Body of Knowledge

“Time to Fix the Roof When the Sun is Shining” – Irish Proverb

Let’s face it, Americans have short memories…

There are some people in the world that continue to kill and cause mayhem over some transgression that happened so long ago that the original cause has long been forgotten, clouded, or even corrupted, and is irrelevant to life today. There are the Balkans, the Middle East, and most of Africa, whose various conflicts and anxieties are perpetuated from generation to generation over hundreds of years. Then there is the strain born of the history between China and Japan… not to mention the distrust and discord between Eastern Europe and the Russians. … and so it goes…

But, this typically is not the case with Americans. For instance, we wrestled our independence from the British in 1776 (and then had to affirm that independence from Britain in 1812), and then we fight as allies today. In more recent history, we fought horrific wars in Germany, Japan, and Italy and now our countries are close with Germany and Japan, being significant trading partners. Even the toll exacted by the war with Vietnam has been relegated to the past with newfound trade. Of course there is the exception of Cuba, which the politicians have never been able to move beyond, but with whom the vast majority of Americans (and the rest of the world) think the perpetuation of the conflict is silly and even counter-productive.

And, for however short our memories are with respect to global tragedies and conflict, they are even shorter when it comes to economics and business…

Just a few short years ago, we experienced economic turmoil and a recession when the new economy driven by “dot-com” turned out to be “dot-bomb.” I knew there was trouble with this alleged paradigm shift when brokers were measuring company performance in “eye balls to the website” instead of in terms of cash. I even told one who was very zealous that, ” when I can pay for groceries in eyeballs hitting my website, then I will believe in the paradigm.”

No, during this period of “irrational exuberance,” companies were being bought and sold with shares instead of cash and people extended themselves beyond any sound reality, because they believed in the fantasy of a perpetual and limitless increase in share value (a fantasy largely supported by financial institutions). Eventually, reality reared its head and bit those who deserved it to be bit.

Fast forward, and the lessons learned in 2000/2001 are largely forgotten by lending institutions and borrowers alike. However in this case, it’s not the increase in company shares and belief in false financial paradigms which defy reason, but rather the value of property and the mountains of idle cash being held by those wanting to lend. So firm in the belief that the values of properties were going to increase, and so awash with idle cash were all manner of financial institutions (both traditional and “new-age”), loans with imaginative terms and covenants (or lack thereof) were invented.

The so-called “sub-prime” mortgages made with teaser interest rates allowed many first-time and marginal borrowers to get into their own homes. Whilst a full 90% of these borrowers have thus far been able to maintain their repayment schedules (or refinanced to fixed-rate mortgages at favorable interest rates), the other 10% of the sub-prime borrowers have fallen into various stages of default because they have found that, after the expiration of the teaser-rates, the new interest rates on their mortgages caused their monthly payments to increase substantially and their income levels would not allow them to refinance at a manageable fixed rate. To compound the problem, many found that the value of their homes had actually dropped. So, no longer being able to afford their monthly mortgage payments, they default with many deciding it’s easiest to just walk away.

You can bet that similar situations exist in the business world. With traditional financial and lending institutions awash in cash and “new-age” sources, such as Private Equity and Hedge Funds all competing for the placement of investments, it has been a borrowers and / or sellers market. But, the day of reconciliation has arrived and we must be reminded of the golden rule of business, which is, “The person who has the gold, makes the rules.”

Companies have to hit their targets, usually measured in EBITDA (though there are risks associated with relying ONLY on this method of performance measurement). Keeping a watchful eye on cash-flow, companies must continually look for opportunities for improvement and efficiencies. These efficiencies are not just “production” efficiencies, but overall resource efficiencies, including efficiencies in the management and performance of their assets. There are two primary, but related, areas where sins can easily go unnoticed, the first being inventory (including work-in-process) and the second being real-estate.

Production planning should be based on a “pull” system where production and/or replenishment of an item occur only when there is a true demand from the consumer for that item, as opposed to some forecast. A lot of obsolete and valueless inventory is on the books because of a build to forecast. Financial institutions (as well as the manufacturers themselves) would be wise to discount inventory, incrementally based on age over the term of Moore’s Law. In this case, fresh inventory is fully valued and inventory which is 18 months old or older would parabolically have no value. Based on experience, implementing such a model would instill a discipline in a company and have the effect optimizing the use of cash in the management of inventory with the expected results being a net reduction in inventory by up to 70% without sacrificing customer demands.

Production execution should be re-engineered to the “eyes of the customer” where one examines each and every activity associated with the production process, and asks the question, “In the eyes of my customer, is there a value that he is willing to pay for my performing that function?” For instance, material movements to and from a work-in-process storage area has a cost which is factored into the item and passed on to the customer, but adds no value to the item to benefit the customer. If the production process were re-engineered in a manner so that these non-value add activities were eliminated, one should expect that dramatic reductions in: production real estate requirements (30%-50%); work-in-process (40%-60%); production lead-times (50%-90%); and costs to produce (20%-40%).

Keeping those two things in mind will help keep you on-target with the expectations placed on your company. Take it on as religion, and you will remain competitive. Start doing it now, and you will become a star in the eyes of your lenders and investors.

Don’t do it now… and it may eventually be done during a turnaround… but you won’t be around to see it.

 

Paris is the Founder and Chairman of the XONITEK Group of Companies; an international management consultancy firm specializing in all disciplines related to Operational Excellence, the continuous and deliberate improvement of company performance AND the circumstances of those who work there – to pursue “Operational Excellence by Design” and not by coincidence. 

He is also the Founder of the Operational Excellence Society, with hundreds of members and several Chapters located around the world, as well as the Owner of the Operational Excellence Group on Linked-In, with over 25,000 members.

For more information on Paris, please check his Linked-In Profile at: http://de.linkedin.com/in/josephparis

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