Sunday, October 28, 2012

Focus and Leverage Part 155

One of the prevailing messages that Bruce Nelson and I tried to elucidate in Epiphanized is how damaging the effects of cost world thinking can be for companies. In this posting I’m going to focus on one of the most common performance metrics, manpower efficiency and demonstrate why using it can lead your company down the wrong path to profitability.  I hope you will see that monitoring this metric and trying to drive it higher will not only hamper your company’s profits, but it will actually take you in exactly the wrong direction.  Let’s first look at the calculation for manpower efficiency.

Efficiency has been defined as a ratio of an employee's actual time to perform a function compared to some theoretical standard time needed to complete it. For example, suppose an employee actually produces 80 parts in one hour.  Suppose now that the standard for this job is 100 products in an hour (as measured by a time study).  Based upon this employee’s output, this employee is calculated to be 80 percent efficient.   Theoretically this employee has the capacity, if he or she is producing to standard, to produce 20 more parts per hour.

So what would happen if you were trying to achieve maximum operator efficiency within the following simple 4-Step process (Figure 1)?
Figure 1
For each step in this process, the processing times and the corresponding capacities are listed.  So assuming you wanted each step in the process to operate at hypothetically, 100 % efficiency.  What would this process look like after running at full pace for one hour (Figure 2)?


Figure 2
Here is what this process, running at 100% efficiency would look like after running for one hour.  Since Step 1 can produce a part every 5 minutes (i.e. 12 Parts/Hour) while Step 2 can only produce 6 parts per hour, a WIP of 6 parts stacks up in front of Step 2.

Likewise, because Step 2 runs twice as fast as Step 3, 3 units of WIP would be stacked in front of Step 3.  Steps 1, 2 and 3 are running at 100% efficiency, which is what we wanted, but how about Step 4?  Does Step 4 even have an opportunity to run at 100% efficiency?  Step 4 received all three parts from Step 3, processed them in 30 minutes, and then was forced to sit idle because it had no parts to process during that hour.  So Step 4’s efficiency was 50%.  What would happen to this process after 10 hours of operation?


Figure 3

Figure 3 gives us a look at this process if we were attempting to run each step at 100% efficiency for 10 hours.  There would be 60 units of WIP stacked in front of Step 2, 30 units of WIP stacked in front of Step 3 and Step 4 would have finished all 30 units it had to work on to ship to the customer.  The overall efficiency for this process is 87.5%, but think about how much cash this WIP is tying up?  Does it make any sense at all to use manpower efficiency on each individual process step rather just at the system constraint?  In TOC this is known as local optimization.  The key to improving the throughput of this simple process is to focus improvements only on Step 3.  Unless Step 3’s capacity is improved, the capacity of the entire process will remain at 3 Parts/Hour.

At least three negative consequences result from using manpower efficiency in each individual step of this process:

1.    Excessive WIP build-up throughout the process tying up excessive amounts of cash.

2.    Individual cycle times for each individual part becomes extended

3.    On-time delivery deteriorates.

The efficiency model, like the one presented in the above figures, is typically measured and implemented at the wrong system location and usually has distressing effects on companies’ financial results. The end results are typically the opposite of what is ex­pected to happen by companies using this metric.  If companies would measure efficiency only at the constraint and attempt to maximize it there, improved throughput would be the effect.
As I’ve written about before, it’s important to appreciate that the principal focus of Cost Accounting is per part or per unit cost reductions. And because these perceived cost reductions are viewed favora­bly by many companies, it is the reason why there is so much emphasis on operator efficiency? Cost cutting or cost reductions is/are simply not the key to profitability.  There have been many highly efficient companies that have simply gone out of business. Have you ever heard of a com­pany that has saved themselves into wealth and prosperity? Think about it, any perceived savings that the sock maker (Focus and Leverage Part 154) thought he was getting were quickly eroded by buying more raw materials and typing up all of his cash. In fact, it ended up costing the sock maker much more money than he realized and not saving him anything!
Many companies will categorically state that the primary goal of their company is to make money and yet they spend the principal portion of their time trying to come up with ways to save money. The difference between the two approaches is blatant. The tactics you employ to make money are so immensely different than the approach you would use to save money. Quite simply, you make money by increasing throughput!  These two concepts are divergent in their thinking with each taking you in a completely differ­ent course with drastically different outcomes.

In my next posting, we’ll continue to explore some of the problems associated with traditional cost world thinking and discuss ways to overcome them.

Bob Sproull

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