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The factory produces machined assemblies furnished to other plants in the UniWare division as components of end-items, and also sold directly as spare parts assemblies to larger end-user customers. The company has a competent and well-trained staff, each of whom is a subject matter expert in their respective functions. UniCo is led by highly experienced managers, each of whom has been exposed to increasingly broadened responsibilities for different UniCo functions.
UniCo's customers want quality products delivered on-time at a reasonable price. In order to control prices, UniCo's management has become increasingly efficient at reducing costs in several operational areas. Financial performance reporting is provided at every level of production in exquisite detail so that functional cost budgets can be produced and managed with great precision. Automation has been introduced at several levels to increase production efficiencies and have resulted in unprecedented savings in production time and station production rate. Even with the introduction of the robotics, somehow management has been able to satisfy the stringent demands of its unionized workforce to achieve parity in its labor relations.
Problem faced by Alex's division
Alex's plant shares some not-so-complimentary common traits with real-world organizations. He has orders bordering on two-months behind scheduled delivery date. He has over $20 million in unsold finished goods inventory sitting in a local warehouse. The items that can be delivered are being hurried up through the factory with overtime and special handling involved at every step. As a result of the delivery slippage, sales are slowing down, material costs are skyrocketing, and every efficiency metric is heading downward at an alarming rate. Moreover, the division is facing an increasing cash shortage which in turn might lead to its inability to pay wages.
The company informs Alex that he has 3 months to turn around the situation else by the end of the fiscal year, UniCo would shut down this unprofitable operation and sell them off to a highest bidder. Alex's job and career are now on the line as a new owner would not want to keep an unprofitable or ineffective manager around to run the same organization.
Alex by pure chance ran into someone who introduces him to another way of thinking about his situation, his old physics professor Jonah. Alex, describes his firm's investment in automation and how it has led to increased productivity. Jonah, in turn, queries Alex about some key identifiers of productivity such as decreasing inventory, reducing expenses, and selling more products. Although Alex couldn't affirmatively respond to any of them, at that point, he was confident that the issues faced in his plant were only some annoying problems, not the demise of his entire organization. Jonah takes a moment to reveal the fallacy of logic in Alex's reasoning - having accepted many things without questioning the common sense in their purpose and application. Jonah leaves Alex to ponder the concept of productivity and what it means to a business.
Identifying the Goal
Productivity is defined as accomplishing something in terms of goals. In order to identify the goal, Alex has a thinking session with his plant controller Lou, and they both agree that "The goal of any business is to increase net profit while simultaneously increasing return on investment and cash flow, or basically to make money". Though they arrived at a goal, neither was aware of a strategy to achieve all 3 at the same time.
Introduction of new concepts
When Alex discusses this with Jonah, he reveals that operationally, a business must increase throughput, while simultaneously reducing inventory and operational expenses.
Throughput: Rate at which the system generates money through sales.
Inventory: It is the money invested in things intended to be sold.
Operational expenses: All the money spent to convert inventory into throughput.
When Alex asks how he's supposed to measure these elements, he is reminded by Jonah that, "We are not concerned with local optimums," referring to conventional cost accounting reports. Jonah is a busy individual and Alex realizes that Jonah will provide Alex with the constructs for him to divine the answers to the underlying concepts. Alex must think through the answers on his own.
Identifying the Core Problem
Alex takes time to think about how the three measurements would apply to his particular situation. He gathers together his focus group which consists of Lou, the controller, Bob, the production manager, and Stacey, the inventory control manager to tie operational solutions together for the entire plant. Together they reveal that the source of the massive inventory is the result of overproduction of unnecessary parts being made to artificially keep the efficiency metrics up. Instead of producing what is needed for sales, the plant is producing every single part every stage can handle. Capacity for producing needed parts is unavailable because it is being tied up producing the excess parts.
Jonah reveals that:
Money is most important to management over efficiency.
Cost accounting is the number one enemy of productivity.
A plant in which everyone is working all the time is inefficient.
Jonah points out that the only way to create excess inventory is by having excess manpower. By trimming excess capacity to cut expenses, without reducing inventory and increasing sales you trigger downward throughput and increased inventory. If you attain only one or two of the three elements of productivity measurement, you are not working towards your goal - to reduce operational expense and reduce inventory while simultaneously increasing throughput.
Dependent events and statistical fluctuations
Jonah reveals that when capacity is trimmed to marketing demands, throughput goes down and inventory skyrockets. The carrying costs of inventory, an operational expense, also go up. This increase tends to offset the savings presented by the original attempt to lower operational costs through labor reductions. If capacity is trimmed to meet demand, demand continues to drop, carrying costs go up, and eventually you have no more market left for a mountain of inventory.
