Focus and Leverage Part 138

Several weeks ago I sent copy of Bruce Nelson and my book, Epiphanized: Integrating Theory of Constraints, Lean and Six Sigma.  to a member of the US Marines, Michael Teegardin.  Michael is an Aircraft Maintenance Chief at Camp Pendleton, California.  Michael read the book and then sent me the most wonderful review that I wanted to share with you.  I am humbled by members of our armed services for the service they provide to all of use.  Here is Michael's email:

 

Sir,

I apologize in advance because my words cannot truly convey the level of enlightenment that your book has provided.  It is an amazing read...the flow is finely tuned and the appendices provide clarity and purpose.

 

I am now going through to transcribe my notes, ear tabs and highlighted text.  My immediate interest was caught when the text mentioned "leadership not understanding capacity" and the "shot-gun" mentality used to improve a system.  Additionally, the value of describing each step and introducing new material is powerful.  I, with your permission, would like to pursue in having this text added to the required reading list as Marines/Sailors progress with CPI training.

 

The imparted knowledge has spiked my interest in the manner material is delivered to the intermediate and organizational levels.  The cultures between the two are vastly different; however, the training material is the same.  Often times, I am approached and asked how to apply the methodologies of TOC, LEAN, and SIX SIGMA after students have completed the course.  One recommendation, similar to the LSS Black Belt training I received, is to introduce the class to a project(s) that will be complete after the training.  This will provide 'real time' projects/events concurrent with the training.  Additionally, I am in the process of compiling a document, book format, capturing the successes that intermediate and organizational activities have gained through CPI within rotary and fixed wing units encompassing the DON.  My intent is to provide application of learned methodologies in relation to repair, remove/replace, table of organization (T/O), aircraft utilization, phase maintenance, standardized/improved maintenance manuals, MOS training, Qualifications/Certifications/Licenses, Green side training, flight hour goals, and unscheduled maintenance.

Thank you,

Best Regards,

MGySgt M. R. Teegardin

Aircraft Maintenance Chief

HMLA-267? "Stingers"

 

Thank you Michael,

 

Bob Sproull

Focus and Leverage Part 137

As a continuation of my series on Throughput Accounting, I’ve asked Bruce Nelson, my co-author for Epiphanized – Integrating Theory of Constraints, Lean and Six Sigma, to write a posting on a subject he covered briefly in our book's Appendix 8, On-the-Line (OTL) Charting.  This is a very helpful tool to track the state of the business on a daily basis rather than waiting until the end of the month (or quarter) to find out.  I want to thank Bruce for writing this blog for me, especially when I only asked him to this morning.

Recently in his blog Bob Sproull has been writing several pieces about Throughput Accounting (TA).  As a supplement to those writings Bob has asked me to contribute a write-up about On-the-Line charting and how it applies to TA.

Most companies who use financial metrics live and die by the quarterly report.  Some companies are more inclined to look at it monthly as a decision tool and to get a “feel” for the financial numbers to date.  But, even when you track and monitor the financial numbers on a quarterly or monthly basis there are times when the interval of time seems inadequate.  It’s disheartening to review a quarterly report and realize you have been losing ground for the last two months and didn’t know.  Even the monthly interval can be too short to give the necessary “heads up” that a potential problem currently exists.  It is much more preferable to have reliable information available on a much shorter time interval.  However, compiling and presenting a useable profit and loss statement on a daily basis seems unrealistic.  But, what if there were a way to compile and analyze financial numbers on a daily basis to help with the decision making – would you be interested?  Without a doubt, I’m sure the answer is “YES!”  If you had information available that could tell you where you are TODAY based on business activities as of YESTERDAY then, that would be a valuable tool.  With this kind of information you could make the necessary and accurate daily decisions about where you are and where you need to be.  It’s always much nicer to know this information as quickly as you can, versus waiting until the end of the month, or worse the end of the quarter, before realizing a problem is present.

In order to view this information on a daily, enter the on-the-line chart (OTL).  The OTL is a simple concept that is based on the rules of TA to allow the user access to the lasted information available.  Setting up an OTL is very easy.  First, you need to have an estimate for the Operating Expense (OE) on a monthly basis.  In other words, how much does it cost you to keep your business running every month?  The beauty of the OTL is that it does not need to be accurate down to the dollar or the penny.  It is understood that there can be fluctuation in the monthly dollar amounts.  The OTL is strictly a compass to keep you heading in the right direction and notify you of potential issues when they happen.

