The Lean River System – Part 4: ROI and the River

The Lean River System – Part 4: ROI and the River

Now back to the river system analogy. If you haven’t yet done so, I recommend you at least read The Lean River System – Part 3 before proceeding further. But it would be best if you read Part 1 and Part 2 also.

Here is ROI (Return on Investment) again:

ROI = Earnings/Total Investment = (Sales – Cost of Sales)/(Working Capital + Permanent Investment)

The numerator of ROI (earnings) represents the net input and output of the river system. Earnings are sales minus operating cost. Sales are the river output. Operating costs (labor, materials, energy, supplies, etc.) are the river inputs. Inputs and outputs reflect cash flow per unit of time (annually, quarterly, monthly or daily depending on your specific vantage point). Net cash flow is sales (river output) less operating cost (river input). You hope that earnings are always positive. If not you need to unplug that river.

The denominator of ROI (total investment) represents the body of the river itself. It represents the total cost of all river inputs over the period of time it takes to traverse the entire river system from beginning to end. This is the sunk cost of our system at any given point of time. “Sunk” is the key word here – it is not available for any other use until it exits the river body as sales.

There are two reinforcing goals here.

  • Our first goal is to turn that sunk cost into sales as quickly as we possibly can.
  • Our second goal is to minimize this sunk cost so that our resources do not become “sunk” in the first place.

We need to unplug that river.

Thus ROI represents the profitability/productivity of our river system over a given period of time. It represents the “effectiveness” of our cash investment in generating cash flow. The key word here is “flow”. The better the flow, the better ROI will be.

Also notice that I haven’t used the word “efficiency’ in this analysis. “Efficiency” means doing things right. “Effectiveness” means doing the right things. ROI will not be improved by doing the wrong things right. That is why ROI is such a valuable metric. I will cover this in more detail downstream.

Here is a pictorial illustrating a simple but fairly typical river system:

river_system

Source

Actually as river systems go, this river is fairly free of large meanderings, large obstructions, rapids, etc. I don’t know about you, but if I drew a river to illustrate most of the manufacturing operations that I have started with, I would have dams everywhere along the river with large lakes of inventory behind every dam. Every tributary would have a dam and lake at its source and also at the entrance to the river. I would also have a very large central lake that feeds other lakes. And all lakes would be connected with large wandering tributaries interspersed with waterfalls and rapids just to make sure we feel we are earning our keep. Water, water everywhere and….

You get the picture.

So how do we make our river Lean? Let’s look again at this quote from Taiichi Ohno (see Part 2):

“I had this idea of a fast, even-flowing river in which there were no dams that slowed the flow or rapids that sped it up.”

With this in mind, let’s examine our first goal (see above) which is to turn our sunk cost (the body of the river; i.e., working capital) into sales as quickly as possible.

A first inclination would be to add capacity and speed up the flow rate of our river. Lead time would go down, right? That should do the trick. Ohno did say he wanted a “fast” river.

But notice that Ohno also said he had a vision of an “even-flowing” river that did not slow down or speed up. That is why “heijunka” and “takt time” are key components of the “Just-in-time” pillar. You should reduce mura and muri (abnormalities) to smooth the river flow. And you should only make what the customer will buy and reduce muri.

If you look at our river pictorial, you can visualize what would happen if we sped up the river. Since Sales are not increasing in this example, the added flow rate would just accumulate at the river’s mouth and fill up the estuary. You would create inventory (muri/overproduction). That water is still a sunk cost. That doesn’t shorten the lead time. Not Lean!

OK then, how do we speed up our conversion of Working Capital to Sales? How do we make the river “fast” without overproducing? How about shortening the river? That would reduce the sunk cost. How about shortening the lead time that way? That’s Lean!

Yep! That’s Lean! So how do we make the river shorter?

First, get rid of those vast lakes of inventory that I described that not only hold a vast quantity of sunk costs but also add enormous amount of time to lead time. In fact, inventory only consumes time, nothing else. All value-added labor, material, overhead, etc. have already been consumed (operating costs) and are just sitting there doing nothing. (But there may be a lot of non-value-added counting, measuring, moving, inspecting, etc. – muri – going on just to manage this vast quantity of do-nothing stuff). In fact, one source I read recently stated that today, parts and product in process (in the river body) are waiting to be worked on 93% of the time. What a waste!

Second, looking at the pictorial, we need to get rid of all the meanders (mura) in the river path that eat up time and space and often require some type of transportation (muri). Move work centers closer together, create work cells, put offices directly on the floor (people flow too), live at the gemba and not at far away desks, have vendors deliver directly to the workstation and bypass the warehouses (reduce tributaries), eliminate storage areas, eliminate the need for forklifts, etc., etc., etc. We all know the drill, we just need to execute.

