MAAW Home Introduction CHAPTER 1 CHAPTER 2 CHAPTER3 CHAPTER 4 CHAPTER 5 CHAPTER 6 CHAPTER 7 CHAPTER 8 CHAPTER 9 Accounting Theory http://maaw.info/AccountingTheoryMain.htm Agency Theory http://maaw.info/AgencyTheoryMain.htm Contingency Theory http://maaw.info/ContingencyTheoryMain.htm Decision Theory http://maaw.info/DecisionTheoryMain.htm Deming's Theory http://maaw.info/DemingMain.htm Economic Theory http://maaw.info/EconomicsRelatedMain.htm Expectancy Theory http://maaw.info/ExpectancyTheoryMain.htm Fayol's Theory http://maaw.info/Fayol'sTheoryMain.htm Management Theory http://maaw.info/ManagementTheoryMain.htm (2) (12) (17) (34) (45) (72) (89) (103) (104) (108) CHAPTER 10 Theory of Constraints http://maaw.info/TOCMain.htm (191) CHAPTER 12 Links http://maaw.info/TheoryLinks.htm CHAPTER 13 Causal Models, Strategy Canvases, Strategy & Value Stream Maps ============================================================== CHAPTER 11 What is a theory? http://maaw.info/ArticleSummaries/ArtSumChristensenRaynor03.htm (200) (230) CHAPTER 1 Accounting Theory http://maaw.info/AccountingTheoryMain.htm Covaleski, M. and M. Aiken. 1986. Accounting theories of organizations: Some preliminary considerations. Accounting, Organizations and Society 11(4-5): 297-319. Summary by Eileen Z. Taylor Ph.D. Program in Accounting University of South Florida, Spring 2004 Introduction Covaleski and Aiken propose that accounting researchers can benefit by taking an organizational approach to investigating how accounting and its roles impact the coordination and control in an organization. They present a history of the development of accounting and then provide a framework that views accounting from a sociological perspective. This framework is then used to identify research opportunities for the study of accounting as an organizational control. A HISTORICAL PERSPECTIVE OF ORGANIZATIONS The beginnings of the idea of organizational control were found in the private sector, as individuals became employees and the ‘ “visible hand” of management replac(ed) the “invisible hand” of market forces.’ Cost accounting in this time was used to estimate actual labor conversion costs, that until then were determined by the marketplace. Subsequently, capitalists used accounting information to control the work process. This was marked by technical control and advanced measurement techniques. The public sector became involved with the advent of scientific management identified by the authors as first generation. The focus at the time was on fiscal control budgeting. Accountability and expenditure justification was the theme. The stock market crash of 1929 ended that movement. The second generation changed the emphasis to accounting as a system to aid in the social reform movement. Through budgeting, government agencies could be judged as effective (or not). Control then went beyond control of the work process. In the private sector, this was evidenced by bureaucratic control; distinguished by its connection with social structures in the workplace. In an effort to concentrate capital and accumulate wealth, new tools were put in place; all with the effect of tying the employee to the organization and controlling all aspects of the business. The impetus for this development was the contradiction between production processes which were guided by scientific management, and distribution systems, which were still subject to market forces. Thus, the visible hand of management stepped in to organize the flows into and out of the firm. We know this as vertical integration. Changes in accounting paralleled changes in the control structure. Where accounting once focused on production alone; it now was used to monitor and provide information throughout the firm. There was a focus on divisional budgeting and intra-organizational information transfer. In the public sector, accounting was used for budgeting purposes. Planning and resource allocation were both facilitated through program budgets. Interaction between Public and Private Sectors Having covered the development in both the public and private sectors, the authors then focus on the interaction between the two. They point to Larson (1977) who states that the public sector’s progressivism led the way for the private sector to adopt scientific management principles. Kolko (1963) attributes the interaction to political capitalism. This led to a partnership between politics and big business that continues today (summary author’s emphasis). A HISTORICAL PERSPECTIVE ON THEORIES OF ORGANIZATION The authors provide a review of the early organizational theories and sociological approaches to studying organizations. The table below list these theories and the related accounting research perspectives and represents an adaptation of their Table 1. Each theory is discussed below. Table 1: A Historical Perspective on Theories of Organizations & Accounting Research Early Organization Theories Accounting Research Perspectives Application of accounting in the I. Scientific Management monitoring of individuals & work units. II. Classical or Administrative Application accounting in terms of Management departmental responsibility. Application of accounting in a concern for III. Human Relations the motivation & aspiration levels of individuals to be controlled. Application of accounting in management IV. Decision-making perspective decision making under conditions of uncertainty. Sociological Approaches Accounting Research Perspective a. Functionalism Limited emphasis on internal I. The organizational process. Functional b. Comparative Limited emphasis on internal Tradition Structuralists organizational process. c. Comparative Application & design of accounting Structural control systems contingent upon the Contingency nature of the host organization. d. Population Ecology Limited emphasis on internal organizational process. Concern for the role of accounting in the II. Political Economy Perspective interplay of power, goals & exchange systems. Concern for the role of accounting in III. Classical a. Marxists the origin, design & workings of control systems in organizations. Perspectives Concern for the role of accounting in b. Weber the increasing rationalization of contemporary society. Early Organizational Theories Scientific Management Scientific management provides a strong link between organization and accounting research. Accounting information was used to support control over the work process in pursuit of efficiency and productivity. Taylor’s scientific management applied not only to control over individual workers, but structuring of divisions, and proper assignment of managers. Accounting allowed managers to best allocate resources, as well as evaluate performance. The “objective” nature of accounting made it especially well-suited to this type of organizational control. Human Relations Early theorist Elton Mayo introduced a human relations perspective into organizational theory. Specifically, organizations should consider social and psychological factors when designing production processes. This would enhance efficiency and communication. Argyris (1952) applied this perspective to accounting; specifically in the form of participative budgeting. Decision-Making Perspective March and Simon (1958) brought forth the decision-making perspective. It was characterized by an emphasis on individual participants. These ‘decision-makers’ had an unfulfilled need for good, relevant information that went unmet by the organization. Accounting provided some of this information and thus assisted in reducing uncertainty in organizations. SOCIOLOGICAL APPROACHES TO THE STUDY OF ORGANIZATIONS Sociological approaches differ from early organizational theories in that the former takes the perspective of society, while the later takes the organization’s point of view. The Functional Tradition The functional tradition includes functionalism, comparative structuralists, comparative structural contingency, and population ecology. Early functionalists studied societies, their subparts, and how the integration of the subparts led to the survival of the group. Comparative structuralists analyzed organizations as a static structure, and did not examine organizational processes. Neither of the two provided an opportunity for accounting-related research. The advent of comparative structural contingency, however, opened the door to accounting research topics. Contingency theorists examine the organization and its reactions to changes in technology and environment. Contingency theory of budgeting is just one example. The population ecology model “attempts to explain how various environmental factors select those organizational forms that best fit given environments”(p.312). This approach has been criticized for eliminating human factors and focusing only on organizational structure. Hence, the authors do not see an opportunity here for accounting organizational research. Political Economy Perspective The political economy theory of Mayer Zald appears to offer opportunity for accounting research. This approach considers power structures and politics as drivers of the organization. Classical Perspectives Marxist theory focuses on how the current system of social control came to be. The authors state that the most important contribution is the identification of issues of social control and coordination as the central issues in the study of work and organization.(p. 313). The focus on control provides the link between Marxist theory and accounting theory. Weber is also mentioned; however, his approach pursues applied science. The authors do mention that Weber might provide opportunity for accounting research along the lines of examining the role of accounting in “…increasing rationalization and bureaucratization in society.”(p. 313). Some Unresolved Questions The authors conclude with some unresolved questions. • What are the purposes of the field of accountancy and the field of organizational behavior? • What are the areas of greatest mutual concern between the fields of accounting and organizational behavior? • Is the potential for a fruitful dialogue between these two fields equally good in both the public and private arenas? • What are the research methods that have been utilized in these two fields in their concerns for issues of coordination and control? Van der Merwe, A. 2007. Management accounting philosophy I: Gaping holes in our foundation. Cost Management (May/June): 5-11. The purpose of this article is to highlight the extent of the problem with the foundation of management accounting. In this paper Van der Merwe argues that the current state of management accounting is contradictory, confusing, and often absurd. Understanding the Problem First, the management accounting principle of causality is currently applied inconsistently. For example, in lean accounting, causality is deemphasized and the concept of a flow-path becomes the overriding principle. Second, the various management accounting modeling assumption relationships (i.e., throughput accounting, variable costing, lean accounting, traditional full costing, activitybased costing, and resource consumption accounting) produce contradictory results. In addition, management accounting concepts are subject to incongruent treatment. For example, according to Van der Merwe, the idea that the cost behavior concepts of fixed and variable are synonymous with the decision support concepts of avoidable and unavoidable is commonplace. The area of decision support has the greatest potential for inconsistency since the various management accounting approaches view the same decision in different ways. This is illustrated with a product mix example where different approaches produce different decisions, i.e., where the decision is based on either throughput or variable costs. The main problem is that contradictions and inconsistencies frequently result when the various management accounting approaches are applied because the underlying fundamentals are interpreted differently. What is needed is a set of disciplined fundamentals that all in the profession can subscribe to that will serve as a foundation for learning and communication. Getting Help from Philosophy Two of the laws of logic can be used to reveal the problem and to develop a solution. These include the law of non-contradiction and the law of rational inference. The law of non-contradiction is emphasized in this paper, while the law of rational inference is emphasized in part II1 of this three part series. The law of non-contradiction states that two contradictory statements cannot be true at the same time and in the same sense. This law of logic is the basis for the search for underlying principles and it reveals that the prevailing view that there is no single correct approach to management accounting is fatally flawed. He refers to this view as relativism, i.e. "there is no absolute truth". When applied to management accounting, relativism is the idea that a number of different approaches to management accounting can all be simultaneously valid and correct. However, this relativist view refutes the existence of truth and violates the law of non-contradiction. Thus, the law of non-contradiction reveals the root cause of problem with the foundation of management accounting. It also indicates the path towards finding a solution. The relativist view creates several problems for management accounting including the following: 1) it holds management accounting in a state of ambiguity, confusion, and frustration, 2) if there is no truth, there is no basis for evaluating the various theories and approaches to management accounting, 3) frequent bias by those with vested interest in a particular approach causes arguments that range from factual statements to character assassination, 4) if there is no truth, there is no lie, 5) real progress is difficult since there is no underlying basis for critical thinking, 6) no common frame of reference makes it difficult to communicate with managers and others looking in from the outside (e.g., students and prospective students), 7) no convincing case can be made for the value of management accounting to the enterprise. As a reality check one might argue that the world is not that simple, an absolutely accurate cost number is impossible to determine, but the reality of imprecision is not a valid argument against the need for truth. Van der Merwe notes that other objections can be raised to what he proposes, but although our understanding of an existing truth can change, the underlying truth does not change. In part II of the series Van der Merwe proposes two principles to serve as the cornerstone of management accounting's restoration. These include 1) causality and 2) analogy. In part III2 Van der Merwe recommends an evaluation framework to critically evaluate some of the assertions related to the prevailing approaches to management accounting. Van der Merwe, A. 2007. Management accounting philosophy II: The cornerstones of restoration. Cost Management (September/October): 26-33 In the previous article1 Van der Merwe argued that the current state of management accounting is contradictory, confusing, and often absurd. The purpose of this paper is to establish the principles that will serve as the cornerstones for the restoration of management accounting and to demonstrate how they are integrated into an existing management accounting framework. This integration will serve to highlight the required adjustments to the framework and to validate the cornerstones' implementation feasibility. In part III2 Van der Merwe recommends an evaluation framework to critically evaluate some of the assertions related to the prevailing approaches to management accounting. Two principles from inductive logic that provide the basis for drawing cause and effect inferences are presented as the cornerstones of management accounting. These include: 1) causality and 2) analogy. Causality Causality is recognized in philosophy as a first principle, i.e., a principle that is self evident. It embodies the law of rational inference and is a universal principle in inductive logic. Although the traditional management accounting definition of causality relates to value as stated in dollars, managers need both a quantitative model of operating cause and effect relationships as well as a value representation of those relationships. Therefore the definition of causality that is needed here is a correspondence definition (i.e., corresponding to the facts), or a definition related to the quantities of the goods and services produced by the enterprise, i.e., the real things. The dual nature of the information produced for management is illustrated in the value chain integration graphic presented below. The illustration above shows that the quantities of inputs and outputs are never separated from their values as in traditional management accounting systems. The integrity of quantity-value is maintained which allows management accounting to support the general ledger, but at the same time to become independent of the general ledger. The correspondence definition of causality and the value chain integration enhances management accounting's usefulness, separates it from external reporting, lowers the cost of sound management accounting information, and renders the method centric approaches to management accounting obsolete. Analogy Analogy is the second cornerstone proposed by Van der Merwe and is related to making inferences based on known cause and effect relationships. Analogy involves the application of causal information and is used in management accounting to help analyze and understand financial results and to make inferences related to future events. Integration of the Cornerstones into the Existing Management Accounting Framework Van der Merwe begins with Shillinglaw's management accounting framework3 that includes concepts, criteria, and constraints (See the graphic below). Concepts include cost, cost objective, and variability. Criteria refers to elements such as the two proposed cornerstones, i.e., causality and analogy. Shillinglaw's original framework includes causality. Constraints include what Van der Merwe refers to as filters such as objectivity, accuracy, and materiality. His revised framework is illustrated below. The revised framework goes beyond product costing for external reporting and allows for greater levels of detail. Analogy serves to limit the detail to what is required for enterprise optimization. Under concepts, the new framework excludes variability (traditionally the relationship between total volume and total cost), and adds responsiveness. According to Van der Merwe, responsiveness relates to the relationship between input quantities and output quantities. Under constraints articulation is amended to apply only to the extent that management accounting is required for external reporting. This is accomplished through a separate financial accounting valuation layer as indicated in Exhibit 1, i.e., the first graphic illustration above. Conclusion The cornerstones proposed in this paper are philosophically sound, customercentric, seamlessly integrate into the existing management accounting framework, provide a framework for enterprise optimization and the restoration of management accounting. CHAPTER 2 Agency Theory http://maaw.info/AgencyTheoryMain.htm Tiessen, P. and J. H. Waterhouse. 1983. Towards a descriptive theory of management accounting. Accounting, Organizations and Society 8(2-3): 251-267. Contingency theory provides an approach to developing a descriptive theory of management accounting systems (MAS) based on the idea that the effectiveness of a management accounting system is contingent on an organization's structure. But, according to Tiessen and Waterhouse, a more elaborate theory can be developed drawing on agency theory and the theory referred to as the markets and hierarchies framework. The purpose of this article is to provide a more elaborate view of contingency theory by including these additional concepts and to indicate the implications of this view for management accounting systems. In addition the authors attempt to explain why companies continue to use responsibility accounting in spite of the frequently cited dysfunctional behavior associated with responsibility accounting systems. The theme of the paper is that management accounting measurements, organizational, behavioral and economic factors combine and interact to create desirable organizational effects. The article includes five sections as follows: 1. Contingency theory. 2. Agency theory. 3. Markets and hierarchies. 4. MAS implications. 5. Summary and conclusions. Contingency Theory One popular view of contingency theory is that the structure of an organization depends on the company's technology and environment, and that the effectiveness of managerial processes (including the management accounting system), is contingent on the organization's structure. The location of information in relation to technology and environment has an important influence on organization structure. In uncertain environments with non-routine technology, information is frequently internal. Where environments are certain, or where technology is routine, information is external. The dimensions of structure and control include authority structure and activities structure, i.e., rules and procedures that determine the discretion of individuals. Authority relates to social power. In the contingency model, decentralized authority is more appropriate where uncertain environments or non-routine technology exist. Centralized authority is more appropriate when environments are certain. The graphic below reflects my interpretation of these theoretical concepts. Although the contingency theory explanation of the relationships between organization structure, environment and technology seems reasonable, the model does not explain the many similarities in management accounting systems across organizations, or the stability of these systems. This observation supports the need for an elaborated model. Agency Theory Agency theory is developed around the concept of contractual relationships between two groups with conflicting objectives, i.e., principles and agents. The objective in agency theory is to structure the contractual relationship between these groups so that agents take actions to maximize the welfare of principals. The problems related to accomplishing this objective include the following: 1. the agent's utility function is based on the utility for wealth and the disutility for effort, while the principal's utility function is only based on wealth. 2. the effects of both ex ante and ex post uncertainty, 3. the effects of risk where the principal is assumed to be risk neutral and the agent is assumed to be risk averse. 4. the effects of incentives and payoffs, 5. the moral hazard problem - not knowing the effects of the agent's effort vs. randomness, 6. the adverse selection problem - not being able to determine the agent's skill level. The following graphic shows my interpretation of the the main ideas in this section. The authors discuss several cases, or situations related to these issues, as well as some limitations of agency theory but indicate their belief that agency theory provides insights related to the structure of organizations and the role of accounting in maintaining this structure. For example, contracts between principals and agents show which actions are observed and reported, and how information is used to determine shares of risk and payoffs. Thus, proposed changes in accounting methods that fail to consider contracts between principals and agents, along with the various issues addressed in agency theory, may receive considerable resistance. Markets and Hierarchies According to Tiessen and Waterhouse, the markets and hierarchies framework is referred to as the "organizational failures framework" and emphasizes information, structure and control. Hierarchies replace markets in determining relationships between those engaged in transactions when the costs associated with contracts become too high. This theory or framework goes beyond agency theory where all transactions are assumed to be governed by contracts. (A review of Ouchi's three control mechanisms, i.e., market, bureaucracy and clan, might be useful to the reader at this point since the term "hierarchies" as used by Tiessen & Waterhouse appears to have essentially the same meaning as the term "bureaucracy" as used by Ouchi). Non-market modes or organization, i.e., hierarchies (Ouchi's bureaucratic form) provide a comparative advantage over markets in an uncertain or complex environment because together with bounded rationality and opportunism, a condition referred to as "information impactedness" is created, i.e., sufficient information is not available for the market contracting mechanism to work. The graphic below illustrates my interpretation of the authors' ideas is this section. An important part of the hierarchies concept is the imbedded internal labor market where a set of administrative rules and procedures determines the pricing and allocation of labor. The goal is to encourage individuals to cooperate. Tiessen and Waterhouse discuss some problems associated with internal labor markets in this section related to joint activity, uncontrollable external events and how "information impactedness" confounds accountability. MAS Implications In this section the authors tell us that agency theory and the markets and hierarchies literature highlight the interdependence between information, structure and control and may serve to enrich contingency theory. All three concepts identify uncertainty as a key variable and support the view that different control mechanisms are appropriate in different situations. In highly structured situations, where the environment and technology are well specified, hard identifiable performance measurements may be designed. In less structured situations, where ex ante uncertainty is high because of technological and environmental uncertainty, decentralization is necessary and internal labor markets are useful to promote control and cooperation. In situations where "information impactedness" is extreme, or highly non-routine technologies or uncertain environments exist, hard MAS measurements are difficult to develop and management control would rely on selection and socialization, i.e., Ouchi's Clan concept or control mechanism. Summary and Conclusions The authors summarize their work in this section and add the following idea related to why companies continue to use responsibility accounting in spite of the frequently cited dysfunctional behavior associated with responsibility accounting systems. Recognition that changes in management accounting systems involve re-contracting costs (e.g., costs associated with making the changes understandable and acceptable), and that these changes may also require other changes in the organizations structure related to employment contracts, may help explain why management accounting methods are resistant to change. CHAPTER3 Contingency Theory http://maaw.info/ContingencyTheoryMain.htm What is Contingency Theory? Findings from Contingency Based Research Management Accounting and Contingency Theory Organizational and Sociological Theories Organizational Design and Accounting Information What is Contingency Theory? The following graphic illustrates Otley's original (1980) view of contingency theory1. Contingency Theory (From the Tiessen & Waterhouse summary) An expanded view of contingency theory is that the structure of an organization depends on the company's technology and environment and the effectiveness of the management accounting system is contingent on the organization's structure. The location of information in relation to technology and environment has an important influence on organization structure. In uncertain environments with non-routine technology, information is frequently internal. Where environments are certain, or where technology is routine, information is external. The dimensions of structure and control include authority structure and activities structure, i.e., rules and procedures that determine the discretion of individuals. Authority relates to social power. In the contingency model, decentralized authority is more appropriate where uncertain environments or non-routine technology exist. Centralized authority is more appropriate when environments are certain. The graphic illustration below reflects my interpretation of these theoretical concepts. The Functionalist View of Contingency Theory (From the Chenhall summary) Chenhall discusses contingency theories from a functionalist perspective where the assumption is that management control systems are developed, or adopted to aid in achieving desired organizational goals and outcomes. The appropriate management accounting system is contingent on the external environment, technology, organizational structure, organizational size, organizational strategy and national culture. The graphic below illustrates this functionalist perspective. Article Summaries related to Contingency Theory MAAW includes a variety of article summaries related to contingency theory, in addition to the three mentioned above. For example, Langfield-Smith reviewed a number of contingency studies related to management control systems and strategy. See that summary and other summaries for more on how contingency theory has been used as a basis for examining various research questions. ________________________________ 1 Otley, D. T. 1980. The contingency theory of management accounting: Achievement and prognosis. Accounting, Organizations and Society 5(4): 413-428. Findings from Contingency Based Research Chenhall, R. H. 2003. Management control system design within its organizational context: Findings from contingencybased research and directions for the future. Accounting, Organizations and Society 28(2-3): 127-168. Summary by Eileen Z. Taylor Ph.D. Program in Accounting University of South Florida, Spring 2004 This paper is a review of the empirical contingency-based literature regarding the development and structure of management control systems. It categorizes the literature by topic: meaning of MCS, outcomes of MCS, and contextual variables including external environment, technology, organizational structure, size, strategy, and national culture. The paper provides a thorough review of studies that examine these topics. Additionally, Chenhall provides recommendations for future research. The study limits its focus to contingency-based theories developed from a functionalist perspective. In other words, the assumption is that management control systems “are adopted to assist managers achieve some desired organizational outcomes or organizational goals. The appropriate design(s) of MCS will be influenced by the context in which they operate” (p.128). The figure below has been designed to clarify the functionalist perspective. The Meaning of MCS There are multiple terms that have been used in describing ‘management control systems.’ The author chooses to use MCS to refer to the broad application of a system that provides both financial and non-financial information on both internal and external factors, to managers for the purposes of control and decision-making. When studying MCS, one of two approaches can be taken. First, one can build on existing areas, trying to extend overall theories. Second, researchers may choose to evaluate new and novel ideas as they come into practice. Both types of research make important contributions. Primarily, because MCS change over time, it is important to study the implementation and success of new managerial accounting tools. Furthermore, as old MCS lose relevance, research on them does not have significant practical applications. The author also warns of the dangers of studying accounting MCS in isolation. Consideration of other organization control systems is imperative given the interactive nature of MCS with those other systems. One suggestion is to classify organizational controls as organic or mechanistic. Table 1 puts forth a taxonomy which classifies controls in this way. Another potential issue in MCS research is the assignment of dependent and independent variables. Some studies classify performance as the dependent variable, and MCS as the independent variable. The criticism of this approach is that, given rational economic theory, organizations will always choose the MCS that leads to the highest performance; thus nullifying meaningful results. Others look at the contextual variables as independent and the MCS as dependent. Finally, some studies examine implementation of MCS and link it to performance. The author cautions that prima fascia adoption does not necessarily lead to actual use, thereby clouding the link between performance and implementation of MCS. The External Environment The first contingent variable examined is that of the effect of the external environment on MCS. Many studies narrow this down to uncertainty and risk assessments. However, there are many other characteristics of the external environment which may be relevant. Propositions concerning external environment (Note: Propositions are paraphrased from the original article. For exact wording, see original work). Uncertainty leads to open/ externally focused MCS. Hostility and turbulence are associated with reliance on formal controls. Even when MCS are tightly controlled in an uncertain environment, flexibility and interpersonal interactions also exist. Generic Concepts of Technology The author defines technology as hardware, materials, people, software, and knowledge. The majority of studies examine complexity, task uncertainty, and interdependence as contingent factors related to MCS. When using complexity as a factor, the technology relates to the complexity of the production function. There is also a focus on the complexities of the value chain and their implications for MCS design. Overall, the more complex a process is, the more likely the MCS will be organic and less traditional. Task uncertainty is considered as a factor associated with functional departments. For example, marketing departments have more task uncertainty than production departments, and thus need a system that includes a broad scope of information (p.140). Interdependence, as noted earlier, can affect the study of MCS. In this case, interdependence refers to interdependence between functional areas. Propositions concerning technology The more technologies are standardized and automated, the more formal and traditional the MCS. The more uncertain the task, the less formal and traditional the MCS. The more interdependent the technologies, the less formal and traditional the MCS. Contemporary Technology Chenhall gives space to discuss the most recent managerial accounting technological advances. These include JIT, TQM, and FM (flexible manufacturing). Overall, these new tools seem to work best when in the presence of less formal, more externally focused MCS. However, there is some indication that a hybrid MCS best serves these implementations. Propositions concerning advanced technologies and MCS TQM is associated with broadly based, externally focused MCS. Reward and compensation schemes impact the effectiveness of the combination of advanced technologies and non-financial performance measures on performance. JIT and FMS are associated with informal controls and non-financial performance measures. FM is associated with informal, integrative mechanisms. Supplier partnership practices are associated with non-financial measures and informal meetings. Organizational Structure Basically, in this context, organizational structure refers to the “…formal specification of different roles for organizational members, or tasks for groups, to ensure that the activities of the organization are carried out”(p.144). This paper looks at some studies that classify organizational structure as mechanistic or organic. Mechanistic structures are characterized by the degree of formalization of “… rules, procedures, openness of communications, and decision processes” (p.145). There are also studies that classify organizational structure as centralized/ decentralized or functionally differentiated/integrated. Propositions concerning organizational structure and MCS Large, more decentralized organizations tend to be associated with more formal, traditional MCS. Characteristics of functional departments, specifically task uncertainty, influence the MCS. Higher task uncertainty and higher external environment uncertainty are associated with open, informal MCS. Leadership style can impact MCS. Team-based structures are associated with participation and comprehensive performance measures. Organic structures are related to future-looking MCS. Organizational Size Size has been studied as a contextual, influential variable, however, many studies are limited because they only examine large firms. As firms grow larger, MCS tend to become more formal and controlling. These are primarily administrative controls and rules. In small firms, MCS focuses on interpersonal controls. Chenhall (p.149), gives a useful analysis of possible ways to measure size. These include: number of employees, net assets, sales, and profits. Choice of a measurement depends on the dimension of MCS studied. Propositions concerning size and MCS Large organizations are more diversified and characterized by formalization of MCS. Large organizations are associated with more divisionalized organizational structures. Large organizations are associated with an emphasis on participative budgeting and sophisticated controls. Strategy Strategy, at the business unit level, has been associated with MCS. As expected, for conservative strategies, formal controls ruled. However, as seen before, a hybrid MCS was evident in entrepreneurial strategies. Specifically, in these cases, tight controls operated together with organic communications and decision processes. Chenhall discusses ‘build and harvest” strategies, as well as prospector strategies. There is also a discussion on possible strategy measures. Propositions concerning strategy and MCS Conservative strategies (defender and cost leadership) are associated with formal MCS. Competitor-focused strategies are associated with broad scope MCS. Entrepreneurial strategies combine formal and informal MCS. Defender and harvest are associated with formal performance measures. Prospector strategies are associated with informal, open MCS. Culture Although research in this area is limited, it remains relevant. The basic premise is that culture will impact the development and effectiveness of MCS. This is especially relevant given the increased globalization of corporations. Culture classifications by Hofstede (1984) are often used in these studies. This results in some limitations. First, studies that rely on a subset of the Hofstede taxonomy may be omitting some relevant characteristics. Second, using only the Hofstede values may limit the study and exclude other relevant variables. Third, cultures change in response to globalization; therefore, the values assigned by Hofstede may not be currently applicable to the country. Last, such stereotypes may not apply equally to all individuals within a country. Given that findings are mixed, there is only one proposition concerning culture and MCS. National culture is associated with the design of MCS. CONTINUING RELEVANCE OF TRADITIONAL ELEMENTS Although some of the previous elements will continue to be of interest; there are new elements to be considered. For example, there is an increased focus on environmental reporting and control. Additionally, there is a social emphasis on employee empowerment and fulfillment. Finally, as globalization becomes the norm, issues of size and culture will continue to be relevant. Issues relating to theory development Various statistical and modeling variations can be used to examine MCS design. Selection studies, interactions approaches, and systems models are all considered. Statistical approaches include linear regression, structural equation modeling, and cluster analysis. Causality Care must be taken to address causality. Is the model unidirectional (context variables influence MCS), or is it bidirectional (context variables influence MCS, which then influences context variables)? Level of analysis The level of analysis may be individual, subunit, or organizational. Alternate Theories and contingency-based research There is much to be gained by exploring theories from other disciplines, including psychology and economics. Psychological constructs look at how ethics and fairness can influence human behavior. Economics allows us to use agency theory to explain the development of certain MCS structures. Management Accounting and Contingency Theory Macy, G. and V. Arunachalam 1995. Management accounting systems and contingency theory: In search of effective systems. Advances in Management Accounting (4): 63-86. Summary by Anita Reed Ph.D. Program in Accounting University of South Florida, Spring 2002 PURPOSE/MOTIVATION The authors are motivated in the study by various methodological issues related to the existing research in management accounting systems (MAS) utilizing contingency theory. These issues include the use of individual data to represent organizations, non-insightful correlations between variables, inappropriate exclusion of variables and inappropriate or inconsistent measures of variables. The authors make two conclusions regarding the extant literature on contingency theory: 1) that it is "rather piecemeal in nature, requiring redirection and synthesis in order to enhance its value; and 2) the contingency framework may have been underspecified …" (p. 64), and they state their purpose in the current work as an effort to "integrate and interpret contingency theory research as it relates to MASs in order to draw descriptive as well as new prescriptive insights into the design of effective MASs" (p. 64) by reviewing the existing literature, developing a theoretical framework and utilizing the framework and methodological issues to suggest extensions to the research. SUMMARY REVIEW OF PRIOR RESEARCH The current study defines MAS as "those systems which support managerial planning, evaluation, and control activity and, in a broader sense, facilitate strategic choice" (p. 65). The use of contingency theory would suggest that organizations align their systems and processes with their environment (external factors) and strategy (internal factors), and that the effectiveness of MAS will depend on the extent to which the MAS’s characteristics meet the requirements of the various contingencies faced by the organization. The MAS characteristics studied in prior research are based on the accounting information systems framework proposed by Gordon & Miller (see figure 1 p. 66) and include the following: environment, technology, organizational characteristics, decision style, systems characteristics and MAS effectiveness. Figure 2 on pg. 67 lists the most common operationalizations of each characteristic. Environment is defined for this study as "phenomena that are external to the organization and which have either potential or actual influence on the organization" (p. 68). Uncertainty is the most commonly used measure of environment in prior research. Technology is defined as "the organizational process of transforming inputs into outputs" (p. 68). Technology has been measured by a number of factors, with the two most consistent being routineness and interdependence. Organizational characteristics have most consistently been measured by structure ("the patterns and relationships that exist among organization or work unit elements" p. 69) and strategy ("the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals" p. 69). Decision style is "the decision style used by executives to help the organization better cope with the environment" (p. 69), and is an individual characteristic used to represent the organization. The existing literature does not contain a measure of organizational decision style. Systems characteristics are typically measured using "the type of data reported by the system" (p. 70) and three data type characteristics have shown some consistency in the existing literature: internal/external, financial/nonfinancial and ex post/ex ante. Measuring MAS effectiveness has been problematic in the prior research. Two approaches have been to measure either user preferences or actual usage. Based on their review of the existing literature, the authors contend that key contingent variables have either been ignored or measured inappropriately, contributing to lack of generalizability of the results and an inability to draw unequivocal conclusions. Their assessment is that the factors associated with the effective design of MAS have not been properly specified and that an explicit framework for evaluating MAS using a contingency theory approach has not been developed. They then propose such a framework and refine the factors that should be examined. They also make recommendations regarding various methodological issues. AN UPDATED CONTINGENCY FRAMEWORK The authors use the Gordon and Miller framework as a starting point for developing a more explicit framework and also adapt Franz and Robey’s distinction between factor and process research. They define factor research as follows: factor research "empirically examines user and situational attributes to see how they relate to the outcome of system implementation", process research "emphasizes managing the organizational change that takes place during the development of the system" (Franz & Robey, 1987, p. 207). The use of both factors and processes as variables of interest are needed to expand the value of research in the design of MAS. To expand the framework, the authors include systems change (adaptability) and organizational decision making as processes instead of factors. Figure 3 on p. 74 illustrates the updated contingency framework and highlights the various relationships that have been studied in prior research. The relationships between decision style, systems adaptability and organizational decision style have yet to be examined and represent opportunities for future research. Decision style is a factor that has not been properly defined or measured in previous research, as discussed in the previous section. It represents the "range of individual variations in decision style that can be found among the decision makers within the organization" (p. 76). Systems change (adaptability) is the ability of MAS to adapt to changes in the organization’s internal and external environment. It is viewed as a process in the framework. These changes include structural changes, information processing changes, external changes and procedural changes. These changes impact the organizations technology, people, policies and procedures and both renovation of existing MAS and new implementations should be examined with a view towards increasing adaptability to future changes. Organizational decision style is also viewed as a process in the framework and is "concerned with how organizations make decisions, what information is needed to make decisions and how those needs can be supported" (p. 76). Use of a decision orientation allows the researcher to develop measures of systems effectiveness that are both practical and meaningful. The value of this perspective has been discussed in the information systems literature, but has not been examined in the contingency literature with respect to MAS design. Factors related to the organizational decision making process include technological complexity, overall organizational strategy, and organizational structure. Two methodological issues are identified as essential to the evaluation of MAS design utilizing the contingency theory: "theoretically-based measures of effectiveness and an adaptive mechanism through which effectiveness is achieved" (p. 77). These require future research to address issues regarding the method and level of analysis used. Contingency theory implies a conditional association of two or more independent variables with a dependent outcome. This relationship cannot be evaluated using correlation or unmoderated regression, methods commonly utilized in prior research, but instead requires the use of analysis methods that examine fit using either a reductionist or holistic approach. Path analysis is one such method. One other issue to be addressed is the level of measurement. Previous studies have measured data at the individual level and used it in aggregated form to represent organizational level data. This may lead to inconsistent results or to inappropriate conclusions if the individual level data is not representational of the entire organization. Data should be collected and measured at the appropriate level for the research question being addressed. The authors also encourage development of more representational measures of effectiveness. Effectiveness is a multidimensional construct, with important dimensions being efficiency and goal attainment. One recommendation for developing measures of effectiveness is to utilize the decision-making context and to adopt the criterion suggested by Huber and McDaniel of measuring effectiveness as "the maximization of the quality (broadly defined and including timeliness) of organizational decisions" (Huber & McDaniel, 1986, p. 573). In conclusion, the authors are "positive about the potential for contingency research in the future", which should "specify meaningful system and organizational characteristics that impact actual usage patterns and the capability of these systems to improve the quality, effort or timeliness of decision making" (p. 81). They encourage further refinement of the framework and variables, taking into consideration the constraint of increased data requirements. Organizational and Sociological Theories Covaleski, M. A., M. W. Dirsmith and S. Samuel. 1996. Managerial accounting research: The contributions of organizational and sociological theories. Journal of Management Accounting Research (8): 1-35. Summary by Michele Martinez Ph.D. Program in Accounting University of South Florida, Spring 2002 Preface Traditionally, Managerial Accounting Research (MAR) has utilized adapted versions of sociological and organizational theories in an attempt to investigate anomalies in managerial accounting practices. Consequently, this paper is an evaluation of the organizational and sociological theoretical traditions, which have been utilized throughout MAR. As a result the authors hope to facilitate a deeper understanding of such theories, while influencing greater usage by academics embracing more traditional research perspectives. Contingency Theory In this section of the paper the authors discuss the notion of contingency theory and what role it has played in situating control processes and structures of organizations in the context of managerial accounting. Contingency theory is "a theoretical perspective of organizational behavior that emphasizes how contingent factors such as technology and the task environment affected the design and functioning of the organizations." Based on its historical roots of the 1950s and 1960s, contingency theory represents a fusion of organizational theory and sociological functionalist perspectives of organizations. Through this blend of organizational decision-making and sociological functionalist concerns, contingency theory absorbed and took on the views of critical organizational processes such as decision-making and control. It is this explicit concern for issues of "coordination and control that has provided important contributions to MAR in ones understanding of issues (design of information and control systems, budgeting and strategic planning)." Traditionally, the MAR utilizing contingency theory reflected and promoted the belief that decision-making should be rational, hence the managerial accounting information used by managers served as a quantitative terminology of organizational goals. However, currently accounting researchers have attempted to widen the contingency arguments to embrace the relationships between firms’ strategies and the design of their control systems. While current and traditional contingency theory has had an overall broad influence on MAR, it has been criticized for representing a "deterministic, ahistorical view of organizations which provides limited insight as to the mediating processes of organizations." Interpretive Perspective Overall, the second section of this paper is concerned with the social construction and disbursement of rationality and the way in which this rationality affects the power and political structure of organizational functioning through a variety of organizational and sociological theories. The organizational and sociological theories utilized are referred to as interpretive perspectives, which also draw from the organizational decision-making perspective. Exclusively, a number of organizational and social theories including institutional theory, resource dependency theory, political perspectives, and the sociology of professions are looked at to examine the relevance of interpretive perspectives. In summary, "interpretive perspectives of managerial accounting have begun to see managerial accounting practices and information as socially constructed phenomena with the full implications of the power and politics of social construction rather than as a technically rational function driven by and serving the internal operations of organizations." Managerial accounting is seen as being implicated in the social construction of reality rather than as being passively reflective of the reality as depicted in contingency theory. Critical Perspectives The third section of this paper deals with the critical perspective. Explicitly, the critical perspective is concerned with the role that accounting plays in relation to issues of conflict, domination, and power as defined by the forever conflict of capitol and labor. The critical perspective provides an even more direct view of power and politics through organizational and sociological theories. Labor Process Perspective Labor process theorist deny that management accounting is a "neutral tool serving the general interests, of efficiency and emphasizing its role in legitimizing partisan interests, in contributing to the control and domination of labor, and in reinforcing the dominant mode of production. Labor process theory is consistent with the other organizational sociological perspectives such as contingency theory and interpretative work in the sense that it "embeds management accounting in a wider context than more orthodox approaches." However, labor process theory departs from these approaches by focusing on the "structural antagonism between classes inherent in capitalist societies." The Foucaultian Perspective The Foucaultian perspective remains consistent with the underlying views of the critical perspective. This perspective situates management accounting in a wider political and social context. Management Accounting is considered as part of a larger historical trend through which people are subjected to several disciplinary techniques. In contrast, labor process theory appears within the context of a class divided society. This perspective reveals management accounting as a general historical process by which people are made calculable and governable. In addition, the Foucaultian view also considers management accounting as a social practice rather than a technique. Conclusion The last section of the article provides concluding remarks in which the relationships among the organizational and sociological theories are discussed. SUMMARY OF CONCEPTS Interpretive TheoryContingency Institutional Theory Perspective 1. Reflect and 1. Serves as a promote rationality ceremonial means for in decision-making symbolically demonstrating an organizational commitment to a rational course of action. Critical Theory- Critical TheoryLabor Process Foucaultian Perspective Perspective 1. Marxists 1. Historical trend tradition through which people are 2. Demonstrates subjected to a variety of the ambiguous disciplinary position of techniques mangers in accounting firms Assumptions Purpose of Management Accounting 2. Develops 3. Contributes to legitimized categories the control and domination of labor 4. Reinforces capitalist production 1. A set of legitimizing 1. Class-divided organizations though society to aid the construction of an economic appearance of expropriation rationality and efficiency 2. Social practice 2. Socially constructed phenomenon with the full implication of the power and politics of social construction How Management 1. Quantitative Accounting is expressions of Used organizational goals 2. Passive reflection of the technology 3. Technically rational function driven by and serving the internal operation of the organization 1. People are made calculable and governable 2. Social practice Organizational Design and Accounting Information Kaplan, S. E., and J. T. Mackey. 1992. An Examination of the association between organizational design factors and the use of accounting information for managerial performance evaluation. Journal of Management Accounting Research (4): 116-130. Summary by Michele Martinez Ph.D. Program in Accounting University of South Florida, Spring 2002 Preface Prevalent in the majority of organizations, individual managers performance is based on accounting information. This practice referred to as responsibility accounting, is one of the most important functions of accounting information according to cost textbooks. However, concerns have been expressed about the effects this practice has on management’s behavior. For example, several researchers feel that under the right circumstances management may be motivated to engage in dysfunctional behavior (Hirst, 1981, 1983; Hopwood 1972; Otley 1978). Thus, under certain conditions accounting information may not be the ideal criteria to evaluate management. The purpose of this paper as stated by the authors, is to provide evidence on the association between the use of accounting information to evaluate the performance of production managers and factors of organization design. Contingency Theory In this study the authors utilize contingency theory as the theoretical basis for this paper. Contingency theory "asserts that there is a relationship between organizational structure and situation, and that organizational effectiveness results from this relationship. The most effective organizational structure will depend or be contingent on the organization’s particular situation." In reference to this particular study contingency theory was applied to suggest an association between the use of accounting information to evaluate managerial performance and design factors of the organization. In addition, the contingency perspective suggests that the use of accounting information to evaluate managerial performance will be contingent upon task uncertainty and departmental interdependence. When a mismatch occurs between task uncertainty and accounting performance measures, dysfunctional behavior occurs. Thus, the author’s state that the incidence of dysfunctional behavior associated with different uses of accounting performance measures is contingent upon the level of task uncertainty. Research Questions Due to the exploratory nature of this study, research questions instead of hypotheses are proposed. The author’s proposed the following research questions because they focus on the relationship between specific production characteristics and the use of production cost information to evaluate the performance of production managers. 1. Are organizations that have a flow shop more likely to use production cost information to evaluate production managers’ performance than organizations with job shops? 2. Are organizations that use work-in-process inventories more frequently more likely to use production cost information to evaluate production managers’ performance? 