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How I Reengineered a Small Business by Richard H. Snyder, Strategic Finance (May 1999)

Case Study

REENGINEERING IS NOT JUST FOR LARGE BUSINESSES. IT'S TRUE THAT ONLY GIANT CORPORATIONS CAN AFFORD TO PAY THE FEES FOR HIGHPOWERED CONSULTANTS TO COME IN AND TURN THE ORGANIZATION UPSIDE DOWN. BUT FOR THOSE BRAVE SOULS IN SMALL BUSINESSES WILLING TO THINK THE UNTHINKABLE, REENGINEERING CAN BE MANAGED WITHOUT HUGE MONEY OUTLAYS. The major stumbling block in reengineering a small business is the staff who has worked at the business for years and tends to develop an ownership in the current process and, as a result, may be unable or unwilling to consider a revolutionary change in the process. What is required is knowledge of the system that exists and a willingness to consider radical new processes that would dramatically improve the system. In such circumstances an outsider may be necessary in order to produce dramatic change. Take as an example the case of James Street Fashions dba LattGreene, a knitting and converting operation in Vernon, Calif. I became controller of the company on January 2, 1990, at the request of the owner in order to introduce control into the activities of the company. I had a prior knowledge of the textile industry, having been in public

accounting for many years and having had some textile companies as clients (not Latt- Greene). I also had controllership, internal auditing, and cost accounting experience and

had guided businesses though bankruptcy. LattGreene knits textiles for the women's and children's apparel market, dyes and prints designs on the textiles according to customer instructions, and delivers the product to the customer ready for cutting and sewing into clothing. The customers of the company consist of clothing manufacturers who sell to clothing retailers. In the initial interviews at this familyowned and operated company, I discovered some of the concerns: severe negative cash flow, a belief that not all sales to customers were being billed or collected, a paperheavy system that was being crushed by its own weight. In my initial walkthrough, I was astonished to see that the accountant was still keeping records on a "onewrite" system. There wasn't a single computer to be found on

the premises. I told the owners that if I were hired I would be making some dramatic changes including introducing data processing. UNRAVELING THE OLD The first thing I did upon being hired was to purchase a personal computer. I purchased one without any networking software because at that moment I had no one to network with. But I did look forward to that day in the future and purchased a computer with the capability of being turned into a central server at a future date. The only software that I installed at that time was a powerful spreadsheet, Quattro Pro. In order to gain insight and perspective into the problems of the system, I loaded into a spreadsheet all the invoices billed to customers during the month of November 1989, the most current period available at that time. I then began filling in columns with dyeing and printing costs from the subcontracting companies who did this work for LattGreene. I also calculated and added yarn costs and added a knitting cost, a tricky and inaccurate process because such costs had never been accumulated or calculated. The only financial records being prepared at this time were the general ledger, cash receipts journal and customer ledgers, and a cash disbursement journal. As yarn was knitted into unfinished textiles (called greige goods), sheets were manually prepared showing what pieces were assigned to what lot and what the lot weighed. But no attempt was made to cost the greige goods. When the finished goods were delivered to customers, they were billed as per the purchase order, but again no attempt was made to cost the product. The owners believed they knew what their knitting costs should be, and so I used that number as a starting point. Table 1 YEAR ENDED NET 05/31 SALES ROI 1985 16.5 113% 1986 19.8 (46%) 1987 24.8 (18%) 1988 33.6 33% 1989 39.2 11% 1990 54.8 (6%) SEVEN MONTHS ENDED 12/31 1990 31.3 63% YEAR ENDED 12/31 1991 54 61% 1992 30 7% 1993 32 41%

1994 38 53% 1995 31 28% 1996 30 30% 1997 36 43% 1998 30 24%

As I developed the cost sheet, several problems began to surface. One, I couldn't locate dyeing and printing invoices that could be matched up against the sales invoices. There was no controlling order number that followed the job through all its steps before the finished product was delivered to the customer. The dye house assigned its own number to the orders, and the print plant did the same. In some cases it was virtually impossible to determine to which order the costs applied. Two, I found purchase orders for which no shipment to the customer could be located. Three, I found many orders being delivered late. The person who placed orders into work kept the orders in an alphabetical file on her desk and each day rummaged through the file, pulled some orders from it, and told her assistant to put them into work. Many orders were delivered very late simply because they didn't get pulled from the file, and there was no control over the orders that were in process. As I completed input for the month of November, I began seeing that a large number of the orders either had a too low gross margin to generate a profit on the sale, or even incurred a gross loss. I began analyzing these orders, and several problems came to the surface. First, like a conscientious baker who regularly gives his customers a "baker's dozen," LattGreene was producing textiles that were heavier than required. If an order called for goods that weighed eight ounces to the running yard, we were filling it with goods that weighed nine ounces. This extra weight made for a nice finished product, but it also often meant the difference between a profit and a loss. Second, in many cases, while the weight was okay, and all other factors in the production were correct, the order didn't produce a profit. We came to the conclusion that in many cases the product was simply being sold for too low a price. No wonder the company's sales increased from $16 million to over $54 million in five short years. During the time that I was developing this spreadsheet, the solutions to the problems being uncovered were becoming clearer. I developed a manual costing system whereby every new order coming in was costed as it progressed through the stages of production. When it was delivered to the customer we knew immediately whether we made or lost money and the reasons for an unsatisfactory result. But this manual costing system required a tremendous amount of time to maintain and keep current. KNITTING TIlE NEW TOGETHER While searching for computer software that would take the place of the manual system, I looked at several programs, but each had some faults or shortcomings that disqualified

