Operational Excellence: Setting the Target for Performance

By Bruce E. Jacobs

In the June issue of MPO, this column defined four “Must Get Rights” in creating competitive distinction: Product Leadership, Operational Excellence, Customer Delight and New Business Growth. This month, we will focus on setting the target for performance, which drives the continual work effort to achieve operational excellence and maintain it.

Operational excellence results when an enterprise’s management is involved with every aspect of the business operations, including improving and simplifying processes; improving direct, indirect and support costs incurred by the company; improving productivity of assets and labor; and eliminating anything defined as waste. The ultimate benefit is the continual improvement in cost structure and asset utilization—doing more for less.

Manufacturers and providers of medical products already are under pressure to lower their prices. As healthcare costs continue to spiral upward, customers will exert greater pressure on every player in the medical device supply chain to lower prices, as well as to search for alternate sources for lower-priced products. With every player in the supply chain incurring increased costs for raw materials, skilled labor, manufacturing, distribution, energy, regulatory compliance, interest and other direct and indirect costs, the inability to raise prices to offset cost increases erodes the profit margins for all players in the supply chain. Medical device companies that compete in their markets on the single dimension of price require a business model with two core competencies—high-volume products and least total landed cost. Enterprises recognized for competitive distinction within their industry and by their competitors are able to compete on more dimensions than price because product price is not the only value component perceived by the customer.

How to Measure Operational Excellence

Manufacturers of medical products are asset-based companies; therefore, operational excellence should be measured in terms of the return on assets a firm generates. By comparison, the minimum threshold of acceptable return generated by the assets of a medical device company would be the return on investment that can be obtained in the open financial market, with minimum risk involved. The challenge is to determine your company’s return-on-assets target. Moreover, as your company absorbs cost increases and is unable to raise prices to offset them, achieving year-over-year improvement in the return on assets requires rigorous effort by management.

The objective is to maximize your company’s long-term value and to manage the company to achieve sustainable higher value in the long term.  As a performance measurement, return on assets is defined as the percentage of operating profit to total net assets, calculated on a before-tax basis for operating profit. By establishing a return-on-assets target and year-over-year improvements, executives and operating management can improve the investment return by focusing on several areas:  

• Asset utilization and productivity to increase output with fewer assets employed

• Cost improvement to raise operating profit and offset cost increases

• Revenue growth to increase volume, market share and penetration

Defining the target return on assets can be as simple as stockholders and management deciding a reasonable return on assets the company should attain. Other methods may include comparisons of industry competitors or comparisons to other companies that have similar markets, products, customers, processes and industry issues.

To establish a realistic return-on-assets target:

• Identify your company’s return on assets for the last five years and determine the five-year average return

• Develop a peer group of companies for comparison and identify each firm’s returns on assets; limit the group to 20 companies to keep the required data maintenance to a minimum

• Establish the return on assets for the peer group using each company’s performance

• Determine the gap between your company’s return on assets performance and the peer group’s performance

• If the peer group’s performance is better than your company’s, determine the economic benefits your company would achieve if it performed at the same level as the peer group

Based on the expected operating profit margin, if a company only focuses on improving revenue, then revenue generally has to increase an inordinate amount in a single year to achieve the targeted return. If the enterprise focuses on asset utilization and productivity, including cash accounts receivables, inventory and net plant property and equipment, the operating profit doesn’t have to improve to achieve the targeted return because the asset base becomes more productive—more for less.

Based on the projected operating profit and total net asset base of the company, determine the targeted return on assets by calculating the operating profit required to generate the targeted return. The gap between the planned operating profit and required operating profit to meet the return-on-assets target must be achieved through cost reductions or increasing prices, which may not be possible.

Achieving year-over-year improvements in return-on-assets performance creates a compounding growth effect. However, as the return-on-assets performance improves every year, the greater the magnitude of the performance gains required in revenue, asset utilization and operating profit. Using return on assets to make the most of your company’s longer-term value will require various combinations of revenue improvements, asset utilization and cost improvements—combinations that depend on the current business and economic climate. Smart executives and operating managers can take the appropriate actions they know are right in the longer term for the company.

In view of your company’s historical return-on-assets performance and the peer group’s performance, determine the return on assets the company should achieve. This is the targeted performance.

Now, the work begins for the executives and operating management:  improve performance and achieve the targeted return on assets. To achieve the target, does management work on asset utilization, costs and profitability, revenue growth or some combination thereof? Once you establish the target return on assets, you must decide where to focus management’s efforts to make improvements. Based on the previous year’s financial performance of total costs, operating profits before taxes and total revenue, as well as the net total asset base of the company, assess the following:

• Is the asset base with the new year’s additional capital investments adequate to support the projected revenue for the new year?

• Based on the prior year’s total expenses and operating profit margin, will the projected sales revenue generate sufficient profit to meet the targeted return on assets?

• If the required return on assets will not be achieved, what tactics will help increase revenue, reduce assets and improve profitability?

Your company can achieve operational excellence and maintain it by establishing return on assets as the primary measurement of financial performance, establishing consistent operating profitability and by efficiently managing the company’s assets. The measurement is easy to calculate and use and is easily understood by the operating management that makes operating decisions to improve return on assets and the company’s long-term value.


Manufacturing companies are asset based. Driving operational excellence based on return on assets requires management to focus on continuous improvements that generate the targeted return. Ideally, executives for the enterprise review its prior year’s performance and establish the target return on asset performance the company should achieve. From there, the executives and operating management go to work on improving performance.  Each year, the target performance is increased, requiring year-over-year performance gains and demonstrating consistency in profitability and growth in the company’s longer-term value.

Bruce E. Jacobs is a principal with BKD, LLP, a CPA and advisory firm, and a member of BKD Manufacturing & Distribution Group, providing solutions for the management and financial needs of medical device businesses. Bruce has more than 26 years of experience in manufacturing and distribution strategies. Contact the author at [email protected].