Eli Schragenheim

A case about a strategic dilemma

Following the topic of The Key Element of Any Strategy I like to present a case for discussing the basic conflict when we consider a significant change. Please, send me your answers and analysis.

GoodChoice is a chain of small supermarkets throughout the Large-City. It was initiated by Marcello when he inherited the GoodChoice bakery his father built from scratch. Today, ten years later, the overall worth of Goodchoice Chain, including the bakery, which sells its variety of breads through the supermarket chain, is dozen times larger than the business of Marcello’s father.

Should Marcello be proud of his achievements?

He certainly likes to continue to grow. The hard competition with the other three supermarket chains, all of which are larger than GoodChoice, forces relatively low overall profitability of just 1.4% of the sales. The battle with the competitors is on every promotion and on every supplier, causing Goodchoice to pay higher prices to suppliers, while charging the customers lower prices than the competitors.

The marketing message that GoodChoice tries hard to spread is that they choose the items sold in any branch very carefully and guaranty high quality. Every GoodChoice branch holds between 1,500 – 2,200 SKUs. The GoodChoice branches are all located within the city itself, and thus have very limited space and limited parking. A typical branch of the competitors, usually located at the outer parts of the city, where parking is not a problem, carries between 4,000 to 12,000 SKUs.

All three competitors have their own private-labels, covering wide-range of items, with average price of 15% less than the price of the leader brand. Marcello already started his negotiations with various suppliers to establish the GoodChoice private-label. However, he likes to do something quite different and charge HIGHER price, of about 4%, for the private-label!

Marcello also wants to emphasis the message that GoodChoice gives to its customers absolute guaranty on the quality of the private-label products. He thinks of letting customers return even open packages if they claim they don’t like it. This idea invokes many negative reactions from Marcello’s team as they are concerned that too many customers will cheat to get refunds.

What do you think? Should GoodChoice make the change with their new private-label, charge more for an exceptionally strong guaranty policy? Or, follow the norm in the specific business area?

Strategy, with a capital S, is a plan to achieve the goal. Too many organizations do not have any plan for the future. Some try hard to survive; others are simply stagnated, serving the same group of customers with the same products and with very little initiated changes. Other organizations have very ambitious vision and mission, but they don’t take them seriously.

What could be more important for an organization, any organization, than to plan how to achieve more of the goal? How come so many organizations are stuck with their current situation to the point that ideas about the future look to them irrelevant?

Fear of losing what we already have plays a big part in being reluctant to look for new initiatives that could make a difference. The compromised solution is to imitate the competitors. You see this behavior in the banking and airline sectors where the copying capabilities are highly developed.

This imitation behavior keeps the organization within the comfort zone of the accepted norms of the specific sector. One risk is that a “crazy” competitor would challenge a basic norm, making it difficult to copy, and get a lead in the market. Southwest Airlines did that to the big airlines and opened a new trend of low-cost carriers.

Going out of the inertia is better provided by collaborating with people outside the specific comfort zone, letting them ask silly questions and irrelevant suggestions, looking for the one that would stir the question “why not?”

Strategy dictates a certain flow-of-initiatives. The flow-of-initiatives in an organization is always internally constrained by management-attention. Exploiting this ultimate constraint is through FOCUSING on the few most promising future initiatives. Thus, we should look for one key element that, once achieved, would bring the organization to a new level of performance. Any key element requires a group of different initiatives to make it work. The necessary characteristics of this key element have to be:

• It vastly enhances sales, allows charging higher price or vastly reduces the cost
  • Delivering new value to large enough market segment(s) is the most effective direction and it impacts both the quantity to be sold and the ability to charge more

• Whatever is the key element – it should not be easy for competitors to imitate

• The key element has to be based on a unique capability of  the organization
  • Otherwise it is easy to imitate
  • The unique capability could be learning or acquiring new capabilities

• The risk, associated with the proposed change, is small, or can be carefully tested in a way that would not cause big damage

Such a key element of Strategy was called by Goldratt: a decisive competitive edge (DCE), as this is what it targets to achieve. Note that if the organization truly achieves a DCE then the level of overall risk goes down! The risky part is to ensure that the DCE is truly effective.

Note, gaining a DCE does NOT mean dominating a whole market! It means being superior in a certain market segment(s). Still, competitors might dominate other market-segments due to superiority in another need of the market.

