Part 1 of the series Creating Well-Defined Processes What if your sales went from $100,000 to $110,000 a day and your profits from $10,000 to $11,000? Has it improved by 10%? The answer might surprise you… Because the answer is no. There was no improvement.
In fact, her process deteriorated. Sure, sales are up, but is that really an improvement? Let’s look at the problem in terms of income and expenses. Additional effort prevents process improvements Let’s take a look at the before and after scenario.
In the image above, suppose you have revenue of $100,000, fixed costs of $20,000, and variable costs of $70,000. The total expenses are $90,000, giving you a gross profit of $10,000. In the figure, revenue then increases to $110,000 while variable costs increase to $77,000 plus $2,000 in additional expenses, giving you total costs of $99,000 and gross profit of $11,000. However, in the figure below, remember that fixed costs are fixed and do not change with additional income.
So you should be making more than 10% (11.8% to be exact) gains from 10% growth. But to maintain a 10% gain, we need to spend $2,000 on additional expenses. These additional costs represent the inefficiencies of your process. These expenses can be sales discounts, travel, overtime or other.
Names don’t matter. The important thing is that we don’t improve. Process development enables improvements Improvements result from process development, not from scaling up. What’s the difference?
Scale increases as we hire another person, increase spending, or buy more assets to acquire or service more businesses. Process evolution occurs when we change the process, thereby freeing up hidden capacity and being able to serve more businesses without incurring additional costs – and this is a form of efficiency. You can measure efficiency with the formula: Efficiency = Performance / Cost But process development is more than just changing costs.
It’s about moving time, speeding up the process and getting more out of the costs you already have. Reducing costs alone does not advance a process. In fact, cutting costs without properly understanding how those costs relate to the process can actually slow down the evolution of the process (payback). Let’s see an example… A case study in cost reduction and process training
A company reduces costs by changing suppliers and using cheaper materials in its manufacturing process. Purchasing is now happy about the savings. The bottom line looks better when profits increase initially. And so it improved the process, right? Well…
But then there are complaints from practice. Products break faster. Support costs are increasing and customers are starting to reduce their orders. It’s not just profits that evaporate, but also the goodwill of customers. To compensate, your first reaction might be to go back to the old provider.
This is much simpler and will fix the immediate problem, but will not recover any lost sales.