The managerial need and the illusion of being “in control”

Living under uncertainty is scary. We invest huge efforts to predict the future and prevent, whenever possible, the truly negative outcomes.  Humans use superstitious beliefs to set clear expectations of the future and make sure it is not going to be too terrible.  Others are using statistics to relax their fears and, at least, put them in perspective.

Being ‘in control’ means having good enough prediction of the future. Some definitions speak of ‘dominating’ the system, but this is more to say that no big deviations from the current status are expected due to who dominates the system.

In order to be in control we need a control mechanism. I suggest the following definition for a control mechanism:

A reactive mechanism to handle uncertainty by monitoring information that points to a threatening situation and taking corrective actions accordingly

Threatening situations are the cause of our fears. When we deduce the possibility of a threat we are able to look for signals that point that the threat is on.  For instance, we fear from burglars breaking into our home.  We put alarm systems to warn us when this happens.  We also need to know what we do when the alarm is on – calling the police or local security provider.

Fears play a very big part in managing organizations. Managers fear from possible negative impacts on their organization and even more from the personal impact on them.  The culture of organizations forces a seemingly rational approach that pushes for optimizing everything even in highly uncertain situations.  Actually organizations use a different set of superstition, especially one that believes that people are always able to meet their commitment to an ambitious target.  When they fail to do so – it is their own failure because they have demonstrated either their incompetence or their unwillingness to do whatever it takes. This kind of widespread behavior actually means ignoring uncertainly and this is a special brand of superstition.

Uncertainty should include, in my mind, not just the natural fluctuations of variables, but also the limitation of the human mind to absorb complexity and digesting huge amount of data.  When Goldratt claimed that every system is based on inherent simplicity he pointed to the practical inability of human-beings to control truly complex human systems.  Organizations simplify the complexity by maintaining excess capacity and buffers so most small disruptions would cause very little damage, if at all.  The irony is that organizations try to hide the massive excess capacity and their buffers, because it clashes with the utopia of optimization. Personal hidden buffers protect the safety of the individual in the organization, and the need to hide the buffer is not too high price to pay. The individual, sometimes groups of employees, fight to be able to commit to targets that are achievable in a very high confidence level.  Once the individual reaches the target he/she are careful not to achieve more, because that would worsen the chance to get comfortable targets in the future.  It is my view that this is the core problem of the vast majority of the business organizations in the world.  Kiran Kothekar has made similar arguments in the TOCICO conference in 2016.

Setting targets is a key common control mechanism. The two objectives controlled by this mechanism are to keep people under constant pressure to perform well and to keep good synchronization between the functions.  Thus, the targets for Sales are translated to targets for Operations.  The targets also serve the construction of the budget, which serves as a synchronization plan for the organization.

Does this control mechanism work?

It does work to a certain limited degree, but also causes serious negative effects. Most organizations have adequate stable delivery performance to their clients.  So, when I go into a supermarket with a list of twenty items I usually go out with seventeen items from the original list plus one or two acceptable replacements.

Do I like the situation of not finding one or two of my priority items?

Well, do I have an alternative? The uncertainty of finding everything forces me to take certain steps, like buying more of some products I suspect might be missing next time.  If someone would solve that problem it’d be of high value for me.

The key point is that most organizations do not behave in a chaotic way!!!

Most of the prior expectations do materialize in the relatively short-term and thus they are “in control”. However, there are still two problems with the current practice of maintaining adequate control:

  1. The performance is far from exploiting the true potential of the organization.  Actually it is also far from the flawed optimization dream. Much better performance could have been achieved with different methods of control.
  2. While most expectations materialize, some are not. The constant fire-fighting with unexpected events raises the level of nervousness throughout the organization. It takes huge amount of management attention to bring the situation to an acceptable control, and eventually very few lessons have been learned.

TOC has been focused on the rules for planning and on the different rules for execution.  The execution phase is part of the overall control – making sure the outcomes are close enough to the planned/expected objectives and targets.

The TOC wisdom has introduced the insights of looking for the weakest-link to dictate the potential limits of the planning, and then add visible buffers to protect the objectives from common and expected uncertainty. The TOC wisdom for the execution phase is to closely monitor the state of the buffers, and when the buffer consumption penetrates its last one-third part to treat the situation as threatening, invoking actions like expediting to fix the shaky situation.  TOC has on-going objectives depending on the limits imposed by the constraint and monitoring the buffers is one of the logical ways to identify blockages.  TOC offers a control mechanism that allows going for much more ambitious objectives, while still protect the performance from too high fluctuations.

However, the current TOC BOK does not do enough to face incidents and events that happen outside the planning and execution, many times originated outside of the organization.

An example: a new competitor offering new products or services that compete with the natural market of the organization.

Another example: A high level manager is publically accused of sexual harassment of an employee.

What control mechanism could cope with such external, yet meaningful, cases?

The two examples above point to two different categories of such threats:

  1. A threat that is recognized a-priori as a possibility. For instance, being aware that a new competitor might emerge with a new technology or offering.
  2. An unexpected threat.  for instance, Someone behaves in an unacceptable and unexpected way.

The first category of potential threats enables management to design the appropriate control mechanism that would be able to identify the rising threat as early as possible and prepare the procedures for handling the threat when it appears.

The second category is tough, because there is no clear control mechanism. Such surprising events break the illusion of being ‘in control’ and send a message that we might, even though not too often, lose the control we think we have. In my last post I dealt with the transition period, which is the time when the company is especially vulnerable and less in control.  The generic advice was to ask the question “what could go wrong?” Answers to the question move some potential threats to the first category.  The other advice was: “be on your toes!”

