Manufacturing Breakthrough Blog

Viable Visions: Simpler Frames of Reference

Friday July 29, 2016

Review

In my last post I presented some problems associated with what Kendall refers to as the silo mentality.   I completed the post by listing four major challenges that senior managers must overcome as:

  1. Identify the biggest leverage point for improvement, not within your silo, but within the overall organization. 
  2. Define what each part of the organization must do to exercise that leverage.
  3. Remove distortions by developing a deeper understanding and measurement system among all managers of the cause-effect ramifications of their decisions across the supply chain.
  4. Develop the logistical systems to alert the entire senior management team to the early warnings necessary to prevent disaster in their day-to-day operations. 

In today’s post we will begin to provide practical answers to help you overcome these challenges by presenting what Kendall [1] refers to as a new frame of references.

Decision-Makers Simpler Frame of Reference

Kendall tells us that, “For the most part, top management teams use a holistic frame of reference (such as net profit or return on investment) to make decisions.”  The problem is that this does not mean that the lower levels of the organization do the same.  The fact is, just as soon as the organization is segmented into isolated components and measured individually, non-holistic actions begin.  It’s clear that if we want to achieve our Viable Vision, according to Gerald Kendall [1] our new frame of reference must:

  •          Identify the huge leverage point
  •          Connect every action and every decision at any local level to the impact on the
  •          Remove the distortions

Just to give you a feel for what has happened in other companies using this frame of reference, in a study conducted by Mabin and Balderstone [2] of dozens of reported cases, the following mean improvements were noted: 

  • Lead time: 70%
  • Due date performance: 44 %
  • Inventory reduction: 49%
  • Revenue Improvement: 83%
  • Profitability improvement: 116%

Based upon these results, Kendall [1] tells us that “the first recommendation is: Move away from the super sophisticated, complex cost allocation system to a much simpler frame of reference.”

Kendall also tells us that “to be effective, the new frame of reference must act like a compass to guide managers, at any level, to make good decisions as indicated in the five major areas of judgement:

  • Judgement of the system as a whole. We must be able to help managers at all levels, judge the impact of a decision in their local department on the company as a whole.
  • Investment. In reality, an investment is only a tangible benefit to the business owners if additional products can be made and sold, or real costs can be eliminated.
  • Profit center. Many organizations turn a part of their company into a profit center which is a mistake.
  • Make or buy. If you are managing a plant that is under pressure to reduce costs, decisions like outsourcing to a “cheaper” source must be made based on system improvement.
  • Product cost/profit. How is it possible for a company to cut a money losing product and end up worse off than before?  When a product is discontinued, may of the overhead costs don’t go away, they’re just reallocated.

The New Frame - Part I Throughput Accounting

I have written about Throughput Accounting (TA) numerous times in this blog, but never in the context of a Viable Vision. In our new frame of reference, there really are only three global parameters required to measure management decisions at any level within the organization, namely Throughput (T), Investment/Inventory ( I ) and Operating Expense (OE).

Throughput (T) is the rate at which the organization generates goal units and in a for-profit organization, goal units are expressed as dollars ($’s).  The calculation for T is revenue received from customers in a given period minus the amounts paid for raw materials and direct expenses to outside suppliers for each piece of product sold.  And since T is a “rate,” you can express it per hour, per week, etc.

In order to generate T, a company makes an investment ( I ), both in terms of capital (i.e. buildings, equipment, computer systems, etc.) and in terms of inventory (i.e. raw material, work in process, finished goods).

The money spent by the company to turn Investment ( I ) into Throughput (T) is Operating Expense (OE).  OE includes salaries, depreciation, supplies cost, energy usage, rent, etc.

And from these three global measure we can calculate two important derivatives:

  • Net profit (NP) = T – OE
  • Return on investment (ROI) = (T – OE) ÷ ( I )

It should be apparent that we can use these parameters and calculations to judge the financial impact of most every decision.  It’s important to understand that simply removing the distortions associated with financial decision-making according to the rules of cost accounting and moving to Throughput Accounting is not sufficient enough to implement a Viable Vision, but it is an important first step.  According to Kendall [1], the next big question we must answer is “Where must we focus our resources to get the biggest leverage on company results? The fatal mistake made years ago, when Total Quality Management (TQM) was popular, was to apply the TQM process everywhere. Other popular improvement philosophies are making the same mistake. Most of these methodologies are correct, but only when applied to the right problems.”

Next Time

In my next post, we will look more into our new frame of reference as it applies to the five focusing steps.  As always, if you have any questions or comments about any of my posts, leave me a message and I will respond.

Until next time.

Bob Sproull

References:

[1] Viable Vision – Transforming Total Sales into Net Profits, Gerald Kendall, 2005 self-published

[2] International Journal of Operations and Production Management, Spring 2003

 

 

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