SOURCE: Kay Sever | March 28, 2024
The Renaissance Period was rooted in a desire to explore and discover new knowledge. Renaissance thinking focused on discovering “what was unknown, overlooked, missing or misunderstood”. In 2024, we will be using Renaissance Thinking to understand what’s missing from a traditional optimization scope and how to broaden that scope to capture millions of additional dollars with no additional capital.
The Optimization Dis-Connection – a review
In February we explored the history of accounting and learned that the 800-year-old accounting system developed by merchants to track trade (i.e., “buy and sell”) transactions, inventories and profit is still in use today (with few modifications). Companies around the world use it to track/report revenue, costs, inventories and profit. We also learned that if your goal is optimization (i.e., “best possible” performance), the metrics you need to achieve that goal are either missing from or buried in the financial system (and budget). When metrics for optimization/”best” are missing from management’s toolbox, several things happen:
- You can’t achieve your best performance if you can’t measure what “best” looks like.
- There are questions you can’t answer about your business (see last month’s article).
- Executives and management teams have beliefs about a company’s performance and capabilities that may not be accurate.
Let’s explore #3 in greater detail…
Management beliefs about performance and capabilities are instilled in college classes and handed down from one generation of leaders to the next in older well-established companies. These beliefs are shaped and supported by actual and budget data, the two datasets used by every company to set goals, assess operational and financial performance, and formulate forecasts, budgets and long-term plans. Once you have metrics linked to optimization/”best possible” performance, you gain new perspectives about what is possible to achieve. You may also realize that some of your beliefs about your company’s performance and capabilities no longer align with what you can now see and measure.
As examples, let’s review two beliefs you may begin questioning during your optimization journey…
BELIEF #1 – We have all the data we need to minimize our risk of loss.
Managing a company’s risk of loss is a preventive exercise where management takes action to minimize or eliminate hazards/problems/losses before a loss event happens. Known areas of risk that are actively managed include safety (a top priority), damage from weather or fire, and failure to meet regulatory requirements.
There is one area where the financial risk of loss is unknown because the data required to quantify the risk is missing… the financial risk of not achieving “best possible” performance. These dollars are potential profit dollars (unreported losses) created when equipment and the organization are not performing at pre-defined “best-possible” levels. The dollars linked to this risk can reach into the millions, but are not reported unless management has a third dataset that quantifies them.
Why is this dataset missing from your current toolbox? As we learned in February, the financial system only records transactions/dollars for what happens in a company… revenues collected from customers and costs spent for production and the organization. Potential profit dollars are linked to “best” performance that did not happen but could have happened. The financial system was not designed to report these dollars, so you don’t see them without data that reveals them. As a result, potential profit remains unknown, unmeasured and untouched, which means your risk of loss for these dollars is 100% (because you cannot convert them to profit on the income statement).
BELIEF #2: Variable/Fixed Cost Analysis will tell us where to cut cost.
All accounting classes cover variable and fixed costs. Variable costs are generally explained as dollars that vary with production levels of a product (hourly labor, materials, reagents, supplies, power, etc.). Fixed costs are generally explained as dollars that seldom vary over time such as rental/lease payments, administrative salaries, depreciation, etc. When profit margins are squeezed, management may ask sites to cut costs by a certain percent to minimize or prevent a loss. To meet that objective, the wrong variable costs may be cut, resulting in breakdowns, high overtime or quality problems. Why does this happen? Variable costs are “muddied” on the ledger.
NOTE – You did not learn this is accounting class: There are really two kinds of variable costs, not one. The first kind is made up of true variable costs that fluctuate with production levels and are value-added. The second kind of variable cost has a different pattern of variability. I call these costs “event-based” costs because they vary with events (as defined within the optimization metric framework) across the production value stream and in the organization. If you were pursuing optimization/”best possible” performance, you would target them for elimination FIRST because they are a reflection of something less than “best” performance. When you eliminate event-based costs, performance and profit go up because you stopped losses that partially offset earnings.
NOTE – The financial system is not designed for reducing event-based costs: Event-based costs are combined with value-added costs due to the design of the financial system, which means that across the board cost reductions will not yield the desired result. The GOOD NEWS is optimization metrics can quantify and prioritize event-based costs so action can be taken to eliminate them without affecting value-added variable costs. Optimization metrics also make it possible to SHIFT from traditional cost reduction methods to targeted loss reduction, a more effective way to cut costs.
In both of these examples, a shift in management thinking occurs when executives and managers gain new knowledge and new data that expose potential profit dollars. For the very first time, they begin to understand the gap between today’s performance and their goals for “best possible” results. These insights bring them closer to the truth about what is possible to achieve and change in companies!
Next month: We will continue our optimization journey and talk more about “million-dollar” mindset shifts and how they move your company to a sustainable platform for optimized performance.
Thought for the year: Renaissance thinking has a direct application in positioning your company for success with capital-free optimization. If executives and management teams foster and nurture the desire to explore for hidden profit potential everywhere, what they learn will give them a huge advantage when they want answers to “what’s possible to achieve”.
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Kay Sever is a Performance Optimization Expert and Optimization Management Strategist/Coach. Kay helps executive and management teams quantify and tap their hidden profit potential to reach their optimization goals. Kay has developed a LIVESTREAM management training system for Optimization Management called MiningOpportunity – NO TRAVEL REQUIRED. See MiningOpportunity.com for her contact information and training information.
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- About Us
Kay has worked side by side with corporate and production sites in a management/leadership/consulting role for 35+ years. She helps management teams improve performance, profit, culture and change, but does it in a way that connects people and the corporate culture to their hidden potential. Kay helps companies move “beyond improvement” to a state of “sustained optimization”. With her guidance and the MiningOpportunity system, management teams can measure the losses caused by weaknesses in their current culture, shift to a Loss Reduction Culture to reduce the losses, and “manage” the gains from the new culture as a second income stream.
