How much is this waste costing us?

Nowadays, waste disposal costs usually have a place in the accounts.  Standard landfill tax costs £56 per tonne (set to rise to £80 per tonne by 2014), and waste disposal services have their fixed and variable fees on top.  Recycling may provide some relief, but still typically involves some cost.  However, waste has hidden costs as well, and these can be considerably more than the disposal or recycling cost.

There are two big hidden costs in waste: the materials, and the production cost.  The first is easier to spot – if you purchase a tonne of steel, and sell products containing 990g of steel, you know you have wasted 1% of the material.  Production managers are usually aware of this, but the finance department may not be.

The second cost is less obvious – the cost of the facility.  Let’s say that a manufacturing firm has operating costs of £100m per year, and is working fairly near its current capacity, so waste products displace products that could be sold.  If the reject rate is 0.1% of products, then the operating cost of producing that waste is £100K per year (0.1% of £100m).  Alternatively, consider this from a time perspective.  If a typical production line in our hypothetical facility spends just 10 minutes of a 16 hour day producing product that can’t be sold, that would be 1% of the time – or £1m cost per year.  Move to another perspective: the opportunity cost of the goods not produced because the line is at capacity.  If gross margins are just 10%, then waste at 1% of production is equivalent to £100K of foregone profit, displaced by waste.

These hidden costs of waste are rarely part of any management accounting system, and may be difficult to pin down.  However it’s worth the effort – keeping track, even at the “guestimate” level, can help companies work out the value of investing in waste elimination initiatives.  Putting a price on waste helps to focus attention on a big win for both the environment and the bottom line.  Recycling may deal with the waste that can’t be eliminated, but the biggest win comes from avoiding waste entirely.

What to do about high energy prices

As oil prices reach a new sterling high, and experts cast doubt on a significant price fall in this decade, there are few words of comfort for British businesses. The low oil prices in the 1990s now look like a temporary reprieve.  Electricity prices are likely to rise as coal plants close and the UK invests in new capacity.  What does this mean for UK business? 

The UK faces the combined threats of inflation and a return to economic recession.  This is “stagflation”, and can occur when inflation due to commodity price rises (like energy) result in lower productivity in the economy.  There is no certainty about what energy costs and productivity will do, and this uncertainty is far from reassuring.

Small businesses can be particularly hard hit because they lack buying power, often cannot risk buying fuel on long term forward contracts, and face having their increasingly price-sensitive customers consolidate their purchases with the “big box” stores (for B2C) or with large suppliers who can reduce their transaction costs (B2B).  However, this is also a time of opportunity for agile SMEs who can negotiate the uncertainty of these economic conditions.

The solution to the energy squeeze is clear: reduce dependency on energy and increase productivity.  Britain is already doing this, though the 5% drop from 2000 to 2008 hides wide variation between firms, even in the same industry.  As a second option – become an energy producer.

Office space can consume energy when not in use.

The first solution, reducing dependency on energy, essentially means eliminating waste.  If a firm reduces its use of unneeded resources – anything from heating empty office space  to producing goods and services too poor to sell – then it reduces its consumption of energy.  Firms often have unnoticed waste, from the unused space mentioned above to the waste of material that is considered “just part of the way this industry does business”.  Successful waste reduction efforts start by identifying all the resource consumption that does not create value for customers, and then working with employees, suppliers, customers, and other organisations to find ways to eliminate this waste.

The second solution – becoming an energy producer – works best when a firm identifies a resource it already has in excess which can be turned into energy.  As a simple example, some firms in suitably windy locations install wind turbines.  Others turn their waste into energy, either directly (for example wood waste becomes biomass), or indirectly, by selling their waste to a firm that can produce energy from it.  It is often surprising how many waste streams contain energy that can be released cost effectively as a fuel.

The critical message for SMEs is not to stand still.  Although no one can predict future energy prices, recent history does not encourage complacency.  To avoid being trapped between rising energy costs and downward pressure on margins, firms should act to cut waste in all its forms – this is a tried and tested route to reducing energy consumption.  With whatever excess resources are left, look for smart ways to turn these into energy.

How deeply should you cut your energy consumption?

This week’s Economist argues that decarbonising developing economies matters much more than reducing emissions in the developed world.  Although emissions from production in developing countries is now greater than in the industrialised nations, there is in fact no excuse for complacency about energy use in the wealthier economies.  Just over a month ago, DECC released their provisional estimate for UK greenhouse gas emissions for 2010.  They showed the first year-on-year increase in two decades.  As major consumers of energy, businesses need to play their part in turning this around, both because it’s right and also because it makes business sense.

