{"id":4592,"date":"2010-09-07T06:45:43","date_gmt":"2010-09-07T13:45:43","guid":{"rendered":"https:\/\/staging.opexlearning.com\/resources\/?p=4592"},"modified":"2020-12-26T19:56:49","modified_gmt":"2020-12-27T00:56:49","slug":"lean-management-and-cost-reduction","status":"publish","type":"post","link":"https:\/\/staging.opexlearning.com\/resources\/lean-management-and-cost-reduction\/4592\/","title":{"rendered":"Lean Cost Savings and Profit=(Price-Cost) Explained"},"content":{"rendered":"<div class=\"a296a24fa2fc69ef5487857f02f111e8\" data-index=\"9\" style=\"float: none; margin:10px 0 10px 0; text-align:center;\">\n<script async src=\"\/\/pagead2.googlesyndication.com\/pagead\/js\/adsbygoogle.js\"><\/script>\r\n<!-- Single Post readerboard -->\r\n<ins class=\"adsbygoogle\"\r\n     style=\"display:inline-block;width:728px;height:90px\"\r\n     data-ad-client=\"ca-pub-8207522353004717\"\r\n     data-ad-slot=\"1144967431\"><\/ins>\r\n<script>\r\n(adsbygoogle = window.adsbygoogle || []).push({});\r\n<\/script>\n<\/div>\n<p>In a tight economy, there is an added emphasis on <a title=\"cost reduction strategies for a warehouse\" href=\"https:\/\/staging.opexlearning.com\/resources\/warehouse-reduce-costs-increase-service-level\/10028\/\">cost reduction<\/a>, to maintain healthy profitability for the company. At these times, many organizations turn to Six Sigma and \/ or Lean methods for help. But, the traditional corporate finance worldview prevents <a title=\"lean or six sigma - which strategy makes more sense?\" href=\"https:\/\/staging.opexlearning.com\/resources\/lean-or-six-sigma\/2822\/\">Lean and or Six Sigma<\/a> from effectively helping the organization in the long-run because the traditional corporate finance model is almost antithetical to the fundamental tenets of Lean Thinking.<\/p>\n<p>Let me explain <sup class='footnote'><a href='#fn-4592-1' id='fnref-4592-1' onclick='return fdfootnote_show(4592)'>1<\/a><\/sup>.<\/p>\n<h2>Cost Plus Model (Traditional Corporate Finance)<\/h2>\n<p>Most organizations believe and build their models based on the following model:<\/p>\n<blockquote><p>Cost + Profit Goal = Sales Price<\/p><\/blockquote>\n<p>For example, suppose I sell lollipops and I want to make $0.75 profit and each lollipop cost me $0.25, then I&#8217;d price the lollipops at $1.00.<\/p>\n<blockquote><p>$0.25 + $0.75 = $1.00<\/p><\/blockquote>\n<p>This simple example describes, in general, the corporate finance worldview. The main assumption and emphasis in the traditional corporate finance worldview are the following:<\/p>\n<ol>\n<li>Costs is fixed (not controllable)<\/li>\n<li>Price is determined by the company policy or profitability goal<\/li>\n<\/ol>\n<p>The corporate finance worldview might be illustrated as a traditional cost plus model:<\/p>\n<h2 style=\"text-align: left;\"><img loading=\"lazy\" decoding=\"async\" class=\"size-full wp-image-4593 aligncenter\" title=\"lean-management-cost-plus\" src=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-plus.jpg\" alt=\"corporate finance, cost plus model\" width=\"520\" height=\"330\" srcset=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-plus.jpg 592w, https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-plus-300x190.jpg 300w\" sizes=\"(max-width: 520px) 100vw, 520px\" \/><\/h2>\n<h2 style=\"text-align: left;\">Lean Thinking Model (Costs are Controllable)<\/h2>\n<p>In contrast to the traditional corporate finance worldview, the Toyota Production System (also known as the Toyota Production System, Lean Management, Lean Thinking, Lean Manufacturing), views the model differently and with a different emphasis:<\/p>\n<blockquote><p>Profit = Sales Price &#8211; Cost<\/p><\/blockquote>\n<p>In the Lean Thinking model, the belief and emphasis are the following:<\/p>\n<ol>\n<li>Costs are controllable and can be reduced through the application of lean manufacturing methods<\/li>\n<li>Sales Price is determined by what customers are willing to pay, not by company profitability policies (EBITDA Goals)<\/li>\n<\/ol>\n<p>In the lollipop example, the market (customer) would define the price of $0.75 per lollipop, and with a cost of $0.25, then the profit would be $0.50. In order to increase the profit, the focus would be on reducing the cost below $0.25, not increasing the cost to the customer (and reducing overall sales and dissatisfaction).