3. Are organizations that use aggregate accounting methods for set up costs less likely to use production cost information to evaluate production managers’ performance? Method Sample Companies For this study the authors’ selected the sample of companies from the Dun and Bradstreet’s 1984 Canadian Guide to Manufacturers and the Harris Michigan Industrial Directory, 1986. The elimination of companies from this list began with companies that were located more than 30 miles from the authors’. Accordingly, approximately 120 organizations were contacted. Of the original 120 organizations contacted the final sample contains the completed responses from 47 firms, representing a response rate of 39%. Independent variables This study includes three independent variables. The first variable, a dummy variable is the type of production process used by the plant. The second independent variable is a forced choice response variable, which concerns the extent to which work-in-process inventory is used. The final independent variable is a trichotomous measure, which concerns accounting procedures for set up costs. Dependent Variable The purpose for costing in production departments was the dependent variable for this study. This variable required a 0,1 coding response. Results Due to the dichotomous nature of the dependent variable and the possible associations between the independent and dependent variables and the directional research questions Probit regression was utilized to analyze the data. Research Question 1 (the association between the use of production cost information and the type of production process employed) – production process was significant at conventional levels and the negative beta coefficient indicates the results were in the expected direction. There was a greater tendency for flow shops as opposed to job shops to use production cost information for managerial performance evaluation. Research Question 2 (the association between the use of production cost information and the frequency that work-in-process inventories are used) – was marginally significant at the .10 level. The positive beta coefficient indicates that there was a greater tendency to use production cost information for managerial performance evaluation when work-inprocess inventories were used. Research Question 3 (accounting method for set up costs is associated with the use of production cost information for managerial performance evaluations) – marginally significant and an increased tendency for production cost information to be used for managerial performance. The probit model correctly classified 70% of the observations as opposed to the naïve model, which classified the observations, correct 62% of the time. In addition, the hit rates for the probit model were 86% and 44% indicating that the model is able to greatly improve the prediction of non-use of accounting information. Discussion This study is exploratory in nature and explores the association between three organizational design factors and the use of production cost information to evaluate the performance of production managers. There are a few limitations in this study. First, the sample was relatively small and contained only push manufacturing organizations. Thus, the results will not be very generalizable. Future research should examine various types of manufacturing organizations and various types of design factors. CHAPTER 4 Decision Theory http://maaw.info/DecisionTheoryMain.htm Decision Theory Decision Theory Bibliography Simulation Bibliography Decision Usefulness vs. Fairness Problem: The commonly accepted notion that “accounting’s purpose is to provide information useful in making economic decisions” has been the guidepost for both accounting research and standards setting. According to the author, this concept of “decision usefulness” should not be directing accounting research or practice, because it does not both evaluate and explain accounting data. Furthermore, the final result of decision making is distribution of resources, which is an issue of fairness not adequately addressed by decision usefulness. Defining Constructs: The following are definitions assumed by the paper. Decision Usefulness – “Justification for those accounting products if they facilitate making choices that lead to the achievement of some goal.” It is focused on the end result. Accountability – “obligatory relationship created via transactions in which one party is expected to give an account of its action to other parties (not necessarily parties involved in the transaction).” It is a constraint and is focused on the means of reaching the end result. Fairness – “noun that describes an evaluation process with two interrelated attributes.” These attributes are: (1) Evaluator knows his/her actions will be judged fair/unfair and (2) Evaluator attempts an objective perspective. Relationships Among Constructs: As defined above, the constructs of decision usefulness, accountability, and fairness are related as follows. • Decision usefulness facilitates while accountability constrains. Facilitating and constraining are opposing objectives; therefore, they will not lead to the same conclusion and should be considered separate and unrelated constructs. • Accountability relationships are mediated by fairness. The constraint issues associated with accountability cause conflict that is then resolved using some criteria of fairness. THE ASYMMETRY OF DECISION USEFULNESS According to (Burchell et al., 1980), “accounting research has, generally, two objectives in which decision usefulness plays two potentially different roles,” which he says creates a problem of asymmetry. The two objectives of accounting are (1) Investigating the value of data and (2) developing accounting theories. In the first objective, the role of decision usefulness is as a “criterion for making a value judgment about the data” and the object of concern is data value. In the second objective, the role of decision usefulness is an explanation for the data it represents; therefore, its concern is on an explanation. The author says that for these two roles to be symmetric, they must be substitutable. The argument that decision usefulness lacks symmetry. He says that lack of symmetry can be inferred by considering the implications of symmetry for some assumptions about the accounting environment. To understand, the reader has to systematically make a case built upon these assumptions. The following steps start with the basic assumptions and then provide a point-by-point explanation for his argument that decision usefulness lacks symmetry. 1. Accounting data is created by and about identifiable entities. 2. These entities are goal driven. 3. Decisions aren’t always independent as some decisions are based on the outcomes of others. 4. Management and the entity’s goals are congruent. Stakeholders base their actions on management’s actions and all parties are aware of each other. 5. Accounting data is both a decision input and evaluation about consequences of a decision. 6. Accounting data has the unusual characteristic of being a proxy for objects that are unobservable and the numbers are the only things observable. He says this transforms the accounting data, which is about an object, into the object itself. 7. Because accounting data represents an object and at the same time is the object, accounting data is not only an evaluation about the consequences, but it is the consequences themselves. 8. The choice of accounting data can be the choice of what outcome the decision maker wants and is unrestricted because he/she is the object of concern. Modeling of decisions assumes that there are constraints on the production of accounting data and the choices of decision makers (users of accounting data don’t have unrestricted choice in selecting accounting operations); however, as shown in steps 1-8 above, decision usefulness does not provide for such constraints. It is accepted that accounting constrains whereas Williams has logically argued that the concept of decision usefulness results in no constraints. Since the two are incompatible, then they are asymmetric. Instead, he argues that accountability is compatible with constraint and it also inherently contains the concept of fairness. EFFICIENCY AND DISTRIBUTION The following model shows two viewpoints about the result of decision usefulness. Some say that optimal distribution of economic resources is not the focus of accounting and is distinctly separate from efficient allocation of resources (modeled by straight lines). They further insist that market forces will take care of equitable distribution, which is a societal goal. Williams posits that the two are inseparable (modeled by both straight and dotted lines) and that both efficiency and distribution require value judgments of fairness. MARKET JUDGMENT OF FAIRNESS Adherents to decision usefulness base their position on their belief that the “free market” will ensure equitable distribution and that accounting just makes market forces more efficient. He explores the Libertarian and utilitarian interpretations of accounting’s emphasis on efficiency and concludes “from a decision usefulness perspective reliance on efficiency criteria and market justice serves only to make accounting’s fairness judgments implicit, not absent.” As such, accounting must not only consider efficiency, but also consider moral consequences. See also Pallot, J. 1991. The legitimate concern with fairness: A comment. Accounting Organizations and Society 16(2): 201-208. (Summary). The Analytic Hierarchy Process INTRODUCTION The main purpose of this article, as stated by the authors, is to review the need for multiple performance criteria to measure long-run profitability, the potential difficulties of using such measures, and to present the analytic hierarchy process and its potential use in synthesizing multiple performance measures. The authors also describe a case and apply the analytic hierarchy process to illustrate the way in which it can be used to transform multiple criteria into a composite performance measure. MULTIPLE PERFORMANCE CRITERIA VS THE SINGLE INDICATOR Performance evaluation has been a difficult problem for businesses that can be viewed from several perspectives. 1. The shareholders’, Board of Directors’ or CEO’s perspective: • The perspective of the organization as a whole. 2. The upper management perspective: • The perspective of the organization or its segments as it pertains to the effectiveness of the unit or the individual managing the unit. 3. The operational perspective: • The perspective of the management and supervisors as it relates to the efficient day-today operations. Performance evaluation has been treated by management accountants as a by-product of their connection with the accounting system in the organization. If profit maximization is the main economic goal of the firm, then the profit measure will be the most important measure of performance. Kaplan (1984), believes that while financial measures are important, other measures such as product innovation, product leadership, employee skills and morale, or customer loyalty, can be much better indicators of future profitability than annual profits. The authors believe that a firm is effective in the long run only if it achieves its goals and that performance evaluation is closely connected to goal setting in that it feeds back information to the system on how well strategies are being implemented. Several possible reasons given by the authors for why businesses have not embraced the multiple performance criteria performance evaluation include: 1. The cost of designing and collecting multiple criteria is high, 2. Non-profit performance criteria are difficult to interpret and evaluate because of their subjectivity, and 3. A single comprehensive measure is often needed for decision-making purposes. THE ANALYTIC HIERARCHY PROCESS The authors define the analytic hierarchy process as a participation-oriented methodology that can aid coordination and synthesis of multiple measures. It models the way in which the human mind structures a complicated problem. It has been applied in a variety of decision and utility contexts to help groups arrive at decisions where varying values are held by group members. It is ideally suited to help resolve problems that arise when multiple criteria are used in performance evaluation. An Example of the Analytic Hierarchy Process The authors provide an example scenario where a senior executive must decide on which of three candidates to promote. The decision maker will compare three criteria (leadership, human relations, and financial management ability) in pairs to develop a ranking. The comparisons would be: 1. Is leadership more important than human relations skills for this job? 2. Is leadership more important than financial management ability for this job? 3. Are human relations skills more important than financial management ability for this job? A ratio scale of 1 to 9 is added to the ordinal ranking provided by the responses to these questions to provide the relative importance of one criterion over another. The pairwise comparisons are summarized in a square matrix and the eigenvalues and preference vector are then computed to determine the relative ranking of the criteria. Then each of the candidates is compared on the basis of the criteria as follows: 1. Is candidate A superior to Candidate B in leadership skills? 2. I s candidate A superior to Candidate C in leadership skills? 3. I s candidate B superior to Candidate C in leadership skills? Contributions of the Analytic Hierarchy Process to Performance Evaluation The analytic hierarchy process can allow for multiple viewpoints to be incorporated into the priority ranking by being used at many levels of the organization. Its most important contribution to performance evaluation is that it provides a systematic approach for weighting performance to provide a comprehensive performance measure. This measure can be used to assess the overall performance of the organization, to rank organizations or segments of organizations, to serve as input to incentive compensation schemes, and as input into decisions about the organization. PERFORMANCE EVALUATION AND THE ANALYTIC HIERARCHY PROCESS – A CASE EXAMPLE The authors provide an example of a hypothetical decentralized organization with division located in several countries. This decentralization meant the need for a means of monitoring and evaluating the division managers. The corporation had three indicators to assess divisional performance and to set bonuses: 1. Return on investment. 2. Net income per unit of labor. 3. Change in market share. After analyzing these indicators, they decided to reaffirm the companies goals: 1. To sustain growth in market share through the production of quality products which meet customer needs. 2. To enhance profitability through efficient production and distribution of the products. 3. To provide a healthy working climate for employees. 4. To maintain the reputation of flexibility and innovation in the industry. Since the divisions of the organization were located in several countries, the effects of foreign currency fluctuations had to be taken into consideration. They added six new performance indicator measures: 1. Operating margin ratio. 2. Proportion of net income contributed by foreign exchange gains or losses. 3. Percentage of employee turnover in the year. 4. Customer satisfaction. 5. Product and technology innovation. 6. Total operating cost variance. To apply the analytic hierarchy process, a questionnaire was given to the division managers and two Divisional Vice-Presidents to compare the relative importance of the nine evaluation criteria. The results formed a 9 x 9 matrix from which the preference vector (eigenvalues) was computed. Based on the performance vector, the nine evaluation criteria were ranked as follows: profitability, product and technology innovation, hedging effectiveness, operating efficiency, marketing effectiveness, customer satisfaction, productivity, operating effectiveness, and employee morale. After the priorities were established, the two vice presidents were asked to complete a second questionnaire which requires pairwise comparisons between the divisions on the basis of the actual values of each of the nine evaluation criteria separately. The results of the analytic hierarchy process showed that one of the divisions was the best in terms of some factors while another was the best in terms of others. It was difficult from the information provided to determine which division has the best overall performance. These results were different from the company’s original evaluation scheme. The authors believe that the analytic hierarchy process experiment was successful for this firm even though the results were different from the company’s original three-factor weighted scheme. Advantages of this Methodology 1. Both quantitative and qualitative measures can be included in the evaluation scheme. 2. It allows for multiple input in the setting of priorities of the evaluation criteria. 3. Subjectivity in setting priorities for evaluation criteria and assessing divisional performance is reduced. 4. Consistency in judgment is improved. 5. The evaluation of performance against standards can be incorporated in the process. 6. The resultant vector from the analytic hierarchy process provides a composite performance measure which can be used for other purposes (e.g., the allocation of bonuses to divisions). Limitations of This Methodology 1. It requires substantial time and effort. 2. It can be difficult and complicated to understand because of its quantitative nature. 3. Although it is systematic, it still requires managers to make subjective judgments about interpretation of the qualitative criteria. 4. The relative ranking of the original alternatives may be reversed when an identical alternative is added to the list. ____________________________________________________ Note: This study was somewhat confusing to us because the company sounds like a real organization although Chan and Lynn include the word hypothetical after the company name in parentheses on page 69. Kasanen, Lukka and Siitonen (1993) list this paper as a study in which a construction is developed further, but which lacks, in one way or the other, practical implementation. For a case study where the authors used the technique in an insurance company, see Chan, Y. L. and B. E. Lynn. 1993. Organizational effectiveness and competitive analysis: An analytic framework. Advances In Management Accounting (2): 85-108. I suppose the 1993 study passes the semi-strong market test of a managerial construction mentioned by Kasanen, Lukka and Siitonen on page 253 of their paper mentioned above. Why Executives Should Care about Theory The formula for success at one company does not always translate into success for another company. Yet, consultants and managers all too frequently apply the same principles of success in every situation. It is imperative that the dynamics of the company be examined before applying any theory. Management must first understand what a theory is and from where it is derived. “A theory is a statement predicting which actions will lead to what results and why” (p. 68). Actions are not just arbitrarily taken; rather they are the result of an expectation by a manager. Theories are important for two reasons: 1) Assist in helping individuals make decisions; and 2) Provide guidance for understanding what is happening in the present and why. Theories are the product of a three-stage process. First, a phenomenon to be investigated must be described. The first stage is very important because the phenomenon needs to be carefully observed, taking note of its breadth and complexity. In the second stage, aspects of the phenomenon are classified into useful, relevant categories. This categorization allows researchers to organize complex information into meaningful distinctions. Finally, during stage three, researchers can develop a hypothesis of cause and effect relationships of the phenomenon. The three stages of theories are constantly repeated until researchers are confident enough to make predictions about what should happen in similar circumstances. Frequently, while repeating the process, researchers observe something in the theory that cannot be explained or predicted, an anomaly that implies something different is occurring. It is then imperative to revert to the second stage to re-examine the categories defined. The presence of an anomaly allows researchers to more accurately explain how the phenomenon should work in a variety of situations. For example, Michael Porter saw anomalies in the theory of comparative advantage that had for many years explained international trade. His research demonstrated that while the traditional theory on comparative advantage was valid, other factors played important roles in a country’s ability to increase its advantage in the global market. His theory of “clusters” explained how a country could exploit its natural resources, but another country lacking essential natural resources can create policies to build “process-based comparative advantage” (p. 69). Typically, early in the research process, categories are defined according to the attributes that seem to be correlated with a particular outcome. However, categorization based on correlations is actually based on the researchers uncertainty. Stating that a casual relationship exists as a result of correlation implies that researchers do not fully understand what causes a given result. Unfortunately, many researchers use the correlation basis, incorrectly believing that they can increase their results using supercomputers and databases for number crunching and regression analysis to manufacture statistical significance. Breakthroughs in determining causality do not come from number crunching, but from a careful, detailed inspection of the companies to view the processes in action. For example, it was superficially thought that Toyota’s success in manufacturing had to be related to Japan’s culture. However, after researchers visited a Japanese plant, they noticed more significant characteristics of the system, including minimum levels of inventory and kanban card scheduling systems. Sadly, the researchers then equated the attributes of the plant’s success with its results. Many wrote books and articles encouraging managers in manufacturing plants to adopt the Toyota philosophy to improve quality, increase efficiency, and reduce costs. More careful analysis of Toyota by Spear and Bowen revealed that the success of the company was attributed to “four specific rules that create automatic feedback loops, which repeatedly test the effectiveness of each new activity, pointing the way toward continual improvements” (p. 71). In order to be predictable, researchers have to ask, “What will cause this theory to fail?” instead of asking, “What characteristics are associated with success?” Researchers need to not only identify causal mechanisms, but also need to explain which situations cause the mechanisms to fail or succeed. Elaborating on circumstances, known as circumstance contingent, allows managers to understand when theories should be adjusted to fit their particular environment. It also helps management recognize changes in their competitive environment and to begin shifting in efforts to sustain success in the new environment. Theories that are circumstance contingent help success become predictable and sustainable. It is essential that researchers not only understand what factors lead to success, but also the factors that lead to failure. Simply following the “best practices” of successful companies very often ends with disastrous consequences. For example, in 1999, Lucent Technologies followed the management restructuring and reorganization fad. The company divided into 11 “hot businesses” with each operating independently. Much to top executive’s surprise, the division autonomy did not increase growth or profitability. Instead, the reorganization made Lucent less flexible, slower to respond to customer needs, and created new costs. The company fell victim to the remedy of the moment. When researchers identify circumstance contingent theories, managers are better able to diagnose the situation that they are in, and conversely, not in. Studies conducted by the authors indicate that rarely are success theories bound by industry barriers such as product-based versus service-based. Therefore, theories should only be trusted when they explain how phenomenon leads to success as a company’s circumstances change. It is important for managers to learn how to identify a good theory. Foremost, be skeptical of articles that merely describe a phenomenon. Researchers who have formulated circumstance contingent theories often build on descriptive accounts of causal relationships. Second, be careful not to trust an article with a solution that cures all business’s problems. It is very rare that new categorizations reshape established thinking. Third, if authors categorize a phenomenon based solely on attributes, just assume that it is a starting point for a circumstance contingent theory to be discovered. Fourth, “correlations that masquerade as causation often take the form of adjectives. . . a real theory should include a mechanism – a description of how something works” (p. 73). And lastly, remember that a researcher’s test results should not be considered final. Progress is a result of constant testing to understand which situations will lead to failure in efforts to refine the theories. CHAPTER 5 Deming's Theory http://maaw.info/DemingMain.htm W. Edwards Deming's Theory of Management Deming's Theory of Management Bibliography Deming's Theory - Short Summary Deming's The New Economics Deming Quotes What is the Red Bead Experiment? Effects of Ranking People Plan Do Study Act Graphic Pratt & Whitney Rocketdyne - A Thinking Roadmap Deming Links Discussion Questions Multiple Choice Questions Deming's Theory - Short Summary Deming's Theory of Profound Knowledge (Deming's Theory of Management Main) Short Summary by James R. Martin Theory of Profound Knowledge I. Appreciation for a system. A leader must understand the system he or she is attempting to manage. Without this understanding the system can not be managed or improved. A system cannot understand itself or manage itself. Optimization of the parts does not optimize the whole. System optimization requires coordination and cooperation of the parts which requires leadership. Relation to the 7 Deadly Relation to the 14 Points Diseases and Obstacles 1. To create constancy of 1. Lack of constancy of purpose which means to purpose. 2. emphasis on short constantly attempt to term profits or performance, optimize the system. quarterly dividends etc. 3. Everybody in the system evaluation by performance needs to understand how their reviews, merit ratings builds effort or output fits into the fear and destroys teamwork. system. Each person is 4. management mobility. 5. viewed in terms of how they running the company on contribute towards optimizing visible figures alone all the system. Points 2. adopt distract from the purpose of the new philosophy, 3. cease the organization, i.e., they all dependence on inspection, 4. prevent optimization of the end purchasing on price tag system. alone, 5. improve constantly, 6. institute training, 7. Obstacles: Neglect long term institute leadership, 8. drive planning, relying on out fear, 9. break down technology to solve problems barriers between departments and seeking examples to 10. eliminate slogans, 11. follow rather than developing eliminate numerical quotas, solutions all prevent 12. remove barriers to pride optimization of the system. in workmanship, 13. institute education & training in teamwork and statistical methods, all relate to the concept of optimizing the system. II. Knowledge about Joiner and Gaudard (Quality 3. Annual reviews and ranking variation. Refers to Progress, December 1990) employees indicates the Shewhart's concept of compare each of the 14 points absence of a knowledge of common or system causes of to the concept of variation, variation and an absence of an variation and outside but 5. improve constantly, 6. understanding of the system. assignable or special causes institute training, 7. institute A manager who understands of variation. Relates to the leadership, 11. eliminate variation would not rank Red Bead experiment and work standards, quotas & people because he or she blaming people for variation MBO appear to be the most would understand that ranking caused by the system. relevant. A knowledge of people merely ranks the effect variation helps one of the system on the people. understand the system so that This causes tampering & it can be managed and destroys motivation and improved. teamwork. III. Theory of Knowledge. Relates to 5. improve Relates to the obstacle: Knowledge depends on constantly, 6. institute Seeking examples to follow theory. Information is not training, 7. institute rather than developing knowledge. Experience leadership 10. eliminate solutions. Theory leads to teaches nothing without slogans, 11. eliminate quotas questions which lead to theory. Practice makes since the emphasis is on answers which leads to permanent, not perfect. teaching people how to think knowledge and subsequent Copying examples does not on a continuous basis and not improvement, i.e., the lead to knowledge. to assume any two problems Deming-Shewhart plan-doare the same. check or study-action (PDCA) cycle. IV. Knowledge of Relates to 7. institute A lack of knowledge of Psychology. Leaders must leadership - helping people psychology causes, or understand human behavior do a better job, rather than supports 3. evaluations with to motivate, coordinate and ranking them, 8. drive out annual reviews, merit ratings manage people to optimize fear, 9. break down barriers and ranking people and 5. the system. between departments -so that running the company based on they cooperate rather than visible figures alone - results. compete, 10. eliminate People need a method to slogans, 11. eliminate quotas improve, not objectives, and 12. remove barriers to quotas & rankings. pride in workmanship. Deming's The New Economics Preface In the preface Deming states that the present style of management is a modern invention and represents "a prison created by the way in which people interact." The present system includes competition between people, teams, departments, divisions, students, schools and universities. Although economists have taught that competition will solve our problems, we now know that competition is destructive. A better approach is for everyone to work together as a system. The solution to problems comes from cooperation, not competition. We need a transformation to a new style of management Deming refers to as Profound Knowledge. This includes four parts: appreciation for a system, knowledge about variation, theory of knowledge, and psychology. The purpose of this book is to start the reader on the road to knowledge and to create a desire for more knowledge. This book, according to Deming, is a textbook for engineering, economics and business students, to be used to prepare students for the future. Chapter 1: How are we Doing? Will best efforts bring improvement? No, Deming argues that best efforts not guided by knowledge will dig us deeper into the pit we are in. What is needed is new knowledge. There is no substitute for knowledge. In order to improve living standards, people must trade with each other and the market is the world. Trade depends on quality. In terms of the balance of trade, the U.S. is not doing well. We have been in economic decline for three decades. What must be done? Our problem is education and the development of a culture that places value on learning. Your customer expects only what you and your competitors have led him to expect, but he is a rapid learner. Customers do not know what they want. They may be satisfied and switch. A customer may be loyal and switch. What is needed is innovation. Deming provides several examples of companies that were doing well and lost their market to an innovator. The question to ask is what business are we in and what will it be in the future? How do we achieve quality? Which of the following is the answer? Automation, new machinery, more computers, gadgets, hard work, best efforts, merit system with annual appraisal, make every body accountable, management by objectives, management by results, rank people, rank teams, divisions, etc., reward the top performers, punish low performers, more statistical quality control, more inspection, establish an office of quality, appoint someone to be in charge of quality, incentive pay, work standards, zero defects, meet specifications, and motivate people. Answer. None of the above. All of the ideas above for achieving quality try to shift the responsibility of management. Quality is the responsibility of management. It cannot be delegated. What is needed is profound knowledge. A transformation of management is required. Chapter 2: The Heavy Losses According to Deming, the present style of management causes huge losses that cannot be evaluated or measured. His purpose for this chapter is to identify the most important sources of loss (or waste) and to suggest better practices. At the beginning of this chapter he tells us that the reason for many wrong practices is management's failure to understand the difference between common causes of variation and special causes of variation. He provides several tables similar to the ones I have provided below. I have condensed his ideas and tried to capture his main points, but the reader must consult the book for the many examples used to support his views on the present style of management. Present wrong practice. (What is wrong?) Recommended Practice Short term thinking. (Short term solutions Adopt constancy of purpose. Develop long have long term effects, frequently term objectives and importantly, methods for undesirable effects.) achievement. Ranking people. (Ranking is a farce and Abolish ranking. Manage the whole indicates the abdication of management. If x company as a system. Study and understand is the contribution of an individual and yx is how every component contributes towards the effect of the system on his or her optimization of the system. performance, then x + (yx) = performance. Ranking people ignores the predominant (yx) term. Ranking does not help anyone improve or help improve the system.) Merit systems, incentive pay and annual Abolish these methods. Study the appraisal of people. (These are forms of capability of the system (chapter 3), ranking that create competition between leadership (chapter 5) and the people and are demoralizing. They do not management of people (chapter 6) and use help anyone improve or improve the this knowledge to manage. system.)* Manage the individual components Manage the company as a system focused (individuals, teams, departments, etc.) as on the future. Encourage communication profit centers. (This ignores the and continual learning. Draw a flow diagram interdependences between the components, to show how each component depends on causes sub-optimization and everybody others in the system so that people can see loses.) the process and improve it. Management by objectives, numerical Manage the system. Develop methods for goals and quotas. (These methods ignore improving the process. Develop a horizontal the interdependences and provide no method self directed work force. for achievement. As a result they may cause behavior that destroys the system.) Management by results. (Action based on Use the concepts and tools related to outcome is not action on the causes of the variation to understand and improve the outcome. Emphasis on cost reduction is an system. Deming estimates that around 94% example. Costs are not causes.) of the possible improvements belong to the system - the responsibility of management. Buying based on the lowest bid. (Ignores Buy based on estimates of all related costs the related costs and effects on quality.) and effects on quality. Delegate quality to an individual or group. Recognize that quality is management's (The responsibility for quality cannot be responsibility. delegated.) Although the losses from faulty management practices cannot be measured, Deming argues that it is a myth to assume that if you can't measure it, you can't manage it. We must learn to manage these losses and the transformation requires a system of profound knowledge (Chapter 4). * See the Herzberg, Kohn, and Pfeffer summaries for some related arguments about money as a motivator. Chapter 3: Introduction to a System Deming begins this chapter by saying that the prevailing style of management is a modern invention and a trap that has led us into decline. He defines a system as "a network of interdependent components that work together to try to accomplish the aim of the system." A man made system must have an aim and this purpose, or aim must be clear to everyone in the system. Deming continues by stating that "A system must be managed. It will not manage itself." Left to themselves the components of a system become selfish and competitive and this behavior has a destructive effect on the system. An organization is a system if it has an aim or purpose. This purpose, or aim precedes the organizational system and the people working in it. The system must be defined in terms of the aim, not in terms of methods. When the whole system is optimized, everybody wins. Any less than optimization of the whole system means eventual loss to everyone. A system includes the future and part of management's job is to govern the organization's future. A system cannot manage itself. It needs guidance from outside. Managers must learn that in order to compete, they must learn to cooperate. A system includes competitors who working together to provide better service and to expand the market, contribute towards optimization for the entire industry. Deming argues that rather than worry about market share, companies would be better off to work together to expand the market. Deming includes a diagram (used in Japan starting in 1950) that illustrates how production is viewed as a system. The flow of information and materials from any part of the system (from suppliers to customers) must match the input requirements of subsequent stages. It is used for planning from the idea stage through design, production, distribution and customer service. It also helps in making predictions of how changes in one component will affect the other components and shows the people in the system where their jobs are and how their work is related to the work of others in the system. This knowledge helps people take joy in their work. The flow diagram is a more meaningful organization chart than the usual pyramid showing who reports to whom. The diagram shows the value chain concept described by Porter, although Deming does not use that term. The pyramid type organization chart ignores customers (internal and external) and contributes to the fragmentation of the organization into individual profit centers. The terms silos and stovepipes have been used by others who have described this problem. (See the Mintzberg & Van der Heyden summary on developing Organigraphs). Two important jobs of management include: Recognizing and managing interdependence. Defining jobs to include what the work will be used for and how it contributes to the aim of the system. Deming provides several examples of how lack of cooperation is destructive to an organization. In one company example, an increase in the cost of an engine of $30 would decrease the cost of the transmission by $80. The responsibility center in charge of the engine would not accept the idea because of the effect of the change on that segment's profits. If the components of an organization are all optimized, the organization will not be optimized. If the whole is optimized, the components will not be optimized. "If economists understood the theory of a system, and the role of cooperation in optimization, they would no longer teach and preach salvation through adversarial competition. They would instead lead us into optimization of a system, in which everybody would come out ahead." In a 1990 statement of the Interstate Commerce Commission (ICC), Deming states that forcing motor freight carriers to compete on the basis of price in a zero sum game will destroy a healthy transportation system. Deming points out that cheaper is not always better. It is more important to increase reliability and dependability by reducing variation in time of transit and time of delivery. He urges the ICC to take a leadership role in promoting cooperation between the components of the industry. At the end of this chapter, Deming describes fifteen examples of cooperation that provide benefits to everyone. Some of these include common international measurements of time and date, red and green traffic signals, the metric system, and standardized parts such as batteries. Another example involves two service stations on opposite corners of an intersection that share each others tow trucks and stay open late on alternate nights. These companies compete with each other, rather than against each other and everybody wins. Chapter 4: A System of Profound Knowledge Deming states that the prevailing style of management must undergo transformation and this requires a new map of theory he refers to as profound knowledge. His purpose in Chapter 4 is to describe the components of the system of profound knowledge. The first step, according to Deming, is the transformation (more appropriately conveyed by the Greek word metanoia or spiritual conversion) of the individual. He describes this change as a reorientation of one's way of life to apply the principles of profound knowledge in every kind of relationship with other people. The system of profound knowledge includes four components as indicated in the preface, each described briefly below. Appreciation for a System An appreciation for a system includes knowledge of what a system is (defined in Chapter 3) and how interdependence between the components of the system creates a need for communication and cooperation. The greater the interdependence, the greater the need for the parts to work together. A bowling team, orchestra and business are used in a graphic illustration to show how interdependence ranges from low for the bowling team, to high for the orchestra and is very high in a business organization. Knowledge of Variation A knowledge of variation includes knowledge that life is variation, knowledge of the difference between a stable state and an unstable state, knowledge of the difference between common and special causes of variation and knowledge of the effect of the system on the performance of people. It also includes a knowledge of the implications of all this for management. The Theory of Knowledge The theory of knowledge includes an understanding that management in any form is prediction. A statement, if it conveys knowledge, predicts a future outcome including the risk of being wrong. Prediction requires theory. Without theory, experience has no meaning and there is no learning. Copying examples without understanding the underlying theory may lead to disaster. Any number of examples cannot establish a theory. Deming states that "There is no true value of any characteristic, state, or condition that is defined in terms of measurement or observation." "There is no such thing as a fact concerning an empirical observation." An operational definition is needed. He defines this as a procedure agreed upon for translation of a concept into a measurement. But this produces information and information is not knowledge. Knowledge comes only from theory. Psychology A Knowledge of Psychology includes a knowledge that people are different from one another and knowledge of how to use these differences to optimize everybody's abilities and inclinations. It includes the concepts of intrinsic and extrinsic motivation and the phenomenon of over justification. People are born with intrinsic motivation that is often destroyed by various practices at school and work. Grades cause students to work for grades, or a reward from parents for grades, rather than to work for the purpose of learning. Rewards at work such a merit pay cause people to work for rewards rather than for job satisfaction and to find meaning in their work and lives. Some extrinsic motivation helps develop an individual's self-esteem, but over emphasis on extrinsic motivation eventually destroys an individual's intrinsic motivation and leads to detrimental effects on self esteem. Work and life eventually have no meaning. Ranking people, even if it could be done accurately (as opposed to ranking the effects of the system on the workers) would not improve the performance of the people, or the system. Chapter 5: Leadership This is a very short chapter. Deming explains that the job of a leader is to accomplish the transformation of his organization. A leader needs theory, obligation, a plan and persuasive power. Chapter 6: Management of People Deming begins this chapter by saying that "We are living in prison, under the tyranny of the prevailing style of interaction between people, between teams, between divisions." We must replace the idea that we need competition between people with cooperation. He provides a graphic illustration similar to the one below to show how present practices squeeze intrinsic motivation, self esteem and dignity out of people over their life time. Across the top of his illustration he lists the forces of destruction such as forced distribution of grades, merit systems, competition between people and groups, incentive pay, numerical goals, explanation of variances, and treating every group as a profit center. Along the vertical axis he shows the characteristics that people are born with such as intrinsic motivation, self esteem, dignity, cooperation, and joy in learning. All of the forces of destruction must be replaced with new ways to manage people. The purpose of this chapter is to examine how to do this under the new philosophy or theory of profound knowledge. The role of a manager of people After the transformation, a manager will: 1. Understand the meaning of a system and convey this to the people in the system. 2. Help people see how they must cooperate with the preceding and following stages as a component of the system to optimize the system. 3. Understand that people are different and use this knowledge to develop their abilities to optimize the system. 4. Be a continuous learner and encourage continuous learning for others in the system. 5. Be a coach and counsel, not a judge. 6. Understand a stable system and that anyone's performance will reach a stable state. 7. Develop and mainly use knowledge, personality and persuasive power in the management of people, and not rely on authority of office except to change the system for improvement. 8. Study results to improve as a manager of people. 9. Try to discover if anyone is outside the system in need of special help. This is an extension of item 6 above. 10. Create an environment of trust to encourage freedom and innovation. 11. Not expect perfection. 12. Listen and learn without passing judgment. 13. Have an unplanned and unhurried conversation with each worker at least once a year to understand their aims, hopes and fears. 14. Understand the benefits of cooperation and the losses created by competition between people and groups. The Shewhart PDSA Cycle Deming discusses the Plan, Do, Study, Act continuous improvement cycle developed around 1950 he refers to as the Shewhart cycle. He provides an illustration showing a circle where a plan for a change or test of a change in the process or system is developed in the first step, the change or test of change is made below clockwise in the do step, the results are examined in the study step, and the change is either adopted or abandoned in the act step. This leads to the start step, i.e., next plan for change or test of a change in the process or system, the foundation for the whole cycle. The development of a new engine is used as an example. The secret to shorter development times is to put more effort into the early stages and understanding the interaction between stages. The manager's job is to manage the whole process, not to optimize any stage. Everyone involved including marketing people, suppliers, toolmakers, etc. should be included in the planning stage. Problems with Accounting Current accounting practices reinforce the incorrect perception that decisions made during the development stage are independent of the future costs related to capital expenditures, maintenance, operations and the losses suffered by customers. What should business schools teach? Business schools should teach the theory of a system and the theory of profound knowledge for transformation, some economics, statistical theory, language and science. They should teach that un-measurable damage is created by short term thinking, ranking people, merit systems, incentive pay, management by results, and tampering. How should the education system change? To achieve notable improvement, the education system should abolish grades, merit ratings for teachers, comparison of schools on the basis of scores, and gold stars for athletics. Joy in learning comes more from learning than from what is learned. A grade is a permanent label for opening doors or closing doors, a way to achieve quality by inspection, rather than building in quality, a way to produce competition between people, rather than cooperation, a way to label people as winners or losers, a way to humiliate those at the bottom, rather than to promote their desire to learn and future achievement. In this chapter, Deming says that he does not grade students, but gives them a "P" for pass. Some thoughts on grades. Chapter 7: The Read Beads I summarized the Red Bead experiment earlier and refer the reader to that Summary. Chapter 8. Shewhart and Control Charts In this chapter, Deming discusses Shewhart's concepts of variation, common causes variation caused by the system and special causes - variation caused by something that is not part of the system of common causes. He mentions the two mistakes, i.e., reacting to an outcome as if it came from a special cause when it came from a common cause, or reacting to an outcome as if it came from a common cause when it came from a special cause. One of Shewhart's contributions was to develop control charts to minimize the loss from the combination of both mistakes. When the chart indicates no special causes, the process is in statistical control, or stable. In a stable system the performance of the system can be predicted within a range of variation. The performance of an unstable process cannot be predicted. After statistical control is achieved, the process may be improved. An improvement is either a reduction in variation or a movement in the average, up or down, closer to the optimum level. "The control chart is the process talking to us." There are many potential applications of the control chart concepts, or techniques in industry, education and government. The most important application is in the management of people. Some managers set specification limits where they think the limits should be. However, there is no logical connection between control limits and specification limits. Using specification limits based on intuition causes loss either from mistake 1 or mistake 2, but no one could know which or the extent of the losses. Deming discusses some examples where common causes are often confused with or interpreted as special causes. These include accidents on the highway, fires, absenteeism, and malpractice suits. Highway accidents arise mostly from common causes such as drunk driving and unintelligible road signs. These, he says, are not special causes. Malpractice suits in medicine, engineering and accounting all treat the event as a special cause - somebody is at fault. Study and knowledge of variation leads to the conclusion that the event could have come from the process itself. The system may be at fault. Chapter 9: The Funnel The purpose of this chapter is to illustrate the losses that are caused by tampering with a system or process. At the beginning of this chapter, Deming defines tampering as management by results. Other ways to define tampering include trying to improve the performance of a process or system based on an individual observation or result, or trying to improve the process or system without theory. The funnel demonstration includes a funnel, a marble and a table, preferably with a cloth on it to record the results. A dot is drawn on the table cloth to represent the target. Then four rules or procedures are used and the results are recorded on the cloth. Rule 1: Hold the funnel over the target and drop the marble through the funnel 50 times marking each spot where the marble stops. A distribution of spots or plots will occur. Rule 2: After each drop, move the funnel from the previous position to compensate for the last error. The last error is the basis or reference point for each new drop. Record the spots with a different symbol. A wider distribution will occur. Deming calculates the diameter of this rough circle will be 41% wider than the circle based on rule one. This is tampering, i.e., trying to improve the performance of process each time based on an individual result. Rule 3: After each drop, adjust the funnel using the target as the reference point. The results will be worse than before. Rule 4. After each drop, set the funnel over the spot where the marble stops. The results continue to spread out and are even worse than in rule 3. Tampering with the process (Rules 2, 3 and 4) only makes things worse. Deming says that possible improvements in this process include lowering the funnel, using a thicker table cloth, and using a steel ball rather than a marble. A magnetic target and marble will also improve performance of the process. Deming provides seventeen examples of tampering based on rule 2. Some of these include reactions to a complaint of a customer, adjustments in interest rates made by the Federal Reserve Board, a reaction to stock market news, changing company policy based on the latest attitude survey, continuous tax law changes that try to correct a previous mistake, and price wars. Examples of rule 3 include nuclear proliferation, barriers to trade, illicit drug enforcement, and a gambler increasing their bet to cover losses. Examples of rule 4 include workers training other workers in succession, a group of players in an orchestra tuning their instruments sequentially not against the same source, hanging wallpaper, and copying examples with no theory. A process may be stable and produce defects and errors. To adjust the process based on a single defect or error is tampering with the process and will make performance worse. Improvement in a process requires studying the process to understand the capability of the process, including the mean outcome and range of variation. If the process is stable, then a planned change can be developed based on theory, then tested, studied, then implemented or rejected. Chapter 10: Some Lessons in Variation The purpose of this chapter is to provide: 1) some easy lessons in variation including examples of situations where common cause variations are confused with special cause variations, and 2) some illustrations based on the concept of a loss function. Deming explains that variation is life. Life is variation, but those who have no knowledge of statistical theory tend to attribute every event to a special cause. One qualification useful to anyone, and definitely needed by anyone in management, is to understand the concept of variation. This understanding of variation will help them understand the system and to stop asking people to explain the day to day, month to month, and year to year ups and downs that come from the variation that is built into the system. Loss Functions Deming explains that a loss function shows the losses that a system suffers from different values of some adjustable parameter. A loss function is useful to help one change from the idea of meeting specifications to continual reduction in variation and improvement in the mean outcome through improvement of the process or system. Each individual has a loss function and a combination of people have a loss function. Loss functions are usually not symmetrical but may look something like the illustration below. Two distributions are shown in the extended graphic illustration below to convey my interpretation of the concept Deming explains in Chapter 10. The distributions are identical except for their means, i.e., the range of variation is the same in both distributions. However, the one on the left creates more loss than the one on the right. The mean of the process described by the distribution on the left is further away from the optimum or minimum loss. The mean of the process on the right is very close to the optimum value. Improvements in both mean and range of variation are possible for the process on the left. Improvement in the range of variation, i.e., reduction of the amount of variation, is possible for the process on the right. Why was Deming critical of the zero defect philosophy? Deming was critical of the zero defect philosophy because it is associated with the idea of meeting specifications as opposed to continual reduction in variation and improvement in the mean outcome through improvement of the process or system. This point was not entirely clear to me when I read the last chapter of The New Economics. Several articles by Albright and Roth helped to clear up my confusion (See references below). According to these authors, there are two philosophies associated with quality. One concept is the zero defects philosophy and the other concept is the robust quality philosophy based on the Taguchi loss function. According to Roth and Albright, the zero defects philosophy is associated with defining quality as conforming to specifications where the only costs attributed to variation are those that fall outside the specification limits. They refer to this as the goalpost view. However, the robust quality philosophy views any variation from a target value as undesirable because it causes unnecessary costs to be incurred by the manufacturer, the customer or society. The lost function provides a way to estimate these costs. Deming subscribed to the robust quality philosophy as indicated by his discussion of the loss function in Chapter 10. See the summaries below for more on this issue. _________________________________________ Albright, T. L. and H. Roth. 1992. The measurement of quality costs: An alternative paradigm. Accounting Horizons (June): 15-27. (Summary). Albright, T. L. and H. P. Roth. 1994. Managing quality through the quality loss function. Journal of Cost Management (Winter): 20-37. (Summary). Anderson, S. W. and K. Sedatole. 1998. Designing quality into products: The use of accounting data in new product development. Accounting Horizons (September): 213233. (Summary). Kim, M. W. and W. M. Liao. 1994. Estimating hidden quality costs with quality loss functions. Accounting Horizons (March): 8-18. (Summary). Roth, H. P. and T. L. Albright. 1994. What are the costs of variability? Management Accounting (June): 51- 55. (Summary). Sedatole, K. L. 2003. The effect of measurement alternatives on a nonfinancial quality measure's forward-looking properties. The Accounting Review (April): 555-580. (Summary). Taguchi, G. and D. Clausing. 