Translating Lean Gains into Superior Shareholder Value

Part 2 of 2. Previous: A Three-Step Process for Capturing the Financial Benefits of Lean

Make no mistake about it. The lean journey is all about generating shareholder value. It starts by focusing on the customer and responding to and serving customers well in order to grow. But in the end it comes down to generating maximum value. Lean enables superior value creation by both increasing profit and reducing the assets required to generate it.

Shareholder value can be expressed as a simple equation of profit over assets, or return on assets (ROA). Profits consist of revenues minus costs; and assets consist of net working capital plus fixed assets (see chart below). This may be obvious to most business managers, but it’s important for the management team to think about these factors when marrying their lean journey to financial performance. The actions, process improvements and investments that they decide to pursue will increase or decrease ROA.

It’s important to remember that most people in an organization, even supervisors and department managers, don’t fully understand financial statements or what effect their actions can have on the numbers. Lean efforts will affect both the numerator and denominator of this equation.

A typical lean initiative, whether it’s a project or event, will generate double-digit improvements in profits by decreasing costs or improving labor productivity, and create double-digit improvements in asset utilization by reducing inventories, floor space and working capital and future investment requirements. Organizations have achieved and documented such returns from a lean kaizen event or project over and over again, even if they’ve already attacked a process in the past and sustained the gains.

For example, if we start out with a 1:1 ratio for ROA (profits:assets), and a lean project increases profits by 20% and reduces asset requirements by 20% (1.2 ÷ 0.8), the net gain is a 50% increase in shareholder value (from 1 to 1.5). That’s leverage. Such gains can really add up if a company can continually improve both the numerator (profits) and the denominator (assets).

Business leaders at The Wiremold Company (West Hartford, Conn., now part of Legrand) in the 1990s understood this. During that decade the company made more than 15 acquisitions. They integrated more than half of those acquisitions into their existing footprint, leveraging those fixed assets while growing sales and improving profitability to generate enormous compound growth in shareholder value.

Hayward Pool Products (Elizabeth, N.J.) offers a more recent and detailed example. Hayward acquired a marginally profitable heat pump company with a 45,000-sq.-ft. facility, 43 salaried and hourly people and annual volume of 3,700 units. They brought the product line into Hayward’s existing plant in Clemmons, N.C., manufactured it with less than 10 people and drove sales through the company’s existing distribution channel. They then tripled sales on the strength of their sales network and by putting the Hayward brand on the product. In the end they more than tripled sales without increasing their fixed asset structure.

Lean projects and a lean culture can contribute to superior shareholder returns by enabling innovation, reducing scrap, improving productivity, improving equipment utilization, boosting throughput and effectively integrating acquisitions, as the Hayward example illustrates. Such initiatives can also improve velocity and reduce inventory, receivables, and facility requirements. There are high- and low-level performance metrics for all of these that can be tied to the direct financial benefits of lean. Revenue per square foot, for example, is an indicator of facility productivity that pushes people to think about how to add revenue or volume without adding buildings.

Framing lean in terms of increasing shareholder value takes the focus away from the tools or creating impressive but isolated areas of excellence. No matter how long a company has been working at it, managers who target and work on specific factors of the ROA equation can link a company’s business strategy and vision to its lean journey, thereby maximizing shareholder returns.

Part 2 of 2. Previous: A Three-Step Process for Capturing the Financial Benefits of Lean

Bill Schwartz was a math major in college and he still likes the numbers. He is currently Managing Director of TBM’s Medical Products and Pharmaceutical Consulting Practice. He challenges clients to leverage lean as a strategic tool for growth by implementing strategy deployment and driving culture change.