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Memo: The Goal
March 17, 2013
Jilnar El-Masri 3/17/2013 1
Eliyahu Goldratt’s theory of constraints has helped many companies around their world manage their business processes. Goldratt first introduced this theory in his now famous book, “The Goal”. This book introduces the concepts, measures, and relationships that are the foundations of the theory of constraints, through a gripping story of a manager trying to save his plant from being shut down. Goldratt takes the reader on the learning journey through the eyes of this manager. This paper will summarize the story, and clarify the theory of constraints through the business model that Goldratt proposes. Throughout the summary, the basic foundations of this theory will be defined and explained. Towards the end, it will become clear that even though this theory was founded in manufacturing plants, it can actually be applied to all combinations of product and service industries. I firmly believe that the concepts presented in The Goal can help our firm perform better, and be more profitable now and in the future.
To begin with, Goldratt introduced our protagonist, Alex Rogo, and the evident problems his production plant is facing. His plant is losing money, and customers are complaining about their late orders. After a very upset customer approaches Alex’s boss, Bill Peach, Peach and Rogo have a lengthy argument, where Alex is given an ultimatum; either he shows some improvement in three months, or his plant would be shut down. Alex is almost certain that he would not be able to make this transformation in this very short amount of time, and he does not know where to begin diagnosing the problems his plant is facing.
To add to that, Alex appears to be having problems on the family front. When he accepted this job, he had relocated himself and his family back to his hometown of Bearington, a small, quiet, and lifeless town that his wife was not very fond of. Alex’s two children seem to be doing fine, but his wife is resentful of this move, and expresses her disdain at Alex for not spending enough time with her and the children. This only adds to Alex’s list of worrisome issues he must confront. Back at the plant, Peach calls a meeting, where he explains to his managers and staff that the gravity of the situation, and gives them targets to achieve by the following quarter. During this meeting, however, Alex is detached, his mind wandering back to a recent business trip he took, where he ran into his old physics professor, Jonah, at an airport. Alex had shared his concerns with Jonah, and was surprised at how well Jonah was able to predict the problems the plant was facing, even though he was from a very different background. Accurately, Jonah had guessed that Alex’s plant was facing problems with late orders and large amounts of inventory, and Alex wonders how he knew that. In the course of their hasty discussion, Jonah had told Alex that all companies have one goal, and one goal only, and any action or decision that moves them closer to that goal is productive, while any action that does not, is a waste of time. Jonah did not, however, tell Alex what that goal is, leaving him to ponder things on his own. Preoccupied, Alex decides to leave the meeting, for some pizza and beer in a secluded location. It was then that he figured out what the goal was; to make money now and in the future. Now, it made sense, any decision he makes that moves his plant closer to making money and being profitable, is an effective decision, otherwise, he should not bother with it.
Back at the plant, Alex begins an attempt to understand how he should proceed to move his plant closer to the goal. With the help of Lou, in accounting, they translate the goal into three specific measures; increasing net profit, return on investment, and cash flow. With that vision in mind, Alex decides to start looking further into Jonah’s logic, and reaches out to find him again. At his next conversation with Jonah, Alex is introduced to three concepts that will be the defining factors of his plant’s turnaround. These concepts are throughput, inventory, and operating expense, and according to Jonah, everything in the plant can be classified under those three main headings. Jonah’s definition of the terms, however, was different from what Alex initially believed, and critical in his future understanding of what they truly meant. Jonah defined throughput as the rate at which the system generates revenue through sales. Inventory was defined as all the money the company has invested to purchase items it intends to sell. Finally, operational expense is all the money the plant spends to turn inventory into throughput. Alex