My advice is that you should temper your expectations when it comes to adopting a continuous improvement philosophy. Continuous improvement is inherently gradual and incremental without the dramatic, spectacular, or singular event we often hope for. Silver bullets are rare in life.
The notion of Lean and other like approaches is one of small wins that build upon each other over time. Improved viability here, reduced cycle-time there, standardization of methods here, and alignment there. Before long, it will all add up. There’s opportunity everywhere we look if we can only adjust our focus to see it. Hence the question becomes, where should I be focusing the company’s energies and resources? ROCE is a great tool if this is where you find yourself today.
What is ROCE? Return on Capital Employed (ROCE) has been used in the business world for decades. The measure is an interesting one. By itself, ROCE represents the overall financial efficiency of an organization. Comparatively, however, ROCE provides valuable insight into the ways different business units or geographies are managed and also can help you prioritize where assistance is best applied. The higher the ROCE, the better the organization (or sub-organization) is performing from a financial perspective.
Let’s break down ROCE (or it’s close sibling RONCE) into its respective components. It’s fairly simple.
First, consider the EBIT in the numerator. Logical improvements to EBIT might include reducing your quote-to-cash cycle to boost revenue recognition, selling more goods and services, reductions in Cost-of-Goods-Sold, higher profit margins, lowering warranty expenses, or faster product development and deployment cycles. EBIT is simply income. Anything that brings in more money faster or prevents the waste of money unnecessarily will gradually boost your EBIT. These are the types of prime continuous improvement activities that led to Lean in the first place, decades ago.
Next, we examine the Total Assets component of ROCE. As the positive attribute of the denominator, growth of Total Assets will undermine our objective to increase ROCE. Hence, it is imperative to minimize Total Assets and make the most of what you already have. Total Assets includes the hard assets (such as facilities and equipment) as well as the variable assets (primarily inventory). Asset utilization and inventory control are key to taming this factor. Lean is an excellent methodology to drive inventory to appropriate levels, in part by focusing on the speed of inventory rather that the amount. Asset utilization is key as well and requires that capacity be well managed and equipment either be operational or removed.
We cannot neglect the 3rd and most often overlooked factor of ROCE: Total Liabilities. Our liabilities are simply the ongoing operational expenses of doing business. Wages, outstanding payments, company debt, and long-term commitments are examples of Liabilities that will impact your ROCE calculation. Because Liabilities effectively reduce the Total Assets factor, you might be inclined to believe Liabilities are useful. Beware. Liabilities interfere with cash flow and presume upon tomorrow’s EBIT figures. Keep your liabilities small to protect your long-term viability.
ROCE is a useful way to measure the financial performance of your business or even your smaller business entities. ROCE helps to qualify the overall management of the organization and grants valuable insight as to where additional improvement efforts might best be applied. As a comparative tool, ROCE can be a powerful metric to help you bring your organization to the next level. Try applying ROCE in unconventional ways to deploy targeted improvement initiatives. You’ll be surprised by the results.
Lean in and Lean on.