would look for very low employee turnover and a wage structure higher than the local average for similar work.
I would look for senior leadership with strong technical orientation. In looking around the table when the senior staff meets, I would hope for more than half of the folks there to come from engineering, manufacturing and supply chain backgrounds; rather than finance and marketing.
That's about it. Of course if I were to go into a company as a consultant I would look for a lot more than this, and I would look at these things in a lot more detail. As an investor, however, with limited access to the company's detailed operations, these are the criteria I would look at very hard before I put my money in on the promise that the company is 'lean'.
Did I miss anything?