Do the numbers that you look to navigate your improvement journey give you the right picture?

The din about Management Accounting practices, especially those related to Product Cost Accounting, not helping at all the leaders / top managers as well as operational managers, has been around for quite some time.

Dr. Eliyahu Goldratt in his famous 1983 presentation at APICS proclaimed “Cost Accounting is enemy number one of Productivity”.

Tom Peters’ published an article in 1987 “The Accountants Are Letting Us Down” where he gave numerous examples how the Cost Accounting numbers instigate the operational and top managers to take decisions and actions which are detrimental to organisation’s medium term performance as well as long term endurance and survival.

Many decades before the above two, Henry Ford had stated his “common sense” principle – “We should not let Cost Accounting run the business!”

Even Taiichi Ohno, founding father of the Toyota Production System was quite alergic to cost accounting. He famously said – "It was not enough to chase out the cost accountants from the plants. The problem was to chase cost accounting from my people's minds"

If such has been the vehemence with which certain practices are being continuously denounced, what keeps these practices afloat? 

As per The American Institute of Certified Public Accountants, both IFRS and GAAP recommend direct production cost and overheads allocation to arrive at value of the inventory. http://wiki.ifrs.com/Inventories (See 13.8 and 13.9). This is precisely at the root cause of some of the distortions and incorrect decisions.

Still the "authority" recommends!

Completely beats me.

Can someone throw light on this?

Efforts to strengthen links other than the weak link are wasted

According to a survey of manufacturing executives conducted in May and June 2011 by AlixPartners, the global business-advisory firm.

•  Most large manufacturers last year failed to reach their cost-savings targets, despite significant investments in lean manufacturing, Six Sigma, and other productivity programs.
•  70 percent of manufacturing executives say that their manufacturing-improvement efforts led to a reduction in manufacturing costs of less than 5 percent, the typical minimum threshold for successful productivity programs.
•  36 percent of respondents indicated that their cost savings due to productivity efforts were 3-to-4 percent of total manufacturing costs, while 18 percent said their savings were less than 2 percent.
•  Fully 14 percent of manufacturing executives said they didn’t even know how much they were saving through their productivity-improvement efforts.
•  Illustrating a gap between industry perception and reality, 91 percent of the respondents described their improvement efforts as “very effective” or “somewhat effective.
• 60 percent of the respondents believe that half of the savings that they generated last year will be unsustainable.
• Only 13 percent said they could sustain more than three-quarters of the identified savings.
•  Most of the respondents worked at companies or divisions with annual revenue of more than $500 million, with some two-thirds of the participants based in the United States. Nearly half of the respondents oversaw operations that generated more than $2 billion in annual revenue.
• The survey also found deep skepticism that productivity-improvement investments would be recouped quickly. When asked to identify their average annual return on their continuous improvement investments, only 15 percent cited a full payback within one year. Four in 10 respondents simply aren’t sure when it comes to an expected return on investment.

The study findings are not very surprising. 

In fact, it is predicted that unfocused efforts would disappoint.

Parts of organisations are interlinked. Total output (Throughput) produced by an organisation is outcome of these interconnections.

Late Dr. Eliyahu Goldratt gave an analogy of chains for viewing functioning of organisations. There are two possible ways at looking for improvements in a chain.

•  Improvement in weight  
•  Improvement in strength.

If we look for improvement in weight of the chain then every improvement in all the links would add up to the total improvement.

But, if we look for improvement in strength of the chain, the above additive feature does not hold true. The strength of the chain is governed by the strength of the weakest link. So only the improvement efforts to increase the strength of the weakest link would result in improvement in the strength of the chain. 

The efforts put into increasing strength of links other than the weak link would be totally ineffective.

Working on weight of the chain is equivalent to working on COSTS. Cost reduction efforts are additive in the first glance.

Whereas, working on strength of the chain is equivalent to working on THROUGHPUT. Throughput improvement efforts need aligning the entire organisation to focus on a very few things which are important.

An organisation not having a mechanism to focus its improvement efforts courts two dangers:

1. If it fails to improve the weak link, then it is deemed UNRELIABLE. It does not live up to the promise of delivering the projected improvements.
2. If it fritters away the resources in strengthening links other than the weak link, then it is deemed INEFFECTIVE. It wastes away costly resources.

