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In my Lean Six Sigma classes, I’ve been ask if someone with Six Sigma training could have saved Enron. This is a great question. In my analysis is that an insider could have seen this coming and an external professional could with the right data. This is powerful statement since many financial experts didn’t see the fall in Enron until it was too late. Having such a tool for a financial analyst will proved opportunities to short the stock for abnormal profits. This is a Blue Ocean concept applied into a service technicians skill set, unusual but effective.
Let’s define the problem. Enron was a fast starting gas company that rose to the 7th largest corporation in the US being recognized as a “top 100 companies to work for in America” and “most innovative company”. Later, it was implicated for causing a power outage in California allowing for the company to charge 20 times the normal rate for electricity. Before we get into the Lean Six Sigma aspect of this case, the first question to ask is why didn’t any regulator figure out whom or what was responsible for the power outages at the beginning of this process. This would have saved everybody all this trouble.
In this case, the accounting principles are what brought the company to pay for its crimes. The non-technical view of Enron’s accounting is the fact they misapplied future profits as if they already occurred and used the most positive projection possible. Thus, Enron was able to show non-profitable plants as profitable on the financial statements.
How could Lean Six Sigma has saved Enron is based on the fundamentals, by basing analysis on actual and unbiased data results. Lean Six Sigma avoids self-deception or manipulation. This is evident though the use of statistics, control charts, histograms, design of experiments (DOE), testing of the measurement system.
Internal auditors using these skills could have reviewed the aspects of Enron’s stated performance against the history of companies in their industry. Using such metrics of profit yield and life cycle maturity would have indicated Enron was the only company to experience these results in their industry history. This would trigger a red flag for auditors since why is Enron able to benefit why others organizations cannot. Also, the unexpected profits from plants that are not selling product are clearly a red flag for auditors.
External professionals have a harder case. The first issue is to chart the profit centers against historical baselines. This will identify the leaders for Enron. A follow-up analysis is to obtain actual results for a comparison. This is a common practice for many in financial analysis. Another common Lean Six Sigma practice is the FEMA analysis, Failure Modes and Effects Analysis. This would expose the risks for the Enron profitability and indicate for the analyst where to search and test for sensitivity to the growth potential of Enron. By using a Pareto chart against revenues, the analyst can understand the flow of the revenue of Enron and concentrate the focus on the top 80% of revenue generating facilities.
This analyst would be common for any practitioner since the unique climb to success in a short period of time would raise questions to any investor or employee. It seems in this case the finance professionals were not trained properly in applying this accounting principal. Having a background in accounting, I understand some of these concepts can be difficult. This is the reason for the team to be structured to gather the experts when necessary to understand the data properly. Clearly, there were some investors that understood Enron and were able to earn profits by short selling the stock. Clearly, if this was more evident, the time frame for Enron to continue this deception would have been reduced.
In the big picture, the SEC and Environment regulators have the power and authority to catch the fraud by Enron. The secondary issue is the internal auditors for not becoming whistle-blowers not only within the internal framework at Enron but also to the SEC. The third ring of failure is the external auditors. By not validating actual sales from year to year is inexcusable. This is the definition of “the blind leading the blind”. As reported by many covering this case and my own understanding of the culture at Arthur Anderson were a positioned for an event such as Enron to exist. The move of the auditors toward consulting and away from their compliance customers (SEC and investing public) proved to be too strong of push towards not holding firm on these deep accounting issues. The fact that the auditors held a “shredding party” once Enron was raided by the SEC prove to lose the public trust and their right to practice as a trusted independent external auditor.
As I learned early in my career, all data needs to be validated.
Gary Kapanowski – Lean Six Sigma Master Black Belt – Excelsior
The following blog is the opinion of Gary Kapanowski and Garykapanowski.com. It is the sole intent to broadcast this opinion from Gary Kapanowski and Garykapanowski.com exclusively and not to reflect on any other institutions or organizations associated with Gary Kapanowski or Garykapanowski.com.