Nick Katko | 5 Areas of Performance you Must Measure

The shift from the mass production of the 20th century to just-in-time to on-demand to lean has forced companies to radically change the way they operate – and not just in manufacturing, says Nick Katko.

As a CFO of several companies, consultant, and now president and owner of industry leader BMA, Nick has seen first-hand how this new approach has impacted marketing and sales and… compelled the creation of a lean approach to accounting.

You can create an environment where people close to problems understand how to boost productivity and quality while reducing waste and controlling costs… and use a “customized” accounting strategy to monitor results.

Nick gives us a road map to get there, including…

• The two types of accounting – and how lean fits in
• Why “old school” financial statements get in the way
• How to overcome complexity to control costs and increase revenue
• The simple measurements you need to uncover the root causes of problems
• And more

Listen now…

Mentioned in This Episode: www.maskell.com

Episode Transcript:

Michael Webb: Hello, my name is Michael Webb and this is the Sales Process Excellence Podcast. Some businesses focus on selling skills, senior-level decision makers, leveraging the internet for marketing. Other people focus on evidence and data and eliminating waste and continuous improvement. In this podcast, we focus on both. I’m really pleased that our guest today, Nick Katko of BMA, a leading authority in lean accounting. I’m really excited because this is a topic that turns peoples’ heads around. And it’s a topic that really changes the way you think and it’s a topic that actually is quite relevant to sales. So, Nick, welcome to the podcast.

Nick Katko: Thanks, Mike, glad to be here.

Michael Webb: Super. Could you, for the benefit of the people in the audience who might not have heard of you before, could you give us a little bit about your background and how you got to be where you are now?

Nick Katko: Sure. I’ve been involved in lean organizations and lean accounting for over 25 years both as a chief financial officer of a few companies and as a senior consultant at BMA and now as the president and owner of BMA. I first got involved in lean and lean accounting as a CFO in the 1990s where the organization I was working with, we had a very successful lean transformation, and I made a lot of changes in terms of the information that’s used inside the business to make it relevant for senior leaders and operational people to measure and manage and make decisions. And a lot of that was just sort of natural because of the lean strategy we were embarked upon. And then later on I met Brian Maskell, who was the founder of BMA and since retired. And he brought me on as a consultant and learned a whole lot more about lean accounting.

Lean accounting is really a management accounting system for a lean organization, and management accounting is the internal information that is used inside the business by all parts of the business.

Michael Webb: Yeah, so that’s a really … that’s an important point there that distinguish … people think of accounting and they automatically think of financial accounting, and there’s plenty of senior executives who run the whole business based on financial accounting, and management accounting’s a whole different thing. Can you explain the difference?

Nick Katko: Yeah. So you have the accounting function. And there’s really two parts to every accounting function, which is the financial accounting, which is what everybody thinks about with accounting is doing the debits, doing the credits, balancing the books, producing financial statements. And that is an essential function of any organization. The other piece is called management accounting. And management accounting is the information that’s used inside the business by managers to measure the business, be able to control the business and to make sound business decisions in alignment with the business strategy.

So for financial accounting, you have a lot of … that’s what I would say regulated by generally accepted accounting principles or the International Federation of Accounting Standards. Management accounting is not regulated externally. It’s whatever the company needs to measure and manage the business. And so those are the two distinctions. Now, management accounting does contain some financial information, but it contains a lot of operational information. And the whole idea behind management accounting is to have good information inside the business to drive long-term financial success.

Michael Webb: So, my understanding of management accounting is that one of the key things it can do is to dollarize the various activities going on in the business so that the executives can know … like you may have a low yield on a manufacturing process, one of the manufacturing processes, and so that’s causing waste and that’s costing money. But there might be another manufacturing process that may have a little bit better yield but the cost of the waste there is so much greater that that’s the place that deserves attention. And unless you can dollarize these things, it’s hard for senior executives to know for certain where to put their resources. Is that right?

