A Guide to Implementing the Theory of
When we set out to implement change we must remember that there are 3 possible outcomes. These outcomes are;
(1) A change which is a significant improvement.
(2) A change which is neither a significant improvement nor a significant decline.
(3) A change which is a significant decline.
Naturally enough, it is the first option that we are really seeking. We want to make a difference, and we want that difference to be manifestly positive. In order to do so, we must make decisions prior to carrying out the desired actions, and to be certain in the knowledge that those decisions will deliver the necessary results that we seek.
How we evaluate the improvement will depend upon the goal of the system. If the goal is a monetary one, then the evaluation is relatively straightforward. And that is what we will concentrate on here. In not-for-profit, or more correctly, for-cause situations how we evaluate an improvement is a little more involved; however, if you look at the argument for healthcare (supply chain section) then you will find some good indications of how this can be achieved.
We are evaluating changes within the context of the whole system – or the system as a whole. We are not interested in local improvements that do not have system-wide impact. How, then, would we judge an impact in such a circumstance? We need a context. We already have one, let’s revisit it.
On the measurements page we derived our rules of engagement. These tell us how to define the entity that we want to improve. We define the boundaries, the goal, the necessary conditions, and the fundamental measurements. Without these, we do not have a context within which to evaluate change. Moreover, this forces us to determine what it is that constrains us from moving towards our goal; we have to define the role of the constraints.
The constraints are central to our ability to move forward. In order to define the role of the constraints we need to invoke our plan of attack, the one we developed on the process of change page. Of course, our plan of attack is Goldratt’s focusing process. The second step of this plan, where we decide how to exploit the constraints, is the step that provides commonality between these two schemes.
We have previously summarized the relationship between the rules of engagement and the plan of attack as follows;
In order for a change to be an improvement it must either have a direct positive effect upon the current exploitation or elevation of the system’s constraints, or an indirect effect via improved subordination which in-turn ought to improve the exploitation or elevation, either now or in the future.
To quantify these effects we must return to our fundamental measurements.
In the first page, the page on measurements, we briefly introduced the concepts of; throughput, inventory/investment, and operating expense; a triumvirate set of measures for quantifying effects in Theory of Constraints.
Throughput as you may remember was described as;
Throughput = Sales - Totally Variable Costs
From this we came to define our net profit as;
Net Profit = Throughput - Operating Expense
And return-on-investment is;
It is through these 3 fundamental measures of; Throughput, Inventory/Investment, Operating Expense, and the two basic relationships of net profit and return-on-investment that we are able to evaluate change.
The reason that we can do so much with so little is because of the fundamental relationships that exist between each measure. They are systemic.
Let’s try to reinforce the fundamental and systemic nature of these measures by way of analogy. By this means we will be in a far stronger position to understand change and how to evaluate it.
The analogy is a see-saw.
A see-saw! How does the evaluation of change relate to a see-saw? Well, let’s have a look.
Let’s draw a simple see-saw as a start.
In this simple example a lever – a plank – sits centered exactly across a fulcrum, therefore we have 1/2 of the plank on one side and 1/2 of the plank on the other. We can quite easily balance two equal masses at either end of the plank.
The two equal masses – “people” are located equidistant from the mid-point of the plank, so let’s label that.
The mid-point is also the point of balance, so let’s add that as well.
Now; what if we move the plank along a bit? What if we move the plank along so that it is now half way closer towards one end than the other, so that we have 3/4’s of the plank on one side and 1/4 on the other? What would be the effect?
The effect is that we can now balance 3 times the mass on the shorter end. In effect we have gained some leverage. And for the purists amongst us we have balanced the 3 masses over a pivot under the middle person on a secondary upper plank. Both planks have been tested by applied mathematicians and deemed to have “no real mass,” so for the purposes of this analogy we can ignore the mass of the planks themselves. It is only the leveraging ability that we are interested in.
Can we use this simple analogy of a see-saw for evaluating internal management decisions, change in other words? In terms of physical aspects it is apparent that we seek to leverage inputs of some kind via a process of some sort in order to produce outputs. In fact, the process does not exist in isolation but rather it exists in conjunction with a set of operating assumptions; the things that we call policies. How then would this look using our model? Let’s see.
Does this reflect reality? I think so. We use our physical process in conjunction with our operating policies to produce more output than input.
How then would our model look in terms of financial aspects? In the terms of financial aspects it is apparent that we seek to leverage expenditure via investment to produce income. Once again the investment does not exist in isolation but rather it exists in conjunction with a set of working assumptions; policies once again. Let’s see how this looks.
