Cost Reduction Potential

All process improvements are not created equal. How should we select which processes (or process steps) to improve? How do we approach this for a really large migration project? Start with understanding the potential for improvement and then narrow it down from there.

The Basic Concept

When re-engineering a business process, ultimately we want to maximize the ROI of our improvements. That means understanding the costs of today’s process, the costs of tomorrow’s process, and the costs of creating and transitioning to the new process. On a large project, this can be a herculean task. We don’t have enough time to do all the math. We don’t want to get paralyzed with analysis activities. Where should we start?

We should start with the processes that have the highest potential for improvement. Since profit can be simplified to a simple equation of savings minus deployment costs, we should start by finding the processes (or process steps) with the highest initial costs (and therefore the highest potential savings).

A Simplification

To simplify the presentation of this idea, we will ignore probabilistic costs (risks, errors, modeling) – not because they aren’t relevant, but because the cloud the issue. Imagine for the rest of this article that the only costs in a process are operating costs. The same approach can be extended and refined to include other very real costs.

We will also use an example that depicts process steps – it could easily depict processes. The only difference is the level of detail. On really large projects, use this technique to identify high potential processes, then drill down into them to identify high potential process steps.

Potential

To calculate potential, we calculate the costs of existing process steps. Consider the following simple (existing) process:

The process has five steps, A through E. Step B is a decision, meaning that some times we execute step C, and other times we execute steps D and E.

We want to know which step of the process to focus on improving – so we have to identify the step with the greatest potential for savings.

There is a simple formula for defining the cost of any step in the process.

Frequency x Effort x Burden x Period

• Frequency (number of occurences per unit of time)
• Effort (units of time spent in the task)
• Burden (money per unit of time)
• Period (unit of time for the analysis)

We can represent this with a simple template of a spreadsheet.

Sample Data

By creating sample data for each input, and calculating the cost, we can compare the potential for each step in the process.

If we were to ignore frequency information, then step C would appear to have the most potential, because it has the highest “per occurence-cost (with an effort of 5 hrs at $20 / hr). However, by recognizing that step C is only executed 10% of the time, we see that the cost of step D is actually the highest (at $36,000 per year).

Interpretation

Our interpretation is that step D has the greatest potential for savings, because it has the highest cost. Steps A and E come are next, followed by step C. Step B is so cheap that it isn’t likely to be worth evaluating.

Next Step

The next step is to propose a replacement for the highest potential step (D). Alternately, we may look for a way to combine steps D and E with a single replacement (as mentioned in this article about process improvement). After exploring this solution approach, we would look at steps A and E as candidates for replacement. Estimating the costs of replacing these steps is the next thing we do. The costs of performing the steps today, minus the costs of performing the new steps in the future (plus the development and transition costs) determine if we should consider this as a step for replacement.

We will only consider those steps where the profitability of change exceeds our hurdle rate for investment.

Once we have profit data for each proposed step change, we can prioritize these changes, and then schedule them in conjunction with the skills of our development team.

Strategic Change Loophole

Executives like loopholes. Perhaps because their accountants find so many for them. We have a loophole here too – a process step may need to get replaced because of internal office politics, or for “strategic” reasons. We need to make sure our stakeholders have a way to include financially excluded choices.

Summary

Identify the most expensive processes to run. Determine ways to replace them. Calculate ROI and use it to drive prioritization.