Nick Katko: Yes. And in a lean company, what we try to do is not necessarily dollarize everything, but try to get the right information to the right people to make the right decisions to, for example, either drive a cost down or increase revenue. And one thing about trying to reduce costs, and this is in the lean company, you have to look at the operating activity and understand what is … what’s driving the activity. How much wasteful activity is in a process. And the more you can eliminate the wasteful activities, then over time, the lower your costs will be. So what’s interesting about lean accounting and lean management accounting, is that what we recognize is that many, many people in operations, many, many people in functions, like even sales and marketing, they’re not financial experts, they’re not accounting experts. So we want to give them relevant information that they can act upon, that they understand intuitively, that you don’t have to run to an accountant every time and say what does this mean. So we’re trying to build knowledge inside every function of the business as to how they can control costs, how they can drive revenue growth.

Michael Webb: Yeah. Fascinating. So it’s not easy necessarily in these complex business environments to know how to prioritize and to know where the waste is, and so each company necessarily is going to have to have its own measurements that make sense to their own people. And as long as they’re traceable down to observable reality, then they’re going to be able to make good decisions. Is that fair?

Nick Katko: Yeah. What you want, lean performance measurements are designed to drive root cause analysis. So let’s just take a very simple thing, quality. Looking at a defect rate on a manufacturing floor. You want a simple, easy measure that at the right level of the organization to understand the true root causes of why you have poor quality. If you understand the root cause, then you could do something about it. Now let me give you the traditional example. The traditional example of quality is that the senior leaders of a company, they want to understand the cost of quality, and they think that they’re going to be able to figure something out from that. But the reality is they can’t, because they’re too far removed from the process. But the people that are in operations that are doing the work, they probably know the real reasons why quality is poor.

Michael Webb: And so you have to create an environment where the people who are close to the problems, who can understand them best, can do something about them.

Nick Katko: Yes. Yes. The people who … it’s about who in an organization, who is actually creating the value and … go ahead.

Michael Webb: Yeah. So, I want to get into what the heck does this have to do with sales? In just a minute, we’re going to do that, because that’s a fascinating and a very important kind of a question. And before I do that, though, I remember, because back in the ’80s and ’90s, I was involved in the sales of ERP systems. And we didn’t always call them enterprise resource planning systems, but it was complex software that was supposed to help in the production operation to figure out … it was a management accounting system and a scheduling system for more efficient the computers would work.

Nick Katko: Reporting.

Michael Webb: So I learned about cost accounting, and I learned about production scheduling, and inventory control, and all those sorts of things, and there were several books that came to my attention and I read, and just really turned my head around. One of them, I believe it was called Management Rediscovered, and I’m looking through my bookshelf here trying to find it. But it was by some professor and he was pointing out that in the past, accounting had been so financially oriented that you, as I recall, for real management you need to use management accounting. And another book I read was called Relevance Lost, The Rise and Fall of Management Accounting. Famous book.

Nick Katko: Robert Kaplan, right.

Michael Webb: Yep, Robert Kaplan. And then another one I have on my shelf here, Counting What Counts. You’re probably familiar with that one, too.

Nick Katko: Yeah.

Michael Webb: Epstein, I think, is the author. So a word about the progression there, and maybe I missed some big books along the way. But the change in perspective here, I wonder if you can speak to that?

Nick Katko: Yeah. I think all of those books, and really I think this really started … the idea of looking more at management accounting, started probably in the early 1980s as the traditional 20th-century paradigms of manufacturing started to change. And most management accounting systems, and I’m going to … in terms of manufacturing, were based on early to mid-20th-century mass production practices. Because that was generally how all manufacturers worked. So, what you have is you have this transformation of manufacturing strategies in terms of in the early 1980s becoming more just in time, which turns into lean, satisfying the customer, high customization mass production.