Few organizations have a clear DCE. However, these organizations are well known, creating the impression that many organizations have such a DCE. Just to quote some clear examples: Apple, Google, Toyota, Mercedes, Lonely-Planet and Zara.

Very large organizations have a natural DCE from being big: their products look like a “safe purchase” (you cannot go wrong with SAP, IBM or LG). Thus, it is the duty of the smaller organizations to come up with an idea for a specific DCE and by that “steal” part of the market from the big ones.

Avis got a lot of attention by the slogan “We are number 2, we try harder.” It promises more value to the customers through better service. This promise divided the market segments into two: those who preferred no. 1 because it seemed safer, and those who liked to be treated well. Avis’ DCE targeted the ‘better treatment’ market segment.

Dr. Eli Goldratt came up with several potential DCEs based on the TOC knowledge as a unique capability. Committing to availability is one option in certain cases, rapid-response is another. It is a huge mistake to assume that these are the only options for gaining a real DCE.

I claim it is the duty of top management of every single organization to come up with a DCE. What could be safer for the future of an organization other than a well-established DCE?

How should organizations come up with a DCE?

1. Recognize it as the responsibility of top management
2.  Examine the capabilities of the organization, including learning new capabilities
3.  Identify a need, or a wish, of many potential clients that can be delivered by the organization
   1. Note, the need defines a market segment for which the need is important
4. Make sure it would not be immediately copied
5.  Develop the ways to radiate the full value to the potential clients
6.  Carefully plan and execute whatever is required to deliver the extra value to the clients
7.  Test the idea first and put signals to warn whenever the minimal expectations are not met

More posts would be dedicated to Strategy, covering the range from checking the power of the DCE to planning the transition to identifying potential threats early enough.

Would you like to discuss potential ideas for DCEs?

This post should be read after the post on “The Categories of Value”.

Suppose you like to have a new pair of glasses.  How much are you ready to pay for the best fit glasses?

This is certainly a difficult question because there are several variables that impact the translation of value to money.

1. Considering the practical need: what limitation the new glasses reduces?
2. Considering the status value: what people would think of me wearing these glasses?
3. Considering my own pleasure when I look at the mirror – what is the value of me liking my look with those glasses?
4. How much money I have? Can I afford the truly best fit glasses? Would I have to give up something else?  If so what is the value of that?
5. What is the “fair price” for the glasses? We all hate to pay more than what we have to.

The first three parameters state the difference between the three categories of value.  Personally I assume the practical need is the most important in this case.  But, it seems others value it quite differently.

The decision, involving all the five key parameters above, has to be done every time we face a choice. When we face a complicated decision we should always look for the inherent simplicity.  The last parameter, the not-too-rational question of whether the price is “fair”, poses a major simplification of the decision process.  The reason is that instead of translating our perceived value to money we rely on universal “fair price” as representing the value.

Establishing a fair price requires finding a reference-price.  What could be the common reference price for a pair of glasses?  As there could be a variety of practical-need features (multi-focal, anti-scratches etc.) as well as a variety of esthetical parameters and variety of brand-names (important for the status), there are several price-references, like $15, $200 and $800 for a combinations of features and brand-names.  When a specific choice is considered one is able to “tolerate” a certain deviation from the reference-price when there is a justification. In other words, the reference represents the worth of the average value, and when a specific product is perceived as somewhat ‘better’ than the average, all the customer has to do is to validate that the additional value is worth the deviation from the reference.  This justification works when the deviation from the reference is relatively small. When the deviation is significant there is a need to find a new reference, like the multi-focal glasses has different reference than regular glasses.

Marketing has to face the reference-price and find the justification for charging more, or establish a new reference, which covers the added value of the specific product/service. When the main value is based on practical-need the rational should be the unique value of the extra practical-need that the product yields.  Status has its own rules and opinion-leaders and if they give the product a nod it is possible, even desirable, to charge much higher price.  The real difficulty lies with the category of value of pleasure, because not only the client has a real difficulty to translate value to money, she is not going to tell us what she thinks.  Presenting the product image as significantly higher than the reference is a real marketing challenge.

The good news about the reference-price is that it limits the negotiations between sellers and buys.  When there is no reference, like when the product is actually a project, developed according to the specifications of the client, then both sides fall into the trap of cost-plus.  This is a natural lose-lose situation.  I’m afraid we still do not have a universal solution for a win-win.  Do you?

