Transition from a cost to a flow-centric organization
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The document discusses transitioning from a traditional cost accounting approach to a throughput accounting approach based on the Theory of Constraints. It explains that traditional cost accounting focuses on profit margins by product, but this does not consider system constraints. The Theory of Constraints identifies the constraint in a production system and prioritizes production to maximize throughput. The document provides an example of a clothing company that increases profits by identifying sewing capacity as the constraint and allocating production accordingly. It advocates adopting a demand-driven operating model to further elevate system constraints and improve inventory, lead times, and alignment between strategy and operations.
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Transition from a cost to a flow-centric organization
- 1. Transition from a cost to a flow- centric organization by ForgeFlow
- 2. 2 Where to invest money? What products to promote or to kill?
- 3. 3 Traditional focus Profit Margin = Net Income Sales x 100 Look at product’s cost and promote the products with highest profit margin
- 4. 4 But… have you considered the big picture?
- 5. 5 ● Goldratt ● Theory of Constraints ● Throughput Accounting
- 6. 6
- 8. 8 We are not competitive due to… ○ The competitors ○ Globalization ○ Picky customers ○ Slow suppliers
- 9. 9 What if.. ○ No competition ○ Low taxes ○ Constant market ○ Steady customers ○ Good employees ○ Reliable suppliers ○ … We only need to define a company policy
- 11. 11 The process FABRIC CUT SEW WOMAN T-SHIRT MAN T-SHIRT
- 12. 12 $105 $100 120 units/week 120 units/week $45 $50 WOMAN T-SHIRT FABRIC FABRIC MAN T-SHIRT
- 13. 13 2 mins 15 mins Required total Sew time/week: 120 units/week x 15 mins/unit = 1800 mins/week Required total Cut time/week: 120 units/week x 2 mins/unit = 240 mins/week Scope WOMAN T-SHIRT CUT SEW
- 14. 14 10 mins 10 mins Required total Sew time/week: 120 units/week x 15 mins/unit = 1200 mins/week Required total Cut time/week: 120 units/week x 10 mins/unit = 1200 mins/week Scope MAN T-SHIRT CUT SEW
- 15. 15 ● Capacity/work center: 2400 minutes/week (8 hours x 5 days) ● Weekly operating expenses: $10,500 (rents, energy,wages,..)
- 16. 16 2400mins 240 mins 1200mins 2400mins 1800mins1200mins capacity manwoman manwoman capacity CUT SEW Produce to full demand. Possible?
- 17. 17 Allocate resources to most profitable product How much to produce for each variant? WOMAN T-SHIRT MAN T-SHIRT BEST PRICE RAW MATERIAL PROCESS TIME $105 $45 17min $100 $50 20min woman woman woman
- 18. 18 2400mins 1800mins capacity woman 600mins 600mins capacity man We can only make 60 man’s t-shirts (600 mins / 10 mins / shirt) with the remaining capacity available in the sew Make 120 women's t-shirts Make 60 man’s t-shirts Make woman’s t-shirt first (the most profitable) SEW SEW
- 19. 19 Make 120 women's t-shirts Make 60 man’s t-shirts Cost accounting’s obsolecence CUT CUT 2400mins 1200mins capacity woman 1200mins 600 mins capacity man
- 22. 22 Cost accounting’s obsolecence What if we produce all man’s demand? We can only make 60 women's t-shirts (1200 mins / 15 mins / shirt) with the remaining capacity available in the sew Make 120 man’s t-shirts Make 60 women's t-shirts SEW SEW 2400mins 1200mins capacity man 1200mins 1200mins capacity woman
- 23. 23 Cost accounting’s obsolecence CUT CUT Make 120 man’s t-shirts Make 80 women's t-shirts 2400mins 1200mins capacity man 1200mins 600 mins capacity woman
- 24. 24 Revenue $20,400 Raw Materials $9,600 Gross Margin $10,800 Operating Expense -$10,500 Net Profit $300 Cost accounting’s obsolecence
- 25. 25
- 27. 27 ● See the company as a system. ● The global performance of the system depends on the joint efforts of all the elements of the system. ● All systems have at least one constraint that limits them from achieving a higher performance versus it’s goal. Theory of Constraints (TOC)
- 28. 28 Identify the System’s Constraint(s) Decide how to exploit the system’s constraint(s) Subordinate everything else to the previous decision Elevate the system’s constraints TOC process
- 29. 29 Throughput = Sell Price - Totally Variable Costs
- 30. 30 Throughput / time on the Saw Men’s Women’s Throughput per unit ($) $100 - $50 = $50 $105 - $45 = $60 Minutes in the Saw 10 15 Throughput/time on Saw ($/minute) 5 4
- 32. 32 Stock Buffers
- 33. 33 Green Yellow Red LateEarly Scheduled start at Control Point Scheduled entry to buffer Work orders WO0323 WO0534 WO0223 Time Buffers How to protect the constraint?
