Focus and Leverage Part 234

Recently I had the opportunity to meet with an executive of a very large and diversified company.  The meeting was a follow-up to a meeting I had several months ago with the same executive.  This particular company has been very successful and profitable in the past, but their most recent financials indicated that their profitability was moving downward.  Since for-profit companies are in business to make money, the Board of Directors was not very happy with the company’s current direction and wanted something done to stop the bleeding.  This company had been working on a plan to improve profitability, but it wasn’t working as well as they had hoped it would.

I asked this executive to share the essence of their profit improvement plan with me.  He explained that they were cutting all unnecessary overhead and scrutinizing all purchases wherever they could.  In addition, they were looking at possibly unloading parts of the company that were driving profitability lower.  For me, it wasn’t much of a plan or should I say an effective plan.  When I asked him how this plan was working for them, he just smiled and said, “Well Bob, if it was working well, do you think we would be having this meeting?”  I smiled back and said, “I guess not.”  He told me that he wanted my thoughts on what they should do.

I explained to him that there are two distinctly different approaches to achieving profitability.  On one hand, many companies like his company, believe that the path to profitability is through saving money.  He immediately responded by saying, “What’s wrong with that approach?”  “Isn’t that what most companies do?”  I shook my head affirmatively and agreed that this was the most common approach, but it simply doesn’t work in the long run.  I further explained that I have seen many companies using this approach that have failed to improve their bottom line.  He replied, “You mentioned that there were two distinctly different approaches…..so what’s the other one?”  I explained that the other approach focuses on “making money” rather than saving money.  He asked me what the difference was because in his mind, by saving money, you automatically make money.  The following is how I explained the difference between the two approaches.

I first asked this executive if the goal of his company was to make money now and in the future and he confirmed that it was.  I then said, since the goal of his company was to make money, doesn’t it make sense that the primary measurements of how well the company is doing should be expressed in some form of money unit?  He agreed that the measurements should be reflected by money in some form.  I then explained that with traditional cost accounting the focus is on measurement like Net Profit, ROI and Cash Flow.  And while these metrics are good for financial reporting, they don’t answer questions in real time because they are based on what happened yesterday and not today.  Typical financial reports being used today tell us what happened last month, but what we need is some way of being able to judge the impact of decisions now and in the future.

Throughput Accounting (TA) is that way.   TA uses three easily understood measurements of Throughput (T), Investment/Inventory ( I ), and Operating Expense (OE) which are defined as follows:

-  Throughput (T):  The rate at which the system generates money through sales.  The key word in this definition is sales because product produced, but not purchased by the consumer is simply inventory.  Money must be received before actual throughput is calculated.  The formula for Throughput is:

Revenue (R) – Totally Variable Costs (TVC) or

T = R – TVC

-  Inventory/Investment ( I ):  All of the money tied up in the system in things the organization intends to sell.  Part of this measure is inventory (i.e. raw materials, WIP and Finished Goods) and part of it includes those things owned by the company which is intended to generate Throughput (e.g. buildings, equipment, etc.).

-  Operating Expense (OE):  All of the money spent by the organization in the conversion of investments and inventory into Throughput.  Unlike traditional Cost Accounting (CA), OE includes labor expenses of all kinds.  It also includes things like supplies or any cost needed to create Throughput for the company

The executive pushed back immediately by telling me that his company doesn’t build consumer products, so these measures don’t apply to them.  I chuckled to myself and then told him that all three measures actually did apply to his company.  His company is primarily a construction company, so I explained that Throughput for him was completed projects and that if they could reduce the cycle times on his projects, his profits would skyrocket.  He then asked, “How does Throughput Accounting calculate Net Profit and ROI?

I explained to him that the three basic TA measures, T, I and OE are combined in different ways to provide the fundamental performance measures.  For example, Net Profit is simply Throughput minus Operating Expense or NP = T – OE.  Return on Sales (ROS) is TA’s measure of the effectiveness of the bottom line to the top line performance measures of the company.  ROS is simply the ratio of net profit and sales or ROS = NP ÷ Sales Revenue.  At this point the executive was becoming more and more interested in what I was saying and said, “Bob, these formulas are so much easier than typical Cost Accounting formulas.”  I then told him to understand that TA is not a replacement for CA because you still have to use Generally Accepted Accounting Principles (GAAP) when you report to the government.  But what TA does do is to provide an easy and effective way for your management team to make financial decisions in real time.  He liked the explanation.