Eventually managers need to recognize that even unknown threats send us, many times, certain signals that point to the emerging threats. We cannot specifically prepare for these signals of threats we do not think of.  So, who should be constantly looking for signals that something is happening, deduce the threat and what could still be done about it? Every army, preparing for a war where chaos takes over, has intelligence officers who actively look for both the expected and the unexpected.  I think that normal companies need such a role as well.

The role of the Transition Period in implementing a change

For this post I come back to my 2011 presentation at the TOCICO annual conference. Any significant change opens the door to new undesired effects and other signals that need interpretation. TOC implementations certainly involve significant changes in the mindset of managers and their subordinates.  This topic seems to me a most relevant topic to discuss now, six years after the death of Dr. Goldratt, as the responsibility for the success of the change lies on us and the challenge is bigger than it can be judged from the wonderful change management process we have so carefully planned.

An unavoidable ramification of any significant change is a temporary level of confusion.  There is no way that all the outcomes of the change have been properly analyzed prior to the change.  While we definitely should use all our logic and intuition to look for negative branches ahead of time, we are not all that clever and we better acknowledge that fact and become ready to face the consequences.  Confusion means that some people in the organization have different understanding of what to do and what to expect.  Confusion also means we are unsure whether what we see is what we should see.  The consequence of being confused and uncertain is making mistakes causing variable level of damage.  In itself this is not a big deal as quick fixing mistakes usually reduce the damage considerably.

Transition period is the time it takes from the start of the implementation of the change until we feel confident that the system has been stabilized under the new rules of the change, especially that the intuition is satisfactorily restored.

One characteristic of the transition period is:

The rules in the area of the change during the transition period are neither the old ones nor the new

The term ‘rules’ used above is about the actual way actions are handled. The change has some immediate impact on the current way the area is managed.  But, the change itself has not been completed yet, so we might get a mixture of different, even contrasting, actions done by different people.  It is also possible that some of the rules and processes have been temporarily changed with the intent of fine tuning them later.  The implementation plan has to outline the intermediate steps and for how long they are going to apply.  Of course, within the implementation there could be further changes and even deviations from the original plan.

Planning according to TOC includes placing buffers at the critical points protecting from both uncertainty and flaws in the planning logic.  Among them are time buffers, but also excess capacities, excess capabilities and readily accessible management attention for solving emerging problems before more damage in done.

A critical element in such planning of a change is asking a typical TOC question:

What could go wrong?

This is a very problematic question because it radiates doubt in the plan and its underlining detailed logic. The point, made by Eli Goldratt, is “Never Say I Know”, and it is this effect in reality that should force everyone to ask that question.  It is of special relevance for the transition period where the whole system is vulnerable.

There are three different categories of what could go wrong:

  1. Flaws in the logic behind the change and the planning.
  2. Flaws in the implementation. These include:
    1. Misunderstanding of the logic or the instructions given by the champions of the change.
    2. Resistance to the change causing deliberate sabotage of the implementation plan.
    3. ‘Murphy’ – uncertainty that exhausted the planned buffer and caused damage.
  3. External event that has considerable negative impact on the implementation.

Some examples:

  1. Moving from Make-to-order (MTO) to Make-to-availability (MTA) without noticing the need to build the stock buffers before moving to the operational rules of MTA! Building stock buffers defines a transition period that has to be carefully monitored.
  2. The MRP planners took ‘chocking the release’ too severely to the degree of starving the constraint. This could easily happen by defining too short time buffers.  Such a flawed move could be the result of misunderstanding, miscalculation OR intentional sabotage.
  3. A project that serves as the proof-of-concept for CCPM had gone into difficulties due to many new requirements, creating unbearable pressure and delays. Some late additions were caused because of flaws in the planning.  Other new requirements were raised because of new information that the competition had been going to introduce new features.
  4. The planned change required a special budget for additional operating expenses, but then the Bank demanded the immediate return of an old loan, which robbed the organization from its cash buffer.  This is an example for an external  event.

How should the transition period be managed?

Considering the possible answers to the question what could go wrong should trigger specific inclusion of signals that point to a specific potential threat that is actually materializing. For instance, sales people, who are concerned that their clients get the delivery as promised, cite an earlier due-date to press Production to prioritize “their order”.  Checking whether finished goods are actually shipped, within 24 hours, to the clients could note exceptions that show that this is actually happening.

I think that in any operational TOC implementation buffer management should be implemented as early as possible. While this control mechanism is an integral part of the TOC change, its value for the transition period is especially important.

The format of the Strategy and Tactic Tree (S&T) could easily incorporate entries monitoring “what could go wrong” as specific low level entities. In a good S&T one should include the list of signals to be monitored within the Parallel Assumptions part of the relevant entry.

This set of signals should be part of the transition period practice. Most of these monitoring schemes could be shut-off when the transition period is over.

However, this does not address the emergence of an undesired-effect we have not expected. The required general managerial behaviour for this kind of problems is:

Be on your toes!

I highly recommend the champions of the change to be clearly aware of the fact that unexpected problems, sometimes also unexpected opportunities, could emerge in such a period.  It could happen at all times, but during a transition period the probability is higher and the potential damage of failing to notice the unexpected is very high.

What makes Eli Goldratt a true GENIUS in the art-and-science of managing an organization?

ELI_GOLDRATT

There are many brilliant people. There are very few effective leaders, most of them are not even brilliant, but they are charismatic and effective in achieving a goal.  Effective leaders see to it that they have brilliant people to help them achieve the goal they have chosen.