So you have the strategy changing, you have operations changing, you don’t have the management accounting system adapting to the new strategy and the new operating practices, and that’s why Robert Kaplan’s book, Relevance Lost was so appropriate. Because management accounting was not relevant to the way manufacturers were operating. When you talked about manufacturing production systems, ERP systems, many of them are still based on, and I’m not knocking any, but many of them are still based on 20th-century mass production practices. They’ll give you all the information you want, but if you don’t operate in mass production, some of that information really doesn’t help you.

Michael Webb: And there’s lots of assumptions embedded in there that can get in the way. I remember hearing a story of a problem, companies would be doing lean transformations and they would be reducing inventory, reducing lead time, increasing quality, but because the financial statements, the traditional financial statements comparing before and after the transition, the work in process went down, the accountants were saying this is not a good thing, because work in process was called an asset as if it was of some value to the corporation and it’s not.

Nick Katko: Right. And that’s just the way, part of that is the way management accounting systems, or traditional management accounting systems are designed. Another part of that is the way companies, the way accounting departments are required to value inventory for financial reporting purposes. And we could probably talk for 45 minutes on this, but I’m not going to get into it. But you have to have the relevant information based on the strategy of the business and the operating practices. And when I talk about operations, I’m not just talking about, for example, manufacturing, I’m talking about all of the other functions of the business. How they operate. The information needs to be relevant.

Michael Webb: Right. Let’s discuss how this is relevant to sales. I have, for example, always been fascinated by the parallels between manufacturing production and sales production. And a simple example, the simple example is it’s extremely commonplace, especially in businesses where … B2B businesses where there’s a complex sales environment that when you look at the sales opportunities that salespeople are claiming that they are working on, and there’s no doubt they are working on them, but it’s almost invariable that at the end of the quarter, there’s only a small percentage of the deals closed. So you have to get the bulldozer out to push the forecast date out another 90 days because they’ve got so many deals they’re going to push out later, we’re going to get them! We’re going to close them someday! And they keep doing that over and over again. It is like this “inventory,” I call it inventory, of unclosed business, these deals that salespeople are “working on,” that’s so similar to the work-in-process inventory of pieces and parts that manufacturing companies tend to accumulate if they’re not managed properly.

So yet in sales, none of that’s visible. They don’t measure it, they don’t account for it anyways. So I’d love to have your thoughts and maybe some things you’ve seen about how this lean accounting might apply to sales and how it might have helped some companies in their sales and marketing.

Nick Katko: Well, there are two distinct areas that lean accounting applies to sales and marketing in a lean organization. One area is being able to measure the performance of various sales and marketing processes. The second is the financial management practices inside the sales and marketing departments. Each one of those separately because they’re totally different.

So you have a sales and marketing department, and you start looking at it in terms of applying lean practices to improve performance, to create sales process excellence. Alright, how do you know how well you are improving? That’s the question. The only way you understand that is through relevant performance measurements. And performance measurements, whether it’s in manufacturing, in sales, in accounting, or in human resources, that is part of a lean management accounting system. You are doing accounting work, it’s not debits and credits, but measuring performance in terms of understanding are our process getting better, are the activities that we’re working on to improve or eliminate, is that effective? You have to be able to measure it. That is the only way you know. You can’t rely on sort of people saying yeah I think we’re getting better or whatever. You need objective factual information.

Michael Webb: Let me stop you for a second to ask for a definition. Measuring performance. Needs work processes. Now at the root, the way I understand it, what you’re measuring is productivity, output over input. Is that fair?

Nick Katko: Yeah. Really, when you talk about a lean performance measurement, you want to measure one of five aspects of performance: productivity, quality, delivery, flow, which is the speed, and cost. Five areas of performance. So yes, productivity is how … how productive is our lead generation process? How is the quality of our quotes? Go ahead.

Michael Webb: So it seems to me, and I’ll ask you this, is it seems to me that productivity is the common denominator because if you have changes in quality, that’s going to affect productivity. If you have changes in delivery, that’s going to affect productivity. If you have changes in flow, that’s going to, that’s going to affect productivity, and changes in cost. They’re all going to affect productivity, so the granddaddy of them all is productivity.