1990. Robust quality. Harvard Business Review (JanuaryFebruary): 67-75. (Summary). Deming Quotes "It is a mistake to assume that if everybody does his job, it will be all right. The whole system may be in trouble." "The process is not just the sum of its parts." "The problem is that most courses teach what is wrong." "Management is prediction." "A goal without a method is nonsense." "Without theory, there are no questions." "Monetary rewards are not a substitute for intrinsic motivation." "The merit system will put us out of business." "A leader is a coach, not a judge." "A leader must have knowledge. A leader must be able to teach." "Does experience help? No! Not if we are doing the wrong things." "If you destroy the people of a company, you do not have much left." "Management by results is confusing special causes with common causes." "We should work on the process, not the outcome of the processes." "Build in quality." "No one has to change. Survival is optional." What is the Red Bead Experiment? The components of the red bead experiment include a box of 4,000 wooden beads (800 red and 3,200 white), a paddle with fifty bead size depressions, a second smaller box for mixing the beads, six willing workers, two inspectors who make independent counts, a chief inspector who verifies the counts, an accountant who records the counts and a customer who will not accept red beads. The job is to produce white beads and the standard for each worker is fifty white beads per day. The daily production operation for each worker includes: 1) poring the beads from the first box into the second box and then back into the first box (to mix the beads), 2) dipping the paddle into the first box without shaking it, 3) carrying the loaded paddle to each inspector for separate counts and then verification, and 4) dumping the day's work back into the supply box. The six workers perform this operation four times to represent four days' work. The results of one of Deming's experiments appear in Table 1. TABLE 1 RED BEADS RECORDED IN ONE OF DEMING'S RED BEAD EXPERIMENTS* Worker Dick Pat Bob Steve Horst Dave Total Mean Day 1 14 17 11 8 12 9 71 11.83 Day 2 10 5 6 8 11 11 51 8.50 Day 3 9 8 5 9 12 7 50 8.33 Day 4 10 5 9 6 8 10 48 8.00 Total 43 35 31 31 43 37 220 9.17 9.17 Mean 10.75 8.75 7.75 7.75 10.75 9.25 *Conducted in a seminar in West Springfield Mass, February 6, 1985 (Walton, Chapter 4). Table 1 reveals that each of the six workers performed differently with daily defects (red beads) ranging from five to 17 and four day averages ranging from 7.75 to 10.75. The first point is clear. With identical tools, tasks and abilities, performance will vary. Now, perhaps the reader is thinking that over the long run the mean defects for each worker will be ten. Logically, since there are 20 percent red beads in the box, the long run average will be 20 percent, or ten. Right? Wrong! First, the beads are different. No two beads are, or could be, exactly alike and the red beads tend to be slightly larger and heavier than the white beads (or it could be the other way around depending on how the beads were produced). The paddle responds to the red and white beads differently and the red and white beads respond to the paddle differently. In addition, the depressions in the paddle are different. No two depressions are exactly alike. The different depressions and beads interact differently. Even though all of these differences are undetectable without precision equipment, they affect the results. In addition, although each of the six workers in the experiment used the same paddle, the variation in the results would be different if each worker had used a different paddle. Deming used four paddles over the forty-five to fifty-year period and the long-run mean defects for the four paddles were 11.3, 9.6, 9.2 and 9.4 (Deming 1993, 168). All of the variation in these experiments was attributed to the system, i.e., incoming beads and paddles. What is the point of the red bead experiment? There are several. 1. The experiment provides a typical illustration of bad management. There are too many employees involved (e.g., inspectors), and the rigid procedures do not allow workers to offer suggestions for improvement. In addition, during the experiment, Deming (who serves as the manager) continually blames the workers for defective products that are caused by the system. 2. System variation (frequently referred to as random variation) is inevitably present in any process, operation or activity. 3. Knowledge of one source of system variation, such as the proportion of defects (red beads) in the incoming supply, cannot be used to determine the total effect of system variation, such as the proportion of defects in the output. This is because unobservable factors will always affect performance and there is no basis for assuming that the effects of these factors will be equally distributed across workers. 4. All workers perform within a system that is beyond their control. 5. There will always be some workers that are above the average and some workers that are below the average. 6. A worker's position in the ranking may vary from one period to the next. 7. Workers should not be ranked because doing so merely represents a ranking of the effect of the system on the workers. In the red bead experiment, 100 percent of the variation in the workers' performances is determined by the system. Even in this controlled experiment where the workers use the same inputs and tools, they are all victims of the system and cannot be compared in any meaningful way.1 8. Only management can change the system. 9. Empirical evidence (i.e., observations of facts, as opposed to secondhand information, or information further removed from fact such as opinion) is never complete. There are always a large number of variables that affect any set of performance results, many of which are unknown and unknowable. The red bead experiment is deceptively simple because it provides a powerful message that is difficult for many to grasp. In summary, the misconception that workers can be meaningfully ranked is based on two faulty assumptions. The first assumption is that each worker can control his or her performance. Deming (1986, 315) estimated that 94 percent of the variation in any system is attributable to the system, not to the people working in the system. The second assumption is that any system variation will be equally distributed across workers. Deming (1986, 353) taught that there is no basis for this assumption in real life experiences. The source of the confusion comes from statistical (probability) theory where random numbers are used to obtain samples from a known population. When random numbers are used in an experiment, there is only one source of variation, so the randomness tends to be equally distributed. This is because samples based on random numbers are not influenced by such things as the characteristics of the inputs and tools (e.g., size of the beads and depressions in the paddles) and other real world phenomena. However, in real life experiences, there are many identifiable causes of variation, as well as a great many others that are unknown. The interaction of these forces will produce unbelievably large differences between people (Deming 1986, 110) and there is no logical basis for assuming that these differences will be equally distributed.2 FOOTNOTES 1. Some readers may think that Deming's experiment is inappropriate because he deliberately chose different size beads, and paddles with different size depressions, but this was not the case. Deming points out that the only way to remove system variation from an experiment is to use random numbers (Deming, 1986, 334). 2. Deming was critical of probability theory and central limit theory in his seminars. For example, in response to a comment from the audience that the mean number of defects in the read bead experiment would be ten based on these concepts, Deming said "I think it is necessary to think and not to assume what you don't know" (Walton 1986, 49). REFERENCES Deming, W. E. 1986. Out of the Crisis. Cambridge, MA. Massachusetts Institute of Technology Center for Advanced Engineering Study. Deming, W. E. 1993. The New Economics for Industry For Industry, Government & Education. MA. Massachusetts Institute of Technology Center for Advanced Engineering Study. Chapter 7. (Summary). Walton, M. 1986. Deming Management Method. New York, NY: The Putnam Publishing Company. Red Bead Experiment Videos by Steve Prevette (You Tube link). Effects of Ranking People According to Deming, evaluations with annual reviews, merit ratings and ranking people destroys intrinsic motivation and teamwork. The illustration below is part of my summary of The New Economics For Industry, Government & Education.* ____________________________________ * Deming, W. E. 1993. The New Economics for Industry For Industry, Government & Education. Cambridge: Massachusetts Institute of Technology Center for Advanced Engineering Study. Chapter 6. (Summary). Plan Do Study Act Graphic This graphic is from MAAW's Chapter 8. This graphic is from the Continuous Improvement Topic The graphic below is from the Francis and Gerwels summary. Pratt & Whitney Rocketdyne - A Thinking Roadmap Beginning in 1995, colleagues within Pratt & Whitney Rocketdyne (PWR) in Canoga Park, California (then a division of Rockwell International) created the concept of "A Thinking Roadmap" as a means to formally integrate their classroom education efforts (both seminars and workshops), all with the aim of leading a thinking transformation, both individual and organizational. The need for the thinking transformation is to foster better thinking about sub-systems, psychology, variation, knowledge, and their interactions - elements recognized as the basis of W. Edwards Deming's R20;System of Profound Knowledge (SoPK)". In seeing the vast opportunities for simultaneously improving the thinking skills of the entire enterprise, including employees, suppliers, and customers, Rocketdyne's Enterprise Thinking Network was formed to lead a thinking transformation, with a Thinking Roadmap as a means to create awareness of the thinking of Russell Ackoff, Edward de Bono, W. Edwards Deming, Tom Johnson, and Genichi Taguchi, to name a few of the thinking pioneers whose writings and teachings they have incorporated into their roadmap. Discussion Questions Deming's theory of profound knowledge includes four components: I. Appreciation for a system, II. Knowledge about variation, III. Theory of knowledge and IV. Psychology. Questions related to component 1: 1. What does Deming mean by appreciation for a system? (See the summaries of The New Economics Chapter 3 and Chapter 4, Mintzberg & Van der Heyden, and Castellano, Young & Roehm). 2. Why does Deming say the parts cannot manage themselves? (See the summaries of The New Economics Chapter 3 and Stevens). (See the summary of Senge's description of The Beer Game for the same idea). 3. Why is Deming against management by objectives? (See the summaries of The New Economics Chapter 2 and Levinson). 4. Why is Deming against voting and compromise? Questions related to component 2: (Knowledge about variation) 5. What does he mean by knowledge about variation? (See the summaries of The New Economics Chapter 4 and Castellano, Young & Roehm). 6. What is the red bead experiment and why did Deming use it? (See the Red Bead summary). 7. Joiner and Gaudard indicate that there are four causes of variation: common, special, tampering and structural. What is tampering? How do we know it is tampering? (See the summaries of Joiner & Gaudard and The New Economics Chapter 9). 8. How is the funnel experiment used to illustrate the concept of tampering? (See the summary of The New Economics Chapter 9). 9. What is structural variation? (See the Joiner & Gaudard summary and MAAW's Chapter 3 Class problem 2). 10. Do you think there are four types of variation or just two? Explain. 11. Explain why Deming was opposed to ranking people from the variation perspective? (See the summary of The New Economics Chapter 2). Questions related to component 3: (Theory of Knowledge) 12. What does Deming mean by the theory of knowledge? (See the summary of The New Economics Chapter 4). 13. Deming said that you do not find knowledge in a dictionary. What did he mean by this? (See the summary of The New Economics Chapter 4). 14. According to Deming, information is not knowledge. Why not? (See the summary of The New Economics Chapter 4). 15. Why does Deming say that experience teaches nothing without theory? (See the Deming quotes and the The Beer Game summary for some ideas). 16. Why is Deming against copying examples? Questions related to component 4. (Psychology) 17. What does Deming mean by psychology? What motivates people? (See the summaries of The New Economics Chapter 4, Herzberg, Levinson, Katzenbach & Santamaria and Amabile). 18. Why do organizations need to drive out fear? (See the summary of The New Economics Chapter 4, Herzberg, Levinson, Katzenbach & Santamaria and Amabile). 19. What did Deming learn at the Hawthorne plant lighting experiment? 20. Why was Deming opposed to ranking people from the behavioral and system's perspectives? (See the summaries of The New Economics Chapter 4 and Chapter 6). (Also see the summaries of Pfeffer, Stevens, Herzberg, Amabile and Kohn). 21. What is wrong with exhortations such as "Do it right the first time"? Questions related to diseases and obstacles: Diseases include: 1. Lack of constancy of purpose, 2. Emphasis on short terms profits 3. Evaluation by performance reviews and merit ratings, 4. Management mobility, 5. Management by visible figures alone, 6. Excessive medical costs, 7. Excessive costs of liability. 22. What does he mean by lack of constancy of purpose? (See the short summary). 23. Which diseases and obstacles are related to accounting? (See the summary of The New Economics Chapter 6 and the short summary). Other questions: 24. Deming did not use, or even recognize, the term total quality management. Why do you think Deming was opposed to this term? 25. From Deming's perspective, what is wrong with managing by results? (See Deming quotes and the Collingwood, Healy & Wahlen, Dechow & Skinner and Chow, Kato & Merchant summaries). 26. Compare Deming's concept of a leader with the traditional American management concept of a leader. (See the summaries of The New Economics Chapter 6 and Spear, Sobek, Stevens). 27. Do you disagree with any of Deming's arguments? Explain. 28. Deming said "We are being ruined by best efforts." What did he mean? (See the Deming quotes and The Beer Game). 29. There is a popular saying, "If you can't measure it, you can't manage it." Deming disagreed. Why? 30. From Deming's perspective, what should be the role of government? (See the Stevens summary). 31. Deming was not a fan of the ISO 9000 series of international standards. Why not? (See the ISO website and the Stevens summary). 32. Deming was critical of the Malcolm Baldrige award. Why? (See the Malcolm Baldrige National Quality Award and the Stevens summary). 33. Although Deming was a consultant for some of the largest organizations (e.g., General Motors, Ford, Xerox, Procter and Gamble, and of course Japan), he was not a rich man. He lived in a relatively small two story brick house in Washington D.C. and worked in the basement. What do you think is the reason for Deming's modest lifestyle? (See the Herzberg, and Amabile summaries). 34. Bazerman, Loewenstein & Moore (BLM) and Healy & Palepu make some recommendations related to auditing. BLM argue that the problem is unconscious selfserving bias in the client-auditor relationship. Are they blaming the auditors or the system? Discuss their recommendations in relation to Deming's views on leadership and solving problems. 35. Read the Joke on American management. Can you relate this to Deming's criticisms of American management? 36. Dr. Deming taught that companies should compete with each other, not against each other. What did he mean ? Discussion Questions Related to Statistical Process Control Discussion Questions Related to Statistical Process Control 1. In developing a control chart, the analyst recognizes that there are two types of variation in a system. One type of variation is produced by common causes and the other type is generated by special causes. Explain the difference. (See Chapter 3 Part II, Deming Chapter 8 and Nolan & Provost). 2. Why is it important for management to know whether a variation in performance came from common causes or special causes? (See Chapter 3 Part II and Deming Chapter 8 and Nolan & Provost, Roehm & Castellano, Roehm, Weinstein & Castellano, Reeve 89 and Francis & Gerwels). 3. Why are control charts developed using sample means? (See Chapter 3 Part II). 4. Why do we need both X-bar and R control charts? (See Chapter 3 Part II). 5. Does an observation (i.e., sample mean) plotted outside the control limits necessarily indicate a special cause? Explain. (See Figure 3-11 for an example). Do observations plotted inside the control limits necessarily indicate a common cause? (See Francis & Gerwels and Walter, Higgins & Roth). 6. How do confidence intervals developed around a regression line differ from the upper and lower limits of a control chart? 7. Discuss the two types or errors connected with the use of control charts. What type do you think managers tend to make more often? Why? (See Chapter 3 Part II and Deming Chapter 8). 8. To say that a system is stable means that the performance of the system is predictable within a specified range. Explain this statement. (See Figure 3-11 for an example and the Dog in the Yard illustration). 9. Does a stable system mean that the system is efficient? Explain. (See Chapter 3 Part II). 10. How can control charts be used to promote continuous improvement of a system? (See Chapter 3 Part II, Reeve & Philpot and Francis & Gerwels summaries). 11. Think of some practical applications of the control chart you could use to monitor your health, the performance of your car, or the performance of some other system you come in contact with in your daily life. (See the Walter, Higgins & Roth summary). 12. Is the control chart methodology a top down or a bottom up approach? Explain. (See Chapter 3 Part II). 13. Does the traditional standard cost system recognize the concept of variability that is the basis of the statistical process control methodology? Explain. (See the Roehm, Weinstein & Castellano, Reeve & Philpot, Francis & Gerwels and Reeve 89 summaries). 14. What is required for control? 15. Compare the SPC control concept with the accounting standard cost control concept. (See the Roehm, Weinstein & Castellano, Reeve & Philpot, Francis & Gerwels and Reeve 89 summaries). 16. Is the variation within the upper and lower limits of a control chart considered to be controllable or uncontrollable? Explain. (See the Dog in the Yard illustration). 17. Is the variation within the upper and lower limits of a control chart considered to be in control or out of control? Explain. (See the Dog in the Yard illustration). 18. Is the variation within the upper and lower limits of a control chart considered to be predictable or unpredictable? Explain. (See the Dog in the Yard illustration). 19. Is the variation outside the limits of a control chart considered to be controllable or uncontrollable? Explain. (See the Dog in the Yard illustration). 20. Is the variation outside the limits of a control chart considered to be in control or out of control? Explain. (See the Dog in the Yard illustration). 21. Is the variation outside the limits of a control chart considered to be predictable or unpredictable? Explain. (See the Dog in the Yard illustration). 22. GE's Jack Welch developed a program at General Electric referred to as Six Sigma. What is a sigma and what does six sigma mean? (See the Six Sigma summary, the Lucier & Seshadri summary and GE's Six Sigma site). 23. How does GE's Six Sigma program different from the SPC concept? (See the Lucier & Seshadri summary and GE's Six Sigma site). 24. What was the main idea or purpose of GE's "Work-Out™" program started by Jack Welch ? (See the Lucier & Seshadri summary). 25. The SPC concept is a prerequisite for understanding Deming's Theory of Profound Knowledge. Explain. (See the Deming category to begin). Multiple Choice Questions (NOT DOWNLOADABLE) CHAPTER 6 Economic Theory http://maaw.info/EconomicsRelatedMain.htm Economics Related Bibliography ASCE Report on U.S. Infrastructure ASCE 2001, 2005, and 2009 Report Cards for America's Infrastructure The ASCE (The American Society of Civil Engineers) studied and evaluated the status of America's infrastructure in fifteen categories as indicated in the exhibit below for 2009. Although the U. S. seems to be doing better in some areas, the overall grade assigned by the civil engineering study was D (down from an overall D+ in 2001). See the full report at ASCE Report Card. Infrastructure Category Aviation Bridges Dams Drinking Water Energy (National Power Grid) Hazardous Waste Inland Navigable Waterways Levees Public Parks & Recreation Rail Roads Schools Solid Waste 2001 Grade D C D D D+ D+ D+ D+ DC+ 2005 Grade D+ C D DD D DCCD D C+ 2009 Grade D C D DD+ D DDCCDD C+ Notes on 2009 Infrastructure Outdated traffic control system. 26% of the nation's bridges are deficient or obsolete. 4,000 deficient dams. 1,819 are high hazard. $11 billion needed to replace aging facilities. $1.5 trillion needed investment by 2030. Superfund cleanup of the worst toxic waste sites has declined steadily. $125 billion needed for replacement of locks. $100 billion needed to repair the nation's levees. $7 billion maintenance backlog. $200 billion needed for growth. 4.2 billion hours lost per year stuck in traffic cost $78.2 billion. $186 billion needed to improve the nations highways. $322 billion needed for repair. Public safety threatened by increasing Transit Wastewater CD D+ D- D DD Overall D+ D Comparative Economic Systems disposal of electronic waste. $15.8 billion needed to maintain conditions, $21.6 billion needed to improve from current to good conditions. $390 billion needed over the next 20 years. Investment needed $2.2 trillion. Economies of Scale The graphic illustration below (based on Figure 11-12) shows the short-run average cost curve for a specific size plant based on increasing then decreasing productivity. The average cost decreases as productivity increases, then increases after the point of diminishing returns is reached. See Chapter 11 for more on these relationships. An important point to grasp is that the short run average cost curve is U-shaped because of the phenomenon known as diminishing returns. Economies of Scale versus Diminishing Returns The concept of economies of scale is based on the long-run average cost (LRAC) curve as indicated in the graphic illustration below. The LRAC curve is derived from the short-run average cost (SRAC) curves represented by alternative plant sizes. The U-shaped function drawn tangent to the various short-run cost curves represents the long-run average cost curve and illustrates the concept of economies of scale. An important point to grasp is that the long-run average cost curve is U-shaped because of the phenomenon known as economies of scale. Note on The World is Flat These brief comments represent my notes on an MIT video that I recommend to everyone. The video is about Friedman's book that helps explain what's going on in the world. A couple of comments in the video emphasize the point. While we were sleeping, the world became flat and we were not ready. As a result of this flattening, there is no such thing as an American job anymore. In the MIT video Friedman talks about the first three chapters of the book. In the first chapter he describes how he developed the idea for the book. From the realization that the global economic playing field is being flattened came the title "The World is Flat". Friedman tells the audience that there have been three stages or eras of globalization including the following: 1. The first era involved countries globalizing from around 1400 to 1800. 2. In the second era companies or multinationals were globalizing from 1800 to 2000. 3. The third era is when the world became flat as individuals and small groups from all nationalities began globalizing themselves after 2000. While we were sleeping, the world changed dramatically when the third era of globalization began. The world flattened in all kinds of ways. Some of these ways are mentioned in the video, e.g., what's going on in China and India. In the second chapter, Friedman describes how the world became flat. According to Tom this phenomenon came about because of ten flatteners as follows: 1. The fall of the Berlin wall in 1989 was the beginning along with the introduction of Microsoft Windows. 2. Netscape's web browser brought the internet to life in 1995 by bringing the web to average folks, not just technical types. 3. The dot com boom and investment in a "glut of fiber optic cable" made it possible for everyone to communicate for free. 4. Workflow - Software applications were developed that allowed connecting workflow which created multiple forms of collaboration. 5. Outsourcing - a new form of collaboration was created. 6. Off shoring - another form of collaboration. 7. Open sourcing - more collaboration, e.g., Firefox was developed by two people who never met. 8. Supply chaining - Walmart's system provides an example. 9. Insourcing - the UPS/Papa Johns connection provides an example. 10. Steriods - File sharing and ... In chapter 3 Friedman describes how all ten flatteners converged to create a tipping point or platform. (See The Tipping Point summary). After some additional comments about chapter 3, Friedman answers some interesting questions like What is the effect of this phenomenon flattening on third world countries? The day after I put my notes about Friedman's book on the web I got the following e-mail message from Scottie Jacob of Meghan-Kiffer Press. Just off press ... The World is Flat? “Globalization is Threatening to Hollow Out America’s Middle Class,” Assert Business Analysts Thomas Friedman’s recent New York Times bestseller, The World is Flat, asserts that the international economic playing field is now more level than it has ever been. As popular as it may be, some reviewers assert that by what it leaves out, Friedman’s book is dangerous. “The world isn’t flat as a result of globalization,” say Ronald Aronica and Mtetwa Ramdoo, business analysts and authors of a critical analysis of Friedman’s book. “It’s tilted in favor of unfettered global corporations that exploit cheap labor in China, Indian and beyond. Today’s global corporations go to the ends of the earth to employ factory workers for 20 cents an hour and PhDs in science and technology for $20,000 a year,” add Aronica and Ramdoo. In short, “Globalization is the greatest reorganization of the world since the Industrial Revolution,” says Aronica. This epic change has shaken up the way the world does business, and Americans are reluctantly facing a shift of wealth and power to the East. Across the country, a growing number of Americans fear that they could be replaced by someone from a developing country. Recent polls indicate that millions of Americans are preoccupied with the outsourcing of American jobs and the threat of global economic competition. From boardrooms to classrooms to kitchen tables and water coolers, globalization has become a hot topic of discussion and debate everywhere. But by what Friedman’s book ignores or glosses over, it misinforms the American people and policy makers. Aronica and Ramdoo’s concise monograph, The World is Flat?: A Critical Analysis of Thomas L. Friedman’s New York Times Bestseller, brings clarity to many of Friedman’s stories and explores nine key issues Friedman largely disregards or treats too lightly, including the hollowing out of America’s debt-ridden middle class. To create a fair and balanced exploration of globalization, the authors cite the work of experts that Friedman fails to incorporate, including Nobel laureate and former Chief Economist at the World Bank, Dr. Joseph Stiglitz. Refreshingly, readers can now gain new insights into globalization without weeding through Friedman’s almost 600 pages of grandiloquent prose and bafflegab. “It’s of utmost urgency that we all learn about and prepare for total global competition. If you read Friedman’s book, and were awed, you really should read more rigorous treatments of this vital subject. Globalization affects all our lives and will be of even greater significance to our children and grandchildren,” says Ramdoo. Aronica and Ramdoo conclude by listing over twenty action items that point the way forward for America and other developed countries. They provide a comprehensive, yet concise, framework for understanding the critical issues of globalization. They paint a clear and sometimes alarming picture of the early twenty-first century landscape, and present timely information needed by governments, businesses, and individuals everywhere. 200 Years of Economic Development in 4 Minutes The video below is an interesting presentation by Hans Rosling illustrating the economic development of 200 countries over the last 200 years. Life expectancy is placed on the vertical axis and income per person is represented on the horizontal axis. Life expectancy ranges from 25 years to 75 years while income per person ranges from $400 to $40,000. According to Rosling, the series of graphics illustrated represents 120,000 numbers plotted to show the changes in life expectancy and income per person from 1810 to 2010. Each country is presented as a circle or bubble, and the size indicates the relative size of the country's population. The colors of the bubbles indicate the country's location. Blue is Africa, Red is Asia, Orange (he calls it brown) is Europe, Yellow is the Americas, and Green is the Mid-east. The 2010 graphic (see below) shows what Rosling refers to as a converging world where all countries are moving up from the condition of poor and sick toward a condition of rich and healthy. A couple of other screen captures show the changes since 1948. Perhaps this illustration represents an argument for trickle down economics, but see my note on the Universal law of wealth. ___________________________________ Some useful links: For an explanation of the software used in the video see http://en.wikipedia.org/wiki/Trendalyzer For more on this software and Rosling's work see http://www.gapminder.org/ For more Rosling Gapminder videos see http://www.gapminder.org/videos/ To see the entire 200 years develop see the Gapminder World Tool To get Gapminder Desktop go to http://www.gapminder.org/desktop/ Stock Market Indicators This short article by Blackman included a table of stock market indicators similar to the illustration below. Economist surveys are always wrong, so if they think the market is going up, it is probably going down instead. Box-office receipts, Gift-wrap sales, the Philadelphia Fed's survey, the NFIB confidence survey, Food services & drinking places sales, Truck tonnage and Presidential ratings are all directly related to stock market movements. If they are up, the stock market tends to be going up as well. The Universal Law of Wealth The purpose of this article is to describe a universal law of wealth based on a network effect that appears to have some important implications for economic policy. According to Buchanan, the universal law of wealth is simply stated in the following way. Each time you double the amount of wealth, the number of people involved falls by a constant factor to form a Pareto curve, e.g., in the U.S. approximately 80% of the wealth is held by 20% of the people. In some other countries it might be 90% of the wealth held by 20%, or 95% held by 10%, but the point is that in any society a small percentage of the people always own a large proportion of the wealth. This Pareto curve distribution of wealth appears to be based on a network effect that is applicable across societies and has little to do with differences in backgrounds, talents, and the education of an area's citizens. However, a network model developed by two physicists, Bouchaud and Mezard, shows how Pareto's distribution of wealth can be influenced. Their model shows that the greater the amount of money flowing through the economy, and the more often it changes hands, the greater the equality in the economic system. The model also provides some test of political justifications for various policies. For example, recent economic policy dominated by the free market ideology and government deregulation has been promoted using the argument that wealth will trickle down to the poor. The network model suggests the opposite in that increased investment without an increase in the flow of funds between people will lead to an increase in inequality - and that is exactly what happened over the past 30 years. Wealth distribution in the U.S. has become much less equitable. The model also indicates that income taxes will tend to produce a more equitable distribution of wealth if those taxes are redistributed to society in an equitable way. On the other hand, a decrease in taxes without an increase in the flow of funds between people will lead to an increase in wealth inequality. Two Global Variants of Capitalism (Chapter 1 of James Martin) World Competitiveness Reports The concept of competitiveness has been a hot top, as well as a controversial topic for several years. Two organizations publish annual competitiveness reports. The World Economic Forum (WEF) has published the The Global Competitiveness Report since 1979. The International Institute For Management Development (IMD), has published a similar report referred to as the The World Competitiveness Yearbook since 1989. The Global Competitiveness Report was originally published jointly by the WEF and the IMD, but according to a note in the Economist1 differences over how to define and measure competitiveness (originally titled the competitiveness index) caused these organizations to split and produce separate reports. The World Economic Forum defines competitiveness as "the ability of a country to achieve sustained high rates of growth in gross domestic product (GDP) per capita". On the other hand, the IMD defines competitiveness as "the ability of a country to create added value and thus increase national wealth by managing assets and processes, attractiveness and aggressiveness, globality and proximity, and by integrating these relationships into an economic and social model." Other differences include which factors to include in the competitiveness index and how to weight these factors. The WEF's GLOBAL COMPETITIVENESS REPORT There are two main indexes and several sub-indexes. The two main indexes prior to 2003 were the Growth Competitiveness Index and the Current Competitiveness Index. The 2003 report uses the terms Growth competitiveness Index and the Microeconomic Competitiveness Index. The Growth Competitiveness Index (GCI) The WEF's growth competitiveness index (referred to as the Competitive Index prior to 2000) is based on estimates of each country’s ability to grow over the next five to ten years. These estimates were based on each country’s economic conditions and institutions including 155 related criteria aggregated into eight factors determining competitiveness. The eight factors are as follows: 1. Openness of an economy to international trade and finance. 2. Role of the government budget and regulation (e.g., public spending/GDP) 3. Development of financial markets. 4. Quality of infrastructure. 5. Quality of technology. 6. Quality of business management. 7. Labor market flexibility. 8. Quality of judicial and political institutions. According to the executive summaries by Porter, Sachs and McArthur2, the growth index is based on three sub-indexes including: The Technology Index, The Public Institutions Index, and The Macroeconomic Environment Index. For 21 innovating (core) economies, the GCI weights technology 1/2 and public institutions and macroeconomic environment 1/4 each. For the non-innovating (non-core) economies, these measurements are weighted 1/3 each. There are numerous sub-indexes underlying these three indexes. The Current Competitiveness Index - Microeconomic Competitiveness Index The current competitiveness index (first presented in 2000 and renamed microeconomic competitiveness index for 2002) is based on the current levels of productivity in the 80 economies now covered by the report. This is an aggregate measure of current competitiveness. There are two sub-indexes including: The company operations and strategy index and The quality of the national business environment index. The Microeconomic Competitiveness Index, as defined in the 2002 executive summary, uses microeconomic indicators to measure an economy's effective utilization of its current stock of resources, i.e., measures the current productive potential. The amount of free information made available by the World Economic Forum varies from year to year, but the main index rankings and executive summary are available on the WEF website or click on the links below for the information available on Amazon's website. The Global Competitiveness Report 2002 The Global Competitiveness Report 2001 The Global Competitiveness Report 2000 Some information can be found in press releases and some on the WEF web site. The Executive summary is available as a PDF file. Some recent rankings by the World Economic Forum appear in the table below. The formulas were changed for 2003. See the executive summary report for more information. WEF Growth Competitiveness Index Rankings and Current or Microeconomic Competitiveness Index Rankings in Parentheses (Order based on 1999) Country Singapore U.S. Hong Kong Taiwan Canada Switzerland Luxembourg U.K. Netherlands Ireland Finland Australia New Zealand Japan Norway Malaysia Denmark 1996 1 4 2 9 8 6 5 15 17 26 16 12 3 13 7 10 11 1997 1 3 2 8 4 6 11 7 12 16 19 17 5 14 10 9 20 1998 1 3 2 6 5 8 10 4 7 11 15 14 13 12 9 17 16 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 2000 2 (9) 1 (2) 7 (16) 10 (21) 6 (11) 9 (5) NA 8 (8) 3 (4) 4 (22) 5 (1) 11 (10) 19 (19) 20 (14) 15 (20) 24 (30) 13 (6) 2001 4 (9) 2 (2) 13 (18) 7 (21) 3 (11) 15 (5) NA 12 (7) 8 (3) 11 (22) 1(1) 5 (9) 10 (20) 21 (15) 6 (19) 30 (37) 14 (8) 2002 4 (9) 1 (1) 17 (19) 3 (16) 8 (10) 6 (5) NA 11 (3) 15 (7) 24 (20) 2 (2) 7 (14) 16 (22) 13 (11) 9 (21) 27 (26) 10 (8) 3 1 10 14 11 9 15 12 7 5 2003 6 2 2004 2005 200607 8 1 10 13 12 4 25 2 11 22 6 16 21 5 17 19 3 200708 7 1 12 14 13 2 25 9 10 22 6 19 24 8 16 21 3 Iceland Sweden Austria Chile Korea France Belgium Germany Spain Portugal Israel Mauritius Thailand Mexico Lithuania China Philippines Costa Rica Italy Peru Romania 27 21 19 18 20 23 25 22 32 34 24 NA 14 33 36 31 28 41 38 - 38 22 27 13 21 23 31 25 26 30 24 NA 18 33 29 34 43 39 40 - 30 23 20 18 19 22 27 24 25 26 29 NA 21 32 28 33 34 41 37 - 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 - 23 (17) 12 (7) 17 (13) 27 (26) 28 (27) 21 (15) 16 (12) 14 (3) 26 (23) 22 (28) 18 (18) 35 (38) 30 (40) 42 (42) 40 (44) 36 (46) 37 (43) 29 (24) 47 (49) - 11 (16) 9 (6) 18 (13) 27 (29) 23 (28) 20 (12) 19 (14) 17 (4) 22 (23) 25 (31) 24 (17) 32 (52) 33 (38) 42 (51) 43 (49) 39 (47) 48 (54) 35 (50) 26 (24) 55 (63) 56 (61) 12 (17) 5 (6) 18 (12) 20 (31) 21 (23) 30 (15) 25 (13) 14 (4) 22 (25) 23 (36) 19 (18) 35 (49) 31 (35) 45 (55) 36 (40) 33 (38) 61 (61) 43 (39) 39 (24) 54 (66) 66 (67) 8 4 20 9 18 27 23 15 24 23 4 15 26 11 18 20 5 29 38 17 57 28 49 36 34 67 59 43 80 70 13 7 29 43 14 55 28 52 39 35 75 68 47 78 73 Indonesia Hungary Estonia Slovenia Czech Republic Trinidad & Tobago Jordan Uruguay Latvia Greece Argentina Dominican Republic Poland Turkey Slovak Republic El Salvador South Africa Vietnam Sri Lanka Egypt Jamaica 30 46 35 28 39 37 44 42 NA NA 43 NA 29 - 15 46 32 43 48 37 50 36 35 NA 44 49 28 - 31 43 35 34 44 36 49 40 48 NA 42 39 38 - 37 38 39 40 41 42 43 44 45 46 47 48 49 - 43 (47) 25 (32) 31 (34) 46 (35) 33 (33) 44 (45) 34 (41) 39 (29) 38 (36) 49 (51) 32 (25) 52 (53) 41 (39) - 64 (55) 28 (26) 29 (27) 31 (32) 37 (35) 38 (34) 45 (44) 46 (46) 47 (42) 36 (43) 49 (53) 50 (59) 41 (41) 54 (33) 40 (39) 58 (64) 34 (25) 60 (62) 61 (57) 51 (45) 52 (40) 67 (64) 29 (28) 26 (30) 28 (27) 40 (34) 37 (44) 47 (53) 42 (62) 44 (45) 38 (43) 63 (65) 52 (41) 51 (46) 69 (54) 49 (42) 57 (63) 32 (29) 65 (60) 59 (47) NA 60 (59) 54 38 26 40 31 76 46 79 48 61 70 93 45 58 37 53 36 64 81 71 67 51 44 27 37 33 78 46 71 40 61 79 88 48 50 39 63 41 64 66 73 74 Panama Venezuela Brazil India Ecuador Columbia Guatemala Bolivia Bulgaria Zimbabwe Ukraine Honduras Bangladesh Paraguay Nicaragua Nigeria Russia Croatia Haiti Morocco Namibia 47 48 45 NA 40 NA NA NA NA 49 - 47 42 45 NA 41 NA NA 51 52 53 - 45 46 50 NA 47 NA NA 51 53 52 - 50 51 53 53 54 55 56 57 58 59 - 53 (54) 45 (31) 48 (37) 58 (57) 51 (48) 50 (58) 57 (55) 55 (50) 56 (56) 54 (52) - 53 (48) 62 (66) 44 (30) 57 (36) 68 (72) 65 (36) 66 (69) 67 (75) 59 (68) 75 (65) 69 (60) 70 (74) 71 (73) 72 70) 73 (71) 74 (67) 63 (58) - 50 (50) 68 (72) 46 (33) 48 (37) 73 (77) 56 (56) 70 (73) 78 (79) 62 (68) 79 (70) 77 (69) 76 (78) 74 (74) 72 (76) 75 (75) 71 (71) 64 (58) 58 (52) 80 (80) 55 (48) 53 (51) 60 85 66 42 94 63 91 100 74 112 69 90 92 108 101 95 59 56 ? 65 72 56 90 68 45 94 65 81 96 75 120 69 77 98 112 102 87 55 54 ? 60 82 Tunisia Botswana Some of the recently listed countries Kuwait Qatar UAB Bahrain Barbados Cyprus Malta Kazakhstan Azerbaijan See recent reports for other countries - - - - - - 34 (32) 41 (57) 33 57 32 72 - - - - - - - - - - 30 32 34 48 41 49 51 50 62 30 31 35 40 47 52 53 58 62 - - - - - - - - - - - - - - - - - - - - - - - - - IMD'S WORLD ECONOMIC YEARBOOK Information related to the IMD's current competitiveness rankings can be found on the IMD website or click on the links below for the information available on Amazon's website. The World Competitiveness Yearbook 2002 The World Competitiveness Yearbook 2001 SOME THOUGHTS Part of the controversy related to the competitiveness reports is the term "competitiveness". As many economists have pointed out, countries do not compete the way companies compete. Countries trade with each other, but it is not a zero-sum game. All trading parties benefit. However, countries do provide the foundation needed for business organizations to compete in the global economy. Without a well developed infrastructure (e.g., roads, education systems, communication systems etc.), as well as well developed financial markets, technology, government support, and judicial systems, an economic system cannot support the development of competitive business organizations. How much government involvement is needed? This is an ongoing political controversy. The Largest Economies One of the most interesting facts revealed in the data and discussion related to these reports is the size of the U.S. and Japan in relation to the world economy. In 1998 the U.S. economy (GDP) was $8,511 billion, while Japan, the second largest economy, was $3,784 billion.3 Based on this data, the Japanese economy is 44.5% as large as the U.S. economy, or the U.S. economy is 125% larger than the Japanese economy. According to a related discussion on the IMD website (August 2001), the U.S. and Japan account for 46% of the world GDP. FOOTNOTES 1 1996.The C-word strikes back. Economist (June 1): 76. 2 Porter, M. E., J. D. Sacks and J. W. McArthur. 2002 and 2003. Executive Summary: Competitiveness and Stages of Economic Development. 3 Sacks, J. D. and A. M. Warner. 1999. Year in review. WEF website. CHAPTER 7 Expectancy Theory http://maaw.info/ExpectancyTheoryMain.htm Expectancy Theory Bibliography An application of expectancy theory Monetary incentives, expectancy and other theories What is expectancy theory? Griffin, L. and A. Harrell. 1991. An empirical examination of managers' motivation to implement just-in-time procedures. Journal of Management Accounting Research (3): 98-112 MOTIVATION/PURPOSE Foreign competition has prompted manufacturers in the United States to adopt new methods and technology, such as the Just-in-Time (JIT) concept. When a firm implements the JIT concept, major physical, psychological, and organizational changes occur in the organization’s work environment. The firm develops more intimate relationships with suppliers, significantly reduces its inventories, and implements simplified manufacturing procedures. Several individuals within the firm may be reluctant to adopt the JIT concept. For example, management accountants may not be aware of the benefits associated with JIT, because they received limited coverage of JIT while completing their undergraduate accounting program. Managers and supervisors may not be motivated to implement JIT because the JIT concept seeks to eliminate the slack used by middle managers and supervisors as a cushion against difficulties caused by defective raw materials, production errors, and irregular supply and demand schedules. The authors propose that the expectancy theory can be used to examine the motivation of middle managers and supervisors to implement JIT procedures. Management accountants are not sampled in this study. CONTRIBUTION The expectancy theory variables (valence model and force model) can provide an appropriate conceptual framework for understanding how an organization can gain the support and cooperation of middle managers and supervisors in the implementation of JIT procedures. Both models have the strong ability to explain variations in individual motivation levels. THEORY Expectancy theory is a theory of motivation based on the belief that people's efforts to achieve depend on their expectations of reward. Vroom’s formulation of expectancy theory involves two models, the valence model and the force model. Expectancy-Valence Model: ependent Variable: Attractiveness D Independent Variables: (1) Second Level Outcomes and (2) Strength of the Instrumentality (relationship) between the first-level outcome and associated second level outcome. The expectancy-valence model depends on the person's expectations of reward. People's motivation to achieve something depends on the product of their estimation of their chance of success (perceived probability of success) and the value they place on success (incentive value of success). Force Model: Dependent Variable: Motivational Force Independent Variables: (1) Valence of First Level Outcome and (2) Expectancy Two forced models are tested: additive and multiplicative The force model depends on both the valence and the expectancy. When both valence level and expectancy are high, motivational force is high. The force model implies the motivation of a middle manager or supervisor to implement JIT procedures is explained by the valence (attractiveness) of implementing JIT procedures and the expectancy (probability) that some particular level of effort will result in implementation. PROPOSALS Proposal 1: The valence model will predict the valence (attractiveness) of implementing JIT procedures to middle managers and supervisors. Proposal 2: The force model will predict the motivation of middle managers and supervisors to implement JIT procedures Proposal 2a: Most individuals will employee additive information processing procedures (the additive model), rather than the multiplicative information processing (the multiplicative model) As expected, the typical individual reached a greater motivational force decision for higher expectancy levels than for lower expectancy levels. This increase is, however, relatively modest when the wide change in expectancy (from 10 percent to 90 percent) is considered, indicating the typical individual placed less weight on expectancy than upon valence in reaching motivational force decisions. METHOD The judgment analysis approach for expectancy research was used to examine whether the valence and force models can predict the motivation of middle managers and supervisors to implement JIT procedures. This approach uses individuals’ decisions as operational measures of valence and motivation. Each participant was given 1 of 32 cases that described a unique hypothetical JIT implementation status. A regression model was obtained for each participant and the average values (i.e. adjusted R2 and beta weights) for each group were reported. SAMPLE 70 participants in Group One were middle managers and supervisors (or individuals who had previously held supervisory positions), who were enrolled in an evening MBA program. Group Two consisted of 35 mangers that were attending a one-day JIT seminar. Group Three participants were 50 middle managers and supervisors who were employed by one of the nation’s leading textile manufacturers. RESULTS Proposal 1: The valence model will predict the valence (attractiveness) of implementing JIT procedures to middle managers and supervisors. The typical participant in all three groups placed the greatest valence upon the fourth second-level outcome, the rewards associated with increased productivity in the new work environment. The typical participant found employment security and the more challenging production standards and output goals associated with the new work environment to be the second and third most attractive secondlevel outcome and placed the least value upon the greater coordination of departmental activities outcome. The adjusted R2 values obtained from the person-by-person regression analysis provided an indication of the ability of the valence model to explain variations in the participants’ valence decisions. Proposal 2: The force model will predict the motivation of middle managers and supervisors to implement JIT procedures. The adjusted R2 values obtained from the person-by-person regression analysis provided an indication of the ability of the force model to explain variations in the participants’ motivational force (or effort level). Proposal 2a: Most individuals will employee additive information processing procedures (the additive model), rather than the multiplicative information processing (the multiplicative model). o The results indicate the additive version of the force model performed well, even for those participants who actually did employ the multiplication information processing procedures. Even for these participants, the additive model explained over 95 percent of the total explainable variance in the participants’ effort-level, or motivation. These findings are in consonance with prior expectancy theory studies, which employ the judgment modeling within-persons approach used in this study. PRACTICAL IMPLICATIONS These finding provide guidance for accounting researchers who may wish to employ expectancy theory to examine the motivational aspects of implementing new procedures and systems in organizations. In a practical sense, the results provide some knowledge of the valences individuals place on second-level outcomes, which are associated with the implementation of JIT implementation. This suggests management accountants who advise senior executives regarding appropriate incentives for motivating the implementation of JIT procedures might advise publicizing the productivity rewards and employment security result from implementation, for these outcomes were highly valued by the members of all three groups of participants. FUTURE RESEARCH The wide range of valence values obtained across individuals implies the need for research aimed at explaining these differences. A possible explanation is suggested by Klien (1989), who proposes the attractiveness of outcomes differs for individuals who have different values and intrinsic needs. Accounting researchers might, therefore, examine whether differences in individuals’ intrinsic needs influence the valences they associate with the various outcomes within the context of expectancy theory. Future research, which employs expectancy theory to examine the implementation of JIT procedures, is also desirable. The various departments of a firm are usually affected differently by the implementation of JIT procedures, so future research might be focused at the department level. Behavioral Issues and Culture Behavioral Issues Bibliography How to Manage Yourself & Other Advice Social Networks Bibliography ABKY Chapter 10 Summary Accounting and Culture Summary Herzberg on Motivation Hidden Bias or Implicit Association Tests What is the Tipping Point? Herzberg, F. 2003. One more time: How do you motivate employees? Harvard Business Review (January): 87-96. (This paper was originally published in the HBR in 1968). The purpose of this article is to bridge the gap between knowledge and speculation about what motivates employees. MOTIVATING WITH KITA Many difficulties exist with moving employees to action. The quickest way to get an employee to do something is to ask, but if the person declines, the next solution is to give them a kick in the pants (KITA). However, there are problems with KITA and motivation. The employee, of course, does move when the KITA is applied, whether it is physical or psychological, but KITA does not lead to motivation, it only leads to movement. If an employee needs no outside stimulation, then he or she wants to do it. MYTHS ABOUT MOTIVATION Next Herzberg confronts KITA practices that were developed to instill motivation. 1. Reducing time spent at work – The idea here is to motivate people to work by getting them off the job. The truth is that motivated people seek more hours, not less. 2. Spiraling Wages – Spiraling wages motivate people to seek the next wage increase. If rising wages won’t motivate, reducing them might. 3. Fringe Benefits – These benefits have gone from rewards to rights. The cost of fringe benefits is approximately 25% of the wage dollar. People are spending less time working expecting more security and money. Fringe benefits do not motivate. 4. Human Relations Training – More than 30 years of teaching and training and the question is still the same: How do you motivate employees? 5. Sensitivity Training – Because of the failure of Human Relations Training, sensitivity training was developed. Many employees were forced to get to know themselves better and no motivation was garnered. 6. Communications – This was the next management training program to instill motivation. The idea was to let employees understand what management was trying to do for them. But communication didn’t lead to motivation, it only lead to management realizing that it was not listening to employees. 7. Two Way Communication – Management now began welcoming suggestions and surveys. The two-way communication brought some improvement but still had no motivating effect. 8. Job Participation – Job participation was designed to give employees the sense of achievement, or to show the employee the big picture. This, of course, doesn’t lead to motivation. 9. Employee Counseling – Employees could talk to someone about their problems and perhaps that would motivate them. But the counseling also failed to yield the desired results. In fact, counseling services were often interfering with the operation of the organization itself. HYGIENE VS. MOTIVATORS Herzberg developed a motivation-hygiene theory based on a study of engineers and accountants. The findings of the initial study suggest that factors involved in producing job satisfaction (and motivation) are different from the factors that lead to job dissatisfaction (hygiene). These findings have been replicated by sixteen other investigations. The problem with semantics is resolved when understanding human behavior. Two differing needs are involved. One set of needs comes from the animal-like nature – built in drive to avoid pain and all other biological needs that drive humans. For example, hunger, makes it necessary to make money, and thus money is a specific drive. The other need is the ability to achieve and to experience growth. The tasks that satisfy the growth need are found in the job content, but also factors that induce pain-avoidance behavior are found on the job. Growth or motivator factors are achievement, recognition, work itself, responsibility, advancement and growth. The dissatisfaction avoidance or hygiene factors are company policy & administration, supervision, relationship with supervisor, working conditions, salary, relationship with peers, personal life, relationship with subordinates, status, and security. See below for a graphic view of the results of twelve of Herzberg's investigations. The motivation-hygiene theory proposes that work must be enriched to successfully utilize, or motivate, personnel. Job enrichment provides the opportunity for growth. Job enrichment must be vertical job loading and not horizontal job loading. Horizontal loading consists of challenging the employee to increase production amounts or adding another meaningless task to the existing one. Vertical job loading could be removing controls while keeping accountability and introducing new and more challenging tasks not previously handled. Job enrichment needs to be a continuous management function according to Herzberg. CONCLUSION Herzberg disputes the ideas shared by managers that money and benefits motivate employees. Instead, Herzberg believes continuous job enrichment will motivate employees. He provides ten steps at the end of the article that managers should follow to implement his motivation-hygiene theory. Atkinson, A. A., R. D. Banker, R. S. Kaplan and S. M. Young. 2001. Management Accounting 3rd edition. Upper Saddle River: NJ: Prentice Hall. CHAPTER 10 Motivating Behavior in Management Accounting and Control Systems 1. INTRODUCTION This chapter includes five main sections related to the behavioral aspects of control systems. The first section is fairly short, but provides a discussion of the important underlying management philosophies related to human behavior. The second section is devoted to ethical issues such as the organization's code of ethical conduct, the hierarchy of ethical principles, the elements of an ethical control system and the dimensions of motivation. The third section provides an introduction to the balanced scorecard concept including the four perspectives that are addressed when developing an organization's scorecard. Section four includes a brief discussion related to employee empowerment and the control system design. The last section includes several sub-sections related to various types of incentive systems and some of the controversial issues involved in the human behavior and motivation literature. Four Major Behavioral Considerations in Control System Design These four items from the previous chapter are included in the introduction. 1. Embedding the organization's ethical code of conduct. 2. Using a mix of balanced measurements, i.e., balance short term and long term, quantitative and qualitative measurements etc. 3. Empowering employees. 4. Developing an incentive system. 2. CONTROL SYSTEMS & HUMAN RESOURCE MODELS Goal congruence is a key concept underlying the development of control systems. Goal congruence occurs when the goals of managers and employees are consistent with the goals of the organization. In this section, ABKY compare the scientific management model of human behavior with the human resource model. McGregor discussed these models over forty years ago and labeled them Theory X and Theory Y. The scientific management model follows the lazy man theory McGregor referred to as theory X. The human resource model fits McGregor's theory Y. These models are summarized in the table below. The main point to grasp from this section is that these models provide the underlying assumptions related to how control systems are designed. The attitudes of most managers probably fall somewhere between the two extremes. Issues related to human behavior and motivation are very controversial. Blake and Moulton's Managerial Grid is also applicable to this section. Summary of McGregor's Theory X and Theory Y* Management Objectives, Theory X Theory Y Attitudes & Assumptions Overall objective of Organizing resources to Organizing resources to produce management. produce economic results. economic results. Management Must direct their efforts, Provide conditions and methods attitude towards employees. motivate, control and modify for people to achieve their own their behavior. Without active goals directed towards intervention, employees will organization objectives. be indifferent towards the Employees are not by nature goals of the organization. indifferent to the organization's Thus, they must be rewarded needs. They become indifferent and punished. Emphasize as a result of experience. external control. Emphasize internal self control. Managements Employees are lazy, lack Employees have needs based assumptions about ambition, dislike responsibility on Maslow's hierarchy: employee and prefer to be led. They are Physiological - rest, exercise and characteristics and self centered, indifferent to shelter. Safety - protection from behavior. the needs of others, resistant the elements. Social - friendship, to change, gullible and not belonging and love. Ego - self very bright. esteem, status and recognition. Self fulfillment - realizing potential. Behavioral problems are caused by need deprivation.