There are a couple of ways to get these numbers.  You could take yearly expenses and divide by 12 to get an estimate of monthly cost, or you could take monthly OE and divide by the number of days in the month to get a daily cost.  What we want to end up with is an estimate for the daily OE being accumulated.  Once you have that number we can plot it on a graph using Excel.  Suppose, for an example we had a business that had a monthly OE of $30,000, and we want to plot this number for the month of June.  If we take the $30,000 and divided by 30 days then, the estimate is about $1,000 per day of OE.  We would plot this in Excel as a cumulative number, i.e., Day 1 equals $1,000.  Day 2 equals $2,000. Day 3 equals $3,000, and so on.  Figure 1 gives an example of what this chart might look like.

Figure 1 – The daily plot of Operating Expense for one month.

With the information plot this graph shows the daily cumulative totals for the entire month.  It is possible that the OE numbers could change in any month.  Some employees quit, and new employees are added.  If the variance is high then, adjust the numbers accordingly.  However, what we are really trying to establish here is the view of the OE from the ten-thousand foot level and not necessarily the day-to-day changes.  Think BIG picture and not finite detail.

With the OE line established, we now want to the collect the throughput data.  REMEMBER:  this only works if we are collecting and reporting throughput in accordance with TA rules.  As such throughput is calculated as product selling price – total variable costs (T=SP – TVC) while Net Profit equals Throughput minus Operating Expense (NP = T – OE).  As you probably already know but, let’s refresh anyway, TVC is any cost associated with the product.  This will include raw material, sales commission and shipping charges.  Remember labor charges ARE NOT added into this number.  Labor costs are part of the operating expense.  Suppose for our example the product we make has a selling price of $90.00 and a TVC of $25.00.  That means for each product sold we have a throughput value of $65.00 ($90.00 (SP) – $25.00 (TVC) = $65.00 (T)). With this information we now know that in order to break even on the OE we must make 15 or more product per day.  With 16, or more, product per day we start to make a profit.  It is interesting to note that the CA rules will tell you that you are making a profit with each product sold.  TA counters with the realization that profit does not and cannot begin until the 16th product is made.  It is a vastly different financial concept to think of products, product pricing and product margins using TA.

If you track the daily throughput from the system and, calculate throughput correctly, you should have a pretty good idea where your company stands right now.  Figure 2 shows the impact of throughput to OE after 17 days of tracking.

Figure 2 – This figure shows Throughput track to the OE line.

Using throughput accounting and looking at this chart on a daily basis can give a General Manager or department manager accurate and useful information.  The analysis is simple.  If throughput is tracking below the OE line then, you aren’t making enough money to cover the OE expense.  The management team can determine the issues causing the lower than necessary throughput and initiate corrective actions to bring the throughput line up.  If the throughput line is tracking above the OE line then you are making a profit and possibly no actions are required.

The OTL is a great tool to track and monitor the OE and T on a daily basis.  It gives you a good “Kentucky wind age” analysis to determine where you company is today – right now.  No need to wait for the month end, or quarterly reports to figure out what happened – good or bad.  Using the OTL you can have a pretty good estimate of how the company is doing, and make corrections, as necessary, to get back on track for revenue and on-time-delivery.

I hope this has been a helpful explanation of the On-the-Line chart and how it can be used for a daily assessment of where your company is.

Bruce H. Nelson

Thanks again Bruce for your excellent posting.

Bob Sproull

Focus and Leverage Part 136

Although I’ve written about performance metrics in past postings, I want to expand upon what I’ve previously written.  Selection of the right performance metrics is critical to the success of any organization, no matter whether they produce products or deliver a service.  There are three key objectives of performance metrics as follows:

1.    First and foremost, performance metrics should stimulate the right behaviors.  Sounds simple enough, but unless the desired behaviors are well thought out, it is very easy to go astray.  For example, if your organization produces products and uses the performance metric operator efficiency, ask yourself what behaviors should you expect to see?  Translated, efficiency deals with minimizing waste and maximizing the capabilities of your human resources.  From a Cost Accounting perspective, it is believed that improving operator efficiency has a direct impact on the profit of a company.  So, if we increase operator efficiency, then we should see a corresponding increase in profits……right?

