interdepartmental information requests in many organizations. However, since everyone is aware of the importance of the organization’s Archimedean constraints, everyone in the organization gives top priority to matters dealing with or relating to constraints. 15 The request could be for a decrease, but we doubt that that would happen very often. Nevertheless, before discarding the notion we might consider that such a procedure could present an avenue for obtaining agreement for budget decreases that could then be a component of a POOGI Bonus. 16 The payback allocation method and the sources of future improvement are discussed in Chapter 5. 17 Class D labor will still be an internal physical constraint. This is at variance with the analysis in Chapter 3 which suggested that the entire $150,000 of potential throughput listed in the Expansion and Replacement Funnel would be received. This discrepancy arises because in Chapter 3 we had not yet discussed the implications of different t/cus for accepting potential orders. Now, in Chapter 10, we add the assumption that the sales function has been exploiting and subordinating appropriately. 18 This assumption about future T is discussed further in Chapter 11. 19 The purpose of the commitment to employees is to continually satisfy the third necessary condition for successful constraint management: a reason for people to subordinate appropriately as discussed in Chapter 11. 20 The time value of money refers to the fact that, as a rule, given a lump sum of money—say $100—we would rather have it sooner than later. However, probably at some point we would prefer a future amount. For example, we might prefer a reliable promise to receive $120 one year from today to receiving $100 today. Such a preference implies that there is some amount between $100 and $120 at which we are indifferent to having the money today rather than a year form now. If our indifference amount is $110, then we would say that our time preference for money is 10% per year ($100 plus 10% interest for one year = $110). Another way of stating this is that $110 one year from now has a present value of $100 when discounted at a discount rate of 10%. (Discount and interest are essentially the same thing. The term interest is used when calculating future values of present amounts, and the term discount is used when calculating present values of future amounts.) When cash flows occur over periods spanning several years, it is necessary to adjust the annual amounts to compensate for the time value of money. The techniques for doing this are known as present value or discounted cash flow methods and are discussed in most introductory management accounting and finance textbooks. 21 We are indebted to Harvey Opps for this insight and for providing an example of a software company that attempted to establish a cost buffer equal to three years of wages and salaries for this purpose. 22 Rounded from $817,306. 23 The process for determining the stated employment investment described herein is intended to be a general example of how such a process might proceed rather than an established procedure for making such a determination. The concept is new and undoubtedly subject to substantial refinement in terms of actuarial assumptions and technique. Nevertheless, even the rough methodology presented accomplishes the purpose of setting an investment amount to recognize the impact of the decision process on the organizational commitment to employees. 24 See Chapter 5 for a discussion of sources of future improvement. 25 $820,000 / $123,000 per month = 6.67 months. Notes 255 5070_Pages 7/14/04 1:56 PM Page 255 26 The Sources of Future Improvement section of the earnings statement is discussed in Chapter 5. 27 Section H, Estimated Cash Flow Changes, represents the cash flow analysis referenced in footnote 33 in Chapter 5. 28 Recall that the reciprocal of the payback period (expressed in years) gives the upper limit on the internal rate of return and approximates the rate of return when the economic life is more than twice the payback period. In this case, [1 / (6.67 months / 12 months per year)] = 1.799 per year or approximately 180%. 256 People: A Valuable Asset 5070_Pages 7/14/04 1:56 PM Page 256 11 Strategy and Conclusions STRATEGY The organization’s strategy is its path to the future. Conventionally, we think of strategy as involving the creation of an elaborate and systemic plan. But we need to modify our conventional understanding of strategy for the constraint management environment. The elaborate nature of strategy implies planning with painstaking attention to numerous details. Instead of an elaborate plan, a constraint management strategy reflects the elegant simplicity lying on the far side of complexity (see Chapter 3). Focus on the relatively few constraints allows strategic planning to cross the complexity divide, resulting in just two aspects of a constraint manage- ment strategy—the overall management philosophy and the specification of strategic constraints—requiring the routine action of the corporate gov- ernance group. In the first part of this chapter, we delineate responsibilities for strategic planning, distinguish between strategic and tactical constraints, specify potential attributes of strategic constraints, examine the role of markets in strategic planning, and resolve the short-run versus long-run dilemma. Strategic Responsibilities Strategy is the stuff of generals. The very highest organizational levels must be involved with both strategic considerations. The uppermost levels of the corporate governance group (the board of directors, executive manage- ment, and—sometimes—owners) establish the overall management philos- ophy, that is, the essential enabling rules for satisfying the three necessary and sufficient conditions for successful constraint management. 