Our meeting time ended with a promise from me to visit again so I could explain more about the Theory of Constraints.  I am in the process of writing a brief white paper for him to that end.  It will include how his team can use TOC’s Thinking Processes (TP) to identify their one or two core problems that were causing the negative symptoms he was seeing.  I’ll also explain how he can use the Goal Tree to develop a strategic improvement plan to turn his company in the right direction.  It should be a fun next meeting…..at least for me.

Bob Sproull

 

 

Focus and Leverage Part 233

This is the final video in this series by Dr. Goldratt and answers the question, How to cause the change to happen?  Answering these three simple questions, What to Change?  What to Change To? and How to Cause the Change to Happen? changed my approach to continuous improvement forever.  I hope you have enjoyed this series.

http://www.youtube.com/watch?v=nifWBhDGeCg

Bob Sproull

Focus and Leverage Part 232

This is the second of three videos from Dr. Goldratt and answers the question, What to change to?

http://www.youtube.com/watch?v=Od8BaeFzIFc

Bob Sproull

Focus and Leverage Part 231

The secret to effectively using the Theory of Constraints is to answer three fundamental questions:

1.  What to Change?

2.  To what to change to?

3.  How to cause the change?

In the next three postings, I want to share videos from Dr. Goldratt where he answers each of these questions.

http://www.youtube.com/watch?v=prrA-onO0Nc

Bob Sproull

Focus and Leverage Part 230

The reaction to the 3 bottleneck video that I posted last time was simply overwhelming in terms of the number of people watching it.  With that in mind I am posting another video that I have used in my training to help explain TOC and Throughput Accounting.  I hope you enjoy it.

http://www.youtube.com/watch?v=F-06WFXJARo

Bob Sproull

Focus and Leverage Part 229

I want to share a short YouTube video that demonstrates quite nicely how to improve flow through a bottleneck using TOC concepts.  I have watched it several times and I recommend that everyone should use it as part of your TOC training.  I know I plan to.

As you watch it, think about Goldratt's 5 Focusing Steps.....especially Step 2, deciding how to exploit the constraint and then watch the video.  You will see three different methods to empty a bottle of water along with cycle times for each method which get faster and faster.

http://www.youtube.com/watch?v=mWh0cSsNmGY&feature=youtu.be&t=13s

Bob Sproull

Focus and Leverage Last of 2013

As 2013 draws rapidly to a close, I thought the best thing I could post would be the most popular one of all.  The most popular post of all since I began writing this blog is Focus and Leverage Part 227.  This posting is how I present the Theory of Constraints to people not familiar with it.  And since # 228 is the second part of how I do this, I thought I'd finish out the year by posting these two postings.  I want to thank everyone for a very remarkable year for my blog.  Back in 2010 when I first started posting here, I averaged roughly 1000 page views per month.  This month I fully expect the monthly total to be approaching 19,000!!  So here are postings 227 and 228 and thank you to everyone.  Happy New Year!!!!!

 

The best way I have found to help people understand just what a constraint is and how it impacts the flow or throughput through a process is by using a simple piping system diagram with each pipe having a different diameter.

In this first slide I simply explain that this is a drawing of a cross section of pipes used to transport water through each section of pipe and into a collection receptacle at the bottom. I then tell them that we need more water flowing and that they have been chosen to fix this system.   I emphasize that this system is fed via gravity, so they can’t simply increase the water pressure.

 

In my next slide, I pose the question that if enough water isn’t flowing through this system, what must they do to make more water flow?  Someone in the group will automatically state that in order to have more water flowing through the system, we have to increase the diameter of Section E.

 

I ask everyone if they understand why they must increase Section E’s diameter and most will answer that they do.  For anyone who doesn’t, I simply explain that because of the constricted nature of Section E, water flow is limited at this point. Since they all now have an understanding of this basic concept, I then move to the next slide.

