The 5 Steps to Focus - The Limiting Factor Step3 (B)

In business, what is focus? The objective or goal of most businesses is to make money – as much as possible now and even more in the future. Every manager and every employee is (or should be) focused in a way that achieves that. My question is: Are all managers correctly focused to make as much money as possible now and in the future?

If I where to ask almost any manager in any business I believe the answer I would get is an incredulous look for such a silly question. Of course that is their focus.

Nevertheless I am quite sure that the majority of managers, while focused, have the wrong focus (sometimes what is called focus is something like focus on everything). Their company’s bottom line is damaged.

(I owe the 5 Focusing Steps to Dr. Eliyahu M. Goldratt)

 

The Limiting Factor is the Market – What then?

If the limiting factor is the market then the business will not have an internal bottleneck – although there will still be one resource that has the least amount of capacity – just as every chain or section of a chain must have a weakest link.

To exploit the market a business should extract both the greatest volume and the highest prices from it. To do so the business must cause clients to buy more and to buy at higher prices. What are the actions a business can take to produce such a result?

1. Price

Price is a dangerous tool! Every competitor has a "copy" of this tool and can use his price tool as easily as you in your business. To lower price usually will not increase Throughput. One might expect the sales volume gained will offset the lost margin. Unfortunately competitors are almost always unwilling to give up market share and simply adjust their price accordingly. Both you and your competitors lose Throughput and profit. Price is generally and ineffective tool to exploit the market.

2. Market Segmentation

Clients have different perceived values for the products they buy from you. Their perception may be correct – your product delivers the value they perceive. Alternatively they may have a faulty perception of values – such clients will either over- or undervalue your product. For the moment lets assume clients’ perceptions are correct.

The perceived value for your product will still cover a significant range of prices from lower than your price to (significantly) higher. Those potential clients that see your price as too high will not buy and you lose contribution to your bottom line. Those that put a much higher value (than your price) on the product get it for a discount relative to what they would be willing to pay.

To maximize Throughput and profit, your sales and marketing must somehow capture the potential clients not willing to pay the full price and they must realize the (much) higher prices other clients are willing to pay. The concept to do this is market segmentation. A market is segmented if, and only if, the price applied in one segment has no impact in any of the other segments.

The airline industry is the prime example given for segmentation. It is possible to sit next to someone that has paid half the price – just by meeting certain conditions like the duration of his stay at the destination.  Another example is a material, made in exactly the same way for all prices, but guaranteed for various levels of performance. The price for this material ranges from the simple to double. The market is segmented because clients are buying the guarantee of performance.

Good segmentation can increase volume and realize higher prices – both can have a powerful positive effect on the bottom line, as segmentation can often be achieved without adding resources. To segment correctly does take some serious thinking.

3. Value in Use

Clients, particularly buyers, do not always understand the value of your offering. Unfortunately a buyer’s focus is on the objective against which he is measured – how much money he has saved for the company. Improvements realised through your product are benefits to his company that he cannot claim. In any case, a lower price seems easier to achieve, requires less effort to understand than the overall benefits of the supplier’s offer and the monetary benefit of a lower proce is entirely due to the buyer.

Value in use is a simple concept, but not always easy to define and calculate for the customer. Often the right question to ask is, ‘what is the damage if your company does not get this benefit?’ You (the supplier) should have a very good idea of all the benefits your offer brings to clients. There is the product itself; reliable supply eliminates the need for high stock levels; short lead-times can get clients out of a difficult emergency situation; etc.

Marketing’s job includes gaining a very good understanding of the value of your offering in all market segments. A clear understanding of all the benefits (values) and the ability to present these to clients effectively is of huge value to the bottom line and ensures better exploitation of the market constraint.

Understanding and effectively communicating value in use can maintain something like a 5% price premium that can easily transform a 10% margin into 15% through better prices and/or added volume.

