Measurements That Count (and Some That Don t) Hank IT DEPENDS Barr CFPIM, CSCP, CLTD, CSCM, 6σBB, C.P.M., CLA/CLT Vancouver BC November 1, 2018

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1 Measurements That Count (and Some That Don t) Hank IT DEPENDS Barr CFPIM, CSCP, CLTD, CSCM, 6σBB, C.P.M., CLA/CLT Vancouver BC November 1, 2018

2 Introduction The Goal Is To Make Money Managers Want To Manage Well Most People Believe That Businesses Have A Multitude of Constraints To Deal With The Theory of Constraints Proposes That You Only Have One Constraint At A Time

3 Agenda To Consider What Your Constraint Is And What It means To Your Organization To Discuss Some Common Measures of Performance To Examine Some Costs And Question Some Benefits

4 Let Me Count The Ways To Describe, Qualify Or Quantify Costs Or Expenses 100+ and still counting!!!

5 Words to describe, categorize or Qualify Costs or Expenses Activity Actual Admin Allocated Allotted Allowable Amortized Artificial Assigned Average Benefits Buildings Capital Carrying Change Changeover Contract Cost Damage Delay Delivery Direct Education Event Expedite Expense Facilities Finance Fixed Handling

6 Words to describe, categorize or Qualify Costs or Expenses Hard Historical Holding Idleness Imaginary Implied Imputed Incremental Indirect Info Systems Inspection Insurance Interest Interruption Investment Irrelevant Item Job Land Landed Lease Legal Long Term Machine time Marginal Materials Measurement Medium Term Obsolescence Operating

7 Words to describe, categorize or Qualify Costs or Expenses Operation Opportunity Ordering Out-of-pocket Overhead Paperwork Period Process Procurement Production Quality Real Receiving Relevant Rent Resource Rework Risk Salaries Selling Set-up Shipping Short term Shrinkage Soft Standard Stock-out Sunk Tax Theft

8 Words to describe, categorize or Qualify Costs or Expenses Time Tools Total Tracking Training Transaction Transfer Transportation Utility Value-added Variable Virtual Wages Wrap rate Associated Incurred Recognized

9 Overview Every Business and Every Person Has To Deal With Constraints In Manufacturing, Significant Constraints Are Addressed During Master Production Scheduling In A Process Called Rough Cut Capacity Planning Dependency, Variation, And Change Are Constants

10 Vocabulary RCCP - process of converting the MPS into requirements for major resources in time. MRP - a process for calculating the timing and quantity requirements for components. Bottleneck - constrains throughput Productivity - output compared to input Throughput (not to be confused with output) revenue from sales minus totally variable costs

11 More Vocabulary Resources - together provide capacity Fixed Costs - don t change on a day to day or decision by decision basis Average Costs - usually fixed costs divided by an estimated time or quantity Incremental Costs - change with almost every decision

12 Dependency Vertical Dependency - requirements for components come from the Planned Order Releases of the next higher planning echelon Horizontal Dependency - you can t make the next higher assembly if all items at the same level are not available Process Dependency

13 Traditional Bottleneck 100/hr /hr /hr Output= 50/hr Process Dependency

14 Variation & Change Forecasts Change Designs Change Early or Late Shipments From Vendors Machine Breakdown New Technology Sickness or Injury Good days and Bad days

15 I want to be a great manager, but clouds are in my way?

16 Spider Web Conflict Cloud Used with permission of Debra Smith author of the Measurement Nightmare.

17 5 Step Process for TOC & DBR Identify System Constraint Maximize Use of Constraint Subordinate Everything Else Elevate the Constraint Keep Going!

18 What, When, How Many, Cost? $6,000,000/day profit after tax/737 Customers 75/Month Final Assembly 75/Month Sales/Mkt, Finance, Mfg, HR, IS, Purchasing, Engineering WG 1 50/Month WG /Month Vendors 100/Month Land Facilities Machinery Tools Labor Materials Setups Temporary Interruptions Idle Capacity Outside Purchases

19 What, When, How Many, Cost? Customers 50(75)/Month Final Assembly 50(75)/Month Sales/Mkt, Finance, Mfg, HR, IS, Purchasing, Engineering WG 1 50/Month WG (not 75)/Month Vendors 50(not 100)/Month Vertical and horizontal dependency require a scheduled output of approximately 50 per month. What happens to traditional productivity metrics and variance analyses? And, how do you deal with variation (Murphy)?

20 EOQ Graph & Formula Costs Total $ Quantity or Lot Size EOQ= 2 * U * S I * C U=annual usage, S=setup or order cost, I=hold %, C=item $

21 Order/Set-UP Costs $1,000 Weeks

22 Incremental View of Total Costs Costs Quantity or Lot Size EOQ= 2 * U * S=0 I * C U=annual usage, S=setup or order cost, I=hold %, C=item $

23 Comparison Using average costs in EOQ results in larger lot sizes and larger average inventory. Using incremental cost analysis leads to ordering only what you need and only when you need it.

