There can be differences in the approach for calculation and determination of lean Six Sigma financial benefits. Let’s examine alternatives for the calculation.
Lean Six Sigma Financial Benefits
While in Toronto teaching a Lean Six Sigma Master Black Belt (MBB) class this week, I had a chance to meet with one of my past MBB students (and friend). We talked about financial validation of a Lean Six Sigma Program. He was struggling with the right goal, and had heard that an optimal goal was savings of $1 million per Black Belt per year and less per year for a Lean Six Sigma Green Belt. I generally recommend that organizations avoid fixed -savings goals for belts for many reasons, so that we talked at length about the pros and cons of different variations used by companies. During the discussion, I recalled my review of the financial analysis module for the MBB course along with a talk by Dr. John Daly on Tuesday and had a unique thought that I now believe is the right answer to how to value and report on any Lean Six Sigma (LSS) program.
But first let us consider the standard answers and their issues.
Financial Validation through $ Per Belt
Financial validation through money per belt is probably the most common program validation method. It seems great because these types of methods are used to sell consulting programs. One thing I have liked in working for Forrest Breyfogle and Smarter Solutions is our sales pitch on this topic. Forrest has often said that the savings based on each belt or project is truly a function of how big the problem is rather than how well the belt is trained. How can any program forecast a million dollars per Black Belt per year without an idea of the value of the problems? Do you think that a black belt at a $300-million-a-year company could achieve this goal? No way. Perhaps a Black Belt at a $20-billion-a-year company could achieve this goal, but it might be tough if there were ten black belts all with the same goal.
This also may not be achievable if you require it to be accomplished with hard-savings money. If you include soft-money savings, it might be possible, but it is not really saving that type of money. A quick way to devalue your LSS program is to claim a great financial validation through soft savings.
As a testimonial on savings, when I worked at Bechtel, prior to Smarter Solutions, our highest value project was accomplished by a yellow belt in procurement. The improvement to our procurement program through a better use of p-cards saved almost $400k per year for ever.
Lean Six Sigma Program Validation – Not Financial
My prior preference in measuring Lean Six Sigma program performance was to report engagement metrics. Most programs have a side goal to adopt the LSS methods into the basic work functions, which can be represented with engagement.
Use metrics like the engagement rate of business units quarterly or monthly. If the business unit has an active project or one in the project pipeline at the end of the reporting period, it gets a 1, others get a zero. Report the rate.
For business managers, also use an engagement metric. How many managers have sponsored an active project or have one in the pipeline within the past six months or past year? This can be reported as a rate each month or quarter.
For active belts, report the average active project load per belt. Report monthly. If they are holding an active project at least twice a year, they are dropped from the program.
I like these metrics because they lead to the right behavior and do not focus on the money. To make it work, there must be a solid project approval process to make sure only valid projects make it into the pipeline.
Validation of Lean Six Sigma – Financial Language
When we talk about advanced project value estimation in the MBB class, we focus on the time-value of money; NPV and IRR/RRR. We stay away from ROI or straight pay-back period. That same night I begin talking about LSS program justification by a ROI method.
Let us consider who the final arbiter is in the financial health of a company, the CFO or the finance department. If we consider that the LSS department is an overhead cost that we need to justify so that it is not cut, then why we would we pitch the benefit of LSS to the company as a ROI or payback method that the financial group does not trust for valuing other expenditures? What if we consider the LSS department as an ongoing investment by the company, such as a capital expenditure or an acquisition? In these cases, we would evaluate the benefit in a completely different method.
We would compare the expenditure against our Required Rate of Return (RRR) that we use in all financial decisions. If the Individual Rate of Return (IRR) exceeds the RRR, then we invest. This evaluation method considers the time-value of money and even a bit of cash-flow (indirectly). Now if we provide a financial analysis of our LSS program through a collection of all expenses (i.e., labor, materials, burden/overhead, equipment, training, software….) as the investment cost, then to be a sound financial decision we must return value at a rate exceeding the RRR in hard savings to the budget reduction or revenue growth.
Consider this hypothetical case:
- Fire black belts at a burdened cost of $200K each per year
- Two BB training courses @ $20K total
- Two Minitab licenses @$3K
- Space and IT costs @$2K/year
This comes to $1025K per year in expenses.
Let us assume a 10% RRR (which might be a bit high for some businesses but low for others)
Using this set of assumptions, the RRR would be met with a hard savings of 1.1*1025 or $1.13 million a year in booked hard savings. If we look for a IRR equal to 20%, it would require $1.23 million in booked hard savings. Allocate that across five black belts and you will find the goal to be $246K per Black Belt, which is reasonably attainable in nearly every large business.
Why guess on the goal for project savings when you can select it based on your company’s investment goals?
The CFO View of Lean Six Sigma
Now when times are tough and the company needs to cut costs, using the language of the financial team, it is going to compare apples-to-apples when everything is considered for a cut. It may look at Lean Six Sigma and find that it is providing the highest investment return of any portion of the company. If so, do you think that it would be cut? No way.
Now if the CFO sees a budget line item for LSS and all of the savings are accounted in business units, then it looks like an overhead cost with little risk to being cut.
Final Message
If you are providing a financial justification for a Lean Six Sigma program, it makes sense to justify it with the same language that the company uses to validate spending decisions. Treat Lean Six Sigma as an investment rather than an overhead burden. Why would any CFO recommend cutting an expense that is returning a 20% IRR? They would not do it. Lean Six Sigma would be safe.
Give it a try.
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