You Can’t Spot Serious Shareholder Value? … Check Your Paradigms - I

 

By Rudolf Burkhard; winner of the 1999 PricewaterhouseCoopers award for the best article on shareholder value add

Summary:

Executives are under too much pressure to spend time looking for and developing new and better solutions to running their business. They are aware of the need to manage their business as a system but on the whole do not do so, because they are lacking the tools to do so. Goldratt’s five focusing steps are a way to solve this missing capability by focusing on the very few constraints any (business) system can have. Policies (the way things are done) are key constraints to better profits and improved SVA and many need to be changed. Some examples show how policies from the past are blocking businesses from earning much better SVAs.

1. Introduction

There is an explanation (attributed to Dilbert) why top executives make so much money going around the World Wide Web. It begins with two statements that we all know and believe. They are “Time is Money;” and “Knowledge is Power”. The engineering formula that “Power equals Work divided by Time” completes the premises. So, when we substitute Power with Knowledge and Time with Money we get the new equation that “Knowledge equals Work divided by Money”. Solving this for Money we get: “Money equals Work divided by Knowledge”. So the conclusion is that - as Knowledge approaches zero, Money goes to infinity – explaining executive salaries!

Not very flattering if you happen to be a senior manager! However before we dismiss this Dilbert impudence we should consider that behind humour lurk real problems. (Russians are famous for innumerable jokes critical of their political system and politicians and with good reason.) Dilbert often puts his finger on some painful truths, so maybe we should look for the real problem(s) hiding behind this story. Maybe understanding it will lead us to some very significant shareholder value.

Over at least the past thirty years there have been a number of studies trying to understand how busy executives manage their jobs. No one was really surprised to learn that most top-level managers address a large number of issues every day, and influence or make many decisions. We also learned that these people do not solve every problem or issue from scratch – they use their vast experience to respond quickly to almost any situation. They use paradigms - guidelines and rules developed from experience. Could this be bad? Relying on paradigms inevitably prevents (or at least slows down) a person from developing and applying new knowledge. Maybe this inertia, sticking to paradigms, is why managers’ knowledge seemingly approaches zero over time.

Every management problem actually requires two decisions – the decision that solves the problem itself, and the decision of how to solve the problem. Should a manager solve the problem from scratch or use paradigms he is used to and has been successful with? This second decision is what interests us here, because it defines whether or not an executive wants to (or can) improve. Should he invest his valuable time in developing better (more competitive) solutions or should he use his paradigms to arrive at a quick solution – and move on?

All executives are acutely aware of the need to look for better and better solutions. If they do not, they are putting their business in danger. If they do look for better solutions they could also be putting their business at risk, because some important problems or issues might not get addressed or should not be entrusted to others. Executives always face this contradiction. Should they look for and try new and better ways, or should they stick to what they know? The dilemma is – to question, or not to question (paradigms).

Niccolò Machiavelli describes it very well in ‘The Prince’:

“It follows that an acceleration in the rate of change will result in an increasing need for reorganisation. Reorganisation is usually feared, because it means disturbance of the status quo, a threat to people’s vested interests in their jobs, and an upset to established ways of doing things. For these reasons, needed reorganisation is often deferred, with a resulting loss in effectiveness and an increase in costs.”  Reorganising our paradigms, our thinking, is no different from reorganising an organisation and just as difficult to achieve.

E.M. Goldratt claims that every contradiction or dilemma can be ‘evaporated’ – that there can be no contradiction in reality. Just as in the physical sciences, we should examine our contradictions to find the flaw that will eliminate them. He demonstrates that behind all conflicts, dilemmas and contradictions there is a series of assumptions underpinning both sides. All it takes is to find an invalid assumption, or have the ability to invalidate an assumption, and the contradiction disappears – it “evaporates”. In the above dilemma executives assume (implicitly) that their business is very complex and only they have the ‘big picture’. So only they have the vision and capability to attend to the many different problems facing their business. Goldratt contends that businesses are really quite simple. There are, in fact, almost never more than one (1) or two (2) things blocking a business from achieving more of its goal – the goal to make (more) money (SVA) now and in the future.

This claim, if true, greatly simplifies an executive’s job. Suddenly he can focus a high percentage of his attention on just two things. What a revelation; what a relief; and what a simplification. Now he can really concentrate on new ways to address those most important issues. With executive focus things do get done. He will spot and achieve serious shareholder value.

However, why should the claim be correct? Is the whole world wrong in its view of business? Well, much of the business world has embraced the idea of ‘Systems Thinking’. We all know a business is a system of interdependent functions and that a business should be managed in a holistic way. So, we can look at a business as a chain – with many interdependent links. All a businessman has to do is to look for the constraining function of his business – the weakest link. There will always be one. Rarely if ever will there be more than two. Too many constraining factors lead to chaos in a system making it very difficult to control.

Therefore, to spot serious SVA executives have to first find the constraint(s) of the business. This is the first of Goldratt’s Five Focusing Steps of continual improvement. There are four different types of constraints – physical constraints within the business, a supply constraint, a market constraint (the market will not buy all we can sell) and policy constraints. Policy constraints, the way things are done, are probably the most important and least understood.

What is the most frequent response to a physical constraint? Often it is to invest in more capacity. Is this the correct response? Of course not! The direction must be (and this is Goldratt’s second focusing step) “what decision(s) must I take to exploit the constraint?”  This decision will, if implemented, ensure that the output of the system is maximised. Nothing less will do. If a business were to invest before it knows how much can be wrung from its constraint it could very easily spend money unnecessarily – hurting SVA.

To implement the exploit decision we must now subordinate everything else to the above decision (Goldratt’s third step). This is a huge paradigm shift for many managers. How many times have you seen a sales director subordinate to manufacturing, or vice versa? How often does the constraining resource determine what will be done? However, for really serious SVA every executive must get the most from his constraints – which necessarily means subordination by the rest of the organisation.

If the constraint is still in the same place after it has been fully exploited it is time to elevate capacity by investing money (the fourth step). Only now do you know you are investing in the right place. When a business adds capacity and/or breaks the constraint – the whole situation changes – all the things it knows about a business need to be re-evaluated!

The last of Goldratt’s five focusing steps is simply: If during any of the above steps the constraint is broken go back to step one. BUT do not let your inertia (your paradigms about your business system) become the systems constraint! This caution is extremely important. We must re-evaluate all our assumptions about our system – or we will make grave mistakes and leave really serious SVA on the table. It appears that questioning our paradigms should be very high on every manager’s agenda.

Goldratt has given us an approach to address a business' constraints – at least for the three first types. Policy constraints are different. If you find one – get rid of it, or make it appropriate for your current situation. The other four steps are not valid for policy constraints. Many policy constraints make our life difficult. Many of these policies are not even written policies – they are just ‘the way things are done around here’ or simple behaviours we have all become used to. No matter, they are hurting our SVA, our earnings. We must change them!

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Technorati Tags: Strategy and Tactics, Theory of Constraints, TOC

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Technorati Tags: Strategy and Tactics, Theory of Constraints, TOC, Focus

Technorati Tags: Focus, Strategy and Tactics, Theory of Constraints, TOC, Continual Improvement, Shareholder Value Add, SVA

Technorati Tags: Continual Improvement, Focus, Shareholder Value Add, Strategy and Tactics, SVA, Theory of Constraints, TOC, Goldratt