24 Make vs. Buy An opportunity comes your way. It will take 2 hours to make an item and $50 of raw materials which you have to buy. When completed you can sell it to Delta for $150. Or, you can buy it for $100 and sell it for $150. Should you make it or buy it? What does it depend on?

25 Make vs. Buy Using full absorption costing I d have 2 labor $140/hr and the $50 of materials for $330 of cost. Since I could only sell this thing for $150, I would lose $180. At the non-bottlenecks I have time on my hands and if I make it I will contribute $100 in throughput to profit. If I make this at the bottleneck, I don t lose $180, I interfere with the $250,000/hr throughput stream

26 Comparison At a non-bottleneck we only need to cover variable expenses. Using full absorption costing would keep us from making a contribution to profit and overhead at the non-bottleneck. At the bottleneck, purchasing outside services would preserve the primary revenue stream.

27 What, When, How Many, Cost? Customers 50 not 75/Month Final Assembly 50 not 75/Month Sales/Mkt, Finance, Mfg, HR, IS, Purchasing, Engineering WG 1 50/Month Buffer Buffer Buffer Land F Facilities F Machinery F WG not 75/Month Tools F Labor F Materials V Vendors 50 not 100/Month Setups 0 or $$$ Temporary Interruptions 0 or $$$ Idle Capacity 0 or $$$ Outside Purchases Save $250K/hr at bottleneck, Cause missed contribution at non-bottleneck

28 Measurement Thoughts Traditional Productivity Everywhere Leads To Chaos and Large Inventories Improvement For The Organization As A Whole Depends On The Bottleneck Use Buffers To Protect Throughput Production or purchase is started to maintain the buffers so use simple visual signals (Kanban)

29 Product X $100 price 180/wk demand D 3 min Product Y $100 price 180/wk demand D 7 min C 1 min B 3 min C 3 min B 2 min B 5 min A 6 min A 5 min A 3 min RM 1 $12 RM 2 $4 RM 3 $14

30 Resource requirements if you try to make 180 (current market demand) of each product Resource Minutes necessary for X Minutes necessary for Y Total necessary minutes Necessary/ Available A % B % C % D %

31 Total Cost of the Activities Activity Cost Production $4,800 Quality Testing $3,000 Shipping $3,200 Total $11,000

32 Cost Driver Rates Activity Activity Cost Cost Driver Cost Driver Capacity Cost Driver Rate Production $4,800 Minutes Quality Testing $3,000 Minutes Shipping $3,200 Pounds 4,000.80

33 Use of the resources by the products (minutes) X Y A 11 8 B 5 7 C 4 3 D 3 7 Total 23 25

34 Tracing Production Costs to Products X Y Total Minutes to make one item Cost Driver Rate per minute Production Cost/Unit $11.50 $12.50

35 Tracing Quality Testing to Products X Y Test time per product (minutes) Cost Driver Rate (per minute) Quality test cost per unit $1.25 $1.25 $15.00 $15.00

36 Tracing Shipping Costs to Products X Y Pounds per unit Shipping driver rate Shipping cost per unit 5 5 $.80 $.80 $4 $4

37 Total costs per unit using ABC Sales Price Direct Materials X $100 Y $ Production Quality Testing Shipping Total cost Margin $53.50 $50.50

38 Maximum profit using ABC: 180 X (best margin) and 52 Y (remaining capacity) X Y Total Revenues 18,000 5,200 23,200 Raw Material Costs 2, ,816 Gross Margin 15,120 4,264 19,384 Operating Expense Maximum Profit 11,000 8,384

39 What is the throughput or contribution per unit of limited resource? Product Price Totally Variable Cost Throughput per Unit Time on limited resource Throughput per unit of limited resource X $7.64 Y $10.25 Product Y actually contributes the most to profitability because of its contribution per unit of scarce resource. This is very different than ABC would have led us to believe. To get the most profit, we should produce and sell all the Ys the market wants and use remaining capacity to produce and sell Xs.

40 Maximum profit using TA: 180 Y (best throughput) and 87 X (remaining capacity) X Y Total Revenues 8,700 18,000 23,200 Raw Material Costs Gross Margin Operating Expense Maximum Profit 1,392 3,240 3,816 7,308 14,760 22,068 11,000 11,068

41 ABC v. TOC or LEAN Traces costs Generates many transactions Aggregates value to WIP and FG Did not properly guide towards profit Inconsistent between accountants Does not trace costs No transactions Few calculations Guides towards profit So simple it s hard to be inconsistent

42 Questions?

43 Where to get more information Hank Barr , APICS, The Goal, It s Not Luck, Critical Chain, The Measurement Nightmare, Throughput Accounting, Necessary But Not Sufficient, Lean Thinking, Who s Counting, Real Numbers, Learning To See

44 Thank You Let s keep in touch. Hank Barr home cell hankbarr@comcast.net