Two specific phenomena are identified which cause this effect - dependent events and statistical fluctuations. Dependent events are a series of events that must take place prior to another one beginning, or in other words, the subsequent event depends on the ones prior to it. Statistical fluctuations are the result of certain types of predictive information that cannot be determined precisely. These fluctuations influence prediction of error percentages, market demand estimates, and attempts to measure productivity.
Alex understands these 2 phenomena when he goes on a hiking trip. During the hike, he notices that the line of hikers exhibits an odd pattern of stretching further and further apart the longer they hike. He notices that one hiker Herbie appears to be holding up the remaining behind him. According to management science, even though these hikers are all at different rates, their average rate of progress should be estimable. This average rate should become the nominal rate of progress for the entire troop. Instead the troop is making final progress, or completing the hike, at the rate of its slowest member, Herbie.
The hike is similar to a set of dependent events subject to statistical fluctuations. Over time, the fluctuations do not average out, but rather accumulate because the influence of dependent events limits the opportunities for gain fluctuations. The length of the line of hikers becomes comparable to the total production time of a process.
Alex tries an attempt at re-balancing the capacity by placing Herbie at the front of the line, that way the production length won't tend to stretch out as before. It doesn't stretch, but it's still going as slow as Herbie. Herbie must be made faster, or gain throughput capacity, in order for the whole line to gain throughput. Herbie's backpack load is lightened and distributed among the troop and the entire troop doubles its pace as a result of the change.
Alex returns to the plant only to have his observations in the hiking trip confirmed by a production capacity test. Jonah now introduces the constructs of bottlenecks and non-bottlenecks. A bottleneck is any resource whose capacity is equal to or less than the demand placed upon it. A non-bottleneck is any resource whose capacity is greater than the demand placed upon it. If bottleneck capacity is kept equal to demand, and demand drops, costs will go up resulting in a loss of money. The objective is to maintain capacity at slightly less than demand.
Alex now starts to identify the plant's bottlenecks. The two obvious bottlenecks turn out to be the multi-process automation machine and a heat-treating furnace.
The multi-process automation machine NCX-10 can process an item taking 16 minutes and 10 operators in 10 minutes and using just 2. But there is a six month lead time to train a NCX-10 operator because of the specialty position requirements. And trained operators are leaving the company faster than it can re-train replacements, so the machine isn't running at full capacity which makes it a non fully-utilized bottleneck.
The furnace is being run at partial loads because of expediting, another non-fully utilized bottleneck.
In order to eliminate bottlenecks, Alex invites Jonah for a plant tour during which he notes that the composition of much of the work-in-process waiting at each of the bottlenecks is actually non-saleable parts destined for warehouse storage. This is hidden excess capacity. He asks about alternative methods which could be used in addition to the present processes, addressing the old retired machines as a potential capacity source. He asks if every part actually needs to be processed by the bottleneck and identifies additional hidden capacity.
Alex learns to consider using alternate processes or off-load to increase capacity. Quality controls should be placed prior to a bottleneck to ensure the bottleneck will not be processing defective parts and wasting valuable bottleneck process time. Rejecting materials prior to the bottleneck then becomes simple scrap rather than consuming additional capacity. Process controls at a bottleneck should be designed to ensure zero defects based processing to minimize re-work and system impact costs.
The team determines that one of the underlying causes of their present parts pile-up at the bottlenecks is because the operator cannot tell the difference between a bottleneck-destined part and an ordinary one. The operator, in an attempt to keep busy, processes batch after batch of non-bottleneck parts when what they really need to do is work on bottleneck parts. They attempt a solution for this by placing identifying tags on the parts which are destined for a bottleneck process.
The bottle neck capacity is increased by recalling old machines which resulting in an increase in bottleneck capacity. The furnaces are not being manned by dedicated personnel to keep them operating and reloaded during the idle times, so additional personnel are assigned to them on a full-time basis.
Additionally, some of the bottleneck foremen come up with methods of streamlining their processes to increase throughput at their stations. And for a time, things seem to be improving - inventories are slowly shrinking and more backlog orders are being filled.
New problems come up
A new problem is revealed with shortages of non-bottleneck parts now occurring in addition to the bottleneck parts. This could be potentially a new bottleneck as a result of overtaxing the rest of the system.
