From time to time corporate management will put such a restriction on a division that is performing poorly. This policy is actually not that unusual in industry. But, does it make sense? Could it be this policy that makes it impossible for the business to survive? The feeling in the targeted business might be that the policy is just the first step before it will be shutdown. If this is the feeling, won’t it cause employees to jump ship in search of greener pastures? Is there a better way?
The Goal
A company’s goal is to make money. A corporation that supports a business with insufficient profitability will feel that such a business is draining a lot of energy from management to try and deal with the problem. If the lack of profitability persists there will eventually come an ultimatum – something like, “Please don’t ask for more resources until you have shown proven positive bottom line results.” Fair enough? I think it is fair, although I also believe there is a better way to motivate the business and properly support it when it does hit the resource wall. (When it hits that wall the business cannot produce any more sales and the only remaining hope will be to reduce cost wherever excess exists – a very demoralizing tactic.) The Goal will seem to recede into the distance, impossible to meet it. At this point employees are quite likely to jump ship – especially those with that alternative.
The Approach for Success
The business in trouble needs a way to focus so that it gets the absolute maximum Throughput possible. (Throughput is meant as the money they generate through sales). To do this they have no choice but to find and then exploit their limiting factor to its absolute maximum. This means the limiting factor should work 24/7 and it should produce only the most lucrative products. The rest of the organisation makes sure that not a single minute of the limiting factor (the constraint) is wasted by a work stoppage or through the production of a low value product. What the paragraph above describes the first three steps of the 5 focusing steps for continual improvement.
- Find the constraint (the limiting factor). The limiting factor is key … if its limiting results, then we must use it well.
Many times a company will believe there are many constraints throughout their production process. This is in reality not possible. The impression of many constraints or constraints that move from one place to another are the result of the way the production process is managed. The policies that control how production is managed are very often the source of ‘many constraints’.
To find the real constraint, operate with smaller batches and look for the operation before which work piles up and must wait. The real constraint is usually immediately after the pile of waiting work. - Now that we know where and what our constraint or limiting factor is, we need to decide how to get the most from the limiting factor. Only if we can get this maximum can we expect our business to maximize its results.
What this means is not only to maximize the output of the limiting factor, but the constraint must also be used effectively – it should produce those items that produce the greatest Throughput (sales less materials cost) with the least amount of constraint effort. That maximizes the result.
There may be products that do not require the constraint resource – they give the highest amount of Throughput of all since they require zero from the limiting factor (as long as Throughput is positive. Decide to maximize sales of these products. - We have decided how we want to exploit (get the maximum from) the limiting factor. How should the rest of the organisation behave?
All of the rest of the organisation, including senior management, should subordinate to the limiting factor – even if this means their efficiency will suffer. If any other resource seeks to optimize his or her efficiency and in doing so hurts the limiting factor then the business as a whole suffers – the bottom line and all employees!
Subordinate starts with management. Management sets targets and Key Performance Indicators for the business and functions within the business. This usually a good thing, but must be done with the decision how to exploit the constraint in mind. Resources (being good people) will seek to reach their targets. If targets and KPIs are set incorrectly they will inadvertently harm business Throughput.
In the discussion of the exploit decision we recommended the production and sale of items that do not require the constraint. This tactic must be monitored carefully since too much of it can cause the constraint to be starved of work … a feeding resource is working on a product that does not pass through the limiting factor.
These first 3 focusing steps are an excellent framework but they must not be used blindly. The business must continue to think and reflect about the consequences of its actions … focused especially the consequences for the limiting factor.
The advantage of these three steps is the focus on the limiting factor. The 3 steps give a logical framework to the corporate policy “No new hires, no replacements”. They help the business successfully achieve the desired outcome of more profit from existing resources. In fact followed correctly they will by themselves prevent new hires or replacements or investment in equipment until no more Throughput can be wrung from the limiting factor. (These 3 focusing steps should be used in every business in order to prevent unnecessary investment in additional resources until these are truly necessary. The focusing steps should be in continual use.
Many times the decision to exploit and the actions taken to subordinate cause the constraint to move – the business has a new limiting factor. The business must identify the new constraint; decide how to exploit it and how the rest of the organisation should subordinate to it. Care must be taken to do this correctly … the initially identified constraint may not have so much spare capacity.
The Value of One Hour
Previously we recommended focus on the limiting factor in order to maximize Throughput. How much is an hour at the limiting factor worth?
Assuming a month has 30 days of 24 hours (our operation runs around the clock) then there is an absolute maximum of 720 hours. Clearly some of these hours are not productive as resources (machines) must be maintained or if they are people there are very few than work 100% of the time during an 8-hour shift. For the purposes of this experiment lets assume 100 hours are currently not productive for one reason or another … so net we are using our resource for 620 hours every 30-day month.
The resource of interest is our limiting factor … it currently is the limiting factor in our production that results in 10 million€ turnover. If materials are 38% of sales, then Throughput is 6.2 million€ and 1 hour of constraint time produces 10000€ Throughput. Every additional hour we are able to utilize our limiting factor produces 10000€ to the bottom line … additional profit! If the business is able to utilize the limiting factor for an additional 50 hours, that means an extra .5 million€ to the bottom line. That is an extra 5% of return on sales.
Utilizing a non-constraint an extra hour has a negative effect on the business unless the constraint can use the extra material. Otherwise utilizing a non-constraint for more than capability of the constraint simply increases work in process and increases lead times (Little’s Law).
