People do not often offer Lean improvement details. When they do, it does not take much to find the real underlying factors of success.
This article examines Dr Pepper Snapple Group’s Rapid Continuous Improvement program and argues that Lean may have improved productivity, inventory turns, and margins, but it did not explain the company’s overall business trajectory.
A closer look at Dr Pepper Snapple’s Lean success story
Someone presented this story about DPS (Dr. Pepper Snapple Group) to me as an example of a Lean success. Their source turned out to disprove their claim[1]. Mike Esterl’s article interviewing DPS CFO Martin Ellen provides most of the details of what really went on at DPS. Annual reports and EDGAR helped fill in the rest.
Starting in February of 2011 Ellen set a three-year productivity target of $150 million. By the time of the interview, the company had accumulated $270 million. DPS confirms the timeline in its own 10-K. In 2011 it adopted RCI (Rapid Continuous Improvement). The filing describes it as using Lean and Six Sigma methods to deliver customer value and improve productivity. So, the label is theirs, not mine.
The $270 million across five years averages $54 million a year. That is a modest 2.2% of FY2015 operating expenses of $2.313 billion in SG&A (selling, general and administrative expense) plus $105 million in depreciation and amortization.
The Story the Data Tells
The article holds real operational results worth looking at. Changeover time on a fountain-syrup line went from thirty-two minutes to thirteen. Ellen also reported inventory turnover improving by 35%. Asked directly about job cuts, he said there were none to his knowledge, attributing headcount reduction to natural attrition. Did DPS use the recovered time to improve turns?
A setup reduction’s value is time saved multiplied by frequency. Nineteen minutes recovered on a line that changes over twice a shift is different from nineteen minutes on a line that changes over twice a month. The article supplies saved time but not how it was used. The impressive reduction of line changeovers is what people remember. How it was used often goes unanswered but a question most finance people will ask.
Where does a setup reduction actually show up? The classic use has been more production or fewer employees. It appears the payoff for DPS came as smaller batches and lower inventory rather than as output. Setup reduction and inventory turns seem to go hand in hand, and it is a working capital result.
Success Factors
Two of the key factors that drive the flavored beverage market are taste and distribution.
“The LRB industry is highly competitive and continues to evolve in response to changing consumer preferences. Competition is generally based upon brand recognition, taste, quality, price, availability, selection and convenience.” — Dr Pepper Snapple Group, Form 10-K for fiscal year 2017, Item 1, Business
Nothing from the article points to Lean improvements in any of those. In addition, the article mentions nothing about what capacity DPS had before its implementation of Lean.
Every method the article documents lands on the balance sheet. Inventory released. Capital expenditure governed by ZBB (Zero Based Budgeting). Marketing down as a share of sales. The question was never whether anything happened. It is whether what happened explains the trajectory of the business.
The Other Initiative
The journalist asked some interesting questions. Answers to two of those are worth more than the headline number.
On spending, Ellen muses that in general, capital expenditure budgets are typically managed similarly to that of government, spend it if you got it. He says: “This is where we do zero-base budgeting.”
For those unfamiliar, zero-based budgeting means every department, site, and division starts each year’s budget at zero, and each expense added must be justified.
Zero-based budgeting is not Lean. It is an unrelated method, governing spending RCI does not touch.
The interview also records marketing spending falling to about 7.6% of sales from just over 8%. No period given for either figure and DPS does not break out marketing separately from SG&A. So, there is no way to date the decline or convert it to an annual number. Which is a smaller example of the bigger problem. The figures attached to Lean success stories are rarely the ones you can pin down.
Lean is not a business strategy
An initiative to improve efficiency and operating effectiveness can help with a productivity strategy. But making that initiative a focus does not make it a strategy. At best, it is a distraction. An example of a strategic choice for productivity would be to bring capabilities in-house before you have to react to outside supplier forces.
The annual reports tell a different story
Reading the annual reports between 2011 and 2016, the same period as DPS’s Lean implementation, the CEO spells out the intended strategy. Get the brands in front of the consumer. The 2016 annual report organizes it under headings: “Build Our Brands,” “Execute with Excellence,” and then “Rapid Continuous Improvement.”