I agree with Andrew Csicsila, director in AlixPartners’ manufacturing practice. Ultimately, it’s not about chasing a process or philosophy. It’s about the  CASH.

Expect results only when the efforts are focused on the above  GOAL.

How does nature synchronize planning and execution?

30K Feet view - Organizations as flow entities

History bears witness that rivers have played a very important role in making and sustaining ancient civilizations. Rivers offered two main advantages to a developing civilization. They provided water to irrigate the fields, and they offered the easiest method of transport for a society without paved roads.

Can this lesson from history be useful for identifying what organizations need to do to be successful?

Can we imagine a similarity here?

The profit potential for various stake holders as water for irrigating the fields and the movement of material as a method of transformation for the society.

Organizations – A flow concept

A satellite image of a river basin depicts how water from various sources (tributaries) combines to form a river which flows some distance and then again gets divided into distributaries. The water flows from origin of river towards the ocean under the force of gravity. Every drop of water that vacates space by dissolving into ocean is replaced by another drop from the source. It is a perfect ‘pull-mechanism’.

If we take a thirty thousand feet view of most manufacturing and distribution organizations, it would resemble the image of the river (Production Operations) with all the tributaries (raw material and component vendors) and the distributaries (supply chain channels) to reach sea ( end customers). Once we take this view, it becomes clear that the organization is well served by making the flow even across the whole system and then finding ways of increasing the flow.

Current practices in planning and execution - overview

An important aspect of this view is that the flow, in case of manufactured products, is decided by the end customers who chose to buy or not buy a particular SKU. What is visible has a chance to be sold. Only when a product is available at the retail shelf, it stands a chance to be in the consideration set for the buyer.

Although, on the surface it might appear that it is various decision makers in the organization who influence what would be sold and what would not be sold, where and when, slightly scratching the surface, we would realize that such a notion is highly delusionary. The known facts of surpluses and shortages, as well as many new products failing to catch the fancy of customers at the retail end, clearly point towards the inevitable conclusion that most of the times the decisions taken are wrong.

We tend to read this phenomenon as an indication that our decision making process is imprecise or the inputs required to arrive at the decisions are incomplete. We continue to refine our decision making models by taking feedback from the variances in what was planned and what actually happened. We also try to increase the variables and the inputs we use in our models to arrive at the right decisions.

We also notice that the two activities of planning and execution are taken as very separate activities and in most of the cases, done by different set of people. The planning functions with their precise looking models hold an upper hand. The plans created for the year or quarter or month are taken as a benchmark and the variance is calculated by comparing how the actual strayed away from the plan due to improper execution. Sometimes, a concession is given to accommodate the fact that there is possibility that the plans are not correct by creating what is known as rolling plan. The rolling quarterly plan would mean that the immediate month plan is fixed and the remaining two month plan is open for change based on new inputs as well as how the actual pans out for the first month.

There are two levels at which exercise of planning and execution goes on.

The first involves regular operations and it involves which SKU in what quantity would be sold in which retail outlet in a particular period of time. This involves regular conversion of raw materials into finished goods and transferring the finished goods closest to the point of planned sale. There is an element of certainty in the plan which guides us to move entire planned quantity to the location closest to point of sale.

The second level involves conversion of ideas into new products and preparing the operations to roll out the new products. Again very precise plans lead to reserving operation capacity and even raw materials based on new product production plans.

The game of catching up between the planning and execution continues month after month, quarter after quarter and year after year. Even when, with lot of hard work and ingenuity execution is close to the plan, we have mechanisms to cover up how the plan did not live up to the actual or in other words “Reality”. We cheer the shortages by labeling them “Sold Out” and the surpluses by labeling them opportunities to get new customers through “Discount Sale”.

It would be worthwhile to step back for a moment and examine the basic premise of any plan as depicted above. We realize that all planning activity is founded on a notion that we can come up with forecasts which are reasonably accurate and also it is possible to make very precise forecast drilling down to the SKU, place, and period etc level.

It seems reasonable that we have to have an overall forecast, based on PESTLE (Political, Economic, Social, Technological, Legal and Environmental) factors,  to provide us a direction in which the market as a whole is likely to move in next few quarters.

But taking this larger forecast and breaking it down into precise plans at SKUs level stretches the limit of credulity that we subject ourselves to.