A genius is another matter. It is a person who sees far into the future pointing to necessary changes in the current practices that would achieve a new and better reality for mankind.  That far away broad vision is what characterized a true genius from a typical brilliant person who is able to find a temporary solution, without offering a change in perception.

There are number of true geniuses in art, who dramatically changed the artistic environment. This means it is possible to clearly see the difference between the artistic situation before and after the specific artist. Let me just mention the names of Beethoven, Van Gogh, Picasso, Homer, Shakespeare and Beckett to demonstrate just a few who changed the world of art.  We know, of course, of few scientists who challenged the older paradigms and came up with new ones, like Copernicus, Newton, Pasteur‏ and Einstein.

In order to achieve a true change just being a genius is not sufficient.  There is a need also for one or more opinion leaders to make it happen.  In art it requires some open-minded, but highly influential, critics to persuade the world of the worthiness of the new approach to art.  In the academia there is a need for open-minded journal editors to allow the challenge to the current thinking to make the impact.   The typical genius is looking so far ahead that it is not easy even for the brilliant contemporaries to see the vision.  It could be a very slow process to achieve the wide recognition of the change and its wide ramifications.

Eli Goldratt was, to my mind, a true genius in the field of management. Goldratt perfectly understood the current situation in the world market that is complex and uncertain and the lack of capability of the existing tools of Math, Statistics and Psychology to solve the difficulty to maintain an acceptable control. The problem is that with the accelerated speed of technology, especially in big data and communication, the complexity and uncertainty grow so fast that being ‘in control’ looks like a dream.

Goldratt the genius has found several key insights that together make it possible not only to be on good enough control, but also to see the way to grow in a reasonably stable way.

He taught the world to realize the absolute need for excess capacity, actually also for excess capabilities.  He taught the world to identify the weakest link that currently prevents from achieving more.  He looked for the inherent simplicity that without it there is no way for an organization to act reliably.  He defined the buffers that have to be part of any plan and how to draw from their state the right priorities. All of these insights, and many more, are part of what Goldratt left us to implement in the mind of managers and executives.

Managers are impatient people relative to artists or scientists. It took the world many years to fully recognize the revolution of the music of Bach or understand the ramifications of Quantum Theory.  Managers need answers NOW.  Frightening insights, which might have unexpected or unclear ramifications and also question the wisdom of the managers themselves, are difficult to handle and convince in the short term.  If Goldratt was ‘just a genius’ it would have been impossible to turn his insights into practice.

In order to be able to spread the new provocative ideas Goldratt had to become a leader himself. It is a necessary condition for changing the mind of managers.

A leader needs to have followers who believe in the same goal and are ready to accept the leadership of one person. The vast majority of the geniuses are not leaders.  They are loners who despise the world for not recognizing their greatness.  Thinking of other people as idiots is a normal characteristic of brilliant people and certainly of geniuses, but this contempt is an obstacle for spreading a new message.

Like other geniuses Goldratt thought that all other people are stupid, BUT he recognized that telling someone that he is an idiot does not bring good results, except some minor good feeling for very short time. So, in order to become an effective leader Goldratt had to identify people with relatively good capabilities and convince them to join him.

This mission of attracting good people, even though he still did not truly appreciate their intellectual capabilities, is part of the Theory of Constraints, because being constrained by the capacity of people with fair capabilities doesn’t make sense. The constraint for changing the mind of managers had to be the capacity of Goldratt himself.  To overcome the obstacle Goldratt had to fight with his own basic character of being so brilliant that anybody else was viewed as slow.

Goldratt succeeded in attracting a variety of truly excellent people to help him accomplish his vision. More, he succeeded to attract many more people, who did not work closely with him, but were ready to put efforts to implement the ideas and spread the word to others.  Others just tried their best to implement the insights. While Goldratt philosophy is based on simplicity it does not mean it is easy to understand or to implement, so many new challenges were revealed on the way.

Goldratt died six years ago. Is TOC in 2017 the recognized way to manage an organization? I don’t think so.  After more than 30 years since the five-focusing steps, which, for me, mark the birth of a new pragmatic managerial theory, there are thousands of people who practice TOC all over the world.  Thousands, but not millions!  Eventually Goldratt was more of a genius than an effective leader.

What does that tell us? Goldratt ideas should be widely used in managing organization, but right now this is not happening.  Organizations are NOT managed according to the best available knowledge that exists today.

What do we do to make the knowledge spread and practiced?

TOC is far from being complete and it is far too rich in value to be ignored.  Do we expect another leader to show up?  Would that leader need to be also a genius, or just an effective leader, who listens to others, who develop the BOK further, while the leader finds the most effective way to spread it?  Many questions lie open and the obvious danger is that most of Goldratt ideas would be lost.  The problem of losing control on the performance of organization is still a huge threat to the world economy.  Running away from the challenge of handling complexity and uncertainty together would worsen the situation.

I hope we find the way to spread that knowledge more and more, wider and deeper. I personally think that the key lies in collaboration, rather than waiting for the one leader.  I’m ready to collaborate with those who like to collaborate with me.

The huge obstacle digital stores have to overcome

By Eli Schragenheim and Henry Camp

E-Commerce offers real added value to many different market segments. The value of the new technology has been analyzed in a previous post: “Applying the six questions of technology to digital stores.” This added value changes the whole business of retail.  But, it is not just a disruptive technology; there is a risk of being self-destructive, because digital stores face a huge threat to their own survival.

The main question every single digital stores faces is:

What added value can we offer relative to other digital stores?