Third, fourth, fifth, sixth… just look where smooth, continuous flow is disrupted or stops (for anything) and fix it!

Take the waterfall in the pictorial, for instance. A tremendous amount of gravitational work is being applied to the river as it goes over the falls (muri). But then what happens? The river forms a plunge pool and just sits there (mura). How many times have you seen a process get behind schedule and tons of manpower and effort get thrown at it to catch up (and even get a little ahead) – and unbeknown to the good people involved, it just sits in front of the next process step as WIP? Hurry up (muri) and wait (mura)? That is not continuous flow!

Also take a look at the “Oxbow Lake” in the pictorial. That is formed during flooding (overproduction/muri) when the river overflows its banks, or the river bypasses one of its large meandering loops and forms a new flow path (mura). When the river returns to a more normal flow rate and flow path this oxbow lake is left sitting all alone by itself. This is excess inventory left unused, and maybe forgotten, after the muri subsided. A true sunk cost. (I have personally experienced this many times).

Now let’s tackle our second goal (see above) which is to minimize our sunk cost so that our resources do not become “sunk” in the first place.

Oh! Wait…! I think we just did that when we implemented our first goal…  Didn’t we…? By shortening our lead time we reduced our costs? The river is shorter and thus contains less water. Inventories (lakes) have been reduced, which involved a lot of water removal. Entire tributaries have been eliminated, so no water there. Large meanderings have been eliminated, so we are not moving, transporting water further than it needed to actually go to reach a final destination.

But what happened to our ROI? Well the numerator (sales less operating cost per unit time) did not change. We are getting the same sales and we still need to input the same labor, raw materials, etc. to achieve those sales (we probably need less labor because we have less water to manage – but save that for later). But our denominator (working capital, sunk costs) has been significantly reduced. If we were able to cut our river length in half, our lead time would be cut in half, and our sunk costs will be cut in half, and….

Our ROI would double!!

Nice work if you can do it – and we can! Will the cost accountants pay attention? Maybe? Will the people working on the river, who made the river shorter, notice the difference? Definitely!

Yes, by shortening the river lead time we reduced our cost!

Sounds familiar. Where have I heard that before?

The underlying principle behind TPS/Lean is the systemic creation of the shortest possible lead time for the continuous flow of materials and information in order to generate the highest quality and lowest cost.

Oh, yeah.

Can you see it better now?


4 thoughts on “The Lean River System – Part 4: ROI and the River

  1. I wish you would make the statement and develop the philosophy that where R.O.I. is concerned the “river” includes supply chain, and unless your supply chain is Lean, the best you can do internal to your factory is tweek overall financial results. Again, most executives I know think purchasing should have a sole piece price focus and the rest will take care of itself. Not true.
    Paul

    1. The River System model I have been describing should include the entire supply chain. They are all the tributaries that feed into the river proper. The entire system, including suppliers, should be modeled. Now if you can get your suppliers to feed you their broad, high level financials pertaining to your specific supply chain (sales, operating cost and inventory), you could do an ROI for the entire system (supply chain plus in-house operations). That would highlight the critical system based impact of supply chain performance. But I don’t know if you can get your suppliers to provide that information. But, based on your proven experience with getting suppliers to work with you on lead time reductions, you just may be able to pull it off.

  2. “Also notice that I haven’t used the word “efficiency’ in this analysis. “Efficiency” means doing things right. “Effectiveness” means doing the right things. ROI will not be improved by doing the wrong things right. That is why ROI is such a valuable metric. I will cover this in more detail downstream.” This is an important distinction. Most IEs I’ve been around want to tweek current processing which can mean missing the big picture opportunities.
    “In fact, one source I read recently stated that today, parts and product in process (in the river body) are waiting to be worked on 93% of the time. What a waste!”
    When I used to conduct “tagging” exercises with clients their normal reaction was horror, as they saw that only a couple of percent of the overall processing time was “value add”.
    I’ve always liked the River analogy. Too many Lean advocates use the “lowering the water level”, i.e. to identify and remove waste. That, in my opinion, is how current Lean practice has become primarily focused on reducing individual instances of waster rather than increasing the effectiveness of the overall system.

    1. Yes, Yes! Your last sentence encapsulates the problem with today’s Lean that I am trying hard to counter. But this is not new. Ohno described the same problem in his early days with Toyota (see quotes in “River System – Part 1”).

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