Jack Vinson asked me: What is your biggest challenge today?

This riddle represents my challenge! Convince you to use TOC for developing Strategy for yourself, your organization and your clients (if you are a consultant). I define Strategy, with a capital S, as a plan to achieve the goal.

If you did not read the riddle, I suggest you do it now, before you read my view.

The future of any organizations depends on its Strategy. Being lucky can help or damage, but much more depends on the effectiveness of the Strategy and the execution.

Strategy starts with the goal. From 2002 onwards Goldratt tried to teach us to move from the goal of “more money now and in the future” towards the higher-level idea of ever-flourishing organization where T (throughput) grows consistently faster than OE (operating expenses), while being stable.

The value of art is definitely about pleasure (category #3 of value), which highly depends on taste, which varies considerably in spite of being guided by some “rules”, including the price tag, and subject to influence of opinion leaders and fashion.

What I look for is a state where the variability actually supports the business objectives!

The answer by Kevin Kohls started by improvement of the flow of sales of the gallery, and then he expanded to something bigger. Kevin did not ignore the role of Rudolf as an opportunity. Let me cite Kevin’s bigger vision:

“He may also pitch ways to break his space constraint – expanding his gallery, renting space in more promising areas, setting up galleries outside of Philadelphia, leveraging other businesses that are in Rudolf sphere of influence, having a special gala that Rudolf attends with some of the high throughput artists, etc.  He should also give some thought about the problems that will arise with success – how to manage the growth of this business without generating any additional undesirable effects.”

My own vision for WideArt Gallery is:

Running an international chain of WideArt Galleries

The chain should ship a lot of art between the galleries and by that enliven the display everywhere and increase the chance of finding a buyer for every item.  Thus, the tricky prediction of whether a specific work of art is going to be sold at the given price is vastly reduced.  Different locations are subject to different arbitrary influences concerning art and culture.  The cost of shipping of relatively cheap pictures would be just a small part of the T generation.  At least, this is my assumption.

Several additional excellent ideas, which could be incorporated within this vision, have been raised by the answers to the riddle:

1. David Peterson raised the brilliant idea of art loans, similar to the idea of a library. This kind of idea answers a potential need that nobody else offers.  I think that it is easier to let the buyers of any item the right to replace the item by another from the same price range, once a year. I think that such a move could prove itself to be a decisive-competitive-edge.
2. Digital display. Let me cite from Fishamaphone’s answer (it was mentioned by others as well): “Reserve a certain section of art works and have them digitally scanned at as high a resolution as possible, and place them on high-definition displays in a slideshow configuration… This solves the problem of physical area, while also ensuring that a patron receives a totally unique experience every time they enter the gallery.” This idea should certainly be implemented also as a website.
3. Using pictures under consignment. Actually many galleries are doing exactly that. The downside of consignment is that it is often a compromise: not everything the artist wants to display the gallery believes it should be.  Displaying items on consignment is bounded by time, as the artist likes to get his works back and try somewhere else. For a chain of galleries it is be easier to get better choice and arrangements for such consignments, as the works are going to be displayed at a variety of different locations.

The arrangement of the four rooms, with the most expensive art at room #4, attracted various reactions.   Is it good to have the expensive pictures in one room? I assume most visitors come in to watch art without any intention to buy. The expensive pictures attract such visitors. Point is – they might see something they truly like and are able to afford. I believe that most of the visitors look, even briefly, also at the pictures in the other rooms. Should the gallery mix all pictures together? I’m not sure, but as we deal with psychology rather than robust cause and effect I simply suggest testing this paradigm in one gallery for a month and then decide.

The above ideas should be integrated and used for planning a full strategy and tactic tree (S&T).  I cannot stress enough my view that we all need to go deeply into Strategy.  I intend to pursue this topic more in my future posts.

What is the value of the above item to you?

What might be the value to other people?

I intend to dedicate a number of posts to Strategy, which I define as a plan to achieve more of the goal. In order to achieve our goal we need to deliver value, which is what causes clients to buy, and by that generates value to ourselves. The value to the clients has a major impact on the competitive status of the organization, and thus it has a major impact on Strategy.

