15 Oct Four Profit Drivers
The four profit drivers concept helps explain Hoshin Kanri’s unique power to drive multiple improvements right across an enterprise all at the same time.
Successful business transformation is not just about creating one, or a handful of barnstorming ideas. On the contrary, transformation requires the use of all four profit drivers to instigate, develop and follow through on many practical and realistic improvements simultaneously and throughout the enterprise.
Typically, when we introduce Hoshin Kanri into a company, the planning team instigates anything between twenty to fifty short-term improvement plans. Each of these improvements slots into one or more of the four profit drivers (Sales volume, Sales price, unit cost and overhead costs see below for fuller explanation).
The action plans emerge as a response to detailed feedback from staff and other stakeholders. The accumulative impact of all the improvements being put into place within such a short space of time is to literally transform a company’s productivity and profitability. And this can all take place in a matter of weeks.
How does this work?
During a Hoshin Kanri exercise we find that generally, improvement projects are both closely interrelated and interdependent. This complex interconnection needs to be coordinated to avoid waste, delays, unintended consequences, duplication of effort and conflict. Hoshin Kanri not only orchestrates the implementation of diverse improvements, it also ensures close alignment between improvements and overall strategy.
Through the planning workshop process the successful implementation of one idea has a positive knock on effect on the development and operation of other aspects of the company and other projects. Improvements generated through Hoshin Kanri, stimulate a ripple effect throughout the company, as all the integrated improvements tend to compound improvements elsewhere and vice versa.
One way of demonstrating this unique planning feature is to use the four profit drivers’ matrix as a model.
Simplistically speaking there are only four fundamental ways to increase your profit. What that means is that, of all the possible strategies, tactics, devices, new technologies and products that you might devise to increase profits, they all fall into one of four drivers of profitability.
In essence the quickest way to increase your profit is to work on all four “profit drivers” AT THE SAME TIME, and this means your team plans to:
1. Increase your sales volume,
2. Increase your sales price,
3. Reduce your unit costs, and
4. Reduce your overheads per unit of sale.
Of course the key success factor here is that any changes you might make to any one of the above drivers has to be carried out without adversely changing anyone of the others as a result. Let’s look at a couple of illustrations.
Lower variable or unit costs might lower quality
You might manage to lower your variable costs, only to find that as a result you have damaged your quality. As a result of the quality problems you then find that this cost saving has had a detrimental impact on either price or sales volume or even worse – both. So in this case a lowered variable or direct costs might be offset by a reduction in your profits. You are back to square one.
More sales may be at the expense of higher overheads
Or another example; you may have raised your sales volume but at the expense of increasing fixed costs with perhaps an extra sales salary or you might have reduced sales prices due to discounting. So again, the risk is your actual profit might go down.
Obviously then, you have to watch that the benefits you introduce are not cancelled out by the disadvantages. Or to put it another way you want any extra costs to be more than compensated by extra benefits. Experience shows that the larger the improvement of one driver, then the more this is likely to create a strain on one or more of the other three drivers. Incidentally, this phenomenon explains why we see so many companies who have grown their sales, find that their profits flat line or even go down.
There are two tricks to pull off
The first trick is to generate a large number of apparently small improvements within each profit driver that combine to improve that particular driver significantly without detrimentally impacting the other three.
The second trick is to aim to improve all four of the profit drivers at the same time. What happens then is that you achieve the multiplier effect. This means that where you extract even small increases in each driver, reap an incremental effect that accumulates to become a huge increase in net profit. The best way to see this is to look at an example.
Profit acceleration example:
Below is a typical example of a small engineering company with the following basic statistics:
In this particular example the Hoshin Kanri process introduced twenty-four improvement projects. Collectively, these projects then had an impact across the four profit drivers that drove profit up by 465%. See below:
But how were these improvements accomplished?
