A Reader Asks About Benchmarking, Headcount and Efficiency

Simioni from Brazil writes:

In my role as Director of Operational Excellence for a global company I am looking at headcount productivity for all of our sites and using global benchmarking as a reference. Your web site and writing have been very helpful. I have a couple of questions: When you refer to a direct to indirect ratio of 4:1 do you mean cost or headcount? How do you determine where people fall in this calculation, such as maintenance people? Are they always indirect?

 
For starters, I have to caution you to be very, very careful in measuring headcount and labor productivity.

There are only five outputs from manufacturing that matter:

  • profit
  • cash flow
  • delivery
  • quality to the customer
  • and safety

Everything else that you might measure – such as labor efficiency or productivity, headcount or direct to indirect ratios – is merely a subset of or a contributor to these outputs. When you start to measure and ‘improve’ headcount or labor efficiency in isolation – treating it as a measurement of its own – it is almost unavoidable that one or more of the five outputs that really matter will suffer.

Cash flow will deteriorate as inventory builds, quality and safety will be compromised. Headcount and labor efficiency are only important (or not) as they might tell you something about profit – but make no mistake – no stakeholder in the company benefits from lower headcount by itself, so it is critical that you move carefully in this area.

I am also not a fan of benchmarking.

It can be helpful to get the attention of a too-internally-focused management team that believes its lousy performance is just the way things have to be, but benchmarking is usually harmful for a good management team. Same with putting much stock in comparing this year’s results with last year’s. It breeds complacency and a reluctance to change and improve.
Bear
It is like the two hikers running from a bear, where one guy stops to put on his running shoes even though it will not help him outrun the bear – he knows he only has to outrun the other hiker.

The business the equivalent is thinking you don’t really have to create optimum value for the customer – you only have to create more value than the competition.

Far better to focus on the Toyota true north – one piece flow, zero defects, $0 non value adding expense, and 100% employee engagement. Worrying about how far you have to go, instead of how far you have come, breeds a much stronger culture of continuous improvement.

The direct to indirect ratio is merely a general indicator of value adding. It is used simply because it is easy to calculate. Typically the direct labor headcount is comprised of ‘touch labor’ – people that actually touch the product (or operate the machines that touch the product) in the course of its actual transformation.

Management, supervision, material handling, quality inspection, maintenance and clerical personnel are all in the indirect category. Essentially it is a comparison of the number of people who actually make the product compared to the number of people in supporting positions. Note that a very common mistake is to apply it only to factory people, assuming that office, staff and management people are somehow necessary and exempt.

The real concern is not direct to indirect, however. It is the value adding ratio.

This is a bit more complicated and is a measure of the percentage of cost that actually was incurred to create value for your customers as a percentage of your total costs. This is not limited to payroll costs, but looks at all spending.

Normally direct labor costs are value adding while the direct labor people are actually making things. Time spent on breaks, waiting for materials or their machines to be fixed, in meetings or in training is non-value adding. The maintenance people you asked about might be considered value adding when they are performing preventive maintenance to production equipment, and non-value adding while they are repairing machines that broke down.

A critical exercise you should lead your company through is to go through all of your spending, account by account or activity by activity, and try to reach an agreement as to whether each area of spending is value adding or non-value adding. Typically you will find that there is far from a consensus understanding of this, with wide ranging differences of opinion. This is essential, however, for your lean effort to succeed.

Lean is all about eliminating those costs that do not create value for customers – things your customers will not pay you for – and it is impossible to eliminate them if you don’t clearly know what they are.

I hope this answer was helpful – good luck!

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