Achieving quantum increase in performance through Theory of Constraints

Batliboi Ltd
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Agenda

Fundamental beliefs Organizational Goal Conventional measurements for the Goal Five levels of Goal achievement New operational measurements Concept of Constraint Process Of On Going Improvement -Five focusing steps Implemented case studies from India Next steps for tomorrow Stopping some existing practices Starting some new actions Summary

Fundamental Beliefs / Paradigms

Traditional Belief/Paradigm 1. Inherent Constraints 2. Inherent Complexity 3. Inherent Conflict 4. Inherent Certainty & Optima 5. Inherent Bad People 1. 2. 3. 4. 5. TOC Belief/Paradigm Inherent Potential Inherent Simplicity Inherent Win/win Inherent Uncertainty & Good Enough Inherent Good People with Bad assumptions

The Goal?

What is the Goal of your organization?

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The Goal?
Some organizations state that their Goal is to be a World Class Quality Company. Stated differently they would like to delight their customers now as well as in future.

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The Goal?

Many other organizations say that their Goal is to keep their employees happy now and in future.

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The Goal?

A few organizations declare that their Goal is to make money now and in future!

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The Goal?

Is there any conflict between the three Goals stated or a hierarchy of Goals?

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The Goal?

For example let us choose that our Goal is to delight customers now and in future. In order to achieve our chosen Goal i.e. to delight our customers now and in future, it is absolutely necessary to keep our employees happy now and in future. Similarly it is imperative to make money now and in future in order to continue to keep our employees happy.
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The Goal?

Now let us decide that our Goal is to keep our employees happy now and in future. In order to achieve our chosen Goal, it is absolutely necessary to make money now and in future. It is impossible to make money now and in future unless we continue to delight our customers now and in future.
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The Goal?

Now if we decide that our Goal is to make money now and in future, is it really possible to achieve it without delighting our customers now and in future! And can we satisfy our customers without keeping our employees happy now and in future!

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The Goal?

In reality there is no conflict between the three different Goals. Choose any of the three Goals, the other two become the necessary conditions for achieving the chosen Goal! For the purpose of this presentation we will assume that the Goal is making money now and in future.
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Measures for the Goal-Making Money

Generally accepted measures are Profit Return on investment Cash flow We do not question the validity of these measures. However we do question the usefulness of these measures as operational measures!
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Current situation

Only 23 out of 3000 (0.8%) companies actively trading on the Bombay Stock Exchange have increased their profits continuously in the last 10 years (The Economic Times 24th September 2005) And the Goal of the organization is to make more and more money Hence as per our agreed definition of Goal, 99.2% organizations are not achieving their Goal!
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Five levels of financial health Making more and more money

1.
2. 3. 4.

5.

Unable to meet financial commitments Meeting financial commitments but not making profits Meeting financial commitments, not making losses, but profits fluctuating Profits increasing continuously period after period Return On Investment (ROI) / Return On Capital Employed (ROCE) increasing continuously
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What measurements should we use?

For the average employee, seeing the effect that any given action has on Net Profit (NP) or Return On Investment (ROI) is almost impossible. As a result we have created local measures like efficiency & utilization because we believe that they are linked to NP or ROI. We do know that 99%+ organizations are not achieving their Goal.
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What measurements should we use?

New Operational Measures Throughput (T) Investment (I) Operating Expense (OE)

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Flow of money
Cash in bank

RM

+
OE

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Throughput (T)

The rate at which Contribution Rupees are coming into organization. Only Rupees generated by the system are counted; e.g., Rupees spent on purchasing raw material or services do not count as they are passed on to your suppliers. T=(Net sales-all truly variable costs)

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Investment (I)

All the money currently tied up inside the system. All the inventory in raw material, WIP, or in Finished Goods. Money blocked in plant and machinery. Receivables are also part of I.

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Operating Expense (OE)

All the money that system spends on converting inventory into throughput. All the expenses are clubbed together as OE and are thought as fixed. All employee expenses are part of OE.