- 35. 35 First company to integrate the 3 levels of certification in Demand Driven in an ERP: - Demand Driven MRP - Demand Driven Operating Model - Demand Driven Sales & Operations Planning
- 36. 36 Inventory Service Level Lead Time Alignment to Flow Reconciles strategy with operation Benefits of becoming a Demand Driven
- 37. 37
- 38. 38 Jordi Ballester Alomar CEO & Founder | ForgeFlow (+34) 629530707 | jordi.ballester@forgeflow.com | https://www.forgeflow.com Twitter: https://twitter.com/jordibforgeflow Linkedin: https://www.linkedin.com/in/jordiballesteralomar
Editor's Notes
- Companies have traditionally faced their management decisions with a focus on the cost. If we are to select various products to sell from a portfolio, which one should we promote? Traditional management accounting would recommend to promote the products with the highest margin. And as a result you would kill/promote products and resources based on this information.
- But this approach does not consider looking at the organization from a global perspective. What if your organisation, as if it was a chain, was limited in it's strength by it's weakest link? Can you identify this weak link, then adapt your rhythm to it, before you can strengthen it?
- In this talk you will discover the principles of Throughput Accounting developed by Eliyahu Goldratt as part of his work on the Theory of Constraints, and how can simple flow-based performance measurements help you guide your decision making process towards achieving better Profits and Return on Investment for your organization. We will follow an example described in the book by Thomas Corbett.
- We will then introduce the Demand Driven Adaptive Enterprise framework as a flow-centric approach to managing your organization that focuses on promoting the flow of relevant materials and information. ForgeFlow is a world leader in the Demand Driven Adaptive Enterprise framework, developed by the Demand Driven Institute, and has achieved the highest certifications of compliance of it's Odoo based implementation.
- Many people believe that the reasons for a company’s lack of competitiveness are out of the control of its managers. Generally they blame the government, the competitors, the globalization, the customers or the suppliers.
- To see if that reasoning is correct, if the causes for lack of competitiveness are out of the control of their managers, let us analyze a situation where we do not have all these external causes. Consider the world of pink ponies. Let us use a very simple example where all the external causes have been eliminated. Taxes are low, competition is not fierce, the market is constant and client do not change their minds, employees are wel trained and suppliers are reliable. The only thing we need to define is the company policies.
- We are going to analyze a very simple company. This company makes t-shirts
- This company has two machines. One that cuts fabric and another one that sews the pieces together, making two kinds of t-shirts. A man’s and a woman’s. First we have to cut and then sew the pieces together.
- Both women’s and men’s both have a weekly demand of 120 units. The selling price is 105 dollars for women’s and 100 dollars for men’s shirts. To sell one women’s shirt we need to buy a Raw Material for 45 dollars. To make a man’s t-shirt we need 50 dollars. The process sequence is the same for both products. What differs is the process time, the raw material cost and the selling price.
- To make a woman’s t-shirt we need 2 minutes to cut and 15 minutes to sew. If we took the full demand of 120 units per week we would require 240 minutes/week of cut time and 1800 minutes of sew time in total.
- To make a woman’s t-shirt we need 2 minutes to cut and 15 minutes to sew. If we took the full demand of 120 units per week we would require 240 minutes/week of cut time and 1800 minutes of sew time in total.
- Each machine has an operator, and all the operators work 8 hours a day, 5 days a week, which adds up to 2400 minutes a week. The company’s weekly operating expenses are 10,500 dollars, including wages, rents, energy, and everything the company spends to keep working. Now we need to use cost accounting to define which product mix maximizes the company’s profitability.
- The first reaction is to try to calculate how much profit we would make if we sold all the demand for both products. But the company does not have enough capacity to produce 120 women’s shirts and 120 men’s shirts in one week. We cannot sell everything the market wants to buy, so we need to decide what we will produce and sell. To maximize the company’s profitability we need to know which product is more profitable in order to produce as much of it that the market demands and only then, if there is any time left on the sewing machine to produce the other product.
- Nowadays we use cost accounting as the tool to calculate which products contribute the most to the company’s profitability. Let’s find which product is more profitable according to this methodology. To calculate the cost of a product we need its raw material costs and we need to add up the costs to produce this product, including how much time it uses each resources, how much each resource costs, how much of the indirect costs should be allocated to each product and so on. To find out the profit per product we need to subtract the product cost from is price. This table shows that the women’s short is superior to the men’s shirt in all the characteristics. This makes it the most profitable product.
