Answer to Eli Schragenheim's Riddle

You can find the winning answer to the riddle here:

Answer to the Riddle: Can we offer perfect availability of every single item?

Learning from Experience IV

Earlier this here I posted a link to an article by Russell Ackhoff. That article is still relevant and especially so in relation to 'Learning from Experience'


Here is Russell Ackhoffs Article "A major mistake that managers make" The link is to a page in my blog, where you will find an external link.


Ackhoff's article and my various small contributions show how important learning from experience is - I hope many of you come o Munich for the workshop with Eli Schragenheim.


If you are interested The Workshop (in English) will be at the hotel Schiller in Olching (near Munich) followed by the TOC4U Meeting (mostly German) on Saturday Nov. 12th. You can register here: Register or call +49 6252 795 3070 if you have problems with the German registration page.

Learning from Experience III

Paradigms

An inappropriate paradigm will result in unfulfilled (or even over fulfilled) expectations.
In the Post “Where should we hold Stock” the organisation may have followed the following paradigms:
1. Distributors are given a good margin to sell our products – it’s only right that they invest in the correct amount of inventory to supply their customers.
2. Adding value – through cutting the rolls and sheets to customer requirements is an additional way to make more money.
3. Holding stock close to customers (at distributors) ensures a better customer service. Material availability is better; lead-times are shorter.
Unfortunately the result was quite different – not only did distributors complain about the high cost of holding inventory, but; customer service to the end client actually deteriorated. What is going on?
Maybe holding inventory centrally and cutting to size centrally is much more effective. Maybe the aggregation effect (at a central warehouse) causes less waste in added stock and makes it much easier to service the market. Maybe aggregation of demand makes demand at that level much less uncertain. The aggregation paradigm is well known in a number of areas – insurance aggregates many risks that offset each other.
Maybe the right paradigm is aggregation! Don’t many supply chains use aggregation to prepare inventory at such a point and differentiate the product when customers actually order?

It seems you should ‘watch your paradigms’!

Nov 11th,2011 Eli Schragenheim will lead a workshop on Learning from Experience. The purpose is to learn how to understand the cause and effect (the why) of disturbing and unexpected results from our actions AND, more importantly to take and apply the important lessons we learn.
The stories in these posts are all about unexpected effects that someone has experienced and that he or she could not properly understand. With Eli, we will look at such problems (bring your own!) and analyse them.
If you are interested the Workshop (in English) will be at the hotel Schiller in Olching (near Munich) followed by the TOC4U Meeting (mostly German) on Saturday Nov. 12th. You can register here: Register or call +49 6252 795 3070 if you have problems with the German registration page.


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

Below is the text from an email I received in the 90-ies (as a copy). What Chandrashekhar explains is still valid. Anyway, I thought I would post this after I found the email again by accident - especially in relation to my last post "Isn't It Obvious (part of the Learning from Experience series.)

CHICKENS

Hi Luis This is Chandrashekhar from India.

From the inputs what you have provided, ToC’s distribution / replenishment solution is the best solution. To design the solution completely you need to have past data.  I have implemented replenishment solution in the distribution of a Chicken (Shelf life of 24 hrs only).

The case was:

• The supplier had one factory from where he was supplying to more than 200 outlets in the city. All outlets were giving their next day’s requirement by afternoon 3.00 • Live birds then transported to factory by 10.00 in night.• Factory used to start the production late night and complete it by morning 6.00. the finished product was delivered to all outlets in the morning by 10.00• If a shop sells less than what he has ordered, the extra chicken is wasted.• If a shop sells more than he ordered, there is stock out and sale is lost.  17% of the rejections were taking place due to this. Sale lost – no data available

Solution:

• Instead of one delivery, now we are making two deliveries, one in morning, second in evening. • In first delivery (Morning 10.00) we supply 40% of the forecast or ordered quantity by the retailer.• At 3.00 they call up all retailers and take sale figures.
• If sale is less than forecasted, then quantity in second delivery is reduced • If sale is more than forecasted, extra quantity is supplied in second delivery.