** Management Groups are a threat to Groupiness can be beneficial to attitude towards management and should be the organization. groups. discouraged. * McGregor, D. M. 1957. The human side of enterprise. Management Review (November) and McGregor, D. M. 1960. The Human Side of Enterprise: 25th Anniversary Printing. McGraw-Hill. ** Employee indifference to the needs of the organization, hostility and refusal to accept responsibility are not indications of inherent human nature, but symptoms of illness caused by the deprivation of social and egoistic needs. A satisfied need is not a motivator. Once a person fills a need, it cannot be used to motivate that individual. However, a person deprived of some needs may attempt to substitute more of one for the lack of another. For example, although money cannot satisfy many higher level needs, in many organizations, demanding more money may be the only available means of attempting to do so. 3. ETHICAL ISSUES Developing a code of ethics is important to help motivate ethical behavior. ABKY discussed beliefs systems and boundary systems in Chapter 1. These combined systems or concepts provide a comprehensive code of behavior for employees. As Simons points out, effective control in "an age of empowerment" also requires diagnostic control systems to insure that employees follow the code of conduct. (Simons summary) A Hierarchy of Ethical Principles ABKY discuss a hierarchy of ethical principles that provide general guidelines for understanding and addressing ethical problems. These include: 1. Legal rules. 2. Societal norms. 3. Professional memberships. (Links to the IMA, AICPA and other ethics sites). 4. Organizational or group norms. 5. Personal norms. Problems arise where an employee's personal code of ethics conflicts with the other levels within the hierarchy. The In-Practice note at the top of page 399 makes an interesting point. According to the note, 55% of the executives surveyed admitted cheating at golf. The point: Golf cheats and job cheats are highly correlated. A Whistle-Blower's Choices ABKY list and discuss nine choices for a whistle-blower on pages 399-400 ranging from reporting unethical behavior and refusing to act unethically to doing nothing. They point out that the control system should include a way for employees to report inconsistent ethical behavior without fear of retribution. They suggest the internal audit function as a possible answer. Elements of Effective Ethical Control 1. A statement of the organization's values and code of ethics. 2. A statement of the employee's ethical responsibilities. 3. Training in identifying and dealing with ethical issues. 4. Actions and communications from senior management that a. state the consequences of violating the ethical code, b. provides a means of dealing with violations, c. includes visible support of ethical behavior and d. provides a line of communication to top management. Steps for Resolving Ethical Issues* A model for resolving ethical issues is presented in Exhibit 10-1 and includes a discussion of the following steps: 1. Determine the facts - what, who, where, when and how. 2. Define the ethical issues. 3. Identify the principles, rules and values involved. 4. List the alternatives. 5. Compare alternatives. 6. Assess consequences of choosing alternatives. 7. Make the decision. *From May, W. W., Editor. 1990. Ethics in the Accounting Curriculum: Cases and Readings. American Accounting Association: 1. 4. Dimensions of Motivation This sub-section (page 402) provides three dimensions of motivation: 1. Direction, or focus. 2. Intensity, or effort. 3. Persistence, or duration. Controls to guide direction include: 1. Employee self control. 2. Task control. Follow standard procedures. Applicable when there are legal requirements or precious assets involved, and there is no need for judgment. Two types of task controls: a. Preventive control. b. Monitoring, or surveillance as with croupiers (dealers) in gambling casinos. 3. Results control. Applicable when employees understand the objectives, have the necessary knowledge, and individual contributions can be identified. 5. THE BALANCED SCORECARD Using a single measurement to motivate and guide performance can create several problems including conflicts between workers, gaming to enhance the performance indicator, and data falsification. Although boundary systems provide a partial solution for these problems, ABKY recommend the balanced scorecard approach as a more effective way to guide behavior. Their discussion on page 407 compares the older traditional organizational structure and control system design to the new organizational structure and control system. Concept Traditional Organization New Organization Organizational Structure Tall or vertical. Flat or horizontal. Improvement focus Focus Measurements and focus Reengineering - systems redesign. Individuals and functions. Groups of cross functional teams. Quantitative financial Quantitative financial and cost non-financial and qualitative profit, sales, ROI, etc. - yield, cycle time, schedule attainment, defects, customer retention and satisfaction, employee morale etc. Cost minimization. Balanced Scorecard Perspectives As indicated in Exhibit 10-3 (p. 409) the balanced scorecard includes four perspectives that help a company translate its strategy into operational terms. These include: 1. Financial - measured by income and return on investment. 2. Internal Business Process - measured by critical factors such as cycle time, yield, schedule attainment, etc. 3. Learning and Growth - sources include people, systems and procedures measured by level of skills, employee satisfaction, employee retention etc. 4. Customer - measured by customer surveys, customer retention, market share. 6. EMPLOYEE EMPOWERMENT Employee empowerment involves two elements: 1. Delegating the authority to employees to make decisions, and 2. Employee education to support the decisions. Employee empowerment benefits may include: 1. Higher employee morale and job satisfaction. 2. Increased productivity. 3. Increased potential for improvement. 7. INCENTIVE SYSTEMS Intrinsic and Extrinsic Rewards Intrinsic rewards come from within the individual and reflect "joy in work" to use Deming's term. The idea that employees derive pleasure from work is consistent with McGregor's Theory Y concept. Extrinsic rewards are frequently in monetary terms such as bonuses, but can also be non-monetary such as recognition, employee of the month etc. Controversy Over Pay as a Motivator The literature on compensation systems is very controversial. Some researchers have questioned the idea that pay is a motivator. Herzberg, Kohn and Deming provide some notable examples in this area. Herzberg identified a number of myths related to motivation and developed a motivation-hygiene theory. Herzberg's research findings support the view that factors involved in producing job satisfaction (and motivation) are different from the factors that lead to job dissatisfaction (hygiene). Intrinsic factors (e.g., job enrichment) motivate people while extrinsic factors (e.g., salary, bonuses) are mainly related to hygiene or dissatisfaction avoidance (See summary). Kohn argues that incentive plans cannot work and provides six reasons for the failure of reward systems: 1. Pay is not a motivator. 2. Rewards punish. 3. Rewards destroy cooperation. 4. Rewards ignore the reasons for problems and the possible causes of improvement. 5. Rewards discourage creativity and risktaking. 6. Rewards undermine interest in work. (See summary). Deming argued that pay is not a motivator and placed most pay related schemes in the category of deadly diseases, e.g., employee annual performance reviews, ranking employees, management by objectives and merit pay. Deming argued that most of the variation in any system is caused by the system, rather than the people working in the system. Ranking people, simply ranks the effects of the system on to the people. (Deming's perspective on the Effects of Ranking people) and (MAAW's section on Deming). (Some other article summaries related to motivation include: Amabile, Katzenbach & Santamaria and Levinson). ABKY point out that most organizations ignore the role of intrinsic rewards and rely on extrinsic monetary rewards to motivate performance (p. 413). It is possible however, that for most people, the absolute amount of money is not the motivator, but instead people respond to how much money they earn relative to others. One major problem with pay schemes and rewards is that they tend to promote competition between employees rather than cooperation and teamwork. Incentive Compensation Pay-for-performance can be based on absolute measures or relative measures. Absolute measurement schemes include piece-rate systems and pay based on the organization's results such as profitability, stock share price or other performance. Relative measurement schemes include rewards for meeting a target, or provide a percentage of a bonus pool, or are based on performance in relation to an average. Six Attributes of Measurement Systems 1. Employees must understand the system and believe it measures what they control. 2. The system must be based on inputs or outputs depending on which is applicable. Inputs are applicable when the employee has little control over output, or outputs are impossible to measure, or too expensive to measure. 3. Performance measurements should be balanced to reflect the organization's critical success factors. 4. The system must have clear standards of performance. 5. The system must establish a clear relationship between performance & outcome. 6. When cooperation is critical, the system should reward group performance, rather than individual performance. Cooperation is needed when there is interdependence. Incentive Compensation Plans Incentive compensation plans are based on internal measures, or an external measure of the company's stock price. Incentive plans include: 1. Cash Bonuses - rewards based on some measure of performance that do not become a part of the employee's base pay. 2. Profit Sharing Plans - based on a percentage of a profit measurement such as residual income, i.e., income less a minimum based on the cost of capital. 3. Gain Sharing Plans - are group incentive plans such as: Improshare - based on productivity increases indicated by the direct labor efficiency variance, i.e., (actual hours - standard hours) multiplied by the standard labor rate. Scanlon Plan - Amount added to bonus pool = (Value of production)(Base ratio) - Actual payroll costs where the base ratio = Payroll cost ÷ Value produced Rucker Plan - Based on the Rucker standard = Payroll costs ÷ Production value where production value = net sales - inventory change - materials & supplies 4. Stock Options - the right to purchase stock at a specified price usually above the current price. 8. QUESTIONS 1. What are the four major behavioral considerations in MACS design? (See the introduction above). 2. What is the scientific management view of motivation? (See item 2 above). 3. What is the human relations movement view of motivation? (See item 2 above). 4. What is the human resources model view of motivation? (See item 2 above). (The Caplan summary is also related to questions 2-4). 5. What are the four requirements of ethical conduct by which certified management accountants (CMAs) have to abide? (See the ethics links page). 6. What are some choices that individuals can make when ethical conflicts arise? (See item 3b above). 7. What is an ethical control system, and what are its key elements? (See item 3c above). 8. What are the three key dimensions of motivation? (See item 4 above). 9. What is goal congruence? (See item 2 above). 10. How does task control differ from results control? (See item 4 above). 11. List and explain the two categories in task control. (See item 4 above). 12. List three quantitative financial measures of performance in a manufacturing organization of your choice. (See table above). 13. List three quantitative financial measures of performance in a service organization of your choice. (See table above). 14. List three quantitative nonfinancial measures of performance in a manufacturing organization of your choice. (See table above and MAAW's Chapter 8). 15. List three quantitative nonfinancial measures of performance in a service organization of your choice. 16. List three qualitative measures of performance. 17. What is gaming? (See the Collingwood summary). 18. What is data falsification? 19. What is a balanced scorecard? (See item 5 above). 20. What are the four measurement perspectives in the balance scorecard? (See perspectives under item 5 above). 21. What are two essential elements in employee empowerment? (See item 6 above). 22. What is an intrinsic reward? (See item 7 above and the Deming summary). 23. What is an extrinsic reward? (See item 7 above). 24. What is incentive compensation? (Look under item 7 above). 25. What are six attributes of effective performance measurement systems? (See item 7b above). 26. What type of organization is best suited to incentive compensation? (See the Kohn summary). 27. What is a cash bonus? (See item 7c above). 28. What is profit sharing? (See item 7c above). 29. What is gainsharing? (See item 7c above). 30. What is a stock option plan? (See item 7c above). Additional Questions: 1. Is there a difference between ethical problems and systems problems? If so, what is the difference? 2. Can the problem of unethical behavior be solved with the proposed ethical systems outlined in this chapter? Discuss the issues. (See item 3c above, and the summaries of Simons, Bazerman, Loewenstein & Moore, and Collingwood). (Some other article summaries related to behavioral problems (e.g., gaming, earnings management etc.) include Healy & Wahlen and Dechow & Skinner). CHAPTER 8 Fayol's Theory http://maaw.info/Fayol'sTheoryMain.htm According to Crainer (2000), Henry Fayol (1841-1925) was a French mining engineer who recognized management as a legitimate discipline. Fayol is perhaps the first author to define the functions and objectives of management. Managers, according to Fayol, plan, organize, command, coordinate and control. Fayol extended these basic concepts by defining fourteen principles of management as follows: (Crainer, p. 4). 1. Division of Work. 2. Authority & responsibility. 3. Discipline. 4. Unity of command. 5. Unity of direction. 6. Subordination of individual interest to general interest. 7. Remuneration of employees. 8. Centralization. 9. The scalar chain. 10. Order. 11. Equity. 12. Stability of personnel. 13. Initiative. 14. Esprit de corps. Fayol's lectures were published in book form in 1925 and translated into English in 1930. The following comment by Fayol appears in Chamber's Accounting Thesaurus (1995): "Accounting activities - This group is the visual organ of business. It must throw up at any moment, present position and future trend, must afford accurate, clear and precise information about the economic position of the concern. An efficient accounting system, clear and simple, giving an accurate idea of the firm's condition is a powerful managerial instrument". See the references below. A Google search of the web provides a great deal of additional information related to Fayol's theory of management. NOTHING MORE IN THIS PAGE CHAPTER 9 Management Theory http://maaw.info/ManagementTheoryMain.htm Quotes by Russell Ackoff "The appeal of gurus lies to a large extent in the simplicity of the doctrines they put forth. They are simple no matter how complex the problems at which they are directed. They provide a life raft to those managers who are incapable of handling complexity." "Contrary to what happens in politics and religion, in business circles there are so many gurus competing for followers that no one of them can dominate the minds, let alone the emotions, of potential followers." Educators stand in sharp contrast to gurus. Educators do not try to bring thinking to a halt but to initiate it. They want their students to extend and expand the ideas they present and students are encouraged to question and modify without constraint. Educators want their solutions to be treated as beginnings, not ends. Gurus lead into; educators lead out of. Gurus provide ready-made solutions but educators provide ways of finding individualized solutions." "An educator tries to transmit a way of thinking and a way of conducting inquiries. And he does not pretend that these are the only ways. Among other things, he recognizes that differences in personality lead those with different personalities to select different ways of thinking and behaving." "I find that business schools tend to avoid the important complex strategic problems that corporate management is currently involved with. Not too long ago at a meeting of the deans of business schools I identified the set of six or seven corporate problems on which I was working. I asked them if any of them had courses that addressed such problems - not a single one of them was covered." "Managers are not confronted with problems that are independent of each other; but with dynamic situations that consist of complex systems of changing problems that interact with each other. I call such situations messes....Managers do not solve problems, they manage messes." Koontz, H. 1961. The management theory jungle. The Journal of the Academy of Management 4(3): 174-188. (JSTOR link). The purpose of this article is to identify the various schools of management theory, indicate the source of the differences, and to provide some suggestions for disentangling the management theory jungle. Koontz describes six schools of management theory as follows. 1. The Management Process School The management process school views management as a process of getting things done with people working in organized groups. Fathered by Henri Fayol, this school views management theory as a way of organizing experience for practice, research and teaching. It begins by defining the functions of management. 2. The Empirical School The empirical school views management theory as a study of experience. Koontz mentions Ernest Dale's comparative approach as an example which involves the study and analysis of cases. The general idea is that generalizations can be drawn from cases that can be applied as guides in similar situations. 3. The Human Behavior School The central thesis of the human behavior school is that since management involves getting thing done with people, management theory must be centered on interpersonal relations. Their theory focuses on the motivation of the individual viewed as a socio-psychological being. 4. The Social System School The members of the social system school of management theory view management as a social system. March and Simon's 1958 book Organizations published by Wiley is used as an example, but Koontz indicates that Chester Barnard is the spiritual father of this school of management. The social system school identifies the nature of the cultural relationships of various social groups and how they are related and integrated. Barnard's work includes a theory of cooperation which underlies the contributions of many others in this school. Herbert Simon, and others expanded the concept of social systems to include any cooperative and purposeful group interrelationship or behavior. 5. The Decision Theory School The decision theory school of management concentrates on the rational approach to decisions where alternative ideas or courses of action are analyzed. This school is believed to have grown from the theory of consumer's choice associated with Jeremy Bentham and tends to by oriented toward economic model construction and mathematics. The decision is the central focus. 6. The Mathematical School The mathematical school of management views management as a system of mathematical models and processes. This includes the operations researchers and management scientists. But Koontz points out that in his view mathematics is a tool, not a school. The Major Sources of Mental Entanglement that create the Management Theory Jungle Five sources of entanglement or confusion include the following: 1. The Semantics Jungle - There is no agreement on the meaning of the words management, organization, leadership, communication, and human relations to give a few examples. 2. Differences in the Definition of Management as a Body of Knowledge What is management? Who is a manager? If everything is management and everyone is a manager, how can management theory be regarded as a useful or scientific? 3. The a priori Assumption - Ignoring the work of Fayol, Mooney, Brown, Urwick, Gulick and others on the grounds that they are universalists. 4. The Misunderstanding of Principles - For example, confusion over the validity of principles such as unity of command, and span of control. 5. The Inability or Unwillingness of Management Theorists to Understand each other - The roadblock to understanding is unwillingness. How to Disentangle the Management Theory Jungle 1. Definition of a Body of Knowledge - The first need is to define the field. Koontz defines management in terms of the practitioner's frame of reference as "the art of getting things done through and with people in formally organized groups, the art of creating an environment in such an organized group where people can perform as individuals and yet cooperate toward attainment of group goals, the art of removing blocks to such performance, the art of optimizing efficiency in effectively reaching goals." In defining the body of knowledge management theorist must not confuse tools with content. For example, mathematics, operations research, accounting, economic theory, sociometry, and psychology are significant tools of management, but they are not part of the content of the field. 2. Integration of Management and other Disciplines 3. The Clarification of Management Semantics 4. Willingness to Distill and Test Fundamentals Criteria to Remember in Clarifying Management Theory 1. Management theory should deal with a manageable area of knowledge and inquiry. 2. Management theory should be useful in improving practice. 3. Management theory should not be lost in semantics, jargon not understandable to the practitioner. 4. Management theory should provide direction and efficiency to research and teaching. 5. Management theory must recognize that it is a part of a larger universe of knowledge and theory. Blake, R. R. and J. S. Moulton. 1962. The managerial grid. Advanced Management Office Executive 1(9). ALL THE BELOW ONES ARE BIBLIOGRAPHIES Management Theory Bibliography Administrative Science Quarterly Decision Sciences Harvard Business Review Management Science MIT Sloan Management Review The Academy of Management Journal Fayol's Theory Frederick Taylor Management Pioneers Pratt & Whitney Rocketdyne - A Thinking Roadmap CHAPTER 10 Theory of Constraints http://maaw.info/TOCMain.htm The Theory of Constraints Drum Buffer Rope Summary MAAW's Chapter 8 Pop Company: Comparative Income Statements ROI Comparisons Necessary But Not Sufficient The Haystack Syndrome The Goal The Dice Game Traditional Costing, ABC, JIT and TOC What is this thing called TOC? TOC Problems Discussion Questions Multiple Choice Questions Blank Graphs Links Drum Buffer Rope Summary OVERALL PURPOSE: TO BALANCE THE FLOW CONCEPT DRUM PURPOSE OR SCOUT FUNCTION TROOP Sets the pace Slowest scout FACTORY The Constraint BUFFER Inventory in Protects the pace Slack in the rope front of the constraint Rope tied between first scout and slowest scout Some type of pull system, e.g., kanban type or OPT schedule ROPE Enforces the pace MAA W's Chapter 8: James R. Marti Management Accounting: Concepts, Techniques & Controversial Issues James R. Martin Chapter 8 (see the book) Goldratt, E. M., E. Schragenheim and C. A. Ptak. 2000. Necessary But Not Sufficient. The North River Press. Prelude It begins on Jan 24, 1998, and within a period of 16 months, Eli Goldratt spins a tale of the implementation of a production delivery system in a large scale environment, based on the principles of the Theory of Constraints (TOC). Within this span of time, the implementation leads to significant problems for other units of the organization such as distribution and sales. The story unfolds around Pierco, a large manufacturing company that delivers a wide variety of products to market, and the investment it made in a new computer system developed by BGSoft, and implemented by KPI, a subsidiary of BGSoft. The players are Scott and Lenny, the masterminds behind BGSoft, Maggie, the head implementer for KPI, Gail, VP of Sales for BGSoft, and Craig, the CEO of Pierco, Brian, a Pierco division manager, and a cast of supporting characters. Through an interesting and easy to understand story, Eli Goldratt is able to explain and justify, no exemplify, that implementation of TOC concepts into real business application can lead to 20, 30 even 40% quarterly increases in the production, distribution and sales for a production company. He also ardently defends implementing a change in “the rules”, in the cultural makeup of a company at the same time when it implements a data driven system that will give it those statistical increases. Chapter 1 We begin the story by meeting Scott Duncan, head of BGSoft, one of the most successful software companies in the world. Scott is lecturing one of his account managers, discussing “the global picture” for which his vision becomes, apparently, visionary. Scott believes strongly that a company’s success is based on more than just a good product. Early on his strategy focused on what made a good product for the customers system at hand, not just in how well it worked. And it has worked well for him. His company has been the leader in setting the standards for the computer industry, and it has led to change in the way things are looked at. The factor to determine the value of his company, based on the profit it generates, is higher than the normal standard by 75%. This is the key to its rapid growth. BGSoft is driven not by the parameter of profit, but maintaining its growth rate. This is also the dilemma, because the company cannot continue this growth rate…trouble is lurking ahead. Chapter 2 One month later. Here we meet Lenny Abrams, brash, often icy, number two at BGSoft, who met Scott while they were both in graduate school. Scott had come up with the idea that computers would revolutionize business, and Lenny challenged him to act on it. Well, here it was 20 years later, and Lenny is facing an ever increasingly hectic schedule, and has grave concern about the future growth rate of his business. Too many of the implementations they have installed are getting their clients the results they said they would get, but nobody really knows why. The software works, the modules are getting through the bugs, but the bottom line of the clients hasn’t changed. And there are problems, problems that aren’t getting solved by his people in the field. It’s time for a meeting of the minds to discuss the problems. Chapter 3 Here we meet Maggie, head of KPI, prime implementation consultant for BGSoft, and are immediately introduced to her problem – the current system is deteriorating. The response time from BGSoft’s tech-support centers has decreased by over 80%. The general consensus is that BGSoft’s key product Enterprise Resource Planning (ERP) has become too complex, which has serious ramifications for BGSoft. But it’s not just this delay, it’s a broader problem – the computer system is “just one component in the game. There is also the company that implements it, and its clients. To find a solution, they must look at the global picture.” (p. 31) Here again we are led to “the global picture” which will become a mainstay of thought through out the novel. Chapter 4 Three months from start. We meet Gail Collins, VP of Marketing and Sales for BGSoft. At a company sales force bar-b-que, Lenny has introduced a new architecture for ERP, which has gotten all the sales people excited. For the first time in years Gail was worried about BGSoft not meeting its forecast. She predicts that they will be short, and that this will trickle into the next quarter. It appears that they are not losing their market position, but instead they have saturated their market of large companies who have or are willing to implement their software. They need to figure out how to expand into the mid-size market. But, to compound the problem, it isn’t any easier to sell to a mid-size company than a large one. To top it all off, they are having serious quality assurance issues. Lenny must go to the company’s plant in India, where most of their code is written and packaged. Chapter 5 Five months from start. Scott and Maggie have been called to visit Pierco, one of their largest clients. Craig has been grilled by his Board of Directors, particularly a new, young, aggressive fellow, who has questioned the huge investment Pierco has put into BGSoft, and wants to know what do they have to show for all the money they spent. Craig didn’t have an answer. He assumes that no real savings has occurred regardless of how many cents or fractions of cents have been saved, because no lay off had occurred. “No head-count reduction means no real cost reduction, no impact on the bottom line.” (p.48) So, Maggie, Scott and Craig discuss what would be bottom line examples: 1) sales information from Pierco’s warehouses is now streamlined to its production plants. Such information is available to plants on the same day of the sale. (p. 50) This leads to improved production forecasting and planning according to market consumption. Faster response from the plants mean losing fewer sales to competition, because fewer shortages in distribution mean more sales. “And more sales is more money,” Craig concludes – real bottom line impact. (p. 51) 2) Better distribution leads to less unneeded inventory, which also has an impact on the bottom line. BGSoft gets excited about concentrating on the bottom line instead of cost reduction. But they realize that they have been talking the wrong language – the computer system’s language – and not the language of the clients’. Lenny’s insight runs the deepest. He realizes there are three languages to contend with: 1) the computer system’s, 2) the client’s language, and 3) the top managers language – bottom line. That is the most important. With this in mind they also continue to see the ever increasing, unnecessary complexity that is creeping into ERP. Chapter 6 Five months from start. In a nod to Deming, Goldratt suggests that to the sales people of BGSoft, salaries are not the most important things. They thrive on intrinsic values like challenge and the thrill of overcoming each obstacle. (p. 60) Maggie is lamenting the fact that it has become increasingly difficult to find the right talent. The rate of implementation has stretched her work force thin, and she is bearing the brunt of current clients dissatisfaction. She reminds herself that “the customers are not always right, but they are always customers.” (p. 61) Through this, she can barely stop thinking about what Craig has said to them, and wonders if all her clients will start to demand real bottom line justifications. “Does this mean the rules are changing again,” she wonders (p. 61) It seems as though the industry is experiencing perpetual change. Chapter 7 Six months from start. “We’re just a herd of animals stampeding towards the cliff,” is this chapter’s opening thought from Scott (p. 65) and he believes everyone else in the industry is acting like the cliff doesn’t exist. His main market is saturated, and its limits are beyond his control. On top of that, the increasing difficulties of his product put it in real danger of becoming too complex to handle. And they don’t know what to do about it. Goldratt provides a bigger picture of the high tech industry here. Not only is this happening to BGSoft, but also its competitors. Some will even report negative growth this quarter. The assumption is that this will lead to greater scrutiny from Wall Street analysts, whom will demand proof that BGSoft is not heading towards the same fate, and if he can’t his stock will nose dive. (p.68) He can’t get past the problem of selling to mid-size companies, still faced with the same complexities involved in implementing the system to a large-scale company, and not reaping the same incentive/reward. Scott goes back to the basics. Neglecting the bottom line has led to a large number of meaningless features being added to the software because the client demanded it, which drastically increased the systems complexity. But he can’t link this to the long sales cycle they experience in the mid-size market. If he can answer that, he believes he will establish the link between the two dilemmas – satisfying customers while simplifying the product, and finding new markets. (p. 70) Chapter 8 Six months from start. Maggie is holding a meeting with Gail and another team member George to finish up their bottom line justification presentation to Pierco. The team encountered trouble from the start, trying to agree on what should be considered a measurable benefit. After a slow start, Maggie impatiently gets to the point – what is it about their software leads to either a decrease in cost, or an increase in revenue? (p. 73) She believes that what needs to be shown is economic benefit, not catchy phrases like system optimization, or greater operations visibility. George begins discussing that since ERP was implemented, invoices are correct the first time, an improvement over the old system (legacy system) which means the customer gets its money faster which means improved cash flows – a bottom line answer. Another key savings is identified in material-cost reduction – an ongoing annual benefit. And there has been impact on inventory reduction, which will free up cash reported on the balance sheet. Fewer stock outs are mentioned, which correlates to higher sales. The savings identified by these features mean that Pierco is basically getting its new ERP system for free, and have a slew of ongoing benefits. What is significant to the group isn’t so much the savings they have identified, but by focusing on the bottom line, they have discovered that of the key justifications BGSoft lists as its benefits, only 3 out of 20 made it onto the list of being a benefit to the bottom line. Chapter 9 Still six months later. The important theme that Goldratt is suggesting is that in order for these companies to succeed, they must keep maintaining their growth rate, which more and more seems like an impossible predicament. (p. 81) Once again Lenny is lamenting that of all the new features that he has authorized of late, not one of them contribute to the client’s bottom line. But the client’s demand it, so therefore they must provide it. But Scott disagrees. He has just seen the true value of his system to a large company, stripped of all the “admiration of technology,” and it boiled down to four items: 1) reduction in the days of outstanding receivables, 2) reduction in material costs, 3) reduction in inventory, and 4) increase in sales. (p. 83) Here we begin to see where Goldratt will eventually lead us. Scott believes that a shift must occur in the company’s business paradigm. If they continue to focus on their current features, the backbone of their sales tactics, then they will continue to offer very little real value to their clients. Therefore, they must sell value. (p. 85) This elicits a barrage of debate. “It’s one thing to state that (one) must provide a product that brings value, but a totally different story to do it,” exclaims Gail (p.86) She doesn’t believe that they have a clue how to do it. Scott decides the answer is to investigate adding a new Advanced Planning and Scheduling (APS) module to the software. Apparently, all the marketing of the leading APS companies is based on the claim that they will significantly decrease inventory and lead to an increase in sales – the key to impacting the bottom line. This is going to mean a paradigm shift in BGSoft’s own sales tactics, and Gail is uncomfortable. The group decides to visit one its smallest clients who is their best bottom line reference, Stein Industries. Chapter 10 Stein Industries is a company that has grown from $50 million to over $250 million in three years. Maggie, Scott and Lenny are paying a visit to Gerald Stein, CEO, to find out the details of his success using ERP. After some jovialities and sparring, Gerald admits that although the system worked as advertised, he didn’t get the benefits that he presumed would occur – a reduction in lead-time. What was happening was that a project would come out of one unit 2 weeks ahead of schedule, but would get stuck at the first bottleneck. There the work would pile up, forcing the managers of that unit to make more and more decisions, incorporating more opportunity for error. Eventually all the allotted time was fully used. So Stein introduced the Drum-Buffer-Rope method, a method that “chokes the material release according to the due date of the order” (p. 96) delaying the release of work orders until the actual lead time necessary to meet the final due date. This seemed to be counter intuitive. This led to connecting the entire project progress to the bottleneck, and for Stein they did this inside BGSoft’s ERP system. By focusing on the bottleneck, they could improve its performance. This led them to another concept, Buffer-Management, a follow-on step to DrumBuffer-Rope. Whenever anyone has product waiting in line, they look at the developed buffers to make their decision about what to do next. Scott and Lenny leave the meeting thinking that they have found their first connection to how they can tap into the mid-size market. By introducing DrumBuffer-Rope into their software package, they are still focusing on value, and believe have an answer for the mid-size company. But what they don’t see is that to implement such changes entails more than just implementing new code; it means changing what actually gets measured. By synchronizing the release of materials to the bottleneck schedule, the efficiencies of the workers who man the non-bottlenecks suffer, but local efficiencies are a standard benefit to be measured. This led them to the first conclusion that what was needed was a change in culture, and the answer lay in bringing value. (p. 103) Chapter 11 Lenny is paying a visit to Intelogic, one of the best APS companies. The visit is not going well. Lenny is being fed the standard sales pitch, but he came to look at possibly buying the company. He finally gets hooked up with the VP of Engineering and Intelogic’s top programmer, and begins discussing the concept behind its algorithm – providing the best practical schedule. This idea is the key to Intelogic’s product. The planning of the Master Schedule will tell you in advance what problems the various units are going to face, so that enough time can be buffered into the schedule to take corrective action. But what Lenny discovers is that the meaning of an optimized schedule has to be redefined. A reality to schedule optimization is that “the same amount of safety time when inserted in one stage of the process can help much more than if it is inserted in another stage.” (p. 115) But, the bottlenecks may move, and it is very difficult to forecast the potential bottlenecks. Therefore, Lenny concludes that a better way to protect the schedule would be to use safety capacity, not time. The user decides on capacity only after the disruption occurs, so the amount used is exactly the amount needed. (p. 116) This could be of value to any plant. Lenny leaves thinking he is drawing near to an answer on how to tap the mid-size market. Chapter 12 Lenny believes he has figured out how to add something to their ERP system that will cause the system to generate more bottom line value, even for mid-size companies. After his visit to Intelogic, he spent the next week meeting with Intelogic’s successful clients. What he discovered at each plant is very surprising. He learned that at each plant, they had to re-think the entire way they run their operations. (p. 123) As he is relaying this Scott, Scott acts as if he has already figured it out. Scott leads off their meeting. “When does a new technology bring value?” he asks. It will bring benefits when it surpasses an existing limitation. The paradox is that when we deal with a new technology, it defines that we have been living with an existing limitation for a while. So, we install a new technology to surpass the existing limitation, but we continue to operate with the old rules – the rules that assume the existence of the limitation. In that case, the rules themselves impose a limitation. (p. 125) Here again we see where Goldratt is drawing us. Technology is a necessary condition, but it is not sufficient. To get the benefits of the new technology, we must also change the rules that recognize the limitations of what it replaced. One way of doing this is to confine optimization to only the constraint. By doing more, you destabilize the schedule. Here Goldratt introduces us to a lesson from Deming – “trying to optimize the noise within a system doesn’t help, it hurts. As long as the system is vibrating within the limits of its noise, any tampering just increases the fluctuations.” (p. 129) Lenny and Scott conclude the chapter by figuring that their biggest obstacle is not the market or their product – it’s them, it’s how they have been thinking about the problem. They too must consider a cultural change within their own company structure. Chapter 13 Seven months from start. Craig and Maggie are enjoying a round of golf during Pierco’s top executive retreat. There is no better opportunity for a golf game than an executive retreat. (p. 133) They are soon joined by Brian and Stan, two of Pierco’s division vice presidents. One of the strongest arguments in BGSoft’s ERP justification was an expected increase in sales, which would have been reflected as a substantial increase in net profit. But it hasn't materialized. Their sales have remained flat. Inventory has gone down, shortages went down, but sales went down too. What we’re seeing here is the intricate connection the implementer of new technology faces when even after successfully installing the new technology (and getting the product to work according to spec), it still doesn’t deliver the essential bottom line value. When this becomes apparent, who is to blame? Brian has come to the same conclusions that Scott and Lenny have been arriving at, that in order for his division to meet its forecasts and deliver more value, Brian understands that he must abolish the traditional way of running a plant and change his fundamental measurements of success. (p. 142) He understands in order to do this he must get everyone on board, from the plant manager to machinist – everyone must be educated in regards to the new paradigm, and your company culture must be on board. Based on the ensuing discussion it is agreed that BGSoft will develop a Drum-Buffer-Rope module for the ERP system, and KPI will begin working on the re-education of Brian’s division. Chapter 14 Eleven months from start. It’s the end of the year, and BGSoft has completed the best year in its history. But Scott’s earlier predictions are beginning to come true: their main competitor has announced negative growth for the quarter, another has announced a 600-person layoff, and share prices are plummeting. Wall Street is getting antsy, and is looking for some hard answers about the future of the industry. “Is this just the separation of the chaff from the wheat, or has the industry reached its growth limits?” (p. 144) The answer is important, because if the first point is true, then BGSoft is emerging as a true leader, but if the second point is true then shares could be dropped like a hot potato. Lenny and Scott are debating about what the clear message to radiate about BGSoft’s success should be. They are at the crossroads, because they know they cannot continue to maintain their current growth, but they still can’t quite see what will get them over the hurdle. Scott is convinced that it is in their hands. He believes the answer lies in the decision to change the way they do business. By doing this, he believes that growth is unlimited. (p. 145) It is here that Scott consummately declares that BGSoft has to switch from selling information technology to selling value. But what does selling value entail? Determining and focusing on results is the real target. That’s what the DrumBuffer-Rope method does, it focuses your efforts. It tells you what’s really important. ERP has used this to focus on increasing capacity and increasing the flow in production, without increasing costs. New capacity is unearthed each week in Brian’s division. Now it has been spread to five other plants. Here Goldratt sings the praises of TOC, because its logic is so addicting. He labels it “comprehensive, practical, and still common sense.” (p. 153) Based on Goldratt’s scenario, all indications show that the theory does work. However, what still seems to be looming in the background is the fact that a major change has occurred in only one function of the organization. Up to this point, we have not been shown what this change may be doing to the other interconnected units of the organization. Here we are given an inkling into this connection by the foreboding of Lenny, who at the end of the chapter is far from relaxed. Chapter 15 Thirteen months from start. The chapter starts out with Maggie and her people at KPI totally swamped and frazzled. They are working 90 hours a week, and still can barely keep up with the demand. Things are getting out of hand. (p. 161) Staffing for new projects is increasing by 60 people per day. BGSoft has instituted a new module which implements a TOC paradigm, and they have retrained their staff to identify that what is important to the client is making sure that relevant information will be available for the right people at the right time so that bottom line results will be guaranteed. This represents a paradigm shift for the system integrators. It’s a madhouse, but they prefer it to the fear they had just a month ago when their market appeared to be drying up. Chapter 16 We are introduced to the first sign that all is not right in paradise. The chapter opens with a picture of the time it takes to unload a truck at the warehouse. Inventory has been piling up at the warehouse – yet several products are experiencing shortages, while others have almost six months capacity. At this rate, the warehouse manager Fred concludes that his space will be filled to capacity within one month. He whips off a strong email to the division VP (Brian) and all the plant managers. The warehouse managers are claiming that the plants are making and shipping things that the warehouses don’t need, and they want more of a say on what gets shipped to them. The plant managers defend themselves, as their records show that production is only triggered by an urgent need from at least one of the warehouses. But, the problem we see is that when a plant produces a product, it produces it for more than one warehouse. In order to fix the problem of increased set-up time due to small batch production, they produce the quantity needed for the entire network. The plant managers, however, feel that the ERP system is providing them with to-date data about actual inventories. They don’t guess about what to ship. They do not understand why there are so many products with excess inventory. We meet Harrison, plant manager in Brian’s division. He has been studying the problem since receiving Fred’s strong email. As he studies the problem, Harrison uncovers a huge discrepancy in the ERP system: the sales forecasting is being increased and decreased based on other factors, but this information is not tied into production or distribution. And inventories continue to rise. (p. 175) Brian has also noticed the increase in inventories. Since the implementation of the Drum-Buffer-Rope method, there has been a huge release of much hidden capacity in the plants. But what is also discovered is that it is virtually impossible to accurately forecast sales for a product in a single region. Brian believes the answer lies in a better forecast. But BGSoft doesn’t agree with him. Once again we are led into the notion that something else has to change, not just the technology. We cannot continue to think that technology will solve the problems. This example is amply detailed in this chapter. Chapter 17 The problem identified in chapter 16 has led to a company wide presentation by BGSoft at Pierco. Craig has gathered together all of his division VP’s, plant managers, distribution managers, and support staff. Scott starts off by identifying that the production application of the TOC in all plants has been successful beyond expectations. Without adding any machines or manpower, each plant is able to produce at least 40% more than before. But this improvement in production has had nasty side effects on other units. Inventory is increasing in the distribution warehouses, whom have no control over the problem. So Scott and Brian introduce a solution: adopt the TOC application for distribution. This leads us to the idea of rather than producing products based on impossible forecasts and shipping the inventory to the distribution centers, the inventory should be held in the place where the relevant forecast is the forecast for the entire network – a far more accurate forecast. That place is identified as the plant. The idea is that if a product is ordered from one distribution center, the plant will produce five times as much, ship what the warehouse needs and store the rest, because it shouldn’t take long before another warehouse demanded the same product. (p. 191) And then they take this concept one step further – in order to eliminate the need for plants to produce small quantities, which eat into their set up time, produce a 3-week inventory that is held at the plant. This tied into a 3-week inventory held in the warehouses means that the plants can produce larger batches, and will always have sufficient inventory to keep the warehouses stocked. Since the plants will know which products need to be replenished, this can lead to Pierco offering service levels that the industry is unaccustomed to, thereby increasing sales significantly. (p. 194) This should lead to a huge release of cash, while putting an end to cross shipments and shortages – a win-win proposition for the plants and distribution. Of course, once again this brings up the reality that for an organization to succeed it cannot only rely on implementation of new technology, it has to reorganize its fundamental philosophy on how it operates its business. In this case, Pierco implemented technology that did improve production, but led to problems in distribution. But once it implemented the same application in distribution, which involved a significant change in the way they did business by holding inventory at the plants instead of relying strictly on the warehouse to define its inventory, the problems virtually disappeared because now the right source was deciding how much product needed to be produced. Chapter 18 Fifteen months from the start. The new system has been implemented for 2 months. Not only has it changed the way Pierco did business, it has led to a shift in the way that BGSoft does business. BGSoft has deduced that changing the rules is key to success in its implementation of its ERP. But there are new problems – not enough TOC experts to lead the charge. (p. 205) Chapter 19 Lenny, Scott, Gail and Maggie are meeting to discuss the new direction that Scott and Lenny have been cooking up for BGSoft. Once again they are bringing up the concept of selling value rather than technology. “It’s not just the software, it’s the frame of mind,” says Scott. (p. 208) The ERP system brought the ability to do things that were not possible before. Now data can be quickly transferred between different units of an organization, and the relevant information can be quickly retrieved from the oceans of data collected and inputted. But what BGSoft has learned is that while its ERP system has led to significant improvements and diminished major limitations of its client’s, it ignored the rules that resulted from the existence of those limitations. Those were left unchallenged. (p. 211) So when ERP was installed, the old rules were still used. Again Scott confirms what he had earlier deduced: “ To realize value, bottom line value, technology is necessary but not sufficient.” (p. 211) Now, BGSoft has hit upon the same idea it is selling to its client’s – it can no longer play by the same rules. It cannot remain as just a purveyor of technology, but as a company that will provide everything that is needed to get potential value, “even if it means doing things that a software company is not supposed to do.” (p. 211) And that means forcing its prospects to change their old management rules. What BGSoft has also discovered in this is that by focusing on these concepts, it also has led to a simplification of the code necessary for its system to be optimized. But switching from selling technology to selling value means a synchronized change in all units of an organization. And it means that a new function must be introduced, the TOC agent. (p. 214) But what BGSoft learned was that their success also became their bottleneck. And the only way to overcome it was to reinvent its organizational rules. Chapter 20 Sixteen months from start. Craig from Pierco has invited Maggie and Scott to dinner to discuss Pierco’s success story, but he also has a bombshell to drop. What Craig has realized is that his organization’s success is just the beginning. What they have done so far is good, but he has an idea to see it move to a new level. Even though Pierco has become more agile, this agility isn’t making its way to the end customer. And as long as the end customer doesn’t see it, Pierco isn’t reaping the biggest reward they expected, which is an increase in sales. (p. 220) The reason behind this is based in the vendor chain. If Pierco wants to win, it must look beyond the limits of itself, and look at its entire supply chain. (p. 221) Craig asks BGSoft to consider selling the TOC concept to its supply chain, which includes hundreds of businesses, most small to mid-size companies. BGSoft instantly recognizes the opportunity laid before it – finally, the way to capitalize on the mid-size market that has so far alluded them. Scott is ecstatic. Here lies the opportunity to institute fundamental changes in the operations of hundreds of business. Connecting all the businesses in the supply chain will force each individual link to act like a chain. Scott sees this as the answer he has been thinking did not exist. This solution solves the problem completely. It will provide a constant stream of clients and income. It can provide incredible stability (p. 230) And it will increase everyone’s rate of growth. But this means a drastic change in the way BGSoft does business - the paradigm shift that BGSoft has been requiring of its clients. Goldratt ends by suggesting “The end…or just the beginning.” Conclusion In Necessary but not Sufficient, Eli Goldratt leads us to a startling conclusion: In order for today’s high tech industry to succeed, they cannot afford to simply look at themselves as simply purveyors of technology, but they must show how their new technology will bring real value to their clients, bottom line value, because that is the cornerstone of business – what bottom line value is delivered to the shareholder. And they must also consider that once the operational limitations have been overcome by implementation of new technology, the limitations of the mind must be overcome. Business must redefine the rules that were put into place because of the old limitations that technology is now erasing. Goldratt clearly suggests that technology is necessary, but alone it is not sufficient. It must be incorporated with a shift in the business paradigm. And Goldratt suggests that the application of the Theory of Constraints as the foundation for this new paradigm fits well for re-educating business to work differently by focusing on different measurable benefits. I think Goldratt’s analysis presents a good argument, but in the context of this book it was somewhat oversimplified. What I saw throughout the story were the difficulties that new technology companies face in selling their new technology, and the difficulties companies face when implementing new technology and figuring out the changes that it creates in the way they do business. Alone they each have limitations, but together Goldratt suggests the possibilities are endless, and the opportunity for growth virtually limitless. A tall order for any industry. Necessary But Not Sufficient Goldratt, E. M., E. Schragenheim and C. A. Ptak. 2000. Necessary But Not Sufficient. The North River Press Prelude It begins on Jan 24, 1998, and within a period of 16 months, Eli Goldratt spins a tale of the implementation of a production delivery system in a large scale environment, based on the principles of the Theory of Constraints (TOC). Within this span of time, the implementation leads to significant problems for other units of the organization such as distribution and sales. The story unfolds around Pierco, a large manufacturing company that delivers a wide variety of products to market, and the investment it made in a new computer system developed by BGSoft, and implemented by KPI, a subsidiary of BGSoft. The players are Scott and Lenny, the masterminds behind BGSoft, Maggie, the head implementer for KPI, Gail, VP of Sales for BGSoft, and Craig, the CEO of Pierco, Brian, a Pierco division manager, and a cast of supporting characters. Through an interesting and easy to understand story, Eli Goldratt is able to explain and justify, no exemplify, that implementation of TOC concepts into real business application can lead to 20, 30 even 40% quarterly increases in the production, distribution and sales for a production company. He also ardently defends implementing a change in “the rules”, in the cultural makeup of a company at the same time when it implements a data driven system that will give it those statistical increases. Chapter 1 We begin the story by meeting Scott Duncan, head of BGSoft, one of the most successful software companies in the world. Scott is lecturing one of his account managers, discussing “the global picture” for which his vision becomes, apparently, visionary. Scott believes strongly that a company’s success is based on more than just a good product. Early on his strategy focused on what made a good product for the customers system at hand, not just in how well it worked. And it has worked well for him. His company has been the leader in setting the standards for the computer industry, and it has led to change in the way things are looked at. The factor to determine the value of his company, based on the profit it generates, is higher than the normal standard by 75%. This is the key to its rapid growth. BGSoft is driven not by the parameter of profit, but maintaining its growth rate. This is also the dilemma, because the company cannot continue this growth rate…trouble is lurking ahead. Chapter 