Theory of Constraints Handbook - James Cox Iii [265]
2. There are no formal metrics or there are significant gaps in the formal metric system. This means resources tend to drive behavior around how they perceive they are measured or believe they should be measured. In the absence of a formal metric, this perception is often driven by a resource’s own view of what the right thing is. This creates the opportunity for conflicts driven by interpretation or assumptions.
3. There are formal metrics, there are no conflicts in those metrics, and there are no significant gaps between those metrics but there is no effective feedback and accountability system. Many of us can probably remember coworkers who did whatever they wanted to do regardless of what they probably should do with little or no individual consequences. Additionally, many of us can remember a situation in which behaviors persisted according to a metric that was obsolete. Why was the metric still in place? There was no effective feedback system to point out that it needed to be changed or eliminated.
The question becomes, how do we set up a formal and coordinated system of metrics without significant gaps and conflicts with clear feedback and accountability?
This chapter is organized into three sections. The first section explores the basic global metric dashboard that companies should use to facilitate and judge progression in relation to the goal. The second section outlines the basic coordinated local measure dashboard that supports the global measures. The final section lays out how to build an effective feedback system to drive visibility and accountability in order to better resolve any remaining dilemmas and drive continuous improvement.
Global Metrics
This chapter assumes that a company has a defined goal and strategy. If there is no defined goal and strategy, then why measure anything? See Chapters 17, 18, and 19 in this Handbook for company goals and strategy.
Critical performance measures at the global level ultimately boil down to one basic measure of performance; some form of measure for return on equity. The specific return equation that a company uses is essentially irrelevant. Common measures are ROI, RACE, return on capital employed (ROCE), and return on assets (ROA). Essentially, two components come together to create that equation in whatever forms the company has chosen to use:
FIGURE 14-3 The components of ROI.
A measure of profit. Profit can be derived simply by the equation of Throughput (T) minus Operating Expense (OE). Throughput is calculated both at the aggregate and product levels by taking sales dollars minus all direct variable costs. Direct variable cost (also called totally variable cost) is any expense that has a one-for-one direct relationship to the product or service, raw materials, freight, sales commissions, etc. OEs are all of the expenses of a business other than the directly variable cost of the product. This accounting approach eliminates the distortion in earnings between periods when the product produced is greater or less than the product sold by eliminating the allocation of fixed costs to inventory. This approach does not reward the building of inventory that does not protect either current or seasonal future Throughput. This approach better aligns cash flow of the period with the income statement of the period.1
A measure of investment or capital employed. Capital employed has many definitions. In general, it is the capital investment necessary for a business to function. It is commonly represented as total assets less current liabilities or fixed assets plus working capital. In most companies, there are two predominant factors in the investment equation. The first is the total amount of inventory. The second is commonly referred to as Property, Plant, and Equipment (PP&E).
Figure 14-3 shows the global metric hierarchy.
Effectively deploying these metrics, however, requires