Comment: My analysis of the riddle, and the good answers I have received, would appear during the weekend. You are invited to submit answers by August 7^th. There is a certain relevancy of this post to the riddle.

I suggest recognizing three different categories of value. The importance of the categories is their different impact on marketing.

Category 1: answering a practical need.

I use Goldratt’s “The Six Questions for Assessing the Value of New Technology” to define a practical need: It eliminates, or reduces, a current limitation!

Goldratt referred to new technology, but I claim his logic can be applied also to products and services. The reduced limitation could be something small like: the size of the regular package is too small, forcing me to buy two. Another example could be that the product does not contain Gluten, which exists in other products and causes health problems. We can also recognize “being easy to purchase”, due to availability at the nearest store as answering a practical need.

Category 2: Radiating a certain status.

The idea is that by owning the product other people appreciate it and by that have an opinion on the owner, which is the essence of the value. Rolex watches, Porsche cars and Gucci suits yield status of being rich. Driving an old Volkswagen Beetle creates a different image that could be desirable in certain situations. We all wear clothes that we think radiate the right image of us. You could claim that creating status is, many times, a practical need. But, being an indirect kind of practical value makes it worthy to stand as a category of its own.

Organizations also try to radiate status through their offices, the design, the space and the decoration.

Category 3: Personal pleasure of any kind.

Art, esthetics, games, watching landscape – anything that we, human beings, like to enjoy. There is no practical need for those. A picture hanging on the wall at home does not eliminate any limitation. However, a picture, like many other things give us joy in a subjective way. The big difficulty is that forecasting the demand is problematic.

Many of things that give us pleasure were originally made for a need. A watch has a certain practical need, but most watches are not carried just to show the time.

The vast majority of B2B sales are based on practical needs of the client-organization. However, there is a twist when the product targets consumers for pleasure, but the client-organization buys them to make more profit, in other words, for practical need.

B2C can be based on any of the categories of value above. The full value could be a combination. Most food products are consumed for pleasure, but the basic need is there as well. Apple’s products have the rare characteristic of providing all three categories of value.

A characteristic of the third category of value is that the customer might already have many similar products and still wish for more! Books are an obvious example. This means the basic competition in this field is about delivering high value, no matter what the competition offers. Competition exists only because clients are limited by cash or time.

This is certainly not true for the practical-need products. If you have already a coffee-machine you don’t need another. Just to be clear on the practical need: the coffee itself might be just for pleasure; the coffee-machine removes the limitation of having to go out to a coffee-house. Thus, the machine itself yields practical need.

Can you comment whether you see a practical value in considering the categories of value when you struggle with key decisions for your organization?

This case is about an art gallery, which means it is far from the normal “TOC environment” where we all feel we know what to do. TOC knowledge is not a requirement, but it could provide guidance.

Please, send me your ideas to my email, elischragenheim@gmail.com, or comment here at the blog.

I’m sorry I cannot provide any prize other than mentioning you in one of my posts when I publish my take on the case.

Is there a future for the WideArt Gallery?

Sergey worked hard for ten years to materialize his dream of opening his own art gallery in Philadelphia. He loved art, knew a lot about it and he especially knew well the artistic situation in Philly. His idea was to offer good art at affordable price.

The WideArt Gallery contained four rooms. Each had pictures and sculptures for prices that fall within a certain price range. The cheapest one contained lithographs and other pictures valued from $100 up to $500. Next room contained items up to $1,500. The third room’s prices went up to $5,000. The last room contained the most expensive pieces of art. Naturally it contained outstanding works of art and most visitors spent more time in that room than in the others.

Problem is that Sergey felt somewhat disappointed from the amount of sales. The gallery attracted quite a lot of people who came in to look at fine art for free. Some people even commented that they expected more new items to be displayed since their last visit to the gallery. Eventually relatively small percentage of the visitors showed an interest to buy an item. Still, the gallery made enough money to provide reasonable living for Sergey and his family, but not much more. Sales improved a little after Sergey published an article on “How to place art in your home for great effect” in a known home design magazine. He made copies of the article so every visitor to the gallery could take one.