257 5070_Pages 7/14/04 1:56 PM Page 257 For example, the governance group might state that it is the policy of the organization to pursue a process of ongoing improvement through constraint management practices. In order to accomplish this policy, ap- propriate training is provided for all employees, all capital expenditures and requests for operating budget increases are evaluated with reference to constraints and necessary conditions, 1 the governance group would mandate that financial reporting at the executive level be accomplished on a constraints accounting basis (ensuring that Archimedean constraint location is reviewed periodically), and the governance group ensures that all employees have a reason to subordinate appropriately, such as the POOGI Bonus described in Chapter 4. Top managers of individual independent business segments desig- nate strategic constraints for their segments. 2 These strategically selected constraints typically should include a desired internal resource or capabil- ity and an element tying to the markets to be served by the organization. Strategy versus Tactics Whereas strategy provides the vision, tactics are the day-to-day actions taken in carrying out the strategy. Every organization has at least one tacti- cal constraint. An organization may—or may not—have one or more strategic constraints. However, an organization ought to have tactical con- straints and at least one strategic constraint. The tactical constraints actively constrain current bottom-line per- formance. These are either actual physical constraints (materials, re- sources, markets) or are the manifestations of policy constraints. Tactical constraints exist as part of every system that has an open-ended goal. All open-ended systems have at least one tactical constraint. Strategic constraints, on the other hand, are quite different. A strategic constraint is declared by management and therefore exists only if management establishes it. A strategic constraint is simply a statement of where management would like to locate a tactical constraint. But the importance of a strategic constraint should not be underesti- mated. It is through designation of strategic constraints that the organiza- tion avoids a random walk into the future. The selection of a strategic con- straint defines the future capabilities of the organization, which, in turn, define where the organization will go in the future. The selection also de- termines the pattern of future investment expenditures. The selection of a strategic constraint is analogous to a young person making a career choice. Will the person be an auto mechanic, or perhaps a pharmacist, an accountant or a physician, a teacher or a professional athlete? The choice will define the capabilities that the individual needs to develop and thereby direct the expenditure of funds, time, and effort to develop those capabilities. The career choice itself is both a very impor- 258 Strategy and Conclusions 5070_Pages 7/14/04 1:56 PM Page 258 tant decision and a very personal decision. In similar fashion, the selection of a strategic constraint is a very important and very personal decision. The strategic constraint should be consistent with the pursuit of the organization’s goal. The TOC focusing steps apply to both tactical and strategic con- straints but a little differently for each: 3 1. Identify the constraint. For tactical constraints, find the existing active constraints; this is a reactive step. For strategic constraints, select the desired constraints. Note that because this step is important in defin- ing the long-run course of the organization, this is a responsibility of senior management of the independent profit center; this is a proac- tive step. 2. Decide how to exploit the constraint. This step is similar for both tac- tical and strategic constraints. For example, consider a decision about pricing a new product. Assume that the product requires time on both Machine A, the current tactical constraint, and Machine B, a strategic constraint. Here we would examine two price ranges— one based on the active tactical constraint and the other on the strategic pseudo-constraint. 4 3. Subordinate everything else to the exploitation decisions resulting from step 2. Strategic decisions typically have precedence over tacti- cal decisions. For example, continuing the pricing example, if the price ranges overlap, there is no conflict—pick a price within the in- tersection of the ranges. However, if the price ranges do not over- lap, then a conflict exists and the strategic decision “trumps” the tac- tical decision, with the price being set at the end of the strategic range closest to the tactical range. 4. Elevation is expensive and always has strategic implications. 5 If a tacti- cal constraint is not also a strategic constraint, then the tactical con- straint must be broken when causing the desired strategic constraint to emerge as an active constraint. Tactical constraints that are not also strategic constraints are either removed from the system or are expanded to a level where they have enough protective capacity to subordinate properly. Strategic constraints are elevated when the long-run increase in throughput contribution is expected to be greater than the long-run increase in costs (including the cost of commitment to employees). 