4. Capturing new Customers and/or more Contracts

To make a sale or to capture a new customer is a process that can be likened to production. In most industrial sales there are many steps before a contract is signed. In sales and marketing we speak about the sales funnel – it starts with a large number of potential customers and ends, at the bottom of the funnel, with a much smaller number of orders or new customers. The question is, ‘What is blocking us from capturing more orders or from gaining more new clients?’

Analyse your sales process and you are likely to find many steps that must be successfully passed before your potential client signs up with an order. These steps are qualification steps the client goes through with you. Often enough one or two of the sales process steps take too long or are too complex causing potential clients to give up and stick with their current supplier. If you check further, these long and/or complex steps have many potential customers waiting to be "processed". This pile of work waiting in the queue is a sign that the following step is the constraint or bottleneck - of the sales process.

If such a constraint exists in your process, then the decision how to exploit that step becomes very important. Even more important will be the rules of behaviour so that the limiting step can produce at its capacity.

Analyse the situation at the sales process constraint and you should be able to find simple ways to get more potential clients through this bottleneck and enhance your chances of gaining more clients faster. Use these 5 Focusing Steps in sales and marketing! (See ‘The Cash Machine’ by Klapholz and Klarman.)

5. Availability and Delivery Reliability

Which baker gets your business – the one that makes sure he has croissants available for you – or the one that often has run out?

Which builder is more likely to get your business – the one with an excellent record of (real) on time delivery – or the one that is known to deliver late?

Near perfect reliability is key to gaining and keeping business. Isn’t it true that an unreliable supplier is likely to lose more clients than he gains and slowly lose market share. Isn’t it true that the truly reliable supplier will gain business more rapidly than he loses it?

In most industries and markets competitors are more or less equal in the products and services they supply. If this is the case, then gains and loses offset each other – market shares don’t move. However, what if one competitor can make a step change in his availability or delivery reliability? If the value of reliability is high enough and the market realizes the difference, then market shares will shift. By delivering reliability this supplier is exploiting the market – giving clients what they need to improve their business.

To understand the value of reliability, understand the damage caused to clients by (your) unreliability. A missing component might make your client late to his customer. To compensate for your unreliability your client may have to hold significantly higher stock levels than he can really afford. Apart rom the cash tied up there is a real risk of loss with high stocks. Many of the items might become obsolete or overage.

How can a business exploit the market through reliability without causing high cost and investment in their own business? You target is near perfect availability and reliability without adding cost and investment (in fact both should decline)

6. Speed

Reliability is a great tool to gain business. Add speed – shorter than competitors’ lead-times and a reliability guarantee (penalties for late delivery) and you may well have an even more powerful offering to gain sales. If your competitors cannot or do not dare to copy your offering, then you are truly on a winning run.

The offer exploits the market – it causes more and more customers to buy from you. Your task is to make it possible without breaking your company’s financial back. Short lead-times and near 100% reliability could together with a penalty be a recipe for disaster if you have not acquired the right capabilities in your production and distribution.

7. Flexibility (Urgent Demand)

In many industries suppliers experience urgent demand. Customers sometimes forget to order, ordered too little or have run into some sort of problem with their production. Whatever the reason they need materials or components urgently to meet their commitments. Lets assume you are 20% of your market and you experience about 5% urgent demand.

If urgent demand is a sign that clients need real help to meet their own commitments then these clients will be willing to pay a significant premium for a fast or super fast delivery. If you represent 20% of the market and the 5% level of urgent demand you experience, then the urgent demand market represents a quarter of your business.

To exploit this rather special part of your market a very short (say ½ to ¼) of the normal lead-time would be ideal for urgent demand. Can you do it? If the touch time (the actual transformation time for one unit in your factory) is say 10% of the lead-time, then your products wait in a queue 90% of the time. If you are able to cut lead-time in half – then the queue is still 80% of the lead-time. ¼ the lead-means queue time is still 60% of the new lead-time. It should be possible to achieve short and super-short lead-times! If you can implement short and super short lead-times reliably and consistently you will gain the majority of the urgent and super-urgent business – at a premium and with little or no added production cost.

