How to decide if your Lean project is worthwhile
As the champion of Lean Six Sigma in your organization you’re excited to get started on a continuous improvement project. Maybe you’ve already identified what needs to be improved, you know which processes are involved in creating our problem, and you’ve determined the current level of performance.
But wait, there’s more!
Now it’s time to determine how much the problem is costing you. Doing this will be the deciding factor if your continuous improvement project is worthwhile.
As a general rule, you want all of your Lean Six Sigma projects to produce a financial benefit—either directly or indirectly—through cost reductions, revenue growth, balance sheet improvements, or accomplishing strategic goals.
Generally speaking, cost improvements come from reductions in labor, inventory, material, cost of money, scrap, excess equipment, space, and so on.
Categories of savings
Traditionally, savings fall into two categories: hard savings and soft savings. Lean is all about what can be quantified and measured, so it’s not surprising that most organizations prefer to measure success in terms of hard savings—dollars to the bottom line now—and are less impressed with soft savings—the possibility of dollars to the bottom line in the future. A good way to estimate the potential value of a project is to imagine how much you could save if the problem was completely eliminated.
Hard savings reduce expenses and result in a financial improvement. Hard savings are those that are directly attributed to an actual expense. There should be no confusion about how much was actually saved, as there is an invoice, payroll stub, bill, receipt, or the like associated with the expense.
Examples of hard savings are: reduction in unit cost of operation, such as, cost of sale and unit cost of production; reduction in transaction cost; lower overhead costs; lower head count; and increased throughput, resulting in increased sales or revenue.
Potential savings are a form of hard savings but require some action or decision to be realized. An example is a project that optimizes the design of an existing product. Until the redesign is implemented, the savings are only potential.
Soft savings are real benefits to the organization from a Continuous Improvement Project that may not show up on the company’s financial statements like a hard savings would. Soft savings are calculated by using a rational assessment of the expected benefits and a probability analysis of their likelihood.
Soft savings tend to fall into two basic categories. The first is the intangibles. Lower frustration, improved job satisfaction, shorter lead times, greater trust, and the like are all extremely difficult to directly apply dollar values to. All of them, though, do impact the bottom line. The problem is that it is extremely difficult to quantify precisely how much the savings are impacting the profit and loss statement.
The second category of soft savings are those that will likely result in a quantifiable savings, but rely upon so many projections and estimates that a hard value can’t be assigned. Consider the addition of a piece of safety equipment to machine. There will be intangible savings that come from the increased job satisfaction that employees will experience from feeling that their employer cares about them. But there is also a potential hard savings in medical or legal costs if an employee was injured. The problem is that even though this would ultimately be a quantifiable expense, there is simply too much speculation to apply an actual dollar value to it.
Soft savings are, in fact, real savings. Companies save money when employees are more satisfied. For example, acquisition costs go down because satisfied employees are more likely to land new business than disgruntled once. There are also more likely to appease upset customers. Both of these impact the bottom line.
Hard and soft savings guidelines
Creating a continuous improvement culture drives cost savings over time. Having a team of empowered employees that attacks problems can have a tremendous impact on profit.
- Don’t confuse hard and soft savings with cost avoidance. They’re two different categories. You can have an actual hard savings—as in when you save enough space that you can stop renting a production facility—or you can avoid the hard cost of having to rent a new facility to handle expansion. Both situations involve hard savings.
- Be accurate when tallying hard savings. There’s a tendency to inflate savings when reporting on a project. Resist the urge to be overly aggressive in assigning credit.
- Don’t double count the same savings. This is common when two continuous improvement teams both report that they saved the same money. This is very important for maintaining credibility of a Lean program, especially if there are opponents in the executive ranks. Reported savings must make it to the bottom line to keep naysayers from having ammunition in resisting change.
- Don’t neglect soft savings at the expense of hard savings. Some soft savings, especially those linked to job satisfaction, can pay off much more than a hard savings. Be careful, though. Soft savings are extremely difficult to calculate.