This slide reinforces what I just explained, but then I ask another important question about how large the new diameter should be.  In other words, what would this depend upon?  What this is supposed to demonstrate is that demand requirements play a role in determining the level of improvement needed to satisfy demand requirements.

 

In the next slide, I demonstrate the new diameter of Section E and how water is now flowing at a much faster rate than before the diameter change.  The important point I emphasize is that the system constraint controls the throughput of water through every section of pipe and if we don't subordinate the rest of the system to the same throughput rate as the constraint, we will automatically have a WIP build-up in front of the constraint.

 

I then ask the class to identify other physical changes to this system have occurred as a result of our exploitation of the constraint (i.e. increasing the diameter of Section E).

I give them time to answer this question, and most of the time the group will answer correctly.  I then post the next slide to reinforce that changes to the system.

I point out that, first and foremost, the system constraint has moved from Section E to Section B. I next explain that the new throughput of water is now governed by the rate that Section B will permit.   And finally, I point to the queue of water stacked-up in front of Section B.  I now make the point that if the amount of water is still not enough, then we must decide how to exploit the new system constraint and that the process of on-going improvement is continuous.

In my next slide I ask the question, “Would increasing the diameter of any or all other sections have resulted in any more throughput of water through this system?”  This question is intended to demonstrate that since the system constraint controls the throughput of a system, focusing improvement anywhere else in the system is usually wasted effort.  What I finish with is a before and after slide just to reinforce how things have changed by focusing on the constraint.

Focus and Leverage Part 228

This posting is the second and final piece on how I present the concept of the system constraint in my training material.  You will recall in my last posting, we discussed a simple piping diagram with different diameter pipes and that the smallest diameter controlled the throughput of water through the system.  In this posting we will expand that thinking to a simple 4-Step process used to make some kind of product.  But for anyone new to this blog or the Theory of Constraints, here are Goldratt's 5 Focusing Steps:

 

1.  Identify the system constraint

2.  Decide how to exploit the system constraint

3.  Subordinate everything else to the system constraint

4.  If necessary, elevate the system constraint

5.  Return to Step 1, but don't let inertia create a new system constraint

 

Because I want the class to get the connection from the piping system to the real world, my next slide is the aforementioned simple 4-step process with cycle times for each step listed.  I ask the audience to tell me which step is constraining Throughput.  It's been my experience that only about 40 % of the class makes the connection between the flow of water through the pipes and the flow of product through this process.  What I have found to be very effective is to select someone who does understand the connection explain his or her reasoning.  It's important that we don't move on until everyone understands this connection..



I use my next slide to reinforce what their fellow classmates or team members have just explained.  I also relate Step 3 of this process to Section E of the piping diagram.

 

In my next slide, I have the class become consultants who are told that the company who owns this process needs more Throughput.  I ask them what would they do and ask them to explain their answers.  I usually break the class up into teams and let them discuss this question and that seems to work well.

 

After the team(s) have explained their plan to improve throughput, I then show them this next slide to reinforce each team's answer on what they would do to increase Throughput. 

 



Because I want the class to understand the negative implications of running each step of this process at maximum capacity, I then ask the class what would happen to the WIP levels if they did.

 

In the next slide, I demonstrate the impact of trying to maximize the performance metric, efficiency, in each step in the process.  The key point here is that the only place where maximizing efficiency makes sense, is in the system constraint.  The excessive WIP build-up encumbers the process and extends the cycle time of the process.

 

 



I then ask the class, "How fast should each step in this process be running to prevent this excessive build-up of WIP?"  This is intended to demonstrate Goldratt's 3rd step, subordination.  That is, why it's so important to subordinate every other part of the process to the constraint.  This next slide explains, in more detail, the concept of subordination.  Steps 1 and 2 must be forced to not outpace the constraint, but must also assure that the constraint is never starved.  This slide usually creates an epiphany of sorts for the team or class.

 

 



My final slide is one that lists Goldratt's 5 Focusing steps.  We talk through each step and relate both the piping diagram and the 4-step process to each of Goldratt's 5 steps.

