High principles

Private equity firms are realising they need to know about lean thinking.

How do we judge the progress of the Lean Movement? One indicator is our success in extending lean thinking to new industries and activities. In recent years I have been encouraged that lean thinking is moving far beyond its origins in manufacturing to distribution, retailing, maintenance and overhaul, consumer services, construction, and - perhaps most striking - healthcare. Indeed, the latter may be the most energetic area.

However, I have been concerned about our prospects for changing the thinking of investors, and specifically the giant private-equity investment firms that now control large parts of the American economy. While we have gained a strong foothold in financial services, this has been at the operating level. Most efforts to date have focused on how value streams within financial firms can be made lean - for example, those for processing loans or making credit checks. This is important work but it is on a different level from how financial firms think about investments and specifically how they might instigate lean transformations in the firms they control in many industries.

I was therefore delighted recently when I was contacted by one of the largest private-equity firms. The partner contacting me noted that conditions in this industry have changed with the credit crisis and weak equities markets. Instead of selling firms after two or three years it may be necessary to hold on to them for a long time, even a decade, before they can be sold to advantage. His question was a simple one: "Given that we may now need to hold firms for many years, how can we take the long view? Indeed, how can we turn firms into the 'Toyota' of their industries in order to maximise their price when they are sold?"

I needed to start by comparing a traditional private equity 'turnaround' with a 'lean transformation'. In the former, the objective to this point has been to go quickly to produce a dramatic bottom-line result. This has often meant 'rolling up' two or more companies in the same industry to reduce competition and increase prices to consumers; negotiating lower wages and benefits; cutting spending on long-term development projects not critical to the firm's strategic plan; reducing headcounts in activities judged non-essential; restructuring the balance sheet to add bank debt, often creating instant dividends for the private equity firm but high levels of long-term debt for the firm once it is sold; and re-negotiating prices with suppliers, on threat of loss of business.

These actions shift wealth from customers, employees, suppliers, and former owners to the new owners. This may do more good than harm, because otherwise the firm in question may fail. But it is often unclear that any additional value has been created in the sense of better satisfying customers with a given amount of human effort and capital investment. And, from society's standpoint, the only way to increase living standards is to change the ratio of human effort and capital going into firms to the amount of value coming out. Otherwise the outcome is zero-sum, with some winners and some losers.

By contrast, the objective of a lean transformation is to analyse the core value-creating processes of organisations in light of customer needs, then figure out how to create more value with the same resources so the organisations can grow and society can prosper. It's the difference between shifting wealth from one party to another and creating more value.

I was relieved that after a discussion of the differences between traditional and lean private equity, the firm in question was still interested. Indeed, this firm has now launched a range of experiments to 'lean' the processes of its portfolio firms, and other private equity firms are following.

Managers and owners will favour anything quick and easy - even if it doesn't work - before they try anything long and hard that does work, such as intense process analysis linked to customer needs to create more value from the same resources. Perhaps the massive private-equity industry, by virtue of the recent shifts in the global economy, is now ready to take the more difficult road to success.

James P. Womack is founder and chairman of the Lean Enterprise Institute in the US. www.lean.org [new window]

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