Goal: Making Money Now and In the Future
What is the Goal of a business?
This is the first question to answer in order to establish a process of on going improvement (POOGI). The goal must be clear, simple and measurable, and it must be understood by all players in the organization, who are involve somehow in improving the system.
A general goal could be something like this “To make money by increasing net profit, while simultaneously increasing return on investment, and simultaneously increasing cash flow.” as told by Alex to his team members in The Goal novel written by Dr. Eliyahu M. Goldratt. (in short making money now and in the future.)
Therefore, any action that moves the organization toward this goal is productive and any action that takes the organization away from it is non-productive. (this is not the same as efficiency, forget efficiency for now, this is about productivity and effectiveness, I deal with efficiency later).
Actually, such a goal can be applied to many for profit organizations. Let’s take an Advertising Agency as an example. For such an agency Customer Satisfaction is critical but it may not be the goal. In fact, main goal (making money now and in the future) is dependent to customer satisfaction. Therefore any action that increases customer satisfaction will take the organization toward increasing net profit, return on investment and cash-flow.
Eli Goldratts has also proposed an alternative to traditional cost accounting to measure and monitor the goal and implemented changes in the “entire” organization and “the system”; called Throughput Accounting (TA). TA has been applied to many industries and hundreds of research papers and case studies have been written about it, but here it is in short:
TA focuses on three main measurements and their relationship together: throughput, Investment and Operational expenses.
Throughput is the rate at which the system generates money through sales. Throughput is through sales and not production, if you produce and not sell, it is not throughput.
Inventory is all the MONEY that the system has invested in purchasing things which it intends to sell. This could be Raw materials, machinery, premises, finished goods, work in progress (WIP), Ideas, requirements and etc. Therefore, a high level of inventory in the system causes a high level of liability as inventory consists of items such as unfinished work, unrealised ideas, unfinished products and undelivered projects.
Operational expenses is all the money the system spends in order to turn inventory into throughput. Such as labor cost.
Measurements used by TA ensures all improvement, changes and actions focus on the ultimate goal of the whole system and organization as its entirety. Based on TA, the longer it takes to produce a product or completing a project the higher the inventory; high inventory results in low Return of investment and cash-flow which it is against the Goal. Therefore, TA promotes faster production and faster project delivery.
It is important to know that the goal of TA is not to treat each measurement in isolation, the goal is to reduce operational expenses and reduce inventory while simultaneously increasing throughput for the entire organization or system.
Based on the above, you may conclude that to stay focus on the goal and therefore simultaneously improve three TA measurements, we should have a balance system, meaning we have to match the capacity of each and every resource to market demand.
However, Goldratt demonstrates that there is a mathematical proof which could clearly show when capacity is trimmed exactly to market demand, no more and no less, throughput goes down, while inventory goes through the roof and therefor your organization goes away from its main goal (i.e making money now and in the future).
The combination of two phenomenons cause a balance system to fail and a system or organization with excess capacity to succeed: Dependent Events and Statistical Fluctuation.
Dependent Events: Series of events that must take place before another can begin, the subsequent event depends upon the ones prior to it.
Statistical Fluctuation: Not all factors in the system can be predicted precisely, and therefore there is a different statistics for each event to occur at any single time.
Events depend to each other and rarely they occur one after each other one at the exact time. Many factors may impact the duration of one event. Things happen at various speed at different times, the accumulation of such fluctuation impacts the whole system. So, when you combine dependent events and statistical fluctuation phenomenons, you understand that balancing a system or organization will not work by matching the demand to exact capacity.
As, statistical fluctuation will strike and system will not have excess capacity to recover delays and accumulated fluctuation will increase work in progress, as a result operational cost goes up ,and return on investment goes down; and organization goes away form the goal.
To establish Process of Continues Improvement, you must set a clear and measurable Goal for the entire system
The goal must cover the system as it’s entirety, not one department, but the whole organisation.
The goal must be measurable based on throughput accounting principles.
Throughput accounting focuses on three measurements and their relation : Throughput, Inventory and Operational Expenses.
The goal of throughput accounting is NOT to focus on each measurement in isolation, they are deeply interrelated.
Throughput Accounting promotes fast production and fast project delivery.
Matching demand exactly to resource capacity to have a balance system will imbalance the entire organisation, because of the combination of the two phenomenons: Dependents Events, Statistical fluctuation.
Excess Capacity on resource level is Good and Necessary.