 

I have been using this simple method of teaching the concept of the constraint for quite a few years now and it has worked quite well for me.  I strongly suggest that you try it yourself.

Bob Sproull

Focus and Leverage Part 227

This past week I was asked a question about how I present the basics of the Theory of Constraints to people not familiar with its teachings.  Or more specifically, how do I teach my students or improvement teams about how to understand the basic concept of constraints.  So in the next two postings I’m going to share with you a series of slides on how I present this basic concept.

 

The best way I have found to help people understand just what a constraint is and how it impacts the flow or throughput through a process is by using a simple piping system diagram with each pipe having a different diameter.

In this first slide I simply explain that this is a drawing of a cross section of pipes used to transport water through each section of pipe and into a collection receptacle at the bottom. I then tell them that we need more water flowing and that they have been chosen to fix this system.   I emphasize that this system is fed via gravity, so they can’t simply increase the water pressure.

 

In my next slide, I pose the question that if enough water isn’t flowing through this system, what must they do to make more water flow?  Someone in the group will automatically state that in order to have more water flowing through the system, we have to increase the diameter of Section E.

 

I ask everyone if they understand why they must increase Section E’s diameter and most will answer that they do.  For anyone who doesn’t, I simply explain that because of the constricted nature of Section E, water flow is limited at this point. Since they all now have an understanding of this basic concept, I then move to the next slide.

This slide reinforces what I just explained, but then I ask another important question about how large the new diameter should be.  In other words, what would this depend upon?  What this is supposed to demonstrate is that demand requirements play a role in determining the level of improvement needed to satisfy demand requirements.

 

In the next slide, I demonstrate the new diameter of Section E and how water is now flowing at a much faster rate than before the diameter change.  The important point I emphasize is that the system constraint controls the throughput of water through every section of pipe and if we don't subordinate the rest of the system to the same throughput rate as the constraint, we will automatically have a WIP build-up in front of the constraint.

 

I then ask the class to identify other physical changes to this system have occurred as a result of our exploitation of the constraint (i.e. increasing the diameter of Section E).

I give them time to answer this question, and most of the time the group will answer correctly.  I then post the next slide to reinforce that changes to the system.

I point out that, first and foremost, the system constraint has moved from Section E to Section B. I next explain that the new throughput of water is now governed by the rate that Section B will permit.   And finally, I point to the queue of water stacked-up in front of Section B.  I now make the point that if the amount of water is still not enough, then we must decide how to exploit the new system constraint and that the process of on-going improvement is continuous.

In my next slide I ask the question, “Would increasing the diameter of any or all other sections have resulted in any more throughput of water through this system?”  This question is intended to demonstrate that since the system constraint controls the throughput of a system, focusing improvement anywhere else in the system is usually wasted effort.  What I finish with is a before and after slide just to reinforce how things have changed by focusing on the constraint.

In my next posting, I'll present the rest of my training package moving from the abstract piping system to the real world.....a process.

Bob Sproull

Focus and Leverage Part 226

This will be the final posting on the Constraints Management series and I hope you have enjoyed it.  In this posting we'll take a look at TOC's most famous scheduling system, Drum Buffer Rope. 

4.  Drum Buffer Rope Scheduling – One of the lessons learned from those who have read The Goal is that TOC’s scheduling system known as Drum Buffer Rope (DBR) is very effective for synchronizing the flow of work.  It got its name from a troop of boy scouts hiking across country, but were continually slowed by an over-weight Boy Scout named Herbie.  DBR was used to describe how a typical system has dependencies and statistical fluctuations that must be accounted for is work is to flow smoothly.  In The Goal, Herbie was the Drum (constraint) because he walked at the slowest pace.  The Buffer and Rope were techniques used to synchronize the Boy Scout’s walking pace as they traversed the path on their hike.  Let’s look at each of these three components in a bit more detail.

-  The Drum – In a manufacturing (or service business) the drum is actually a schedule for the resource with the most limited capacity and is referred to as a Capacity Constrained Resource (CCR).  Because this resource has the least amount of capacity, it determines the maximum output of the entire business.  Doesn’t it make sense that since the drum determines the maximum output of the business, it should be protected against upstream disruptions?  This is where the buffer and the rope come into play.