We take these SKU level precise looking plans and inflict them on the people who are responsible for execution, sales and production. It is a given that the actual would always to different from plan. But instead of questioning the planning processes or the planners, it is the people on the field or the shop floor who have to come up with the reasons for ‘variances’ during the regular ‘reviews’ – monthly, quarterly, annual. We throw scarce and costly resources (top management time)in this futile exercise and continue to exert efforts to live up to the plan. We observe in most such review exercises a lot of time is devoted on understanding how the variances have panned out and then arguing on variety of hypothesis on why this has happened. A very little time is then devoted to how best to move forward into future. The moving forward into future is always within the boundary of the plan.

 An annual business plan becomes a sacred document and is used to decide various incentives. The linkage of individual rewards based on performance against the plan creates a new level of gaming that goes on in the organization. People know that the plans being asked from them are most likely to be bumped up and converted into targets which they would have to meet. People tend to under project as they know that there will be demand to have stretch target and there will be some increases. At the time to of execution also people tend to be conservative and moment they are closer to achieving the target; they try to limit the actual within 10-20% above the plan. They know that next year’s target would be based on this year’s actual. If they are likely to continue in the same organization in the same role, it would create an difficult situation when they have to achieve even higher target. We find it very rare that someone goes 100% or 200% above plan.

A better way?

Going by the above analysis, it would appear that detailed planning for production, supply chain and procurement based of forecasts, and executing the operations to meet these plans is quite unproductive. We have to find a way if at all it is possible to function without forecasts or with minimal forecast at the broadest possible level.

For that, we need to understand how the practice of generating forecasts came about. We realize that initially forecasts were required when the mode of communication and transportation were primitive and there was a huge distance in terms of space and time between production and consumption. In other words that all the components of lead time – Order Lead Time, Production Lead Time and Transportation Lead Time were large due to the status of the available technology of production, transportation and communication. Practice of forecasting was developed to overcome the limitation that businesses had to operate with i.e. execute for demand for products based on information which was delayed by a long period of time.

Over the period these technologies have improved manifold. But organizations continue to follow the ‘business rule’ created at a particular time when power of technology was limited. This ‘business rule’ is treated almost like a commandment – “There shalt be a forecast and thou shalt strive to achieve the forecast”. With the advent of technological advances, especially those in Information and Communication Technology, it is time to relook at the efficacy of the business rule of forecast.

The limitation need no longer be there. Can the business operations work to meet the reality as it actually unfolds rather than having a fixed notion of forecast based plan? Can we establish a ‘pull-mechanism’ to dictate what the upstream needs to supply?

Does it drastically change the way organizations are run?

A simple reflection will tell us that the nature of transactions will not change at all. Procurement will continue to deal with and place purchase orders on vendors, operations will continue to convert raw materials into finished goods and ship them to market, sales and marketing people will continue to be on the field to improve sales and marketing of the products. Only the decision making criteria for these functions would have to be reworked.

Planning and execution would be perfectly in synch.

Are you making the most from your ERP?

When it comes to technology there are three ways of adopting it.

The first one is to naively believe in a magical technological solution for leading your business to increased productivity. You will be quickly placed on an IT company's sucker list that's labeled, "They'll buy anything."

The second is to be genuinely interested in doing the right thing. But, beware of being unwittingly surrounding yourselves with IT hotshots who are interested in having the opportunity to play with the latest technology and brag to their friends about how IT-cool they are. These brilliant nerds would willingly bankrupt your company in order to have the latest, greatest, best and most cutting-edge technology.

Finally, there is more sober way to be prepared to embrace and invest in technology as a tool when you understand exactly how you'll be rewarded by significant improvement in your company’s competitive advantage, nothing less. A Rupee invested in IT should be expected to return not less that 1000% ROI if not more.

Take the case how one of the companies understood the power of RFID scanning system for one of its huge distribution centers, fifteen football fields in size. They realized they'd be able to receive a pallet from a manufacturer, scan it and move it onto one of their dispatch trucks in as little as eight minutes, They were ready to move ahead. The scanning system they finally decided on increased productivity more than 15 percent and paid for itself within two years.

Is the above example a good enough case to decide the connection between IT investment and productivity improvement? Should the company stop looking for possible changes/improvements beyond the immediate vicinity where the technology is installed?

