Compare and contrast major approaches to managing and improving organizational performance from the book The Goal,

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Week 7: How Can You, as a Manager, Optimize Your Systems?

Weekly Briefing As we proceed through the final chapters of The Goal, we begin to see how Alex and his team are able to turnaround the Bearington Plant, through the applications of effect- cause-effect and systems thinking—along with their recognition that traditional cost accounting and activity based accounting can actually get in the way of the organization making decisions that optimize profit. The Corbett (2006) and other assigned articles this week address this last phenomenon by introducing the concept of “throughput accounting.” Your learning outcomes this week are:

• Apply a throughput accounting methodology to improve organizational decision making outcomes

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

• Synthesize knowledge of applied systems thinking and performance management

• Create goals for personal, professional, and organizational development using concepts related to systems thinking and organizational performance

Throughput Accounting In his article “Three Questions Accounting (CITE),” Thomas Corbett (2006) argues that sound managerial decision making rests on the ability to answer three fundamental questions about a given situation:

• What will be the impact of our decision on the amount of money the company generates (throughput)?

• What will be the impact of our decision on the amount of money we spend to operate the company (operating expense)?

• What will be the impact of our decision on the amount of money captured in the company (investment in inventory)?

Corbett discusses the concept of “throughput accounting,” which he demonstrates as a method to account for the relationship among a system’s three primary measurements in order to evaluate the impact a decision will have on a company’s profitability (Corbett, 2006, p. 52). From a traditional cost accounting point of view, as represented in UniWare’s performance management system, reductions in operating expense will always lead to an anticipated increase in profit. That said, given our understanding of opportunity cost

and its relationships to constraints, only measurement systems that account for the value of time at the constraint can help you make good managerial decisions. If one, for example, reduces operating expenses and inventory at the constraint—thereby reducing the constraint’s capacity and the throughput capacity for the entire system— that system in all likelihood will show less profit (it definitely will over time). The Value of Activities Within a Constrained System One of the very important (and least discussed) benefits of a theory of constraints approach to organizational management is that it is a very sound way to implement and understand economic reasoning concepts. In economics, decision-makers are taught that optimal choices come where marginal revenue equals marginal cost (MR = MC = P in microeconomic equilibrium). In the real world of complex systems, however, most economists cannot tell you how to find this organizational sweet spot. That said, TOC can get you in the ballpark. How? What defines MC in a constrained system? The constraint, of course! In the case of Uniware, despite the best efforts to deploy “efficient robots” and to keep people busy, by increasing local productivity, profit—the real king—is not improving. Why is that? Because the Uniware senior leaders believes that improvements that will exploit the constraint and subordinate the work of non-constrained resources will reduce “efficiencies” and increase “costs”, in part because they are not as interested in increasing throughput! The major insight here is that when a system’s primary constraint is physical, that constraint subsystem defines marginal cost for all the products that depend on the constraint resource. This, then, has implications for marginal revenue and even pricing. In fact, although we will not discuss it at length in this course, product pricing very much depends on understanding the system’s constraints. The value of time at the constraint is the value of all lost sales of the entire system’s throughput (that depends on the constraint). If the system could have sold $100,000 of final goods inventory in a day and the constraint puts the system out of operation for a day, then the cost of that downtime is $100,000, not the cost of labor, materials, etc. That is, the value of time of a constrained subsystem is the opportunity cost of sales that that system is limiting. This, then, is how the theory of constraints is related to good economic reasoning— investments in resources outside the constrained subsystem are essentially wasted, as are improvements in productivity outside the constrained subsystems. The opportunity cost for changes in the non-constrained subsystems is near zero—unless they impact products that do not depend on the constrained resources.

Effect-Cause-Effect Reasoning As we proceed into the final third of the book The Goal, we begin to see Alex and his team wrestle with the various causes and effects of various actions, both within the Bearington plant and across the Division (through Alex’s new job). It has become apparent to everyone that pursuing initial process improvements throughout the system is insufficient in improving the entire organization’s performance for the longer term. They discover that a process for thinking about “what to change”, “what to change to”, and “how to change”, in combination with the 5 focusing steps for constraint management, can lead to ongoing and sustainable performance improvements. Alex and the team are under dire pressure to turn the situation around, determining whether the organization will be closed or sold. This pressure puts an interesting organizational change dynamic into play. What is it? Resolving the Relationship Between LSS and TOC: Essay at the End of the Book One of the major themes in The Goal , and especially the essay after the novel (required reading), is that it is important to understand the interrelationships and the fundamental assumptions of the management paradigms, tools, and techniques that we use when making decisions. It is also important to understand the fundamental goal of the system. One of the central insights from Goldratt’s essay, Standing on the Shoulders of Giants, (begins on page 340) centers around the relationship between Lean Six Sigma and the theory of constraints. As he notes, Lean has not worked in many implementations because it requires a very specific set of starting/system states to work. However, if one uses principles of the theory of constraints, one can use Lean Six Sigma to optimize nearly any organization’s performance. Overall, a very sound management process would be to use TOC to identify the bottleneck/constraints relationships within an organization, then apply Lean and Six Sigma to reduce variation and improve flow through the bottleneck subsystems—and to apply Lean to all other areas such that they do not become constraints or affect the buffer of the system’s bottleneck. Remember, this is a general systems outcome—and the thinking processes can be applied to service organizations just as effectively as manufacturing organizations!

Sticking to the Core Measurements Of course, Alex and his team do implement an action plan based upon their E-C- E/undesirable effects analysis, despite Peach’s insistence that there must not be any backsliding on any of the metrics. Note how ironic it is that if Alex’s team were to meet Peach’s request seriously, the overall organizational performance would degrade—that is, the company would make less money, have more inventory and waste, and have unhappy customers. The ONLY metrics the organization needs to keep its eye on, from a strategic standpoint, are T, I, and OE, and the relative changes in each given potential strategic or tactical choices. So long as a decision leads to a delta-T that is greater than the sum of delta-I + delta-OE, profit will increase. If ΔT ≥ ∑ (ΔI + ΔOE), then that decision will help an organization move toward its goal (to make more money now and in the future in pursuit of its mission). By the end of the book, it is clear that, despite tremendous improvement in profitability and overall performance of the Bearington plant, Hilton Smyth still does not get what is important, and continues to insist that the only way to profit is through reducing costs and increasing efficiency everywhere! Of course, you now know the rest of the story and can explain why that is not good systems thinking! Smyth’s paradigm rests on the assumption that increases in local efficiency, or reductions in “waste,” will always lead to increased profit. He, like many other organizational leaders who do not think systemically, cannot understand that only a critical few activities within an organization actually make a big difference in organizational performance, at the margin. Leaders who learn how to successfully identify major physical, policy, and market constraints—and then deploy appropriate tools such as TOC, sound economic reasoning, Lean process improvement, Six Sigma, total quality management, and others—will do well, whereas those that focus on local KPI’s will likely be ripe for the taking. References Corbett, T. (2006). Three-questions accounting. Strategic Finance, 87(10), 48–55. Retrieved from the Walden Library databases.