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May 20, 2014

What are the Best Lean Performance Measures?

I believe there is a serious problem with most of the measures that organisations use to measure their “lean” improvements. The key measures in most large-scale “lean” approaches are cost-reduction (i.e. headcount) and productivity. Neither of these are lean measures and can, in fact, lead to totally anti-lean behaviours. For instance, I have witnessed discussions in an organisation implementing a mechanistic approach to “lean” where paranoia reigned in discussions about improving “standard operating procedures”. The management were terrified of amending the procedures in case this added “time” to the procedures and, thus, removed headcount savings that had already been banked. They blithely ignored the fact that the procedures were, in reality, neither correct, nor adhered to by staff. This, of course, means that the originally reported cost savings were, in fact, completely illusory!

Productivity is a poor measure of improvement because changes that improve the flow through the process as a whole (reducing the lead time), such as batch reduction or set-up reduction, may actually increase the number of labour minutes in a process.

Headcount reduction is not a measure of lean improvement either. Lean is about reducing the time-line (lead time/ flow time) of a process. Headcount tells us nothing about this, and may lead us in the opposite direction.

So the measures are wrong. But large organisations face the problem of comparing (or accumulating) measures across a wide variety of locations. That’s why headcount is used as the principal measure – it is easy to understand, compare and accumulate. But that does not make it lean. Lead time reduction is a measure of process improvement, but it is not a measure you can compare across diverse processes, or accumulate. That means it is not something you can report to shareholders, or discuss meaningfully at management meetings.

Capacity is a better measure, but it is still not something you can “bank”. The purpose of lean is to remove “waste” from a process and, therefore, create available capacity which can then be made available for value-adding work. The financial benefit of lean comes, not from reducing headcount, but from using the capacity you have created (from waste) profitably. Trouble is, free capacity is difficult to explain as “good news”. Creating 10,000 hours of capacity, without having a clear strategy to use it profitably, may be taken very negatively!

I suggest that net cashflow (cash in less cash out) is the best way to measure improvement. It is tangible and relatively easy to understand, and it can be aggregated in management reports and discussed meaningfully at management and shareholder meetings. Cashflow is a great measure of lean in a manufacturing environment because inventory levels can be reduced relatively quickly freeing up lots of cash. In service environments, stock becomes much less significant, so the cashflow measure becomes trickier. Where people costs are the major element in the process then there is also the danger that cashflow reduction becomes a proxy for headcount reduction. However, for most processes, we should be able to develop some simple ratios which reflect process improvement by showing the increasing speed of cashflow – for example, a measure of cash turns (similar to the lean measure of inventory turns used in manufacturing).

To make net cashflow (or cash turns, or similar) a worthwhile measure of improvement we need to determine the cashflow of the current state and make cashflow projections for various future states – for example, the cashflow when waste has been removed from a process but not yet used; and the cashflow that will be generated when that free capacity is used profitably (to do more revenue generating work with the same resources).

Perhaps, then, the ultimate measure of lean improvement is the cashflow profile of the Value Stream over time (say three to five years).