Challenge of Profitable Growth
The challenge for most small and medium-sized manufacturing businesses is how to grow revenue and profits as well as develop a sustainable niche in the competitive globalised marketplace. TXM’s experienced lean consulting team have helped more than 100 small and medium-sized enterprises (SMEs) to overcome these challenges and grow their businesses.
The Dis-economies of Scale
Economic theory dictates that as a business grows, fixed costs stay fixed, variable costs grow in line with sales, and this increases profit margins. This is called the economies of scale and many of us will have studied the concept in high school economics. Unfortunately for many SMEs, the opposite process occurs. As sales grow, overheads also grow, and variable costs grow faster than sales, as productivity falls. As a result, profit margins fall and in some cases disappear. Working capital in the form of debtors and inventory also increases and the business may struggle with sourcing enough cash to fund its day to day operations.
Lead times, customer service and quality are often then compromised as financial resources and management capacity become overstretched. Eventually the business has to stop growing or it will fail, when it runs completely out of cash.
The root cause of dis-economies of scale (as we refer to this process) is the lack of an effective management system. A lack of effective management systems means that more managers, supervisors and expeditors are added in an effort to maintain control of the growing business. This increases overheads. A loss of management control, poor communication and a reduction in employee engagement as management layers are added lead to reduced productivity and more errors and waste, increasing variable costs. Finally, inadequate processes for day-to-day execution of orders and management of backlogs and materials means that lead times often increase, leading to increased inventory, costly expediting and expanding factory buildings filled with inventory and work in process (WIP).
All of these problems combined means that the leaders of the business spend their days fighting fires instead of planning the future growth of the business.
How Lean Can Help
Many managers in SMEs view Lean as a big company, Japanese, automotive industry approach that is simply not relevant to their business. The reality is, however, that Lean is a simple, practical and highly adaptable management system which can deliver excellent results for all types of manufacturing enterprises. The key is to customise the Lean approach to develop a management system suited to each specific business.
In our experience, a well-implemented Lean production system reverses the dis-economies of scale. Simplified and streamlined processes for order fulfilment dramatically reduce lead times, inventory and factory footprint, reducing working capital as a consequence. Robust systems for planning, ordering and responding to customer needs reduce or eliminate expediting and material shortages. Improved business organisation and communication as well as enhanced problem-solving skills drive decision-making towards the front line. This means that workers are more engaged and problems that lead to waste and defects aren’t left unresolved.
The overall result is increased productivity and increased capacity. Streamlined production processes enable higher throughput with the same people and equipment. Middle management and supervisors have increased capacity to lead their teams and improve performance, facilitating growth in overheads. Senior management is no longer focused on day-to-day firefighting and is able to focus on strategy and growth.
The combined effect of all these improvements is that variable costs, overheads and working capital are all reduced, meaning that profits increase faster than the rate of sales growth. The business is then in a position to generate additional sales growth and a virtuous cycle of improvement is born.