This reduced the rejection (chicken coming back from retailers) from 17% to 6%. On one side the rejections came down, i.e. the loss of throughput is arrested on other side the sale improved by 11% i.e. Throughput increased. I hope this example will help you in developing solution for your problem.

 

 

Technorati Tags: Availability, Consumer, Cost Accounting, Distribution, Efficiency, Goldratt, Inventory, Inventory Management, Replenishment, Retail, Sales, Shareholder Value Add, Strategy and Tactics, Supply Chain, SVA, Theory of Constraints, TOC, Value Chain

Learning from Experience II

Friday Nov. 11th,2011 Eli Schragenheim will lead a workshop on Learning from Experience. The purpose is to learn how to understand the cause and effect (the why) of disturbing and unexpected results from our actions AND, more importantly to take and apply the important lessons we learn.

The stories below are all about unexpected effects that someone has experienced and that he or she could not properly understand. With Eli, we will look at such problems (bring your own!) and analyse them.

The Workshop (English) will be at the hotel Schiller in Olching (near Munich) followed by the TOC4U Meeting (mostly German) on Saturday Nov. 12th. You can register here:REGISTER or call +49 6252 795 3070 if you have problems with the German registration page.

“Isn’t It Obvious?”

Eli Goldratt’s latest book (and I think his last) is about retail. The store manager is on his way to work when he receives a call that a water main has burst in the shopping centre and that his storage area is under water. He finds out that until repairs are made he has no storage available within the shopping centre. To further compound his problems the price of other local warehousing has jumped – obviously because the know demand will be high!

The store manager comes to an arrangement with the regional warehouse that they supply he with what he needs on a daily basis to be able to sustain sufficient stock in the store. The two of them work out a system whereby the store locates its inventory at the warehouse and the warehouse replenishes the store based on whatever they order the evening before.

The surprise for the store manager is the sudden jump in performance. Before the burst water main the store was languishing somewhere near the bottom of the performance rankings. Soon after the ‘disaster’ the shop’s performance jumps to the top of the pile – not just in the region, but, for the entire chain. The store manager is at a loss to explain what has happened.

What do you think was the real cause for his sudden spurt in performance?

What can we all learn from the story?

To find out what really happened – read the book!

Technorati Tags: Availability, Consumer, Distribution, Efficiency, Focus, Goldratt, Inventory, Inventory Management, Replenishment, Retail, Supply Chain, Theory of Constraints, TOC, Value Chain

Learning from Experience I

Learning from Experience

Friday Nov. 11th,2011 Eli Schragenheim will lead a workshop on Learning from Experience. The purpose is to learn how to understand the cause and effect (the why) of disturbing and unexpected results from our actions AND, more importantly to take and apply the important lessons we learn.

The stories below are all about unexpected effects that someone has experienced and that he or she could not properly understand. With Eli, we will look at such problems (bring your own!) and analyse them.

The Workshop (English) will be at the hotel Schiller in Olching (near Munich) followed by the TOC4U Meeting (mostly German) on Saturday Nov. 12th. You can register here: REGISTER or call +49 6252 795 3070 if you have problems with the German registration page.

Where should we hold our Stock?

The business produces sheets of an insulating and fireproof material sold to the electrical, electronic and speciality construction industries. Sheets are produced in a standard width and must be cut to size for the various specific applications – into roll widths, and various panel (or sheet sizes). The company had a central stock together with a slitting and cutting operation to produce to customer requirements. From there material is sold through distributors throughout Europe (one distributor per country).

The division was under constant pressure to reduce stock levels. Levels were always high because cutting to customer requirements resulted in many end-products produced against a forecast and many partial rolls and off-cuts kept in stock in case a customer required something that could be supplied from these rests. Their computer system always selected material from these off-cuts whenever this was possible.