5. We must constantly guard against the inertia of our thinking in iden- tifying both tactical and strategic constraints. A change in the physi- cal reality of the organization changes the environmental back- ground. The changed background may lead to a different tactical Archimedean constraint. Here the organization has a choice. It may Strategy 259 5070_Pages 7/14/04 1:56 PM Page 259 accept whatever constraints emerge as the cyclical focusing process is followed, or it can decide the nature and location of its constraints. The fifth step applies equally to tactical and strategic constraints. Appropriate selection of a strategic constraint assumes that a holistic approach to constraint management is being followed. Most organiza- tions implementing individual applications of the constraint theory are not yet at that stage. Let us return to the analogy of a young person mak- ing a career choice. Many young people don’t make a specific choice. They just go where luck draws them. Some of these youths will be quite successful, and others not so successful. So it is with organizations that do not select a strategic constraint. They will go where luck draws them. Some organizations will be quite lucky, and others less so. But rather than relying on the fickle nature of Lady Luck, an organization can take control of its destiny, a destiny that will continually reflect favorably on its bottom line. Selecting a Strategic Constraint Robert Newbold suggests several potential attributes, including the follow- ing, on which the selection of strategic constraints might be based: 6 • A place that required a large capital expenditure to expand. • A technology or concept to which the organization has exclusive rights, such as by a patent, that differentiates its products or serv- ices from those of a competitor. • A resource that is difficult to elevate. • A point to which it is easy for other areas to relate. • Toward the beginning of the production process (to have lowest work-in-process inventory and production lead time). • A currently active tactical constraint (or near constraint). • A resource that is used only once for a significant portion of the organization’s output (thus avoiding an interactive constraint). • A resource within the organization’s control. • As the market (if all resources are easily elevated). Strategic Constraints Relating to Markets The constraint management philosophy is a growth strategy that relies on development of throughput from sales as an essential element of long- term success. At the time of this writing, most defined constraint manage- 260 Strategy and Conclusions 5070_Pages 7/14/04 1:56 PM Page 260 ment applications deal with the logistics of providing goods and services (operations, project management, and distribution). The sales expansion component has largely been addressed within constraint management cir- cles by exhorting the organization to greater sales. It is assumed that the competitive edge factors (better quality, shorter quoted lead times com- bined with better due-date performance, and timely introduction of new features) resulting from the logistical applications—as well as reformu- lated prices—will produce the requisite sales. Segmentation of markets is recommended, and the thinking processes are applied. Nonetheless, such a process lacks the focus that one would expect from a constraint manage- ment implementation. Recently, Bill Hodgdon has provided greater focus by suggesting that the organization’s strategy must include both specification of the market(s) to be served and identification of the products and/or services that will be offered to those markets. 7 Short Run versus Long Run The failure to correctly identify the short-run versus the long-run dilemma can lead to much mischief in a constraint management implementation. For example, not considering this question may lead to the erroneous conclusion that throughput accounting should be used for the short-run fi- nancial decision making and activity-based costing should be used for long- run financial decision making. If we assume that we are operating using a constraint management philosophy, then we will have a strategic plan that includes identification of strategic constraint(s). The long-run versus short-run question then re- duces to the question of subordinating to the decisions about exploiting the strategic constraint (what we want the constraint to be—the long run) as opposed to exploiting a tactical constraint (where the constraint actu- ally is today in the short run). If the strategic constraint and the tactical constraint are the same, then there is no conflict. But if they are different, then the strategic con- straint is also a pseudo-constraint, and there may be a conflict that can be expressed in the generic, or generalized, evaporating cloud portrayed in Exhibit 11.1. For (A), the objective of the cloud, use your favorite statement of making money (or throughput, in the case of a not-for-profit organiza- tion). (B) is the need to exploit (decide how to get the most out of) the current tactical constraint, which means that you must (D) use the tactical constraint for higher t/cu (throughput per constraint unit) products or services. On the other hand, there is also the need to (C) subordinate to the exploitation decisions contained in the strategic plan, which means that you must (E) use the tactical constraint in a way that will cause (or Strategy 261 5070_Pages 7/14/04 1:56 PM Page 261 not impede) the shift of the tactical constraint to the desired strategic lo- cation. If (E) requires use of the tactical constraint in a way that is in con- flict with (D), then the long-run versus short-run conflict exists. Note that in need (B), the term exploit is a shortened form of decide how to exploit. For the long run, the senior managers of the organization select, as part of their strategic planning process, what and where the de- sired constraints are to be. The long-run strategy, then, is the set of deci- sions made about how to exploit those desired strategic