Who Pays for Waste

January 1, 2011

What is waste? Waste (or Muda) is anything (activity or material) that does not produce value for the customer. There are two kinds of Muda. Type 2 Muda is waste we can see and quickly eliminate using point kaizen. Type 1 Muda is waste that is systemic, hidden in plain sight, and is very difficult to eliminate without a concerted, sustained and systemic effort. We will talk about that in the next issue. How wasteful is the average “non-lean” manufacturing company? In my practice, I have found that it is possible to double the production in the same space without increasing labor costs, and with very little capital investment. Thus, 50% of the factory capacity is wasted. A lean colleague says “It has been proven that while up to 30% of the efforts in a factory are waste, over 60% of the efforts in an office are waste.”

Where is the waste? It is hidden in plain sight, but it is hard to see. We call it inefficiency, but inefficiency is too nice a word for it. Inefficiency is really the waste we are willing to tolerate, either because we have not identified it, or we know about it but we have not taken the trouble to eliminate it. Inefficiency is the waste that we can afford to tolerate. The truth is that we can always be more efficient. That is the basis for the Lean philosophy of kaizen, also known as continuous improvement.

How does the waste manifest itself financially? Since the factory is under-producing, each unit of production must “absorb” twice as much direct labor and twice as much overhead as it should. If the selling price is capped at some upper limit (because the price is set by the competitors and buyers in the marketplace), then the margin suffers. While the company might be able to “afford the waste” and make an acceptable margin, the company is not as profitable as it could be. Even a detailed look at the Income Statement does not reveal this waste because the waste is “hidden”, buried as lost seconds and minutes within each line item of expense.

The bottom line is this: You pay for the waste, not your customer. Very few inefficient companies can maintain a high margin while their customers pay for waste. Most companies will have to eat the cost of both kinds of waste and suffer with low margins. Why is this? Competitors offer choices to the buyer. The buyer is constantly seeking value, which consists of a better product or service at a lower price. At some point, even the most loyal customer will try something new, which leads to defections. In this manner, the market relentlessly seeks value, quality and efficiency, thus punishing those suppliers that do not. Companies with high prices and wasteful habits must adjust or die.

What is the danger of complacency? Doing nothing is to guarantee a crisis in the near future. We don’t know what some creative and inventive person (or company) is doing out there, right now. One day a new product or service pops onto the scene, and suddenly our product is hopelessly obsolete or too expensive. A high price for a mediocre product is an invitation for a competitor to enter the market. Conversely, an “impossibly” low price for a superior product is a barrier to entry. It all comes back to the mindset of the company, which is a choice. We can relentlessly seek the causes of waste and eliminate them, and pass the savings on to our customers. Or, we can do just enough to “get by”. As long as we make our numbers this month, we are OK. What happens when the storm comes? If next month, our revenue is half of what it is today, are we still OK? Or, is that when we panic, and start looking for the “easy” and obvious places to cut?

These cuts are painful because usually it is labor or plant locations that are cut, because these costs show up on the income statement and are thus easy targets. Hidden in every line item of the income statement is systemic waste. Eliminating systemic waste (Type One Muda) is difficult, but can be done relatively quickly (6 to 12 months) and relatively painlessly through a well planned Lean Transformation initiative. Even in the toughest times, such an initiative can liberate working capital, expand capacity, and free up resources for new product launches. Andy Pattantyus is president of Strategic Modularity, Inc., a systems engineering consulting firm that works at the plant level with its clients to do Lean Transformation projects that eliminate Type One Muda (systemic waste).

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