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Financial Links
Is there any link between the new Operational Measures T, I, & OE, and conventional measures as P, ROI, & Cash Flow? P = T- OE ROI = P/ I = (T-OE)/I What happens to P, ROI & cash flow when we improve either T, I or OE, keeping other two as constant?
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Financial Links

If we increase T keeping I & OE constant, P=(T-OE) improves, ROI= NP/I improves, and so does the cash flow. If we decrease I, keeping T & OE constant, P improves due to reduced carrying cost, ROI improves, and of course cash flow improves. When we reduce OE keeping T, and I constant, P, ROI, and cash flow improve.
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Financial Links

Improving Throughput, Investment and Operating Expense have a positive co-relation with improving P, ROI, and cash flow. Throughput, Investment and Operating Expense are valuable operational measures that can guide our day to day actions to making money now and in future.

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Constraint for making money

What is that limits your organization to achieving more of its Goal - to make more and more money?

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Theory of Constraints (TOC)

The core idea in the Theory of Constraints is that every real system such as a profit-making enterprise must have at least one constraint that limits the system to achieving its Goal. Every for profit organization will have a constraint in Supply, Operations, or Market. Current constraint may shift, but there cannot be any situation when there is no constraint. Had it been so, its profit would have been Goldratt India infinite!

Theory of Constraints (TOC)

Constraints are neither good nor bad.

They are facts of life.

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Theory of Constraints (TOC)

There is really no choice in the matter. Either you manage the constraints or the constraints will manage you.
The constraints will determine the output of the system whether they are acknowledged and managed or not.
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Organization as a chain

An organization can be compared to a chain. The activities that constitute a business are chain of dependent events. For example we do not dispatch components unless they are packed, and we do not pack parts until they are manufactured.

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Organization as a chain

The output of the organization is achieved through the synchronized efforts of various functions. The output is limited by the weakest area. The strength of the chain is determined by the strength of the weakest link. What should be done to improve the output of an organization?
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Organization as a chain

Should we improve all functions or all links? Or should we strengthen the weakest function or the weakest link? It is common sense that unless we improve the weakest link, the organizational output or chain strength would not increase at all. Is it possible that overall organizational effectiveness is reduced by improving performance in one department ?
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Organization as a chain

The global improvement is not the sum total of all the local improvements. Often organizations spread their energies thin in all areas in order to improve the output. In the TOC world optimizing a sub-system would sub-optimize the whole system.

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How does TOC help companies

1.

2.

Focusing improvement efforts where it will have the greatest immediate impact on the bottom line. Providing a reliable process that insures Follow Through

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A process of on going improvement (POOGI)

1. Identify the constraint. 2. Exploit the constraint 3. Subordinate all policies, decisions and procedures to exploiting the constraint. 4. Elevate the constraint. If we need still more output from the constraint, elevate it. 5. Avoid inertia. If in a previous step constraint shifts, start the cycle once again.
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POOGI: Step 1
Identify the Constraint. The constraint can be internal or external to your organization. Internal constraint is preferable. The constraint can be tangible or intangible. For example it could be an equipment or a policy. Invariably (> 95%) the constraint is a policy.
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POOGI: Step 2
Exploit the Constraint. Get the most possible out of the existing capacity of the constraint. Utilization at the constraint is critical.

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POOGI: Step 3
Subordinate all decisions to exploiting the constraint. All policies and measurements must be designed to get the most out of the constraint. Utilization and efficiency at the non-constraint resources must not be measured. However this does not imply that there are no measurements for non-constraint resources. This step is often missed, and thereby the majority of financial benefits of TOC is lost. This is the toughest step.
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POOGI: Step 4
Elevate the constraint. If more capacity is required after steps 2 &3 to meet the market requirements, increase it through capital investment, outsourcing, or offload the constraint by defining alternative routings, processes or design. Capital investment should not be the first option. Often times, Exploitation and Subordination are sufficient to reach the needed output. Do not increase the investment too soon.
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POOGI: Step 5
Avoid Inertia. If in a previous step the constraint is broken, go back to Step 1. Do not let inertia be the system constraint. Often times when a new constraint is identified, it is necessary to change the policies you have just made!

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POOGI: Step 5
Avoid Inertia. The long term strategic application of TOC does not call for continuous removal of all constraints. Rather, the idea is to choose where the constraint should be in order to best exploit the market opportunities, and then keep it there!

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Summary
Stopping existing wrong actions is priority # 1 Start new right actions only after stopping wrong actions!

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This is not the End.

It is not even the beginning of the End. It is perhaps the End of the beginning!

THANK YOU!

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