Nick Katko: Yeah. I, yes go ahead, I agree.

Michael Webb: Let me ask this question, because in manufacturing, they are so completely oriented toward quality. What’s the cost of quality, how do we increase quality, and there’s specifications for quality. But I’m not sure that that is the right thing to base … it’s not the north star, although I understand where it came from and why it’s so valuable. Wouldn’t the north star in a plant be productivity? Because …

Nick Katko: In sales and marketing or in a plant?

Michael Webb: In a plant.

Nick Katko: Yeah, well, one thing about quality, when you’re talking about a product or a service, you have to maintain a certain … a market wants a certain level of quality. If you can’t achieve that level of quality, you’re not going to even compete. Like a restaurant that serves poor food, poor quality food, it’s going to be out of business.

Michael Webb: They call those table stakes, if you’re going to compete you have to have this.

Nick Katko: So quality is … you want high quality. In terms of quality, in terms of operations, really with lean is you want to know before you deliver the service or you ship the product that you will achieve the quality that your customer wants rather than waiting for your customer to tell you, later on, oh by the way. So that’s really the difference. But yes, overall I agree. Overall we are trying to improve productivity. That’s what lean does. Lean makes organizations more productive.

Michael Webb: And it does it by maximizing value and minimizing cost.

Nick Katko: Yes.

Michael Webb: And so that’s where we get to one of the issues, and I’ve used this same logic a bunch of different times, and maybe there’s a better way to think about it, but when you have people working in a production facility and they have to decide … we have some waste here, we have to decide what to do, they need a rule of thumb way to figure out is this value here? This way this department works? These big piles of inventory or is this big machine that only gets utilized ten percent of the time, is this value? Or is this waste?

And the rule of thumb answer is if the customer will pay for it or not. And I buy that, makes sense to me, and I think you’re dealing with the production people in the plant and you need a common sense way in any human endeavor, for average people to figure out what’s the goal, what’s the north star. But I always had trouble with that in sales. Because by definition you don’t know what they will value, what they will pay for. So the ability to distinguish value from waste is key, so go ahead, speak to that.

Nick Katko: Okay. What you have to do … first of all, let me give you the dirty little secret about lean and productivity and waste elimination. So, if whatever process your talking about in whatever part of the organization you’re talking about, if you eliminate waste, what you do is you create time. And then you use that time to apply it to doing what your customers want. And that’s what lean does and that’s why productivity is very important.

Michael Webb: It essentially increases capacity.

Nick Katko: Yes it does. So when inside sales and marketing, you have many different processes. You have lead generation, you have request for quote to quote. You have all different types of processes. And you have to understand from that process what does the customer want. And you have the whole lead generation is the nurturing process. And so you want to focus on what are the activities that we should be performing to try to move this along.

Now I realize you can’t … moving a potential customer through a lead nurturing process is not like making a product. It’s not going to happen in two weeks or whatever.

Michael Webb: Well it might sometimes.

Nick Katko: Well it could, but what I’m saying is you have to know what you should be doing and in what cadence you should be doing it, and is the process performing as it should. If the process is performing as it should, that’s what you want to measure. Then the outcomes will improve. That’s the whole idea. What you want people in a process to understand is to become aware of what activities create value, what activities don’t create value. And that, go ahead.

Michael Webb: So that’s the rub in sales. Because if you have five salespeople, guaranteed you’re going to have 15 opinions.

Nick Katko: Right.

Michael Webb: They may all agree on some stuff, our prices are too high, or something. So the issue in sales is they don’t have a rule of thumb way to distinguish the work that creates value from the work that creates waste. They’ve been so long in the environment where management is just looking at the end result. We need the revenue coming in. And so when you start breaking down the process, they run into all kinds of … they go in the ditch every which way in sales because they’re trying to come up with some sort of best practice of how sales should be done and then enforce that with the salespeople, but not all sales opportunities fit that. Right?