Sales volume driver:
Several projects combined to increase sales volume by 10% yielding £200,000 extra turnover to create a new turnover of £2,200,000. Examples of low cost improvements to this particular driver included:
- Carefully targeted coaching for the sales manager improved the coordination and motivation of the sales staff . This in turn improved their sales performance;
- Highly targeted sales training focused on skills weaknesses revealed by the bottom-up analysis;
- An improved incentive schemes aligned performance with strategic priorities;
- TBD provided a series of Kaizen events in production. This had the indirect impact that reduced time was spent by sales people “troubleshooting” their jobs through the system. Less time troubleshooting enabled the sales team to focus more on proactive sales activity; we estimated time-savings increased sales capacity by 25%.
- Improved customer retention emerged due to improvements in delivery and quality.
- A direct response marketing plan implemented new strategies for cross-selling and up-selling.
Sales price driver:
Numerous projects combined to create an additional 5% increase in price. This increased the new level of turnover by a further £110,000. The combined price increase and volume increase meant the turnover climbed to £2,310,000. Improvements included:
- Improved consistency of the estimating process prevented artificially low quotes from reducing the average price achieved;
- Improvements to the estimating system due to improved data on overhead rates; this was facilitated by improvements to the Management Information System (MIS);
- Changes to invoicing methods capture the full value of work done;
- Targeted market research identifying areas of potential price increase;
- Improved market positioning improved customer perception of product value;
- Improved customer service and delivery times reduced the level of discounts being offered to placate dissatisfied customers;
Unit cost driver:
Various improvement projects generated a 5% reduction in unit costs and this generated unit costs of £808,500 which combined with the extra sales and sales prices led to a new gross profit of £1,501,500. Low cost improvements achieved for this driver involved:
- Improved stock control;
- Various Kaizen events reduced movement, make-ready time, bottlenecks, scrap rates and rework;
- Improved maintenance schedules reducing machine downtime;
- Rescheduling and manning improvements;
- Introduction of more appropriate KPIs helped improve performance;
Overhead rate driver:
A range of different improvement projects reduced overheads by 5% and this produced overhead costs of £1,045,000. Improvements generated here involved:
- Kaizen events enabled people from different functions to work together to improve efficiency and information flow;
- Focused debt recovery reduces finance charges on sales;
- 5 ‘S’ programmes create space savings;
- Analysis of outsourcing of key services finds major savings to procurement prices;
- Management training on key aspects such as time management and delegation improve key executive effectiveness.
The overall effect of these small improvements taking place in each profit driver is a new net profit of £456,500 or 4.5 times the former net profit of £100,000.
Increase in capital value
Generating such a steep rise in profitability is great in its own right. But add this extra profitability to the implementation of a sound business operating system and you create a commensurate and dramatic increase in the capital value of the business. There is a good reason for this. And that is that accountants tend to use a slightly higher profit multiplier to a more professionally run enterprise with a track record of consistent business improvements. So if we assume the original business was valued at £400,000 with a multiplier of four times the net profit of £100,000, then we can now apply a multiplier of five times the new net profit. As a result, this business will see a rise in capital value from £400,000 to £2,282,500 providing an extra £1,882,500 of value to the owner.
The challenge here, as you will see, is how can you possibly identify, plan, coordinate and implement all the large number of improvements needed to make a real overall difference. This is where TBD’s Hoshin Kanri team planning can help.
The outcome of the first TBD planning workshop is the instigation of a Management Action Plan (MAP). This MAP comprises a schedule of anything between twenty to fifty prioritized and delegated semi-autonomous “improvement projects” or “action plans”. Each of these projects improves the profitability of at least one or more of the four profit drivers.
“We’ve achieved more changes in six weeks with these team planning workshops than I’ve seen in twenty years of my time here.” Dave Medhurst Projects Coordinator Steelfields Concrete Batching Plant Manufacturer.
Find out more about how you can use Hoshin Kanri to generate and integrate a mass of new improvement projects that collectively transform your profitability and performance:
Download our free white paper on ‘Hoshin Kanri and the art of rapid business transformation’
For more information on how Hoshin Kanri can get you better results faster, contact Jeremy Old on: 0845 0945 819 or email [email protected]
In this groundbreaking book, the author explains the psychological reasons why collaborative management methods such as Hoshin Kanri are so much more successful than conventional top down command and control.
Jeremy is qualified to MBA level, with a post-graduate diploma in psychotherapy.