A Process Of On-Going Improvement (POOGI) - Part 13

We are continuing our series based on The Goal by Eliyahu M Goldratt.

The core idea in the Theory of Constraints (TOC) is that every real system, such as a for-profit business, must have at least one constraint. If it were not true, then the system would produce an infinite amount of net profit. Because a constraint is a factor that limits the system from getting more net profit, then a business manager who wants more net profit must manage constraints. The constraints will determine the output of the system whether they are acknowledged and managed or not.

Dr. Goldratt says it this way: “Before we can deal with the improvement of any section of a system, we must first define the system’s global goal; and the measurements that will enable us to judge the impact of any subsystem and any local decision on this global goal”.

It is impossible to disentangle using TOC in operations (DBR) from TOC accounting (known as “Throughput Accounting”). Any attempt to run TOC in operations while using traditional management accounting measures and controls is doomed to failure. TOC is a radically different way to control operations and does not work with conventional cost accounting systems.

As an alternative, TOC and Throughput Accounting introduce three measurements for increasing net profit:
1. increase Throughput (Sales minus truly variable costs such as raw materials),
2. decrease Operating Expenses (that is, fixed costs), or
3. decrease Investment, particularly in inventories.

To make decisions according to TOC, we need to quantify the decision’s impact on these three measurements and then we will be able to determine the change in net profit and return on investment.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang

(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.

A Process Of On-Going Improvement (POOGI) - Part 12

What is the effect on the monthly Profit and Loss statement from this?

Because cost accounting (and GAAP) requires that inventory absorb allocated costs, the effect is that all of the cost allocations from prior months that are attached to the inventory will be recognized in the month of the inventory reduction, causing a significant “loss” from this change in inventory.

If your management is aware of this, it may block the implementation of DBR in order to avoid the perceived negative impact. If no one blocks the implementation of DBR, the result will be recognized when the P&L is compiled. At that time, management will be “surprised”. So will be the bank and any other outside entity that has interest in your company’s financials.

Efficiency measurements typically evaluate the effectiveness of labor and equipment utilization. The goal is to strive for as high of efficiency as possible for all resources. However, DBR strives to have high utilization on only one resource: the system’s constraint. As a result, all other labor and equipment resources will have lower efficiencies. Again, if management perceives this as a negative outcome, it may block the implementation. Or, if DBR is implemented, when the efficiency reports are generated, management will be “surprised” by the lower efficiencies on most resources. So will anyone else that has interest in your company’s efficiencies.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang
(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.
_____________________________________________
About the authors:Brad Stillahn is a business owner that has successfully implemented Eliyahu M Goldratt's Theory of Constraints (TOC) methods in his own business and is now helping other business owners do the same. His consulting company, TOC Professionals engages in long-term relationships with companies implementing TOC. His business and personal partner is Dr. Lisa Lang. Brad can be reached at Brad@ScienceofBusiness.com or 303-886-9939.

“Dr. Lisa” Lang is President of the Science of Business. Her speech “Maximizing Profitability” is popular with Vistage groups and as a keynote speech. Recently Dr. Goldratt’s Global Marketing Director, she offers the “Mafia Offer Boot Camp” for companies wanting to develop and implement a Mafia Offer. She can be reached at DrLisa@ScienceofBusiness.com or 303-909-3343.

Increasing Throughput -- Other Considerations

Continuing our cash velocity discussion started on March 16, 2007

Increasing Throughput -- Other Considerations

In previous sections we have covered raw materials and how to reduce them. We also need to cover WIP (Work In Process) and finished goods inventory. DBR Scheduling* reduces WIP by releasing raw materials at the rate at which the constraint can consume the raw materials. Demand Pull* can also be used to reduce finished goods inventory. If we make to stock, or use a replenishment system to supply our customers, then we can minimize the amount of finished goods we carry while at the same time increasing the probability that we will have on hand what is needed. When DBR Scheduling and Demand Pull are implemented, we see a mean reduction in all inventories of about 50%. All of this, of course, helps us to further reduce cash-to-cash cycle time.