2 One month later. Here we meet Lenny Abrams, brash, often icy, number two at BGSoft, who met Scott while they were both in graduate school. Scott had come up with the idea that computers would revolutionize business, and Lenny challenged him to act on it. Well, here it was 20 years later, and Lenny is facing an ever increasingly hectic schedule, and has grave concern about the future growth rate of his business. Too many of the implementations they have installed are getting their clients the results they said they would get, but nobody really knows why. The software works, the modules are getting through the bugs, but the bottom line of the clients hasn’t changed. And there are problems, problems that aren’t getting solved by his people in the field. It’s time for a meeting of the minds to discuss the problems. Chapter 3 Here we meet Maggie, head of KPI, prime implementation consultant for BGSoft, and are immediately introduced to her problem – the current system is deteriorating. The response time from BGSoft’s tech-support centers has decreased by over 80%. The general consensus is that BGSoft’s key product Enterprise Resource Planning (ERP) has become too complex, which has serious ramifications for BGSoft. But it’s not just this delay, it’s a broader problem – the computer system is “just one component in the game. There is also the company that implements it, and its clients. To find a solution, they must look at the global picture.” (p. 31) Here again we are led to “the global picture” which will become a mainstay of thought through out the novel. Chapter 4 Three months from start. We meet Gail Collins, VP of Marketing and Sales for BGSoft. At a company sales force bar-b-que, Lenny has introduced a new architecture for ERP, which has gotten all the sales people excited. For the first time in years Gail was worried about BGSoft not meeting its forecast. She predicts that they will be short, and that this will trickle into the next quarter. It appears that they are not losing their market position, but instead they have saturated their market of large companies who have or are willing to implement their software. They need to figure out how to expand into the mid-size market. But, to compound the problem, it isn’t any easier to sell to a mid-size company than a large one. To top it all off, they are having serious quality assurance issues. Lenny must go to the company’s plant in India, where most of their code is written and packaged. Chapter 5 Five months from start. Scott and Maggie have been called to visit Pierco, one of their largest clients. Craig has been grilled by his Board of Directors, particularly a new, young, aggressive fellow, who has questioned the huge investment Pierco has put into BGSoft, and wants to know what do they have to show for all the money they spent. Craig didn’t have an answer. He assumes that no real savings has occurred regardless of how many cents or fractions of cents have been saved, because no lay off had occurred. “No head-count reduction means no real cost reduction, no impact on the bottom line.” (p.48) So, Maggie, Scott and Craig discuss what would be bottom line examples: 1) sales information from Pierco’s warehouses is now streamlined to its production plants. Such information is available to plants on the same day of the sale. (p. 50) This leads to improved production forecasting and planning according to market consumption. Faster response from the plants mean losing fewer sales to competition, because fewer shortages in distribution mean more sales. “And more sales is more money,” Craig concludes – real bottom line impact. (p. 51) 2) Better distribution leads to less unneeded inventory, which also has an impact on the bottom line. BGSoft gets excited about concentrating on the bottom line instead of cost reduction. But they realize that they have been talking the wrong language – the computer system’s language – and not the language of the clients’. Lenny’s insight runs the deepest. He realizes there are three languages to contend with: 1) the computer system’s, 2) the client’s language, and 3) the top managers language – bottom line. That is the most important. With this in mind they also continue to see the ever increasing, unnecessary complexity that is creeping into ERP. Chapter 6 Five months from start. In a nod to Deming, Goldratt suggests that to the sales people of BGSoft, salaries are not the most important things. They thrive on intrinsic values like challenge and the thrill of overcoming each obstacle. (p. 60) Maggie is lamenting the fact that it has become increasingly difficult to find the right talent. The rate of implementation has stretched her work force thin, and she is bearing the brunt of current clients dissatisfaction. She reminds herself that “the customers are not always right, but they are always customers.” (p. 61) Through this, she can barely stop thinking about what Craig has said to them, and wonders if all her clients will start to demand real bottom line justifications. “Does this mean the rules are changing again,” she wonders (p. 61) It seems as though the industry is experiencing perpetual change. Chapter 7 Six months from start. “We’re just a herd of animals stampeding towards the cliff,” is this chapter’s opening thought from Scott (p. 65) and he believes everyone else in the industry is acting like the cliff doesn’t exist. His main market is saturated, and its limits are beyond his control. On top of that, the increasing difficulties of his product put it in real danger of becoming too complex to handle. And they don’t know what to do about it. Goldratt provides a bigger picture of the high tech industry here. Not only is this happening to BGSoft, but also its competitors. Some will even report negative growth this quarter. The assumption is that this will lead to greater scrutiny from Wall Street analysts, whom will demand proof that BGSoft is not heading towards the same fate, and if he can’t his stock will nose dive. (p.68) He can’t get past the problem of selling to mid-size companies, still faced with the same complexities involved in implementing the system to a large-scale company, and not reaping the same incentive/reward. Scott goes back to the basics. Neglecting the bottom line has led to a large number of meaningless features being added to the software because the client demanded it, which drastically increased the systems complexity. But he can’t link this to the long sales cycle they experience in the mid-size market. If he can answer that, he believes he will establish the link between the two dilemmas – satisfying customers while simplifying the product, and finding new markets. (p. 70) Chapter 8 Six months from start. Maggie is holding a meeting with Gail and another team member George to finish up their bottom line justification presentation to Pierco. The team encountered trouble from the start, trying to agree on what should be considered a measurable benefit. After a slow start, Maggie impatiently gets to the point – what is it about their software leads to either a decrease in cost, or an increase in revenue? (p. 73) She believes that what needs to be shown is economic benefit, not catchy phrases like system optimization, or greater operations visibility. George begins discussing that since ERP was implemented, invoices are correct the first time, an improvement over the old system (legacy system) which means the customer gets its money faster which means improved cash flows – a bottom line answer. Another key savings is identified in material-cost reduction – an ongoing annual benefit. And there has been impact on inventory reduction, which will free up cash reported on the balance sheet. Fewer stock outs are mentioned, which correlates to higher sales. The savings identified by these features mean that Pierco is basically getting its new ERP system for free, and have a slew of ongoing benefits. What is significant to the group isn’t so much the savings they have identified, but by focusing on the bottom line, they have discovered that of the key justifications BGSoft lists as its benefits, only 3 out of 20 made it onto the list of being a benefit to the bottom line. Chapter 9 Still six months later. The important theme that Goldratt is suggesting is that in order for these companies to succeed, they must keep maintaining their growth rate, which more and more seems like an impossible predicament. (p. 81) Once again Lenny is lamenting that of all the new features that he has authorized of late, not one of them contribute to the client’s bottom line. But the client’s demand it, so therefore they must provide it. But Scott disagrees. He has just seen the true value of his system to a large company, stripped of all the “admiration of technology,” and it boiled down to four items: 1) reduction in the days of outstanding receivables, 2) reduction in material costs, 3) reduction in inventory, and 4) increase in sales. (p. 83) Here we begin to see where Goldratt will eventually lead us. Scott believes that a shift must occur in the company’s business paradigm. If they continue to focus on their current features, the backbone of their sales tactics, then they will continue to offer very little real value to their clients. Therefore, they must sell value. (p. 85) This elicits a barrage of debate. “It’s one thing to state that (one) must provide a product that brings value, but a totally different story to do it,” exclaims Gail (p.86) She doesn’t believe that they have a clue how to do it. Scott decides the answer is to investigate adding a new Advanced Planning and Scheduling (APS) module to the software. Apparently, all the marketing of the leading APS companies is based on the claim that they will significantly decrease inventory and lead to an increase in sales – the key to impacting the bottom line. This is going to mean a paradigm shift in BGSoft’s own sales tactics, and Gail is uncomfortable. The group decides to visit one its smallest clients who is their best bottom line reference, Stein Industries. Chapter 10 Stein Industries is a company that has grown from $50 million to over $250 million in three years. Maggie, Scott and Lenny are paying a visit to Gerald Stein, CEO, to find out the details of his success using ERP. After some jovialities and sparring, Gerald admits that although the system worked as advertised, he didn’t get the benefits that he presumed would occur – a reduction in lead-time. What was happening was that a project would come out of one unit 2 weeks ahead of schedule, but would get stuck at the first bottleneck. There the work would pile up, forcing the managers of that unit to make more and more decisions, incorporating more opportunity for error. Eventually all the allotted time was fully used. So Stein introduced the Drum-Buffer-Rope method, a method that “chokes the material release according to the due date of the order” (p. 96) delaying the release of work orders until the actual lead time necessary to meet the final due date. This seemed to be counter intuitive. This led to connecting the entire project progress to the bottleneck, and for Stein they did this inside BGSoft’s ERP system. By focusing on the bottleneck, they could improve its performance. This led them to another concept, Buffer-Management, a follow-on step to DrumBuffer-Rope. Whenever anyone has product waiting in line, they look at the developed buffers to make their decision about what to do next. Scott and Lenny leave the meeting thinking that they have found their first connection to how they can tap into the mid-size market. By introducing DrumBuffer-Rope into their software package, they are still focusing on value, and believe have an answer for the mid-size company. But what they don’t see is that to implement such changes entails more than just implementing new code; it means changing what actually gets measured. By synchronizing the release of materials to the bottleneck schedule, the efficiencies of the workers who man the non-bottlenecks suffer, but local efficiencies are a standard benefit to be measured. This led them to the first conclusion that what was needed was a change in culture, and the answer lay in bringing value. (p. 103) Chapter 11 Lenny is paying a visit to Intelogic, one of the best APS companies. The visit is not going well. Lenny is being fed the standard sales pitch, but he came to look at possibly buying the company. He finally gets hooked up with the VP of Engineering and Intelogic’s top programmer, and begins discussing the concept behind its algorithm – providing the best practical schedule. This idea is the key to Intelogic’s product. The planning of the Master Schedule will tell you in advance what problems the various units are going to face, so that enough time can be buffered into the schedule to take corrective action. But what Lenny discovers is that the meaning of an optimized schedule has to be redefined. A reality to schedule optimization is that “the same amount of safety time when inserted in one stage of the process can help much more than if it is inserted in another stage.” (p. 115) But, the bottlenecks may move, and it is very difficult to forecast the potential bottlenecks. Therefore, Lenny concludes that a better way to protect the schedule would be to use safety capacity, not time. The user decides on capacity only after the disruption occurs, so the amount used is exactly the amount needed. (p. 116) This could be of value to any plant. Lenny leaves thinking he is drawing near to an answer on how to tap the mid-size market. Chapter 12 Lenny believes he has figured out how to add something to their ERP system that will cause the system to generate more bottom line value, even for mid-size companies. After his visit to Intelogic, he spent the next week meeting with Intelogic’s successful clients. What he discovered at each plant is very surprising. He learned that at each plant, they had to re-think the entire way they run their operations. (p. 123) As he is relaying this Scott, Scott acts as if he has already figured it out. Scott leads off their meeting. “When does a new technology bring value?” he asks. It will bring benefits when it surpasses an existing limitation. The paradox is that when we deal with a new technology, it defines that we have been living with an existing limitation for a while. So, we install a new technology to surpass the existing limitation, but we continue to operate with the old rules – the rules that assume the existence of the limitation. In that case, the rules themselves impose a limitation. (p. 125) Here again we see where Goldratt is drawing us. Technology is a necessary condition, but it is not sufficient. To get the benefits of the new technology, we must also change the rules that recognize the limitations of what it replaced. One way of doing this is to confine optimization to only the constraint. By doing more, you destabilize the schedule. Here Goldratt introduces us to a lesson from Deming – “trying to optimize the noise within a system doesn’t help, it hurts. As long as the system is vibrating within the limits of its noise, any tampering just increases the fluctuations.” (p. 129) Lenny and Scott conclude the chapter by figuring that their biggest obstacle is not the market or their product – it’s them, it’s how they have been thinking about the problem. They too must consider a cultural change within their own company structure. Chapter 13 Seven months from start. Craig and Maggie are enjoying a round of golf during Pierco’s top executive retreat. There is no better opportunity for a golf game than an executive retreat. (p. 133) They are soon joined by Brian and Stan, two of Pierco’s division vice presidents. One of the strongest arguments in BGSoft’s ERP justification was an expected increase in sales, which would have been reflected as a substantial increase in net profit. But it hasn't materialized. Their sales have remained flat. Inventory has gone down, shortages went down, but sales went down too. What we’re seeing here is the intricate connection the implementer of new technology faces when even after successfully installing the new technology (and getting the product to work according to spec), it still doesn’t deliver the essential bottom line value. When this becomes apparent, who is to blame? Brian has come to the same conclusions that Scott and Lenny have been arriving at, that in order for his division to meet its forecasts and deliver more value, Brian understands that he must abolish the traditional way of running a plant and change his fundamental measurements of success. (p. 142) He understands in order to do this he must get everyone on board, from the plant manager to machinist – everyone must be educated in regards to the new paradigm, and your company culture must be on board. Based on the ensuing discussion it is agreed that BGSoft will develop a Drum-Buffer-Rope module for the ERP system, and KPI will begin working on the re-education of Brian’s division. Chapter 14 Eleven months from start. It’s the end of the year, and BGSoft has completed the best year in its history. But Scott’s earlier predictions are beginning to come true: their main competitor has announced negative growth for the quarter, another has announced a 600-person layoff, and share prices are plummeting. Wall Street is getting antsy, and is looking for some hard answers about the future of the industry. “Is this just the separation of the chaff from the wheat, or has the industry reached its growth limits?” (p. 144) The answer is important, because if the first point is true, then BGSoft is emerging as a true leader, but if the second point is true then shares could be dropped like a hot potato. Lenny and Scott are debating about what the clear message to radiate about BGSoft’s success should be. They are at the crossroads, because they know they cannot continue to maintain their current growth, but they still can’t quite see what will get them over the hurdle. Scott is convinced that it is in their hands. He believes the answer lies in the decision to change the way they do business. By doing this, he believes that growth is unlimited. (p. 145) It is here that Scott consummately declares that BGSoft has to switch from selling information technology to selling value. But what does selling value entail? Determining and focusing on results is the real target. That’s what the DrumBuffer-Rope method does, it focuses your efforts. It tells you what’s really important. ERP has used this to focus on increasing capacity and increasing the flow in production, without increasing costs. New capacity is unearthed each week in Brian’s division. Now it has been spread to five other plants. Here Goldratt sings the praises of TOC, because its logic is so addicting. He labels it “comprehensive, practical, and still common sense.” (p. 153) Based on Goldratt’s scenario, all indications show that the theory does work. However, what still seems to be looming in the background is the fact that a major change has occurred in only one function of the organization. Up to this point, we have not been shown what this change may be doing to the other interconnected units of the organization. Here we are given an inkling into this connection by the foreboding of Lenny, who at the end of the chapter is far from relaxed. Chapter 15 Thirteen months from start. The chapter starts out with Maggie and her people at KPI totally swamped and frazzled. They are working 90 hours a week, and still can barely keep up with the demand. Things are getting out of hand. (p. 161) Staffing for new projects is increasing by 60 people per day. BGSoft has instituted a new module which implements a TOC paradigm, and they have retrained their staff to identify that what is important to the client is making sure that relevant information will be available for the right people at the right time so that bottom line results will be guaranteed. This represents a paradigm shift for the system integrators. It’s a madhouse, but they prefer it to the fear they had just a month ago when their market appeared to be drying up. Chapter 16 We are introduced to the first sign that all is not right in paradise. The chapter opens with a picture of the time it takes to unload a truck at the warehouse. Inventory has been piling up at the warehouse – yet several products are experiencing shortages, while others have almost six months capacity. At this rate, the warehouse manager Fred concludes that his space will be filled to capacity within one month. He whips off a strong email to the division VP (Brian) and all the plant managers. The warehouse managers are claiming that the plants are making and shipping things that the warehouses don’t need, and they want more of a say on what gets shipped to them. The plant managers defend themselves, as their records show that production is only triggered by an urgent need from at least one of the warehouses. But, the problem we see is that when a plant produces a product, it produces it for more than one warehouse. In order to fix the problem of increased set-up time due to small batch production, they produce the quantity needed for the entire network. The plant managers, however, feel that the ERP system is providing them with to-date data about actual inventories. They don’t guess about what to ship. They do not understand why there are so many products with excess inventory. We meet Harrison, plant manager in Brian’s division. He has been studying the problem since receiving Fred’s strong email. As he studies the problem, Harrison uncovers a huge discrepancy in the ERP system: the sales forecasting is being increased and decreased based on other factors, but this information is not tied into production or distribution. And inventories continue to rise. (p. 175) Brian has also noticed the increase in inventories. Since the implementation of the Drum-Buffer-Rope method, there has been a huge release of much hidden capacity in the plants. But what is also discovered is that it is virtually impossible to accurately forecast sales for a product in a single region. Brian believes the answer lies in a better forecast. But BGSoft doesn’t agree with him. Once again we are led into the notion that something else has to change, not just the technology. We cannot continue to think that technology will solve the problems. This example is amply detailed in this chapter. Chapter 17 The problem identified in chapter 16 has led to a company wide presentation by BGSoft at Pierco. Craig has gathered together all of his division VP’s, plant managers, distribution managers, and support staff. Scott starts off by identifying that the production application of the TOC in all plants has been successful beyond expectations. Without adding any machines or manpower, each plant is able to produce at least 40% more than before. But this improvement in production has had nasty side effects on other units. Inventory is increasing in the distribution warehouses, whom have no control over the problem. So Scott and Brian introduce a solution: adopt the TOC application for distribution. This leads us to the idea of rather than producing products based on impossible forecasts and shipping the inventory to the distribution centers, the inventory should be held in the place where the relevant forecast is the forecast for the entire network – a far more accurate forecast. That place is identified as the plant. The idea is that if a product is ordered from one distribution center, the plant will produce five times as much, ship what the warehouse needs and store the rest, because it shouldn’t take long before another warehouse demanded the same product. (p. 191) And then they take this concept one step further – in order to eliminate the need for plants to produce small quantities, which eat into their set up time, produce a 3-week inventory that is held at the plant. This tied into a 3-week inventory held in the warehouses means that the plants can produce larger batches, and will always have sufficient inventory to keep the warehouses stocked. Since the plants will know which products need to be replenished, this can lead to Pierco offering service levels that the industry is unaccustomed to, thereby increasing sales significantly. (p. 194) This should lead to a huge release of cash, while putting an end to cross shipments and shortages – a win-win proposition for the plants and distribution. Of course, once again this brings up the reality that for an organization to succeed it cannot only rely on implementation of new technology, it has to reorganize its fundamental philosophy on how it operates its business. In this case, Pierco implemented technology that did improve production, but led to problems in distribution. But once it implemented the same application in distribution, which involved a significant change in the way they did business by holding inventory at the plants instead of relying strictly on the warehouse to define its inventory, the problems virtually disappeared because now the right source was deciding how much product needed to be produced. Chapter 18 Fifteen months from the start. The new system has been implemented for 2 months. Not only has it changed the way Pierco did business, it has led to a shift in the way that BGSoft does business. BGSoft has deduced that changing the rules is key to success in its implementation of its ERP. But there are new problems – not enough TOC experts to lead the charge. (p. 205) Chapter 19 Lenny, Scott, Gail and Maggie are meeting to discuss the new direction that Scott and Lenny have been cooking up for BGSoft. Once again they are bringing up the concept of selling value rather than technology. “It’s not just the software, it’s the frame of mind,” says Scott. (p. 208) The ERP system brought the ability to do things that were not possible before. Now data can be quickly transferred between different units of an organization, and the relevant information can be quickly retrieved from the oceans of data collected and inputted. But what BGSoft has learned is that while its ERP system has led to significant improvements and diminished major limitations of its client’s, it ignored the rules that resulted from the existence of those limitations. Those were left unchallenged. (p. 211) So when ERP was installed, the old rules were still used. Again Scott confirms what he had earlier deduced: “ To realize value, bottom line value, technology is necessary but not sufficient.” (p. 211) Now, BGSoft has hit upon the same idea it is selling to its client’s – it can no longer play by the same rules. It cannot remain as just a purveyor of technology, but as a company that will provide everything that is needed to get potential value, “even if it means doing things that a software company is not supposed to do.” (p. 211) And that means forcing its prospects to change their old management rules. What BGSoft has also discovered in this is that by focusing on these concepts, it also has led to a simplification of the code necessary for its system to be optimized. But switching from selling technology to selling value means a synchronized change in all units of an organization. And it means that a new function must be introduced, the TOC agent. (p. 214) But what BGSoft learned was that their success also became their bottleneck. And the only way to overcome it was to reinvent its organizational rules. Chapter 20 Sixteen months from start. Craig from Pierco has invited Maggie and Scott to dinner to discuss Pierco’s success story, but he also has a bombshell to drop. What Craig has realized is that his organization’s success is just the beginning. What they have done so far is good, but he has an idea to see it move to a new level. Even though Pierco has become more agile, this agility isn’t making its way to the end customer. And as long as the end customer doesn’t see it, Pierco isn’t reaping the biggest reward they expected, which is an increase in sales. (p. 220) The reason behind this is based in the vendor chain. If Pierco wants to win, it must look beyond the limits of itself, and look at its entire supply chain. (p. 221) Craig asks BGSoft to consider selling the TOC concept to its supply chain, which includes hundreds of businesses, most small to mid-size companies. BGSoft instantly recognizes the opportunity laid before it – finally, the way to capitalize on the mid-size market that has so far alluded them. Scott is ecstatic. Here lies the opportunity to institute fundamental changes in the operations of hundreds of business. Connecting all the businesses in the supply chain will force each individual link to act like a chain. Scott sees this as the answer he has been thinking did not exist. This solution solves the problem completely. It will provide a constant stream of clients and income. It can provide incredible stability (p. 230) And it will increase everyone’s rate of growth. But this means a drastic change in the way BGSoft does business - the paradigm shift that BGSoft has been requiring of its clients. Goldratt ends by suggesting “The end…or just the beginning.” Conclusion In Necessary but not Sufficient, Eli Goldratt leads us to a startling conclusion: In order for today’s high tech industry to succeed, they cannot afford to simply look at themselves as simply purveyors of technology, but they must show how their new technology will bring real value to their clients, bottom line value, because that is the cornerstone of business – what bottom line value is delivered to the shareholder. And they must also consider that once the operational limitations have been overcome by implementation of new technology, the limitations of the mind must be overcome. Business must redefine the rules that were put into place because of the old limitations that technology is now erasing. Goldratt clearly suggests that technology is necessary, but alone it is not sufficient. It must be incorporated with a shift in the business paradigm. And Goldratt suggests that the application of the Theory of Constraints as the foundation for this new paradigm fits well for re-educating business to work differently by focusing on different measurable benefits. I think Goldratt’s analysis presents a good argument, but in the context of this book it was somewhat oversimplified. What I saw throughout the story were the difficulties that new technology companies face in selling their new technology, and the difficulties companies face when implementing new technology and figuring out the changes that it creates in the way they do business. Alone they each have limitations, but together Goldratt suggests the possibilities are endless, and the opportunity for growth virtually limitless. A tall order for any industry. The Haystack Syndrome Goldratt, E. M. 1990. The Haystack Syndrome: Sifting Information Out of the Data Ocean. New York: North River Press Written in 1990, this book is still ahead of its time. The issue of data and information incongruence continues to be a hot-button issue in every boardroom. A "must" for every manager concerned with meeting the challenges of the 21st century. Examines the differences between data and information in a new light, and shows precisely how misunderstanding those differences can affect the quality of the decision-making process. PART I (FORMALIZING THE DECISION PROCESS) 1. Data, information and the Decision process—how they relate We are drowned in oceans of data; nevertheless it seems as if we seldom have sufficient information. Goldratt examines the key differences between data and information. Data is any answer while information is "the answer" to the question asked. In fact, he points out that what we call information systems are really just immense data systems. They tend to collect and store volumes of data and produce mammoth scores of reports—but fail to answer the questions we need to answer. The decision process itself is imbedded in any good information system and the decision process is changing. If we want information systems and not just data systems, we need to adjust accordingly. Goldratt recounts an Israeli legend of an Army captain who decided to stop printing a certain report. This huge report was run periodically and distributed in paper copy to several locations. When the report ceased to exist, only one complaint was recorded…from the person who's job it was to neatly file the reports. 2. What a company tries to achieve Just in time (JIT) is not just reduction of inventory on the shop floor or a Kanban technique—it is a new overall management philosophy. Theory of Constraints is not just bottleneck reduction on the shop floor or an optimized production technique--It is a new overall management philosophy. Total Quality Management (TQM) is not just about the quality of products or a mechanical statistical process control technique—it is a new overall management philosophy. To begin to understand how this is so, we must answer the question, “why is an organization built?” From there, “who decides the goal of an organization?” Is it the customers, the employees, or the owners? Is it some other power group? In conclusion, Goldratt states that the goal of a company is solely in the hands of the owners, or shareholders. And from that, the goal of any organization is “to make money now as well as in the future.” To see how JIT, TOC, and TQM are new overall management philosophies, these fundamental points must be understood. 3. Getting a hold on measurements Measurements are a direct result of the chosen goal. We do not choose to measure “things” before we know the goal. Most companies judge their performance based on 2 bottom line numbers (Net Profit and Return on Investment). Another measure that is very important is the data found on the cash statement. But these are NOT the measurements we are after. We are looking for measures that show the impact of local decisions. From a Gedunken (or a mental, “thinking” exercise) about a cash-making machine, we come up with several questions that lead us to local measures that impact the goal (if we equate buying a money-making machine to investing in a company). a. What is the rate at which this machine makes money? b. How reliable is this machine? c. How much money is captured by the machine? d. How much money will we have to pour into the machine on an ongoing basis to turn the machine’s wheels? 4. Defining Throughput Throughput is defined as the rate at which the system generates money through sales. Through sales can be omitted and the definition can be used across all industries. In any case, throughput means bringing fresh money from the outside, whether through sales, investments, etc. Two considerations are important to defining throughput. First are the costs of increasing the sales, investments, etc. If it costs $30 in materials to increase sales by $100, then throughput is increased just $70. The second consideration is the timing of the transaction. You can measure throughput at the point of sale (when the money changes hands) or by the accrual method of accounting (when the transaction is considered irreversible). Each possess up and down sides, but are not critical to understanding what throughput is. These concepts simply affect to what degree your throughput is actually increased or decreased. 5. Removing the overlap between Inventory and Operating Expense Inventory is the money the system invests in purchasing things the system intends to sell. Traditionally, inventory is considered an asset. However, Goldratt views inventory differently. The question is how does inventory add value to the company? It only does so when we sell products (increase throughput). Looking at inventory only as a means for increasing throughput creates problems in traditional cost accounting. You can reduce inventory and still improve customer service, meet or exceed production needs, and increases sales…but still fail the bottom line. Why? Because a reduction in inventory reduces the asset side of the balance sheet which lowers net profit. This requires a change in thinking by top management. The reluctance of mid level managers to move away from the traditional way of measuring inventory (or anything really) stems from the saying: Tell me how you will measure me, and I will tell you how I behave. If you measure me in an illogical way…do not complain about illogical behavior. Operating expense is defined as all the money the system spends in turning inventory into throughput. Money is invested in inventory and spent in operating expense. Note the distinction. When we buy oil for a machine, it is inventory. When we use the oil to lubricate the machine, it is operating expense. When we purchase material (raw materials) it is considered inventory. As we use the raw material, some is scrapped. That portion is considered operating expense. As a machine (asset) is used, some portion of it gradually is scrapped, which we term depreciation—removing it from inventory into operating expense. 6. Measurements, Bottom Line and Cost Accounting Have we reached the point of fully explaining why we are dealing with a “new overall management philosophy? Not quite. The fundamental measures of throughput, inventory, and operating expense are used in conventional management. So, there must be more to explore. The three measures relate to each other creating two relationships among each. Throughput minus operating expense equals NET PROFIT. Throughput minus operating expense divided by Inventory gives us RETURN ON INVESTMENT. Throughput divided by operating expense is PRODUCTIVITY and throughput divided by inventory is called TURNS. No new measures here…So, how can we justify TOC as a new overall management philosophy? To help get that answer, we must look at cost accounting’s affect on organizations. When invented, cost accounting was a powerful solution to a huge problem. But, like all solutions, it was not the ultimate solution. In a dynamic environment, yesterday’s solutions become tomorrow’s problems. Cost accounting has created assumptions that (because of technology) have rendered it obsolete. 7. Exposing the foundation of cost accounting To judge a local decision, we must break down the measurements we have established. Throughput is just the summation of all the gain from sales of all the individual products. T= ∑pTp (p=individual products) Operating Expense is simply the summation of the individual categories of operating expense (workers and managers time, banks for interest, utility companies for energy, etc.). Note that “products” are not a category of operating expense…you don’t pay money to a product. And money paid to a vendor is considered inventory. The formula looks like this: OE = ∑cOEc (c=individual categories) Remember that the final judges for any local decision is NP and ROI. We may have a problem. If NP = T – OE, then NP = ∑pTp - ∑cOEc This set of formulas makes us compare products and categories (apples and oranges). It becomes very difficult, if not impossible to see how a local decision will impact the net profit of a company. How will launching a new product impact sales of other products? We can’t answer that unless we know the impact the new product will have on the various categories of operating expense. Throughput may be high for the new product, but NP may go down any way. Cost accounting was developed to help answer these questions. First, cost accounting admitted to searching for a very good approximation versus precision in getting answers. Second, the method is to make apples and oranges into apples and apples—thus allowing true comparisons. For instance, taking an operating expense like direct labor and breaking it into the products the labor is used for, allows us to consider it against throughput measures. This concept allows for ALLOCATION of the categories of OE across products. From there we can simplify our formulas into: NP = ∑pTp - ∑pOEp or, NP = ∑p (T – OE)p This allows us to dissect a company into product by product classes. But the business world today has changed and cost accounting has been slow to react. They have not reexamined the fundamentals, the financial statement logic, to create new solutions. Instead, they have formulated ineffective answers like “cost drivers” and “activity-based costing.” We can no longer allocate based on direct labor. So allocating expenses at the unit level, batch level, group level, and company level is meaningless. These cannot be aggregated at their respective levels nor at the top. So why do it? Remember that cost accounting solved our main purpose—the ability to have one classification of products and categories. That gave us the ability to make decisions. We need to be able to judge local decision’s impact on the bottom line. Simply expanding the number of classifications does not do that. 8. Cost Accounting was the traditional measurement The financial community would gladly give up cost accounting if there was a “better way.” It is the other managers that hold on to cost accounting—primarily because of the nomenclature. For instance, operating expense of a product is product cost, yet we never have paid money to a product. Since Net Profit ONLY exists for the company, we can dispense with terms like product profit, product margin, and product cost. Sales managers could not live if these terms were abolished in practice! The use of budgets is another example of this thinking. Corporate level uses profit and loss statements, but down at the lower, local levels of the organization, we use budgets. What happens when the net profit of the corporation does not match the net profit of the budgets? We call it variance and that makes them match. Cost accounting and the terminology that goes with it has shaped the decision making of managers. The decision to drop a product is made using cost accounting concepts. Rarely is the impact of the decisions on the system ever considered. Just local product cost numbers. Product cost, product margin, and product profit are the basic language of industry. The entire business seems to be classified into a “by product” status. 9. The new measurements’ scale of importance Throughput, Inventory, and Operating expense continue to be the measurements. Maybe the key is in how we relate to them? We know cost accounting is now invalid. So where do we go from here? We still have to understand how this is all a new overall management philosophy. The final judges are Net Profit and Return on Investment. Both are shaped by throughput, operating expense, and inventory—although not equally and all at once. Traditionally, operating expense is the most important measure, then throughput because both impact NP and ROI. But OE is more tangible to managers, so it ranks first. Since inventory only impacts ROI, it ranks third. Based on the way “cost” is emphasized in firms, this order of emphasis is precisely how local decisions are made. Go back and review the 3 movements we are examining (JIT, TOC, and TQM). All feature a process of ongoing improvement. Also, the goal of any company is to make more money now and in the future. That said, what is the rank order of our 3 measurements? Since the focus is to limit inventory and operating expense, they are theoretically limited to zero. So improvement has some limit. Throughput is limitless. The continuous process improvement focus realigns our measurements’ importance: throughput, inventory, and then, operating expense. How did operating expense lose ground to inventory? We chose NP and ROI as bottom line judges of success arbitrarily. If we chose productivity and turns, you see the shift in importance. Further, we must consider the INDIRECT cost of inventory (especially the time-related aspect of it) as featured in The Race. Inventory actually determines the future ability of a company to compete. Thus, all three movements (JIT, TOC, and TQM) recognize inventory’s importance. TOC: Local optima do not add up to the optimum of the total. TQM: It is not enough to do things right. It is more important to do the right things. JIT: Do not do what is not needed. 10. The resulting paradigm shift The “cost” world looks at our organizations and systems as a series of unconnected outlets. Each is an opportunity for waste and “leaks” that are individually examined and “fixed.” Is this reality? Our organizations are connected systems where tasks and missions are carried our in synch until a sale is gained. This is the “throughput” world full of dependent variables. In the throughput world the Pareto principle (80-20) turns into (0.1-99.9) rule. All systems are only as good as their weakest link. Statistically speaking, there is really only one weakest link in any system at one time (0.1%). This link is called the system CONSTRAINT. TQM and JIT actually fall short in understanding that there is really one problem to deal with at a time. They focus on the Pareto principle at least (20% of the problems). They also moved away from cost accounting (good), but now rely on too many non-financial measures (not good). Non-financial measures do not help you judge the impact of a local decision on the organization’s bottom line. Remember, the goal is making money…so $$$ must be in the measurements! Since there is only one constraint at a time, these theories tend to measure too much anyway. In the throughput world, constraints replace the terminology that products played in the cost world. As we look to launching new products, the only measure that matters is, “what is it we do not have enough of?” In other words, find your system constraints. 11. Formulating the Throughput World's decision process Management makes a huge mistake by focusing a little bit on everything. That's a by-product of the "cost world." The "throughput world" shows us that we should only focus on the constraints. They determine the performance of the company. Are there any companies that have no constraints? Not likely--every chain must have at least one weakest link. There are 5 steps in focusing: 1. Identify the System's Constraint(s): Those things that we just don't have enough of that limit the system's overall performance. We need not rank them if there is more than one. Just do not worry about what looks like a constraint if it does not have overall system impact (Goldratt calls these trivialities choopchicks). 2. Decide How to Exploit the System's Constraint(s): Exploit is the key word. We must get the most out of our constraints in an effort to eliminate them. If your market is the constraint--set 100% on-time rate as an expectation and meet it. 3. Subordinate Everything Else to the Above Decision: Non-constraints must supply constraints with all they need and no more. This is when you are truly managing the situation. 4. Elevate the System's Constraint(s): After Step 2, we may find that fully exploiting the constraint shows there was actually plenty of the resource. But, if after Step 3, we still have a constraint, we need to add more and more to it until we do have enough (subcontracting, advertising, etc.). 5. If, in the Previous Steps, a Constraint Has Been Broken, Go Back to Step One: OK, you've broken the first constraint you've found. Are you done? No! Many constraints are tied to policy (some archaic) that must be examined to reflect the new way of doing business. 6. If, in the Previous Steps, a Constraint Has Been Broken, Go back to Step 1, But Do Not Allow Inertia to Cause a System Constraint: Very important warning. Most companies do not have physical constraints--they have policy constraints. Very few bottlenecks (capacity constraints)--usually production and logistical policy constraints. This was the case described by the Goal. So, make sure to keep policy up to date with process. 12. What is the missing link? - Building a decisive experiment Back to the issue at hand--what is new in our NEW OVERALL MANAGEMENT PHILOSOPHIES? The goal of an organization is to make more money now and in the future. Can we answer the question, "What will our net profit be next quarter?" We should be able to, shouldn't we? But, instead we can list the reasons (complaints) as to why we cannot answer that question. Are they nothing more than excuses? We seem to have 2 real problems--lack of information or not defining it correctly and the diverse approach companies take to making improvements. Maybe we need to do another Gedunken experiment: The following is given: Ours is a "Perfect Plant" Two products P and Q Defect Rate is Zero Selling Price P = $90/unit; Q = $100/unit Market Potential = Sales Forecast; P = 100 units/week; Q = 50 units/week Each worker is available 5 days per week, 8 hours per day Plant Operating Expense is $6000 per week. The Production/Engineering Diagram looks like this: All data is given. All data precise. No excuses. Can we answer the question now, "What is the maximum net profit we will earn next week?" Do we have enough information? To solve this problem you will begin to see information in a whole new light. 13. Demonstrating the difference between the Cost World and the Throughput World Most people would solve the previous chapter’s question like this: P: 100 units X ($90-$45) = $4500 Q: 50 units X ($100 - $40) = $3000 NP = ($4500 + $3000) – ($6000 “operating expense”) = $1500 Wrong. This calculation neglects the first step “IDENTIFY THE SYSTEM CONSTRAINTS.” Look at the load forecast for each resource. For A, the load placed by Product P per week is 100 units times 15 minutes per unit (1500 minutes). Product Q places an additional load on resource A of 50 units times 10 minutes (500 minutes). The load is a grand total of 2000 minutes and the availability of resource A is 2400 minutes per week. No problem. Resource B—after doing the same calculations is shows that the demand for Resource B is 3000 minutes. This is a constraint. Note: The demand for C and D after doing the same calculations falls far below the system availability. We cannot satisfy the entire market potential. Hence the wrong answer above. We must make a choice as to which products in which capacities to make. Most managers approach the problem from three angles: profit per unit, cost per unit, or time/effort per unit. If we examine each product per those criteria, we might decide to make more Q’s than P’s. We can sell 50 Q’s per week (1500 minutes). We have 900 minutes left over to make P’s. That gives us a NP formula of (50 X$60) + (60 X $45) = $5700. Subtracting operating expense ($6000)…we find out that we will loose $300 per week. That puts us in a position of promising NP of $1500 (first formula) and actually losing $300 per week. This won’t do! We must go to the second step “DECIDE HOW TO EXPLOIT THE CONSTRAINT.” This forces us to offer P to the market first. The new product mix formula is (100 X $45) + (30 X $60) = $6300. Subtract out operating expenses ($6000)…we have a NP of $300. The key impact of this throughput thinking is not in the world of production. They could care less how much they produce and when. The sales department will care if management makes them sell P’s ahead of Q’s. Sales (normally on commission) earn less for P’s…they favor selling Q’s. This is how “systems thinking” is a real life dynamic. 14. Clarifying the confusion between data and information—some fundamental definitions What is data and what is information? Resource B is a constraint—data or information? For production—it is information. For the sales force…it is data. Sales would consider “Push P and only then Q,” as information. Information is not simply the data NEEDED to answer the question…it is the ANSWER itself. More so, information is the answer to the QUESTION ASKED. Data can be further separated into “data” and “required data”—an important distinction. Information is arranged in a hierarchal way. At each level, information is deduced from the data. Two conditions must be met to acquire information: data availability and decision process validity. The decision process will follow the five focusing steps introduced in Chapter 11. Some working definitions: INFORMATION: An answer to the question asked. ERRONEOUS INFORMATION: A wrong answer to the question asked. DATA: Any string of characters that describes something about our reality. REQUIRED DATA: The data needed by the decision procedure to derive the information. ERRONEOUS DATA: A string of characters that does not describe reality (might be a residual of an erroneous decision procedure). INVALID DATA: Data that is not needed to deduce the specific desired information. 15. Demonstrating the impact of the new decision process on some tactical issues We have come to the conclusion that we will Produce 100 P’s and 30 Q’s. That brings us to SUBORDINATE EVERYTHING ELSE TO THE ABOVE DECISION. What happens (in reality) if we ask our production managers to make 100 P’s and 30 Q’s? The result is idle time. It takes 15 minutes to make P’s and 10 minutes per Q. That is a total of 1800 minutes used out of 2400 minutes available. Our production manager won’t want to stay idle for 600 minutes. So, produce more? NO. The excess made won’t add to throughput…It’ll just become finished goods down the line (unused inventory). Subordinate everything else to the above decision forces us to look beyond the results of local decisions to the impact a decision has on the system. Further, our work ethic seems to be “If a worker does not have anything to do, find him something to do.” Subordination as a concept runs counter to our normal way of thinking. We are familiar with the saying, “Tell me how you measure me and I will tell you how I will behave.” But, without fully understanding how the subordination concept works and explaining it to workers/managers, the new saying might well be, “Change my measurements to new ones, that I don’t fully comprehend, and nobody knows how I will behave, not even me.” Goldratt offers an illustration of local measurements in terms of elevating the system’s constraints. He shows that in the cost world, a manager that offers a suggestion that increases processing time by 1 minute per part and costs $3000 to implement (buy a new fixture) would be fired. But under throughput world thinking, the manager who makes this suggestion really understands elevating the system’s constraints. How? Because if the manager (who in fact is in charge of a non-constraint) implements a change that makes his resource go slower, but frees up time on the system’s constraint (and increases overall throughput), he or she is a genius! The other aspect of this example is true as well…if the same manager wasted their time finding “cost reductions” for the non-constraint, the impact to the total system would still be meaningless. But, isn’t that how managers are rewarded today??? 16. Demonstrating inertia as a cause for policy constraints Moving on, we now see our system’s constraints and we subordinated and elevated as needed. Our next step was to go back to step 1 and (at the same time) not let inertia cause policy constraints. There is a complex example of taking our products to Japan.They want just as many P’s and Q’s as we sell in America. All the costs of production are the same as in America, but the Japanese want us to sell for 20% less per each unit. Should we? We can look at selling all the P’s we can make. Since we see that this new market will bear all we can make, maybe we should buy a new machine to make P’s. That eliminates the previous constraint (constraint broken). After all the calculations, we find that NP is just about $800 per week. But, have we let inertia take us in the direction of producing P’s (the most profitable product)? Reexamined, we see that if we increase production for domestic sales rather than sending so much to Japan…we can still have about 400 idle minutes on Resource A…and that will result in $1500 per week NP. That’s almost double the NP than if we simply bought the new resource and sent all the P’s over to Japan! The moral of the story is to go back to Step 1 when you break a constraint, but when you get to step 1, look at the system as a brand new system. Avoid the temptation to simply build on previous assumptions and let inertia create new problems. Ask, “which product contributes more, through the constraint?” PART II (THE ARCHITECTURE OF AN INFORMATION SYSTEM) 17. Peering into the inherent structure of an information system—first attempt Information—the answer to the question asked. The most needed information relates to questions that cost accounting was supposed to answer. There is a missing link between data systems and information systems. This lays the groundwork for the discussion ahead. Information is arranged in a hierarchal structure, where information at higher levels can be deduced from lower levels using a decision process. If we didn’t use a decision process, our needs would only be data. Our current data systems lack decision processes, or at least are based on erroneous decision processes from the cost world. We reserve the term information system for those that are able to answer the question asked using a decision procedure. To construct an adequate information system, we must build the relevant decision process. We have already identified the five focusing steps. This is our starting point in building an information system. A discussion follows about a simple inventory and ordering system for 2 products with different demand schedules, ordering schedules, and vendor lead times. In building the information system to address this issue and determine raw material levels, three major factors have to be considered--Frequency of delivery, the unreliability in consumption levels, and vendor reliability. Of course, a need for numerical evaluation must be built in as to the system as well. 18. Introducing the need to quantify “protection”. One of the pieces of the information system that Goldratt is discussing concerning inventory he calls “level of paranoia consumption.” This sounds much like the concept of Safety Stock from Operations Management theory. In any case, to formulate this information, we will go through the five focusing steps. We will Identify the System’s Constraints, decide how to Exploit them, and Subordinate to them. Our first action will be to decide the procedure to get us to the five focusing steps. Is the process as generic as our five focusing steps (that is, work in any situation)? We look at a make versus buy decision from the throughput world instead of the cost world and we see very interesting differences in the results. Product cost is NOT the way to make this decision. We Identify our constraints. Then we Exploit them—in this case, we do that by making the part in-house. The next step is Subordination. But what does that mean? In Subordination, attention is focused on the stronger links in the chain. What this boils down to is simply what is the difference between protective capacity and ordinary excess capacity. The first, as Goldratt illustrates in this chapter, is desired to account for Murphy, or unexpected production outages on nonconstraints. The second is waste. To fully capture this distinction in our operation, we must mandate our information system not only Identify and Exploit the constraints—but also distill for the actual events in our company some means for determining the level of Murphy. 19. Required data can be achieved only through scheduling and quantification of Murphy Any information system that lives up to its name must be able to answer all the “what if’s” we have discussed in previous chapters. Unfortunately, much of this information is unavailable. So, to help build this information, we need to distinguish between 2 types of missing data: 1. Knowledge of what are the company’s constraints Current and future…physical not policy…found in incremental phases 2. The ability to simulate future actions—scheduling Who should do what, when, and in what quantities? So how can we measure Murphy? Possibly, it can be measured only through an examination of the aggregate impact of the local perturbations. This is better termed Buffer Management because the few places where Murphy’s actions aggregate is in the inventory (safety stock) that sits in front of non-constraints. 