When we buy a business (an investment) it consumes cash (expenditure) and produces even more cash (income) as a result. We definitely leverage our expenditure via our investment. This is why some businesses are described as “cash cows” and, equally, why some are not. Of course the physical aspects and the financial aspects are just different views of the same system, simplified here by a one to one correspondence between physical and financial units – the masses that sit on the plank.
We need to ask then; will this simple analogy, a see-saw, also work as a description for evaluating change in Theory of Constraints? Well, I think so, so let’s try.
From our cash expenditure we take all raw material or 1:1 variable costs out of contention to obtain our operating expense – that is, after all, how we define operating expense. From our income we also take all raw material or 1:1 variable costs out of contention to obtain our throughput – again, this is how we define throughput. The 1:1 variable costs are simply equal flows into the system as raw material and inputs, and equal flows out of the system as sales. In essence then, we leverage our operating expense via our capital investment to produce throughput. And, yes, we still have policies to guide us.
It seems then, that our analogy will hold for our fundamental measures. Great.
Any change in throughput, or operating expense may change the balance of our system. Do you agree? Our analogy shows the interrelationships between these various aspects.
Do you want to push the analogy a little bit further? What is our profit then?
Let’s have a look.
Throughput minus operating expense equals profit. So now we know that our analogy will accommodate our definition of profit as well (call it operating surplus if you prefer). So, in reality, we leverage our operating expense via our investment to produce a profit.
What about the balance point then?
The balance point is a measure of the leveragability that we have attained. The greater the leveragability, the further the balance point will move along the plank towards the right in our model.
We know the location of the balance point, but this begs a question. What is the fulcrum that we leverage across?
Let’s have a look.
The fulcrum is not a physical constraint, the fulcrum is time. Take a breath; stop and think about it for a moment.
I know that all too often we loosely talk about leveraging the constraint – we have used that language throughout these webpages and it is probably ingrained. But in reality we are leveraging our entire system over the fulcrum – time – and the only way that we can do that, either literally or metaphorically, is via the constraint. So we leverage the system via the constraint for a given unit of time.
So, yet another question; what exactly is the constraint in our analogy then?
Well, it must be the seating capacity, or the seating spacing – different ways of saying the same thing. Ultimately it is the length of the secondary plank which constitutes the constraint in our see-saw analogy.
Now that we have identified the constraint, how can we get more of this limiting factor? How in our metaphor can we get more people sitting balanced on the right-hand side? How can we improve the Throughput? How can we improve the profit? There are two answers to these questions, and they are that we can increase the productivity, and/or we can increase the production. We need to tease these two strands apart in order to better understand each of them. Let’s do that.
Making a distinction between productivity and production is important in understanding how to most effectively drive improvement, and such a distinction is also useful in developing our understanding of the dynamics of exploitation, subordination, and elevation. Production is the simpler, and certainly more familiar of the two concepts, so let’s start with that.
Essentially any increase in production is a pro rata increase in both inputs (operating expense), and outputs (Throughput). Let’s investigate this with our see-saw analogy.
Let’s start again with our original model with a balance point located 3/4 of the way along the plank.
Without moving the balance point we could double our throughput by doubling our operating expense. Let’s do that.
Two units of operating expense now balance 6 units of throughput. The initial ratio is preserved. In fact, by doubling operating expense and doubling throughput, we must also double the profit at the same time.
In effect the increase in inputs (operating expense) drives the increase in outputs (throughput). The leveragability of the system remains unchanged. The fact that the balance point doesn’t change is a simple indication that we are dealing with increases in production rather than productivity. In effect we elevate the existing system by bringing something new into the system – in this case new and additional expenditure as operating expense. Of course there must be latent capability to do this. In the real world this might equate to an additional shift as a simple example.
Increasing production, seductive as it is – after all this is what almost everybody else does – is nowhere near as sexy as improving productivity per se. Moreover, if we were to go around doing what everyone else does then there is hardly any strategic advantage to be had at all. So let’s investigate the impact of improving productivity; many people talk about increasing productivity but few actually manage to do it. Doing it is not at all difficult if we have focus.
Rather than settling for a pro rata increase in both operating expense and throughput, which means constant productivity – only more of it, we actively seek to decouple throughput from operating expense, which in-turn means increased productivity. Throughput should increase and ideally operating expense should remain static or even decrease; something other than additional operating expense drives the additional throughput. It is the leveraging of the entire system via the constraint’s throughput relative to the fulcrum, time, that drives the additional throughput. Let’s show this by example.
Let’s start again with our original model with a 3:1 ratio.
This time, instead of increasing operating expense, we will move the lever, and thus the balance point, even further to the left while maintaining the same operating expense. Let’s halve the remaining distance between the fulcrum and the right-hand side so that we now have 7/8’s of the lever on one side and 1/8 on the other. What do we get? Let’s see.