-  The Buffer – Because starving the CCR would delay the completion of work, a protective buffer is created to protect it from inevitable disruptions and variability from upstream processes feeding the CCR.  The buffer is a period of time (not feeder products) in advance of the time scheduled to begin work on the CCR, to ensure that the non-constraints complete their work in time so that the CCR is never starved for work to do.

-  The Rope - The purpose of the rope is to guard against over-production by the non-constraints.  Over-production on these resources effectively creates pockets of excess WIP which negatively impacts overall cycle times and delays deliveries to customers.  The rope is a signaling process which tells the gating process when to release raw materials to the front end of the process.  It is, in effect, a raw material release schedule that will presnt the early release of materials into the system.

In DBR there are three types of protective buffers to protect various parts of the process.  As we just mentioned, there is a buffer in front of the CCR, but we also have a feeding buffer in front of any assembly process that combines with the CCR's product.  Finally, we insert a shipping buffer to protect customer deliveries.

 

By using the drum, the buffer and the rope effectively it is not uncommon to see on-time deliveries approaching 100% while overall lead times for products being reduced from 50-70%.


At the beginning of this series of posting I said I wanted to present my thoughts on Constraints Management (CM) and what it means to me.  The fact is, Constraints Management is not simply a collection of tools used to solve problems….it’s much more than that.  CM is even more than, as the name Theory of Constraints might suggest, just a theoretical basis for how a business enterprise should be run.  Constraints Management, for me has become a way of life.  It defines how I think and act both as a consultant and as a human being.

As I began looking through the Constraints Management lens years ago, I began to see the world differently than I ever had before.  I realized that I had been looking at improvement in the wrong vein.  By that I mean that I had fallen into the "fix everything" trap rather than focusing on the system's leverage point, the system constraint.  So for me, what Constraints Management is, is the same name as my blog....it's all about focus and leverage.  By being able to identify the leverage point of the system I'm working in, I can focus my improvement work on it to gain maximum effectiveness.
  

As a final thought on this subject, there seems to be a "power struggle" of sorts going on between the "believers" of the individual improvement components, Lean, Six Sigma and the Theory of Constraints.  It's as if they are saying, my way is the best....forget the other two!  My view is very simple and it's why I didn't name my second book TLS or some other title combining the individual components.  I named my second book, The Ultimate Improvement Cycle for a very good reason.  The true ultimate improvement method is a combination of best practices, with each individual component bringing something important to the mix.  From a ten thousand foot view, Constraints Management provides the laser-like focus on what to change and where in the system you should focus your efforts.  Lean provides the tools required to identify and remove or at least reduce existing waste.  Six Sigma's tools help us stabilize our processes and make them much more predictable.  But when you combine all three of these methodologies, you are able to optimize the system in which you are working.  This symbiosis truly is the ultimate improvement cycle.

 

 Bob Sproull

 

 

 

 

Focus and Leverage Part 225

In this posting we'll review an additional TOC methodology used for improving the completion rate of projects.  We'll do this by comparing TOC's version of project management to one of the most commonly used project methods.

 

3.  Critical Chain Project Management (CCPM) – Most companies today are using the more traditional Critical Path Method (CPM) for executing projects.  The problems experienced using this method are typically projects being completed later than the promised due date, and when they do get completed, a high percentage of them are  over budget with the original scope reduced.  CPM uses estimated task durations with well-defined individual task start and completion dates.  Typically progress is measured by a percentage of tasks completed against the projected delivery date.  The problem with tracking a project like this is that not all tasks have the same duration and the tasks resources have a tendency to choose easier tasks to work on so that their tracking metric looks good (i.e. cherry-picking).  Using this metric to track progress, it’s not uncommon to see 90 % of the project completed fairly quickly, only to see the remaining 10 % dragging-on endlessly.

In addition, when the project is being planned, resources responsible for completing tasks add excessive amounts of protective safety to the estimated durations to guard against variation and uncertainty. When this happens, the final delivery date is a reflection of these inflated task durations.

