THE MAJOR COMPONENTS OF ANY ORGANIZATION
SUBSYSTEM 2 FINANCE AND MEASUREMENTS
The Eight Major Subsystems 97 but available to protect other more critical resources. For example, in NASCAR races, while the driver is the critical resource, his or her mechan- ics will stand idle for most of the race, ready to act if and when needed to help the driver win the race.
In order for operations people to work as a team with the rest of the organization, they must accept that the primary purpose of their organiza- tion is not to be efficient. Of course, if too much waste exists in the system, then the products are often priced out of the market by competition. At the same time, the rest of the organization needs to understand that constant disruption to operations can hurt flow.
What operations needs is a system that allows it to meet two different operations goals — minimize waste and good flow. The system must be predictable, according to Deming’s standards. This means that the product or service must be delivered consistently on time to customers, meeting quality and other expectations, better than 95% of the time.
For the PMO, the significance of having a predictable operation is in the number of projects required. The more predictable the operation, the fewer the projects required to make the system work.
Goldratt invented such a system that applies widely to many types of operations. The system typically simplifies operations and implements the relay runner approach. It is called Drum, Buffer, Rope*, and it assumes that Murphy exists in operations. It provides a method of distinguishing easily between common and special cause variation, and tells managers when to investigate problems and when to ignore them. The system also lends itself to ongoing improvement and integration with other techniques such as TQM, Lean Manufacturing, and Six Sigma.
By having executives understand how efficiency measurements hurt them, and by seeing one example of an operations system with predictabil- ity, executives are prepared to discuss their own environment, the inherent measurements, the behaviors of people, and to what extent they have a sys- tem with predictable results. This lays the groundwork for good strategy.
In these circumstances, each active project blocks the progress of other projects. It is like having the organization’s arteries clogged. The lifeblood of change, projects, cannot flow very quickly or sometimes cannot flow at all.
Who put all those projects into the system? In many cases, the answer is the executives. If the executives created the problem, why can’t they sim- ply solve it by removing some active projects? We believe the answer lies in measurement systems within each organization that drive executives to continually activate new projects.
Goldratt suggests, “Tell me how you measure me, and I will tell you how I will behave. If my measurements are unclear, then no one can predict how I will behave, not even me!”
In most organizations, executives cannot keep their jobs for long if they do not meet their specifically designated goals. Since CEOs hold each ex- ecutive accountable for their local contribution to the corporate goal, each functional executive is left with no choice but to initiate projects to meet their functional goal. In operations, the goal is often couched in terms of reducing costs or increasing efficiencies. In sales, it is increasing revenues.
In engineering, it may be in terms of reducing scrap, increasing quality or producing more specifications with the same resources.
Goldratt suggests that “The purpose of measurements is to motivate the parts to do what is good for the system as a whole.”* When we analyze the measurements within each functional area of an organization, we typically find dozens of measurements, many conflicting with each other. Conflict- ing measurements pit people against each other, even when they have com- mon goals.
For example, consider measurements on inventory. In Figure 7.1, we see that the sales organization wants to increase inventory to be able to satisfy more customers on the spot. It is very frustrating for salespeople to make a sale, only to find that the company cannot meet the customer’s re- quired date due to lack of available inventory. Production, on the other hand, is trying to decrease inventory to meet its goal of cost cutting. Since it is charged with inventory carrying costs, Production appears to be in conflict with Sales. A third player enters the picture and has yet a different goal. The Finance Department wants to maintain inventory where it is. It has to meet banking covenants and shareholder expectations. If inventory is reduced too much too quickly, it causes the cost of goods sold to increase, showing reduced profit for the firm. Inventory is also viewed as an asset by the bank, and is considered to be collateral for lines of credit and loans.
*For further information, see the Bibliography references to Theory of Constraints Self- Paced Learning Program on Finance and Measurements.
The Eight Major Subsystems 99
THREE GLOBAL MEASUREMENTS FOR ANY ORGANIZATION Organizations often initiate projects according to their local measurements.
But will the project really be good for the organization as a whole? The Theory of Constraints identifies three global parameters of any improve- ment effort — a useful measurement system to be able to compare project priorities with a common view. While outlined in Chapter 4, we repeat these definitions here for convenience.
Throughput (T) measures the goal units (typically money) generated by the system. In for profit organizations, this is calculated as the money re- ceived from customers minus the money paid to external vendors for raw materials and other external costs that are incurred per product sale. Simply put, it is the money left in your organization’s bank account after you have paid the external vendors for raw materials and parts.
Investment (I) is the money tied up inside the company in capital invest- ment and inventories at all levels.
Operating expense (OE) represents all the expenses incurred within one year to turn the investment into throughput. Any operating expense that does not help generate throughput is a waste and should be eliminated.
These three measurements have various derivatives, such as net profit (T – OE) and return on investment (net profit divided by investment). These measurements and their derivatives can easily determine the net present value of any project (future cash flows from a project translated to today’s dollars assuming an interest rate).
Figure 7.1 Conflicts Between Functional Measurements
Most organizations we visit do not have these three measurements iden- tified on all projects. Without these measurements, project priorities are subjective and changed frequently, creating chaos for project and resource managers.
Without these measurements, we also witness distortions of cost ac- counting systems that can make any project look justified, even when it does not have a meaningful positive impact on the bottom line. Note that with the three measurements, there are no cost allocations.
These measurements help an organization determine which projects to deactivate, in order to permanently fix clogged arteries. Since an organization’s resources are so limited, the measurements should focus the organization’s resources on its biggest leverage point.
If an organization has excess capacity, the measurements should be lead- ing the organization to implement projects involving sales and marketing.
If the organization’s capacity is less than market demand, the measurements should lead the organization into projects to manage the highly constrained resource, to squeeze everything it can out of it.
HOLISTIC MEASUREMENTS AND THE FIVE FOCUSING STEPS There is an attribute of metrics that we find missing from most organiza- tions — the team attribute. In a successful football team, the receiver is designated and the play is designed so that every member of the team is working to help the quarterback throw the ball and help the receiver get free to catch the ball. There is an old Indian proverb that suggests a tree would never be so foolish as to let its branches fight with each other.
In organizations, the metrics and practices often do not lend themselves to having everyone subordinate themselves to the constrained area. Organi- zations need more of the metrics to cause team play.
Goldratt defines five focusing steps to promote team play. The steps are as follows:
1. Identify the system’s constraint. In this step, everyone in the orga- nization is made aware of what and where the constraint is. By “sys- tem,” we mean the organization or the supply chain, not a computer.
2. Decide how to exploit the constraint. This causes people to squeeze everything they can out of it. Don’t waste any part of a constrained resource.
3. Subordinate everything else to the decision to exploit the con- straint. This means that every part of the organization is now a team player, whose purpose is to help the organization achieve the goal by doing everything possible to help squeeze flow out of the con- straint.
The Eight Major Subsystems 101 4. Elevate the constraint. This usually means spending capital or hir- ing more people, which implies more projects. In many organiza- tions, the improvement effort unnecessarily starts here. Often, a con- straint can be brought under control simply by following Steps 1 through 3. We always find active projects at this stage, when the previous steps have not been taken. When the previous steps are imbedded in everyone’s thinking and processes, some new projects are not necessary.
5. If in the previous steps, a constraint has been broken, go back to Step 1. This becomes a process of ongoing improvement.
The combination of correct metrics, as described above, with the five focusing steps, creates a team from of a bunch of seemingly independent silos. Without the correct metrics and the five focusing steps, project man- agement becomes and remains a battlefield between functional areas.