SATURDAY, NOVEMBER 25, 2017
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Implementation Financial Analysis Hard and Soft Savings: What Counts Can Be Counted

Hard and Soft Savings: What Counts Can Be Counted

Six Sigma is all about what can be quantified and measured. So it is not surprising that organizations which utilize Six Sigma often prefer to measure success in terms of hard savings – dollars to the bottom line now – and are less impressed with soft savings – the possibility of dollars to the bottom line in the future. But it pays any organization to consider both hard and soft savings when evaluating the merits of a Six Sigma project. Sometimes soft savings are harder than management realizes.

Common Hard Savings

  1. Reduction in unit cost of operations
  2. Reduction in unit cost of production
  3. Reduction in transaction cost
  4. Reduction in overhead cost
  5. Reduction in transportation cost
  6. Reduction in manpower
  7. Increased throughput, resulting in increased sales or revenue

Common Soft Savings

  1. Reduction in cash flow
  2. Reduction in need for working capital
  3. Avoidance of capacity enhancement
  4. Conformation to changes in the law
  5. Increased safety in the workplace
  6. Increased employee satisfaction
  7. Increased customer satisfaction

The traditional view of hard savings is pretty standard. According to Karen Lay-Brew, CIO and vice president of knowledge services of BHP Billiton, regularly listed examples of hard savings are: reduction in unit cost of operation (e.g. cost of sale) and unit cost of production; reduction in transaction cost; lower overhead costs; lower head count; and increased throughput, resulting in increased sales or revenue.

Adam Bowden, director of Six Sigma for First Data Corporation, puts it even more simply: “We’re no longer spending the money on X; we were, but now we’re not.” Bowden says that senior leadership can be quite narrow in their outlook: “They want to see X off the P&L, period.” And that can make hard savings an easy sell, but soft savings much more difficult.

A Spectrum: From Hard to Soft

Instead of looking at Six Sigma project savings as hard or soft, it is more reasonable to think of them as a savings spectrum, according to Rob Tripp, a consultant with Six Sigma Consultants. “Think of it as four major categories in hard and soft savings, A, B, C and D. But don’t think of them as separate entities; instead, think of them as a spectrum, from A to D.”

A is the easiest to describe: it’s on the P&L, and for the current period. It’s in the budget. “If a process owner is willing to actually book something into his or her budget, then that’s hard savings,” Tripp says. Category B also is hard savings, but it’s a little bit more out in the future: savings on the balance sheet, cash flow, or working capital. C is when things begin to shift into soft savings, and includes things like cost avoidance or capacity enhancement. Savings will occur, the project team is fairly certain, but there is no positive confirmation of this. For example, when a bottleneck is removed from a process there is an expectation of greater production, increased customer satisfaction or faster transaction speed. And D is when the team knows that it’s the right thing to do (e.g. safety improvements, legal or environmental changes), but you have no proof and no quantifiers. A project, Tripp says, can migrate from one category to another. What starts as soft savings can become hard savings, after time – as the savings which could at first only be theorized becomes quantifiable.

“The word ‘savings’ is,” in Lay-Brew’s view, “too limited to describe what Six Sigma can deliver. The preferred term is ‘benefits,’ in that the bottom line can be affected both by reduction in cost (savings) and by increasing the revenue.” The word savings implies reduction, which suggests an “I-have-to-cut-something” mentality, she says. The term benefits has a more positive connotation, and shifts the focus to growth, not reduction. Many organizations prefer “benefits” because of its broader and more positive focus, according to Lay-Brew.

Hard savings – or hard benefits – still receive most of the attention in companies. But why? Lay-Brew says that it has to do with the culture. “One reason is the focus of our society in measuring the success of companies by hard numbers. Analysts, the stock market and investors all use financial performance as a primary assessment tool of a company’s success.” Companies are expected to show revenue increases and cost savings that affect the bottom line. “Six Sigma is typically associated with cost reduction efforts, and so by natural deduction and association, the focus also tends to be on hard savings,” she says.