Another problem with CPM is that resource contentions are not considered when calculating the critical path of the project.  The critical path in CPM is defined as the longest path of dependent tasks meaning that a task can’t be started until the previous one has been completed.  As a result, when given multiple projects to work on, the resource is forced to use a behavior known as "bad multi-tasking."  Bad multi-tasking occurs because the resource is forced to split time between the multiple projects that have been assigned in order to show progress on each of the assigned projects.  That is, because the resource wants to demonstrate progress on all of the assigned projects, they will work on one project for a while, then switch to the next assigned project and so on.  Bad multi-tasking leads to significantly longer project cycle times.

One of the principal problems associated with CPM is what happens when a task is completed.  Because estimated task durations, with a well-defined task start and completion dates,  are used to develop the CPM schedule, there is no provision for accommodating tasks that are finished ahead of schedule.  Because of this, a behavioral phenomenon known as Parkinson’s Law rears its ugly head.  Parkinson’s Law states that work expands to fill the available time, so the resource will use all of the time allotted to the task.  They do this because their credibility is on the line, meaning that if they said 5 days and the task was completed in only 3 days, they would be expected to duplicate this on subsequent projects.  So even if a task is completed early, it is not reported as such.

Another behavior that comes into play is what Goldratt dubbed the Student Syndrome.  Because the task estimator knows that he or she has loaded the task duration estimate with a protective safety buffer (as much as 50% of the task duration), there is a tendency to procrastinate the start of the task.  And when Murphy strikes, and we know he will, the task can be delayed which causes delays in the project.  The consequence of these two behaviors is that early finishes are not passed on, but delays are.

Once again, TOC offers a different approach to project management known as Critical Chain Project Management (CCPM) and the differences between CCPM and CPM are enormous.  Like CPM, sequential project tasks are laid out and durations for each are estimated.  However, because we know that these duration estimates are many times in the neighborhood of 50% overstated, CCPM removes the task durations from the plan and then pools a portion of the withdrawn safeties to create a project buffer.  This buffer is calculated based upon a certain percentage of the removed safety time (i.e. approximately half of the task duration time estimates).  This project buffer is similar to how a bank account works with deposits and withdrawals.  By that I mean, if a task takes longer than planned, time can be withdrawn from the project buffer.  Likewise, if the task is completed faster than the planned time, the time saved is added back to the project buffer.  CCPM also includes a feeding buffer which protects the planned completion dates for tasks not  located on the critical chain.

CCPM also has a different way of tracking projects than the way CPM does.  CCPM uses a graphical display called a fever chart to provide an early warning when the project is stalled.  The fever chart is much like a run chart in that along the x-axis we see the percent of the critical chain completed while on the y-axis we use the percent of the project buffer consumed.  The fever chart has three different color zones to indirectly indicate the rate of buffer consumption.  If you divide the percent of critical chain completed into the percent of project buffer consumed you will have an index that indicates how the project is progressing.  If this ratio is less than or equal to 1.0 (green zone), the project will either be completed on time or early.  If the ratio is greater than 1.0 (yellow or red zone depending upon how high the index value is), then a plan must be developed and executed to recoup the lost time or the project will definitely be late.

Another stark difference between CPM and CCPM is how resource contentions are handled.  CCPM considers these contentions when it calculates its own version of the Critical Path called the Critical Chain.  Unlike CPM, CCPM considers both task dependencies and resource contentions when developing the project plan.  This acknowledgement of resource contentions helps negate the multi-tasking problem we see with CPM.

CCPM also addresses the two behavioral phenomena spoken about earlier, Parkinson’s Law and the Student Syndrome.  CCPM uses a relay race mentality whereby as soon as a task is completed on the critical chain, the baton is immediately passed on to the next resource.  Because of this relay race mentality, unlike CPM, early finishes are passed on with the saved time deposited back into the project buffer.  Delays to the project are minimized because of the existence of the project buffer.

So what kind of results should you expect to see with CCPM?  When using CCPM it is not uncommon to observe a 30 to 50% reduction in the time required to complete a project compared to that same project using CPM.  On-time completion rates are typically 90% or greater and projects typically finish on scope and on or below budget.