Nick Katko: No.

Michael Webb: And now we’re in a compliance issue, and with the best salespeople who happen to bring in the biggest numbers this quarter or this year, maybe they get a little bit of relief and they don’t have to fill out the reports as much or give as much credence to the specific process that they were taught, and then you have divisions going on within the people. And once you get one of those processes in place it’s like itself is like a monument, it’s there, and that’s the way the company runs things, and if the market changes around it, then the company doesn’t have a way to generate evidence and data telling them that they need to change the way they do things.

Nick Katko: Yeah.

Michael Webb: So as you’ve worked with your clients, have any of them come up and said how can we use some of these ideas in sales?

Nick Katko: Oh, yeah. I’ve had that a few times, and in fact I have a small company I’ve worked with for a few years and I’m helping them out in their quote process right now, because it’s a very complex process. It’s a privately owned company, the owner really believes that the customers if they get quotes faster, that it gives them more opportunity to make a decision. But it’s really rediscovery… it’s really looking at how to break the process. Because everybody in this industry does it the same way. And this owner wants to do it differently. What’s interesting is everybody … the people who do the quoting process are thoroughly convinced that they have to deliver an accurate quote to get an order. But the reality is that sometimes they’re quoting just because it’s really a distributor that’s calling for the quote. The distributor just needs a price to talk to a customer about something that may happen in the future. They’re just trying to put together a bid, or something. It’s not like hey, I’m going to buy this tomorrow.

But they don’t make a distinguishment, they don’t distinguish between that. So every quote is the same.

Michael Webb: To the people who are inside the company doing these quotes, everyone is the same and they’re grinding them out as fast as they can.

Nick Katko: Well, they’re grinding them out, it takes time, and they’re trying to be thoroughly accurate even though when the request for a quote comes in, there’s incomplete information. So there’s a lot of back and forth about trying to get complete information and then the distributor calling really doesn’t know because the customer just said give me a price on this. It’s a very interesting process.

Michael Webb: They’re just exploring things. It’s like they’re trying to create a finished good when the customer doesn’t want a finished good yet.

Nick Katko: Right. Yeah.

Michael Webb: We actually had a conversation about that the other day and about where you focus. I could see, I want you to tell, just relate that conversation we had. Because I can see a lean-oriented person saying well, let’s lean out this quotation process so we can do it perfect every time right now, yet is that really the right place to focus?

Nick Katko: No. Because what is, I guess this is … you want the process to be productive and you want to get quality information back. So the real question is at what stage of the buying process are we in relation to getting this number, this quote. And there’s two pieces to it, number one is the price, and number two is the lead time. And because this company operates in a commodity business, they make wood products, the price of the wood changes depending on availability and the lead time can change depending on availability. Because this company from an operating standpoint is lean, they don’t stock a whole lot of inventory because it doesn’t make sense because everything’s customized.

If I’m calling up and I just need give me a price, but I might not call you back for a few months, well lead time is not important. Price is important, but you know what? The odds are you’re going to give me a price today and then I’m going to call you up two months later and say now give me the real information I need, which is an accurate price and an accurate lead time because we’re about to sign a contract. So it’s really about taking the customer through a process. Where are they in the process and how do you move them along based on your activities in terms of asking the right questions, in terms of getting them arranged, giving them some options very quickly. Well if you want high quality, here’s a price, if you want medium quality, if you want low quality. And right now this is our lead time.

Michael Webb: And for budgetary purposes, right? If they’re not ready to buy yet, but they need to explore their alternatives, they need a budgetary kind of a quote. I know that applies in lots of industries. And a lot of companies struggle because they don’t really have a way to do budgetaires.

Nick Katko: Right. But this is where you have to understand what is the value that your customer wants. What does your customer really, really want. And sometimes they don’t know.

