A Process Of On-Going Improvement (POOGI) - Part 32

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints. {This series was co-written with Brad Stillahn.}

To make managing a complex organization easier, we break organizations into pieces. Many of the current measurements have the purpose of measuring local performance, under the erroneous assumption that the overall performance of the organization will be maximized if each department maximizes its performance.

The role of measurements is to induce the parts to do what’s good for the organization as a whole. What’s good for the organization as a whole is achieving the three objectives stated above.

In previous articles, we’ve referred to some of the measurements used by TOC practitioners:

• Throughput (T) is rate at which the system generates money through sales.
• Inventory (I) is the money invested in purchasing things which it intends to sell.
• Operating Expense (OE) is the money the system spends to turn Inventory into Throughput.

To determine Throughput, subtract truly variable costs (TVC) from Sales dollars. Truly variable costs include raw materials, outsourcing, freight, and sales commission. Throughput is most similar to Gross Profit, except that direct labor is considered an Operating Expense in Theory of Constraints (TOC). It’s not that direct labor does not vary, but it is a period expense and does not necessarily need to vary with sales. Dramatic improvements in Net Profit can be gained when Throughput increases without a proportionate increase in Operating Expense.

...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 30

We are continuing our series based on The Goal by Eliyahu M Goldratt and the Theory of Constraints.

Measurements (Not Incentives)

“Tell me how you measure me, and I will tell you how I will behave. If you measure me in an illogical way…do not complain about illogical behavior”.

This quote by Dr. Eli Goldratt, the father of the Theory of Constraints (TOC), speaks directly to the cause and effect power of measurements, and to the general misuse of measurements.

We business managers often struggle to determine what to measure and control, and how to motivate employees. Some of us measure many, many things, while others of us don’t measure much at all.

Think about these questions:
· What problems are we trying to solve by using measurements?
· What and how are we measuring now?
· What problems do we cause by the way we measure now?
· Is there a better way? That is, what should we be measuring and how?

First, let’s set a context for our discussion of measurements by agreeing on the overall objectives of our organization:

1. Make more money now as well as in the future,
2. Provide a secure and satisfying environment for employees now as well as in the future, and
3. Provide satisfaction to the market now as well as in the future.

The challenge is to accomplish all three objectives simultaneously.

One approach to doing so is called “balanced scorecard”. This proposed solution falls into the trap of trying to measure many, many things. It violates the second objective above in that when we measure many things, there will be some things that will look good and others that look bad. Depending upon the management style of the people involved, management can always find something to find fault with employees.

With TOC, we’re interested in ongoing improvement. We aren’t interested in measuring what is going well as much as we are interested in measuring what can be improved.

...to be continued.

Here's to maximizing YOUR profits!
Dr Lisa Lang
(c)Copyright 2008, Dr Lisa, Inc. All rights reserved.

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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.