them. Finally, I was introduced to a company that had produced a textile conversion system for a business which was smaller than LattGreene, and which did no knitting. But I liked what I saw because it had many fine features and controls. Talking with the developer convinced me that the knitting operation could be added to produce a system that met our needs. In October 1990, we installed a computer system using my old personal computer as the central server and added 10 stations using the Novell system. After installation, I had to train the employees to use the new system. For some who resisted abandoning "the way we had always done it," I had to warn them to either do it my way or I would get someone who would. Over several months they learned to become computer operators, and the old system was forgotten. As better and better cost data was developed using the new system, we refined our sales prices. In some cases major customers were lost because we raised our prices. But most customers were retained because we improved our service to them in several ways. Delivery schedules were met on a more consistent basis, and product consistency and quality improved as the employees were able to spend more time on those aspects of the product and less time on paperwork and trying to track down product location. The system developer and I were able to develop a system that works very well for us because we took the time to thoroughly understand the business of LattGreene and the problems that occur in the textile industry. I took the time to talk to everyone involved in the process of converting yarn into a dyed and printed textile. I looked at every piece of paper being produced and traced an entire month's orders through to the final invoicing of the finished product. This thorough analysis uncovered the problems. All that was left was the development of the systems necessary to fix the problems. I involved as many of the employees of LattGreene as possible in identifying the problems and in suggesting solutions. Then, when the final system was installed, many of the people who would be working with it already felt ownership of the system. The few who felt threatened by it and resisted it subsequently left the company. How successful were we in turning the company around? The table on page 28 displays sales and return on owners' investment (ROI) for the years 1985 to 1998. The big ROI fluctuations up to the year ended May 31, 1990, represent the agonies the company was experiencing because of its rapid growth without corresponding improvements in the systems. The marked decline in ROI in 1992 was due to the upheavals introduced when the recession hit the clothing industry with a vengeance that year. But the important thing here is that even in the deep recession into which the clothing industry sank that year, LattGreene continued to be profitable. The 1998 numbers reflect the fact that tremendous quantities of Asian textiles were "dumped" in the United States at prices that we cannot compete against. Several of our clothing customers closed up because of this situation. Even during this "textile depression,"

however, LattGreene continued to be profitable. The lesson here is that reengineering can have a dramatic impact upon a business. Huge costs to implement change aren't necessary. The entire cost of our new system was approximately $150,000. Turnaround was swift and dramatic. Downsizing did not take place. We have about the same size office staff as we did in 1990 (eight people). The difference is that now we know what our costs are, we bill all our sales, and collect all our receivables. We are able to plan and to develop strategy. While marketing mistakes still occur (for example, when we miss a season because of incorrect designs), the cost of these mistakes is minimized because we can measure them and identify exactly what the nature of the mistake was and make corrections before the mistake becomes a catastrophe. AN UPDATE Nine years after inception, the system has changed considerably from the initial setup, but we have never had to do another reengineering. The staff today is still about the same size as it was in 1990. All the personnel that I hired in 1990 to assist in administering the system are still with us. The only office staff to leave were those who refused to work with the new system and had left by the end of 1990. Some general principles that I learned from this reengineering and which may be helpful to others who would like to upgrade their operation: * Be open with all employees regarding the process. * Solicit input from all employees. * Involve everyone in the implementation of the new system. * Understand the system yourself because this understanding is more important than bringing in consultants and helps to ensure that costs are kept under control.

Discussion Questions:

Briefly describe the company, its products and customers.

What problems did the author discover when he conducted his initial interviews?

Describe the companys old financial costing system, and identify its weaknesses as well as business operating and profit consequences cause by its poor costing system.

What are major impacts of the companys new computerized costing system on its business operations, product prices and quality, and companys profit?

What are general principles learned by the author for changing or reengineering a companys costing system?

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