A firm I visited with the other week took delight in showing me some of the shop floor improvements they had made. And it looked impressive – improvements in setup reduction, workplace organization, and flow improvements. Questioning revealed some deeper problems, however.
When I asked if the firm had reduced the number of workers, the answer was that it hadn’t – the same number of production associates were still employed by the firm. When I asked if sales had increased as a result of the improvements, a similar answer: sales were at the same level as before; however, they had freed up some floor space, they were changing the equipment over faster, and the better flow meant they were accumulating “better levels” of finished goods inventories.
The conclusions I made from these simple questions were the following:
- The firm’s total revenues were unchanged.
- The firm’s total variable costs were unchanged.
- The firm’s total fixed costs were unchanged.
Bottom line: despite the improvements, this firm had not improved its profitability (Profit = Total Revenue minus Total Costs.
Sadly, this picture gets replicated in many firms: process improvements do not result in better economic performance. In some cases, economic benefits that are claimed as a result of improvements are fictitious – they are the result of changed accounting allocations or costing practices.
Real improvement results in economic, not technological, efficiency. Improvements must shift a firm’s supply and/or demand curves. If that doesn’t happen, it wasn’t real improvement and it won’t improve the firm’s profitability.