Michael Webb: Right. That gets to that concept of the customer’s journey. That they are going through certain stages that are pretty predictable, it’s different by market segment, but it’s pretty predictable, and if you know what those are, then what actions or what’s the problem they’re trying to solve right now, is a problem of budgetaires or is a problem of no, we’re going to do a transaction, so we’ve got to have this down to two decimal places.

And so, if you are giving the customer what they want at the right time of the customer’s journey, then sales funnels going to flow more readily. If you’re trying to give them quotes to two or four decimal places at the first inquiry, then you’re not necessarily giving them what they want, and you’re certainly spending lots of your resources to do it.

Nick Katko: And what that would be called, if that was in a manufacturing environment, that would be called overproduction. You’re doing much more work than really what’s needed.

Michael Webb: And they do that all the time in manufacturing.

Nick Katko: Yeah, well we do it in accounting, too.

Michael Webb: Well we certainly do it in sales, I know that for sure.

Nick Katko: Yeah. So it’s needs … if you’re in a highly-customized environment, and think about a quoting process, it’s a highly-customized environment. Not every quote is the same. So in manufacturing, in a customized environment, what you want is you want as many of the specs up front as possible, and if you don’t get the specs, then you keep working that processes till you get all the specs. You don’t start making anything till you get the specs because you don’t know what to make. And so in sales, get the specs before you do the work.

Michael Webb: Or in the early stages, salespeople are trying to qualify their prospect, and there’s all sorts of things that are important to this sales relationship that may not yet be important with regard to specs, like am I talking to a decision maker. Do they have budget? Are they more comfortable with a competitor and they’re just doing price checks here? Or is it really possible that we could establish a relationship and become a major supplier for them? Who in their organization makes that decision? But it’s all sorts of things that go into an effective sales process so that when you get to the place, like giving budgetaires so you can have good dialogue with them and help them solve their problem, but when you get to the place where you need a transaction, then the specs ought to be automatically forthcoming.

Nick Katko: Yeah.

Michael Webb: You’re helping them buy if you’re driving them to become more specific when it’s time to buy. I had a client that … a lot of companies get bottlenecked around this issue of doing quotes. And one of my clients was struggling with it because it’s a key role of sales, or of sales. And so, they would go around and do lunch and learns, very common in technical kinds of industries, and they were selling to the building trade, so these were contractors that are going to be buying from them. And we decided … we discussed with them this possibility of these lunch and learns, they’re well-organized, they’re good meetings, what’s the action you’re trying to get the customer to take after that lunch and learn? What is the action you want this prospect to take? Well, you want them to give you more quotes. Okay, what does the prospect want from it? Well the prospect, when he’s ready for a quote, he wants it quick and he wants it good, but he often doesn’t know how to ask for it. He doesn’t know enough to do a good request for quote.

So they worked up a way to have a lunch and learn that taught the prospect the key issues they need to be paying attention to in order to give a good enough quality quote that they could have a competitive advantage. And there was a test after the lunch and learn. If the client, the prospect, agreed to pass that test, or take that test, and they got a reasonable score, then they entered into a special class of prospects that our best customers are members of this club, and for all the requests for quote that you give us, we’ll guarantee turnaround of 48 hours or … because these are the first ones we work on, and we know you’re going to give us a high-quality quote so that they’re great. So they’re qualifying it. So, the client’s getting something, the prospect’s getting something, the selling organization is getting something, and you’re increasing quality of deal flow.

Nick Katko: Yep. And that’s a very good lean example of trying to understand customer value. And the interesting thing when it comes to like a sales and marketing process, and I’m not talking about the products, for example. I’m just talking about the process of selling. The process of getting the quote … or giving the quote, sometimes the customer doesn’t know what they need. They don’t understand it. So you have to walk them through a process to get them to better articulate and define what they need and then you can give them what they want. Sales doesn’t produce a product. Sales is about relationships. You have to develop the relationship and it’s really … lean’s about learning in terms of understanding problems. And so, at one level lean sales and marketing is, I would make an argument that it’s about eliminating all of the non-value-added activities so you can spend more time developing relationships and understanding your customers better.