It does make sense to utilize a non-constraint for extra hours; if the time is used to produce products that do not have to go through the limiting factor. Such hours are also very valuable since every € of Throughput goes straight to the bottom line.
The Limiting Factor can do no More; What Then?
The fourth focusing step is, “Elevate the Constraint” – expand the constraint’s capacity in some way … through overtime, outsourcing, adding resources etc. The step is the correct action if the limiting factor (constraint) truly has been exploited to the maximum and no more subordination steps are possible. Management’s job is to understand where the organisation stands – they should allow an expansion only at the correct time.
The value of elevating the constraint or limiting factor is enormous (as long as the market will actually buy the additional products).
If the constraining resource is 10 people responsible for 10 million€ sales then adding just 1 person should allow the business to grow from 10 to 11 million€ sales. This 1 extra person would generate 1 million€ in sales, and 600’000€ in additional Throughput and profit (of course I assume the rest of the operation can handle the extra 10% load).
An extra employee in any other area adds only cost. The added person cannot add to the bottom line because the limiting factor is running at its capacity. Such an added person adds no value.
The rule, no new hires and no replacements gets seriously in the way at this point – especially if even outsourcing, over-time and the like are not possible. The business is blocked from progress until the capacity of the limiting factor can be increased. Management needs to seriously consider this fact as well as the time it might take to train an additional constraint resource.
A corporation may not want to hire additional people into a poorly performing division. But if this division is now blocked by the limiting factor and the type of resource necessary at the constraint can easily be placed elsewhere; then the question is why not expand the capacity of the limiting factor? It would seem to make eminent sense.
There may be pressure to reduce costs in areas other than the limiting factor. This might be OK as long as the capacity of all other resources remains sufficiently larger than that of the constraint – there needs to be sufficient protective capacity. Also, consider that employees in operations generally represent just a small percentage of the total fixed costs … less than 10% and often much less. Cost in modern businesses lies in overheads. If overhead costs are reduced care must be taken to not take away essential support for proper exploitation of the limiting factor.
When to Allow Expansion
The Focusing Steps define when expansion should be allowed … whenever the exploit and subordinate steps are successfully and completely implemented. The limiting factor is at its limit and only an expansion of its capacity will lead to more Throughput (sales less materials cost).
However, people have two ways of thinking … fast and slow (see Daniel Kahneman's book "Thinking Fast and Slow"). We use our intuition and experience to come to conclusions quickly and possibly make a serious mistake. There could still be capability left in the organisation if only we would take the time (slow thinking) to go over all possible options to exploit the limiting factor better and/or subordinate to it better!
A recent experience demonstrated to me again; the truth of fast and slow thinking! The organisation believed it had reached the limit of what could be done with and for the constraint. However senior management stood by their no hire and no replacements policy. What happened next was amazing – the organisation found more ways to subordinate even more effectively to the limiting factor and some more capacity was found.
Protective Capacity
If a business in trouble follows the actions outlined above it will very soon be operating near the limit of its capacity – assuming the market buys its products. It is common knowledge that as an operation approaches capacity its flexibility and delivery reliability decline while lead-times extend. These three parameters are, however, extremely important in many competitive environments – flexibility, reliability and short lead-times help ensure the business wins orders. As these qualities deteriorate demand will decrease. A certain amount of protective capacity is essential to maintain these important parameters so that sales can continue to increase.
When the corporation considers their strategy and tactics for a particular (poorly performing) business they should include protective capacity in their considerations. Management can ignore protective capacity; the market will not ignore it. The market will soon realize flexibility, reliability and speed are deteriorating and will react accordingly. Demand will drop, price pressure will increase and all the good work to exploit the limiting factor can be undone. Why go to all the effort if a lack of protective capacity will undo the work?
Within the business all non-constraint resources have and must continue to have sufficient protective capacity to make sure the constraint can always be exploited to its maximum. There is a strong likelihood that the business will experience pressure to reduce costs wherever excess resources exist. Excess resources can be reduced, but the sufficient protective capacity must alwazs be available.
Summary
The 5 Focusing Steps process is an ideal replacement for the commonly applied rule “No New Hires and No Replacements”. Applied correctly it does the same thing as the rule I wish corporations would change. The difference is in the process when no further improvement from the limiting factor is possible. At that point the corporation should allow expansion at the constraint because of the high leverage found at this point. If the limiting factor cannot be expanded, then the business concerned may as well be shut down. No further significant improvement in the bottom line can be expected.
Management should, before they embark on an exercise to try and improve a business in trouble, decide at what point they will allow expansion (at the limiting factor) and this should be communicated to the organisation concerned. The proper exploitation of the constraint becomes the businesses first target. Management needs to be knowledgeable enough to recognise when the organisation has not yet squeezed the maximum from the limiting factor and when they must allow expansion – in the right place.
Following the 5 steps as described should, in the majority of cases result in 20-50% greater internal capability, that if it can be sold should bring most businesses in trouble to profitability! (20% greater internal capability represents 2million€ added sales and 1.2million€ to the bottom line (Throughput is assumed to be 60% of sales) (IF, and only IF you can sell the extra capability)!
If you are wondering, the 5th step is, "If during any previous step the constraint or limiting factor is broken during any of the previous steps, go back to step 1. BUT, DO NOT let your own inertia (fast thinking!) become the system's constraint!
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