The Cost world vs. the Flow world

One of the biggest challenges in Transformation is to change the KPIs used to measure individual and departmental performance. Eliyahu Goldratt said, “Show me how you measure me and I’ll show you how I perform”. KPI’s in the cost world focus on efficiency at the micro level, not taking into account whether it will have a positive or negative impact at the macro level.

I have worked with companies where the focus in operations is to ensure that the overhead recovery is achieved for every operating minute. This often results in high value products being produced in excess of requirements and when you look at the resulting inventories, actual sales and customer service levels, you see the negative impact of this strategy.

Now we must ask ourselves; Which of these measures is real in terms of earnings? What good is it if you produce stock or sub components (intermediates) purely for overhead recovery and have them to lie around waiting for the next step in the process to be freed up so they can move to completion? This is the reality of the linear cost driven world and the direction these KPI’s push us.

waterfall 1Consider this; A process that flows unimpeded through each step to completion in the shortest possible time, All aspects of the batch compliant with GMP and GDP guidelines. This batch would be sold, generating income for the business, freeing up working capital for further investment. This isn’t the only advantage, think about the staff, focusing on adding value to the product at each step. No infighting, laying blame for mistakes or CYA, just one cohesive team collaborating to achieve the ultimate Return on Investment for the business.

We need to ask ourselves what the fundamental differences are between the two scenarios described above. There are a number of factors at play here that need to be exposed and discussed at every level. We then need to look at what is and isn’t working and create a collaborative and informed plan involving all the players to transform the business.

We’re definitely not saying that we ignore cost, what we are saying is that FLOW protects cost, and cost doesn’t protect FLOW.

Protection and Promotion of flow

How do we allocate overhead recovery to a product?

Indirect costs like electricity consumption, indirect labour, support services etc, are used at department level. The standard overhead recovery per product is calculated without understanding what and where the constraint is. Very often, achievement of overhead recovery leads to a build-up of WIP, which in turn leads to congestion and impacts negatively on throughput. We forget that departmental efficiency doesn’t necessarily translate into company profitability. Improvement made at a local level on a non-constraint becomes a non-recoverable cost.

Each process has a single constraint, the rate defining step that controls the speed of the process. Using systems thinking, the analysis of processes starts across the value chain identifying the department that is the constraint. This department then interrogates its internal processes to identify the physical constraint. This is the constraint that is initially focused on and managed closely because it determines the overall rate of flow across the entire value chain. This will optimise FLOW and start the transformation to a PULL system. When we understand the constraint, we can also start looking at meaningful improvement strategies.

Company and departmental metrics need to be adapted to pull and promote flow because this will ensure that our Customer Service levels are increased and that inventories are reduced.

One of the most beneficial tools within the DDMRP toolbox are the demand driven measures. In 2011 Debra Smith and Chad Smith wrote a book called “Demand Driven Performance using Smart metrics”. This book gives a detailed explanation of the need to change the way we measure our businesses. They promote 2 primary measures, Return on Investment and Due Date Performance.

ROI measures the decisions and actions taken by people throughout the business day and their daily use of assets determines the working capital position and decisions regarding further investment of capital.

The DDP measure is secondary to ROI, and measures our ability to meet actual requirements that contribute directly to revenue.

Within the Systems thinking organization, these measures can be broken down into meaningful metrics at department and process level. Compliant production becomes possible, because time previously spent pushing unnecessary production and managing the effects of congestion can now be used to ensure we achieve our Right first Time or OTIF targets. Protect and promote FLOW and you will start the journey to increasing your net profitability.

Should you have any questions or comments, please in the comments section or email to dave@sacoaching.co.za. You can also call me on +27 82 777 0922.

Thanks to Debra Smith and Chad Smith wrote the book called “Demand Driven Performance using Smart metrics”.

About the author

Dave Hudson is a supply chain and operations specialist and executive coach with over 30 years’ experience, and currently 1 of 5 endorsed Demand Driven instructors on the African continent.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s