- As we do not have enough capacity to make all the products, and we want to have the highest possible profit, we must first sell all the demand of the most profitable product, and then, if there’s any time left on the sewing machine, make the other product. We will make all the demand for women’s shirts - 120 units. As every women’s shirt uses 15 minutes of the sewing machine, to produce 120 units we will use 1800 minutes. We have 2400 minutes available. After sewing the 120 women’s shirts we will have 600 minutes left, which we will use making men’s shirts. As each men’s shirt uses 10 minutes of the sewing machine, we can make 60 units .
- In terms of the Cut machine, we will make all the demand for women’s shirts - 120 units. As every women’s shirt uses 2 minutes of the cut machine, to produce 120 units we will use 1200 minutes. We have 1200 minutes available. After cutting the 120 women’s shirts we will have 1200 minutes left, which we will use making men’s shirts. Since we already decided that we would be making 60 units, we will end up with 600 minutes of free capacity at the Cut machine.
- With this mix the company has a total 18600 in sales. The raw material costs in total 8400. The gross profit is 10200. The weekly operating expense is 10500, which results in a net loss of 300. Our conclusion is that we should close the company. But before making this decision, let us examine what would happen to the company’s profit if we sold all the demand for men’s shorts, the least profitable, and only then sold part of the demand for women’s shirts, the most profitable.
- We will make all the demand for men’s shirts - 120 units. As every man’s shirt uses 10 minutes of the sewing machine, to produce 120 units we will use 1200 minutes. We have 1200 minutes available. After sewing the 120 man’s shirts we will have 1200 minutes left, which we will use making women’s shirts. As each women’s shirt uses 15 minutes of the sewing machine, we can make 80 units .
- In terms of the Cut machine, we will make all the demand for men’s shirts - 120 units. As every men’s shirt uses 10 minutes of the cut machine, to produce 120 units we will use 1200 minutes. We have 1200 minutes available. After cutting the 120 men’s shirts we will have 1200 minutes left, which we will use making women’s shirts. Since we already decided that we would be making 80 units, we will end up with 160 minutes of free capacity at the Cut machine. Now let’s calculate our profit from this mix by planning the whole scenario in odoo.
- We did not change anything in the company’s conditions, yet we went from a loss of 300 to a profit of 300 a week. Cost accounting did not supply the correct information about which product most contributes to the company’s profit. What do we do in a company with hundreds or even thousands of products and resources?
- The Theory of Constraints began in the 70’s, when the Israely physicist Eliahy Goldratt created a new method of production logistics. TOC sees any company as a system. Every action taken by a part of the system should be judged by its impact on the overall purpose. All systems have at least one constraint that limits them from achieving a higher performance versus it’s goal.
- The TOC process involves identifying the system’s constraints, deciding how to exploit them, subordinate everything else to the previous decision, elevate the system’s constraint and, if in the previous steps a constraint has been broken, go back to step 1.
- If we pull a chain, where will it break? At its weakest link. If this chain’s goal is to resist traction, where should we concentrate to better it’s performance? We should strengthen its weakest link, this system’s constraint. Strengthening any other link before strengthening the weakest one would be a waste of time and resources, because the weakest link determines the maximum performance of the entire chain. A plant is similar to a chain. In our example the Saw limits our capacity. It is the Capacity Constraint Resource, the weakest link. The constraint is the Saw’s available time. We need to squeeze the the most of it from this available time. We need to give priority to products that have have a greater throughput, and at the same time, give priority that products that use the least time at the constraint. We will have a problem when comparing two products - one has a greater throughput, while the other uses less time at the constraint. How do we decide which one is best for the company?
- To solve this problem we need to adopt a relative measurement, which takes into account that we want to maximize throughput and at the same time minimize the time spent on the Saw. To decide which of the two shirt model contributes most to the company bottom line we need to divide the product’s throughput by the time it uses at the constraint, resulting in the product’s throughput per time of the capacity constrained resource. In this case the men’s t-shirt is more expensive to produce, but it uses fewer minutes of the constraint than the women’s. As the company does not have enough capacity to deliver all the orders, the manager have to decide which product is more important. The throughput/time measurement tells us that for every minute the Saw is producing a men’s shirt it increases 5 dollars, while it increases 4 dollars for the women’s shirt.
- The second step in TOC’s ongoing improvement process is to exploit the system’s constraints. Preventing the constraints from stopping becomes a priority. We need to put a buffer of stock in front of the Saw to guarantee it’s supply in case one of its feeding resources breaks down. We would need a time buffer in front of the saw to guarantee that the preceding activities have been completed well in time before the saw is ready to start. The Demand Driven Adaptive Enterprise Model, created by the Demand Driven Institute and implemented in Odoo by ForgeFlow, picks up those important concepts from the TOC methodology.