Activating a resource and utilizing a resource are non-synonymous because non-bottleneck material continued to be fed into the system in order to maintain the production efficiency quotas, non-bottlenecks began turning out maximum units of non-bottleneck parts clogging the work-in-process inventories at bottlenecks and at non-bottleneck stations. Activating a resource is simply turning it on. Utilizing it means making use of the resource in a way that moves the system towards the goal.
A new material release system was developed which triggers release of bottleneck material only at the rate at which the bottlenecks need it, rather than being triggered by non-bottleneck idle time. Jonah shows that they can use the same methodology to develop a release system for materials throughout the system. By knowing when the bottleneck parts will reach final assembly, the release of the non-bottleneck materials can be timed to coincide along the other routes.
Improvement in results
All the steps to identify and eliminate bottlenecks resulted in better results. Peach was impressed, but not sufficiently to call off the division sale. Alex agrees to another fifteen percent improvement in the net profit in order to prove that the changes are not momentary or unique.
As it turns out, Jonah indicates that after load balancing is performed to meet market demand without excess production, the next logical step is to reduce the batch sizes to reduce the total capital commitment used during production. Reduction in batch sizes also reduces the total time spent in work-in-process. Less time spent in production increases the speed of throughput as well as a faster turn-around on customer orders. Shorter lead times result in better response to the market demands.
The four primary time components include: setup time, process time, queue time (associated with bottlenecks where parts wait for a machine to become free), and wait time (associated with non-bottlenecks when a part waits for another part to continue processing). Time saved at a non-bottleneck is imaginary because when non-bottlenecks are being set up, the time spent is taken away from idle time, not production time. Economic batch quantities are calculated based upon the whole system and not the bottlenecks themselves. As a result, most batch sizes are not optimized to the stations most affected by them -- the bottlenecks.
Now that the plant has the potential of responding better to market demands, Alex focuses on the third component of productivity measurement, that of sales throughput, and gets the division sales manager, Johnny Jons, to market his plant's improved capacity. Together they manage to tie down a major contract using a combination of incremental deliveries and low quantity pricing. This sets the stage for accomplishing the fifteen percent improvement Alex promised to Peach.
Smyth, the division productivity manager and competing plant manager, sets out to identify what Alex is doing to his plant by initiating an internal audit. As a result of the labor changes and the non-bottleneck idle times the cost reports show an increase in per unit costs. Smyth calls Alex in to explain himself in light of the audit findings.
Alex illustrates specific points that are in direct contradiction with conventional manufacturing assumptions:
We should balance the flow with demand, not capacity.
The level of activity from which the system is able to profit is not determined by individual potential but by some other constraint in the system.
Activating a resource and utilizing it are not the same.
An hour lost at a bottleneck is an hour lost by the entire system.
An hour saved at a non-bottleneck is worthless.
Performance of an operation should be evaluated by its bottom line.
Smyth presents his findings - that Alex's plant has decreased productivity, increased product cost, and improper adherence to procedures throughout the organization. This was contradicting evidence that the plant has turned solid profits and lowered operating expenses, increasing cash flow. The division controller pointed out that Alex's plant represents the ideal combination of delivery speed, low cost, and flexibility that the market really needs. With this Alex was appointed as the division manager.
The reason Alex received support of the division controller was because Lou, the plan controller had been working hard behind the scenes re-crunching the numbers and identifying an additional flaw in the conventional cost accounting process - evaluation of inventory costs. Even though using the cash method would clearly demonstrate the decrease in work in process and finished goods inventory, and decreases in purchased material costs, the traditional accrual method shows these actions as period losses since cash payment avoidance is not recorded until the next accounting period. In re-calculating the financial statements, Lou found a projected twenty percent bottom line improvement instead of the promised fifteen. But instead of giving these cumbersome accounting explanations to Alex to use in his defense, Lou took the results directly to Frost, the division controller who understood the ramifications of the numbers
5 primary steps identified to improve processes are:
Identify the system constraints
Decide how to exploit the system's constraints
Subordinate everything else to the above decision
Elevate the system's constraints
If in the previous steps, a constraint has been broken, return to Step 1, but do not allow inertia to cause a system's constraint
Due to the improvements, the plant now has twenty percent additional capacity available to fulfill demand. It turned out that Europe has many potential customers, but the prices they demand are so low below the domestic market, UniCo couldn't possibly take them without losing money. Alex pointed out that when production is used from spare capacity, the only costs are the cost of the materials and as such, any price above material cost represents profit. Combined with an unbelievably short delivery time to shut out unimproved competitors, the company has pocketed many deals ensure the future sales of the plant.