The question targets a huge and sinister obstacle, which becomes more and more dangerous with time. From the point of view of potential customers, what is the difference between buying from one digital store and another? As long as delivery logistics are in place, location has no relevance, unlike traditional brick and mortar stores.

Dr. Goldratt coined the term “decisive competitive edge” (DCE), as being superior to any significant competitor in a given market segment. He also defined the conditions for gaining such a DCE.

  • Answering a need that no other competitor is able or willing to.
  • Competitors refuse or are slow to follow, usually because delivering equal value contradicts a common business paradigm, such as operating efficiently or containing costs.
  • In other parameters important to the segment, the company is on par with the competition.

The direct consequence of lacking a strong DCE is that customers are left with no clear means to differentiate, except based on price. The reality of the internet has encouraged services that compare prices between different digital stores.  Thus, it is quick and easy for customers identify the cheapest digital store for any desired product.

Many on-line shoppers make spontaneous purchases once they see a product they fancy and its price. This is where the vast majority digital stores compete, but without truly gaining any advantage over each other.  They commonly offer a broad variety of products at very low prices and send emails in volume to past customers with the hope of capturing or keeping mindshare.  On top of that, artificial intelligence is deployed to speculate what any potential customer desires.  Could this be a DCE?  Yes, if you are far better than your rivals.  The problem is, since competition is so hot, any gaps close very fast.

When the only reliable competitive differentiator is price, then the Throughput percentage (Margin/Sales) drops, forcing the digital store to look for some combination of two alternatives:

One approach is cutting expenses, seeking profitability at current volumes. Unfortunately, the main expenses of digital stores support marketing as well as being quick and reliable in delivery.

If cutting expenses seems like an obviously bad idea, you will understand why most digital stores choose the opposite approach, spending more and slashing prices in the hope of driving sales growth. Driving OE up while cutting Throughput % typically results in current losses but maybe, just maybe, with enough more sales … someday the digital store will gain enough economies of scale to become profitable.  The required relentless increases in the quantities of items sold, becomes more and more difficult to accomplish, because the cost of entry for new competitors flush with investors’ cash is very low.  Should one digital store fail, then the remainder feel like there is no alternative to spending lavishly on marketing to attract the customers who used to buy from their now defunct competitor.  Furthermore, the survivors try to draw in ever more new clients by dropping prices some more.  This is the vicious cycle of the digital marketplace.

How can a digital store gain a Decisive Competitive Edge that is not price?

First let’s state the obvious: currently the only true DCE for digital-stores is being very big!  So, Amazon and AliBaba have already gained that position but how can others become that big?  There are three separate types of added value that big successful stores deliver to their customers:

  1. Confidence that nothing will go wrong
  2. A broad variety of products
  3. The ability to succeed while delivering at low prices

Is there anything that a smaller digital store can do to gain a customer base that loyally buys from them? This is the most critical question for any digital store facing the grim reality of global and open competition on price.

There are several directions where breaking the vicious cycle is possible:

Building a strong loyalty program for customers

It has been proven by the airlines that loyalty programs work! It demonstrates not only the impact of getting things for free, but also that giving special VIP treatment to people makes an impact.  Translating the concept of a loyalty program to digital stores is far from being trivial but it also brings a new opportunity.  The common paradigm is stuck with investing money to give away value to customers who bought something without being certain of future purchases from those customers.  This paradigm makes such a loyalty program tough to imitate, especially in the current environment of lack of profits among digital stores.

The real challenge of pursuing this direction is not only the free gifts and price reductions but providing special VIP treatment to loyal customers. It could be a certain top product mix sold only to the members of the club, giving high priority in the shipping, free delivery – like Amazon Prime, free returns – like Zappos or any other generic idea for a DCE.

Still, loyalty programs have been copied. What airline doesn’t have one?  The “D” in DCE stands for decisive.  This means others won’t copy the edge, at least for long enough for the developer to gain enough of an advantage, like accumulated profits, to make another leap ahead of the competition that they can’t or won’t afford – again, at least for many years.  For a digital store’s loyalty program to remain exclusive, it must either address a problem caused by digital stores by their very design or an issue that is unresolved by all stores.

One comment about a neglected market segment: the high socioeconomic sector is not actively sought by digital stores who speak the language of low price. While relatively rich people still hate to pay more just because they can afford to, those people are willing to pay more for higher value.  A loyalty program that treats the members specially is something they look for.  If digital stores are able to find its way into this sector – they’ll become antifragile, and that is worth a lot.

Choosing the right product mix

Regular stores carry and display physical items. Virtual stores can only display a picture of an item.  This allows the digital stores to display and sell very wide variety of similar items, without the need to choose the preferred product mix.  On the other hand, even if offering more is virtually free, studies have confirmed what shoppers already feel – having to sort through the haystack to find the desired needle makes what could be easy and fun a boring chore.

What does it mean that a store shows a picture of a certain product? Actually, it only means that the product is for sale.  There is no implied formal recommendation by the store.  “Some people buy it.  So, we have it.”

What if the store took a stand on what it considers good and worthy products? Consumers are rightfully suspicious that stores recommend those items that bring the store the most margin.  If that expectation for self-serving behavior can be overcome, then truly assisting individual buyers choose well for themselves specifically is a significant added value.  Big retail already relinquished all the responsibility of choice to the customer.  The need for help making the right choice is still real for many buyers of many products.  So, being able to identify the right product mix and then directing the consumer to what truly fits his or her needs while clearly projecting pure intentions is a Decisive Competitive Edge.

