Theory of Constraints Handbook - James Cox Iii [302]
1. Increase or reduce Throughput (Sales – TVC)? If yes, by how much?
2. Reduce or increase Investment (Inventory)? If yes, by how much?
3. Reduce or increase OEs? If yes, by how much?
The answers to these questions determine the effect of proposed changes on systemwide measurements:
1. Throughput (T) = Sales Revenue – Totally Variable Cost = SR – TVC
2. Net profit (NP) = Throughput – Operating Expense = T – OE
3. Return on Investment (ROI) = Net Profit/Investment = NP/I
4. TA Productivity = Throughput/Operating Expense = T/OE
5. Investment Turns (IT) = Throughput/Investment = T/I
In summary, TA is an important development in modern accounting that allows managers within both private and public sector organizations to understand the contribution of constraint resources and the frequently nonlinear impact of local actions or decisions on the overall profitability and viability of an organization.
TABLE 15-5 Using TA to Show the Leverage with a 1-Percent Change in Price, Volume Sold, and Wages
Knowing the impact of changes on these variables plays a vital part in both knowing where to focus scarce resources (especially management time) and knowing how to predict the impact of changes on the organization’s profitability/viability. As an example, Table 15-5 provides a baseline case, that shows the leverage achieved in a 1-percent increase in average selling price, a 1-percent increase in volume sold, and a 1-percent reduction in wages on the Net Profit of the organization (10%, 5% and 2%).
Preventing and Correcting Errors of Omission and Commission
It was stated previously that two of the most common types of management mistakes include errors of omission and errors of commission. Another way to look at these errors is by relating the errors to whether action was taken based on a tested or untested hypothesis.
1. Errors of Commission: Doing what should not be done or acting on an untested hypothesis.
a. Do work that is not important (what Goldratt calls choopchiks9) or urgent.
b. Do the wrong thing (it will not solve the problem and may even make things worse).
c. Do too many things at the same time.
2. Errors of Omission: Not doing what should be done or not acting on a tested hypothesis
a. Don’t act because “we still have time” or “we don’t have the time (to act now).”
b. Don’t act because “we are different (it will not work here).”
c. Don’t act because “they will never agree (and without their agreement it’s a waste of time to even start).”
Using the classification of “acting on an untested hypothesis” and “not acting on a tested hypothesis,” is also useful as it helps to identify the simple solution to prevent both mistakes. To prevent errors of omission and commission we should always check (our hypothesis) before we act/don’t act, unless acting is the only way of checking.
But, how do you check your hypothesis? It starts by recognizing that every decision we make and every conclusion we reach and communicate or act on that contains the word “because” or “will result in” contains a hypothesis, such as “We should not make the offer because customers will never agree,” “Customers are buying less because our competitors have reduced their prices,” etc.
We have two ways to check a hypothesis. One is through logic, using the effect-cause-effect method to identify and then validate predicted effects. The more predicted effects are validated, the more valid your hypothesis, considering that even one predicted effect that is validated (if it could not happen by “fluke”) could be enough to validate. At the same time,