The pressure to minimize stock resulted in the strategy to give distributors the job of cutting to customer order. Distributors would order the few standard rolls and cut these to customer requirements. Distributors were happy because they gained an additional way of adding value to their service and the supply chain manager finally got the ‘too high inventory’ monkey off his back.

Soon, however, things did not turn out as expected. Distributors started to complain about the huge investment they had to make in ‘off-cuts’ that then could only be sold with great difficulty. On top of this they had to invest in cutting equipment to produce for clients. Distributors began to demand lower prices and/or consignment stock to take care of their deteriorating financial situation – their increased need for working capital to finance the additional stock.

What is happened?

What can we learn?

What might be the better solution?

 

Technorati Tags: 6-Sigma, Continual Improvement, Costing, Distribution, Efficiency, Focus, Inventory Management, Replenishment, Shareholder Value Add, Strategy and Tactics, SVA, Theory of Constraints, TOC, TQM, Value Chain

A Riddle from Eli Schragenheim

A Riddle from Eli Schragenheim Can we offer perfect availability of every single item? Riddle: Lewis, the CEO and main owner of Lewis Supermarkets, was very frustrated from the wave of over one hundred and thirty complaints the chain received due to the shortage of Soup-97 at all seven branches of his supermarkets in the city.  The point was, of course, that the  competition had the soup available on their shelves.  ... You can find the rest of this riddle here: <http://www.tocico.org/> There are 3-days left, so hurry and submit your answer to the appropriate site. Answer will be given after August 7. Have fun!

Squanderville versus Thriftville by Warren Buffet, appeared in Fortune Magazine in October 2003

I like this article! It seems even more appropriate now almost 8 years after its was first published! I don't think the US  (and large parts of the western World) have much time left to argue the problem or the solution. In the US I hope both the Republicans and the Democrats want to solve the problem for the good of the American people (and I hope governments around the World are all like that - they work for their people). However, the the two parties in the US have massive conflicts - the solution to the common objective (something like the continued welfare of the American people) is the easy part. The two sides have quite different paths of how to get there - s different that the conflict can last long enough to do irreparable damage to the country. Both sides want to do whatever they propose because both of them have strong and very valid needs (of the people) to fulfill. These needs are valid and in important - both sides!!!! The country (the Republicans and Democrats) need to get together and meet those needs. The proposed solutions and arguing over these will not get the US to the goal. In terms of proposed actions one or both sides are making errors - at least 1 error. The solution is to find the way(s) to meet the NEEDS without compromise. To do this the existing proposals need to be scrutinized to find the errors. There is a third way that can lead to the solution that will fulfill all needs (A need is not a wish!!)

DO SOMETHING FOR THE FUTURE OF OUR WORLD!!!!!

Squanderville versus Thriftville  by Warren Buffet

http://www.youtube.com/watch?v=5DvuyvuHmJI

I'm about to deliver a warning regarding the U.S. trade deficit and also suggest a remedy for the problem. But first I need to mention two reasons you might want to be skeptical about what I say. To begin, my forecasting record with respect to macroeconomics is far from inspiring. For example, over the past two decades I was excessively fearful of inflation. More to the point at hand, I started way back in 1987 to publicly worry about our mounting trade deficits -- and, as you know, we've not only survived but also thrived. So on the trade front, score at least one "wolf" for me. Nevertheless, I am crying wolf again and this time backing it with Berkshire Hathaway's money. Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in -- and today holds -- several currencies. I won't give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.

Both as an American and as an investor, I actually hope these commitments prove to be a mistake. Any profits Berkshire might make from currency trading would pale against the losses the company and our shareholders, in other aspects of their lives, would incur from a plunging dollar.

But as head of Berkshire Hathaway, I am in charge of investing its money in ways that make sense. And my reason for finally putting my money where my mouth has been so long is that our trade deficit has greatly worsened, to the point that our country's "net worth," so to speak, is now being transferred abroad at an alarming rate.

