Lean manufacturing is a business performance improvement methodology that focuses on eliminating waste and enhancing quality, cost, delivery and people. It provides for continuous improvement and strives to produce only to meet customer demand and improve overall customer value.
Park Nicollet Health Services, a $1 billion health services provider headquartered in a suburb of Minneapolis, led by senior vice president and CFO David J. Cooke, has transformed its business performance management systems guided by lean principles.
Steve Player: Park Nicollet's story is very interesting, both in terms of what you've accomplished on your lean journey as well as how, in conjunction with that lean journey, you've really transformed finance. Can you take us back to the beginning?
David J. Cooke:
I joined what is now Park Nicollet Health Services just over seven years ago. David Wessner, our president and CEO, whom I worked with earlier in my career, invited me to take on the CFO role here. David and I have always been students of process improvement throughout our careers. We needed to bring a fresh set of eyes, as Park Nicollet had never achieved an operating margin prior to 2000.
Initially, in the early 2000s, we got involved in Six Sigma, and we originally started on that journey. After about a year or so, we just weren't seeing the results. Maybe it was just the way we were going about it -- it seemed like "paralysis by analysis" for us. Though we had some very significant early success, we just weren't seeing the rapidity of improvement we felt we needed to see in health care. We agreed with the studies that say $0.30 of every dollar spent in health care is wasted on non-value-added activities. At about the same time, we learned about the Beyond Budgeting concepts and lean manufacturing.
The budget process here normally began in July. If we were lucky, we had a budget to present to the board by mid-December. A lot of time and energy and effort went into preparing a budget; it was nothing more than a political process. And the budget was anything but predictive. If anything, it guaranteed additions to our expenses without guaranteeing new revenue sources to pay for them.
I had begun promoting the idea of transforming the annual operating budget process but I didn't get any traction until David Wessner came across lean manufacturing at Virginia Mason Medical Center in Seattle. They had been involved in lean activity for about a year. After some initial study, we started our initial project here about three years ago. We had major success, and we've since begun our transformation to a lean organization.
We now have over 140 rapid processing improvement workshops scheduled for this year. On direct costs of about $45 million a year, we expect to see at least a 3- to 4-time payback.
SP: So you're spending $5 million, and you're getting $15 million to $20 million back? In a year?
DJC: Yes, $15 million to $20 million hard, that I can find -- I say cost savings don't count unless I can find them.
SP: That's one way to drag them to the bottom line.
DJC: The payoff is back to our community; we're in the fifth year of charge decreases to the community. In fact, Methodist Hospital -- part of Park Nicollet Health Services -- decreased its charges 10 percent this year compared to the previous year. Like most Minnesota not-for-profits, we're held for the community benefit. We hold our assets in trust for the public and the community's benefit. But we're not a governmental unit, and like everyone else we need to make a profit, first for our bond rating and second because our annual capital budget comes from our prior year's cash flow from operations. We made money for the first time from operations in 2000. We experienced a slight drop-off in 2001, but we've had profitable operations ever since. In fact, in 2003 we came out with our first rated bond issue. Our initial S&P rating was an A- with a positive outlook, and in the spring of 2006 we were upgraded to an A with a stable outlook.
SP: I thought health-care costs have been going up!
DJC: This is our fifth year of charge decreases, and I directly credit our ability to do that to our lean activity. And at the same time, we're a major growth company. Until last year, we had double-digit growth in revenue each year for five straight years. Last year, we only grew 7.8 percent, but we grew market share. In 1999, we did $542 million in revenue. Last year, in '06, we topped a billion dollars. So we're growing, but at the same time we're reducing our charges.
SP: That's impressive. What were the critical steps that facilitated such a radical change in performance?
DJC: Well, with our CEO leading our transformation to lean, the budget process came under greater scrutiny. Lean changed our way of thinking, and the Beyond Budgeting idea -- and the focus on planning as opposed to budgeting -- was consistent with our new approach. We eliminated a very archaic, over-processed operating budget. We're not "locked in" any longer. Instead we now reforecast the next six quarters every single quarter. It's made us much more nimble in the marketplace. Rather than measure ourselves against the budget, we now expect improvement in financial performance each quarter in comparison to the previous quarter and the same quarter last year.
We do two versions of our forecasts: a "run-rate version," where we apply the past-12-month trends, and then what we call an "improved version," where we assume, if our plans pay off, what the numbers will look like. For '07, our run-rate version operating margin is 1.6 percent, forecast at the close of the fourth quarter of '06. The improved version has us coming in at 3.1 percent.
SP: If you do the things you hope to do and are successful, the upside is double your operating margin.
DJC: Which translates to another $20 million of capital expenditures we can plan on in '08 if we're able to make those improvements.
SP: That certainly gives people the motivation to improve, and that investment then pays off even more over time.
DJC: Our incentive programs for management and physicians are based upon that improvement being made.
SP: How were you able to shift? A lot of people still cling to a budget in the belief that's how they have to pay people.
DJC: The board, much to my surprise, wasn't hung up on us not having a budget. They just wanted to make sure we had a target that met our financial needs and that we were monitoring ourselves against that target. The board has given us a target of 3.1 percent for this year because that's what we need to support an appropriate capital budget and our credit rating. The financial incentives are built around us achieving that. If we do better than that, the organization and the community win.
We've gone through two full years now without an operating budget. The first year was really interesting. When August came around and people weren't budgeting, people were thinking: "What am I supposed to be doing now? Shouldn't I budget anyway?" I was afraid it was so ingrained that people would budget behind our backs. That behavior did flare up once in a while, and I would go and have a chat with the VP responsible for it and say, "No, no, you don't need to do that."
SP: Do your operating executives do the forecast?