The ideal energy consumption for any company is zero – in a perfect world we would have no energy costs at all.  But putting aside idealism, how do we set an emissions target for our business that is both desirable and realistic?

One way for a firm to set a target is to look at the governments' targets in the countries in which it operates.  For example, the UK has an emissions target for 2020 of 34% below 1990 levels.  In 1990, emissions were much higher than today – as of 2010, emissions were down by about 25%.  That leaves another 9% to go – or to put it another way, about 11% of 2010 emissions need to go by 2020.  This has to happen even as the economy grows – in other words, emissions per unit of output need to fall even faster.  A company that can cut its emissions by 11% over the current decade while growing at the same pace as the economy can feel that it has done its bit to help meet these targets.

But is this a good target for your company?  It’s a fair share in UK terms, but what about global terms?  If we are trying to be equitable, and just use our fair share of global emissions, we need to aim higher.  A UN Environment Programme report estimates that the world needs to peak at 44GT of greenhouse gas emissions in 2020 to avoid exceeding 2 degrees C of global warming.  If we take into account the estimated populations of the UK and the world now and in 2020, we’d need to reduce our emissions by 34% from 2010 levels in order to be making only our share of emissions.  In other words, we need to cut emissions by about a third over the coming decade in order to be equitable.

Is it realistic to cut a firm’s emissions by 11-34% by 2020?  In a word... yes.  Others have managed it.  For example, Interface Inc, a maker of commercial carpeting, reduced absolute GHGs by 71% from 1996 to 2008, while increasing sales by two thirds.  They didn’t do this by moving into a less energy intensive line of business.  They accomplished this remarkable reduction principally by reducing waste.

This is not to say that massive reductions in emissions are easy.  They need belief and determination.  However, the payoff is substantial – in good profits, good morale, and good reputation.  In the words of Ray Anderson, CEO of Interface Inc, “sustainability... has proven to be the most powerful marketplace differentiator I have known in my long career”.

How cash can kill your business

“Cash is bad” said my MBA professor many years ago. This obviously depends on your perspective. But as many business leaders have found to their regret, cash really can be a killer.

The main problem with cash is that it’s fickle – here today, gone tomorrow. Many businesses have run into difficulty when they couldn’t get a loan to cover the difference between cash and profits. That is, they’ve got paper profits, but the expenses need to be paid, and the cash hasn’t come in yet. Businesses like this use cash flow forecasting for two main reasons: 1) to make sure they grow their sales only as fast as that their working capital can match, and 2) to ensure they’ve actually lined up enough working capital, often in the form of a long term line of credit, to be able to pay all their expenses without embarrassment.

A less well known problem faces the business that has a positive cash cycle – the kind of firm that receives the money before they have to pay the expenses. Companies in this desirable position may think they don’t need cash flow forecasting – as long as they keep trading profitably, the cash will always be there. This type of cash flow can also be a killer, and can take business leaders completely by surprise.

The main pitfall for positive cash cycles occurs when a business uses its cash to finance its operations. Why?  Even a business with very thin profits, but growing rapidly, could find itself apparently swimming in cash. Surely it makes sense to use the cash productively, to invest in business improvements and growth? But what if the cash inflows subside, even just for a few months?

Imagine a (highly simplified) business turning over £1m per month. It has a positive cash cycle of 1 month, and razor thin margins. So although profits are essentially non-existent, it sits on £1m of cash at any one time, which has been paid into the bank, but won’t need to be paid out until next month. By that month, another £1m will have come in, so the company will look appreciatively on that money, which always seems to be there, and may think of investing it in something more productive than savings.

Now, imagine that after a couple of months they’ve invested £1m in new equipment, with the intention of growing the business. This is shown as “Month3” in the table to the right – you can see that after a couple of months of sitting on £1m in the bank, they wanted to do something with it, even though their profits are actually zero. Unfortunately bad weather plays havoc on their market (or some other unexpected event occurs) and sales vanish to nothing the next month – “Month4”. Imagine, too, that they feel safe, because they can reduce their expenses by £1m – they have the ultimate in flexible operations, so their margins will stay the same (zero, but at least they’re not losing money).

Unfortunately their cash position is terrible. The £1m buffer that they used to have is now invested in equipment. The expenses from last month - £1m – were going to be paid for with the £1m in cash coming in this month. Regrettably it’s not there, and they need an emergency loan of £1m from the bank in order to pay their debts. The equipment probably cannot be liquidated for £1m, and this is not a profitable firm, so the bank may ask some very difficult questions about this loan request.  Promise of positive cash flow returning next month may sound to the bank like "jam tomorrow", no matter how justified.  They will want to know why you didn't see this coming.

