Saturday, May 5, 2012

Focus and Leverage Part 106

Over the past year there’s been a growing recognition that we need something different in the way we go about “improving” our processes and systems.  I’ve written before about how Lean or Six Sigma or Lean-Sigma have failed to deliver significant, quantifiable bottom line improvement….at least to the extent that we’re covering the sometimes massive training dollars for any of these methodologies.  It seems as though we all work hard at improvement, but the results just don’t seem to materialize on a consistent basis.  Yes, there are those occasional homeruns that we achieve, but not consistently.  I’ve written many times about why I believe we are in this state, but I keep getting emails to write about a better way.  So the subject of this posting is focused on that “better way” to improve processes and systems.

First let me state up front that there’s absolutely nothing wrong with Lean or Six Sigma or Lean-Sigma.  Nothing wrong, that is, with the principles and tools of each improvement methodology.  However, there is something wrong with the way we decide which process to “attack” first, then second and so on.  The bottom line is this…..we need a method that will allow us to identify and focus on the key leverage points in our processes and system.  Rather than sitting around a conference room and hearing ideas about what we want to improve, we need a method that doesn’t guess where to apply our improvement methods, but rather we need a method that will provide a laser-like focus on what processes or systems we need to improve.

For those of you who follow my blog on a regular basis, you know I’m a huge fan of the Theory of Constraints (TOC), but not at the expense of Lean or Six Sigma….not at all.  TOC by itself is not the answer, but for me it is the starting point for successful improvement initiatives.  TOC can and will provide the needed focus that is missing in most improvement efforts.  So how does TOC do this?

When Dr. Goldratt first introduced the world to TOC through his classic best seller, The Goal, he argued quite successfully in my opinion, that the key to profitability was not through efforts to save money through cost reductions.  Instead he proposed that the key to profitability was through making money.  These two approaches are drastically different….in fact they are totally divergent.  Goldratt used his now famous chain analogy to demonstrate the concept of the weakest link dictating the overall strength of the chain.  Any attempt to strengthen a link in the chain other than the weakest link was basically wasted effort because the weakest link controls the strength of the total chain.  So too is the case with our processes and systems because each has a weakest link waiting to be identified and exploited.  When this happens, throughput increases and increased throughput is what makes companies money.

Goldratt defined a system constraint as anything that limits a system from achieving higher performance relative to its goal.  And if the goal of an organization is to make more money, then the first step has to be to identify or locate the system constraint.
Another thing Goldratt gave the world was a different way of looking at accounting which he called Throughput Accounting (TA).  His definition of throughput was totally different than the traditional definition in that he explained it as the rate an organization generates new money primarily through sales.  He explained that throughput was actually the money received through the sale of a single unit of product minus totally variable costs (TVC).  TVC included things like the cost of raw materials and sales commissions and anything else that varies with the sale of products.  Goldratt also defined Operating Expense (OE) differently than the traditional definition.  OE, to Goldratt, was all of the money the organization spends to operate the business and it included labor costs.  He also defined Investment or Inventory (I) as the money a company invests in things it intends to sell.  The key point here with TA is that simply producing product does not create value until it’s sold and new money enters the company.

So let’s see how these two concepts, the existence of a system constraint and the definition of throughput, play into successful improvement initiatives for companies.  If we were to successfully identify the system constraint and we accept the idea that the key to increasing throughput is by reducing the negative impact of the constraint, then doesn’t it make sense that we should work toward improving the constraint first before we do anything in non-constraints?  And how do you improve the system constraint?  By focusing you improvement efforts on the constraint using the tools of Lean and Six Sigma.  By doing so, imagine throughput increasing while operating expenses are either remaining the same or decreasing and inventory shrinking.

The TA formula for throughput is T = Revenue – TVC and the formula for net profit (NP) and return on investment (ROI) are T – OE and (T – OE)/I respectively.  So by focusing on the system constraint your revenue increases which increases you NP and ROI assuming you did not add any additional OE.  Think about it, if you increase the output of your constraint with the same labor costs, what happens to your net profit and return on investment?  Do you think that your CEO would be happy to see such a thing?

Before I finish this posting, let’s once more see Goldratt’s five focusing steps.

1.    Identify the system constraint. The constraint is defined as anything that limits the system from achieving higher performance relative to its goal.
2.    Decide how to exploit the System Constraint.  All this means is that once you’ve identified the system constraint, how do you get more from it?  In my world, I use the tools and methods of Lean and Six Sigma.
3.     Subordinate everything else to the System Constraint.  Subordination simply means that all of the non-constraint processes run at the same speed as the constraint and that nothing new enters the system until something exits the constraint.
4.    If necessary, elevate the system constraint.  To elevate the constraint implies that you need more constraint capacity to reach your market demand and it might mean spending some money.
5.    If in the previous steps the constraint has been broken, go back to Step 1, but don’t let inertia create a new constraint.  Breaking a constraint means that the current constraint no longer prevents you from achieving market demand, but when this happens, a new constraint will appear immediately.  If this is the case, follow the path just laid out.  The idea of inertia causing a problem simply means that in the process of improving the constraint you may have added new policies and procedures that no longer apply, so get rid of them.

If you are someone who’s been using Lean, Six Sigma or Lean-Sigma, I hope you can see why Goldratt’s five focusing steps are important to you?  The fact is that without a good understanding of system focus that TOC delivers, your improvement initiative can or will fail to deliver significant bottom line improvement.  Bottom line improvement is what we all want and the key to this is directly proportional to how well we drive throughput to higher levels while either maintaining the same OE or reducing it as well as reducing I.  This is truly the difference between trying to save money versus making money.

Bob Sproull

No comments: