Theory of Constraints Handbook - James Cox Iii [266]
Measurement is largely executed to judge performance. Unfortunately, even a judgment as seemingly straightforward as profitability could be disastrously flawed. One example is the common valuation of inventory as it relates to profitability within measurement periods. For decades now, we have known about the negative consequences associated with too much inventory—increased costs, decreased flow, damaged goods, etc. However, how do we judge it on the balance sheet? Not only do we value it as an asset, but we “add value” to it as we absorb labor and overhead into the inventory. This means that companies can build inventories and declare a profit without the sales to support it.2 This means that a dramatic attempt to decrease inventory for improvement in flow and Throughput can result in the punishment of these “go getters” for poor short-term profitability performance or low absorption rates. Yet, at the same time, inventory tends to be a critical measurement within measurement periods as well. Trying to balance these competing factors can lead to absurd behavior. We worked with a company a few years back that would refuse the receipt of incoming inventory at the end of every month (a measurement period) only to expedite it a week later and work overtime to attempt to meet on-time shipments. What impact does this have on cost? What is the impact on on-time delivery performance? They knew this behavior was painful to the organization and yet felt their hands were tied by the corporate measurement. Ironically, when you sit down with a CFO or Controller and explain the cause-and-effect logic of what is happening they often scream, “What!? That’s not what we want them to do!” Is this a situation of conflicting measures? Yes. Is it a poor interpretation? Probably. Does it demonstrate a lack of an effective feedback and accountability system? Unquestionably yes.
The Constraint Is the Primary Relevant Factor
There is a single factor determining the flow through production and to the market. This same factor gives us the assumptions that underlie the cost and revenue opportunity of any potential action or investment. That factor is the constraint. The constraint could be a resource, raw material or purchased part, a skill set, a policy or procedure, a measure, etc. Information about the constraint is what is relevant. Information on the impact that any option has on the constraint is critical to a measurement system and it should point to actions that, when taken, will provide a bottom-line return.
Constraints change how we judge product profitability, short-term profit maximization, ROI, capital, inventory, and manpower. Constraints impact the rate at which an organization can make money—they are a system’s leverage point. This is why having a TOC logistical system and its associated measurements is so vital for operating decisions and improvement in a logistics environment.
TOC is a methodology and a set of processes to maximize a system’s ROI/RACE equation by employing solutions that identify, exploit, and manage a system through its leverage points and their interactions with each other.
When considering any alternative actions, plans, or improvement projects:
1. Consider the impact on the constraint’s performance. This includes knowing if the constraint will move because of your decision and if so, where and what are the implications?
2. For every investment we must know how the economic return will be generated. Will the market buy more products or will there be any reduction in investment (e.g., strategic inventory buffers) or OE?
Cash inflow versus cash outflow should be one of the primary parameters of decision making. The true implications of any assumptions of the system should be judged against “cash in” and “cash out.”
Using the simple performance measures defined previously