 

Bob Sproull

Focus and Leverage Part 224

In a continuation of my series on Constraints Management, I want to discuss some of the tools and methods TOC offers.  The Theory of Constraints has several other strategic tools, or maybe a better word is methodologies, aimed at addressing specific problems that I have written about numerous times in this blog.  Learning these methods was an important step forward for me as I learned how to manage organizational constraints.  Let’s take a look at these critical improvement tools and discuss their implications.

 

1.  Throughput Accounting (TA) - TA was introduced by Goldratt as an alternative to traditional Cost Accounting (CA) for making real time financial decisions. He believed (as I do) that with three simple measurements, the financial impact of the decisions we make could be realized much faster than by waiting for last month’s accounting sheet that many managers don’t really understand anyway.  TA is not a replacement for traditional cost accounting simply because GAAP is required by law.  But if the goal of a company is to make money now and in the future, TA is the method of choice for me in making real time financial decisions.  The three measurements are:

 

-  Throughput (T) – the rate at which the system generates money through sales.  The actual calculation for T is sales revenue minus totally variable costs (those things that vary with the sale of products like raw materials, sales commissions, shipping costs, etc.) or

SR – TVC.

 

-  Inventory or Investment ( I ) – all the money the system invests in things it intends to sell.  While we typically think of parts or materials needed to produce our product, investment can also include equipment, the plant itself, etc. basically anything that could eventually be sold.

 

-  Operating Expense (OE) – all the money the system spends to turn inventory or investment into Throughput.  OE includes things like labor costs, equipment rental charges, etc.

Using TA, daily management decisions became very straight-forward for me in that good decisions moved T higher while I and OE move lower or remain the same.  With TA there was no more waiting until the books are balanced to know if a decision I made was a good one or not.

One of the most noteworthy differences between TA and CA is that TA considers labor costs as a fixed operating expense while CA spreads out or allocates the cost of labor across all products, making it variable.  Another difference between TA and CA is how each views inventory.   Cost Accounting views inventory as an asset on the books whereas Throughput Accounting views inventory as a liability.

There are other financial metrics that are derived from T, I and OE that made decisions much easier for me.  Two of the more common ones I use are:

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

-  Return on Investment (ROI) – Throughput minus Operating Expense divided by Inventory or ROI = T – OE/I

 

The significant ramifications of TA, at least for me, is that by driving Throughput higher, Net Profit increases, even if Operating Expense remains constant.  Likewise, if OE is reduced, then NP improves provided that T at least remains constant.  Finally, if I is reduced, then ROI increases, even if T and OE remain constant.  Let's now look at another one of TOC's methods.

2.  Dynamic Replenishment – The problem with many part’s distribution models is directly related to the inaccuracy of forecasting models.  For example, many companies use a part’s replenishment model referred to as the Minimum-Maximum System of replenishment.  This type of system establishes both a minimum and maximum level of parts to hold in place with the minimum representing a re-order point.  That is, when the stock of a part (or material) reaches this minimum level, an order is placed to replenish the stock level back up to the maximum level.  Because this type of system is based upon a forecast, it is not uncommon for companies to experience a stock-out period until the part arrives, especially if there is a lot of variation in the vendor's replenishment time.  In addition, using this replenishment system results in much, much more inventory than is necessary.

 

TOC offers a different type of replenishment system which is not based upon a forecast of part’s usage, but rather the actual usage of parts.  Instead of forecasting the demand and ordering against a reorder point, TOC’s replenishment solution simply replenishes what’s been used on a regular basis (e.g. once per week).  Many implementations of this type of replenishment system have typically resulted in a 40 to 50 percent reduction in the amount of inventory carried and the virtual elimination of stock-outs.

In our next posting we'll continue looking at more of the tools and methods that TOC uses to solve some problems common to many companies.

Bob Sproull

Focus and Leverage Part 223

You will remember that we finished my last posting by saying we will look at each of the four assumptions of Constraints Management in more depth.  The basis behind the first assumption, that every system must have a goal and a finite set of necessary conditions, is that without a defined final destination (i.e. the organization’s goal), an organization could wander aimlessly and take actions that may or may not help them become a more effective organization.  Unfortunately many organizations don’t take the time to define their goal and necessary conditions or even articulate it to their employees.  It’s so much easier to reach your destination when your entire organization knows what it is.  If, for example, your organizational goal is to maximize your profitability, then you must define a set of necessary conditions required for goal realization.  The bottom line is, you must have a sort of road map that clearly defines the route or pathway to your goal and without defining the necessary conditions for achieving it, the organization simply won’t get to where it wants to be.