20. Introducing the time buffer concept We have established that one way to protect against Murphy is to build in inventory to keep non-constraints running—and allowing us to fully exploit the constraint. Is this the only way? No. Another way is to use time to our advantage. For instance, we can start an order earlier (when possible) and if Murphy happens, we have some flex time in the system. Once the problem is resolved, we can continue operations—without excess inventory on hand. The interesting point is that either way of protecting involved an “early start”…you either pre-build inventory or pre-start a job order. We are simply protecting the constraint. In our effort to exploit the constraint— make the most out of it—we find that excess inventory and early starts are equivalent. For this reason, the proper way to express the protection of the constraint is in TIME. We now refer to the excess capacity that is desirable as TIME BUFFER—the interval of time that we release the task prior to the time that we would have released it if we assumed that Murphy did not exist. What determines the length of a buffer? We know disturbances will happen, just not when and for how long? The following graphs approximate the function of discrepancies. These graphs (particularly the second) show clearly that any disturbance can be overcome depending on the length of time we want to build in (size of time buffer). That length is a management decision. It involves a cost-benefit tradeoff in levels of time-related inventory (work in progress and finished tasks), future throughput, and operating expenses (expediting and control). It also effects throughput in our track record for delivery dates. Who should make this decision? Top management??? No! The decision on the length of the buffers MUST be in the hands of the people directly responsible for the overall performance of the company. 21. Buffers and buffer-origins More detailed statistical data does not necessarily help us get to the core problem—the need for protection from Murphy. There are 2 types of disruptions —one where there is an unexpected change (worker absent, tool breakdown, etc.) and another called Non-Instant Availability. This second type is when a resource is being used to do something else when we need it. To establish buffer origins, we must look at the components of processing time. For almost every product, processing time is almost 100% buffer time. Processing time is actually negligible. So, Murphy accounts for virtually all of the buffer time needed. Is one type of Murphy longer than another? That’s unclear… So how do we insert buffers into our plan? This begins the discussion of buffer origins. To determine our release schedule, we must measure backwards from the consumption of constraints to get our time buffers. The points in time for consumption of constraints is called the buffer origins. Again, these are simply time intervals connected to physical locations where protective inventory accumulates. There is more than one type of buffer origin. There are Resource Buffers—right in front of the resource constraint that contain work in process inventories. There are Shipping Buffers—the shipping dock or finished goods warehouse. There are also Assembly Buffers—that contain pre-released parts from non-constraints to guarantee that other needed parts from the system constraint do not arrive at the assembly point and wait (the second type of Murphy). 22. First step in quantifying Murphy We need to quantify disturbances. Our method will be to devise a mode of operation that takes into account that at any given time, Murphy exists. And that our struggle with Murphy is a continuous one. Let’s look at which problem should we attack first, then next, then after that—in order of their impact (Pareto analysis)? We choose to buffer only when something more important (throughput) would be lost had a disturbance occurred. Buffers are expensive (increased inventory, e.g.). How can we reduce the price of protection? We all know that if a process normally takes a week, we can expedite it in the case of an emergency. But to expedite everything creates chaos. Can we systematically use expediting? Sure. This gives us the Expediting Zone. Refer back to the second graph. The Expediting Zone is an area where we can speed up the arrival rates of resources. We choose to pick those that already arrive at a 90% rate to the buffer-origin. Note that the curve is relatively steep up to 90% probability. To get additional probability that a resource will get to the process—you must drastically increase lead-time. Anyway, choosing 90% means 10% of our tasks to a given resource will be expedited—very manageable. The result? Lower buffers, shorter lead time, and a more favorable trade-off between protection against Murphy and costs of doing so. Now that we have a way to concentrate the protection where it is really needed, maybe we can find a way to concentrate our efforts to reduce the need for protection. 23. Directing the efforts to improve local processes We want to reduce the price paid for protection, we have to concentrate on the tasks that will arrive latest to the buffer-origin. Managing the buffers provides us with several benefits. It enables us to better determine the required length in accordance with the level of existing disturbances. It enables us to systematically and methodically to expedite tasks to shrink overall lead times. Then, tracking the locations where the delayed tasks are found and prioritizing according to the number of times each resource appears on that list (probably with an appropriate weighting factor) provides us with the desired Pareto list—the list that should be our productivity improvement guide. There is one other—even more important-benefit. Maybe a resource pops upon our list and it has a superb process. This is because it does not have enough protective capacity. Quantifying Murphy is quantifying the buffer’s length and the amount of required protective capacity. We now have a way to monitor the expediting efforts—not in fire-fighting mode, but in a constructive way, geared to reduce overall lead time of all tasks. We might refer to this properly as Control—a crucial component to a good information system! 24. Local performance measurements Measuring local performance (as we do now) by efficiencies and variances is counter-productive. We must find a better way. The answer is not in “nonfinancial measurements,” as some guru’s suggest. Remember the goal of any organization is to make more money now and in the future—so financial measures are imperative. Also, remember that human nature is, “tell me how you measure me and I will tell you how I behave.” Control is to know where things are versus where they should be and who is responsible for any deviation—measured via a procedure that continuously attaches a numeric value to each one of the areas responsible for execution. Local performance measures should not judge the end result, but rather the impact the local area being measured has on the end result of the entire system. By this rationale—local measures are related to deviations to the enterprise plan. There are two types of deviations: not doing what was supposed to be done and doing what was not supposed to be done. The first impacts throughput and the second impacts inventory. The unit of measure for deviations, which are clearly liabilities, is DOLLAR-DAYS or more accurately THROUGHPUT DOLLAR-DAYS because it relates to that system measurement versus the others (inventory and operating expense). Multiplying the number of days that have passed since a corrective action should have started by the dollars lost in sales gives a pretty accurate assessment of a deviation’s impact in financial terms. The measure works for the first type of deviation and in just about every business. It makes sense to assign the resulting measure to the business unit where the process is stuck. At first, this seems unfair because they may not be responsible for the lateness—but the result to the system is exactly what we want. The center that inherits the problem will, in effect, expedite the resource like a “hot potato” to get it out of their department. This shows they are conscious of the Dollar-Days measure and the whole system benefits—not just a local department. Will this behavior cause sloppy work as department push the “hot potato” out of their world and into someone else’s area of responsibility? Maybe we should assign a corresponding dollar-days measure to the quality control department. No doubt inferior products will be reported and sent their way. As the trend shows itself, it will be their job to remedy the situation (and guard against other departments shifting poor quality products out the door just to manipulate their dollar-days measure). The minute quality control sees a department simply passed off a poor product…they return the product to that department…along with the corresponding dollar-days. This actually defines TQM…Quality at the Source. We still must deal with the second type of deviation (inflating inventory) and take on a local measurement that relates to operating expense. Those interested in these topics are directed to Theory of Constraints Journal, Volume 1, Number 3. 25. An Information System must be composed of Scheduling, Control and WhatIf modules A sort of review chapter… Data is every string of characters that describes anything about reality. Information is the answer to the question asked. Data needed to derive the needed information is “required data.” We must deduce information from the required data and any good information system will be able to integrate this decision process. Data Systems are those that supply readily available information while the term Information Systems is reserved for only those that supply information that cannot be achieved unless through a decision process. A comprehensive information system must be built in a hierarchal structure. The top of which must be geared toward answering managerial questions that elevate constraints or prevent the unnecessary creation of new constraints. This level is referred to as the What-If stage. We know now that we must first generate data on Identifying the System’s Constraint(s). We cannot start to identify constraints until we understand the scheduling aspect of an organization—hence the second stage of an information system, the Schedule stage. Much of what we concern ourselves with in the Schedule stage relates to what Goldratt called Control. This concept refers to our desire to quantify Murphy (whatever can go wrong, will). We want to get a handle on the trade-off between inventory and protective capacity. Then we can answer What-If questions. We also can answer where to focus our efforts to improve processing and establish local performance measurements. Thus far, we have 3 building blocks for an information system: What-If, Schedule, and Control. What-If is related to Schedule and Control as we have just described. But how are Schedule and Control related? There is a relationship between the Schedule and Control in that Control cannot be used until Schedule is functional. Remember, Control tells us where things are with respect to where they should have been. We control to limit deviations from the strategic plan… thus the schedule must exist first. Deviations that impact throughput and deviations that impact inventory are deviations from our business plans. Our plans must include allowance for Murphy. Our Schedule block must predetermine an estimation of Murphy. Only in this way can the information system provide some realistic way of scheduling and controlling. The discussion thus far has laid the groundwork for us to build on for the rest of the text. PART III (SCHEDULING) 26. Speeding up the process Time to outline the approach to the scheduling phase. The “MRP” has been considered a scheduling tool for some 30 years—it is not one, though. An MRP is a very good database though. But, they are very time consuming to establish. Does the time it takes to make a schedule render it worthless at some upper limit? How can we shrink the run time of an MRP? We must look at every step—even the way the data is handled. Why does an MRP run take so long—computers are fast, right? Most manufacturing experts agree that the way our MRP applications work, most of the process is “shuffling data internally” characterizing MRP’s as “totally I/O bound.” The reason for that is related to technological limitations, Goldratt claims, that no longer exist. Programmers had no choice but to shuffle data between mainframes and smaller computers because of storage and processing capabilities. Since PC’s can more than handle the workload nowadays, you might see the continued MRP run process as one example of letting inertia cause a constraint… 27. Cleaning up some more inertia—rearranging the data structure Product structure is usually broken down into 2 separate categories: Bill of Materials (BOM) and Routings. Both are descriptions of the journey that materials have to go through and have come about because of the problems we have had scheduling the material journey. The first MRP’s ran on magnetic tape. The diagram below shows how a simple Sub Assembly and 2 Finished Products might be related. Sub Assembly A is required for both (Product A and Product B). Old magnetic storage tapes used when MRP’s were first constructed held one copy of the Sub Assembly. For each product that used Sub Assembly A, the tape would have to be “searched” through for the file. Very, very time consuming and inefficient. Another way to do it was to detail the Sub Assembly every time it was needed (for Product A and Product B, for example). Very labor intensive and inefficient as well. What happens if a change occurs in some part of the Sub Assembly…? All the Sub Assemblies must be updated. The creation of BOM’s and Routing has alleviated much of these problems. In picture form, they look like this: But they weren’t perfect. And while magnetic tapes gave way to floppy disks and vast hard drives of random access storage media, MRP structure stayed relatively static since BOM and Routing. Goldratt examines another factor toward shrinking MRP run time in merging separately held “work-in-process inventory” and stores inventory.” Key to this concept is that computers execute instructions far faster than they “reach for disks.” Further, we must convert from the multi-file structure (BOM, Routing, etc.) to a suggested uniform, “task-structure net.” The idea is that the computer would only access the disks at the beginning of the run and hold all data in memory. An information system helps managers at all levels answer “what-if” questions. They, and their specific data must be made available on a distributed, disseminated basis. A data system must be centralized, however, and information systems—fed from a single data bank—must be decentralized. We need not restructure the existing data banks to convert the data format. We must concentrate on the structure of the subset of data format and file layout that must become available for our information system. 28. Establishing the criteria for an acceptable schedule Where to start? A good schedule must be realistic. Our system must be able to carry it out—or IDENTIFY OUR CONSTRAINTS. Also, a realistic schedule should not conflict between the system’s constraints (it will be immune from disruption). When we identify constraints, we must check thoroughly that there aren’t any conflicts between the id’d constraints. Since the conflicts were unrecognized before, we can guess that the data required to resolve them is not clearly specified. The information system, then, must: Reveal the conflicts Highlight the minimal actions needed to resolve the conflicts Stop and Demand the user make a decision (unless clear guidance is available) Linear programming (and dynamic programming) do provide conflict resolving in scheduling—ignoring the lack of data and failing to highlight where the conflicts were encountered. Further it fails to protect against disruptions, in fact disregarding them. Still the method has been the cornerstone of operations research for the last 20 years. The scheduling method of JIT—the KANBAN method—pushes the subject of conflicts from the scheduling phases to the execution phase. No guidance is available for selecting the number and content of the various cards to be located between workcenters—the full load of making the schedule work is placed in the floor personnel. MRP has given up on being realistic—it employs “infinite capacity.” Both JIT and MRP account for disruptions to the extent that they build in time to allow for them—more time than need to carry out the actual task itself (without disruptions). In short, each tries to immunize the schedule instead of the result of the schedule. The need for a schedule to be protected against disruption is simply to ensure it is predictable…nothing more. There is one more (and most important) criteria of schedules. It must be measured (judged) by the same criteria we use to measure results—throughput, inventory, and operating expenses. The end performance that the schedule indicates is judged by whether or not maximum throughput is achieved—exploitation of a company’s constraints. Second, the level of material inventory should be present only to guarantee the throughput. The schedule can only use overtime (Operating Expense) to protect throughput. If the information system does all this and if the user customizes the system contrary to these conditions—judge the end schedule accordingly—not the information system. 29. Identifying the first constraints Here’s where our scheduling should start. We must start by identifying something that is definitely a constraint—no guessing and hoping “buffer management” will save us. We are better off overlooking a constraint than choosing a nonconstraint as a constraint. So, what can we identify as a constraint with a highdegree of probability to get us started? Starting with a material constraint is risky. We need the detailed knowledge of the schedule we are trying to create to accurately identify them. Vendor constraints are likewise risky because in many, many cases—vendors are not the constraint. Resource constraints are not good first choices to target because most “bottlenecks” turn out to not be real bottlenecks and we need time to really decide whether a resource is a constraint or not…again, we need the schedule we are trying to create. So, the only category left is market constraints—client orders. So, let’s use them. The only thing limiting us from making more money is the market demand. It is safe to assume that even if we do have internal constraints, we can still have market constraints. This is true is we have bottlenecks and where we have capacity constraints due to lack of sufficient protective capacity. Neither of these conditions will mask our market constraints and invalidate our process. The only time the market is not a constraint is when we do not have to specify delivery dates to customers. Does that ever happen? Maybe if we only produce one product that is immediately grabbed by the market…very rare. Next we need to exploit the constraint (the market). In this case, we need to simply meet our delivery dates. So, we move to the next step, subordinating everything else to client orders (the constraint). In this chapter—Goldratt chooses to circumvent this process and actually go back and look for additional constraints before subordinating to the market constraint because (in this example) the exploitation phase is inadequately illustrated. To help us find bottlenecks (that by definition are time-dependent), we will set an arbitrary time interval of present date to the most remote due-date of our client orders. These due-dates are defined as the “schedule horizon.” From this we need to look at the workload for resources based on the schedule horizon. This can be misleading data…but we can’t give up. Let’s just concentrate on all orders whose due date is earlier than the scheduling horizon plus a shipping buffer. We will account for all the set-ups, size of the batches, etc. After all the needed calculations are accomplished for our resources, we can compare that to our schedule horizon. If the load placed on any resource is greater than its availability —we do have at least one bottleneck. 30. How to work with very inaccurate data What if we collect all the data and we find we have a constraint—but it is really not? What if it is, but our data says it isn’t? In one instance, the first—it is dangerous to identify a non-constraint as a constraint. In the second case, the only harm is some computer processing time lost—in this day and age, not a big concern. The real question is how can our data show we have a constraint when we really do not? A closer look at the data shows that of all the resources that seem to not have enough capacity, one resource (the one that takes 2 hours to process—the others take just 1) is most likely our resource constraint. But, this little bit of insight does not fully prove anything. If we are right, we have a conflict between the market constraint and the resource constraint. By definition, any resolution of this conflict will yield a degradation in the company’s performance. Is our conclusion based on erroneous data? We know it is almost impossible to keep accurate process times data for ALL processes. But, we can verify just a few… but which few? For resource constraints, we based our calculation on computation of resourcetype availability and on their required load. The availability was based on the calendar (usually uniform for entire organization) and on the data of number of units available from this resource. The number of resource units can be very inaccurate. Let’s assume we checked this data and found it all to be accurate. We move to the data we used to calculate the load. We concentrate only on the process times that are required by this particular resource. This may seem obvious. But usually, when data accuracy is questioned, the normal response is to “clean the data to 95% accuracy.” Any system that goes in that direction misses the point of an information system to highlight clearly which data elements (out of the entire maze) should be checked, narrowing it down to a feasible amount to verify. Our system (per this example) should display to the user a chart dealing with which tasks are absorbing what percent of the availability of our suspected constraint. We now need to match this up against our “big load tasks” (client orders). Avoid the temptation to store all these calculations. How much of it will be accessed later? Remember that computer speed in calculating is much faster than in storing/retrieving. Recalculate instead of storing intermediate results. Once we pass the stage of verifying the very few data elements that caused us to suspect the existence of a resource constraint, we are ready to sort out apparent conflicts between the company’s constraints. Here comes the real test of our information system. Narrow the conflict down to its roots. Give the users clear alternatives so that they have no real difficulty choosing using just intuition. 31. Pinpointing the conflicts between the identified constraints Identifying a bottleneck (constraint) means that we cannot satisfy all orders on their respective dates—not enough capacity at least on one resource. Our information system does not have the required data to make the appropriate decision. Who should we short? By how much? What are the other alternatives? We need our information system to focus on the conflict AND allow the managers to make the decisions—not the computer. We go to our five focusing steps. We have identified our constraint(s) and the conflicts (the market is one). We exploit that resource by making sure every order is one-time. Now, we must subordinate. Subordinating means ignoring any of the resources own limitations and concentrating on finding out exactly what we would like that resource to do to satisfy the constraint. During this phase, you may be tempted to go into a “sophistication” process where you input, collect, and retrieve large, detailed data sets that may have very little meaning or relevance to the outcome. Avoid this temptation. We must deal with only the data we need. In our market constraint example—we allocate our stock based only on due-date. The ones with early due dates take precedence over later due dates—simple as that. Next we want to know WHEN the resource is to perform. We know the due-date of the order and we know the shipping buffer. We should “release” the task from the resource constraint a “shipping buffer” before it’s due to be shipped. If we do that, we may find that many tasks conflict—we expect that. Maybe we should find which tasks conflict (relatively simple computer code based on the calendar of tasks) and adjust. On first blush, let’s take the conflicting tasks and merely push their processing start dates earlier. We will increase inventory—but that’s OK given the example. Having pushed the processing dates earlier, we reduce our conflicts—but create and infeasible solution with some processing start dates becoming yesterday. To fix this, we can adjust our processing dates forward to ensure all dates are future starts—again simple coding for today’s computers. In the end, we acknowledge the arbitrary nature of moving the start dates. Some tasks will be high-risk for Murphy. However, we have adjusted our focus to a manageable level—only a few tasks will require managers to pay close attention to disruptions. 32. Starting to remove conflicts—the system/user interplay At this point we have to make some distinction as to where an information system stops and user intuition must take over. In looking at our processing blocks, the information system will certainly guide us through a valid decision process, but human intuition is needed to avoid pitfalls. As the discussion in this chapter articulates and Goldratt’s series of Socratic type questions demonstrate, the point comes where the user must look at each “red block” and decide in what order to resolve them. For instance, as we require our information system to forecast and attribute various set-up costs/times, it becomes apparent that without human sanity checks, we would end up with a resource constraint that spends most of its time in set-up, not production. The system user (in this example) must decide which blocks to “glue together” and combine steps. Have we now removed the conflicts? Nope…we may have reduced them. It’s time for a bigger gun (overtime). 33. Resolving all remaining conflicts Our information system should give guidance for allowing overtime per resource based on certain parameters, under rare circumstances, and ONLY to increase throughput. Overtime instructions are obeyed by the system without additional intervention from the user. From our present discussion, we have tried to reduce set-up time to free up capacity on our identified constraint. Once that attempt failed, we may look at overtime to accomplish what we need. Overtime may help the task we desire it to. However, it also will help other tasks relative to their due dates. Depending on when we insert the overtime, if we cut it too close to the due date, there may be no effect on the task we targeted—but the tasks downstream are sped up. This relates to the idea that inserting overtime as far in advance as possible increases the likelihood it will work for the tasks it is intended to help. The balance is that you certainly do not want to insert overtime as a first resort, though. Note that one hour of overtime (if it does have an effect) will have the same effect on all resources. Now we must insert overtime into our schedule at all points earlier than the first “red block” or task in danger of not being met. We insert until all the tasks are clearly feasible. If we keep inserting tasks and never get to a point where we can satisfy all tasks…then we get to a point where overtime fails to fix our resource constraints—then we need more drastic measures. Now the user becomes the driver. He/She has to manipulate our information system to off-load a particular task to another resource, split the task and remove part of it to be done at a different time, or decide on a bigger, one-time shot of overtime. Regardless, any action taken for any task by the user will (remember) have major effects on all the tasks downstream. So a constant watch is needed as each individual action is taken. In the end, the user can give up. Maybe they will have to live with some late orders. There may be nothing else they can do. The information system must be able to do this as well. It will do this by setting a new due date equal to the ending time of the latest among the “red block,” plus a shipping buffer. Missing a due date is bad enough…What we must not do is miss a due date without warning the customer. We now have the first attempt at a “master schedule.” It’s a first attempt because we can’t be sure we have found all the constraints yet. It differs from the generally accepted concept in that it is created not only from data regarding orders, but also from data regarding the detailed schedule of the resource constraint. The next step is to Subordinate everything else to the above decision. The actions of all other resources will need to be derived, so that they will safely support what we have already decided. At this stage we come across the concept of the DRUM. We have set the timeline for the schedule which sets the tone for how the process “marches along,” like to a drum. When a second resource constraint is found—a new concept called RODS appears. Now is as good a time as any to define the concept. The length of a rod is one-half the resource-constraint buffer. When a resource constraint feeds itself through operations done by other resources, we need to protect the second (later) operation by inserting these rods. In a picture: The movement of one block may cause the movement of many. The next segment of our journey is the subject of subordination. 34. Manual subordination: the drum-buffer-rope method The due dates for the orders and the exact dates for the resource-constraint operations have already been fixed. We do not have to worry about any mismatch between the dates. Any order is guaranteed to be processed by at least its shipping buffer (in emergencies, half the buffer). Now we have to fix the dates for all other activities. First, determine the dates of release for materials. Our rule is that they should be released a resource buffer before the date they are to be consumed by the resource constraint. Subtract the resource buffer from the dates that have already been established at the drum. For intermediate operations, we want the inventory they create to accumulate before the constraints—nowhere else. Only there does it serve its purpose as a protection against disruptions. We are not telling non-constraint resources, “Do it on a certain day.” We are telling them to, “Do it as soon as you can, preferably the minute the material arrives, but if the material arrives before the specified date, please wait, don’t work on it, someone has made a mistake. The resource constraints must rigorously follow the schedule. We also want those operations that use common parts to also follow the schedule very closely so they don’t push inventory to non-constraints that aren’t ready. For the other non-constraints, the schedule really tells them, “don’t do it before….” Not exactly a rigid command. We have constructed the “drum” by pushing our tasks within the schedule backward and forward until they made sense according to the calendar. We have covered the operation feeding a resource constraint. We have covered the operations feeding free orders. And we have covered the operations between the blocks and orders. The only scenario left is operations that are not between blocks and orders and do not feed a free order. For these, we should follow the corresponding order by using the assembly buffer. The schedule of an action should be derived according to the constraint date the operation feeds. This, and the chapter’s examples, describes the “drum-bufferrope” procedure. We have now finished subordination—what clashes with reality will now occur? After all the discoveries we have made, we may be at a point where the only thing to do is to postpone the corresponding instructions on the drum—postpone an order. How can it be that we are faced with a choice to remove conflicts only by decreasing throughput. Further, how can it be that we can increase inventory and operating expenses and still not fix the problem? Are our assumptions correct to begin with? 35. Subordinating while considering non-constraints’ capacity—the conceptual approach The subordination process seems to be simply subtracting the various buffers from the dates already set by the drum. We also use the info on the length of the buffers. Does capacity have anything to do with the length of the buffers? Yes! Remember “non-instant availability of resources?” Sometimes, when work arrives, a resource may be busy doing something else and the work must wait a little while—not because of a bottleneck. Maybe we can get a handle on when these are going to occur. To do so, we need to construct our schedule with an emphasis on moving backward in time. Reconsider the example of moving tasks (blocks) backwards and then forwards again to subordinate everything to our constraint. We need to build our scheduling system to do that. Doesn’t MRP do that already? No. At best, it resembles a zig-zag pattern over time—with a strong tendency to move forward over time. 36. Dynamic time buffers and protective capacity We are tempted to start with the latest thing we are going to do (the latest order). More precisely, the latest order that is earlier than the horizon date plus a shipping buffer. We shouldn’t—we should start by allocating the stocks and based on due dates (the drum). One dominant reason for a tasks lead-time is non-instant availability of nonconstraint resources. Queuing phenomena results as people release material even earlier than the buffer dictates. Determining queues is very difficult. Most people use an “average queue time.” However, due to the inherent random nature of queues, this is a very misleading number. In using time buffers rather than queuing times—we improve considerably. We can predict expected fluctuations in the workload. We can time the release of materials according to the expected load fluctuations. We wanted a mechanism to identify constraints—we got that and a significant reduction in inventory. We rely on our information system to determine variable time buffer—we supply the fixed portion. We are basically going to use DYNAMIC BUFFERING. A resource needs to have protective capacity to restore the damages caused by disturbances—not just at that resource but all the activities feeding it. The constraint is protected only by the content of the material residing in the bufferorigin. Note: we don’t protect just any inventory—only that which will be consumed by our constraint. When we subordinate, we have to be careful that a resource is not running for too long before we enforce unscheduled time on it. 37. Some residual issues Three chapters from the end…can we start to construct the subordination procedure, yet? No. First we have to spend some special attention on the “peaks” we’ve created by moving them backwards in time—that are the result of activity on the “red lane.” This type of situation will occur only when there is no “slack”—when the date of the block is not earlier than the date of the order minus the shipping buffer. With the right amount of slack—the red lane peak is not a problem. Not enough—we have to deal with the peak. We can live with only half the buffer. Remember that the length of the buffer is key. For every hour above the available capacity on the date of the peak will cause the disruption to penetrate another hour into the buffer-origin. Let’s consider some overtime. Doesn’t work, let’s contact the user. They can authorize more overtime (the system suggests how much) or they can decide to off-load the task to another resource (the system will tell the minimum quantity) or postponing the date (the system must tell to what date). What cam the user do if these don't work? Do we have an additional constraint? The resource exhibiting this peak should be considered a constraint. We’ve done our job and now the system must resolve the conflicts between the already identified constraints. Next open point. How do we take into account the time required to actually perform an operation? It’s the time to do a batch, found by multiplying the process time per unit by the number of units required, adding the set-up time, and then summing the results along the sequence of operations needed to do the task. If we do that, what happens? We get a ridiculous result. We have to include the possibility of overlapping the batches between different operations. In the final analysis, the direct contribution of process times is even less than we stated earlier. If no problem of resource availability exists, as in a line, and Murphy does not exist, then the time it takes to complete the order is almost equal to the time required to complete the order at just one work center. Compared to non-instant availability and Murphy—this value is ridiculously small. Is this the right formula? The direct contribution of the actual process time to the overall lead-time is the time to process the batch on the longest operation, plus the time required to process the batch at operations that cannot be overlapped, plus the time to process one unit at all the other operations. Let’s ignore set-up time because saved set-up is saved time, not money. If we find set-up time is limiting a resource, we will identify it as a constraint. But it is irrelevant to our discussion right now. Under these conditions, set-up time doesn’t affect throughput. In fact, reducing it increases inventory at non-constraints if we are not careful. It has no effect on operating expense—in our example, only overtime has that effect. Now can we start to build the subordination mechanism? 38. The details of the subordination procedure We have all the tools needed to build the subordination process. The chapter describes a very technical procedure. There is one important guideline—to be very consistent in moving ONLY backward in time. First, the system must be concerned with “current date.” It doesn’t want to “leave anything behind”—i.e. move from the current date without a very good reason. What makes us move? Each operation. We need an interval of time to represent the sensitivity of the system. Anything less than this interval can be ignored as a reason for moving forward. Our example lends itself to a one-daytime interval (based on due dates). This gives us 3 categories that will necessitate a move in time: the drum, the buffers, and the peaks of overload. We need to install “reminder lists” in our system. It should contain the entire drum—the due-dates of the orders and the ending time of the resource constraints’ blocks. The subordination process…start with the highest entry on the list (likely an order) and dive from there. Go to the feeding operations, subtract out shipping buffers. Identify the operations that directly feed the order and put the corresponding notes on our reminder list. Follow these steps and eventually, we’ll pick an operation, not just an order from the list. Calculate the load that it represents and adjust accordingly the current available capacity of the resource which is supposed to perform that operation. As we continue to dive down, we will encounter one of 3 situations: • Reach a material—most common situation. Jump back to nearest higher assembly and dive down additional legs if they exist. • Reach an operation of the drum. No action needed. Simply return to the nearest highest assembly if it exists. • Try to adjust the availability of the corresponding resource and we find its current availability is already zero. Go back to the reminder list, since this means we are going back in time. When no conflict has been observed at the end of subordination, we will repeat the entire last round of subordination and finalize the schedule. We will continue to follow this basic process and use the special guidelines developed in the last 2 chapters to deal with the special cases. 39. Identifying the next constraint, and looping back We probably have some resources that are overloaded after the first day, since we’ve completed the subordination stage. There may be a lot of mountains of overloads at our resources and we might be tempted to misidentify new constraints. We must be patient. First, we need to go back and try and minimize the overload by using set-up savings, permitted overtime, and half-buffer, forward shoveling—sound familiar? Then consider the magnitude of the overload based on its effect on the overall system. Again, the user can take steps to overcome an overload…so be careful when trying to identify new constraints. Remember identifying a constraint means an increase in inventory (additional protection). If we do identify a new constraint, the issue becomes the relationship between the first constraint we found and the new one we found. Goldratt refers to the new blocks and the old blocks (the jobs feeding the new constraint and the jobs feeding the old constraint). We have a need to define “time rods” to understand what to do next. Time rods are equal to the length of half a resource buffer, and are sensitive to the date of the old block. The date for a time rod is what an iron wall is for a regular rod. Now we can find any possible conflicts between constraints. The system for finding the conflicts between constraints as described several times in the text, happens over and over until all the overloads on the first day are resolved—all the constraints have been identified, exploited, and subordinated to, and no known conflicts have been left for the floor personnel to resolve. Goldratt as a caution against thinking that what we have done so far ends the discussion offers a corollary situation. In sum, there are situations where a firm has one resource constraint feeding another resource constraint and it still may be in a system without any interactive resource constraints. As we have used market constraint as our first constraint, we have to realize the constraint may act on each resource differently and thus show the caution of Goldratt as having merit. In fact, we need to encourage this situation because it leads to increased throughput. We have now finished the first phase of our information system—the scheduling. But we are by no means ready to move on to automating the control mechanism though. 40. Partial summary of benefits A. Performing net requirement—finding how many units have to be produced at each point— is a matter of seconds of time. B. A dynamic, all-encompassing length of the run times. C. Sales will get a pre-warning D. The ability for Sales to communicate with Production managers (for instance) E. Process Engineers and Quality Managers will be able to point to the processes that need to be improved—rather than to workcenters that don’t have enough protective capacity F. Top Management—since the system by definition does not consider policy constraints— the system is immune and durable. If “the schedule cannot be followed,” then we can be sure we have a policy constraint and top management will have to agree. The Goal Goldratt, E. M. and J. Cox. 1986. The Goal: A Process of Ongoing Improvement. New York: North River Press. The Goal is a very compelling novel. Novel, HUH!! Who ever heard of a novel about a production plant? Well, Eli has made the production managers have quite an epiphany. In one book he might have changed the whole world of cost accounting. Eli approached the production world with a common sense view. Using just one goal, making money, he referenced every activity to it. Eli said, "I view science as nothing more than an understanding of the way the world is and why it is that way." You see, Eli is a physicist, and in being one, has to understand why things work the way they do. His common sense approach is illustrated beautifully in this novel. He has looked at cost accounting from the outside and has developed a whole new system because of it. Everyone from accountants to production managers to CEO’s should read this book. Because of its fundamentals, it should be part of the curriculum of every accounting program. This novel has and continues to help the industry to make strides toward continuous improvement. Chapter One The first chapter gets the reader acquainted with Mr. Alex Rogo and his apparent problems with his production plant. This is shown through a confrontation between Mr. Rogo and his boss Mr. Peach, the Division Vice President. The dispute is over an overdue order #41427. Through their conversation it’s learned that Mr. Peach will not settle for anything less than the order being shipped today, and since the plant is neither productive nor profitable, Alex has three months to show an improvement or the plant will be shut down! Chapter Two This chapter gives insight to Alex’s home life. Since moving back to his hometown six months ago, it seems adjustment isn’t going well for his family. It’s great for Alex, but it’s a big change from the city life that his wife is used to. You also experience Mr. Rogo’s background through his reflections back on his travels to eventually find himself back where he started. "He’s now 38 years old and a crummy plant manager". By the way, the order #41427 does get shipped, but not very efficiently. All hands in the plant are working on one order with forbidden overtime to boot. Chapter Three Mr. Peach calls a meeting at headquarters for all plant managers and his staff. At the meeting everybody finds out how bad things are and are given goals to achieve for the next quarter. Through the grapevine Mr. Rogo finds out perhaps why Mr. Peach has been acting so erratic lately, the Division has one year to improve or it’s going to be sold, along with Mr. Peach. Chapter Four While at this meeting, Alex thinks back on a recent business trip where he ran into an old physics professor, Jonah, at the airport. Jonah puzzles Alex with how well he knows how Alex’s plant is doing. Jonah has no knowledge of where Alex is employed. Johan predicts the problems of high inventories and not meeting shipping dates. He also states that there is only one goal for all companies, and anything that brings you closer to achieving it is productive and all other things are not productive. (See What is this thing called Theory of Constraints for more on Alex's encounter with Jonah.) Chapter Five Alex decides to leave the meeting at the break. He has no particular place he would like to go; he just knows this meeting isn’t for him, not today. He needs to understand what the "goal" is. After a pizza and a six pack of beer it hits him, money. The "goal" is to make money and anything that brings us closer to it is productive and anything that doesn’t isn’t. Chapter Six Mr. Rogo sits down with one of his accountants and together they define what is needed in terms of achieving the goal. Net profit needs to increase along with simultaneously increasing return on investment and cash flow. Now all that is needed is to put his specific operations in those terms. Chapter Seven Alex makes the decision to stay with the company for the last three months and try to make a change. Then he decides he needs to find Jonah. Chapter Eight Alex finally speaks to Jonah. He is given three terms that will help him run his plant, throughput, inventory, and operational expense. Jonah states that everything in the plant can be classified under these three terms. "Throughput is the rate at which the system generates money through sales." "Inventory is all the money that the system has invested in purchasing things which it intends to sell." "Operational expense is all the money the system spends in order to turn inventory into throughput." Alex needs more explanation. Chapter Nine Alex fresh off his talk with Jonah gets word that the head of the company wants to come down for a photo opportunity with one of Alex’s robots. This gets Alex thinking of the efficiency of these robots. With the help of the accountant, inventory control woman, and the production manager, Alex discovers the robots increased costs, operational expenses, and therefore were less productive. Implementing the robots increased costs by not reducing others, like direct labor. The labor was shifted to other parts of the plant. Chapter Ten After explaining everything, Alex and his staff (Bob from production, Lou from accounting and Stacey from inventory control) hammered out the meaning of throughput, inventory and operational expense until satisfied. Lou, states the relationships as follows. "Throughput is money coming in. Inventory is the money currently inside the system. And operational expense is the money we have to pay out to make throughput happen." Bob is skeptical that everything can be accounted for with three measurements. Lou explains that tooling, machines, the building, the whole plant are all inventory. The whole plant is an investment that can be sold. Stacey says, "So investment is the same thing as inventory." Then they decide that something drastic is needed to be done with the machines. But how can they do that without lowering efficiencies? Another call to Jonah is placed and Alex is off to New York that night. Chapter Eleven The meeting with Jonah is brief. Alex tells Jonah of the problems at the plant and the three months in which to fix them. Jonah says they can be fixed in that time and then they go over the problems the plant has. First, Jonah tells Alex to forget about the robots. He also tells Alex that "A plant in which everyone is working all the time is very inefficient." Jonah suggest that Alex question how he is managing the capacity in the plant and consider the concept of a balanced plant. According to Jonah, this "is a plant where the capacity of each and every resource is balanced exactly with demand from the market." Alex thinks a balanced plant is a good idea. Jonah says no, "the closer you come to a balanced plant, the closer you are to bankruptcy." Then Jonah leaves Alex with another riddle, what does the combination of "dependent events" and "statistical fluctuations" have to do with your plant? Both of those seem harmless and should work themselves out down the production line. Chapter Twelve This short chapter tries to capture the essence of the problems the job is causing at home with the extra workload. The marriage is very strained because of the devotion Alex needs to give to the plant. Chapter Thirteen Stuck for the weekend as troop master, Alex discovers the importance of "dependent events" in relation to "statistical fluctuations". Through the analogy between a single file hike through the wilderness and a manufacturing plant, Alex sees that there are normally limits to making up the downside of the fluctuations with the following "dependent events". Even if there were no limits, the last event must make up for all the others for all of them to average out. Chapter Fourteen Finally, through the dice game or match bowl experiment, it becomes clear that with a balanced plant and because of "statistical fluctuations" and "dependent events" throughput goes down and inventory along with operating expenses goes up. A balanced plant is not the answer. (See the Dice Game or Match Bowl experiment note). Chapter Fifteen Fully understanding the "dependent events", Alex puts the slowest kid in the front of the hike and he relieves him of extra weight he has been carrying in his backpack. This balances the fluctuations and increases the kid’s productivity, which increased the throughput of the team. Chapter Sixteen Well, after the camping trip the boys arrive home to find the mother has disappeared. All the stress of his job was too much for her so she left. Now the kids and the job are all Alex’s responsibility. This was supposed to be a weekend for Alex and his wife, but when the hike came up it seemed to be the last straw for her. Chapter Seventeen Alex tries to portray his new revelation to his team at the plant. Nobody seems interested. But the walk in the woods becomes apparent when it is put to the test for an overdue order in the plant. Now even the production supervisor agrees. Now what? Chapter Eighteen In this chapter Jonah introduces Alex to the concept of bottlenecks and nonbottlenecks. Jonah defines these terms as follows. "A bottleneck is any resource whose capacity is equal to or less than the demand placed upon it. "A nonbottleneck is any resource whose capacity is greater than the demand placed on it." Jonah explains that Alex should not try to balance capacity with demand, but instead balance the flow of product through the plant. Later, Alex and his team recognize the bottlenecks, the areas where capacity doesn’t equal demand, like the slow kid Herbie on the hike. With this discovery goes the ideas related to reorganizing the plant like Alex did with the hike. Production is a process and it cannot be moved around so easily. Many processes rely on the previous one to be able to complete the next. Alex would need more machines, which takes more capital, and division is not going to go for that. Chapter Nineteen Well, Jonah makes a visit to the plant. Jonah tells Alex that a plant without bottlenecks would have enormous excess capacity. Every plant should have bottlenecks. Alex is confused. What is needed is to increase the capacity of the plant? The answer is more capacity at the bottlenecks. More machines to do the bottleneck operations might help, but how about making them run more effectively. Jonah tells them that they have hidden capacity because some of their thinking is incorrect. Some ways to increase capacity at the bottlenecks are not to have any down time within the bottlenecks, make sure they are only working on quality products so not to waste time, and relieve the workload by farming some work out to vendors. Jonah wants to know how much it cost when the bottlenecks (X and heat treat) machines are down. Lou says $32 per hour for the X machine and $21 per hour for heat treat. How much when the whole plant is down? Around $1.6 million. How many hours are available per month? About 585. After a calculation, Jonah explains that when the bottlenecks are down for an hour, the true cost is around $2,735, the cost of the entire system. Every minute of downtime at a bottleneck translates into thousands of dollars of loss throughput, because without the parts from the bottleneck, you can’t sell the product. Therefore, you cannot generate throughput. Chapter Twenty Alex organizes the bottlenecks to work on only overdue orders from the most overdue to the least. He then finds his wife. She is at her parent’s house. Through their conversation it is learned that she still needs to be away from everybody, even the kids. Chapter Twenty-One The crew works out some of the details for keeping the bottlenecks constantly busy. In the process they find that they need another system to inform the workers what materials have priority at non-bottlenecks. Red and green tags are the answer. Red for bottleneck parts to be worked on first as to not hold up the bottleneck machine, and green for the non-bottleneck parts. That concludes another week. The true test will be next week. Chapter Twenty-Two Great, twelve orders were shipped. Alex is pleased, but he definitely needs more. He puts his production manager on it. His production manager rounds up some old machines to complement what one of the bottlenecks does. Things are looking up. Chapter Twenty-Three They are becoming more and more efficient, but lag time arouse with the two bottlenecks because of workers being loaned out to other areas and not being at the bottlenecks when needed to process another order. It seems there was nothing to do while waiting for the bottleneck machine to finish the batch. Therefore, in keeping with the notion that everybody needs to stay busy, workers were at other areas between batches. Alex decides to dedicate a foreman at each location all the time. Then one of those dedicated foreman, the night foreman, discovers a way to process more parts by mixing and matching orders by priority, increasing efficiency by ten percent. Finally, one process being sent through a bottleneck could be accomplished through another older way and therefore free up time on the bottleneck. Chapter Twenty-Four Now that the new priority system is in place for all parts going through the bottlenecks, inventory is decreasing. That’s a good thing right? But lower inventory revealed more bottlenecks. This intrigues Jonah so he’s coming to take a look. Chapter Twenty-Five "There aren’t any new bottlenecks", says Jonah. What actually has happened is a result of some old thinking. Working non-bottlenecks to maximum capacity on bottleneck parts has caused the problem. All parts are stacked up in front of the bottlenecks and others are awaiting non-bottleneck parts for final assembly. There needs to be balance. The red and green tags need to be modified. It seems as if the bottlenecks will again control the flow, by only sending them exactly what they need and when they need it. Chapter Twenty-Six Ralf, the computer wiz, says he can come up with a schedule for bottleneck parts and when they should be released. This will alleviate any excess inventory in front of the bottlenecks, but what about the non-bottlenecks? Jonah says with the same data out of the bottlenecks to final assembly, you should be able to predict non-bottleneck parts as well. This will make some time, but there are enough parts in front of the bottlenecks to stay busy for a month. Chapter Twenty-Seven There is another corporate meeting. Mr. Peach doesn’t praise Alex like Alex thinks he should. Alex decides to talk with him in private. Mr. Peach agrees to keep the plant open if Alex gives him a fifteen percent improvement next month. That will be hard because that relies heavily on demand from the marketplace. Chapter Twenty-Eight Fifteen Percent!! Fifteen Percent!! Just then Jonah called to let Alex know that he will not be available to speak with in the next few weeks. Alex informs him of the new problem of more inventories and less throughput. Jonah suggests reducing batch sizes by half. Of course, this will take some doing with vendors, but if it can be done, nearly all costs are cut in half. Also, they get quicker response times and less lead times for orders. Sounds good. Chapter Twenty-Nine Alex is propositioned with a test. They can greatly increase sales, current and future, if they can ship a thousand products in two weeks. Impossible without committing the plant to nothing but the new order? Wrong! How about smaller batch sizes. Cut them in half again. Then promise to ship 250 each week for four weeks starting in two weeks. The customer loved it. Chapter Thirty Seventeen percent!! That’s great, but it’s not derived from the old cost accounting model. The auditors sent down to the plant from Division find just 12.8% improvement. Most of it accounts from the new order. Which by the way, the owner of the company that placed the order came down personally to shake everybody’s hand in the plant and to give a contract to them for not a thousand parts but ten thousand. Anyway, tomorrow is the day of reckoning at division. Chapter Thirty-One Well the meeting at Division started out rough. Alex thought he would be meeting with Mr. Peach and other top executives. Instead, he met with their underlings. He decides to try and convince them it doesn’t work. Just before leaving he decides to see Mr. Peach. It’s a good thing he did, because he just got promoted to Mr. Peach’s position. Now Alex has to manage three plants as the whole division. He calls Jonah desperately and asks for help. Jonah declines until he has specific questions. Chapter Thirty-Two Alex has a nice dinner