Assisting customers can be partially by virtual means, displaying relevant information that helps them realize which needs the product meets or by means of real-time texting or even speaking with a shopper live. Such services add complexity and costs to operations, which is seen as problematic, but could also establish a unique value that makes the specific digital store unique and it attracts high level customers.

Making the delivery a special experience

It is true that customers of digital stores have a somewhat elastic tolerance to the time of the delivery. If they didn’t, they would be forced to buy from a local store that holds stock of those products for which they prefer not to wait.  This does not mean they don’t care how the item finds its way to their home or workplace.  Most digital stores partner with delivery companies to handle shipments.  This means the delivery company treats the item(s) that are delivered just like all other items.  It is enough that they get there reliably.

What if, for the upscale segment, the carrier truly represents the digital store? When this is feasible, the delivery could easily answer a need: allowing the customer to physically check the product and only then decide whether to keep or return it.  It could solve the problem of fitting clothing, by including in the delivery two or three sizes out of which the customer would choose the best fit.  The buyer could decide by actual inspection which of two competing brands is preferred.

Is this too expensive to do?

This is the wrong question, even though this is the most common one managers of digital stores probably ask themselves. The real question is whether some customers are ready to pay for such a service?  If there are customers for whom this service is what they desire, then the price is not the only issue.  What a relief!

The internet created a sea change, the ramifications of which we are still struggling to understand. There are some destructive aspects to the internet economy.  The belief that the number of customers and detailed information about them are enough for making a successful exit are probably over but the damage from making customers expect to getting value for free still exists.  It is time for deep cause-and-effect analysis to outline a way to draw true value, value that answers our needs from the internet.  E-commerce in general and individual digital stores in particular are ripe areas in which to start such an analysis.  Those who do it well and soon will deploy their DCE to earn not just sales but disproportionate profits.

Evaporating an Active Cash Constraint

By Ravi Gilani and Eli Schragenheim

Money is a critical resource as demonstrated by every company that has gone through bankruptcy or has been on the verge of bankruptcy.

Generally speaking cash is also the ultimate constraint of the public sector, as the budget dictates the maximum value that the public-sector organization, a non-profit organization by definition, is able to draw. Limiting the working capital of an organization to the extent that lack of cash limits the throughput happens also to some profit organizations.

This article focuses on companies for which the cash limitation is a direct threat on their survival. This kind of cash constraint is unique because it is imperative to find the immediate way to go out of the situation.

People who are knowledgeable in TOC are aware that any specific constraint of the organization should dictate policies and norms of behavior that could be different than with another constraint. This dependency on the constraint is even more noted when the constraint lies with cash, which prevents purchasing the required materials and the use of capacity and by that disrupts the life line of the organization. The immediate result is that revenues are blocked.  These revenues could have been used to generate more revenues and reduce the pressure on cash.  In such a case money is both the goal and the absolutely required capacity to continue the business. This is a unique situation with very critical ramifications, which should lead the management to behave differently than in any other state. When lack of cash threatens the existence of the organization all the attention of the top management is consumed in fighting one payment crisis after another.

The seemingly complicating factor of money being the goal, the constraint and the direct threat to the organization makes the TOC insights regarding exploiting the constraint and subordinating everything else to it, especially strong. The good news are that the right behavior accelerates the regaining of cash in a non-linear way. The objective of this article is to point to ways to elevate the cash constraint. It is not a constraint a company can live with for too long.  We believe that it is possible, many times, to get out of the cash constraint situation in 15-20 weeks.

The important generic insight for a survival cash-constraint situation is to understand the meaning of cash-to-cash cycle time and cash-velocity. This leads to being able to accelerate the cash-velocity and go out of the current state, even on the expense of the amount of revenues.

Cash to cash cycle time is the total time it takes from cash going out to cash coming in. In other words the time from the actual payment to a supplier until the client pays. We can measure the time by days or weeks as reasonable periods of time.

Cash Velocity (CV) is defined as the contribution-ratio of one unit of cash in one period of time.  For any business every dollar invested in materials, or for providing the capacity required for a sale, is expected to yield, on average, more than one dollar. In other words, the ratio of the cash in to cash going-out should be higher than 1. The idea here is to get the ratio for one period of time, like a day or a week.

Suppose one dollar is the cost to buy materials and the finished item is sold for $2 dollars three weeks later. So, the going out cash is doubled in three weeks and should yield 4$ in another three weeks.

How much did the invested dollar yielded after just one week? The answer is NOT 33%, because if after one week we get $1.33, then we immediately invest the $1.33 to generate more sales and then after the second week we have 1.33*1.33 = $1.7689, and after the third week we should have: 1.33*1.33*1.33 = 2.35, not 2.  In order to get the cash velocity (CV) of the situation where $1 would yield revenue after three weeks of $2 the CV = the 3rd root of 2 = 1.259, or 25.9% contribution rate in one week.

A company that is in the state of struggling with a cash constraint has operational lines working, but it needs to invest its limited cash to buy materials and then turn them into sales. These are the main body of the truly-variable-costs (TVC), the cost saved when one unit of output is not produced and sold.  The quicker these dollars, used for TVC, are turned into Sales the amount of cash would grow until the state where the constraint moves to something else.  The ratio of S/TVC, S stands for sales, representing the contribution of $1 invested in materials to cash coming from sales.  This ratio is called: contribution-ratio.

The overhanging threat on the company is its ability to cover all the other operating expenses (OE). These are all the expenses the company has to carry to sustain the operational line alive.  Without the OE there is no basic ability to survive.  So, it is absolutely critical to have the amount of necessary OE in order to stay alive.  The rest of the limited cash is to make more cash as fast as possible, until the company reaches the state where there is enough cash to support the full market demand.  At that state the constraint might move to the market or to another resource.