The second assumption of Constraints Management tells us that the sum of the system’s local optima does not equal the global system optimum.  This simply means that efforts to optimize each individual part of the system are usually counter-productive in terms of the overall positive impact on the total system.  The fact is, not all parts of the system are of equal importance and unless and until we locate that part of the system that is most important, total system improvements will not be achieved.  This assumption is tied very closely with the third assumption.

The third assumption tells us that usually only one variable limits the performance of a system at any one time….the system constraint.  The key to system improvement is by following Goldratt’s five focusing steps in an orderly manner as follows:

 

1.  Identify the system constraint

 

2.  Decide how to exploit the system constraint

 

3.  Subordinate everything else to the decision to exploit the constraint

 

4.  If necessary, elevate the system constraint

 

5.  If the constraint is broken, return to step 1, but beware of inertia

The real message behind assumption number three is that you should identify, focus on and exploit that part of the system which is limiting performance.  And once you have improved it sufficiently, don’t stop….return to Step 1 and continue this process of on-going improvement.

The fourth assumption tells us that all systems are subject to logical cause-and-effect and that the undesirable effects we observe within the organization are typically symptoms of a larger problem.  Most of these undesirable effects are linked together in a cause-and-effect relationship originating from a single root cause or core problem. 

Goldratt developed what he referred to as the Logical Thinking Processes which are a set of logic-specific trees used to first, identify the organization’s UDE’s and then link them together in a chain of cause-and-effect until the organization’s core problem is identified.  The remainder of these logic trees are then used to develop a future reality in which the core problem has been eliminated.  And when the core problem has been removed, almost magically, 80% of the UDE’s disappear.

The Logical Thinking Process (LTP) tools use either sufficiency or necessity type logic.  Sufficiency type logic uses discrete If-Then statements to provide linkage.  Necessity based logic uses the syntax, In order to have “x”…..I must have “y”…..  Let’s briefly discuss the original LTP tools.

 

-  The Current Reality Tree (CRT) – The CRT was designed to identify the system constraint, but particularly if the constraint was policy related.  The CRT, which uses sufficiency type logic (i.e. if-then statements), is the tool used to identify the organization’s UDE’s and then links them together through a chain of cause and effect to identify the organization’s core problem.

 

-  The Conflict Resolution Diagram (CRD) – The CRD, also known as the Evaporating Cloud, is a necessity based logic tool used to resolve conflicts that arise within an organization.  In effect the CRD helps initiate breakthrough solutions for an organization.

 

-  The Future Reality Tree (FRT) – Although the FRT (as well as the other LTP’s) can be used as a stand-alone tool, it is commonly used in conjunction with the CRT.  Its purpose is to test and validate potential solutions prior to implementing the solution.  It is, like the CRT, a sufficiency based logic tool (i.e. If-Then statements).

 

-  The Negative Branch (NB) – The NB is used with the FRT to help identify and avoid any potential negative effects that might arise from the proposed solution developed as part of the FRT.  The NB uses sufficiency based logic.

 

-  The Prerequisite Tree (PRT) – The PRT assists in the identification and elimination of potential obstacles that might interfere with or block the proposed solution.  The PRT also uses necessity based logic.

 

-  The Transition Tree (TT) – is used to facilitate the development of your overall improvement implementation plan and helps explain your rationale for taking the improvement actions you want to take.  The TT uses sufficiency based logic for its creation.

An important point to remember is that these tools are used to answer three important questions as you attempt to resolve the improvement conundrum:

-  What must I change?

-  What must I change to?

-  How do I cause the change to happen?

Without successfully answering these three questions, improvement initiatives will most likely stall or never even get off of the ground.

 

In my next posting we will begin looking at some of the key tools and methods that TOC offers and continue forming the essence of Constraints Management.

 

Bob Sproull