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo -- but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off -- or simply service -- the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat -- they have nothing left to trade -- but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are -- in economist talk -- some pretty dramatic "intergenerational inequities."

Let's think of it in terms of a family: Imagine that I, Warren Buffett, can get the suppliers of all that I consume in my lifetime to take Buffett family IOUs that are payable, in goods and services and with interest added, by my descendants. This scenario may be viewed as effecting an even trade between the Buffett family unit and its creditors. But the generations of Buffetts following me are not likely to applaud the deal (and, heaven forbid, may even attempt to welsh on it).

Think again about those islands: Sooner or later the Squanderville government, facing ever greater payments to service debt, would decide to embrace highly inflationary policies -- that is, issue more Squanderbucks to dilute the value of each. After all, the government would reason, those irritating Squanderbonds are simply claims on specific numbers of Squanderbucks, not on bucks of specific value. In short, making Squanderbucks less valuable would ease the island's fiscal pain.

That prospect is why I, were I a resident of Thriftville, would opt for direct ownership of Squanderville land rather than bonds of the island's government. Most governments find it much harder morally to seize foreign-owned property than they do to dilute the purchasing power of claim checks foreigners hold. Theft by stealth is preferred to theft by force.

So what does all this island hopping have to do with the U.S.? Simply put, after World War II and up until the early 1970s we operated in the industrious Thriftville style, regularly selling more abroad than we purchased. We concurrently invested our surplus abroad, with the result that our net investment -- that is, our holdings of foreign assets less foreign holdings of U.S. assets -- increased (under methodology, since revised, that the government was then using) from $37 billion in 1950 to $68 billion in 1970. In those days, to sum up, our country's "net worth," viewed in totality, consisted of all the wealth within our borders plus a modest portion of the wealth in the rest of the world.

Additionally, because the U.S. was in a net ownership position with respect to the rest of the world, we realized net investment income that, piled on top of our trade surplus, became a second source of investable funds. Our fiscal situation was thus similar to that of an individual who was both saving some of his salary and reinvesting the dividends from his existing nest egg.

In the late 1970s the trade situation reversed, producing deficits that initially ran about 1 percent of GDP. That was hardly serious, particularly because net investment income remained positive. Indeed, with the power of compound interest working for us, our net ownership balance hit its high in 1980 at $360 billion.

Since then, however, it's been all downhill, with the pace of decline rapidly accelerating in the past five years. Our annual trade deficit now exceeds 4 percent of GDP. Equally ominous, the rest of the world owns a staggering $2.5 trillion more of the U.S. than we own of other countries. Some of this $2.5 trillion is invested in claim checks -- U.S. bonds, both governmental and private -- and some in such assets as property and equity securities.

In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4 percent more than we produce -- that's the trade deficit -- we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.

To put the $2.5 trillion of net foreign ownership in perspective, contrast it with the $12 trillion value of publicly owned U.S. stocks or the equal amount of U.S. residential real estate or what I would estimate as a grand total of $50 trillion in national wealth. Those comparisons show that what's already been transferred abroad is meaningful -- in the area, for example, of 5 percent of our national wealth.

More important, however, is that foreign ownership of our assets will grow at about $500 billion per year at the present trade-deficit level, which means that the deficit will be adding about one percentage point annually to foreigners' net ownership of our national wealth. As that ownership grows, so will the annual net investment income flowing out of this country. That will leave us paying ever-increasing dividends and interest to the world rather than being a net receiver of them, as in the past. We have entered the world of negative compounding -- goodbye pleasure, hello pain.

We were taught in Economics 101 that countries could not for long sustain large, ever-growing trade deficits. At a point, so it was claimed, the spree of the consumption-happy nation would be braked by currency-rate adjustments and by the unwillingness of creditor countries to accept an endless flow of IOUs from the big spenders. And that's the way it has indeed worked for the rest of the world, as we can see by the abrupt shutoffs of credit that many profligate nations have suffered in recent decades.