 

The problem with operator efficiency as a performance metric is that it doesn’t consider the impact on the total system.  The behavior we typically see when using efficiency as a metric is this. Because all of the process steps are encouraged to “run to their maximum capacity” the total system is flooded with excess work-in-process inventory which extends cycle times which negatively impacts on-time delivery.  So do you think efficiency stimulates the right behavior?  The answer is, no it doesn’t.  But having said that, what if we only measured the efficiency of the system constraint?  What would happen then?  We would indeed maximize the throughput of the process because throughput is controlled by the system constraint.  What about the non-constraint process steps?  Because we don’t want them to outpace the constraint, they must effectively “slow-down” so as not to fill the system with excess WIP.  Their efficiencies would deteriorate, but the profit of the overall system would improve dramatically.  This is directly in contrast to what traditional cost accounting teaches.  That is, as operator efficiency increases, profits rise accordingly.

 

2.    Performance metrics should reinforce and support the overall goals and objectives of the company.  If the goal of any for profit company is to make money now and in the future, then the selection of performance metrics must directly support and enhance this goal.

 

3.    The measures should be able to asses, evaluate and provide feedback as to the status of people departments, products, and the total company. The right behaviors of people and departments are critical to the achievement of the overall goal of the company, but many times the metrics chosen encourage and stimulate the opposite behaviors……just as I demonstrated with operator efficiency above.  The fact is efficiency drives local optimization rather than optimization of the total system.

 

When selecting performance metrics, there must be criteria for selection of the correct ones…..right?  Well, in fact, there are at least six key criteria to consider when selecting effective performance metrics.  Let’s look at these criteria and relate each one to operator efficiency.

1.    The metric must be objective, precisely defined, measurable and quantifiable.  There can be no ambiguity at all with the people or departments being measured.  For example, operator efficiency is objective, well defined, measurable and quantifiable, so it would seem to satisfy this first criteria…..right?

 

2.    The metric must be well within the control of the people or departments being measured.   For example, when considering the metric operator efficiency, it clearly is within the control of the people or department being measured, so it would seem that it does satisfy this criteria…..right?

 

3.    The metric must be translatable to everyone within the organization. That is, each operator, supervisor, manager and engineer must understand how his or her actions impact the metric.  For example, efficiency is definitely translatable to everyone, so again, efficiency passes this litmus test….right?

 

4.    The metric must exist as a hierarchy so that every level of the organization knows precisely how their work is tied to and supports the goal and critical success factors of the company. For example, if one of the critical success factors was “maximum throughput” and efficiency was selected as one of the lower level metrics, what would happen?  That is, if it takes 5 minutes to process a part in an individual work station, then the maximum amount of time for the part to be finished should be no longer than 5 minutes.   And if you could somehow produce a part in 4 minutes, the efficiency of that work station could be above 100%.  That would be great….right?  But if the higher level metric was maximum system throughput, would running each individual work station maximize system throughput or would it “clog” the system with excess WIP and cause less than optimum throughput?  For this reason, efficiency is not a good metric because it doesn’t have a positive effect on the system.

 

5.    The metric should be challenging, yet attainable.  Suppose efficiency was selected as a metric.  Is maximum efficiency challenging and attainable?  The answer is no, if you want to optimize system throughput.  Because of step 3 in Goldratt’s 5 focusing steps (i.e. subordinate everything to the system constraint), non-constraints can never be permitted to run as fast as they can or they will choke the system with excessive WIP.  The excessive WIP extends cycle times, ties up cash unnecessarily, and all of the other reasons already mentioned.

6.    The metric should lend themselves to trend and statistical analysis and, as such, should not be “yes or no” in terms of compliance.  We could definitely trend and perform statistical analyses on efficiency.

The point of this posting is to demonstrate why it is so important to select the “right” performance metrics.  The success of organizations is tied directly to the selection of metrics that drive optimal behaviors.  As Goldratt himself said, “Show me how you measure me and I’ll show you how I’ll behave.”  Take a look at the metrics your company is using and see if they pass the metrics litmus test.  If they don’t, then you have a problem.