The best way to head off this sort of problem is to incorporate cash flow reporting into the monthly accounts, and to use scenarios to test cash flow forecasts on a regular basis. This will highlight any risks to future cash flows, and should prevent all but the most extreme of unexpected events from taking business leaders by surprise.

Don’t wait for the markets to save the planet

A current theme in management writing is that companies’ green behaviour leads to greater success.  Green business guru Andrew Winston has recently blogged about the way Dow and The Nature Conservancy are trying to show the “business logic” of protecting the environment.  And some of that logic is right – reductions in materials use, lower energy consumption, and a green reputation can sometimes bring long term, economic benefits that greatly outweigh their costs.  Yet companies still overexploit the seas, pollute the air, and dump waste.  Why?

Companies are not fooled.  Green behaviours that have value to society – public goods like clean air, stable climate, and healthy ecosystems – do not always benefit the company enough to offset the investment made.  Some companies will do it anyway, because of ethical beliefs, or a strategic view that they’ll benefit later.  But many green practices are not worth what they cost the company – at least not to that company.

One proposed solution is to solve this through markets, for example through carbon taxes, or the pricing of “ecosystem services”.  This is a very good idea.  However it involves a lot of negotiation and international agreement to be effective.  Even then, we know that some firms will make the “wrong” decision, particularly in failing to pursue the long term gains from efficiency that current investments could make.  Long term gains are uncertain, and often require a lot of effort to assess them.

It should be no surprise, then, that recent studies in areas such as behavioural economics have shown that purely rational decisions are not the whole story.  Decision-makers use many criteria that lead to apparently irrational outcomes.  And these apparently irrational rules of thumb are actually used far more consistently than the mathematically pure economic models that MBAs are taught.

Why focus solely on a fragile case - that saving the commons is in businesses' self-interest - when the argument doesn’t match people’s decision-making processes anyway?  The evidence base suggests that an important additional approach would be to harness the things that really drive many decisions – and the most promising in my view is the “social contract”.

A social contract is simply a commitment made to others, which has the effect of making the planned outcome more likely to happen, and often encouraging others to make similar commitments.  Weight Watchers uses this very tool, helping people lose and keep off weight by making their goals and progress public.  Companies are led by people who are just as susceptible to this as the rest of us.  If a CEO meets her counterpart at a conference, and hears them say they’re going to reduce their firm’s carbon footprint by 10%, she may well feel that she ought to say something similar – not because it’s economically advisable, but because her peer is doing it.  Once she has made the commitment – particularly if it is done through the media – it will be hard for the company to back down, even with a change of management, and certainly with her in place.

Such commitments are rare and typically small.  At the same time as Sir Terry Leahy told Davos that he would build zero carbon stores in the Czech Republic and Thailand, he also urged governments to put market mechanisms in place.  The belief that markets will solve the problem is still dominant – but there is still a chance that social contracts will catch on.

We all need to cut food waste

This is the conclusion of a new report, The Future of Food and Farming: Challenges and choices for global sustainability, which has just been published by the UK Government Office for Science.  The study concludes that we all need to cut food waste across the supply chain, from producer to consumer, by 50% by 2050.  This is in addition to improvements in land productivity, and changes to the mix of "resource-intensive" types of food. Only in this way, the report says, can we hope to feed the 9 billion population that the earth is expected to carry in four decades' time.

So how do we do this?  The report offers some high level solutions:

1. Narrow the gap in wastefulness between geographies, countries and organisations in terms of waste - spread best practice
2. Advance research that reduces waste further

These are good, high level observations - but now that we have the "big picture" motivation, what we need is action by individuals who can influence waste.

Some may think that in places like the USA and Europe, waste is pretty low.  We don't have the huge losses that are experienced in post-harvest storage and transport where investment in agriculture is low.  However, we do have enormous production, and even marginal waste adds up.  Moreover, recent publicity about fish discards shows an area of waste which is not normally included in official accounts of waste, because the fish are never landed.  Problems like this are due not to lack of investment, but to public policy, and this is rightly an area where the public are demanding action.

However, we cannot all get off the hook by demanding action from our elected representatives.  Much of the supply chain is under the control of businesses and individuals, and we need to accept responsibility.  Many of us can remember our elders telling us to eat up "because there are children starving in Africa".  Back in the days of overproduction, this didn't make a lot of sense.  But now, and in future, all of our waste, from field to fork, is ultimately going to put pressure on the availability of food, and we need to do something about it.

In developed countries, waste by consumers and the food service industry can be on the order of 20-30%.  The waste of food in industry is particularly interesting because in principle, companies should be motivated to reduce waste in order to reduce cost.  This could apply to consumers too, but where incomes are high in comparison to food costs, factors like "convenience" and "culture" can drive up waste.  Are these factors also influencing the food service industry?

I think so.  Most research focusses on using food waste productively (incineration for energy, or composting for fertiliser).  However, these uses generally don't save much money - they're just popular because they're fairly easy.  Much harder is to change procedures and systems so that unneeded food doesn't end up entering the supply chain in the first place.  This requires people in the organisation to accept that there's room for improvement.  That's not an easy ask.  People will ask - "if it were that easy, surely we'd have done it already?"

And that's right - this isn't the easy way to deal with waste.  However, it is the most lucrative.  Not buying what isn't needed - and using as much as possible of what you buy - is clearly going to be much better for the bottom line than disposing of waste productively - food is generally more valuable than the fuel or fertiliser it would become as waste.

How do you escape the “domino effect”?

In the second episode of Michel Roux’s Service, the owner of an Indian restaurant in Birmingham describes the traffic jam in the kitchen as a “domino effect”. Diners have been seated late, and have placed their orders late, so a bunch of orders come into the kitchen at the same time. They’re readied as quickly as possible for the servers to take to the tables. The servers struggle to get them all out as quickly as possible. But the net result is that a lot of people get their food later than intended, and the problems carry on through the rest of the evening.

The domino effect is familiar enough to all of us, but how does it work? It is in fact a potential problem in all systems. On the programme, the problem seemed to occur at “the pass” – the point where orders were coordinated between front and back of house. In fact, the problem started when a party was mis-seated. When the people who should have had their table turned up, this had a knock-on effect on another groups – a total of three groups were re-seated. This in turn affected the timing of the orders, which all came into the kitchen at once. This meant the orders were ready to serve too close together for the servers to get them out promptly. As the service backed up, more and more orders were being delivered late, affecting far more parties than those originally involved. This expanding ripple of service problems is what we call the “domino effect”, because one problem has a knock-on effect on every process step “downstream” of where the problem occurred. Often, the most visible effects of the problem are at this downstream end, and it’s not necessarily clear to those affected just how far back in the processes the dominos had started to fall.

I saw a beautiful demonstration of it at a coffee shop recently, and it will show you how this famous effect actually takes place, and what you can do to change it.

In the coffee shop in question, a branch of a major chain, I observed people being served coffee between 10-11am. They queued at a counter, where a member of staff took their order, gave them any food part of their order, and took their payment. They then moved on to the end of the counter, when they collected their coffee from the barista. The barista got her cue about what to make from the staff member at the till as the order was taken.

The barista could make a coffee in an average of just over a minute. In the course of 40 minutes, 29 orders were taken, so she had enough “capacity” in terms of time to make all those orders, with time left over.

Had the customers come in like clockwork every minute or so, and had all the coffees taken an equal time to prepare, she’d have probably done fine. However, clients don’t come in like clockwork – they come in bunches, with pauses in between. And some coffees are complicated, or get spilled. Also, there were small disruptions – from customers wanting to ask a question, from a member of staff who came through to do some cleaning, and from the staff member on the till having a complicated food order to attend to, so that she had to rush to catch up taking orders, and give a bunch of orders to the barista at once.

This is why the domino effect comes into being. When things work like clockwork, with very little variation, you don’t see it much. Where you see it is in naturally chaotic systems – for instance, those that rely on human behaviour and on chance. The natural variation in these systems puts pressure on the links in the service chain, and if capacity is tight for even a short period, it can have a knock-on effect (a domino effect) on the chain long after the initial cause is gone.

Here’s how my observations went. In the first 15 minutes, only three people came in, and all were served within three minutes of walking into the shop. Then, at 10:16, two people came in – separately, but within a minute. The first was served within a minute, and the second within two minutes, so they went away happy. Then at 10:18, just as the second was getting her coffee, three more people arrived. Unfortunately the first person’s coffee was complicated, taking a full two minutes. The second was normal, but the third one took 2 minutes as well, so this last person wasn’t served until six minutes after she walked into the shop.

Meanwhile, another three people had come in. Although their coffees were quick to prepare, the barista was already behind, so they too had to wait six minutes for their coffee. While their coffee was being made, another three people came in. And while their coffee was being made, three more people arrived. These people all had to wait 3-4 minutes for their coffee. The service times were also lengthened very slightly by the cleaning staff passing through, and a customer asking a question.

At this point things got really busy. Between 10.31 and 10:40, 13 orders were taken. This was more than the barista could deal with at the speeds she’d shown up to now. Three came in at 10:31 alone – and of course the barista had started out a few minutes behind. The first was served in 4 minutes, but all the rest took 6-7 minutes from walking in to getting their coffee.