The U.S., however, enjoys special status. In effect, we can behave today as we wish because our past financial behavior was so exemplary -- and because we are so rich. Neither our capacity nor our intention to pay is questioned, and we continue to have a mountain of desirable assets to trade for consumables. In other words, our national credit card allows us to charge truly breathtaking amounts. But that card's credit line is not limitless.

 

The time to halt this trading of assets for consumables is now, and I have a plan to suggest for getting it done. My remedy may sound gimmicky, and in truth it is a tariff called by another name. But this is a tariff that retains most free-market virtues, neither protecting specific industries nor punishing specific countries nor encouraging trade wars. This plan would increase our exports and might well lead to increased overall world trade. And it would balance our books without there being a significant decline in the value of the dollar, which I believe is otherwise almost certain to occur.

We would achieve this balance by issuing what I will call Import Certificates (ICs) to all U.S. exporters in an amount equal to the dollar value of their exports. Each exporter would, in turn, sell the ICs to parties -- either exporters abroad or importers here -- wanting to get goods into the U.S. To import $1 million of goods, for example, an importer would need ICs that were the byproduct of $1 million of exports. The inevitable result: trade balance.

Because our exports total about $80 billion a month, ICs would be issued in huge, equivalent quantities -- that is, 80 billion certificates a month -- and would surely trade in an exceptionally liquid market. Competition would then determine who among those parties wanting to sell to us would buy the certificates and how much they would pay. (I visualize that the certificates would be issued with a short life, possibly of six months, so that speculators would be discouraged from accumulating them.)

For illustrative purposes, let's postulate that each IC would sell for 10 cents -- that is, 10 cents per dollar of exports behind them. Other things being equal, this amount would mean a U.S. producer could realize 10 percent more by selling his goods in the export market than by selling them domestically, with the extra 10 percent coming from his sales of ICs.

In my opinion, many exporters would view this as a reduction in cost, one that would let them cut the prices of their products in international markets. Commodity-type products would particularly encourage this kind of behavior. If aluminum, for example, was selling for 66 cents per pound domestically and ICs were worth 10 percent, domestic aluminum producers could sell for about 60 cents per pound (plus transportation costs) in foreign markets and still earn normal margins. In this scenario, the output of the U.S. would become significantly more competitive and exports would expand. Along the way, the number of jobs would grow.

Foreigners selling to us, of course, would face tougher economics. But that's a problem they're up against no matter what trade "solution" is adopted -- and make no mistake, a solution must come. (As Herb Stein said, "If something cannot go on forever, it will stop.") In one way the IC approach would give countries selling to us great flexibility, since the plan does not penalize any specific industry or product. In the end, the free market would determine what would be sold in the U.S. and who would sell it. The ICs would determine only the aggregate dollar volume of what was sold.

To see what would happen to imports, let's look at a car now entering the U.S. at a cost to the importer of $20,000. Under the new plan and the assumption that ICs sell for 10 percent, the importer's cost would rise to $22,000. If demand for the car was exceptionally strong, the importer might manage to pass all of this on to the American consumer. In the usual case, however, competitive forces would take hold, requiring the foreign manufacturer to absorb some, if not all, of the $2,000 IC cost.

There is no free lunch in the IC plan: It would have certain serious negative consequences for U.S. citizens. Prices of most imported products would increase, and so would the prices of certain competitive products manufactured domestically. The cost of the ICs, either in whole or in part, would therefore typically act as a tax on consumers.

That is a serious drawback. But there would be drawbacks also to the dollar continuing to lose value or to our increasing tariffs on specific products or instituting quotas on them -- courses of action that in my opinion offer a smaller chance of success. Above all, the pain of higher prices on goods imported today dims beside the pain we will eventually suffer if we drift along and trade away ever larger portions of our country's net worth.