We would say that the company has left a huge value addition on table that is possible after introducing such a powerful technology in their arsenal. The company needs to analyze if the technology is necessary then what else it needs to do to make it sufficient to get extraordinary returns from the adoption of technology. We call it Necessary and Sufficient Thinking inspired by Dr. Eliyahu Goldratt’s novel – Necessary but not Sufficient.

THE REALITY:

Many problems are experienced with the implementation and use of new technology. These problems create great losses in time and money and can cause that the benefits expected from the new technology is never fully realized.

A well-known example is the implementation of the complex technology of ERP.

Many studies have been conducted around the experiences of various companies who have attempted to implement ERP. Some of the studies have asked the questions: “What are the factors causing small and medium enterprises (SMEs) to hesitate in adopting technology that is widely recognized as critical to any organizations’ profitability?  Is making the change considered too difficult, too costly or too risky at the present time?” The answer to these all the questions is all of the above. The experience of SMEs world over with implementing ERP has been patchy at the best and downright waste of money and time for majority of them.

A study published in International Journal of Computer Applications list critical success factor for successful ERP implementation in SMEs. These include: Top management support, highly competent project team, right implementation scope, management program change, data accuracy, education & training.

This, in other words, means impossible for any SME.

Necessary & Sufficient Solution:

Necessary & Sufficient solutions claims to provide a process to ensure new technology implementations will have real bottom line benefits.  But what is the Necessary & Sufficient Solution?

Dr. Eliyahu Goldratt, famous author of the book -The Goal, approaches the aspect of implementing and using new technology in his book Necessary but not Sufficient.  He makes use of simple statements to distinguish between the concepts of necessity and sufficiency of a new technology.

The first statement is:

Technology can bring benefit if and only if it diminishes a limitation

When considering a new technology, this statement implies the following: A new technology should only be considered if it would diminish a limitation. Because if the new technology does not diminish a limitation it will not bring any benefit. And if the new technology does not bring any benefit, then it is not necessary.

The second statement:

Technology is a necessary condition but it is not sufficient.

The concept of sufficiency creates awareness of the additional activities /aspects  that are necessary to ensure the successful implementation of technology. (Goldratt focuses on this activity of changing the rules that recognize the existence of the limitation).

Let’s return to the basic question: Are the benefits expected from the new technology guaranteed by the mere installation of it?

Goldratt states that the existence of the limitation is recognized and accommodated by customs, habits, measurements, policies, behaviors and measures (collectively referred to as rules).

If, as part of the implementation, it is neglected to address these modes of behavior (rules) it means that the new technology is used in an environment that still assumes the existence of the limitation. 

Therefore, the rules will impose a limitation and if the rules are not changed the full benefits will not be realized.

To practically implicate the concepts of necessity and sufficiency, Goldratt formulated four simple questions that should be answered in order to help achieve the successful implementation of new technology.

The four questions are:

1.         What is the main power of the technology?

2.         What limitation does this technology diminish?

3.         What rules helped us to accommodate the limitations?

4.         What rules should we use now?

Goldratt has applied the principles of the “Law of Necessity and Sufficiency” to the ERP environment.  He has answered the four questions for ERP and has even gone so far as suggesting a strategy that ERP providers and integrators should follow to ensure that the complex technology is successfully implemented to ensure fast and significant bottom line improvements for the customers.

ERP IMPLEMENTATION METHODOLGY

Enterprise resource planning (ERP) is an integrated computer-based system used to manage internal and external resources including tangible assets, financial resources, materials, and human resources. It is a software architecture whose purpose is to facilitate the flow of information between all business functions inside the boundaries of the organization and manage the connections to outside stakeholders. Built on a centralized database and normally utilizing a common computing platform, ERP systems consolidate all business operations into a uniform and enterprise wide system environment.

The above-mentioned 4 questions are answered for the ERP implementation environment:

1.         What is the power of the technology?

The power of ERP is its ability to handle data. This means storing, transfer data between silos and retrieve data. This is many orders of magnitude better than technology previously employed – the paper technology.

2.         What limitation does it diminish?

The limitation with which organizations had to live with before ERP is: the necessity of any manager (at any level, in any function, in any organization) to make decisions without having all the relevant data.