Look at the value for your clients and to your business – in the right environments it can be enormous.

To exploit in this way again means getting the most from your market and clients!

8.  Sales

To truly exploit the market your sales organization must learn how to sell. The must learn how to sell the complete offering - not 'just the product.

What happens now? Our sales volume and market share will grow – probably quickly!

If sales volumes start to grow quickly there will be a high risk of overloading the production system. If production is overloaded chaos will eventually take over. The higher the load the greater is the risk of chaos and a sudden deterioration of service. All the gains made earlier are at risk. The business must have some form of load control to accept only business it can safely commit to (lead-times, availability etc.) and to expand capacity in whatever form before operations descend into chaos.

Do not be greedy! Superb profits yes, but do not put them at risk!

 

Technorati Tags: Availability, Continual Improvement, Distribution, Efficiency, Execution Management, Focus, Goldratt, Make to Stock, Management, Production, Risk Management, Sales, Shareholder Value Add, Strategy and Tactics, Supply Chain, SVA, Theory of Constraints, TOC, Value Chain

 

A Roman Bridge over the Torrente Merula near Andora in Italy - I have never seen a torrent here!

The 5 Steps to Focus - The Limiting Factor Step3 (A)

 

 

In business, what is focus? The objective or goal of most businesses is to make money – as much as possible now and even more in the future. Every manager and every employee is (or should be) focused in a way that achieves that. My question is: Are all managers correctly focused to make as much money as possible now and in the future?

If I where to ask almost any manager in any business I believe the answer I would get is an incredulous look for such a silly question. Of course that is their focus.

Nevertheless I am quite sure that the majority of managers, while focused, have the wrong focus (sometimes what is called focus is something like focus on everything). Their company’s bottom line is damaged.

(I owe the 5 Focusing Steps to Dr. Eliyahu M. Goldratt)

 

Optimize the Business – Help the Limiting Factor

How should the rest of the organisation behave towards the limiting factor?

This is an extremely important question. How the rest of the organisation behaves towards the constraint will certainly have a strong influence on how much the limiting factor can deliver. Since the limiting factor determines our bottom line the strong influence others have on the constraint had better be helpful. Let us examine some of the behaviour patterns we are familiar with to see how they help the limiting factor – or possibly prevent it from delivering the maximum possible.

1. Maintenance in the factory:

How does a maintenance engineer decide where to first when he is required in two (or more) locations at the same time? Will he have the knowledge and information to go to the constraint first (even if he has already started work on a non-constraint)? If the limiting factor is not involved, does the maintenance engineer know which of the resources requiring his time is most likely to disturb (stop) production at the constraint? Could it be that maintenance generally goes to the resource that shouts the loudest? Or will he go first to the expensive machine before repairing the low cost (but constraining) machine?

I don’t have the answer. If a production facility has not consciously identified its constraint nor has it decided how maintenance personnel should behave, what are the chances that the maintenance engineer will go to the correct resource?

2. Quality Management:

Imagine a factory with a limiting factor that has resources feeding and that in turn feeds resources downstream. How should the factory think about quality?

The upstream units must not deliver deficient products to the constraint. If they do they will waste the most valuable (in terms of the bottom line) resource in the factory. The organisation must ensure that poor quality is captured before it gets to the constraint. Inspecting bad quality out is acceptable because usually the cost of materials is less than the damage of losing capacity at the constraint. (Of course perfect quality from all machines is desirable, but it is more important in downstream operations – downstream from the limiting factor.)

After the constraint has worked on a product that products quality must not be compromised by operations downstream from the limiting factor. If quality is compromised, then constraint capacity is lost with the consequential high damage to the bottom line. (Do businesses truly understand the value of 1-hour lots (or gained) at the constraint? I really do not think they do.)

Quality management must make sure that poor quality product never reaches the limiting factor, and after the constraint has produced a product its quality must not be damaged downstream from it.

