The Demand Driven Adaptive Enterprise. Carol Ptak
exist, capacity bottlenecks exist, etc. All of these issues are simply impediments to flow and result in “pools” of inventory with varying depth. A river without flow is not a river, it is a lake. Operations with out flow is a disaster.
With this analogy we begin to realize that flow is the very essence of why the Operations subsystem of manufacturing and supply chain companies even exist. The Operations subsystem is typically divided into functions, each of which have a primary objective for which they are responsible and accountable. Figure 1-5 is a simple table showing typical Operations functions and their primary objective.
FIGURE 1-5 Typical functions in operations
All of these objectives are protected and promoted by encouraging flow. Under what scenario does a cost-based focus enable you to synchronize supply and demand or sequence activity to meet commitments? In fact, a cost-based focus most often leads to the exact opposite of these objectives. Thus, if Operations and its functions want to succeed in being truly effective, there is really only one focus–flow. Flow must become the common framework for communications, metrics, and decision making in Operations.
Let’s expand this view to the organization as a whole. An organization is typically divided into many subsystems, not just Operations. Each subsystem is typically tasked with its own primary objective. Figure 1-6 is another simple table showing the typical subsystems of a manufacturing and/or supply chain-centric company.
FIGURE 1-6 Typical organizational functions
All of these functional objectives require flow to be promoted and protected to drive maximum effectiveness. When things are flowing well, shareholder equity, sales performance, market awareness, asset utilization, and innovation are promoted and protected and costs are under control. This was discussed extensively earlier in this chapter. Thus, flow must become the common framework for communications, metrics, and decision making across the organization.
Additionally, flow is also a unifying theme within most major process improvement disciplines and their respective primary objectives.
All of these objectives are advanced by focusing on flow first and foremost. This should not be surprising since we have already mentioned these thought leaders regarding systemic coherence. When considered with Plossl’s First Law of Manufacturing, the convergence of ideas around flow is quite staggering. There should be little patience for ideological battles and turf wars between these improvement disciplines; it is a complete waste of time. All need the same thing to achieve their desired goal: flow. Among these disciplines, flow becomes the common objective from a common strategy based on simple common sense grounded in basic physics, economic principles, and complex systems science.
The concept and power of flow is not new, but today it seems almost an inconvenient afterthought that managers must, if pressed, acknowledge as important. It powered the rise of industrial giants and gave us much of the corporate structure in use today. Leaders such as Henry Ford, F. Donaldson Brown, and Frederick Taylor made it the basis for strategy and management. The authors believe these leaders would be astonished at how off the mark modern companies are when it comes to flow; they are surviving in spite of themselves.
Thus, Plossl’s Law, while incredibly simple, should not be taken lightly. This one little statement has always defined the way to drive shareholder equity and it was articulated by one of the main architects of conventional planning systems! Embracing flow is the key, not to just surviving but adapting, taking a leadership position or being a fierce and dangerous competitor. It is the first step to becoming a Demand Driven Adaptive Enterprise. In order for that first step to be taken, however, a huge obstacle must be overcome: the universal fixation, emphasis, and obsession over cost.
Cost and Flow
Executives of corporations around the world obsess over cost performance, most particularly unit cost. It dominates discussions on a daily basis and constantly influences a majority of strategic, tactical, and operational decisions throughout the organization. We need to understand what unit cost is (and is not) and why it became so prominent.
Any unitized cost calculation has always been based on past activity within a certain period. The calculation of standard unit cost attempts to assign a cost to an individual product and/or resource based on volume and rate over a particular time period. Essentially, fixed and variable expenses within a period are accumulated and divided by volume within that period to produce a cost per unit. This cost per unit can also be calculated by resource and location. This cost then becomes a foundation for many metrics and decisions at the operational, tactical, and strategic levels in the present and for the future.
Where did unit cost come from? In short, unit cost can trace its origin from the 1934 adoption of Generally Accepted Accounting Principles (GAAP) by the United States government as an answer to the U.S. stock market crash of 1929. Many industrialized countries have since followed this example. GAAP is an imposed requirement for the fair and consistent presentation of financial statements to external users (typically shareholders, regulatory agencies, and tax collection entities). GAAP reporting and the unitized cost calculations based on it was then incorporated into information systems circa 1980 with the advent of manufacturing resources planning (MRP II), the pre-cursor to enterprise resource planning (ERP). That incorporation continues today in every major ERP system.
Why was GAAP incorporated into information systems? It was not driven by the need to manage cost today, or to make management decisions or develop strategy in the future; it was driven by the need to fulfill the financial reporting requirements of GAAP in a much easier and quicker fashion. Even today most ERP implementations begin with the financial module. In the United States the Sarbanes-Oxley act of 2002 drove ERP software companies to provide technology that allowed even faster financial reporting using these rules.
GAAP, however, does not and should not care about providing internal management reporting. Why? Because GAAP’s entire purpose is to provide a consistent reporting picture about what happened over a past period, not what should be done today or suggestions or predictions for the future. GAAP is simply a forensic snapshot of past performance within a certain defined time period, meaning that if it is done as required by the law, it is always 100 percent accurate in determining past cost performance information only.
The incorporation of these cost data quickly led to its numbers and equations becoming the default way to judge performance and make future decisions. Why? The higher-level metrics like return on investment, contribution margin, working capital, etc. are much too remote to drive through the organization. Management needed something to drive down through the organization to measure performance. Cost numbers were readily available and constantly updated in the system.
Now, unfortunately, most of management actually believes or accepts that these numbers are a true representation of cash or potential. The assigned standard fixed cost rate, coupled with the failure to understand the basic aspects of a complex system leads managers to believe that every resource minute saved anywhere is computed as a dollar cost savings to the company. GAAP unit costs are used to estimate both cost improvement opportunities and cost savings for batching decisions, improvement initiatives and capital acquisition justifications. In reality the “cost” being saved has no relationship to cash expended or generated and will not result in an ROI gain of the magnitude expected. Cost savings