The technology that diminishes such a huge limitation should bring enormous benefits.

3.         What rules helped to accommodate the limitation?

The rules developed to by-pass this limitation helped to make decisions based on the existing data generated and accessible in local vicinity. These are the “local optima rules”. Since the limitation existed for every manager, it is no wonder that we find these “local optima rules” in every corner of the organization. Some of these “local optima rules” are:

a.         Economic Batch Quantity for Production

b.         Min-Max and reorder level for Purchase

c.         Evaluation of production worker and machines based on efficiency and utilization.

d.         Product Cost for calculating product margin of Sales

e.         Artificial P&L accounts for SBUs, Divisions, Functions etc which share significant common services

f.          Activity Based Costing to attempt reducing the distortions created by Cost Accounting based allocation of overheads.

These are very sensible rules and have given very good results as compared to arbitrary or random decisions. By implications, if even after implementing ERP, these rules remain, then the company would be operating as if the enormous power of technology is not at all harnessed and the company operates within the limitation that existed before implementation of ERP.

4.         What the rules that should be used now?

Local optima rules help to decide what is good for the ‘local’ in the fond hope that what is good for the 

‘local’ is also good for the ‘global’ or ‘total system’. The reality is that that good for different ‘parts’ are in conflict with each other. For example “Economic Batch Quantity” results in increase in inventory and lead time which conflicts with global goal of increasing profits and reducing response time.

The new rule need not be very complex. As every manager in any function, department, level has access to all the relevant information, the decision criteria would be common to everyone and simple to understand.

This decision criterion relates to what is good for the Global or “Total System”. The priority that needs to be followed by every decision maker for all types of decisions – operational, tactical or strategic is as follows:

a)         Priority One: How to increase Throughput (T) of the system?

b)         Priority Two: How to reduce Inventory or Investment (I) in the system?

c)         Priority Three: How to reduce Operational Expense (OE) of the system?

The new rules as described above are converted into practical method by Goldratt in the shape of Drum-Buffer-Rope and Critical Chain Project Management. For supply chain operations new metrics like Throughput Dollar Days and Inventory Dollar Days are suggested to increase reliability and effectiveness of the complete system.

Any organization which has adopted the above approach to plan and implement ERP has reaped returns which are far superior to the current approach of using ERP to adopt or make minor modifications to existing ways of working and just automate what the organization has been doing for ages.

Works Cited

Upadhyay, Parijat, et al. "A Comparative Study of Issues Affecting ERP Implementation in Large Scale and Small Medium Scale Enterprises in India: A Pareto Approach." International Journal of Computer Applications (0975 – 8887) (Volume 8– No.3, October 2010).

http://www.ijcaonline.org/volume8/number3/pxc3871670.pdf

Guru of common sense

Sixty-four years ago a giant was born. Eliyahu Moshe Goldratt (March 31, 1948 - June 11, 2011)

Dr. Eliyahu M. Goldratt spent his entire adult life fighting to show that it is possible to make this world a better place. We must have the honesty to see reality as it is, we must have the courage to challenge assumptions, and above all, we must use the gift of thinking. Having applied these principles to various management fields, he created the Theory of Constraints. His concepts and teachings have expanded beyond management and are being used in healthcare, education, counseling, government, agriculture and personal growth - to name a few fields using TOC. His legacy is invaluable.

On June 11th, 2011 at noon, Eli Goldratt passed away at his home in Israel in company of his family and close friends.

The strength and passion of Eli allowed him to spend his last days sharing and delivering his latest insights and breakthroughs to a group of people who have committed to transfer this knowledge to the TOC Community during the upcoming Theory of Constraints International Certification Organization Conference in New York.
It was Eli's last wish to take TOC to the next level - truly standing on the shoulders of the Giant he is.

"I smile and start to count on my fingers: One, people are good. Two, every conflict can be removed. Three, every situation, no matter how complex it initially looks, is exceedingly simple. Four, every situation can be substantially improved; even the sky is not the limit. Five, every person can reach a full life. Six, there is always a win-win solution. Shall I continue to count?"

The onus to carry forward the torch of clear thinking is on the followers. Hope we are adequate and live up to the responsibility. http://deepaknagar.blogspot.com/2008/12/three-habits-of-highly-effective-clear.html