Bob Sproull

Focus and Leverage Part 135

I had an interesting conversation the other day with one of my clients about traditional Cost Accounting (CA) and the TOC based Throughput Accounting (TA) that might be interesting for everyone.  It seems that one of my client’s bosses at the company’s corporate office asked what they were going to do about reducing their overtime.  Seems like a reasonable request if the overtime is too high…right?  And if you look strictly at the numbers (i.e. $’s spent on OT), and if you’re deeply imbedded in traditional CA, you just might come up with the wrong question.  Now what do I mean by that?

At the direction of their corporate “brothers” and as part of the contract, this particular client had “staffed up” to what they consider “normal” workloads and as long as the workload remains within what they considered to be normal range of workload, then very little overtime was required.  But when the work load increased significantly, they used overtime so that they could meet the new demand?  Isn’t that when overtime is justified and should be used?  I mean it would make very little sense and would probably not be possible to rush off and hire additional workers to cover a sudden increase in workload.  Now, if there was a clear shift upward in workload that sustained itself for a definite period of time, then they might hire more people.  So knowing that the plan was to use overtime to cover sudden increases, why would the corporate experts ask them what they were doing about their increase in overtime?  The answer to this question and other ridiculous one lies in traditional CA’s belief that favors cost reduction above everything else.  Let’s explore some of the differences (maybe conflicts is a better word) that exist between traditional Cost Accounting and TOC based Throughput Accounting.

Throughput Accounting (TA) is really defined by a few simple definitions as follows:

·         Throughput (T): T = The rate of cash generation through sales or Sales Revenue – Totally Variable Costs  or T = SR - TVC

·         Inventory or Investment ( I ): I = All the money invested in things companies purchase that they intend  to sell.

·         Operating Expense (OE): OE = All the money a company spends to turn inventory into throughput

·         Net Profit (NP): NP = Throughput – Operating Expense or NP = T - OE

·         Return on Investment (ROI): ROI = Net Profit ÷ Investment or ROI = NP/I

So with these five simple formulas we can answer, in advance, the impact of the decision we are about to make.  Will the decision:

1.    Increase Throughput?

2.    Reduce Operating Expenses?

3.    Increase our Return on Investment?

It really is this simple.  With Throughput Accounting, good sound business decisions can be made if the actions we are considering increases throughput, decreases operating expenses or increases ROI.  But if you’re making decisions using Cost Accounting rules, your decisions will be much, much different.  Remember, above everything else, cost accounting looks first at cost reduction or "How do we save money?"  So is it any wonder that this guy’s corporate boss was asking him about overtime reduction?  Never mind that the overtime generated significantly more throughput because he’s only looking at how much money he could save by reducing overtime.

And so it goes, cost accounting stimulates the wrong behaviors in other ways.  Consider the belief by CA that embraces efficiencies as a performance metric.  What type of behavior results by using this metric?  If I am being measured by how high I can make my efficiencies, then one of the focal points would be to run my part of the process to the max.  But what happens when I do this?  If my part of the process has the shortest processing time, then the next process step will have a mountain of work in process (WIP) inventory sitting directly in front of it.  My people will appear busy for sure, but have they contributed to improved profitability?  If you ask a die-hard cost accountant, they’ll probably give you a thumbs up because they view inventory as an asset and because higher efficiencies are a good thing.  The fact is excess inventory ties up cash, increases operating expenses, impedes throughput, extends cycle times, hides quality problems and causes on time delivery metrics to deteriorate. The only place efficiency makes any sense at all is in the constraint!

Here’s my bottom line.  Using cost accounting to make daily management decisions is a serious mistake because this is not the intended purpose of cost accounting.  Cost accounting has only one purpose….to satisfy outside reporting requirements (i.e. GAAP).  Traditional cost accounting provides false incentives to build inventories because it views inventory as a positive asset.  Throughput Accounting views inventory as a negative liability because it is indicative of system-wide flow problems.

So back to the original discussion I had with a client the other day.  If the corporate office truly believed in or at least understood even the basics of TOC and TA, the correct question should have been, “What are your plans to increase throughput?”

Bob Sproull

An announcement from Focus and Leverage

For the past couple of months, I've been reading some really good material on TOC and other subject.  The author of this material is Jim Covington and he has graciously given me permission to share his material through a link to his site.  I hope you all enjoy this as much as I have.

www.jpcovington.com

Bob Sproull