* DBR Scheduling and Demand Pull as defined in Goldratt's Theory of Constraints

... to be continued ...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Increase Throughput -- Increase Sales

Continuing our cash velocity discussion started on March 16, 2007

Increase Sales

Increasing sales is a sure fire way to increase your throughput and is theoretically limitless. My first question is: Are you selling all that you can now? If you are a “make to stock” company, do you ever have the case where you don’t have the product your customer is looking for in stock? If so, you could benefit from DBR Scheduling and Demand Pull to ensure that you always have what your customers demand.

But, let’s say that you have already implemented DBR Scheduling and Demand Pull, and you currently can provide what they want on time. To increase sales you must learn and met your customer’s business NEEDS. New customers are earned over time by understanding the business needs that they have, then customizing your products, services, or policies to meet those needs. In TOC we call this creating a mafia offer. Market Segmentation will be a likely result of matching your offerings with your customers or potential customer’s perception of value. All that being said, sometimes business owners already know that they could earn more business from existing customers or know where that can find new customers. What stops them is cash. To grow sales takes cash and to grow sales a lot takes a lot of cash. So how do you increase your throughput without going into cash trouble?

... to be continued ...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Factoring Receivables Reduces Cash to Cash Cycle Time

Continuing our cash velocity discussion started on March 16, 2007
Yesterday we discussed how offering a discount can reduce cash to cash cycle time and today we will discuss an alternative.

Another approach, which leads to similar results is receivables factoring. Factoring receivables, however, takes about a month to set up in order to provide all the necessary information. They charge based on how long it takes your customers to pay. This is typically in the range of 1 to 5% which is a much better deal than the 20% discount. However they typically pay you 80% of the invoice within 2 days but hold 20% of the funds back until your customer has paid. We usually start with the discount offer then switch to factoring once we can get it set up.

In addition to the above ideas, with DBR Scheduling we can also give preference to customers who pay quickly. Customers who pay quickly are certainly better, as demonstrated above, to our cash-to-cash cycle time.

The shorter lead-times that result from implementing DBR can also allow us to offer shorter lead-times for higher prices depending on our industry. This would be determined during your mafia offer development[1].

... to be continued ...

Here's to maximizing YOUR profits!
"Dr Lisa" Lang
(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

[1] We typically do a Mafia Offer Boot Camp over 3 days. For more information see http://www.mafiaoffers.com/

Goldratt's Theory of Constraints Demand Pull

Reduce Material On-Hand to Reduce Cash-to-Cash Cycle Time

To reduce the number of days we have material on hand, be can implement Goldratt's Theory of Constraints Demand Pull[1] solution. We know from Demand Pull that historically we compensated for not having a good scheduling system and for our customers providing ever moving but always wrong forecasts by holding more raw material than we actually need. And still there would be situations when we had too much of some raw material, but not enough of what we needed. By implementing DBR Scheduling and Demand Pull, there will be an overall reduction in the amount of raw material we need to carry, and a higher probability that we will have what we need, when we need it. We also know that our ability to reduce the amounts of raw materials we carry is directly related to the time it takes us to reliably replenish.

Continuing our example from yesterday:
Our vendors have not implemented DBR Scheduling, so it takes them about 21 days to replenish us. So, for our example, let’s say that the mean time we have raw material on hand goes from 90 days to 30[2] days. Now our cash-to-cash cycle time is down 60 days to 55 days (115 less 90 days plus 30 days).

[1] To learn more about Demand Pull see the interactive program, The Insights by Goldratt
[2] We are allowing 3 days of transportation time and 6 days of buffer in addition to the 21 days to replenish.

(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.

Drum Buffer Rope / Simplified Drum Buffer Rope

Reduce Process Time to Reduce Cash-to-Cash Cyle Time

To reduce the number of days to make and ship the product from the time the order is received; implement DBR[1] Scheduling which results in a mean reduction of lead-times of 70%[2]. For the example we started yesterday, let’s say the 4 week lead-time would shrink to 9 days. That gives us a new cash-to-cash cycle time of 115 days (134 days less 28 days lead, plus the new 9 days lead).


[1] We actually implement S-DBR, Simplified DBR (also known as DBR II) in most cases. You can learn more about S-DBR in the book Manufacturing at Warp Speed by Eli Schragenheim.
[2] The World of the Theory of Constraints, Mabin and Balderstone

(c)Copyright 2007, Dr Lisa, Inc. All rights reserved.