with his wife. Through the veal parmesan and cheese cake it is decided that Alex should ask Jonah how he can get other people to understand these techniques that his team has discovered without being condescending. Chapter Thirty-Three Now is the time to assemble Alex’s team for Division. Surprisingly the accountant with two years to retirement is on board, but the production manager isn’t. He wants to be plant manager to continue their efforts. Everything is totally into place at the plant but more is needed for division. Chapter Thirty-Four Alex is firmly engrossed with the problems of taking over the division. With advice from his wife he decides to enlist the help of his team at the plant. Every afternoon they will meet to solve the problem. After the first day it is obvious , they will need them all. Chapter Thirty-Five The second day they are led in a discussion about the periodic table of elements, and how the scientists actually got a table of any sort. Maybe that is how they will solve the massive problems of division, by understanding how the scientists started with nothing and achieved order. A way to define them by their intensive order is needed. Chapter Thirty-Six The team finally comes up with the process: Step one – identify the system’s bottlenecks; Step two- decide how to exploit those bottlenecks; Step threesubordinate everything else to step two decisions; Step four- evaluate the systems bottlenecks; Step five- if, in a previous step, a bottleneck has been broken, go to step one. It seems so simple, just different. Chapter Thirty-Seven The team decides to revise the steps: Step one – identify the systems constraints; Step two – decide how to exploit the systems constraints; Step three – subordinate everything else to step two decisions; Step four – evaluate the systems constraints; Step five- warning!!! If in the previous steps a constraint has been broken, go back to step one, but don’t allow inertia to cause a system constraint. It also has been discovered that they have been using the bottlenecks to produce fictitious orders in an effort to keep the bottlenecks busy. That will free up twenty percent capacity, which translates in to market share. Chapter Thirty-Eight Talking with the head of sales. Alex finds out that there is a market order to fill the capacity. It’s in Europe, so selling for less there will not affect domestic clients. If it can be done, will open a whole new market. Then Alex ponders Jonah’s question, to determine what management techniques should be utilized. Alex determines how a physicist approaches a problem. Maybe this will lead to an answer. Chapter Thirty-Nine Alex experiences a problem at the plant. It seems all the new orders have created new bottlenecks. After analyzing the problem, they agreed to increase inventory in front of the bottlenecks an tell sales to not promise new order deliveries for four weeks, twice as much as before. This will hurt the new relationship between sales and production, but it is needed. Production is an ongoing process of improvement, and when new problems arise they need to be dealt with accordingly. Chapter Forty Finally, struggling with the answer to Jonah’s question, Alex comes up with some questions on his own: What to change? What to change to? How to cause the change? Answering these questions are the keys to management, and the skills needed to answer them are the keys to a good manager and ultimately the answer to Jonah’s question The Dice Game What is the Dice Game or Match-Bowl Experiment? At lunch on the hike Alex develops an experiment with bowls and matches to model a balanced plant. Bowls represent work stations, matches represent product inventory and one die (from a pair of dice) is used to simulate the statistical fluctuations (variation) in performance at each work station or operation. The bowls are set up as a production line representing dependent events where each operation has the same capacity, i.e., six products per day with a range of variation from one to six. Each player (scout) rolls the die to determine how many matches to place in his bowl. This represents one day's production for that operation. For example, if the first player rolls a six, then he places six matches in his bowl. If the next player rolls a four, he can only move four matches from the first bowl to his bowl. Each operation is dependent on the upstream operation for input. If the next scout rolls a five, he can only move four to his bowl because there are only four available in the previous bowl (upstream operation) in the process. The first scout to roll the four became the bottleneck operation. If another player down stream rolls less than a four, then he becomes the bottleneck. The scouts each roll the die several times in sequence to represent several days production and each time the bottleneck nearly always appears at a different operation or scout. The point of this game, or demonstration is to show that where each operation in a sequence of dependent events has the same amount of capacity (a balanced plant), the variation and dependent events will cause the bottleneck to move from operation to operation, i.e., floating bottlenecks occur. Managers will not know where the bottleneck will show up next and will not be able to manage the system. Traditional Costing, ABC, JIT and TOC Traditional Costing, ABC, JIT & TOC Summary & Comparison by James R. Martin Concept Original purpose Traditional Costing Inventory valuation and matching & overall profit Management control - variance analysis 1900 -1950 ABC More accurate product costs for management decisions Leads to activity based management JIT (Lean Enterprise) Reduce waste & increase efficiency TOC Improve scheduling in a job shop Expanded purpose When developed Concept of optimization Emphasis on improvement System philosophy of Continuous improvement System philosophy of Continuous improvement 1980s Promotes system optimization 1910 & Deming + Toyota Rediscovered 1980s 1950-1960 Promotes system optimization Promotes subNot addressed by system optimization ABC Assumes a static Not addressed by set of constraints to ABC, but extends to optimize within, not activity analysis improvement Short run emphasis Long run variable with long run costs implications Production and value added by production departments Cost tracing to provide accurate costs & profits by cost object, e.g., products etc Not addressed Kaizen to reach 5 step method based perfection using the on identifying Plan-Do-Check-Action constraints technique Long run improvement The whole system: interdependence, cooperation & synergy Short run emphasis with long run implications Making money by increasing throughput, decreasing assets and operating expenses Short or long run orientation Main focus or concept Production control or emphasis Overhead cost allocation emphasis & Push system with emphasis on labor efficiency & production volume Allocate using production volume based drivers Pull system using Demand pull using kanban authorizations the drum-buffer-rope to produce concept No cost allocations Trace to activities, Assign costs based then to products on cycle time in the using various drivers cells drivers Product costs accuracy Inventory levels Waste Capacity focus Not accurate distorted High Price and quantity variances Labor & machine utilization, production volume variances Inspect to find spoilage Increases profit Fairly accurate Not addressed Not addressed, extends to ABM Measure unused capacity costs to manage capacity Not addressed Increases profit Fairly accurate Minimum to zero Emphasis on eliminating Measured by cycle time. Emphasis on balancing capacity & the flow of work Quality at the source, Jidoka Using throughput costing it decreases profit Product costs do not exist Buffers in front of constraints Reduce to reveal constraints Balance the flow of work but do not try to balance plant capacity Emphasis at bottlenecks Using throughput costing it decreases profit Quality of conformance Effect producing excess inventory has on profit Relation to framework Consistent with the individualistic concepts Tends to promote it by showing that more diversity creates higher production volume and lower unit cost No explicit recognition of common cause variation Not addressed. Consistent with team Potentially okay with or communitarian either concept concepts Discourages it by showing the additional costs created by product diversity, i.e., overhead creeps up Not addressed specifically from the SPC perspective, but it recognizes that diversity creates variation in costs Product costs, service activity costs and customer costs all related to profitability Discourages it through the concepts of focused factories & dedicated cells Many similarities to the communitarian concepts, but TOC is not as broad Promotes it by showing that more diversity produces more throughput Signals towards increasing product diversity Recognition of the concept of variability Recognized and applied at the operator level with statistical process control (SPC) techniques Non-financial measurements such as cycle time, on time delivery, quality (% defects) inventory Recognizes variability referred to as statistical fluctuations & dependent events in TOC Performance Measurements Mainly financial measurements, i.e., variances, Net income and return on investment Maximize throughput, while minimizing inventory (i.e., assets) and operation expense turns as well as unit costs What is this thing called TOC? Goldratt, E. M. 1990. What is this thing called Theory of Constraints and how should it be implemented? New York: North Press, Inc. According to Goldratt, the purpose of this book is to answer two major questions: "What are the thinking processes that enable people to invent simple solutions to seemingly complicated situations?" and How can we use the psychological aspects of individuals and organizations to implement those solutions. The book includes two main parts and two appendices. Part I: What is this thing called the Theory of Constraints and Part II: How Should it be implemented? Part I: What is this thing called the Theory of Constraints Part I includes four chapters. In Chapter 1, Goldratt builds on the two major questions above by describing the five focusing steps listed below. In Chapter 2, he discusses the process of change, resistance to change, and how to overcome the resistance to change. The Effect-Cause-Effect method for identifying constraints is discussed in Chapter 3 and the Evaporating Cloud method of inventing simple solutions is explained in Chapter 4. These ideas are sketched out in the table below and discussed more fully following the table. 1. The Five Steps of Focusing Steps Expressed in Terms Five Focusing Steps of Continuous How To Implement Improvement 1. Identify the system's What to change? Use the Effect-Cause-Effect constraints. method to identify constraints. 2. Decide how to exploit What to change to? Use the Evaporating Cloud the Construct simple practical method to invent simple system's constraints. solutions. solutions. 3. Subordinate everything How to change? How to Use the Socratic method to else overcome the emotional induce people to invent to the above decision. resistance to change. solutions. The Socratic approach reduces or eliminates the emotional resistance to change and allows the inventor to take ownership of the idea. 4. Elevate the system's constraints. 5. If a constraint has been broken, go back to step 1, but do not allow inertia to cause a system's constraint. 2. The Process of Change The Socratic Method Any change is perceived by some as a threat, so a method is needed to overcome the emotional resistance to change with a stronger emotion. The Socratic method is discussed as a way to overcome resistance to change. Using this approach involves asking questions that help a person invent their own solutions. According to Goldratt, when you provide a person with the answers, you block them from the opportunity of inventing the answers for themselves and create emotional resistance to acceptance and implementation. In The Goal, Jonah (the consultant who appears to have all the answers) asks Alex (the plant manager with the problems) a series of questions, but does not provide the answers. Alex struggles with the questions but eventually discovers the answers and internalizes the whole concept of TOC in the process. By inventing their own solutions, Alex and his employees take ownership of the concepts. 3. How to Prove Effect-Cause-Effect The Effect-Cause-Effect Method Goldratt defines the effect-cause-effect method as the process of speculating a cause for a given effect (hypothesis) and then predicting other effects from the same cause. Verifying each predicted effect builds a logical tree and provides a powerful way to determine core problems. An example is provided from Chapter 4 of The Goal that combines the Socratic and effect-cause-effect methods. Alex meets Jonah, by chance in an airport between flights. Alex tells Jonah that his plant installed some robots that have increased productivity by 36%. Jonah responds, "So your company is making 36% more money from your plant, just by installing some robots?" Alex says no and thinks Jonah is confused. Jonah asks "Was your plant able to ship even one more product per day as a result of what happened in the departments where the robots were installed?" Again, the answer is no. "Did you fire anybody?" No. "Did your inventories go down?" No. "With such high efficiencies you must be running your robots constantly?" Yes, says Alex. Jonah continues, "Come on, be honest, your inventories are going through the roof, are they not? And everything is late, you can't ship anything on time." Jonah keeps building on a constant effectcause-effect analysis to help Alex discover his plants core problems. Walking towards the gate to board a plane, Jonah continues, "You think you are running an efficient plant ... but your thinking is wrong." Alex responds, "What's wrong with my thinking?" Jonah tells Alex that he has accepted so many things without question that he is not really thinking at all. "Tell me again why you believe your robots are such an improvement." "Because they increased productivity" Alex says. "And what is productivity?" With some more help from Jonah, Alex comes to the conclusion that productivity is the act of bringing a company closer to its goal. Jonah tells Alex that productivity is meaningless unless you know what your goal is. Alex responds that his companies goal is to increase efficiencies. Jonah says, "Your problem is you don't know what your goal is." "What is the real goal?" Alex wants Jonah to give him the answer, but Jonah says "Think about it, Alex. You can find the answer with your own mind." 4. How to Invent Simple Solutions Evaporating Clouds The Evaporating Clouds Method The evaporating clouds method is described in Chapter 4 and involves examining the foundations of the system. The idea is to find the minimum number of changes that are needed to create an environment where the core problem (big black cloud) cannot exist. You do not try to solve the problem, but instead cause the problem not to exist. Goldratt says to solve the problem involves a compromise. "The Evaporating Clouds method does not strive to reach a compromise solution, rather it concentrates on invalidating the problem itself." He uses the economic batch size as an illustration. Methods for finding the optimal solution have been taught for more than 50 years in almost every university, but few, according to Goldratt, have bothered to check the local objectives versus the global goal. The idea has been to find the compromise between setup costs and carrying costs. But there is usually a hidden assumption underlying every core problem. The evaporating clouds technique involves verbalizing the assumptions underlying the problem and challenging them to find the invalid assumptions. According to Goldratt, most problems are created when we try to satisfy local objectives that do not match the global goal. An underlying assumption in the batch size problem is that setup costs are fixed. We have learned from the concept of just-in-time that setup costs are not fixed. Significantly reducing setup time and effort eliminates the batch size problem. The cloud evaporates. A compromise solution is not needed. In this section of the book, Goldratt mentions that the word "cost" is a dangerous and confusing multi-meaning word and that the word "product cost" is "an artificial, mathematical phantom" (p. 49). Part II: How Should it be Implemented Part II includes five chapters: 1) How to become a Jonah; 2) The devastating impact of the organization's psychology; 3) Reaching the initial consensus and the initial step; 4) How to reach the top; and 5) What about existing new projects? 1. How to Become a Jonah In this chapter Goldratt provides a discussion of the 10 day Jonah course as it was taught during the time this book was written. The first day concentrates on terminology. Examples used are the process line, line design and line balance concepts. The second day emphasizes multi-purpose lines and simulations designed to focus on the verbalization process and the Effect-Cause-Effect method. The third day involves an assault on policy constraints and their devastating impact on an organization, and on properly focusing on the constraints rather than using a shotgun approach to improvement. The Evaporating Clouds method is introduced next with various homework assignments related to it's use. The homework is discussed and criticized by other students in the next session. The sessions continue through the second week with various case problems related to the particular group of students in the Jonah course. 2. The Devastating Impact of the Organization's Psychology This chapter addresses the questions of who should be Jonahs, how many Jonahs an organization should have, who should be first, and so on to provide the best way to introduce TOC into the organization. It is a discussion of the psychology and politics that make it difficult to introduce anything new. Goldratt says that the organization has it's own psychology in addition to the psychology of the individuals within the organization. Emotional resistance, the defense mechanism, can block the implementation. If TOC starts in one function, without involvement from the other functions within the organization, it is likely to be resisted and blocked by some other function. The message of this chapter is that all parts of an organization need to decide together on how to proceed. 3. Reaching the Initial Consensus and Initial Step From the discussion in the previous chapter it is clear that all functions in an organization need to be involved in the decision to implement the theory of constraints. The questions become who should be Jonahs, in what sequence, who should decide, and so on. The key ideas in this chapter appear to be the following: 1. Start at the division level. 2. Achieve a group consensus by the top people in each functional area. 3. This group should send the division head and the controller to the Jonah course. The controller has to be one of the first Jonahs because finance can block any other function. The controller has a dotted line outside the division to the top of the company. 4. The division head and controller should prepare the implementation plan and the sequence and timing related to the functional heads becoming Jonahs. 5. The implementation plan should be approved by the entire group before the implementation begins. 4. How to Reach the Top This chapter is very short and addresses the question of how a lower level manager, or staff person, can persuade the top people in a division to spend two or more days in a short Jonah course or seminar. Goldratt's advice is to get a top person, or one on your level, in another functional area to work with you to become Jonahs and then through the proper channels (your bosses' knowledge and okay) send a joint letter (signed by you and the other advocate) to the top person in the division. Use psychology and approach everyone in a positive way. Don't be critical of the current system, but point out that there appears to be a better approach to managing the organizations resources. 5. What About Existing Projects In this chapter Goldratts discusses the relationships between TOC, JIT and TQM. Comparing these concepts, with emphasis on the differences helps to blend them into one theory. All three concepts have the same objective, i.e., to increase the ability of the company to make more money. They all attack the same erroneous assumption and use the same new assumption. Each of the three concepts is an overall management philosophy. There are only three ways to improve the ability of a company to make money: 1) increase throughput, 2) decrease inventory or assets, and 3) reduce operating expense. All three concepts, TOC, JIT and TQM, reject the traditional ranking that places costs or operating expense first in the ranking. Part of the problem with the traditional approach is that cost accounting disguises part of operating expense as inventory. The main potential for improvement is in increasing throughput. Both inventory (assets) and operating expense are limited by zero, but the potential to increase throughput is unlimited. All three methods adopt the new ranking. Traditional Ranking JIT, TQM and TOC Ranking Operating expense Throughput Throughput Inventory or Assets Inventory or Assets Operating expense All three methods attack the underlying assumptions that created a problem related to inventory levels. They ask, Why do we need inventory to protect throughput? The answer, Because there are statistical fluctuations (variations) and dependent resources. All three methods attempt to reduce variation and recognize the interdependencies. Statistical process control is emphasized in the quality area to help identify ways to reduce variation. Cells are used to reduce the dependencies "... U cell configurations, where one worker is moving with the processed piece from one machine to another" (p. 120). Predetermined schedules in TOC reduce both variation and dependent resources. Viewing an organization from the operating expense world perspective causes one to believe that almost everything is important, that the organization is composed of independent variables. But viewing the organization from the throughput world perspective forces the realization that the organization is a collection of dependent variables and that the artificial barriers between these variables, or functions, must be eliminated. Managing the parts of an organization as if they were isolated kingdoms is not possible in the throughput world where throughput is the dominant measurement. In the throughput world, constraints become the main tools of management and the previous tool, product cost, can be discarded. Appendix 1: Sections from The Goal 1. The Encounter. Alex's first meeting with Jonah in the airport. 2. The Hike. Alex's discovery of the drum-buffer-rope concepts and the match bowl experiment related to why a company should not try to balance the plant. Appendix 2: The Theory of Constraints Journal Goldratt makes a few comments about each of the following. Volume 1, Number 1: Hierarchical Management - The Inherent Conflict. Volume 1, Number 2: Laying the Foundation. Volume 1, Number 3: The Fundamental Measurements. Volume 1, Number 4: The Importance of a System's Constraints. Volume 1, Number 5: How Complex Are Our Systems? Volume 1, Number 6: Coexistence or Amalgamation. TOC Problems TOC Problems & Introduction to Linear Programming TOC Problem 3: Determine the Optimum Product Mix with Overlapping Constraints TOC Problem 1: Find the Constraint & Product Mix needed to Maximize Throughput TOC Company produces two products, Y and Z that are processed in four departments, A, B, C and D. Product Y requires three types of materials, M1, M2 and M4. Product Z requires two types of materials, M2 and M3. The company's production process is illustrated in the following graphic adapted from Ruhl's Exhibit 1. The requirements for each product are summarized in the table below. Resource Material 1 Material 2 Material 3 Material 4 Department A Department B Department C Department D Required per unit of Product Y $100 $100 $15 15 minutes 15 minutes 15 minutes 15 minutes Required per unit of Product Z $100 $100 10 minutes 30 minutes 5 minutes 5 minutes Each department has 2,400 minutes of available time per week. The Company's operating expenses are $30,000 per week. Based on current demand, the company can sell 100 units of product Y and 50 units of product Z per week. Sales prices are $450 for product Y and $500 for product Z. All four materials are available in sufficient quantities. The needed workers are also available. Required: 1. Determine the company's constraint. 2. Determine the throughput per unit for each product. 3. Determine the throughput per minute of the constrained resource for each product. 4. Determine the product mix needed to maximize throughput, i.e., the number of units of Y and Z that should be produced per week. 5. Determine the maximum net income per week for TOC Company. 6. Suppose the company broke the current constraint by doubling the capacity of that resource. What would become the new constraint? Solution The following approach is useful when there are only two products and there is only one binding constraint in addition to demand. However, a different approach is needed when there are overlapping constraints, i.e., more than one binding constraint. Linear programming is needed to solve the more difficult problems involving multiple products with multiple binding constraints. 1. Determine the company's constraint. Time requirements to meet demand for each department are calculated as follows : Total Time Department Product Y Product Z Required Per Week A (15 min)(100 units) (10 min)(50 units) 2,000 minutes B (15 min)(100 units) (30 min)(50 units) 3,000 minutes C (15 min)(100 units) (5 min)(50 units) 1,750 minutes D (15 min)(100 units) (5 min)(50 units) 1,750 minutes Each machine center has only 2,400 minutes of available time per week. B is the constraint because it does not have enough capacity to process 100 units of Y and 50 units of Z per week. 2. Determine the throughput per unit for each product. Throughput per unit for each product is needed so that we can determine how to use the constraint to maximize throughput. Throughput per unit is as follows: Product Y Z Sales price - Materials Cost $450 - 215 $500 - 200 Throughput Per Unit $235 $300 3. Determine the throughput per minute of the constrained resource for each product. Product Y Z Throughput Per Unit Minutes required in B $235 ÷ 15 $300 ÷ 30 Throughput Per Minute $15.67 $10.00 4. Determine the product mix needed to maximize throughput, i.e., the number of units of Y and Z that should be produced per week. Maximizing throughput requires producing as much of the product with the highest throughput per minute of the constrained resource as needed to meet demand. So the company should produce 100 units of product Y. This requires (100 units)(15 minutes) = 1,500 minutes of time in the constraint department B and leaves 2,400 - 1,500 = 900 minutes for the production of 30 units of product Z, i.e., 900 minutes ÷ 30 minutes per unit = 30 units of Z. Graphic Analysis The following graphic analysis provides a general approach for solving simple product mix problems that is also applicable when there are overlapping constraints. First, plot the constraints to find the feasible solution space. The B constraint is 15Y + 30Z = 2,400 so Department B could produce 160 Y's (i.e., 2,400/15) or 80 Z's (i.e., 2,400/30), or some combination of Y and Z indicated by the constraint line connecting those two points on the graph. The department B constraint and demand constraints define the feasible solution space indicated by the mustard colored area on the graph. 2. Check the solution at each corner point, or plot the objective function and move it to the right as far as possible in the feasible solution space. The objective function is to maximize throughput where Throughput = 235Y + 300Z. Checking the corner points we find that 100 Y and 30 Z provides the greatest amount of throughput. Corner Point 100 Y and zero Z 100 Y and 30 Z 60 Y and 50 Z Zero Y and 50 Z Throughput (100)(235) = 23,500 (100)(235) + (30)(300) = 32,500 (60)(235) + (50)(300) = 29,100 0 + (50)(300) = 15,000 If we plot the objective function 235/300 (i.e., it takes .7833 of a Z to produce as much throughput as 1 Y), we can locate the solution by moving it to the outer most point in the feasible solution space as illustrated below. The first objective function shows that 100 Ys would produce the same throughput as 78.3333 Zs. This is an iso-throughput line indicating that any point on the line represents a combination of Y and Z that produces $23,500 of throughput. The point indicated by 100 Y and 30 Z is the last point the objective function touches in the feasible solution space as we move it up and to the right. This point indicates the solution to our product mix problem. 5. Determine the maximum net income per week for TOC Company. Sales: 100 units of Y = (100)($450) 30 units of Z = (30)($500) COGS: 100 units of Y = (100)($215) 30 units of Z = (30)($200) Throughput Less Operating expense Net income $45,000 15,000 $21,500 6,000 $60,000 27,500 32,500 30,000 $2,500 Note: An assumption in this illustration is that there are no beginning or ending inventories of work in process or finished goods. See the Pop Company problem for an illustration with beginning and ending inventories. 6. Suppose the company broke the current constraint by doubling the capacity of that resource. What would become the new constraint? Doubling the capacity of Department B would allow the company to produce 60 units of product Z in addition to the 100 units of product Y. Since only 50 units of Z are demanded, the company would have unused capacity in all departments. Therefore, external demand would become the constraint. Of course the new solution would be at the intersection of the demand constraints, i.e., 100 Ys and 50 Zs. See TOC Class Problem 2 for an illustration with overlapping constraints. __________________________________________________ Ruhl, J. M. 1997. The Theory of Constraints within a cost management framework. Journal of Cost Management (November/December): 16-24. Ruhl's illustration is based on an example discussed by Goldratt in Chapters 12 and 13 of The Haystack Syndrome. See Goldratt, E. M. 1990. The Haystack Syndrome: Sifting Information Out of the Data Ocean. New York: North River Press. (Summary). TOC Problem2: Determine the Optimum Product Mix with Overlapping Constraints TOC Class Problem 2 (TOC Main) Adapted by James R. Martin from an illustration by Blocher, Chen and Lin Hart Furniture Company produces two products, End Tables and Sofas that are processed in five departments, Saw Lumber, Cut Fabric, Sand, Stain, and Assemble. End tables are produced from raw lumber. Sofas require lumber and fabric. Glue and thread are plentiful and represent a relatively insignificant cost that is included in operating expense. The specific requirements for each product are provided in the table below. Resource or Activity & (Quantity available per month) Lumber (4,300 board feet) Fabric (2,500 yards) Saw Lumber (280 hours) Cut Fabric (140 hours) Sand (280 hours) Stain (140 hours) Assemble (700 hours) Required per End Table 10 board ft @ $10 = $100 30 minutes 30 minutes 20 minutes 60 minutes Required per Sofa 7.5 board ft @ $10 = $75 10 yards @ 17.50 = $175 20 minutes 20 minutes 10 minutes 30 minutes 90 minutes The Company's operating expenses are $75,000 per month. Based on current demand, the company can sell 300 End Tables and 180 Sofas per month. Sales prices are $300 for End Tables and $500 for Sofas. Required: 1. Determine Hart Company's constraint. 2. Determine the throughput per minute of the constrained resource for each product. 3. Determine the product mix needed to maximize throughput, i.e., the number of End Tables and Sofas that should be produced per month. 4. Determine the maximum net income per month for Hart Company. 5. Suppose Hart Company broke the current constraint resource. What would become the new constraint? 6. Solve the Hart Company product mix problem assuming that only 3,000 board feet of lumber can be obtained rather than 4,300 board feet. Solution As indicated in the first example, the following approach can be used to solve a simple product mix problem when there is only one binding constraint, i.e., no overlapping constraints. 1. Determine Hart Company's binding constraint. Resource requirements to meet demand for each department are calculated as follows: Activity & (Quantity available per month) Lumber (4,300 board feet) Fabric (2,000 yards) Saw (16,800 min) Cut &Trim (8,400 min) Sand (16,800 min) Stain (8,400 min) Assemble (42,000 min) End Table (10 board ft)(300) (30 min)(300) (30 min)(300) (20 min)(300) (60 min)(300) Sofa (7.5 board ft)(180) (10 yards)(180) (20 min)(180) (20 min)(180) (10 min)(180) (30 min)(180) (90 min)(180) Total Amount of Resource Required Per Month 4,350 board feet 1,800 yards 12,600 minutes 3,600 minutes 10,800 minutes 11,800 minutes 34,200 minutes The Stain activity is the binding constraint because it does not have enough capacity to process 300 End Tables and 180 Sofas per month. 2. Determine the throughput per minute of the constrained resource for each product. First we need to determine the throughput per unit for each product so that we can determine how to use the constraint to maximize throughput. Throughput per unit is as follows: Product End Tables Sofas Sales price - Materials Cost $300 - 100 $500 - 250 Throughput Per Unit $200 $250 Then we can determine the throughput per minute of the constrained resource for each product as follows. Product End Tables Sofas Throughput Per Unit Minutes required in Stain $200 ÷ 20 $250 ÷ 30 Throughput Per Minute $10.00 $8.33 3. Determine the product mix needed to maximize throughput, i.e., the number of End Tables and Sofas that should be produced per month. Maximizing throughput requires producing as much of the product with the highest throughput per minute of the constrained resource as needed to meet demand. So the company should produce 300 End Tables. This requires (300 units)(20 minutes) = 6,000 minutes of time in the constraint and leaves 8,400 - 6,000 = 2,400 minutes for the production of 80 Sofas, i.e., 2,400 minutes ÷ 30 minutes per unit = 80. Graphic Analysis The following graphic analysis provides a general approach for solving simple product mix problems that is also applicable when there are overlapping constraints. First, plot the constraints to find the feasible solution space. The staining constraint is 20ET + 30S = 8,400 minutes, so staining could produce 420 ETs (8,400/20) or 280 Sofas (i.e., 8,400/30), or some combination of ETs and Sofas indicated by the constraint line connecting those two points on the graph. The Staining constraint and demand constraints define the feasible solution space indicated by the green area on the graph. The lumber constraint is 10ET + 7.5S = 4,300 so the company could produce 430 ETs (4,300/10) or 573.33 Sofas (4,300/7.5) with the available lumber. Plotting the lumber constraint shows that it is not a binding constraint, i.e., it does not limit the feasible solution space on the graph. Next, check the amount of throughput that could be obtained at each corner point, or plot the objective function 200 ET + 250S and move it up and to the right as far as possible without leaving the feasible solution space. The first objective function is plotted to indicate the slope of the function (200/250 = .8 means that it takes only .8 of a Sofa to produce as much throughput as 1 ET) and shows that 250 ETs produces the same throughput as 200 Sofas, i.e., (250 ETs)($200) = (200 Sofas)($250) = $23,500. Either approach (checking the corner points or using the objective function) reveals that 300 ETs and 80 Sofas is the optimum solution. 4. Determine the maximum net income per month for Hart Company. Sales: 300 End Tables = (300)($300) 80 Sofas = (80)($500) COGS: 300 End Tables = (300)($100) 80 Sofas = (80)($250) Throughput Less Operating expense Net income $90,000 40,000 $30,000 20,000 $130,000 50,000 80,000 75,000 $5,000 Note: An assumption in this illustration is that there are no beginning or ending inventories of work in process or finished goods. See the Pop Company problem for an illustration with beginning and ending inventories. 5. Suppose Hart Company broke the current constraint. What would become the new constraint? Breaking the Stain activity constraint would cause Lumber to become the constraint resource because 4,350 board feet are needed and only 4,300 board feet are available per month. 6. Solve the Hart Company product mix problem assuming that only 3,000 board feet of lumber can be obtained rather than 4,300 board feet. Where there are overlapping constraints as in this case, the solution obtained using the first approach indicated above is not recommended. The graphic approach is more reliable.With only 3,000 board feet of lumber, the company can produce 300 ETs (3,000/10) or 400 Sofas (3,000/7.5), or some combination of the two as indicated by the new lumber constraint line on the graph. The feasible solution space is smaller than before and is now defined by lumber and staining as well as product demand as indicated in the graph below. The solution can be found by examining the potential throughput at each of the corner points 1, 2, 3, and 4. Corner Point 1. 300 ETs and zero Sofas 2. 180 ETs and 160 Sofas 3. 150 ETs and 180 Sofas 4. Zero ETs and 180 Sofas Throughput (300)(200) = 60,000 (180)(200) + (160)(250) = 76,000 (150)(200) + (180)(250) = 75,000 (180)(250) = 45,000 Point 2 provides the solution because it provides the greatest amount of throughput. The solution can also be found by using the objective function. If we plot the objective function we can locate the solution by moving it to the outer most point in the feasible solution space as illustrated below. The point indicated by 180 ETs and 160 Sofas is the last point the objective function touches in the feasible solution space as we move it up and to the right. This point indicates the solution to our product mix problem. The objective functions in the graph are iso-throughput lines indicating that any combination of ETs and Sofas on the line produces the same amount of throughput, i.e., $23,500 of throughput for the lower function and $76,000 for the function indicating the solution point. The graphic solutions to the Hart Company problem and the TOC problem are both fairly simple. For problems with multiple products and multiple constraints there is no graphic equivalent, but these simple problems provide a conceptual view and introduction to more realistic product mix problems and are useful for introducing both TOC and the linear programming technique. __________________________________________________ __________________________________________________ Blocher, E. J., K. H. Chen and T. W. Lin. 2001. Cost Management: A Strategic Emphasis, 2nd edition. Irwin McGraw-Hill. TOC Class Problem 3 (TOC Main) Adapted by James R. Martin from an illustration by Elwood S. Buffa Buffa Company produces two products, X and Y that are processed in two departments, A and B. The requirements for each product are provided in the table below. Resource Required per unit of Product X Required per unit of Product Y Department A Department B 2 hours 3 hours 4 hours 2 hours Weekly capacity is 80 hours for Department A and 60 hours for Department B. Throughput per unit is $60 for X and $50 for Y. Required: 1. Assume that the company can sell as much of X and Y as it can produce. Determine the number of units of X and Y that should be produced per week to maximize throughput. 2. Now assume that Weekly demand is 12 for Product X and 14 for Product Y. What would be the new product mix needed to maximize throughput? Solution Question 1: Where there are no demand constraints. The Department A constraint is 2X + 4Y = 80 so the company can produce 40 units of X (80/2) or 20 units of Y (80/4) or some combination of X and Y on the line connecting those two points on the graph. The Department B constraint is 3X + 2Y = 60 so the company can produce 20 units of X (60/3) or 30 units of Y (60/2) or some combination of X and Y on the line connecting those two points on the graph. We can find the solution by checking the throughput at each of the corner points. 1. 20Y @ $50 = $1,000 throughput. 2. 20X @ $60 = $1,200 throughput. 3. 15Y @ $50 + 10X @ $60 = $1,350 throughput. The last point represents the solution since it produces the greatest throughput. Another way to find the solution is to plot the objection function. The objection is to maximize throughput = 60X + 50Y. It takes 1.2Y (60/50) to generate as much throughput as 1X, i.e., (1.2)(50) = 60. The first objective function plotted is 12Y and 10X. Moving the objective function up and to the right, parallel to this function indicates the solution point on the graph at 15 units of Y and 10 units of X. Question 2: Where the demand constraints limit the solution space. We can see that the solution space becomes smaller after plotting the demand constraints and the original solution is no longer feasible. Checking the throughput at the corner points we have: 1. 14Y @ $50 = $700. 2. 14Y @ $50 + 10.67@ $60 = $1,340.20. If we use (14)(2 hours) = 28 hours for Y, then there are 60-28 = 32 hours left for the production of 10.67 X (i.e., 32/3). 3. 12X @ $60 = $720. 4. 12X @ $60 + 12Y@ $50 = $1,320. Point 2 is the solution. Using the objective function also shows that the point where Y = 14 and X = 10.67 is the solution point since that is the last point within the solution space that the objection function touches as we move it up and to the right. As indicated in previous illustrations, graphic solutions are only useful for solving simple introductory problems. A technique such as linear programming is needed for more realistic product mix problems. Linear programming and many other techniques are illustrated in operations management and quantitative methods textbooks. __________________________________________________ Buffa, E. S. 1963. Models for Production and Operations Management. John Wiley & Sons. Chapter 12. Discussion Questions Questions related to the Theory of Constraints What do Deming's New Economics, Senge's Fifth Discipline, Baker's Scoring a Whole in One, and Goldratts What is this thing called the Theory of Constraints? have in common? (See the Castellano, Young & Roehm summary). 1. What is the goal? (See MAAW's Chapter 8) or (See the Ruhl summary). 2. What prevents an organization from achieving the goal? (See the Ruhl summary). 3. What is a constraint? (See the Ruhl, Atwater & Gagne, Rezaee & Elmore and Huff summaries. Question 1 in the TOC Company problem is also relevant). 4. How is a bottleneck defined in TOC? (See the summary of The Goal Chapter 18). 5. Why does Goldratt condemn placing emphasis on the efficiency of nonconstraints? (See MAAW's Chapter 8). 6. How is net profit defined in TOC? (See MAAW's Chapter 8 Exhibit 8-6 alternative). 7. What is throughput? Provide a conceptual definition as well as a calculation. (See MAAW's Chapter 8 or the Ruhl summary and graphic view). (See summary of The Goal Chapter 8 and Chapter 10). (For an example of throughput in healthcare see the Kershaw summary). 8. What is inventory in the theory of constraints? (See MAAW's Chapter 8 or the Ruhl summary and graphic view). (Also see the summary of The Goal Chapter 8 and Chapter 10). 9. How is net profit increased in TOC? (Three ways.) (See the Ruhl summary). 10. What is the order of importance of the three methods of increasing net profit in TOC? (See the Ruhl summary). 11. In reference to question 10, what is the order of importance in traditional cost accounting? (See the Ruhl summary). 12. How is the TOC measure of ROI = (T-OE)÷I = NI÷I different from Dupont’s measurement, i.e., (Margin)(Turnover) = (NI÷Sales)(Sales÷Investment) = NI÷I? (See Comparing Dupont's ROI with Goldratt's ROI). 13. Goldratt argues that traditional accounting mixes controllable and uncontrollable costs in cost of goods sold. What does he mean by this? 14. Goldratt argues that accounting measurements (either traditional absorption costing, direct costing, or ABC costing) all rely on a poor, or invalid assumption about value added. What does he mean by this? When is value added in TOC? (For some ideas, see the Ruhl and Baggaley& Maskell summaries). 15. Goldratt argues that throughput accounting produces the most conservative and objective income statements and balance sheets in the context of GAAP. What does he mean by this and what do you think? 16. Does Goldratt confuse book value with market value in his arguments, i.e., questions 15&16? 17. What is a balanced plant? (See Step 3 in MAAW's Chapter 8 and the summary of The Goal Chapter 11). 18. What is Goldratt’s match bowl experiment designed to show? (See the Match Bowl note and Summary of The Goal Chapter 14). 19. Does JIT attempt to balance the plant? It so, how? 20. What does Goldratt mean by balancing the flow? (See Step 3 in MAAW's Chapter 8). 21. What is the difference between activating and utilizing a resource? (See Rules for scheduling in MAAW's Chapter 8). 22. Why is time saved at a non-constraint resource or non-bottleneck an illusion? (See Rules) 23. What is Goldratt’s prescription for increasing throughput? (See Chapter 8). 24. What is the drum-buffer-rope method? What do the drums, buffers and ropes represent? (See Drum-Buffer-Rope System and the Huff summary). 25. According to Goldratt, what is wrong with the concept of a cost center? (See the summary of Westra, Srikanth and Kane). 26. Why does Goldratt advocate placing a quality control emphasis in front of a bottleneck? 27. In traditional absorption costing, what happens to NI when the product inventory (i.e., work in process and finished goods) increases? Why? (See the Pop Company problem for questions 27-30). 28. What happens to NI when the product inventory decreases in absorption costing? Why? 29. In throughput costing, what happens to NI when the product inventory increases? Why? (See the Pop Company problem for questions 27-30). 30. What happens in throughput costing when the product inventory decreases? Why? 31. Does ABC encourage, or discourage product diversity? Why? 32. Does TOC encourage or discourage product diversity? Why? 33. Goldratt argues that there is no such thing as a product cost and wants to purge the term "product cost" from our vocabulary? Why? (See Goldratt 90 summary). 34. Compare Goldratt’s five step approach to the Deming-Shewhart PDSA cycle. (See MAAW's Chapter 8 for TOC Steps, the PDSA graphics and the Kershaw graphic). 35. Goldratt argues "don’t think cost, think throughput". Why? (See the Goldratt 92 summary). If product costs are not determined in TOC, how are products priced? (See the Baggaley & Maskell summary). 36. Is the goal in TOC too narrow? Discuss the issue. (See the Handy 2002 summary). 37. What are some ways to exploit a constraint? (See Step 2 in MAAW's Chapter 8 and the Kershaw summary). 38. What does it mean to break a constraint? 39. What is a floating bottleneck? What causes this to occur? (See the Match Bowl note and the summaries of The Goal Chapters 18 and 19 and Chapters 1114). 40. Why is Goldratt opposed to compromise? (See Goldratt 90 summary). 41. Discuss TOC in relation to JIT. Is there a conflict between the philosophies and the various practices associated with each? (See the Comparison and see the Goldratt 92 summary). 42. Goldratt is critical of the JIT emphasis on non-financial measurements of performance. What is his argument? (See Chapters 10 and 24 of the Haystack Syndrome summary). 43. Discuss the concept of variability in relation to TOC and JIT. 44. Some authors argue that TOC and ABC can be integrated. What is the main argument related to this view? (See the summaries by Holmen, Huang, Coate and Frey, Demmy & Talbott, Kee, MacArthur 93, Campbell 95 and Campbell, Brewer & Mills). 45. Other authors argue that accounting professionals cannot agree with both TOC and ABC and that those who discuss integration focus on the wrong issue. What is the relevant issue according to these critics? Discuss this opposing viewpoint. (See the ummaries of Louderback & Patterson, Corbett, Westra, Srikanth & Kane and Goldratt 92). 46. What is the Evaporating Cloud Method? What is the purpose and how does it work? (See the Goldratt 90 summary). 47. What is the Effect-Cause-Effect Method? What is the purpose and how does it work? (See the Goldratt 90 summary). 48. What is the Socratic Method? Why does Goldratt advocate using the Socratic method? (See the Goldratt 90 summary). 49. What is the goal of the product mix decision in TOC? See the TOC Problems. 50. How is the product mix determined in a TOC system? See the TOC Problems. CHAPTER 11 What is a theory? http://maaw.info/ArticleSummaries/ArtSumChristensenRaynor03.htm Christensen, C. M. and M. E. Raynor. 2003. Why hard-nosed executives should care about management theory. Harvard Business Review (September): 67-74. Summary by Kelly Brummett Master of Business Administration Program University of South Florida, Fall 2003 The formula for success at one company does not always translate into success for another company. Yet, consultants and managers all too frequently apply the same principles of success in every situation. It is imperative that the dynamics of the company be examined before applying any theory. Management must first understand what a theory is and from where it is derived. “A theory is a statement predicting which actions will lead to what results and why” (p. 68). Actions are not just arbitrarily taken; rather they are the result of an expectation by a manager. Theories are important for two reasons: 1) Assist in helping individuals make decisions; and 2) Provide guidance for understanding what is happening in the present and why. Theories are the product of a three-stage process. First, a phenomenon to be investigated must be described. The first stage is very important because the phenomenon needs to be carefully observed, taking note of its breadth and complexity. In the second stage, aspects of the phenomenon are classified into useful, relevant categories. This categorization allows researchers to organize complex information into meaningful distinctions. Finally, during stage three, researchers can develop a hypothesis of cause and effect relationships of the phenomenon. The three stages of theories are constantly repeated until researchers are confident enough to make predictions about what should happen in similar circumstances. Frequently, while repeating the process, researchers observe something in the theory that cannot be explained or predicted, an anomaly that implies something different is occurring. It is then imperative to revert to the second stage to re-examine the categories defined. The presence of an anomaly allows researchers to more accurately explain how the phenomenon should work in a variety of situations. For example, Michael Porter saw anomalies in the theory of comparative advantage that had for many years explained international trade. His research demonstrated that while the traditional theory on comparative advantage was valid, other factors played important roles in a country’s ability to increase its advantage in the global market. His theory of “clusters” explained how a country could exploit its natural resources, but another country lacking essential natural resources can create policies to build “process-based comparative advantage” (p. 69). Typically, early in the research process, categories are defined according to the attributes that seem to be correlated with a particular outcome. However, categorization based on correlations is actually based on the researchers uncertainty. Stating that a casual relationship exists as a result of correlation implies that researchers do not fully understand what causes a given result. Unfortunately, many researchers use the correlation basis, incorrectly believing that they can increase their results using supercomputers and databases for number crunching and regression analysis to manufacture statistical significance. Breakthroughs in determining causality do not come from number crunching, but from a careful, detailed inspection of the companies to view the processes in action. For example, it was superficially thought that Toyota’s success in manufacturing had to be related to Japan’s culture. However, after researchers visited a Japanese plant, they noticed more significant characteristics of the system, including minimum levels of inventory and kanban card scheduling systems. Sadly, the researchers then equated the attributes of the plant’s success with its results. Many wrote books and articles encouraging managers in manufacturing plants to adopt the Toyota philosophy to improve quality, increase efficiency, and reduce costs. More careful analysis of Toyota by Spear and Bowen revealed that the success of the company was attributed to “four specific rules that create automatic feedback loops, which repeatedly test the effectiveness of each new activity, pointing the way toward continual improvements” (p. 71). In order to be predictable, researchers have to ask, “What will cause this theory to fail?” instead of asking, “What characteristics are associated with success?” Researchers need to not only identify causal mechanisms, but also need to explain which situations cause the mechanisms to fail or succeed. Elaborating on circumstances, known as circumstance contingent, allows managers to understand when theories should be adjusted to fit their particular environment. It also helps management recognize changes in their competitive environment and to begin shifting in efforts to sustain success in the new environment. Theories that are circumstance contingent help success become predictable and sustainable. It is essential that researchers not only understand what factors lead to success, but also the factors that lead to failure. Simply following the “best practices” of successful companies very often ends with disastrous consequences. For example, in 1999, Lucent Technologies followed the management restructuring and reorganization fad. The company divided into 11 “hot businesses” with each operating independently. Much to top executive’s surprise, the division autonomy did not increase growth or profitability. Instead, the reorganization made Lucent less flexible, slower to respond to customer needs, and created new costs. The company fell victim to the remedy of the moment. When researchers identify circumstance contingent theories, managers are better able to diagnose the situation that they are in, and conversely, not in. Studies conducted by the authors indicate that rarely are success theories bound by industry barriers such as product-based versus service-based. Therefore, theories should only be trusted when they explain how phenomenon leads to success as a company’s circumstances change. It is important for managers to learn how to identify a good theory. Foremost, be skeptical of articles that merely describe a phenomenon. Researchers who have formulated circumstance contingent theories often build on descriptive accounts of causal relationships. Second, be careful not to trust an article with a solution that cures all business’s problems. It is very rare that new categorizations reshape established thinking. Third, if authors categorize a phenomenon based solely on attributes, just assume that it is a starting point for a circumstance contingent theory to be discovered. Fourth, “correlations that masquerade as causation often take the form of adjectives. . . a real theory should include a mechanism – a description of how something works” (p. 73). And lastly, remember that a researcher’s test results should not be considered final. Progress is a result of constant testing to understand which situations will lead to failure in efforts to refine the theories. CHAPTER 11.1 Changing Minds - Academic Theories Links http://maaw.info/TheoryLinks.htm This is the deepest level of information on this site, covering lots of academic theories that are relevant to changing minds. • • • • • • • • • • • • • Alphabetic list of Theories: All the theories in one big alphabetically-sorted list! Motivation: Basic systems that get us going (and keep us going). Belief: What and how we believe. Meaning: How we make sense of the world and infer meaning. Emotion: Affect and what we feel as emotion. Memory: Memorizing and recall. Attention: How we pay attention to things around us. Understanding ourselves: How we perceive ourselves. Understanding others: How we make sense of other people. Discomfort: How we handle discomfort. Attribution: How we attribute cause. Forecasting: How we forecast what will happen. Decision-making: How we make decisions. Grouped by type: • • • • • • • • • • • • • • Decision errors: Mistakes when we make decisions. Conforming: Conforming with social rules. Being contrary: Acting differently or in non-conforming ways. Helping others: Sometimes we are just very helpful. Persuasion: Changing the minds of others. Resistance: Resisting attempts to persuade. Trust: Building trust of others. Leadership: Leading followers. Lies: Telling things that are not true. Power: Being able to achieve our goals. Friendship: Making friends with others. Behavior: General behavioral responses. Groups: How groups think and act. Clusters: All theories in clusters of meaning (similar to above). There is also: SEE ALSO Psychoanalysis, Critical Theory CHAPTER 11.2 Management History CONTINGENCY MANAGEMENT THEORY Provides an overview of management theory history. Describes the benefits of systems and contingency theory in integrating managerial techniques. ollie.dcccd.edu Overview of Contemporary Theories in Management Briefly describes the principles of Contingency and Systems theory in the context of modern management systems. www.managementhelp.org Fiedler's Contingency Theory of Leadership Details Fred Fiedler's Contingency Theory of Leadership and its contribution to knowledge management. www.stfrancis.edu Sponsored Links MIT Executive Programs Providing managers with the skills to lead successful organizations mitsloan.mit.edu/execed Contigency Theory Search for Contigency Theory Find Contigency Theory Ask.com Contingency Definition Look Up Contingency Now Fast Definitions with Free Toolbar Dictionary.alot.com Guide to Contingency Management Theory Basics Learn how to become familiar with the basics of contingency management By Lesley Graybeal Contingency theory was developed by a number of key contributors to management thinking, including Fred Fiedler, Victor Vroom and Johannes Pennings, many of whom are still developing their theories today. Fiedler's contingency theory is a model that focuses on individual leadership behaviors and decision-making practices within an organization, while Vroom's models address leadership style. Pennings has developed a theory of interaction between external uncertainty, organizational structure and performance. Contingency management theory asserts that there is no one best way to manage an organization because external factors, known as contingencies, are always influencing the activities and outcomes. The structural contingency theories that emerged in the 1970s have had a major impact on many other contemporary management theories. Get to know the contingency management theory basics by investigating the following: 1. Learn how contingency theory fits into other management theories currently in use; 2. Use contingency management theory to evaluate and understand decision-making; 3. Discover how contingency theory is used to understand individual leadership. Action Steps The best contacts and resources to help you get it done GET TO KNOW THE FACTORS FOR CONTINGENCY MANAGEMENT THEORY BASICS Several main factors of organizations inform contingency management theory and should be considered when using a contingency model. The size of the organization, differences in resource allocation, how the firm adapts itself to the environment, managers' assumptions about their employees and corporate strategies and technologies are all contingencies that affect the activities of a given organization. I recommend: Use the Free Management Library to get a brief definition of contingency theory and place it in context with other contemporary theories of management. You can also find basic information on systems theory in management at 12Manage. UNDERSTAND HOW DECISION-MAKING IS VIEWED IN CONTINGENCY THEORY Contingency theory has specific ways of addressing the decision-making process at all levels of a business or organization. The contingency decision making process targets the creation of a consensus about goals and the use of technical knowledge to inform goal-setting. Contingency decision-making is usually evaluated using a grid of goal consensus and technical knowledge. I recommend: Read more about contingency theory decision-making at Value Based Management. You can also read more about the features of decisions made with high or low goal consensus and technical knowledge at Decide-Guide. USE CONTINGENCY THEORY TO UNDERSTAND INDIVIDUAL LEADERSHIP MODELS Fiedler's contingency theory of leadership is also a main component of broader contingency theory of management, and suggests that there is no best way for leaders to work in an organization with contingencies, that successful organizations and leaders should fit the environment and that management styles should be appropriate to the tasks and nature of the group. Fiedler also asserts that leadership combines with the contingencies of group atmosphere, task structure and a leader's power position to shape group performance. I recommend: Read about the LPC scale used to measure leadership development on the University of Wisconsin Eau Claire website. You can also learn how situational theories of leadership relate to other leadership theories, such as trait and behavioral theories that place more importance on individual characteristics and actions, at Infed. Tips & Tactics Helpful advice for making the most of this Guide • • If you are concerned with having a company that is able to meet changing demands and work dynamically in the global economy, consider adopting some level of contingency management theory in your management style. Contingencies of all types are becoming increasingly important for organizations to take into account as they are asked to constantly adapt their goals and activities to meet diverse demands. Guide to Using Contingency Management Theory Learn how to implement contingency management theory in your workplace By Lesley Graybeal Contingency management theory is one of many contemporary management theories that have come into widespread use since the 1970s. The basis for it is Fiedler's contingency theory, which combines ideas about uncertainty in the environment and external factors influencing work with context-specific features of leadership and decision-making. One important feature to keep in mind when using contingency management theory is the idea that all activities and actions are based within a certain context. Contingency management theory helps businesses take into account the contexts of their work in order to understand their company environments and increase effectiveness. Learn how to best implement contingency theory in your organization using the following steps: 1. Investigate Vroom's contingency theory models and software for discovering leadership type; 2. Use Fiedler's LPC scale to assess leadership behaviors using contingency theory; 3. Implement contingency theory through project and contingency planning models. Action Steps The best contacts and resources to help you get it done USE VROOM'S CONTINGENCY THEORY SOFTWARE TO UNDERSTAND LEADERSHIP AND DECISION-MAKING Vroom's contingency theory of leadership is easy to use in the workplace because Victor Vroom developed a number of user-friendly decision-making models available for use as contingency software programs. Vroom's contingency theories will help you use leadership decisions to map out leadership styles based on responses to contingency situations. I recommend: Download Vroom Contingency Theory Software online at KuduCroc, or just view a diagram of how Vroom's model works. View the Vroom-Yetton-Jago Normative Decision Model, which uses contingency theories to map out leadership type based on how leaders make decisions. USE FIEDLERS' CONTINGENCY THEORY INSTRUMENTS TO ASSESS LEADERSHIP QUALITIES Fred Fiedler developed several instruments for using the contingency theory of management with leaders. The most famous instrument is the LPC scale, or Least Preferred Co-Worker scale, which asks leaders to think of their least preferred co-worker and respond to questions about his/her characteristics. Responses are used to assess leadership qualities. I recommend: Read more about what the LPC scale is and how it is used in contingency theory at the University of St. Francis or Changing Minds. Access an online version of the actual LPC scale for use in your business or organization at Wiley. IMPLEMENT CONTINGENCY THEORY FOR EFFECTIVE PLANNING Contingency theory in management is widely used to create a more effective planning process that accounts for and adapts to a wide range of external factors. While you can't eliminate surprises or uncertainty from the environment, learning to plan for contingency situations is useful for any organization or individual. I recommend: Learn how to implement a project planning model based on contingency theory from Business Balls. Get comprehensive tips and instructions for developing contingency procedures for emergency situations from Contingency Planning and Management. Tips & Tactics Helpful advice for making the most of this Guide • • Educate or debrief all of your employees about the basic principles of contingency theory before using contingency management theory in the office. While many of the tools for using a contingency model seem straightforward, you will have much better results implementing a new way of thinking about planning and decision-making if everyone is on board and understands the basics. Guide to Contingency Management Theory Contingency Theory is a unique approach to leadership By Patricia Flinsch-Rodriguez, Freelance writer, Self-Employed The basic premise of Contingency Theory is that there is no one best way to lead an organization. There are too many external and internal constraints that will alter what really is the best way to lead is in a given situation. In other words, it all depends upon the situation at hand as to what will be the best course of action. Fred Fiedler is a theorist whose Contingency Trait Theory was the precursor to his Contingency Management Theory. Fiedler believed there was a direct correlation to the traits of a leader and the effectiveness of a leader. According to Fiedler, certain leadership traits helped in a certain crisis and so the leadership would need to change given the new set of circumstances. Fiedler's Contingency Theory proposes the following concepts: 1. Fiedler's Contingency Theory says there is no one best way to manage an organization. 