As I have just finished a series on Throughput Accounting a la Steven Bragg, I want to share my thoughts on this subject from a personal perspective. So this posting will be based upon some personal experiences I’ve had with companies I’ve worked for and clients I’ve worked with.
It’s very clear to me that the prevailing attitude regarding how to become more profitable is all about how much money can be saved through cost reductions. By now I’m sure that if you’re a regular reader of my blog, you know that I have a totally different approach. To use a sports metaphor, it’s just like the difference between a team playing to win versus a team playing not to lose. We’ve all seen this many times before when a team who has built a lead in, for example football, basketball, or hockey, in the final quarter or period changes its direction changes from playing aggressively like they were when they built their lead to a defensive mode aimed at protecting that lead. In doing so, many teams have lost their lead and then have to play catch-up or they have lost the game. And so too have companies.
Using a strategy of cost cutting to become more profitable is really no different than a team playing not to lose. The fact of the matter is, there’s a huge difference between a profitability strategy of saving money versus a strategy of making money. Achieving profitability through how much you can save has a distinct lower limit and when you reach it the organization gets damaged….and sometimes beyond repair where bankruptcy occurs. I had a friend tell me that if the pathway to profitability is through saving money (especially through manpower reductions), then why not just lay off everyone and, voila, you’ve saved the maximum amount. In fact, many companies have cut their way to bankruptcy.
On the other hand, achieving profitability through making money, in theory, has no upper limit. The fact of the matter is, if you can continually increase your throughput (i.e. Throughput equals revenue minus totally variable costs), while using the same level of resources and operating expense, your profitability sours upward as long as the demand for what you’re selling is there. It matters not whether it’s a product or service that you’re selling, throughput is throughput! So if you want to make more money, then stop trying to do so by cutting costs. And the good news is, this strategy applies to every single industry type (i.e. healthcare, manufacturing, etc.).
The other subject I want to address is performance metrics. In the world of cost accounting, there are quite a few performance measures that I have a real problem with. My view of performance metrics is that the primary reason we should put them in place is to motivate the right behaviors. I want to focus on two metrics in particular that drive me crazy…..manpower efficiency and equipment utilization. Think about what behaviors exist as a result of trying to drive these two metrics higher and higher? Both of these metrics create an environment that forces the responsible manager into an over-production scenario. Non-constraints are being run to their full capacity, not because the product is needed, but rather because efficiency and utilization make them look good in the eyes of leadership. The same is true for building finished product beyond what is needed. But in reality, the impact of driving these numbers higher only serves to grow WIP, extend cycle and lead times, with the net result being a deterioration of on-time delivery. In other words, you have plenty of product available, but you're not meeting your shipping requirements,
In my consulting experiences and experiences I’ve had with companies I’ve worked for, using these two metrics and other cost accounting metrics have had severe negative consequences on the company’s bottom line and on-time delivery. But how could that be? I mean most every company uses these metrics, so how could they possibly be "bad" metrics. Let’s look at a few examples.
I once consulted for a company that performed Maintenance, Repair and Overhaul for one of the DoD organizations. Their contract called for a specific number of aircraft to be available for the military aviation students to fly each day. If they failed to deliver the number of contracted aircraft, there was a sizeable monetary penalty imposed on them. When I arrived at this facility, they were not meeting their contractual obligation and were actually about 10 aircraft, on average, short of the contracted amount each day. To make matters worse, they were using mandatory overtime in an attempt to drive aircraft availability higher and higher. This company had plenty of aircraft in their maintenance process, but they simply weren't completing them. The problem here was related not only to synchronizing the flow of aircraft into the maintenance arena, but also because they were focused on increasing efficiency in every step in the process. Their WIP was high and their cycle times were protracted, both of which resulted in on-time delivery of aircraft being abysmal. The good news for this company is that when they eliminated efficiency as one of their primary metrics, identified and focused on the constraint, and synchronized the flow of aircraft, on-time deliveries jettisoned (no pun intended) upward without the need for mandatory overtime. As a result, their profitability grew instantly. Another result of focusing on increasing throughput rather than looking for ways to cut costs.
I also consulted for a manufacturing company that produced medical devices. When I arrived, their WIP accumulation was the equivalent of nearly 6 months of production, but their on-time delivery was in dire straights. In this company, one of their key metrics was equipment utilization so instinctively they thought it was necessary to keep producing just to keep their utilization metric high. I demonstrated the concept of constraints management and how it would apply to their operation. Once they understood this concept, they stopped over-producing to burn off their excess WIP and their on-time deliveries improved significantly. In yet another example, in a healthcare environment, the hospital had just gone through a series of layoffs in an attempt to improve their profitability. They had been using efficiency numbers to determine their optimum manpower loading. Clearly this hospital was focused on cost reduction as their pathway to improved profitability.
When I entered the picture, one of the first things I did was to meet with their executive staff to demonstrate Throughput Accounting. As you might have guessed, I received significant pushback from the CFO and his staff of Accounting Managers. It wasn't their fault because they had all been trained in the same, outdated cost accounting techniques. But fortunately the CEO was open-minded and decided to at least complete a project to test out these new concepts. I told him to select an area of the hospital that was a revenue driver, so he selected their surgical process. We selected a team and one of the first things I taught them were the concepts imbedded in Constraints Management. I also taught them Lean basics focusing on the types of wastes and how to identify them. It's my belief that these two methodologies complement each other very well. The bottom line was that within a couple of weeks, this hospital's revenue increased dramatically with almost all of the revenue going directly to the bottom line. Needless to say, the CEO was extremely happy with the results, but was even happier with his hospital's new direction!
I could go on and on with examples of companies from all industry types that believed in these two metrics and in every case the results caused by both of them were quite predictable. Using either (or both) of these metrics will always result in excessive WIP levels, extended cycle times and poor on-time delivery, yet companies all over the world continue using them. The roots of this problem are directly traceable to traditional cost accounting and unless and until companies abandon these two metrics, things will never change.
However, even though I detest these two performance metrics, they can be used effectively. If these two metrics are used strictly in the constraint operation, then higher levels of throughput will be achieved. WIP levels will decrease and stabilize, and on-time delivery rates will always improve. It’s your choice to use them or not use them, but I firmly believe that the only place they make any sense at all is on the constraint.