In my first post about The Goal, I described the general process of elevating the production capacity of bottleneck resources to help an organization reach its full operating potential. Today, I’ll take a brief look into the back room and go over ways to measure the progress of these techniques.
Goldratt measures an organization’s money using three simple measurements – inventory, throughput, and operating expense. He helps the reader understand these measurements by defining each in the context of money. Inventory is the money invested in what the organization will sell, throughput is the rate of money generated by sales, and operating expense is the money spent turning inventory into throughput. If we return to the pizza restaurant analogy from my prior post, inventory is the cost of every ingredient in a pizza, throughput is the amount of money generated by pizza sales, and operating expense is the cost of cooking and delivering a pizza to a paying customer.
Armed with these three measurements, anyone can understand where an organization’s money is going – the amount of money entering the organization is throughput, the amount of money leaving the organization is operating expense, and the money ‘stuck’ inside the organization is inventory. And since money is usually a reliable measure for the health of the organization, understanding changes in money can make simple yet powerful insights into the health of the organization – productivity is up if inventories go down, operating expense goes down, or throughput goes up.
Understanding an organization isn’t always so simple, of course, because it is rare for one of these measurements to fluctuate while the other two remain fixed in place (if all I know is that one measurement went up and another went down, the best I can say about the effect on the entire organization is that it is ambiguous). The value of these measurements is significant, however, because they provide global context that can illuminate the truth hidden by local metrics. Our pizza restaurant from above might boast of ‘cost efficiencies’ such as cutting down on delivery times or using less energy to run the oven – however, if the amount of pizza ingredients (inventory) measured at the end of each day continues to rise, an astute observer will know that finding a way to turn inventory into throughput is critical so that the reduction in operating expense is not offset by the rising inventory cost.
One up: As Goldratt reminds us readers a number of times in The Goal, a vaguely defined measurement is a step shy of useless. A good number cruncher will always keep this fact in mind. If a colleague comes forward seeking help with understanding a suspicious figure, a good approach is to ignore studying the calculations until all the underlying assumptions baked into the figure are understood.
The thought also links nicely to the old adage about the wizened hammer seeing a world full of nails. Just as the hammer knows it has only one song and tries to sing it whenever possible, a highly trained number cruncher is always tempted to crunch the numbers – this is what a number cruncher knows best! There is always going to be a time, though, when validating the assumptions is going to be more productive than redoing the calculations for a twenty-third time.
One down: I wrote a few posts ages ago after reading Hillbilly Elegy about cash flow so I will not harp too much more on the topic today. I’ll simply mention that no matter how strong a company’s books are from the points of view detailed above, there is usually only one solution for an organization suffering a cash flow crisis – more cash. Whenever an organization with a strong financial profile begins making strange financial moves, it is a good bet that a cash flow concern is lurking somewhere in the background.
Returns on investment are all well and good but if the cash on hand is insufficient then a business learns quickly that bankruptcy is a trump card against even the healthiest calculations of thse measurements discussed above. Cash for an organization is like air for a swimmer - even a gold medalist will lose a long enough race to any amateur if the champion is not allowed a breath.
Just saying: In my first post, I mentioned how an organization should change its decision making process based on whether its operating constraints were inside the organization (production capacity of its key resources) or outside of the organization (demand from the market). If the organization’s production capacity was causing a failure to meet demand, decisions should be made to maximize bottleneck resources. If the market was not generating enough demand, a traditional efficiency measure such as sales less material divided by man-hours was perhaps a better option in order to free up raw resources for marketing or product development.
In terms of measurements, what this idea does is take the three productivity measures outlined above and shift the focus of their metrics from revenue generation to cost reduction whenever the operational bottleneck is maximized. The organization is no longer concerned about whether throughput meets demand because, by definition, throughput is equal to demand whenever the bottleneck resource is maximized. A similar thought process applies to inventory because the amount of inventory needed to maintain throughput should become increasingly stable whenever demand is a consistent leading indicator of upcoming throughput. And if the underlying rates associated with operating expenses do not change, the fall in inventory should naturally lead to a reduction in operating expense.