<\/p>\n<p>The Lean Thinking model might be illustrated like this:<\/p>\n<p style=\"text-align: center;\"><img loading=\"lazy\" decoding=\"async\" class=\"size-full wp-image-4594 aligncenter\" title=\"lean-management-cost-reduction\" src=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-reduction.jpg\" alt=\"lean thinking cost pricing profit model\" width=\"520\" height=\"329\" srcset=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-reduction.jpg 591w, https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/lean-management-cost-reduction-300x189.jpg 300w\" sizes=\"(max-width: 520px) 100vw, 520px\" \/><\/p>\n<p>Mathematically, both equations are identical, but the difference in assumptions and emphasis have a significant impact on company behavior, actions in the market, marketing, and the impact on employees and customers.<\/p>\n<p>For example, following the cost-plus or the traditional corporate finance model can lead too pricing products or services above what customers are will to pay, leading to early irrelevance in the market; not to mention, almost completely antithetical to common sense economics.<\/p>\n<h2>Why are they Opposed?<\/h2>\n<p><a href=\"https:\/\/www.amazon.com\/gp\/product\/0470267623?ie=UTF8&amp;ref_=sr_1_1&amp;s=books&amp;qid=1283863674&amp;sr=8-1&amp;linkCode=shr&amp;camp=213733&amp;creative=393185&amp;tag=sixsigma09-20\" target=\"_blank\" rel=\"noopener noreferrer\"><img loading=\"lazy\" decoding=\"async\" class=\"alignright size-full wp-image-4605\" style=\"margin: 4px;\" title=\"extreme-toyota-michael-porter\" src=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/extreme-toyota-michael-porter.jpg\" alt=\"\" width=\"318\" height=\"178\" srcset=\"https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/extreme-toyota-michael-porter.jpg 506w, https:\/\/staging.opexlearning.com\/resources\/wp-content\/uploads\/2010\/09\/extreme-toyota-michael-porter-300x168.jpg 300w\" sizes=\"(max-width: 318px) 100vw, 318px\" \/><\/a>Suppose Lean Methods are adopted to effectively reduce costs from fundamental operations and nothing changes from a corporate finance perspective. In this scenario, the firm could still price itself out the market AND still reap the benefits from lean methods. But, is the firm any better? Perhaps a little &#8211; it&#8217;s improved the performance and cost of its operation, but sales could be simultaneously plummeting because the price is set at a level customers aren&#8217;t willing to pay.<\/p>\n<p>The opposite is also true: perhaps the price customers are willing to pay is higher than where the firm has set it; then, profitability in this case is not maximized.<\/p>\n<h2>It&#8217;s Your Turn<\/h2>\n<p>What do you think? What examples have you seen that follows one of the models above and what was their impact on the employees, customers, and the business?<\/p>\n<div class='footnotes' id='footnotes-4592'>\n<div class='footnotedivider'><\/div>\n<ol>\n<li id='fn-4592-1'> inspired by Art Smalley and his numerous writings on this subject <span class='footnotereverse'><a href='#fnref-4592-1'>&#8617;<\/a><\/span><\/li>\n<\/ol>\n<\/div>\n<!--CusAds0-->\n<div style=\"font-size: 0px; height: 0px; line-height: 0px; margin: 0; padding: 0; clear: both;\"><\/div>","protected":false},"excerpt":{"rendered":"<p>In a tight economy, there is an added emphasis on cost reduction, to maintain healthy profitability for the company. At these times, many organizations turn to Six Sigma and \/ or Lean methods for help. But, the traditional corporate finance worldview prevents Lean and or Six Sigma from effectively helping the organization in the long-run [&hellip;]<\/p>\n","protected":false},"author":12327,"featured_media":4594,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"_genesis_hide_title":false,"_genesis_hide_breadcrumbs":false,"_genesis_hide_singular_image":false,"_genesis_hide_footer_widgets":false,"_genesis_custom_body_class":"","_genesis_custom_post_class":"","_genesis_layout":"","footnotes":""},"categories":[16],"tags":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v23.0 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Lean Cost Savings and Profit=(Price-Cost) Explained<\/title>\n<meta name=\"description\" content=\"Lean Cost Savings and 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