3. Work in Process (WIP):

What does WIP do to the limiting factor? Since the constraint limits, then every other resource is faster and inventory will tend to pile up just before the limiting factor. What this means is that products must wait their turn until the limiting factor has worked off the priority list down to the order we are interested in. The difficult part for the limiting factor is – what is the priority? In what order should I work? Does he get the work-orders neatly stacked according to priority? Does priority remain constant over time? Probably priority does not remain constant – and it will be less and less constant the more orders are waiting to be processed. The consequence must be that the constraint must decide what is important now from all the work-orders he has. Will this cost time and chaos at the limiting factor? Probably yes.

Does the operation need so much inventory waiting to be processed at the constraint? I don’t think so. The limiting factor cannot process more than its capacity. Waiting in the queue adds nothing to the bottom line. The business might just as well restrict release of work-orders to just enough to ensure the constraint is never starved, and a small enough number that the limiting factor has an easy time when priority must be determined.

4. Production Planning

Production planning is the function that should restrict the number of work-orders in the process. They will have pressure to release more than the constraint can comfortably process because all other resources feel the need to be ‘productive’. In many factories production planning does just that – they release enough into the factory to keep resources busy and overload the constraint. They achieve the opposite of the goal – because of the chaotic situation at the limiting factor the company actually produces less than it could.

If the Limiting Factor is the Market – What then?

 

Technorati Tags: Accounting, Continual Improvement, Efficiency, Execution Management, Focus, Goldratt, Management, Quality, Strategy and Tactics, Supply Chain, Theory of Constraints, TOC, Value Chain

The 5 Steps to Focus - Step 2: Exploit The Limiting Factor

In business, what is focus? The objective or goal of most businesses is to make money – as much as possible now and even more in the future. Every manager and every employee is (or should be) focused in a way that achieves that. My question is: Are all managers correctly focused to make as much money as possible now and in the future?


If I where to ask almost any manager in any business I believe the answer I would get is an incredulous look for such a silly question. Of course that is their focus.


Nevertheless I am quite sure that the majority of managers, while focused, have the wrong focus (sometimes what is called focus is something like focus on everything). Their company’s bottom line is damaged.


(I owe the 5 Focusing Steps to Dr. Eliyahu M. Goldratt)

Optimize the Business – Decide to Exploit the Limiting Factor

Since cost is often a primary concern there is a fair chance that the majority of businesses have, at least apparently, a limiting factor internal to their organisation – a person, a group of people or possibly an expensive piece of equipment. If this is the case, and the goal is to make as much money as possible, then the limiting factor must operate at its maximum capacity to generate Throughput. Throughput is not the production of physical goods – it is the rate at which the business makes money.

Your business needs to decide how the limiting factor should be employed so that it does actually produce for the bottom line.

This sounds obvious, but you will find that parts of the organisation will not know what will cause the constraint to deliver optimally to the bottom line. For example, take operations like synthetic fibre or film production. The gauges of such products will range from the very fine (or thin) to the very coarse (or thick). If the products are sold based on a kilo price they will have very different prices per kilo. Price depends on what you can get on the market; while profitability depends on both that price and how effectively the products sold use the limiting factor. Take the following example. Product A has a price of 1000€/Kg, product B has a price of 100€/Kg. The gross margin (Throughput) of A 950€/Kg while that of product B is only 50€/Kg (Gross margin (Throughput) is price less materials cost (acually totally variable cost).) The limiting factor must run for 100 hours to make 1 Kg of product A, but only 4 hours for product B. Product B delivers 12.50€/hour will product A manages only 9.50€/hour. Clearly product B with the much lower margin makes significantly better use of our limiting factor.

That was a simple example, but what about different materials prices? What about products that do not use the constraint – but do use other resources that products that go through the limiting factor also use? What about feeding the limiting factor; what are the consequences of starving the constraint of work? How much of the limiting factor’s capacity should be committed? Do we even want the constraint or limiting factor to be inside our company?

