Incremental Improvement, Part 7 - Pulling it all together

Throughout the recent series of articles, we have analyzed the necessary improvements required in various variables to elevate a company's Return on Asset Investment from 12.5% to 20%. These variables and corresponding actions included:

1. Increasing Prices

2. Increasing Sales Volume

3. Lowering Variable Costs

4. Lowering Fixed Costs

5. Lowering Asset Investment

Each post provided a basic example illustrating the necessary adjustment in a single variable to achieve a 20% return on assets invested (ROAI), assuming the other variables remain constant. Real-life application of these examples reveals the challenges in achieving depicted improvements due to the interconnected nature of variables, where changes in one can affect others (e.g., price increases often lead to decreased sales volume). However, an alternative approach exists.

In reference to James Clear's book "Atomic Habits," we can apply the 1% principle emphasized by the author. By improving by just 1% daily, individuals or organizations can witness exponential growth, with a 37.8X improvement over time.

When applied to a business environment, we can utilize this principle in our ROAI example. Instead of aiming for a drastic improvement in the ROAI metric (12.5% to 20.0%) by altering a single variable, we can assess the impact of enhancing ROAI by implementing the 1% improvement model across each variable simultaneously. In essence, we evaluate the effects of:

1. Increasing Prices by 1% (from $250/Unit to $252.50)

2. Increasing Volume by 1% (2000 units to 2,020 units)

3. Lowering Variable Costs by 1% (60% of Sales to 59.4%)

4. Lowering Fixed Costs by 1% ($150,000 to $148,500)

5. Lowering Asset Investment by 1% ($400,000 to $396,000)

The recalculated ROAI would be as follows:

Revenue = $252.50 x 2,020 = $510,050

Variable Costs = 59.4% x $510,050 = $302,970 (Rounded)

Contribution Margin = $207,080

Contribution Margin % = $207,080/$510,050 = 40.6%

Fixed Costs = $148,500

EBIT: New = $58,580

Asset Investment = $396,000

ROAI: New = $58,580/$396,000 = 14.8%

Although the revised ROAI falls short of 20%, this strategic approach (in the given example) significantly progresses towards the target. The efficacy of the 1% improvement strategy lies in its practicality compared to drastic alterations to variables that could disrupt business operations.

Incremental Changes - The Potential Benefits

Embracing a 1% improvement strategy, can yield numerous advantages for a business. This method, also known as the principle of marginal gains, involves making gradual enhancements across various business aspects. Here are some key benefits:

• Accumulation of Progress - Incremental advancements can lead to substantial overall progress, with a mere 1% daily improvement resulting in a 37-fold enhancement by year-end, delivering long-term benefits without undue pressure.

• Increased Efficiency and Productivity - Continuous improvements streamline processes, reduce inefficiencies, and boost productivity by refining operational procedures for smoother workflows and optimal resource allocation.

• Boosted Employee Morale and Engagement - Cultivating a culture of ongoing improvement empowers employees to contribute ideas, fostering higher job satisfaction, increased motivation, and elevated morale.

• Enhanced Adaptability and Innovation - Consistent adjustments enable businesses to effectively respond to new challenges, nurturing an innovative environment for creative solutions and enhanced organizational adaptability.

• Sustained Competitive Edge - Persistent enhancements empower businesses to maintain a competitive advantage, stay ahead of industry trends, meet customer demands, and fortify market position.

• Reduced Risk of Major Failures - Incremental changes pose less risk than radical transformations, allowing businesses to test and refine changes gradually, minimizing disruptions or failures.

• Improved Customer Satisfaction - Continuous improvement leads to superior products and services, enhancing customer satisfaction through refined offerings based on feedback and market insights.

• Cost-Efficiency - Incremental enhancements optimize processes, reduce waste, and enhance resource efficiency, resulting in cost savings that positively impact financial performance.

• Cultural Embrace of Excellence - Establishing a culture of excellence motivates everyone to strive for superior performance and elevated standards through continuous improvement.

The Potential Disadvantages to Incremental Improvement Practices

While implementing a 1% improvement strategy offers benefits, it can also present drawbacks:

• Resource Intensive - Demands time, money, and expertise, posing challenges for businesses with limited resources.

• Resistance to Change - Employees and management may resist changes, impeding effectiveness.

• Short-term Disruptions - May disrupt daily operations, temporarily reducing productivity.

• Lack of Immediate Results - Emphasizes long-term benefits, potentially disappointing stakeholders seeking quick wins.

• Potential for Overlooking Major Issues - Focusing on minor improvements may overlook larger systemic issues.

• Risk of "Penny Wise, Pound Foolish" Decisions - Small improvements could lead to detrimental cost-cutting measures.

• Employee Fatigue - Ongoing initiatives may induce change fatigue among employees.

Conclusion

When implementing the 1% improvement strategy, businesses must understand that while it can yield significant long-term benefits, there are potential downsides that need to be acknowledged. One key aspect to consider is the need for effective management that can oversee the implementation of these incremental changes. Transparent communication is also vital to ensure that all stakeholders are on board with the strategy and understand its importance.

Moreover, a comprehensive approach that combines both small and large improvements is essential to mitigate any drawbacks that may arise. By incorporating a mix of incremental changes and more substantial initiatives, businesses can create a well-rounded strategy that is better equipped to drive lasting success.

Ultimately, the key lies in finding the right balance between continuous small improvements and larger transformative efforts. This balanced approach can help businesses navigate the challenges that come with the 1% improvement strategy and maximize its potential benefits in the long run.