Michael Webb: Yes, however, it’s also about understanding the value-added activities and how valuable they are.

Nick Katko: Well, right, yeah.

Michael Webb: So, another quick story of a client, this is a company called Burr Oak Tool, and we did an interview with Tim Doot, the corporate VP, and they went through some stages while we were working with them where the salespeople were defining their process. And this is a company that has do to quotes, incredibly complex quotes on million-dollar pieces of equipment. And so the bottleneck was doing those darn quotes and finding a qualified prospect. They know all the customers in their industry. So working with them, finding qualified prospects is a costly thing because of all the labor, the engineering labor that goes into those relationships over time. Quoting and re-quoting and modifying and re-quoting. So they had an opportunity with a new product launch to build a way to do budgetary estimates and they built it into a spreadsheet that was tied to a website.

And the website said, for our new, I think it was a triumph vendor was the thing they called this machine. If you’d like to compare our technology, our ability here to produce parts for you with our three best competitors, then fill out this form. And you give number of parts per shift, number of changeovers, how many per day, what your substrate is, you’re using aluminum or copper or whatever metal, and stuff like that. And then they would provide the customer with a cost per part based on what assumptions are for maintenance costs and electricity costs and all that kind of stuff. And then they show the comparisons with the other competitors.

Within, I believe he said it was within 60 days, it might have been 45, this short time, there were three new account qualified prospects that they didn’t know existed. Because these engineers were attracted to that website and they filled this out. And they were interested to learn more, so the salesperson, instead of having to scratch and make cold calls and find accounts to call on, this is handed to them on a platter, here’s a new company, a new contact, they are in our industry, here’s the details of their production volumes, and they look for these options on the machine, and they would like to talk to you more. So how much did it cost to generate such a qualified prospect the old way, where salespeople had to make cold calls and do all these quotations themselves versus how much did it cost to create a qualified prospect this new way? They didn’t know.

And the fact that they weren’t measuring the cost of producing those interim steps of those leads at the qualified stages of their sales process, it made it difficult for them to justify spending money on marketing websites, opt-in, sales landing pages, and stuff like that. So, cost accounting had they had a better handle on it, would have enabled them to make this kind of investment sooner, I think. Don’t you?

Nick Katko: Yes. I agree. The lean lesson out of that is making an investment to automate part of a process and that saves a whole lot of time.

Michael Webb: For the customer and for the sales team.

Nick Katko: Yes, yes. And therefore … it saves a lot of time and so therefore now we can get down to “the brass tacks” of what we really need to talk about.

Michael Webb: Whereas the traditional approach of executives, company presidents, is we have a problem, we’re not making our sales numbers, we got to focus on the sales department.

Nick Katko: Oh yes. Sell more.

Michael Webb: Well maybe. But how do you know? Where’s your data? Step back and look at the whole selling system and figure out how to improve the system, and that’s going to give you a much greater return.

Nick Katko: Right. And that’s what lean is all about. Like I said, measure performance, define for any process, define what is … excellence. How should the process operate? That’s what the measures tell you. Now in sales and marketing, you’re not always going to have a success, you’ll give out quotes but that doesn’t mean you’re going to win every quote, but at least you know you’re delivering quotes at the rate that the customer wants it and the quality is good.

Michael Webb: Is good enough for what they need at that point.

Nick Katko: For what they need at that point, yeah. How is the process working? That’s what lean performance measures are all about. The other piece is measuring costs. Most of the costs, but not all, most of the costs in your sales and marketing department are fixed. The number of people that you have is not a variable cost. You don’t want to try to lower your sales and marketing labor cost, because the only you’ll lower that cost is by getting rid of people and you don’t want to do that. If you want to measure the cost of sales and marketing, one of the best long-term measures, is our cost improving, is the total cost of sales and marketing as a percentage of sales.

Michael Webb: Yes.

Nick Katko: That over time, if you are eliminating all the non-value-added work and focusing on the value-added activities –

Michael Webb: That’s going to improve.