Rob Tripp terms the items in the D category of the savings spectrum – the softest savings – as “market opportunities” or “operating risks.” Most companies, he finds, don’t have a great appetite for risk. Managers are generally risk averse – they do not want to embark on a cultural change (like Six Sigma) without some hard evidence, and preferably a major dollar impact. So can senior managers be convinced of the value of soft savings, when the data – the numbers – do not seem to be there?

Making Soft Savings Harder

Perhaps they can be, says Bowden. For example, a small company has $10 million worth of inventory, which has to be counted, warehoused and cared for. But what if that inventory could be reduced by $5 million? That savings can become cash flow, or be reinvested in marketing, and then what seemed like soft savings becomes hard and could result in an increase in revenue. Perhaps a process can be improved so 10 people are freed up. If those 10 are good people, with good ideas, then you create new opportunities for them to explore new avenues of revenue or new business ideas. Retaining those people, reusing them, freeing up their capacity, he says, can allow a company to grow “outward” rather than inward.

Lay-Brew lists other ideas for making soft savings “count.” For example, a company could invest in improved safety and risk management measures, which will result in decreased accidents, which in turn could affect company insurance costs over a period of time. That’s a hard savings, which can be proved. Or, cost avoidance or risk mitigations could be realized, depending on how a company budgets and provisions for mitigating risks and disasters. For example, improved preparedness or options for recovery from a disaster, such as an earthquake, could reduce the amount of damage or the cost of recovery should such a disaster happen.

Tripp concurs. His example also involves forecasting. Different companies forecast their numbers differently. Perhaps, a Six Sigma project could reduce future hiring. A company might have forecast a need for 10 new people by the end of February, but now, because of improvements in process, it needs only 5. Or, perhaps the company can reduce overtime, or can prove a reduction in usage costs (e.g., the amount of time on a computer system). All three are soft savings that by year’s end become hard, quantifiable savings.

Using a More Holistic Approach

Changing a company’s approach to improvements or changes can shift a company’s perception of soft savings – or benefits – from less desirable to more desirable. As noted, given some time, soft savings can be recognized as hard savings. But the same also can be achieved, says Lay-Brew, “by a systematic elimination of constraints, or by looking at a more holistic approach to improvement opportunities. This is, of course, dependent on the company’s accounting policies and benefits recognition approach.” A longer view, she says, can be useful. Without it you might miss opportunities to retrain people or change job structures, which could ultimately result in growth opportunities. Longer-term benefits – such as less employee turnover, less time training new employees or less absenteeism – cannot be ignored.

Bowden agrees with the longer view of soft savings/benefits. “Short-termism” can hurt companies in the long run, he feels. For example, consider employees whose jobs are up for elimination. If a company’s senior leadership sees only a few years ahead, then those people will be let go. But if senior leadership takes a longer view, it might think about other ways to use those people, to free up their capacity to grow the business and look for areas to expand or add, according to Bowden.

In the end, however, it might take a real shift in business culture to push companies to consider the value of soft savings, and the ultimate financial rewards they can bring. Some might say that sounds like a great Six Sigma project. Lay-Brew says, “[The business] culture needs to adjust to the rewarding and public recognition of doing the right things.” That often results in soft savings. Then, she says, businesses must encourage employees to relentlessly pursue those soft savings to turn them into hard savings.

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Comments

JustCurious

How is soft savings different than Intangible savings ?

Reply
Neal

Hello Mary – please accept my congratulations – this article provides a brilliant insight into the often misconstured arena of Quantification of Gains from Improvement Projects. I especially liked your categorization of benefits into the four logical classes as part of one spectrum.

Many thanks,
-Neal
—————————–

Reply
Fernando Martinez

Article is well written and adds perspective to measuring an otherwise unquantifiable performance element.

Reply


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