The formal mathematical formula for cash velocity is: CV = ((S/TVC)^(1/n) -1).

The cash-to-cash cycle time is represented as n in the above definition.

Table 1 details the calculations for two different products P & Q.

Table 1

Parameter P Q
Selling price per unit (s) in $ 100 80
Totally Variable Cost per unit (TVC) in $ 50 50
Contribution ratio s/tvc 2 1.6
Manufacturing lead-time in weeks 2 2
Clients credit period in weeks 4 1
Total cash to cash time (n) 6 3
CV/Week =[{(S/TVC)^(1/n)}-1]*100 12.25% 16.9%

It seems that given a choice, due to the lack of cash, between selling P and selling Q, that selling Q would generate cash faster, bringing the company to go out of the cash constraint situation earlier than focusing on selling P. This is not the intuitive answer, just to hint how far are most managers from the right answer when cash appears as a constraint.

The cash the company holds at every point in time when it is in a cash constraint situation is used for two critical objectives:

  1. Covering the critical operating expenses: the must-have expenses to keep going – OE.
  2. Purchasing the absolutely required materials to enables sales. This is the TVC.

The minimal cash required for survival is n*OE, because whatever is purchased now will turn to revenues only in n periods. However, this amount does not leave any room for investing cash in order to get more cash. This means that once the company is left only with that amount of cash it is doomed.  Question is what is the amount of cash that still provides a valid option to survive? We like to find out what cash leaves an option that after n periods the company would still have the same amount of cash. Let’s call it adequate survival cash. So, we look for X cash that after n periods would yield exactly X cash. In the beginning we need first to put aside n*OE from the cash in order to cover the OE payments for all the periods, including the current one, until the new cash appears.  The remaining cash of X-(n*OE) is used to purchase materials to sell end items after n periods getting X in revenues, allowing us to repeat the process. The invested cash in materials would yield c*(X-(n*OE)), where c is the contribution rate, S/TVC, and we like it to be equal to X.

X = c*(X – (n*OE)) = c*X – c*n*OE

X*(c-1) = c*n*OE

X=n*OE*{c/(c-1)}

Sufficient cash means the cash at hand is enough to cover the n*OE plus having enough to purchase whatever is needed to exploit the capacity and/or the maximum market demand. If the cost of materials that fully answer all the demand or the full capacity of the most loaded resource, then it is enough cash to be considered beyond the urgent need pull the company from its cash constraint situation.

Table 2 provides sample calculations for above parameters.

Table 2

Parameter P Q
Contribution ratio (c) ~ S/TVC 2 1.6
Total cash to cash time (n) 6 3
OE / week in $ 500 500
Cash available in $ 2000 2000
Survival time in weeks 4 4
Survival cash requirement:   n*O.E. 3000 1500
Adequate cash requirement: n*OE*{c/(c-1)} 6000 4000
Cash required / week for full capacity 1000 1000
Sufficient cash requirement: n*(OE+1000) 9000 4500

What the table shows is that having on hand cash between $4,001 and $4,500 and focusing on the Q product provides a much better way to bring the organization out of the cash constraint than by concentrating on the P product. If the market for the Q product is limited, and this is what constraining the company from investing more than $1,000 per period in purchasing materials, the organization has more cash than 4,500, and the internal constraint provides enough capacity also for the P product, then the organization can improve even more.

The above example is a simplified reality.  Usually, while having on-hand only $2,000 there are already orders and materials in the pipeline.  That means the cash-flow situation needs to be clearly specified week-by-week.  But the principles are the same.

The process of going out of the cash constraint situation

In cash constraint situation, the focus on generating as much cash and as fast as is possible through effective utilization of existing cash. A small increase or reduction in cash can make or break the organization. This unique property of cash impacting throughput non-linearly could help organizations to overcome cash constraint in a very short period of time.  In most cases it may be possible to come out of cash constraint in less than three months by reducing cash to cash time, and by that accelerating the cash velocity.

Cash to cash cycle time (n) reduction has huge non-linear impact on throughput, cash availability, survival time, adequate cash requirement etc. Often just shrinking cash to cash cycle time is good enough to come out of the cash constraint situation provided the right measurements are in place.

The common TOC techniques of accelerating the flow of value to customers, through chocking the release of orders and the use of buffer management, are already good means to shorten the cash-to-cash cycle and increase cash-velocity.

Additional ways to reduce the cash-to-cash cycle time are:

Reducing the customer paying time. Giving the customer price reduction in exchange of significant faster payment is of paramount importance for achieving faster CV. It can be shown that even after providing 20% price discount to shrink customer payment time from 4 weeks to one week could exploit better the cash constraint. Of course, this might not be the right move when cash is not an active constraint.

Reducing the manufacturing lead-time is also of critical impact. While it is always good to reduce manufacturing lead-time, its impact on exploiting the cash constraint is even more critical.  Even here, when possible, on top of all the known TOC techniques, to use overtime, for extra cash, to vastly reduce the lead-time and by that accelerate the revenues, then it has to be carefully checked.

This thinking on the special devastating impact of a cash constraint, and its practical meaning for exploiting the cash constraint, is a major contribution of the five focusing steps of TOC.  Just remember the purpose here is to get rid of the cash constraint situation.  Cash is not a resource to keep as a system constraint!

