Create a plan for ongoing improvement and increased capability based on an evaluation of an organization’s systemic constraints.or Analyze a complex value creation system using management concepts.

Week 6: Why is it Hard for Managers to Achieve Balance?

Weekly Briefing This week we continue exploring the in-depth case study of organizational performance illustrated in The Goal. Your learning outcomes for this week are:

• Analyze the impacts of constraints on organizational performance

• Evaluate key concepts from The Goal through the framework of selected course outcomes

Alternate Points of View in the Book: Traditional “Cost World” thinking and and the Theory of Constraints and “Throughput World” thinking. Two primary performance management frameworks are introduced in The Goal. One is built within a more traditional productivity/efficiency perspective that argues that by minimizing waste and maximizing local efficiencies, the system as a whole reaches maximum performance. This is often referred to as “cost world thinking” by practioners of the theory of constraints. The senior managers at UniWare (Bill Peach, Ethan Frost, Hilton Smyth) represent this point of view. The other point of view that is rooted in concepts from the theory of constraints, as the theory is discovered by Alex Rogo, Lou, Bob Donovan, Stacey Potazenick and Ralph Nakamura), and as offered Socratically by Jonah (Alex’s former professor). The theory of constraints holds that the performance of the entire system is fully dependent on the performance of any primary internal constraints and the subsystems that support such internal constraints. Battle of Ideas As we proceed through the book The Goal this week, you should begin to see the emerging conflicts between the proponents of traditional financial accounting / measurement and performance management and the theory of constraints. It seems that the more that efforts to maximize local productivity and “reduce costs” is put into effect, the worse both traditional and throughput-oriented measures of total systems performance are becoming—except, of course, measurements related to local efficiency (as measured in the UniWare information system). For example, throughout the book, it is noted that the key performance indicators (KPI) from the UniWare performance measurement system were looking better (locally), but the financial results were getting worse. Resource utilization was as high as it had ever been in the plant, with nearly all workstations reporting higher productivity, and yet productivity was not

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translating into profitability. How can that be? (Hint: Remember from earlier notes what the definition of “productive” should be.) Other conflicts emerge around resource management policies. In particular, Bill Peach and others are critical when they see people on the shop floor “not working”, or when they see computerized robots “sitting idle”. In order to replicate and show you the importance of understanding the fundamental impact that constraints have on the performance of an entire system, you read about the “balanced plant-based, or matches game” in the book. (If you get the chance, you should try to replicate the matches, dice game on your own with some friends!) What are the lessons of the balanced plant simulation? How does variation within a system that has sequential dependency limit the ability of a balanced plant (system) to produce or be effective? Can you think of any organizations that you have been a part of that are not subject to variation or sequential dependency? One of the interesting and important facets of The Goal is that, in addition to showing you a concrete, product-oriented example of a complex system in action (via the Bearington plant production process), it also shows you that the optimization ideas of theory of constraints can be applied to policies and services. The principles of the theory of constraints apply to all organizational systems—not just those that produce physical products, or to those that seek profit (governments could learn from TOC too). It is easy to say, “Oh, this theory of constraints thing only applies to manufacturing plants; it can’t be used in my organization, which is a not-for-profit service organization.” But that is not true, and such a thought is a perfect example of a policy constraint! TOC, is a general systems theory framework that can be applied to any organizational system. Another of the interesting “apparent paradoxes” (but only a paradox within traditional ways of thinking about performance) that emerges in the book is that despite nearly all the efforts to automate the plant with “efficient robots”, overall organizational performance is not improving! Why are the efficient robots’ “productivity” not making it to the bottom line? Again, think carefully about the competing points of view, with respect to how one should manage the complex organizational system. Initially, the UniWare division headquarters is very clear about its priorities and goals. Peach, Frost and Smyth each insist that “efficiencies” and “reducing cost” is the primary, and only way to increase profit. What are the implications of this, from a systems performance standpoint? Improvement in what primary measurement would alone allow UniWare to reach or exceed its goal

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year after year? Why are these “leaders” so fixated on the operating expense measurement? A Measurement Primer on TOC The theory of constraints management framework simplifies business systems performance measurement and is rooted in systems thinking and marginal cost economic thinking. There are three primary measurements that, as they inter-relate with one another, tell the most critical story of an organization's health. They are “throughput,” “inventory,” and “operating expense.” Goldratt insists, correctly, that these are the ONLY measurements one needs to both define a business system and to measure its performance. The definitions below provide how TOC measures business performance:

Throughput: T = GSR – DVC

T = (Gross sales revenue—recognized only at time of actual sale and receipt of money from outside the business system) – (DVC) all direct variable costs associated with a sale

{This is very close to gross profit margin.}

Inventory: I = all money invested in items the system intends to/can sell

Operating Expense: OE = all the money the systems spends converting I into T. OE items should be considered fixed costs.

{This is a tertiary measure—it is the least important of the three, but it is the one that most traditional managers spend by far the most time measuring and “managing.”}

Note that the TOC definition of inventory is much broader than traditional definitions of inventory. Obviously, it includes things that the company buys, which it can then transform and sell. It also includes things that the company invests in, such as its people, which it could then sell, such as through consulting. People are an asset within the TOC definitions and are part of inventory. When you pay people a salary, that payment is considered an operating expense. At the outer boundaries, nearly everything that is considered an asset in traditional accounting could eventually be sold and is considered inventory as part of theory of constraints. Of course, sub-categories of inventory still exist and are needed, such as working inventory, work in process, etc. In terms of relating how the three principal measures of TOC work with respect to traditional financial measures, it is good to note that within the TOC framework:

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Profit = T – OE or Profit (π) = {(Gross sales – DVC) – Fixed Costs} Inventory Productivity = π/I So, using the three primary measurements from TOC, one can replicate many of the most important traditional measurements used in managerial accounting. The important thing to note, however (and as we will see in the Corbett readings and other readings next week), is that sunk costs are irrelevant in TOC, and the primary measurements are really related to flow (rates). TOC is interested in how much flow-rate an entire system can produce at any given time, given specific (and hopefully known) internal physical bottlenecks (constraints), policy constraints (thinking constraints), or market constraints (customers not buying enough). References Goldratt, E. M., & Cox, J. (2012). The goal: A process of ongoing improvement (30th anniversary edition). Croton-on-Hudson, NY: North River Press.

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