1. What about Throughput?

With modern ERP systems it is easy to develop the material cost of a product; so there is no real problem to develop the Gross Margin (or Throughput). In fact materials cost is all you need (more accurately it is totally variable cost - like materials - that we need to know). There is no need to allocate labour and overhead. These costs have to be paid for whether or not we produce. Over a fairly large time span they are fixed. If we do make a change to fixed costs the business must consider the consequences this will have on the Throughput of the company. If the cost reduction is smaller than the (potential) Throughput lost then don’t reduce costs. If adding operating expense does not add significantly more Throughput, then maybe you should think again.

2. What about products that do not use the constraint?

These (in an internally constrained system) can be called ‘free’ products. Earlier we preferred the product with the higher Throughput per hour consumed at the constraint. A ‘free’ product does not use the constraint so the Throughput per unit of time goes to infinity! Such a product is very desirable and will usually make a disproportionately large contribution to the company’s bottom line. Care must be taken that such products do not cause the constraint to be starved.

3. What about feeding the limiting factor?

Your limiting factor is the key component in your value chain. If it cannot perform, it will not produce Throughput – Throughput that is lost for the company's bottom line. If any other resource is down for some time there will be no or very little impact (unless this 'starves' the constraint!). Because all resources have more capacity than the limiting factor they can always catch up – there will be no loss to the company.

This being so means the limiting factor must be protected from ‘starvation’ – he, she, it must never run out of work. Due to the uncertainties we all must live with, the constraint needs a certain amount of buffer as a safety net against ‘starvation’. This safety net could be some inventory strategically placed in front of the limiting factor (or starting production with enough time buffer that material arrives at the limiting factor before it runs out of work).

4. How much of the limiting factor’s capacity should be committed?

Everything we have said so far would indicate 100% of the constraint’s capacity should be committed. But, is this really wise? If you commit 100% of the constraints capacity you make an assumption that can probably never be correct. You assume that demand will be constant at the 100% rate. We all know  this would be Utopia!

As the limiting factor approaches 100% capacity utilisation its ability to deliver on time diminishes – in fact its ability will at some point fall off a cliff – work at the constraint becomes chaotic as it tries to fulfil demand that seems to come from all sides. It cannot be done. If you don’t take the right decision (to maintain some 'protective capacity', the market will help you. As your delivery performance deteriorates, your once loyal clients will begin to switch to your competitors. This will continue until you are again able to deliver on time. (Think about the power of 100% reliability - what costs more? Leaving capacity apparently unused; or losing clients due to unreliability? The decision is yours.)

If the process were just a self correcting feedback loop it would not be a problem. However, your poor performance will be remembered. Customers will take quite some time before they return, and when they do there will probably be price pressure. If you are not a monopoly overextending your constraint is a good way to damage your business. The sales organisation, because they are focused on gaining (new) business are a key factor. In most businesses they do not know the limitations of the limiting factor.

5. Do we want the limiting factor to be inside our company?

In point 4 just above it seems clear that an internal constraint is difficult to manage and, if we have one, we must slow down our sales organisation’s efforts to avoid disappointing our client. We must restrict sales to avoid the reputation loss, lost business and price pressure.

The company should take the strategic decision whether or not to have an internal constraint. Except in situations of very high investment costs it would seem to be preferable to make sure the limiting factor is the market. If the constraint is the market, sales will not cause an overload and business growth will not be impeded. The company will still need a mechanism to understand when capacity should be increased so that the constraint remains in the market.

With the constraint in the market the how to exploit decision becomes how can I make sure customers want to buy from us and continue to buy from us. Reliability is one reason. Speed (short lead-times is another. Frequent and rapid new product and improved product introductions will also certain help maintain loyalty. Now we need to figure out how we can do that!

We have our second step on the road to real focus: 2. Decide how to exploit the constraint.

The pictures below are a poor way to exploit. The idea is to get the most Throughput - make the most money. OVERloading is usually not the way. You want 'protective capacity' to be able to take advantage of opportunities that will arise. Without protective capacity you have to pass!

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