Applying the six questions of technology to digital stores

Amazon made a huge change in Retail and all the large retail chains feel it. The ability to buy online is a disrupting technology, even if it won’t totally shut down the retail chains  The question is how the way current retail stores are going to change in order stay economically viable.  Regular stores will have to emphasis their added-value to the products and customers for which digital stores have difficulty to satisfy.  It is similar to the small shops that succeed to exist along the big stores, because they offer personal service and specific taste that appeal to certain segments.

The focus here is on the general concept of a digital store, which offers wide variety of products through the Internet and ships the purchased items to the client. It does not deal with the need of a specific store to differentiate itself from the other stores.

Question 1: What is the power of the new technology/product/service?

Digital stores have the technology and the logistical capabilities to show variety of items for sale through the Internet, accept orders, accept secure payments and ship the purchased items to the client address.

Question 2: What current limitation or barrier does the new technology eliminate or vastly reduce?

The limitation, removed by the digital stores, is the need to go to a store to choose and pay for the items. Within the limitation there are three different sub-limitations:

  1. Reaching the physical store. It takes time, efforts and money.
  2. Facing limited choice, depending on the space of the store and how it is utilized, thus having lower chance to find the item of choice.
  3. Limited capability to compare prices. In the store the buyer is faced with the price of that store. Even when the buyer is aware of another store with reduced price it still requires going to that store adding more time and efforts.

Amazon started by offering, to the whole world, a wide-range choice of books and CDs that no physical store is able to keep, this is on top of the ability to buy without going out of home.

The limitation eliminated or reduced by the new technology let us analyze the target market for which the new added-value is very high.

Reaching a physical store can be viewed as a burden, but it can be desirable in itself.  The term ‘shopping’ suggests that there is substantial value, for many people, in having good time by going to a store and browsing through the displayed choice.  For these potential customers the limitation is much smaller: only when there is no time, or capability, to go to a store, then there is added-value to the digital store.  For customers who “hate shopping” or customers who are ultra busy at work, the option of buying from home, maybe during the night, is a blessing.

For customers who live far from the worthy stores the value of buying online is most valuable. So, customers in rural areas are a good target.  Customers in big cities, but without a car and far away from the big shopping centers, are a reasonable target as well.

Customers who love to find the cheapest priced items, digital stores offer an advantage, because it is so easy to compare prices and find the cheapest store for a specific product.

It seems to me that second question, as verbalized by Goldratt, lacks a critical part:

What new limitation(s) are imposed by the new technology?

In other words, what are the key current negative branches (NBR) created by the new technology? Some of the new limitations might be eliminated in the foreseen future.  Others do not currently seem to be solvable, so they reduce the value.  It is of special importance to check the new limitations regarding the segment that draws the key value from the removing the old limitation.

The new possible limitations:

  • The display on computer screens is not equivalent to the feeling of looking closely at the product and touching it. What might look esthetically nice in the picture might be much less attractive in reality.
  • Returning the goods is always a hassle. When frequent bad quality or a mismatch between the buyer expectations and the product happen the hassle is combined with disappointment.
  • It takes time, sometimes long time, until the product is received. It is always possible that the purchased item would not arrive at all.
  • While there is an expectation that the price at the digital store is lower than in a store, the additional cost of shipping might increase the overall price beyond the price at the store.
  • The huge available choice in various digital stores could be a curse rather than blessing. Searching for the best product might take very long time. Too much choice is often paralyzing, causing the buyer not to buy, and add the distress of wasting time.
  • Lack of any human interaction reduces the confidence and pleasure of purchasing.

The key limitation that is eliminated or vastly reduced by the digital stores defines the customers, and the appropriate products and other conditions that would yield high value to those customers. The limitations of the solution add more conditions that reduce the original market segment, unless those limitations would be successfully eliminated.

However, in order to fully materialize the potential value of overcoming the need to reach a store we need to evaluate more questions.

Question 3: What are the current usage rules, patterns and behaviors that bypass the limitation?

This is a key question because it is not commonly asked. Identifying a limitation contains important knowledge about the potential value of eliminating it, but the true reference of the added-value is to compare the new situation with the situation prior to the new technology, considering the fact that people find ways to deal with the limitation by reducing its negative impact.

The way customers handle the need to reach a store is to batch many of their needs into the same trip to the shopping center, a mall, or a very large store.  The emergence of large stores, containing diverse variety of departments, greatly supports the idea of batching.  Having a group of stores, each one offering special sales and reduced prices, helps buyers feel that their time and efforts are well spend.  The malls provide ample parking and also restaurants and coffee houses to make the shopping time and efforts pleasant and even rewarding.

The digital stores need to look at the malls as the reference for the current buying norms. The batching of buying many different things at the same time creates habits that impact the buyer facing the digital stores.

Question 4: What rules, patterns and behaviors need to be changed to get the benefits of the new technology?

What does it mean to draw the full benefits of digital stores?

Certainly a basic expertise of operating the computer is required, along with good internet connection.  All safety issues have to be properly handled by the digital store and spread the recognition that buying online is safe.  The change in the behavior means the customer has to be knowledgeable enough in searching the Internet and especially the new safety rules, like when it is safe to reveal the credit card details.

The habit of batching should be grossly reduced for buying online, with the exception of buying items from the same category, like groceries.  The only slight advantage is the option of batching the shipment, but that is available only when the digital store carries all the items at its own warehouse.

Another example where buying several items at the same time online makes sense:  when browsing through the special sales offered by a specific digital store. This is especially important for people who love bargains and “real finds.”

The practical meaning is that in the majority of the cases there is no added value to batch the purchases from a digital store.