Nick Katko: Your cost as a percentage of sales will go down. Why is that? Because the elimination of the non-value-added activities creates time and it allows the people to focus on the value-added activities, which is what you pay them to do.

Michael Webb: So let me ask you a question, because I’ve tried to talk to people about that, and it’s not a generally recognized line item on most company’s income statements, that I know of anyway. But I think I’ve heard it called cost of sales investment. What is it typically described as on the income statement when you’re measuring these particular measures?

Nick Katko: Okay. That measure, the numbers appear on the income statement, you have to do the calculation. And so typically you have a sales department with total expenses, and it’s just the ratio of the total expenses over total revenue.

Michael Webb: But general administrative expenses often get mixed with sales expenses.

Nick Katko: Well, I mean –

Michael Webb: Is marketing a sales expense? Is a trade show?

Nick Katko: Well, again, what are you … there’s not like one standard measure, it’s if you think about all the sales and marketing activities, if you are applying lean practices, are you applying lean practices in how you manage trade shows, are you applying … if you’re applying lean practices and eliminating waste, the cost over the revenue should go down over time. The percentage of cost over revenue should go down over time. Not going to happen in a month, but over the course of a few years, you’re probably going to see it go down.

Let me give you a quick example.

Michael Webb: Okay, and then we’re going to have to start wrapping up here probably.

Nick Katko: Yes. I’m CFO, and I’m working in a lean company, we’re making lots of great progress. I apply lean practices in the accounting department. Over the course of a few years, I … the cost as a percentage of sales improved. The accounting department costs as a percentage of sales went down by about 50% because … I did not fire people, but there were a few people who left for other job opportunities, it was voluntary, and we didn’t replace them. There were other people who took different jobs inside the organization because they said, one person said oh I always wanted to work in customer service, can I work in customer service? Sure. Go ahead, apply for the job. And they got the job and we didn’t replace that person. That’s how, because we eliminated a lot of non-value-added activities, it was easy for people to absorb doing more work that was satisfying for them.

Michael Webb: That’s great. A great story and it reminds me of one that we’ll have to talk about another time. When I was in an engineering firm as the head of sales and marketing for an engineering firm, and we actually measured the cost of sales and marketing relative to the other parts of the business. We’ll have to pick that up. And your client stories of companies that have been trying to … they’re using the cost numbers as a Geiger counter to say where do we need to improve? And then you’re able to demonstrate that improvement is happening. There’s tons of stuff to talk about and explore in applying lean management accounting to sales and marketing. And I think it’s –

Nick Katko: And think about this, let me just say one more thing then we’ll wrap things up. There’s a difference between cost cutting and cost reduction.

Michael Webb: Yeah. Huge.

Nick Katko: Cutting a cost is looking at a number and saying that number has to go down, make it happen. Cost reduction, such as the ratio of a cost compared to sales over time, that is a process. And how do we make that happen? It’s the rate that goes down, it’s not the absolute number. And that’s what has to be … one of the differences in a lean company is they don’t look at cost-cutting, they look at cost reduction.

Michael Webb: Fascinating. Super. So we’re going to have to do this again at some point. I really appreciate your time, and I think that there was lots of great insights and overviews, especially for sales and marketing people who may not be all that familiar or had much interest in the past in accounting. And I really appreciate the insights that you’ve shared. If someone in the audience wants to learn more, I know you’ve writing a book on this and there’s stuff on your website, too, that applies to it. How would they get ahold of you?

Nick Katko: Okay. So the book is called The Lean CFO, and it’s available on Amazon. The website is WWW dot maskell, M-A-S-K-E-L-L, dot com. And my email address is nkatko, K-A-T-K-O, at maskell, M-A-S-K-E-L-L, dot com.

Michael Webb: Super. Thank you very much, Nick, and until we meet again.

Nick Katko: Thanks Mike, appreciate it.

Michael Webb: Take care.

Nick Katko: Bye.