is fazed by these definitions, and goes back to thinking how these can be applied to his failing operations. In the midst of this turmoil, Alex receives news that the head of the company was planning to visit his plant, and take pictures with one of the recently implemented robots, which leads Alex on another train of thought. These robots were installed in the name of improving efficiency, however, after having a discussion with his coworkers, Alex was able to determine that the robots were a bad idea. They were implemented to increase efficiency; however, they had increased operational expenses, and not lead to any reductions in costs or labor, only to a shift of these resources, which had to mean that their installation went against the goal of the company, even though they appeared to increase efficiency, according to upper management. Alex attempts to explain all this, and the concepts he learned from Jonah to his coworkers, Bob, Lou and
Stacey. They are not completely convinced that everything in their plant can be accounted for by the three terms, inventory, throughput, and operating expense, but after their lengthy discussion, the concepts become clearer. Lou states the definitions in his own words; “throughput is money coming in. Inventory is the money currently inside the system, and operational expense is the money we have to pay to make throughput happen”. Armed with this new understanding, the team sets out to find ways to apply these concepts to their plant in such a short time. They start to get the picture; if they are to see any improvement in such a short time frame, some fundamental radical changes will need to be made. Alex finds himself lost on how to proceed, so he schedules another meeting with Jonah. During their discussion of the plant’s problems, Jonah tells Alex to forget about the robots, and goes on to shatter many beliefs that Alex had held to be true. First, he suggests that a plant in which all machines and labor are working at all times is actually quite inefficient. Then, he introduces the concept of a ‘balanced plant’; a plant where the capacity of all resources are balanced with the demand of the market, but tells Alex that any plant that is operating as a balanced plant is actually close to bankruptcy. Here, Alex is baffled. To further add to his confusion, Jonah introduces two more concepts; dependent events, and statistical fluctuations, and Alex must figure out how these concepts affect the production process in his plant. At home, Alex’s relationship with his wife is becoming more problematic, because of the extra unplanned time he had been spending at the plant. He promises to take her out, but ends up being a troop master in his son’s scout hike instead. It was on this hike that Alex made sense of several key issues Jonah had discussed with him.
On the hike, Alex decides to try a little experiment with some matches, bowls, and dice, and recruits some of the boys to play along. He lines up the empty bowls, and rolls the dice, and transfers as many matches as the number that appears into the first bowl. After that, for every dice roll, that number of matches is moved from one bowl to the next. If the matches in the bowl are not enough to cover that number, then the player can only move as many matches that are in that bowl and no more than that. Through this game, Alex was able to understand the meaning of statistical fluctuations; the number of matches in each bowl is dependant on the number of the matches that were in the previous bowl, and he cannot predict what number will come up on the dice roll. Now, the concept of statistical fluctuations can be defined as the variations that appear when one is not able to accurately predict events or quantities that will occur. The hike itself turns out to also be a learning experience for Alex. As he is leading them, he notices that the distance between the boys keeps getting bigger, and the slowest kid, Herbie, was trying hard to catch up with the rest. In an attempt to fix this, he empties Herbie’s heavy backpack and distributes the items evenly amongst the boys. This helps Herbie move a little faster, but the gaps in the line still reappear. Then, Alex puts Herbie in the front of the line, to lead the other boys. This approach seemed to work very well, because now everybody was moving at Herbie’s pace, and the overall fluctuations are reduced, increasing the throughput of the team. For Alex, this is a revelation. Now, he has understood and applied the concept of dependent events; which are processes that must first take place before other processes can begin. In this instance, the boys are moving in a line, and one boy cannot move forward unless the boy in front of him moves forward.
