In my last posting I
demonstrated how efficiency could have a negative impact on your operation, but
before moving on to a solution or a replacement for this metric, I want to look
at the negative impact of using efficiency as a metric a bit further. What I demonstrated in my last posting was
what the process would look like after 100 minutes. Let’s look at the impact of running this
process for a full shift and then 3 full shifts. And by the way, for you purists out there,
these examples assume 100% uptime (i.e. no breakdowns, no breaks or lunches).
In the figure below we see
the impact on the process by running at top speed (100 % efficiency) for full 8
hours. Since Step 1 only takes 10
minutes to produce a part, in a full 8 hour shift it produces 48 parts and
passes them on to Step 2. Because Step 2’s
capacity is only one part every 20 minutes, it can only process half of Step 1’s
parts or 24 of them. Steps 3 and 4 have
the capacity to process all 24 of the parts produced by Step 2. So after 1 shift we see that the accumulated
WIP in front of Step 2 is 24 units while the finished goods inventory is also
24.
The efficiencies at both Steps
1 and 2 are 100% and according to cost accounting beliefs, are both doing their
jobs. But because the Operators at Steps
3 and 4 are well below 100% they are not doing their jobs and should probably
be disciplined. So as before, the
overall system efficiency is hovering around 67%. So, based upon what we’ve seen here, does it
make any sense at all to continue running Step 1 at capacity? Need more proof? Let’s look at the results after 3 shifts of
operating this way.
After running this process
for three full shifts (i.e. 1,440 minutes), look what’s happened to the WIP
levels!! Step 1 produced 144 units
during the 3 shifts, but Step 2 could only process half of them (72), so the
WIP has exploded to 72 units. We were
able to ship 72 units, but believe it or not, WIP costs a company cash. So again I ask you….does it make any sense at
all to continue running Step 1 at its full capacity?
OK, so if efficiency isn’t
such a great metric, then how should we appraise how well our overall process
is performing? Let’s review just the
first three of Goldratt’s 5 Focusing Steps and see if we might be able to move
closer to the answer:
1. Identify the system constraint or which step
is limiting achievement of the goal of the process.
2. Decide how to exploit the system constraint
or how do we get more out of our constraint
3. Subordinate everything else to the above decision
or for our 4-step process, don’t outrun the constraint.
Let’s return again to our
simple 4-step process. In our process,
Step 2 has been identified as the system constraint simply because it has the
least amount of capacity to produce units.
If we wanted to improve the output of our process, we must improve the
capacity of Step 2 by reducing its cycle time.
And if we wanted to reduce the overall WIP in our process, then we must
run all four steps at the same rate as the constraint, even though the other
three steps can all produce units at a higher rate. In other words, we must subordinate them to
the constraint.
Efficiency in the cost
accounting world is considered a measure of productivity, so we need an
equivalent measure to use. In my blog,
many times I have discussed the benefits of using Throughput Accounting (TA). The basis for TA comes from three individual
measurements:1. Throughput is defined as the rate at which a company generates money through sales. This doesn’t mean that we produce product to sit in a warehouse, it means for sales.
2. Operating Expenses includes all expenses except totally variable costs, which in most cases are direct material costs. Another way of saying this is all expenses incurred when turning inventory into throughput. This includes all labor costs (i.e. both salaried and hourly labor costs).
3. Inventory includes all purchases that a company makes for things it intends to sell.
The key is that throughput
isn’t considered throughput until money is received from the sale of
products. In looking at it this way, we
are forced to consider the entire system rather than localized parts of the
system. So how do we measure productivity
in the TOC world? The way we do it in
the TOC world is to divide throughput by operating expenses or T/OE. For
example, if each product sold for $100 and our OE was $25, then our
productivity measure would be 4.0. If we
improved our throughput to $200 and our OE remained the same, our new level of
productivity would be 8.0.
The natural managerial tendency for many companies that utilize traditional
Cost Accounting (CA) is that when excess labor capacity is exposed there should
be a labor reduction. So when operators
in non-constraints have no product to work on, like in our example process, in
the CA world this is considered a bad thing and typically lay-offs result. However,
in my way of thinking, if a company is truly interested in moving forward into
a world-class competitive arena, lay-offs should be avoided at all costs. I do realize that sometimes due to economic
conditions that a company can’t avoid layoffs, but these times must not happen
as a routine way of doing business.
Layoffs can clearly send the wrong message to the remaining employees
about the effects of improvement programs and the improvement effort will come
to a virtual standstill.
So what happens in companies that embrace TOC? What happens when excess capacity is
realized? These companies do one of two
things. One thing they do is focus on developing
new products and entering into new markets.
The problem with traditional cost accounting is that companies that make
decisions based on cost accounting metrics view labor as a variable cost rather
than a fixed cost. If, for example, you
keep the same labor in place, but you create new markets, the new revenue,
minus totally variable costs (e.g. raw material costs, sales commissions,
shipping costs), all flows directly to the bottom line! Wouldn’t this be better than laying people
off? To me it clearly is!!
The other possibility is to increase market share of existing products by
differentiating your company through things like superior on-time delivery, superior
quality, and sometimes even price breaks into other market segments as long as
these reductions don’t create a price war.
So how would you be able to increase your capacity to support additional
shipments? By focusing your improvement
efforts on the constraint to drive throughput levels higher.
In my next posting, we’ll take a look at some other performance metrics and
see how they impact our improvement efforts.
Bob Sproull
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