As long as people don’t mind the wait, this would have been fine - but now the domino effect began. Some of these customers had small children who quickly got bored and started acting up. Some people were so keen to sit down that they went and put their stuff on chairs, before rejoining the queue, to reserve a place – which annoyed customers ahead of them who weren’t doing it. The seating process was becoming disrupted, and that was making clients unhappy.

The biggest problem with the domino effect is that it's most likely to cause service failures at the times when you have the most customers, so even if it happens rarely, it affects a disproportionate number of your clients.  Moreover, it affects people who had no idea what originally happened - to them, it just looks as if bad service is a normal part of your business.

If there is a domino, does this mean the service system is bad? No – but it does show that the domino problems have not been planned for. Every system with more than one process step will get domino effects when demand is high and there is a disruption to the regular working of the system. A good service team understands this, forsees what the domino effects may be, and plans what to do to stop the domino effect in its tracks.

Preventing the problem is not just about throwing capacity at it – that just eats up all your profits. Instead, the plan for preventing domino effects will be to focus on the spots where capacity is a problem, and change them to make it easy to stop the domino effect before it damages your business.

One approach is to tackle the bottleneck resource that has caused the problem. In the case of the coffee shop, the barista was the key to the speed of service. Once the coffee-making got really behind, the whole system was stuck until customers stopped coming. And no one wants customers to stop coming. So what could have happened was to expand the coffee-making capacity:

• Batch processing: The espresso machine could make three coffees at once, and in some coffee shops, you will observe the barista taking advantage of this, setting up and running three espressos at the same time if there is a queue. While they are dribbling out, she can work on the other steps of the coffee preparation.
• Multi-tasking: In other coffee shops, you will see more than one person working the espresso machine. Typically one person will be full time on it, and someone else will be full on the till, but there will be floating capacity – someone who can pitch in to whatever part of the service chain has got backed up, and relieve the pressure, while doing other things (like cleaning) when the pressure is off. Where there are several different services on offer – filter coffee as well as espresso, tea, hot chocolate and so on – this may be particularly effective.
• Personal service: Still other shops will have one individual dealing with each customer – taking their order, getting their coffee, and so on. That way, if one customer is taking a very long time, the queue will keep moving because other servers will be dealing with the next customers. This is typically not an efficient way of working, because people will get more done if they are just doing one part of the process, rather than the whole thing. However, it may well be appropriate where there is very little in common between one order and the next, and where self-service is an option, for example in fashion stores.
• Productivity: Finally, rather than dealing with the systems, many coffee shops would address the underlying problem first: the slow speed of coffee production. The barista in this shop was slow compared to some of those I’ve seen in busy urban cafes. Experience and an effort to make her motions speedier and more accurate will no doubt help this barista serve customers more quickly over time. 

Another approach is to deal with the effects rather than the cause. Here, the principle problem for customers was the combined wait in the queue and risk of not getting seated. Some shops deal with this by avoiding counter service altogether and seating customers before they are served. But even with a counter service, some coffee shops will start taking orders right through the queue, and telling customers to have a seat, and that they will be called when their order is ready.

Each approach will be better suited to some contexts than to others. The point is that the service team needs to have a well thought out plan that suits their business and their customers. They need to know in advance what to do, so that when a disruption occurs, they can take action straight away.

How could the young people in Michel Roux’s care have dealt with their own domino effect? The problem was in serving, so as with coffee shops, they had some obvious options:

1. Used the order-taking process to even out the flow of orders going to the kitchen
2. Move people temporarily from other roles to serving food to the domino tables
3. Batched the serving, for instance by getting a trolley that would hold the orders for many more people than a server’s arms can deal with

Each of these options has advantages and risks. They didn’t spot the problem early enough for option 1 to be useful, and option 3 may also not have been possible given the equipment the restaurant supplied. In the event, the young people chose option 2 – they took their receptionist off the door once the restaurant was full. However, their biggest problem was that they appeared not to have a plan. They did not know what the knock-on effects of their actions would be, and the whole of the evening was spent in crisis management. With a plan, they may have made better decisions, and could also have told customers what to expect.

The domino effect is unusually damaging because it takes a small problem, such as a complicated cup of coffee, and turns it into a service failure for many more people who should never have been involved. Because its effects last far beyond the original incident, it is often hard for staff to remember what the original cause of the problem was, and the rush of dealing with its effects makes it hard to stop and think the issue through. However, by planning in advance with a system that will lessen the effects of a domino incident, businesses can help improve their service to all customers, and deal better with the variability that is natural to customer-facing businesses.