RCI gets its own heading. Equal billing with brand building and execution. Beneath it sits the adoption date, the methods, and a statement of RCI’s purpose. It is a means to achieve revenue and net income growth and to increase cash returned to stockholders. Two sentences while the distribution network, by comparison, gets three paragraphs.
A company gives a heading to what it wants read as strategy. The position and space beneath the heading are what tell you where it actually ranked.
Two things in those filings deserve more attention than the strategy language.
What DPS said RCI was supposed to accomplish
First, what the company said RCI was for. The 10-K describes it as a means to achieve revenue and net income growth and increase the amount of cash returned to stockholders. Shareholder earnings are written into the definition of the improvement program.
Second, what actually happened over the RCI period. Net sales went from $5.903 billion in 2011 to $6.282 billion in 2015. That is 6.4% over five years, roughly 1.01% a year. Below the 1.32% rate of inflation for the period. Income from operations over the same frame went from $1.024 billion to $1.298 billion, up 26.8%.
The program was sold as revenue and net income growth. Margins improved considerably. The top line barely moved. I have seen this many times when a company is window dressing for a sale.
There is a third item under the company’s own list of corporate strengths. DPS attributes its ability to raise dividends every year since 2010 to stable cash flows and the reduction of its capital expenditures. RCI was adopted in 2011. The capital expenditure reduction the company credits predates the program by name. The article did not offer when ZBB started.
Shareholder payouts outpaced productivity gains
Consider what was leaving the business while RCI was running. In 2016 alone, DPS returned $905 million to shareholders. The sum of $519 million in share repurchases and $386 million in dividends. Set that against about $54 million a year in productivity gains. In a single year, the company distributed nearly seventeen times more than what the improvement program contributed annually.
Share Count Drops
They dropped from 183.1 million at the end of 2016 to 180.6 million by September 2017, ending at 179.7 million by February 2018. About a 2% reduction across 2017.
Even the earnings-per-share growth was not what it appeared. Through the first nine months of 2017, DPS reported $3.09 per diluted share against $3.64 in the same period of 2016. The 2017 full-year figure settled far higher because of the December 2017 tax law’s deferred tax remeasurement. A one-time accounting event. Not operations, buybacks, or RCI.
Strategy is what happens regardless of a company’s intentions. Looking at that 2011 – 2018 period, one could argue that the strategy was to window dress a cash-cow and sell. Keurig’s parent, Maple Parent Holdings, merged into DPS as a wholly owned subsidiary. DPS then renamed itself Keurig Dr Pepper. Maple’s holders took ~87% of the combined company. DPS holders received ~13% plus $103.75 in cash. As of February 8, 2018, there were 179.7 million shares outstanding. DPS shares outstanding 179.7M × special dividend $103.75 = $18.7 billion.
What was the real purpose of RCI at DPS?
I see no evidence that Lean changed DPS’s trajectory. I am convinced some good things took place under the RCI program but nothing that could not have been accomplished with other, more focused initiatives. Ellen set up a certification program with the goal of every employee earning one by participating in an improvement event.
A problem with this goal is finding enough meaningful work for everyone. Once every employee has a certificate, what is the certificate worth? It will not be recognized outside of the company. Did employees get raises or bonuses for their improvement efforts? The shareholders sure did in 2018.
Employees are capable of making significant improvements, but when it is done using a productized solution like Lean, the focus on strategy is always lost. In nearly all cases employees’ efforts using ‘cookie cutter’ approaches do not change the trajectory of the company.
None of this is hidden. Ellen volunteers the zero-based budgeting, the marketing budget decline, and the absence of job cuts to a reporter who asked good questions. The company did not claim Lean was the only thing happening. The story handed to me as proof that Lean works singles out one initiative without mentioning the rest. That is the pattern worth sharing. Not that improvement methods fail, but that when several initiatives run at once, the one with a brand and literature collects the credit.
[1] Mike Esterl’s February 22, 2016 Wall Street Journal interview with DPS CFO Martin Ellen, “How Dr Pepper Cuts Costs and Keeps Cutting.”