DJC: Currently, we're helping people further understand the tools we're using and getting their input on the forecast without returning to budgeting. I'd like to get more service-line leadership involved, but we tried that originally, and that's when they wanted to go back-door into budgeting, so we just pulled off that completely. At some point, I'd like to reintroduce them into helping us come up with the forecast, but right now that's strictly within finance.
SP: A lot of people would say the best practice is the other way around; it involves hundreds of people and gets all the operational people involved. Why do you keep them away from it?
DJC: We can go back historically and say, "Well, here's where the budget was and here's where we thought we'd end the year at the beginning of the year." Every single time, we were right and they were wrong.
SP: What makes them wrong?
DJC: Reality.
SP: Are they just overly optimistic, or are they looking for an incentive?
DJC: Overly optimistic. If the incentives were based upon what they forecast, they'd never get an incentive. But we want to re-engage them. That's how I'd like to see this system evolve.
SP: Do you want them to focus on how they're doing and how that target relates to the overall?
DJC: We want them to grow the top line and minimize the expense side. We want them to improve their margins. Or, if we're forecasting a downturn, we want to minimize the damage. Last year was an overall downturn. All the other major health organizations in the Twin Cities had layoffs last year. We did not.
SP: How did you avoid that?
DJC: We saw it coming.
SP: Because you were looking at both the run rate and your improvement plan?
DJC: The forecast told us things were flattening off. While we saw it coming and were able to shift our plan, the other health systems were locked into their growth plans and had added FTEs. They had to lay off all the new FTEs they brought on. We didn't add those FTEs. I actually started here -- in December of 1999 -- on the day of the last broad-based layoff in Park Nicollet Health Service's history. It's fun to tell people that. Where people were once sad to see the budget go, I now get rounds of applause. Especially during the August-September time frame, when they remember punching numbers into the system on late summer Sunday nights for a 9 a.m. Monday cutoff.
SP: How did you break them out of the culture? People often want a lot of detail; they want to budget or plan every account in the chart of accounts. How did you get them to look more at the forest than the trees?
DJC: We create expectations of what they're going to be measured by -- units of service per FTE and cost per unit of service. We only measure it when we roll up. We will not provide them the detail that goes into the forecast. Sure, everybody wants to know the cost center detail that went into the forecast, but I refuse to provide it.
SP: What's their reaction to that?
DJC: "How can I control my operation?" they'd say. I'd tell them there's nothing they get from me that controls their operation. All they get from me is historical. You can't control a single expense that's historical. You control your operation through daily management and visual control at the work-unit level. Expense control happens at the work unit as it's incurred. It's a fundamental lean accounting concept.
SP: Though you studied the lean concept as it applied to health care in Seattle, lean is more of a manufacturing discipline, most notably among the Japanese with Toyota. Were you culturally predisposed to this?
DJC: We don't have all the answers in health care, just like the automobile industry didn't have all the answers. We have something in common: We're operating in challenging business environments. So you go with what's called "fresh eyes," and you learn to see with fresh eyes, and we've benefited from fresh eyes. I've been to Japan for that purpose. And Toyota is a very good example of the benefits of doing lean right. You can't dabble in this; it has to be an organizational transformation.
You go on half of our patient-care floors now and you'll see a visual control board that looks at volumes and staffing that day. The staff has morning and afternoon huddles, and they'll have documented what their problems are that day.
SP: How has your job, and the CEO's job, changed?
DJC: We're no longer basing our decisions on historical records and reports. Two or three times a week we'll go walking around looking at the visual control boards. It's as real-time as it gets, as you can identify the problems and opportunities as they occur.
SP: What ramifications does that have for people in finance?
DJC: Don't get me wrong, we still have the records, and the recorders still exist. But it creates a different route for what I call the analytical group. They're now out in the field, they're assigned to service lines, and they're out in the field helping service-line leadership manage. A senior financial analyst and a senior operational analyst are on each of those teams. Although they report into finance, they're part of that team, so they're helping make those real-life, real-time decisions.
SP: What kind of person is well suited for these positions?
DJC: They still need to have a good accounting/finance background, but we don't want someone with a recording or a rules mentality. We look for people who can contribute to the team in a business advisory role. There are accountants who don't want to play that role, and that's fine, we still need recorders. But that's not how you become CFO. Granted, if you don't produce good, reliable numbers, you won't be CFO for long. But one of the reasons why I was chosen for this job was because I was the CEO of a large physician group practice for five years. I left finance for operations and came back. I think that's added tremendously to my usefulness to the organization.
SP: Would you suggest that approach to other finance executives coming up?
DJC: Yes, get some operating experience at a high level. You need to have that broad-based experience to move up.
SP: How do you create opportunities for your people here? How do you create a career path?
DJC: The liaison role is ideal for that. In fact, my former budget manager -- a position that no longer exists -- is leading a team of specialists who are supporting the medical services line. That prepares him either to come back into finance at a senior level or stay in operations. He has a very traditional finance background, but he knows how to use the lean tools, as it's a lean operation. Unless you know lean, you can't move into a senior level in a lean organization. It's part of the culture.
SP: Were there times when the culture here tried to reject that?
DJC: Absolutely. Physicians are willing to try anything medically, but many are opposed to changing how they run their offices and how they view the world. It took a lot of hand holding, and they needed to see the proof in the results. There still are naysayers. But reliable data is hard to refute, especially when you're talking about hard savings that result in five years of decreased charges.
SP: And that's certainly got to help build the volume coming through.
DJC: It's like a large flywheel. When you first start it spinning, it takes a lot of effort to get it going, and it seems like you're not making any ground. But then you slowly build momentum, you start going faster, and it gets easier. That's the stage we're at right now; we're building momentum.