When he returns home, Alex is shocked to discover that his wife had packed some belongings and left, frustrated by the fact that he had not come through on his plans to spend the weekend with her. Now, the house and kids are added to Alex’s responsibilities. Back at the plant, Alex tries to explain his findings from the Herbie experiment to his colleagues. Nobody seems to make sense of what he is saying, so he attempts to apply the concepts he learned to an order that was overdue. He succeeds in grabbing the production manager’s attention with his theory. Stumped on how to proceed, Alex gets in contact with Jonah again. This time, Jonah again introduces Alex to a new concept; the bottleneck. Jonah defines the bottleneck as any resource whose capacity is equal or less than the demand placed on it. Jonah proceeds to explain to Alex that he should not be worried about balancing his plant’s capacity with the market demand, but rather balancing the flow of the product through his plant, to achieve maximum profitability. Back at his plant, Alex again passes this new information to his colleagues, and together, they work to identify the bottleneck at the plant, which turns out to be a certain piece of equipment they dubbed X, as well as the heat treat machine. Alex believes that he can organize the plant, with the same philosophy he used to manage the kids on the hike, in a way that is going to remedy the situation, however, in the plant, he is not able to move processes and equipment around so easily, because the production is a process where every stage depends upon the stage that precedes it. Later, Jonah makes a visit to the plant. During this visit, he suggests ways to make the bottleneck operation more effective by increasing their capacity. To do that, the team must make sure that the bottleneck equipment has no down time (lunch breaks, for example), and is only working on
quality materials (eliminate the defective materials before they reach the bottleneck). After some calculations, the team figures out that any time lost at the bottleneck is time lost for the entire system, because the final product requires the parts from the bottleneck in order to be fit for sale. And if these products are not sold, throughput is not increased. Stemming from this, Alex decided to re-arrange the process, by making the bottlenecks work on orders from the most overdue to the least. To indicate this priority to the plant workers, Alex and his team come up with the idea of red and green tags; red indicating parts that need to be worked on first, in order to not delay the bottleneck, and green for the other, non-bottleneck parts. Now, things start to pick up around the plant, and they were able to ship twelve orders, but it’s still not enough to be satisfactory. Meanwhile, the production manager, Bob, manages to find some old machines that, together, are able to perform the same function as the bottleneck X, which proves to be helpful in increasing the bottleneck capacity. As Alex continues to see gradual improvements in his plant, more problems are also revealed. Alex decides to reschedule the shifts of workers, in line with increasing utilization. One of the night foremen comes up with a new way to process more parts by mixing and matching orders by priority, which increased efficiency by ten percent. When they implement this system, parts start moving smoother through the bottlenecks, and inventory starts decreasing. This decrease in inventory revealed more bottlenecks, or so Alex thought. When Jonah visits the plant again, he informs him that they are not new bottlenecks, but instead a result of some old-fashioned thinking of keeping non-bottlenecks working at maximum capacity on bottleneck parts. What was happening, is that the parts were piling up in front of the bottlenecks, and others were awaiting non-bottleneck parts for final assembly. The red and green tags system would need to be modified, in order for the bottlenecks to receive exactly what parts they need, at exactly the
time they need it. On the personal side, Alex tries to reconnect with his wife by spending more quality time with her, while she is still staying at her parents’ house. Ralph, the computer specialist at the plant, thinks he can come up with a schedule for the bottleneck parts and when they should be released. With this data, Alex suggests that he can apply the same concept to non-bottleneck parts as well. Alex believes he still has time to show more improvement, and convinces Peach to keep the plant open if he is able to show a 15% increase in sales. In his next conversation with Jonah, Alex informs him of his new problems; the increasing inventories and decreasing throughput, and Jonah suggests they cut batch sizes in half, which will cut costs in half, as well as give them faster response times and shorter lead times. While implementing this, Alex receives an order to ship a thousand units in two weeks, an almost impossible task. With the help of his team, they decide to cut batch sizes in half again, and promise to ship 250 units each week for four weeks. The customer is thrilled, the plant shows a 17% improvement, and they receive an even larger order, representing a greater confidence in their abilities to deliver promised results. This 17%, however, was derived by a non-traditional accounting method, which they believed was a more accurate representation of what had happened in the plant, and upper management is not too thrilled with this method at first. Nevertheless, to reward Alex’s good work, he gets promoted to Bill Peach’s position. Now, his responsibilities include a division of three plants, and he starts thinking of ways to make everyone understand the concepts he had been implementing. Bob, Lou, and Stacey are all on board to be part of his new team, and together, they start brainstorming aspects of management that will help them solve the problems in all three plants. Meanwhile, Alex has reconciled with his wife, which relieves him of some worries, and enables him to focus on his plant. Finally, the team comes up with the process; the five steps of TOC, which are the following:
1) Identify the system’s constraints: A constraint is any resource that limits the amount of
output a company can produce, because the demand placed upon it is greater than its capacity.