constraints. The or- ganization will subordinate to that strategy by elevating constraints in a manner that will cause the desired constraints to appear. With a robust constraint management process of ongoing improvement, then, the long run is more directed than just a series of short-run actions strung together. When the conflict has been resolved, and this is likely to involve manage- ment judgment, the set of exploitation decisions for the tactical constraint will incorporate consideration of subordination to the strategic plan and the conflict will be resolved. SUCCESSFUL CONSTRAINT MANAGEMENT One might well ask how an organization gets started on such a compre- hensive route to a process of ongoing improvement, especially when it in- volves paradigm shifts and changes in the essential culture of the organiza- tion. However compelling and seductive, implementations that focus on autonomous local improvement are destined for ultimate failure. Defini- 262 Strategy and Conclusions Exhibit 11.1 Short-Run versus Long-Run Evaporating Cloud conflict A Your favorite statement of making money (or throughput in the case of not-for-profit organizations). B Exploit the current tactical constraint. C Subordinate to the exploitation decisions contained in the strategic plan. E Use the tactical constraint in a way that will cause (or not impede) the shift of the tactical constraint to th e desired strategic location. D Use the tactical constraint for higher t/cu (throughput per constraint unit) products or services. 5070_Pages 7/14/04 1:56 PM Page 262 tive success requires a companywide holistic approach. Constraint man- agement defines the ingredients for that success. Understanding and us- ing the dynamics nature of constraints, the poweful TOC generic applica- tions, decoupling I from OE, and incorporating a constraints accounting measurement system that fully supports and provides motivation for every- one to act appropriately, constraint management propels organizations to experience a robust continuing process of ongoing improvement. As shown in Chapter 4, successful constraint management imple- mentations involve changing deeply seated paradigms held by individuals throughout the organizations. Such comprehensive culture change in- volves individual risk and comes neither easily nor quickly. The implementation approach advocated here does not result in an immediate move to ultimate outcomes; rather, it concentrates on satisfy- ing the necessary (and when all three necessary conditions are satisfied, sufficient) conditions for successful constraint management. After con- straints have been identified and exploitation decisions made, the mana- gerial focus shifts to controlling day-to-day operations. This step is known as subordination in the classic TOC focusing process (Chapter 2). The con- straint management rule is to subordinate everything else—that is, to subor- dinate all of the nonconstraint operations—to the set of exploitation deci- sions. An excellent plan has been prepared. Now is the time to put the plan into action and ensure that actual operations achieve the intended results. It is through subordination that constraint management realizes its dynamic potential. Let us reflect on the necessary conditions for a success- ful constraint management implementation, consider the role that organi- zational culture plays in subordination, and finally look at how doing con- straints accounting changes data requirements. Necessary Conditions The three components necessary for successful constraint management are: 1. Knowledge about constraint management. 2. Communication of tactical and strategic constraint location and ex- ploitation decisions. 3. A reason for people to subordinate properly. The first component, knowledge about constraint management, con- sists of training or education that results in every member of the organiza- tion understanding the nature and significance of constraints. The second component, communication of tactical and strategic constraint location Successful Constraint Management 263 5070_Pages 7/14/04 1:56 PM Page 263 and exploitation decisions, when combined with the appropriate knowl- edge obtained in the first component, results in all members of the orga- nization understanding how they should behave to subordinate their ac- tions appropriately to the organizational exploitation decisions. When the first two components are in place, individual employees know what actions to take with respect to constraint management. The third component, a reason for people to subordinate appropriately, is distinct from—and complements—the first two components. Current Status of Constraint Management The general state of attempts to establish processes of ongoing improve- ment through constraint management is confusion. Since constraint man- agement education is not widely integrated into general educational cur- ricula, organizations desiring to implement constraint management concepts must themselves arrange for the education. Most organizations do a good job of making the training and knowledge available, but not necessarily evenly throughout the organization. This leads to the unavoid- able result that the second necessary condition, communication of con- straint location and exploitation decisions, is met in only some cases. The training tends to be uneven, and implementations reflect that uneven- ness. 8 Because individual TOC techniques (e.g., drum-buffer-rope sched- uling, critical chain, and the thinking processes) offer extremely powerful results even when used independently, the techniques are frequently em- ployed in local areas and are isolated from the dominant remainder of the organization. If TOC techniques are adopted on a local basis, neither