I believe that ICs would produce, rather promptly, a U.S. trade equilibrium well above present export levels but below present import levels. The certificates would moderately aid all our industries in world competition, even as the free market determined which of them ultimately met the test of "comparative advantage."

This plan would not be copied by nations that are net exporters, because their ICs would be valueless. Would major exporting countries retaliate in other ways? Would this start another Smoot-Hawley tariff war? Hardly. At the time of Smoot-Hawley we ran an unreasonable trade surplus that we wished to maintain. We now run a damaging deficit that the whole world knows we must correct.

For decades the world has struggled with a shifting maze of punitive tariffs, export subsidies, quotas, dollar-locked currencies, and the like. Many of these import-inhibiting and export-encouraging devices have long been employed by major exporting countries trying to amass ever larger surpluses -- yet significant trade wars have not erupted. Surely one will not be precipitated by a proposal that simply aims at balancing the books of the world's largest trade debtor. Major exporting countries have behaved quite rationally in the past and they will continue to do so -- though, as always, it may be in their interest to attempt to convince us that they will behave otherwise.

The likely outcome of an IC plan is that the exporting nations -- after some initial posturing -- will turn their ingenuity to encouraging imports from us. Take the position of China, which today sells us about $140 billion of goods and services annually while purchasing only $25 billion. Were ICs to exist, one course for China would be simply to fill the gap by buying 115 billion certificates annually. But it could alternatively reduce its need for ICs by cutting its exports to the U.S. or by increasing its purchases from us. This last choice would probably be the most palatable for China, and we should wish it to be so.

If our exports were to increase and the supply of ICs were therefore to be enlarged, their market price would be driven down. Indeed, if our exports expanded sufficiently, ICs would be rendered valueless and the entire plan made moot. Presented with the power to make this happen, important exporting countries might quickly eliminate the mechanisms they now use to inhibit exports from us.

Were we to install an IC plan, we might opt for some transition years in which we deliberately ran a relatively small deficit, a step that would enable the world to adjust as we gradually got where we need to be. Carrying this plan out, our government could either auction "bonus" ICs every month or simply give them, say, to less-developed countries needing to increase their exports. The latter course would deliver a form of foreign aid likely to be particularly effective and appreciated.

I will close by reminding you again that I cried wolf once before. In general, the batting average of doomsayers in the U.S. is terrible. Our country has consistently made fools of those who were skeptical about either our economic potential or our resiliency. Many pessimistic seers simply underestimated the dynamism that has allowed us to overcome problems that once seemed ominous. We still have a truly remarkable country and economy.

But I believe that in the trade deficit we also have a problem that is going to test all of our abilities to find a solution. A gently declining dollar will not provide the answer. True, it would reduce our trade deficit to a degree, but not by enough to halt the outflow of our country's net worth and the resulting growth in our investment-income deficit.

Perhaps there are other solutions that make more sense than mine. However, wishful thinking -- and its usual companion, thumb sucking -- is not among them. From what I now see, action to halt the rapid outflow of our national wealth is called for, and ICs seem the least painful and most certain way to get the job done. Just keep remembering that this is not a small problem: For example, at the rate at which the rest of the world is now making net investments in the U.S., it could annually buy and sock away nearly 4 percent of our publicly traded stocks.

In evaluating business options at Berkshire, my partner, Charles Munger, suggests that we pay close attention to his jocular wish: "All I want to know is where I'm going to die, so I'll never go there." Framers of our trade policy should heed this caution -- and steer clear of Squanderville.

http://www.youtube.com/watch?v=5DvuyvuHmJI

FORTUNE editor at large Carol Loomis, who is a Berkshire Hathaway shareholder, worked with Warren Buffett on this article.

HEAR NO EVIL, SEE NO EVIL, SPEAK NO EVIL

 

 

TOCICO announces Dr. Eliyahu Goldratt Foundation

TOCICO announces Dr. Eliyahu Goldratt Foundation

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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