2) Decide how to exploit these constraints: Find ways to generate more output from the
constraint without incurring any additional operating expense. For example, rearranging the lunch breaks so that the constraint is running constantly.
3) Subordinate everything to the above decision: Make adjustments to non-constraints, so
that they are not producing more than the capacity of the constraint. Effectively, this means there is less time products spend ‘waiting’ for the constraint to start work on them.
4) Elevate the system’s constraints: Take some of the workload off the constraint, because
it needs to be producing at the level of demand placed upon it. Using other resources to produce constraint items can be an effective method. 5) Go back to step 1, and don’t allow inertia to create a system constraint: There will always be a constraint that arises which demands attention to elevate it. It is a continuous process of improvement, where decisions are made throughout in order to make gradual changes that increase profitability. Lastly, the book wraps up with Alex contemplating entering the European market, and realizing that production is a continuous process of improvement. Alex ponders the basic questions of effective management; What to change? What to change into? And how to cause that change? Him and his team believe that the answers to those questions are what makes a good manager.
Insights and Practical Applications
Perhaps the most fascinating part of this book is that the conclusions reached at the end seem to be so simple and logical, however, Alex faced significant resistance in the early stages of trying to implement them, because they attacked the most basic principles that have been used traditionally for centuries. Even though the theory of constraints is presented in a manufacturing plant, its concepts can be applied to all industries, and our bank loan department is no different. In fact, it is an excellent example of TOC, because it is an ongoing process that involves a series of dependent events and statistical fluctuations (we don’t know how many applications we are going to be processing until we receive them, and we must issue a decision within 24-48 hours). As a loan department, our throughput is the rate at which we issue loan decisions to customers, our inventory is the current loan applications received and in process, and our operational expenses are the labor invested in this process, as well as the expenses we incur to carry out customer background checks and credit reports. Phone calls we make to the customer, to fill in missing loan information, can also be considered an operational expense that can be reduced. The improvements Alex initially made to his plant can be adopted for our system. To begin with, we can design a better process of early automatic rejection, which ensures that credit officers don’t waste time or resources processing applications, and requesting background checks on customers that will ultimately be rejected. These ‘filters’ can be setup in a way that points out red flags in an application (high ratio of debt to income, or number of dependents, for example), which makes it easier to reject an application before it goes through the whole system. Another issue that we suffer from is the fact that our headquarters are open until 4 pm, while our branches are only open until 2 pm. This means that the decisions we issue at 4pm do not get processed by the branch until the next day. This makes a difference in our response time to the customer; instead of receiving the decision in the same day, they have to wait until the next day when the
branch reopens. If we can rearrange this process to make the decisions happen at noon, for example, it gives the branch ample time to execute it and inform the customer on the same day, which gives us a better turnaround time in the customer’s point of view. Similarly, we can coordinate the times between us and our vendors, ie the companies that perform background and credit checks. These vendors stop receiving applications at 1pm, which means any application not entered into their system by that time, has to wait another 24 hours to be processed. Perhaps we should look into entering these applications into the vendor’s system in the timeframe of 24pm, which means they can process it the very next morning, giving us the information we need to make a decision by noon. Initially, this rearrangement might cause a few applications to be delayed, but in the long run, I believe it would cause tremendous improvement in our response time to the customer, which enhances our competitive advantage relative to the other banks. Similarly to the boys on the hike example, not all of our 5 credit officers work at the same rate, which is a difference in personal work ethics that cannot be easily modified. It can, however, be exploited, by making us all run according to the speed of our slowest credit officer In conclusion, The Goal was an excellent read, because it introduced a groundbreaking theory using laymen’s terms, and made it easy to see that going with the ‘tried-and-true’ methods can significantly hurt your business. As a manager, it is crucial to evaluate the process of your business, and understand how the concepts of TOC can be applied to improve the profitability of your operations.
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