Considering that most customers have free time and they like to go out of home or work clarifies that for the majority of the customers digital stores do not fully replace the retail chains, but they add superior ability to buy specific items easily without going out of home.  So, the change in behavior is to make the differentiation what to buy online and what to buy by physically going to a store.  So, awareness to when there is an advantage in searching the internet and how this should change our buying habits is truly required. It is the interest of both the digital stores and the physical stores to lead the potential customers to recognize their unique added-value and guide them to accomplish it.

The way people choose the store itself is also a habit to be re-considered. Going through many digital stores is time consuming and saving time is supposed to be the key value.  One important factor is the brand name and the past experience in that store, physical or digital.  The esthetics of the physical store has an additional and significant impact, but the factors that create impression from a digital store are quite different.  Digital stores have to find the key factor that influences the right customers to go frequently into the store.

Attracting first-timers and then keeping them as frequent customers is a challenge for every digital store. It requires leading the customers into a unique and focused experience of looking at what they truly like; skipping most items the customer is not interested at.

Here are some characteristics for reasonable items to buy at digital stores:

  • Items that are clearly defined by the picture and written description. In other words, the customer knows what he is buying.
  • Items that are not commonly available in regular local stores.
  • Items that are relatively expensive and digital stores are able to offer a very good price, including shipping.
  • Heavy items that need to be shipped to the customer anyway.

Question 5: What is the application of the new technology that will enable the above change without causing resistance?

There are four critical factors that generate resistance to digital stores:

  1. Safety/security issues.
    1. Getting the products according to the expectations of the buyer.
    2. Being certain that the credit-card details would not be used for other purposes, not by the digital store and not by hackers fishing for such information.
    3. The private data of the buyer would not be sold to someone else and would not breach the privacy of the buyer.
  2. Efficient and friendly navigation, closing the deal and payment.
    • The application has to give the feeling of saving time and hassle.
      • The choice of items to be shown first is critical.
  3. Proper description of the product. The use has to be certain the chosen product is what he/she likes.
  4. On time and quality of the shipping process.

The current digital stores are still struggling with the above factors. While the confidence in the use of credit-cards in the Internet is getting reasonable answers, all the other issues are still open.  The difficulty to describe the features and look of the items and what are the differences between seemingly similar items is especially troubling.  Shipping is another open issue; with some new means of using drones to bring the item to its destination in the fastest and most friendly way.

Question 6: How to build, capitalize and sustain the business?

Every store, digital or physical, needs to re-think their strategy. The important starting point is identifying unique value to well-defined customers who need that value and do not get it anywhere else.  The questions so far have outlined the overall contribution of the new technology, thus pointing to various market segments and what are the key challenges.  What is required now are focused efforts to define the more specific value offered by the store to well-defined target market. This is what TOC calls a ‘decisive-competitive-edge’.

Once a decisive-competitive-edge idea is raised an analysis based on the six questions, but narrowed down to the specifics of the need and the proposed way to handle it would reveal the business opportunity.

Eventually developing the Strategy should lead to answers to the following critical questions:

  1. What should the store sell? What related services need to accompany the sale? At what price? To whom?
  2. How to operate the delivery in a way that would maximize the value to the target group of customers?
  3. How to market the unique value? How to prevent too many competitors to copy the unique value?
  4. How to answer all the concerns and reservations of the customers?

Digital stores are an example to a global change that all the players should analyze carefully in order to adjust to it in a faster and better way.  The six questions are a good tool to guide such a necessary process.

What should United Airlines learn from its latest fiasco?

What should WE, possible future fliers, learn?

And what should the other airlines learn?

The extra brutality is not the real issue. United, or XYZ Airlines, can always claim “it is not us; it is they, police or local authority security forces”. The real message to any passenger is:

“XYZ Airlines would, most probably, fly you to your destination, provided you have a valid ticket AND provided the airline does not have something more important to do. If XYZ would fail to fly you on time, they might compensate you, or maybe not.”

Should United and the other Airlines stick to the above message? Of course they should! Because, what can we, the passengers, do?  Do we know another airline with significantly better commitment to its passengers?

Why should United and the other airlines contemplate to change their basic paradigm of trying to exploit the seats of all their flights? This is absolutely in-line with TOC, isn’t it?  Some flights have the limited number of seats as a micro-constraint.  Overbooking is an exploitation scheme, because many times passengers don’t show up and then it is a waste not to sell the seat to a paying passenger.   Now, if there is a real need to fly several crew members, because otherwise another flight might be delayed or cancelled causing very high cost, then it makes perfect sense to nicely ask some passengers to give up their seat for some compensation the airlines think is fair.

The only question is whether WE, potential future passengers, agree to this widespread win-lose scheme of the airlines.

The scope of question is much wider than this specific case.  There are many other cases where we are, very politely, asked to change our plans because it is too expensive for the airline to fulfil their commitment. The Israeli airline, El-Al, has lately cancelled, at the very last minute, many flights because of lack of pilots.  Let me stress the point: cancelled at the last minute!  El-Al management blamed the pilots, and the pilots blamed the management.  It is nice to have somebody else to blame.  Do I care who is right?  Blaming does not solve anything.

I hope some airlines would see the opportunity to develop a decisive-competitive-edge policy of behavior and make it work. I do not claim it is easy – just that it is possible!

Remember: the real constraint of any business is the market demand! If you fail to subordinate to the demand then the future demand would go down, and then you won’t have an internal constraint as well.

It is still possible to have an internal constraint, but the constraint has to be exploited only to the level that still provides good overall subordination to the market.

Let me point out that having to add crew members to a full flight is a good example of interactive constraints! Another operational wisdom the airlines have to learn.