2. Fiedler's Contingency Theory of leadership says that a leader must be able to identify which management style will help. achieve the organization's goals in a particular situation 3. The main component of Fiedler's Contingency Theory is the least preferred co-worker (LPC) scale which measures a manager's leadership orientation. Action Steps The best contacts and resources to help you get it done CLASSIFY YOUR ORGANIZATION BY THE 3 VARIABLES IN FIEDLER'S CONTINGENCY THEORY The 3 variables to consider are: how well the employees accept the leader; the extent that the employees jobs are described in detail; and the authority your leader possesses through his/her position in your organization. Contingency theories state that leaders will be able to exert more influence if they are able to have good relationships with the employees. In addition, contingency theory management maintains that in organizations where the tasks are spelled out in detail, the leader has more influence over the employees than in those organizations that do not have structured tasks. I recommend: Check out these sites from McGraw-Hill and Mind Tools for determining how you can classify your organization. UNDERSTAND THE INTERNAL AND EXTERNAL FACTORS CONTAINED IN FIEDLER'S CONTINGENCY THEORY Fiedler's Contingency Theory says that there are many internal and external factors that can influence the optimum organizational structure. These factors include the size of the organization, technology that is in use, leadership style, and how the organization can adapt to changes in strategy. I recommend: Look at Fiedler's LPC and e-COACH to learn more about Fiedler's Contingency Theory and other situational leadership styles. EVALUATE YOUR MANAGERS WITH FIEDLER'S CONTINGENCY THEORY MEASUREMENT TOOL Fiedler devised a least preferred co-worker (LPC) scale that can be used to measure whether your managers are task-oriented or relationship- oriented. The test is given to each manager and they simply rate a co-worker that they enjoyed working with the least, either in the past or in their current position. The manager rates that co-worker and chooses between 18 to 25 sets of adjectives on an 8 point scale between each set of values. I recommend: John Wiley & Sons has an online version of the contingency management test that scores the responses automatically so you can get an instant assessment for free. Check out some other leadership quizzes from Your Leadership Legacy, Test Cafe and Ramsay Corporation. Tips & Tactics Helpful advice for making the most of this Guide • Spending some time each day getting to know your subordinates helps strengthen your position in a Contingency Theory of Leadership model because you will be able to exert more influence on the employees. Guide to Contingency Management Theory Key Terms Understanding contingency management theory vocabulary is key to its implementation By Shannon Tani Contingency management theory states that there is no one right way to manage employees. Everything depends on the unique situation. Whether you are looking to use contingency management theory when managing your employees or you are an employee whose manager uses contingency theory, a good knowledge of the key terms associated with the field will help you to adjust. Fred Fiedler is a major player in contingency theory and many companies employ the least preferred co-worker scale. Action Steps The best contacts and resources to help you get it done FRED FIEDLER Fred Fiedler is the main theorist who developed the idea of contingency management. His theories focus on the leader and the way that the leader relates to the employees that he or she manages. I recommend: You can learn more about Fred Fiedler and his theories in the book Great Writers on Organizations by Derek Salman Pugh and David J. Hickson. LEAST PREFERRED CO-WORKER SCALE (LPC) The least preferred co-worker scale, or LPC, asks leaders to rate people with whom they do not enjoy working. The results of this 'test' show what type of leader he or she is. Those with a high LPC score focus on relationships when leading; those with a low LPC score focus on tasks when leading. I recommend: ChangingMinds.org describes the least preferred co-worker scale. VROOM-YETTON-JAGO NORMATIVE DECISION MODEL The Vroom-Yetton-Jago Normative Decision Model allows leaders to ask a series of questions about a project, which in turn shows them the best way to manage a particular project. For example, some projects require a higher level of participation from the leader. I recommend: Learn more about the Vroom-Yetton-Jago Normative Decision Model, including a diagram, from College of St. Scholastica. GARBAGE CAN MODEL The garbage can model states that an organization is similar to a garbage can in that people dump many different types of problems and solutions into it. I recommend: 12 Manage gives a more thorough description of the garbage can model. SITUATIONAL CONTROL Situational control is how a leader maintains control over a particular situation. Different types of situations require different methods and levels of control, and the leader's style should be suited to the project. I recommend: Learn more about situational control from Situational Control and a Dynamic Theory of Leadership. LEADER-MEMBER RELATIONS Leader-member relations are the ways that leaders and employees interact with each other. Good interactions are an important part of an organization's success. I recommend: The article Leader-Member Relations as a Function of Rapport Management discusses leader-member relations. Download the entire article to learn more. Directory Listings | Web Listings | Advertise With Us CHAPTER 11.3 CHAPTER 11.4 MANAGEMENT THEORIES BOB JENSEN'S THEORY PAGE CHAPTER 12 Links http://maaw.info/TheoryLinks.htm http://maaw.info/StrategyRelatedMain.htm MANAGEMENT AND ACCOUNTING WEBMANAGEMENT AND ACCOUNTING WEB =MANAGEMENT AND ACCOUNTING WEB Strategy Related http://maaw.info/StrategyRelatedArticles.htm Strategy Related Bibliography (Strategy Related Main) Abernethy, M. A. and A. M. Lillis. 2001. Interdependencies in organization design: A test in hospitals. 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Strategy and other Graphic Illustrations Causal Models, Strategy Canvases, Strategy & Value Stream Maps (Strategy Related Main) Strategy Canvases Causal Models & Value Curves Fast Food Sears Body Shop Borders and Barnes & Noble EFS Formule 1 Quicken Southwest Airlines Causal Models Fast Food Strategy Map Strategy Maps Balanced Scorecard Fannie Mae Mobil NAM&R Store 24 Value Stream Maps Sales Order Value Stream Sears Strategy Map Strategy Canvases & Value Curves Body Shop's Value Curve Borders and Barnes & Noble Value Curve Borders and Barnes & Noble Value Curve EFS Strategy Canvases See the Kim & Mauborgne summary for more explanation of these graphic illustrations. Formule 1's Value Curve Quicken's Value Curve Quicken's Value Curve Southwest Airline's Strategy Canvas Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost Management (March/April): 23-27.Summary by Hsin-Yi Chen Master of Accountancy Program University of South Florida, Fall 2004 The main purpose of this article is to explain the systems and controls that are best suited to the lean company. According to the authors, there are three major lean management issues that need to be considered: 1. Developing an appropriate management focus, 2. Organizing by value stream, and 3. Costing by value stream. This article (Part I) covers only the first two issues concerning the steps related to organizing the enterprise by value stream. Developing an Appropriate Management Focus A lean company places emphasis on creating value for customers. Value is added through many different processes rather than by one specific process such as production. For example, in the case where a customer places an order, value is added from taking the order, manufacturing products, shipping goods, collecting payment and after-sales services. The chain of these processes would become a value stream for sales (See Exhibit 1). A lean company recognizes the connections along the entire stream of the work performed in order to achieve a smooth flow of the product to satisfy customers; in other words, to create value for its customers. This is the key difference between the management focus of the lean company and the traditional company. The traditional management concept focuses on organizing or managing the company by production departments. Thus, each department is designed to be efficient rather than to produce a smooth flow of work to serve the next process or department. According to the authors, the primary purpose of management in a lean company is to identify the value stream in order to improve the flow of work required to meet customer needs. Organizing by Value Stream When lean manufacturing matures within the company, there is a need to manage the value stream. Thus a manager would be assigned with the profit and lost responsibility related to the value stream. The growth and improvement strategies revolve around the value stream because it provides the visibility for managing continuous improvement. The Simplicity of Value Stream Organization The lean company strives for simplicity of operation. Thus within a lean organization there would be only three or four value streams with a clear cut line of responsibility. A traditional organization would have a complex organization chart, hundreds of cost centers and thousands of transactions to keep track of people. It is obvious that managing with the value stream perspective really simplifies management. Value Stream as the Focus for Improvement For each value stream there would be a continuous improvement (CI) team to review the value stream performance measurement and make improvements on time. The CI team within the value stream can see the entire flow of the work, thus the improvement benefits the whole system rather than a single process. Implementing the Value Stream Organization Implementing lean manufacturing can include implementing value stream management at the same time. Basically, there are three stages in the progression (see Exhibit 2). At stage 1, lean manufacturing is first introduced and a pilot lean cell is implemented. There is no need to change the original organization chart in the short term. At stage 2, lean manufacturing widely spreads in the plant and product groups, crossing organizational lines within the plant as each lean cell is linked into the value streams. At this stage it is necessary to manage by value stream and assign both production and support people to each value stream. Support people are important to the value stream because they make sure that the services are there to maintain the rate of production. The authors provide an example of support functions that need to be more available to a lean value stream: 1. Production Control – to manage the size and number of kanbans required to achieve value stream target rates of production. 2. Transportation – to ensure that the right materials and tooling are at the right cells and at the right time. 3. Procurement – to ensure that materials are received from suppliers in the right quantities and on time. 4. Manufacturing Engineering – to ensure the focus on continuous improvement. 5. Maintenance – to limit equipment downtime, especially in a constraint resource. There may be a problem of assigning people to value streams due to a shortage of people. It may be necessary to have a person serving in many value streams for the short-term, but for the long-term cross training would become necessary to solve this problem. It might appear that implementing lean manufacturing with the value stream concept would require additional people, e.g., several production planners rather than a single production planner. However, this potential problem can be solved in two ways by: 1. Eliminating unnecessary administrative tasks, for example, production planning would not be needed when an effective pull system is in place. 2. Cross training can help in providing support skills in every value stream. Thus, no additional people would be needed and each value stream would have all the required skills. For complex organizations, they may find that a matrix management structure (people still report to their functional bosses, but are assigned to work in particular value stream teams) is a convenient way to adopt lean manufacturing without disrupting the organization. A medium or small size business can simply forego its original structure and adopt a new one to reflect value stream management. Conclusion In conclusion, the authors provide some rules of thumb as guidelines: 1. When implementing lean manufacturing and value streams, move ahead step-by-step. 2. A value stream should contain between 25 and 100 people. When the stream contains too many people, it will not be able to maintain the small-team focus required. When there are too few people, it will not be able to maintain an effective operation. 3. A value stream should represent a significant part of the business. A business usually has three major value streams and a fourth one to combine all the other functions that do not fit in. 4. A key idea of value stream management is to have the majority of people working in the major streams, with only a few additional supporting departments to maintain the smooth operation of the business. __________________________________________ Note: The second article in this set is Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part II. Journal of Cost Management (May/June): 24-30. (Summary). Strategy Maps Balanced Scorecard Generic Strategy Map FannieMae's Strategy Map Mobil NAM&R's Strategy Map Store 24's Strategy Map Value Stream Maps Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost Management (March/April): 23-27. Summary by Hsin-Yi Chen Master of Accountancy Program University of South Florida, Fall 2004 The main purpose of this article is to explain the systems and controls that are best suited to the lean company. According to the authors, there are three major lean management issues that need to be considered: 1. Developing an appropriate management focus, 2. Organizing by value stream, and 3. Costing by value stream. This article (Part I) covers only the first two issues concerning the steps related to organizing the enterprise by value stream. Developing an Appropriate Management Focus A lean company places emphasis on creating value for customers. Value is added through many different processes rather than by one specific process such as production. For example, in the case where a customer places an order, value is added from taking the order, manufacturing products, shipping goods, collecting payment and after-sales services. The chain of these processes would become a value stream for sales (See Exhibit 1). A lean company recognizes the connections along the entire stream of the work performed in order to achieve a smooth flow of the product to satisfy customers; in other words, to create value for its customers. This is the key difference between the management focus of the lean company and the traditional company. The traditional management concept focuses on organizing or managing the company by production departments. Thus, each department is designed to be efficient rather than to produce a smooth flow of work to serve the next process or department. According to the authors, the primary purpose of management in a lean company is to identify the value stream in order to improve the flow of work required to meet customer needs. Organizing by Value Stream When lean manufacturing matures within the company, there is a need to manage the value stream. Thus a manager would be assigned with the profit and lost responsibility related to the value stream. The growth and improvement strategies revolve around the value stream because it provides the visibility for managing continuous improvement. The Simplicity of Value Stream Organization The lean company strives for simplicity of operation. Thus within a lean organization there would be only three or four value streams with a clear cut line of responsibility. A traditional organization would have a complex organization chart, hundreds of cost centers and thousands of transactions to keep track of people. It is obvious that managing with the value stream perspective really simplifies management. Value Stream as the Focus for Improvement For each value stream there would be a continuous improvement (CI) team to review the value stream performance measurement and make improvements on time. The CI team within the value stream can see the entire flow of the work, thus the improvement benefits the whole system rather than a single process. Implementing the Value Stream Organization Implementing lean manufacturing can include implementing value stream management at the same time. Basically, there are three stages in the progression (see Exhibit 2). At stage 1, lean manufacturing is first introduced and a pilot lean cell is implemented. There is no need to change the original organization chart in the short term. At stage 2, lean manufacturing widely spreads in the plant and product groups, crossing organizational lines within the plant as each lean cell is linked into the value streams. At this stage it is necessary to manage by value stream and assign both production and support people to each value stream. Support people are important to the value stream because they make sure that the services are there to maintain the rate of production. The authors provide an example of support functions that need to be more available to a lean value stream: 1. Production Control – to manage the size and number of kanbans required to achieve value stream target rates of production. 2. Transportation – to ensure that the right materials and tooling are at the right cells and at the right time. 3. Procurement – to ensure that materials are received from suppliers in the right quantities and on time. 4. Manufacturing Engineering – to ensure the focus on continuous improvement. 5. Maintenance – to limit equipment downtime, especially in a constraint resource. There may be a problem of assigning people to value streams due to a shortage of people. It may be necessary to have a person serving in many value streams for the short-term, but for the long-term cross training would become necessary to solve this problem. It might appear that implementing lean manufacturing with the value stream concept would require additional people, e.g., several production planners rather than a single production planner. However, this potential problem can be solved in two ways by: 1. Eliminating unnecessary administrative tasks, for example, production planning would not be needed when an effective pull system is in place. 2. Cross training can help in providing support skills in every value stream. Thus, no additional people would be needed and each value stream would have all the required skills. For complex organizations, they may find that a matrix management structure (people still report to their functional bosses, but are assigned to work in particular value stream teams) is a convenient way to adopt lean manufacturing without disrupting the organization. A medium or small size business can simply forego its original structure and adopt a new one to reflect value stream management. Conclusion In conclusion, the authors provide some rules of thumb as guidelines: 1. When implementing lean manufacturing and value streams, move ahead step-by-step. 2. A value stream should contain between 25 and 100 people. When the stream contains too many people, it will not be able to maintain the small-team focus required. When there are too few people, it will not be able to maintain an effective operation. 3. A value stream should represent a significant part of the business. A business usually has three major value streams and a fourth one to combine all the other functions that do not fit in. 4. A key idea of value stream management is to have the majority of people working in the major streams, with only a few additional supporting departments to maintain the smooth operation of the business. __________________________________________ Note: The second article in this set is Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part II. Journal of Cost Management (May/June): 24-30. (Summary). MANAGEMENT AND ACCOUNTING WEB Organization Structure & Restructure http://maaw.info/StructureRestructureMain.htm Organization Structure & Restructure Bibliography Organigraphs Overcoming the stovepipe organization Strategy, structure and ABC The ambidextrous organization Virtual integration at Dell Organigraphs Mintzberg, H. and L. Van der Heyden. 1999. Organigraphs: Drawing how companies really work. Harvard Business Review (September-October): 87-94. Summary by Deborah Bichsel Master of Accountancy Program University of South Florida, Summer 2003 According to the authors, traditional organizational charts are outdated. The concept of a chain of command, with top management is not necessarily an accurate illustration of the manner in which a company operates. If someone were to look at the organizational chart of a company, he or she may not obtain a good grasp of the organizational structure of a company. Thus, the authors suggest organigraphs in response to the changing structure of business and its management today. The most conventional types of organigraphs are the set and the chain. Both of these models are somewhat antiquated. The set is a “collection, a group, or a portfolio.” These sets share common resources and often are unrelated to one another. An example of a set would be a salesperson that has his unique set of customers and products. A car salesman, for example, would only be able to sell one make of car to his repeat clients. There would be no cross sales between salespersons. From a management perspective, a set has managers at the top of the set. These managers do not get involved in the actual business process, but rather supervise from a distance. The second model is the chain. These show a connection between different events in a company. Combined, these events create a business process. Assembly lines and supply chains are two examples of the chain. Each chain in an organization has a manager. They oversee the entire process. Chains are fairly common in business today and companies would not exist without them. Two other types of organigraphs are becoming common. The first is the hub. The hub serves as a central checkpoint, or coordinating center, for all process activities. This is the point through which “people, things [and] information move.” From a management perspective, the person at the center of the hub becomes the manager, or coordinator. The coordinator may not necessarily be in a “management” position. For example, a nurse may be a hub coordinator for patient care, rather than a doctor or hospital administrator. Chains may become hubs by transforming from a small process to a large operation. For example, a supply chain may become a hub for a manufacturing process. The chain is the hub for a larger process. Another newer type of organigraph is the web. In a web structure, the company has several “nodes” that all communicate with each other, without going through a central coordinator. Webs allow for “open-ended communication and continuous movement of people and ideas.” There is no single manager for a web. Rather, all individuals may act in a management capacity. “Managers have to be everywhere.” Management structure may be loose or undefined. While the organigraph is somewhat novel, companies have been using the concepts in their organizational structures for a long time. Other types of structures exist. The four discussed above are the most popular. However, any structure can be designed if it better depicts the organization of the company’s business processes. The more complex the company, the more complex the organigraph is. An organization is not restricted to one type of organigraph. It may have several business functions each represented by the different structures. As discussed before, a chain could be a hub for another, larger process. Also, companies may shift between the different types of organigraphs. It may begin as a more traditional set, move to a hub structure, and then transform into a web. If a company reorganizes, it may change the design of its organigraph. A new idea exists, related to the core competencies of a company. A core competency is a group of “knowledge, skills or resources” that form a foundation for the structure of a business process. These competencies can be diagrammed as the hub of an organization. From this hub, all activities and processes of the company stem. Organigraphs are not meant to replace the organizational chart. Instead, they provide for a new view of the organization. Organizational charts can still illustrate the authority of official management, but they do not represent the actual management of a company's business processes. In order to obtain the best understanding of a company’s operations, it would be to one’s advantage to look at both the organizational chart and the organigraph. See more illustrations below. Some Questions & Additional Graphic Illustrations 1. What is an organigraph? An organigraph is a drawing, picture, or map of the way people and work are organized within an organization. It shows the connections and the interdependences to help managers see critical relationships and competitive opportunities. An organization chart, on the other hand, puts management at the top and treats everything and everyone as an independent box. 2. How do the different forms of organization (i.e., sets, chains, hubs, and webs) differ in terms of how they are managed? According to the authors, managers of a set allocate, managers of a chain control, managers of a hub coordinate, and managers of a web link it all and energize. 3. What is the main point of this paper? The authors point out that management is the servant of the organization, not its purpose and that management needs to be put in its proper place. The relatively new forms of organization (e.g., hubs and webs) require a different form of management that is very different from the older form that emphasized control. If companies are to prosper in today's economy, management needs to fit the organization whether at the center as in a hub or throughout as in a web. Overcoming the stovepipe organization Dolk, D. R. and K. J. Euske. 1994. Model integration: Overcoming the stovepipe organization. Advances in Management Accounting (3): 197-212. Summary by Aarti Nirgudka Master of Accountancy Program University of South Florida, Summer 2002 Today, most businesses are moving from a narrow functional (stovepipe) view of the organization to a cross-functional (holistic) view of the organization. Moreover, models with a functional focus, still exist in many organizations and conflict with the current organizational focus of continuous improvement and being "world class." Thus, process model integration, an organization-wide view, which integrates existing models within different functions, has become the focal point of many organizations. Model integration is consistent with activity-based management and not the function-specific approach that currently prevails. Need for Model Integration to Support Cross-Functional Analysis Traditional functional models tend to achieve functional subsystem optimization at the expense of the overall system. Additionally, compensation systems in organizations have rewarded functional optimization and thus, reinforced a functional focus. However, in an environment characterized by continuous improvement, integrated processes seem to be of more relevance rather than the very limited functional models. A graphical illustration of the move towards model integration is presented below: A cross-functional, process orientation implies a move up the pyramid and a change in the managerial focus. The cross-functional focus emphasizes model integration and thus, is able to provide managers with coherent information for strategic planning and control. An Example of Model Integration A company has the following models developed independently of each other (thus, having a functional focus): Econometric marketing model- forecasts demand in terms of sales volume for a product for the next fiscal year, Event simulation manufacturing model- estimates the required expense to produce enough of the product to meet the specified demand, Transportation model- determines the minimal cost of distribution the product to customers, Pricing model- calculates a price for a produce given a demand volume, and manufacturing and distribution expenses, and Financial model- determines the revenues and net income from sales of the product given demand volume, manufacturing and distribution expenses, and product price. However, these currently existing models, built in isolation of each other, are unable to provide management with useful answers to questions such as: What effect will developing islands of automation in the manufacturing process have on net income? What will happen to revenues if demand for our product softens as a result of decreased spending by Department of Defense? What baseline price do we need in order to provide for customer needs while maintaining long run profit goals? Thus, by integrating these models where the outputs of one serve as the inputs of another, the company is able to achieve global optimization instead of local optimization. An integrated example of the above models is presented below. Nevertheless, to develop such a highly integrated model in a stovepipe organization presents many obstacles including: Conflicting objectives of the respective models, Availability of accurate and valid data, Relative validity of the models, and Software and hardware incompatibility of model implementations. Moreover, the key to model integration is data integration. An organization must be able to develop a shared data management philosophy in order to support cross-functional model development. The Integrated Modeling Environment (IME) IME is a quick and easy way to support the integration of existing models developed within different functions. IME supports the overall life cycle for specific model development and also facilitates the composition of models from two or more existing, constituent model components. The latter process is known as model integration. Model integration, however, requires a shared view of the strategic goals of an organization, the business processes necessary to realize those goals, and the mathematical models required to support those business processes. This, in turn, requires an information system infrastructure that promotes the sharing of data and the models, which use the data. IME is the component of this infrastructure, which supports the development, integration, and maintenance of mathematical models compatible with an organization’s goals. Further, a necessary requirement for model integration is that all models be expressed using a single, consistent representation ("schemata" in IME terms). Representations come in many forms like mathematical, graphical, narrative, and as computer programs. An example of a representation is Structured Modeling (SM) that offers different forms of viewing models that are customized as per user’s interest and technical capability. Another advantage of SM is that it supports and facilitates model integration. The other dimension of IME, besides the schemata, is the library of model solvers (i.e. software, algorithms, etc.), which manipulates the model schema and solves particular model instances. IME is thus, also used as a tool to convert data from the model schema data structure to the particular format desired by solvers (i.e., SAS, Simscript, GAMS, Spreadsheet, etc.). Such "grand scale" IME models however, are not in existence today and are only a hope for the future. Moreover, IME can benefit an organization by facilitating communication among models and thus, extend the utility of any particular model beyond the function for which it was developed. IME can further be used to make models consistent with organizational goals, as it is able to capture both financial and operational impact of specific decisions. This would enable an organization to close the gap between performance measurement at the time of investment and at the time of execution. Organizations that intend to reap the benefits of IME, however, must recognize models as a valuable resource of the organization in the realization of its strategic objectives. What To Do-Models Not Yet Designed Following are the recommendations for models not yet designed: Use cross-functional design teams: Include representatives from providers to, and customers of, the function and choose team-members with great care. Also, it is important to ensure sufficient availability of resources and the creation of an environment that is supportive of the cross-functional team; Make the user the leader of the design-team: Although technicians are organizationally "above" the users, the technicians should be assigned to work and take direction from the user; Develop the model within an IME: Use model schema representation like Structured Modeling (SM). The achievement of this third objective, however, is contingent upon successful implementation of the first two recommendations. What To Do-Models In Process Following are the recommendations for models currently under development: Reexamine the model from a cross-functional perspective: If the development team is not cross functional, this mix should be altered. Also, attention must be given to providing sufficient resources and a supportive environment to the cross-functional team; Convert the model to the IME: Develop appropriate schemata. To do this however, "reverse engineering" may be necessary. What To Do-Models In Place For existing models, "reverse engineering" is necessary to convert them to the IME. This requires developing the appropriate schema. As this is usually a time-consuming and costly process, an organization may want to choose only the most critical models to be reverse engineered and leave the rest untouched. Thus, a cost-benefit analysis may be needed to identify which models are most critical. However, in conducting such analyses, both quantifiable costs and benefits and qualitative impacts must be considered. By performing such an analysis, an organization is able to promote a cross-functional awareness and focus. Thus, in this process, the organization is able to evolve incrementally towards an integrated modeling environment. Conclusion In order to achieve a cross-functional focus a change is necessary not only on the "shop floor but also in the models used to support decision making, and by implication, changes in information resource policies" (p. 211). Further, successful implementation of model integration requires a high level of coordination and cooperation than before. Moreover, "model integration is not an answer to modern management problems, it is simply one of many tools that will help today’s managers make more informed decisions and maintain a competitive market position" (p. 211). Strategy, structure and ABC Gosselin, M. 1997. The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, Organizations and Society 22(2): 105-122. Summary by Eileen Z. Taylor Ph.D. Program in Accounting University of South Florida, Spring 2004 Introduction Although the ABC innovation is theoretically superior to traditional cost methods, it has not been widely implemented within manufacturing firms. This study explores the “ABC paradox” via a diffusion of innovation perspective. ABC is treated as an innovation, and organizational strategy and structure are examined as possible factors associated with ABC implementation. Activity Management This section puts forth the explanation of ABC as a multi-level innovation. Activity management (AM) is the term used for describing the over-reaching concept of ABC. There are three levels of AM. Activity analysis (AA) is the lowest level of adoption. It “consists of identifying the activities procedures carried out to convert material, labor, and other resources into outputs” p.106 (Brimson, 1991). After adopting and implementing AA, the next stage is Activity cost analysis (ACA), in which cost drivers are identified and the structure of the costs is mapped out. Finally, some firms take AM to the highest level, ABC. This stage links product and service costs to activities. In this stage, cost pools are created and applied to better inform decisionmakers. Business Strategy Gosselin uses the Miles and Snow typology for classifying businesses by strategy. The defining characteristic is the rate at which the organization changes its products and markets. Prospectors exhibit the fastest rate of change. Defenders are the exact opposite of prospectors; they “compete aggressively on price, quality, and customer service”(p.108). Analyzers fall somewhere between prospectors and defenders. Reactors do not have a defined strategy. Given that ABC is considered an innovation; and past studies have demonstrated that prospectors are better able to incorporate change into their organizations, the following hypothesis is proposed: H1: A prospector strategy is positively associated with the adoption of an AM level. Organizational Structure Gosselin posits that certain organizational structures will facilitate the diffusion of innovation better than will others. Two theories are examined: dual-core model and ambidextrous model. The dual-core model looks at AM as possessing two characteristics, technical and administrative, depending on the level of implementation. First, “AA and ACA are classified as technical innovations because their focus is mainly on processes and activities.” (p.109). Past research has shown that organic organizations are more adapted to implementing innovative techniques. On the other hand, ABC is classified as more administrative because it calls for administrative rules and policies. A mechanistic structure is better suited to administrative innovations. This provides the argument for hypothesis 2. H2: Among organizations that adopt an AM approach, a mechanistic structure is positively associated with organizations that adopt ABC. (Emphasis by summarizer) The ambidextrous model considers the stage of the innovation process. It specifically looks at differences between the initiation and implementation stages. Initiation of innovations said to be easier in organic organizations; while implementation of innovations is said to be better in mechanistic organizations. The basis for the following hypothesis can be explained as: once a mechanistic organization gets through the early stages of initiation (AA and ACA), they will be better able to implement ABC, in part, because it is an administrative innovation, and the rules and formalized structures of a mechanistic organization support implementation. H3: Among organizations that adopt ABC, a mechanistic structure is positively associated with organizations that implement ABC. (Emphasis by summarizer) Methodology An eight-page survey questionnaire was created and mailed out to Canadian manufacturing firms. Certain firms were excluded: these included highly diversified firms, and small organizations. The response rate of mailed surveys is generally low; in this case, it was 39%. This was deemed sufficient. Three categorical variables were created to test each of the three hypotheses. Measurement of strategy and structure was approached using a multiple measure. Strategy was initially measured through a self-categorization by respondents. This measure was validated by the researcher, who examined the annual reports of each SBU. The correlation was .83. Based on prior literature, structure was measured through three variables: centralization, vertical differentiation, and formalization. Mechanistic organizations are expected be more centralized, more vertically differentiated, and more formalized. Organic organizations are lower on all three categories. (Findings are limited by these measurements, which may not accurately discriminate between the two structures). Results The hypotheses are tested preliminarily through a Chi-Square analysis, and then using a logistic regression approach. H1 is supported: prospectors were found to more frequently adopt AM than analyzers and defenders. H2 was also supported; however, only for one of the three variables, vertical differentiation. It was determined that firms with higher levels of vertical differentiation (mechanistic firms), were more likely to adopt ABC. Finally, H3, which proposes a link between implementation of ABC and strategy/structure, was supported for centralization and formalization, but not for vertical differentiation. In summary, adoption is associated with more vertical integration; whereas implementation is associated with more centralized and formal firm structures. The authors propose that once a firm decides to adopt ABC, a higher degree of centralization and formalization make it harder for management to stop the implementation of the system. Additionally, once committed to putting the system in place, mechanistic firms provide the needed support for full implementation. This article examined both strategy and structure, and their effect on adoption and implementation of AM innovations. It was found that adoption of AM was related to a prospector strategy. Further, mechanistic firms were more likely to adopt the highest level of AM, ABC; and they were also more likely to implement ABC. Further analysis of the structure measures and their relationship to the adoption and implementation of ABC is in order. The ambidextrous organization O'Reilly, C. A. III. and M. L. Tushman. 2004. The ambidextrous organization. Harvard Business Review (April): 74-81. Summary by Lee Salemi Master of Accountancy Program University of South Florida, Fall 2004 In this article, O’Reilly and Tushman examine what happens when contemporary businesses try to expand outside of their existing market and products. The authors discovered that the successful companies are those that separate new exploratory units from exploitive traditional units, but still keep a tightly linked executive team to manage the organizational separation. This type of company is referred to as an “ambidextrous organization”. Managers are expected to be able to explore new opportunities while also making steady improvements to what already exists. Most companies are successful making steady improvements, but cannot succeed at innovation at the same time. The authors utilize Kodak as an example. Kodak has been successful with traditional photography, but has not been able to compete strongly in the digital camera market. Exploiting and Exploring Maintaining several types of innovation is necessary for an organization to compete. The authors identified the following types of innovation: • • • Incremental innovations involve small improvements to an existing product or process to enhance efficiency. Architectural innovations involve incorporating new technology and processes to change business elements. Discontinuous innovations occur when an advance is so powerful, it makes old products or processes obsolete. Exhibit 1 illustrates what the authors refer to as “A Map of Innovation”. The type of innovation as well as the target market can be plotted on this matrix. Companies that pursue modest incremental innovations would be plotted on the lower left while breakthrough innovations would be plotted in the upper right area of the matrix. Exhibit 1 A MAP OF INNOVATION* Incremental Innovations New Customers Existing Customers * Adapted from p. 77. Architectural Innovations Discontinuous Innovations The authors studied various companies’ approaches to innovation through this matrix and found that breakthroughs were structured in one of four ways. Innovation breakthroughs can be integrated into existing functional designs and management structure. They can also be set up as cross-functional teams operating from within the existing organization, but outside of the organization’s management structure. Breakthroughs structured through unsupported teams come from outside the established organization and the company’s management hierarchy. The final breakthrough structure is the aforementioned ambidextrous organization. Under this structure, the breakthrough is set up as an independent unit with its own culture, processes, and structure, but the unit is still integrated within the existing management hierarchy. By comparing the different breakthrough structures, the authors found the ambidextrous organization to be far superior with regards to innovations (90% of goals were reached) as well as the success of the existing business. The structure of an ambidextrous organization allows the organization to share information and processes when needed while still maintaining separate units. Managerial coordination allows resources to be shared, but the organizational separation ensures that the new unit will not become just another part of the company. The authors use two organizations, USA Today and Ciba Vision, as examples of how companies can renew themselves with breakthrough products without harming its existing business. Both companies were struggling to compete in their respective markets until they became ambidextrous organizations. The following are a few managerial and organizational characteristics of ambidextrous organizations such as USA Today and Ciba Vision (in addition, see Exhibit 3 below): • • • • • Senior managers must agree with and be committed to the network strategy involved in an ambidextrous organization. Project leaders must be willing to challenge the status quo. Senior leadership of different units must be tightly integrated and should keep each other informed of necessary information. Executive incentive programs involving the entire company are used as opposed to bonus programs tied to individual units. The company’s research and development budget may be allotted almost entirely to producing breakthroughs while existing business pursues only incremental innovations. A clear vision is crucial in transforming a company into an ambidextrous organization. Exhibit 3 The Scope of the Ambidextrous Organization* Alignment of: Strategic intent Critical tasks Competencies Structure Controls, rewards Culture Leadership role Exploitative Business Cost, profit Operations, efficiency, incremental innovation Operational Formal, mechanistic Margins, productivity Efficiency, low risk, quality, customers Authoritative, top down Exploratory Business Innovation, growth Adaptability, new products, breakthrough innovation Entrepreneurial Adaptive, loose Milestones, growth Risk taking, speed, flexibility, experimentation Visionary, involved * Adapted from O'Reilly and Tushman's illustration, p. 80. Virtual integration at Dell Magretta, J. 1998. The power of virtual integration: An interview with Dell Computer’s Michael Dell. Harvard Business Review (March-April): 72-85. Summary by Linda Bragdon Master of Accountancy Program University of South Florida, Fall 2001 INTRODUCTION Michael Dell founded Dell Computer Corporation in 1984 with a plan for selling custom-built PCs directly to the customer. By using this simple concept, Dell can best understand their customers needs, and efficiently provide the most effective computing solutions to meet those needs. The concept became known as the direct business model. The direct business model had a valuable benefit that Michael Dell didn’t anticipate. It enables the company to have an actual relationship with customers. This provides essential information that is used to leverage relationships with the suppliers as well as customers. Dell uses this information along with technology to eliminate the boundaries in the value chain among its suppliers, manufactures, and customers. Michael Dell describes this process as virtual integration. Technology has allowed coordination between the company’s individual segments such as strategycustomer focus, supplier partnerships, mass customization, and just-in-time manufacturing. This helps to achieve new levels of efficiency, productivity, and remarkable returns to investors. The benefit of a tightly coordinated supply chain is offered through vertical integration. A virtual corporation offers the benefit of focus and specialization. Virtual integration combines the benefits derived from both vertical integration and a virtual corporation. Therefore, virtual integration provides the ability to attain both coordination and focus. Dell is continually refining the direct business model through virtual integration, which relies on information technology to improve the value chain of suppliers and customers. SUPPLIERS Traditional computer companies had to be vertically integrated. They developed the many components of the computer themselves. When Dell started, they could not afford this traditional process. Instead, Dell leveraged investments made by others and focused on the delivery of solutions and systems to customers. This is the heart of the direct business model. It has allowed Dell the leverage their relationships with both suppliers and customers. The few suppliers of Dell are the equivalent of partners. They are treated as if they were actually part of Dell. The partnership will last as long as the partner maintains their leadership in technology and quality. The suppliers of Dell are told exactly what the company’s daily requirements will be. This is made possible from the free flow of information that is shared between Dell and the supplier. Technology enhances the economic incentives of this type of collaboration because it speeds time to market and creates value that is shared between buyer and seller. This type of collaboration posses the challenge of change of focus from how much inventory there is to how fast it’s moving. This is measured by inventory velocity, which has Dell working with suppliers to continually reduce inventory and increase speed. Customers Dell serves a wide variety of customers. They range from governmental institutions to individual buyers. To handle this complex market, Dell benefits from segmenting its customers. Dell is better able to understand their customer needs in a more intimate way. This type of relationship allows Dell to obtain access to information that is critical to their direct model strategy. Without this information, Dell could not successfully forecast what their customers need and when they are going to need it. There are a vast array of information links between Dell and their customers. The ability to sell directly allows Dell to keep track of a company or individuals total PC purchase, country by country. This is information that can ultimately be feed back to them. For example, when a computer isn’t working properly for a company, the IT people don’t have to waste time figuring out the type of configuration of hardware and software the computer has. The close relationships that Dell has formed with its customers have allowed them to extend the value they deliver to those customers. This value can be seen through the ability of Dell to routinely load the customer’s software in the factory. Dell has also set up Platinum Councils to ensure the free flow of information with their customers on a continual basis. At these forums, Dell’s senior technologists share their views on where technology is headed and provide an overview of product plans over the next two years. Groups are then set up to focus on specific product areas and discuss solutions to problems that may not necessarily have anything to do with the commercial relationship with Dell. The ratio of Dell people to customers at the forums is 1:1. The council allows Dell to demand forecast. Dell believes that its customers are in control, and that Dell’s job is to combine all the technology available and apply it in a useful way to meet the needs of their customers. Dell has to stay on top of what the customers’ need, as well as monitor and understand the innovations in the material science world. Virtual integration lets Dell meet customers’ needs faster and more efficiently than any other model. Conclusion The direct business model is a unique concept that separates Dell from others in the industry. Virtual integration relies on information technology to improve the value chain of manufactures, suppliers, and customers. The benefits it produces are coordination and focus. These attributes make virtual integration an organizational model on the horizon for the information age.