____of July, 2015
In real-life business the operating managers of companies face a lot of issues such as market pressure on prices and performance, intensification of competitor rival, picky customers, and dissatisfied shareholders demanding higher revenues, better financial performance as well as gradual increase of business valuation. The book by Eliyahu Goldratt gives the powerful thinking approaches, tools and techniques describes how to deal with this wide variety of issues, and how to apply his Theory of Constrains (TOC) in the different industries’ supply chain: in marketing and product development, sales, inventory management, distribution and logistics. The author proves that TOC methodology is flexible and applicable to various real-life problems. Using thinking skills and TOC toolset, the managers can transform relationships with their clients, make a dramatic shift from losses to profitability and even to impact strategic decisions regarding their companies. Moreover, the proposed TOC techniques in communication, decision making and conflict resolution can be used not only in business but also at personal level, in family life.
It’s necessary to take a closer look at the problems described in the book. The first set of problems is related to excessive inventory. Excessive inventory of finished goods and a huge warehouse to maintain. Discussing the printing house, the author mentions the warehouse “three times as big as the rest of the complex.packed withprinted stuff” storing printing production (Golgratt, 1994, ch. 3). Moreover, excessive finished products inventory, including the stock kept by the distribution network, delays the introducing of new products to the market or, if a new product lines replace the old ones, leads to losses as a result of write-offs (Golgratt, 1994, ch.5.)
The second group of issues can be marked as related to the current market situation. First of all, the market is “buyers’”. Market pressure making the businesses to reduce prices, leaving only a little space for margin, in spite of higher quality delivered to their customers. The company should maintain the highest quality standards just to keep (or increase) its market share with no attempt to increase the prices. It has a negative impact on profitability (Golgratt, 1994, ch.3,12,14) This problem is rather strategic than operational. Then, technologic progress accelerates the obsolescence of the equipment (Golgratt, 1994, ch.3.) Moreover, the existing technologies and equipment doesn’t allow the business to win the competition in large-volume segment, pushing down profits. Increasing pressure on businesses to update their product range and to launch new products frequently, this market need enters into conflict with R&D and product development functions existing capacity (Golgratt, 1994, ch.12.) The customer market puts a pressure on businesses to reduce the prices (Golgratt, 1994, ch.9.) Competition intensifies, especially in advanced material industries (Goldratt, 1994, ch. 15.) If the price per unit for large batches goes down, the buyers expect a proportional decrease of the price per unit for smaller orders. At the same time, marketing function lacks innovative ideas to position and promote products (Golgratt, 1994, ch.12.) Often the marketing within the company doesn’t take full advantage of proper market segmentation and elaboration of unique proposal for each valuable segment (Golgratt, 1994, ch.16.)
The huge set of problems for many businesses, both described in the book by Goldratt and the real ones, is in the distribution model. Maintaining high standard of on-time delivery is risky, because sudden drop in performance can turn off the clients, which are not protected by enough inventory (Golgratt, 1994, ch.3.) Actual shipment and stores demands are out of sync in terms of amount and product range, the orders are often incomplete (Golgratt, 1994, ch.6., ch.8). Shipping of missing items (so called “emergency shipment”) takes time and extra costs. Mismatch between the actual consumption and delivery, where some regional units are over-stocked on some items of product range and run out of stock on other items, results in missed revenues, extra costs and negative experience in retail network. There is significant mismatch between the stores’ inventory and customers’ demand (Golgratt, 1994, ch.23). Along with disproportions between stores demand and regional warehouses or production facilities’ inventory, it exacerbates the mismatch between the production, delivery and actual consumption, creating shortages and excessive inventory. The disproportion, mentioned above, results in “lost sales” (Golgratt, 1994, ch.23), decrease in profitability and turns off the customers. Large inventory of obsolete production forces the retailers to offer huge discounts to their customers; it also harms profitability (Golgratt, 1994, ch.23). Reduction in finished goods inventory has a negative short-term impact on profits. It’s rather an accounting than an operational problem, but it may generate concerns in different stakeholders who care about the business valuation (Golgratt, 1994, ch.7.) But, on the other hand, the obsolescence of the finished goods also gradually decreases with the reducing inventory amount. Introduction of new product lines and new sales channels deteriorates the sales of the existing products within the existing channels. This, along with lack of skills in retail network and workforce overload, creates problems in distribution network (Golgratt, 1994, ch.12, 14.)