identifying nor relating to global constraints, there is no constraint man- agement. Such local applications typically do not incorporate the culture change that is requisite for bottom-line results in a dynamic process of on- going improvement. The third necessary condition seems to be met only rarely. Since all three necessary conditions are seldom satisfied, one rarely finds organizations that have established robust POOGIs in association with constraints management. Subordination The third necessary condition, a reason for people to subordinate appro- priately, directly addresses the point at which the theory of constraint management meets the real world of practical implementation. Given that exploitation decisions exist, organizational members must behave in such a manner as to subordinate their actions to the exploitation decisions. There is a dictum in TOC that says, “Tell me how you will measure me, and I will tell you how I will behave.” 9 Too often this dictum is misin- 264 Strategy and Conclusions 5070_Pages 7/14/04 1:56 PM Page 264 [...]... English Language [Houghton Mifflin Company, 2000]) 17 With respect to planning, Eli Schragenheim refers to this simplified concept as the principle of minimal planning He discussed this concept on the Internet TOC-L list on October 4, 1996 Appendix Accounting System Structure BRIEF HISTORY OF COST ACCOUNTING Cost accounting has penetrated into the composition of the modern corporation to the extent that... systematic elevation of Archimedean constraints Subordination control reports relate to those constraints The Constraints Accounting Earnings Statement having performance profit or the current value of POOGI Bonus pool as its bottom line (Chapters 3 and 4) illustrates reporting progress toward the global goal This Constraints Accounting Earnings Statement shows the degree to which the planned exploitation... managers needed to control expenses in a manner that produced a satisfactory profit This was accomplished by linking expenses to revenues in many ways to ensure that a predictable relationship was achieved because managers considered expenses to be under control if they bore a reasonable (specified) relationship to revenues (that is, total revenues exceeded total expenses by a satisfactory amount).23... strategic constraints If such a situation were to be encountered, the issue would be sent to top management for establishing a priority between the designated constraints that is, removing the strategic designation from one of them 5 Tactical constraints that can be removed quickly and inexpensively should be dealt with immediately and are not strategic issues 6 Robert C Newbold, Project Management. .. Conclusions Exhibit 11.2 Chapter Keys to Locking in a Process of Ongoing Improvement Chapter Title Keys 1 Thinking Bridges Understanding the impact of Archimedes points on the bottom line 2 Constraints Understanding the relationship of Archimedean constraints to the financial reporting system 3 I nternal Financial Reporting 4 M otivation and the Budget 5 Constraints Accounting Terminology and Technique... modern corporation to the extent that some people speak of management by the numbers This discussion of accounting system structure begins with a short trip through history showing that modern cost accounting principles developed in response to needs that still exist today When we change the methods of the accounting system, we must be careful to satisfy the needs that spawned the existing system Taxation... managers of these global enterprises desired to extract sums of money, on a voluntary basis, from many people In response to this desire, joint stock companies with limited liability for shareholders were authorized Brief History of Cost Accounting 275 Limiting the liability of individuals to the amounts of their investments reduced the risk to the individual investor.4 As a result, many different individuals—with... because capital was required to acquire manufacturing, communication, and transportation resources on a large scale.6 Investors wanted to feel a sense of security that their investments were sound Demand for external corporate auditors (public accountants) grew because an independent auditor, skilled in the art of accountancy, lent creditability to an organiza- Brief History of Cost Accounting 277 tion’s... providing a product could be reasonably estimated, customers became unhappy if they were asked to pay a price they considered unreasonably high relative to the cost of the product Often, there was a need to establish a price that could be justified to (or by) a customer In this case, the accounting product costs were used as a starting place for pricing products to which a reasonable markup was added A price... uninhibited involvement of the corporate governance group [owners (or owners’ representatives), board of directors, and top management] Inserting this master key into the global bottom-line lock and unleashing the dynamic power of constraint management to realize a robust process of ongoing improvement is in their hands NOTES 1 As illustrated in Chapter 10 Independent business segments must be at least . promise to receive $120 one year from today to receiving $100 today. Such a preference implies that there is some amount between $100 and $120 at which we are indifferent to having the money today. resource that is difficult to elevate. • A point to which it is easy for other areas to relate. • Toward the beginning of the production process (to have lowest work-in-process inventory and production. about how to exploit those desired strategic constraints. The or- ganization will subordinate to that strategy by elevating constraints in a manner that will cause the desired constraints to appear.