And, finally, the large number of issues can be attributed to management itself. Lack of vision and commitment to strategic goals in managers. “Managers are trying to run their companies by striving to achieve local optima” (Golgratt, 1994, ch.15.) There’s an ongoing conflict between the goal to increase sales and the pressure on capital and operating expenses (Golgratt, 1994, ch.15.) The shareholders and board of directors increase their pressure on operating management to boost sales to maintain market share and revenues (Golgratt, 1994, ch.14, 15.) At the same time, there’s an internal conflict between different functions within a business; the functions blame each other for “lack of performance” (Golgratt, 1994, ch.12.)
The lecture materials provide the list of common problems in supply chains that are faced by many operational managers. In the book by Goldratt (1994), the author described in detail all the mentioned problems, and emphasized the core conflict between too high and too low amount of inventory of finished goods for businesses, where distribution can be identified as actual constraint. Moreover, the author clearly links the supply chain problems with their impact on financial performance of business and its strategic position. The author analyses the business as an open system interacting with its customers, competitors and stakeholders. Thus, the problems, described in the book, address not only operational management, but management of all the business and support functions within the companies (strategy, marketing, innovations and product development, engineering, production, distribution, technical maintenance, etc.)
One of the elements of the solution was the reducing finished goods inventory that decreased the need in warehouse space and boosted the rate of on-time delivery (Golgratt, 1994, ch.3.) Regional units of distribution (regional stocks, buffers to the market constraint) should have inventory on board in the amount corresponding to the short-term sales forecast. It means matching the inventory with actual sales volumes and actual customer demand (Golgratt, 1994, ch.6.) The majority of inventory is kept within production units and the amount of stock is based on aggregated sales forecast. The size of a buffer (regional stock) depends on consumption forecast and replenishment time.
Next, mid-level managers shouldn’t focus on “local optimum” but use forecasting and proper inventory management in their decision-making (Golgratt, 1994, ch.6.). To stimulate consumption and boost revenues, the business may encourage its customers to order more frequently in smaller amounts, offering them a better financial deal and allowing them to control inventory. For some customers, who struggle with cash flow problems, small but frequent orders will reduce the pressure on cash flow and will demand less cash in inventory. That is one of the ways to “break the buyers cloud” (Golgratt, 1994, ch.9) and boost the business revenues.
One of the powerful ways to attract the buyers is to convince them “not to consider the price-per-unit that he purchases, but rather the price that he pays per unit that he is likely to use” (Golgratt, 1994, ch.9); in addition, the frequency of delivering may be increased and the no-penalty cancellations and changes can be applied, preventing obsolescence of the goods. To ensure complete and on-time order delivery, the business has either to keep large inventory, or increase the current capacity workload. For the case, discussed in the 9th chapter (Golgratt, 1994), it’s no need to boost inventory, as the company has an excess capacity.
One of the solution’s elements was changing cooperation terms with retail networks to consignment schedule (Golgratt, 1994, ch. 22). It may create some risk of inaccurate reposting of sales and revenue shortfall, but this risk was eliminated through replenishment schedule – only those products will be shipped that have been already sold. As the time between the shipment to the retail store and sales to end-customer is less than existing time interval between the shipment and payment, the receivables were expected to decrease, and new consignment schedule generated more sales.
The managers put an emphasis on proper market segmentation and using the Current and Future Reality Tree toolkit to address each segment’s core problem and to ensure that the value perception the market (or its segment) has for the company’s goods and services is better than the perception the market has for the products of competitors (Golgratt, 1994, ch. 19, 20)
For one of the groups’ businesses, the managers decided to change the entire business model from selling the equipment, spare parts and maintenance services to offering the clients exactly what they need: the result of work of all the equipment (for the case, discussed in the book, it was pressure steam, Golgratt, 1994, ch. 28.) In today’s world, the similar model is often used by “software as a service” IT companies. The pricing model is based on a flat fee plus a fee based on usage intensity. As a result of the described intervention, this company was taken as an excellence model for the entire holding, as a driver of progress for other companies, to initiate changes and to implement successful strategies in order to strengthen the performance of the entire group of businesses Golgratt, 1994, ch. 29.)
The above list of the solution components, made up based on the ideas and steps, discussed in the book, contains all the three key injections, covered by the lecture materials: replenishment of the pipeline based on sales (consumption) forecast; correct positioning and sizing of inventory by all the units; and management decisions based on buffer management. For businesses, where consumption imposes a constraint, matching business model, operational model and distribution schedule with actual consumption provides more opportunities for gaining competitive advantages and winning new customers. The need for change is especially acute in industries where competition is tough and the market terms are dictated by buyers. Along with describing transformation in marketing approach and operational models, the author offered many useful hints related to strategy and corporate governance.
The management principles, introduced by Eliyahu Moshe Goldratt, have been successfully implemented not only by imaginary companies, described in his books, but by many real world businesses across the globe. For instance, the companies of Indian power and metallurgy industries, such as TATA Steel and TATA Power, successfully implemented the theory of constraints and critical chain project management in various areas such as out-bound supply chain, equipment upgrades and implementation of facilities shut-downs (Pai & Giridharan, n.d.). The results were impressive: if before the CCPM implementation conversion of the boiler took up to 500 days, routine maintenance time didn’t meet the actual needs of production; then after the CCPM principles launch completion time reduced by almost 70% to 120-160 days, cycle time reduced by up to 33 percent within 2007, and by additional 5-33% in 2008; the company received additional revenue of $4M (Realization Technologies, 2014.)
Another evidence of CCPM success is Japanese construction company Sunagogumi, which introduced this management approach in 2005. According to Stratton (2009), tight timeframes of eliminating earthquake damage was the impulsive cause of introducing critical chain project management. As a result, the company was able to shorten the project schedule by 30% and to finish repair before the typhoon season. Also, Sunagogumi was able to “complete more projects with the same resources.” Within the project it established highly valued communication with the government and local community (“Just-in-time Information”). It caused very positive response from the government, which in its turn introduced the “One Day Response” initiative to improve response to contractors. As a result, the average duration of projects was reduced by 20%, and the profits went up by 7% (Stratton, 2009.)
The Theory of Constraints principles are implemented not only by companies producing tangible goods but also by informational technology companies. Caesar, mid-sized IT company (Netherlands), was significantly hit by recession in the beginning of 2000s. Up to 70% of all the company’s project fail to complete within the budget and set timeframe. The year 2005 became the turning point for the company. Based on Goldratt’s works, the new management principles and approaches, such as critical chain project management, problem driven scope management, Time Value approach gave significant results. Within the first year o transformation program, the share of projects delivered on time and within budget, went up to 80%, later, the due date performance increased to 95%. The company was able to take more complex projects and to increase its revenues (de Laat, 2009.)
Another successful case presents implementation of Drum-Buffer-Rope solution in an underperforming Microsoft’s It departments in 2005. The interventions, including adding buffers, removing estimations, and reallocation of resources gave the quick-win results within only first year: throughput has risen three times, time-to-resolve reduced from 5 months to about two weeks, the general productivity rations went up by more than 100 percent (Anderson, Dumitriu, 2005.)
The other TOC tools and approaches also offer significant advantages for companies. For example, according to Partida (2012), implementation of continuous pull replenishment by organizations, reduce their logistic costs sufficiently. At the median, the companies that have implemented continuous replenishment spend $20 less per every $1,000 in earnings to manage logistics and warehouse than their competitors. For example, if a company has annual revenue of $5 billion, it can save on logistics about $100 million (Partida, 2012.)
References
Goldratt, EM. (1994). It’s Not Luck. Great Barrington: North River Press.
Pai, S. & Giridharan, S. (n.d.) Application of theory of constraints and critical chain method for project management in Ultra Mega Power Projects (UMPP). International Journal of Power System Operation and Energy Management. Volume 2, issue 3-4: 2231-4407. Retrieved from http://interscience.in/IJPSOEM_Vol2Iss3-4/105-108.pdf Accessed 22 July 2015.
Realization Technologies (2014). Tata Steel shares results from implementing Critical Chain Project Management (CCPM). YouTube. Retrieved from https://www.youtube.com/watch?v=VTqXim_RCjQ Accessed 22 Jul 2015.
Stratton, R.(2009). Critical Chain Project Management Theory and Practice. Nottingham Business School, Nottingham Trent University. Retrieved from https://www.ntu.ac.uk/nbs/document_uploads/94592.pdf Accessed 22 July 2015.
de Laat, L. (2009). Using TOC to deliver IT projects on time, all the time. First European TOCICO Regional Conference, Amsterdam, The Netherlands, Goldratt Marketing Group.
Anderson, D., Dumitriu, D. (2005). From Worst to Best in 9 Months: Implementing a Drum-Buffer-Rope Solution in Microsoft’s IT Department. TOC ICO World Conference November 2005. Retrieved from http://images.itrevolution.com/images/kanbans/From_Worst_to_Best_in_9_Months_Final_1_3-aw.pdf Accessed 22 July 2015.
Partida, B. (2012.) Continuous Replenishment Lowers Logistics Cost. Industry Week, Dec 12, 2012. Retrieved from http://www.industryweek.com/logistics/continuous-replenishment-lowers-logistics-cost Accessed 22 July 2015.