Rudolf Kempe entered the gallery on July 20, 2015. A date Sergey will remember all his life. Rudolf, an important tycoon with diversity of businesses, is widely known for his colorful appearance and innovative ideas, which few of them made him billions. Rudolf went through all the rooms in the gallery without much attention to the pictures on the wall. Instead he watched the people in the gallery watching the pictures on the wall. Then he saw Sergey sitting at the counter looking at him. Sergey immediately recognized Rudolf and simply hoped he might buy something expensive. However, fine art did not interest Rudolf much. Instead he approached Sergey and asked if he could spare the time to have coffee with him.

The conversation in the nearby coffeehouse took almost an hour, a very long time for such a talk for Rudolf, who showed keen interest in the business called “selling art”.

Rudolf concluded the conversation with the following remarks:

“Dear Sergey, you tell me your business is constrained by two things. One is that your working capital prevents you from buying additional excellent and relatively cheap pictures. The other is being constrained by the space to hang pictures. Are you aware of the clash between your allegedly two constraints?   You told me that items that are not displayed are not sold! What would you achieve with higher stock of art items if your display is limited? How do you think the rate of sales to stock would improve if you have more stock?

“Here is my challenge to you. Think how you are going to reach more potential clients, make them willing to buy moderately priced art items and provide much better return on your stock. This is your business problem. If you come up with a good idea call me. Please note that I’m ready to listen to you just one more time.”

Can you help Sergey to come up with a good idea or even several ideas?

The previous post showed the connections between decisions concerning the market, the capacity profile and how to get good answers by checking certain options.

The example of last post had relatively little uncertainty around it. In most cases any action to enhance the demand is subject to high uncertainty. Other factors like the predicted capacity utilization are also impacted by uncertainty.

Let’s first remember the key question we need an answer to:

Considering the decision on the table would net profit (NP) go up or down?

This means we don’t have to know the exact impact on NP in order to make a sound decision! We need to find out the direction of the impact. We need also to validate that in the worst case the organization would be still viable – it should NOT kill the organization. The practical meaning is to establish a RED-LINE, defining the state the organization would not tolerate and thus no decision should bring the organization too close to that state!

Any prediction of the future is uncertain. However, the valuable intuition of the key executives and key professionals could carefully define the boundaries of what is highly unlikely. What should come out of these assessments is a range of likely results. My suggestion is to check the full ramifications of the two extreme values of the range, provided they are not exaggerated.

For example, suppose that the cost of materials went up by 20%, bringing the T-per-unit down from $20 to only $14 (70% of the original T). The financial people push to increase the selling price by 10% (from $50 to $55) to compensate for most of the increase in cost. The VP of Sales claims such a move would reduce the number of units sold by 20% at the very least, possibly by 50%. She also claims that if the price is not changed then sales would go up by 10-20% because some of the competitors are going to increase the price.

How would YOU handle the case, taking into account the intuition of Sales as there is no other reliable source of information?

My proposed suggestion is to create the reasonable pessimistic scenarios for both alternative decisions, and the optimistic scenarios for both.

Suppose the current T is NT.  Let’s call the new total resulting T: RT

The pessimistic scenario of no change in price would come to: RT = (0.7*NT)*1.1 = 0.77NT.

The pessimistic scenario of increasing the price by 10% (bringing the T to about .95NT) RT = (0.95*NT)*0.5 = 0.475NT

The optimistic scenario and no change in price is: RT = (0.7*NT)*1.2 = 0.84*NT

The optimistic scenario and increasing the price by 10% is: RT = (0.95*NT)*0.8 = 0.76*NT

What should the decision be?

If the pessimistic case is closer to reality then we should not change the price.

If the optimistic case is closer to reality then we should not change the price.

So, the decision is clear.

If we would have conflicting results then the managerial judgment has to take into account the possible loss versus the possible gain. When you consider the loss you need to ensure it does not penetrate into the RED-LINE for the organization. If this happens – choose the other decision.

Note, we did not check the ramifications on capacity of 10-20% more sales. It could change the above results if, and only if, a penetration into the protective capacity of even one resource happens. My assumption is that the current sales are achieved by available capacity, maybe with some overtime that is fully covered by the current T. It might not be the case for 10-20% more sales. So, this part has to be checked, but this post has to be short and simple enough and thus I assume no lack of capacity even for 20% more sales.

Company G, a small manufacturer of textile, looks into its next quarter. Assuming no major decision is taken the company predicts its total T for the quarter to be $485,465. However, its total OE for the period is $485,000, leaving net profit before tax of only $465. Too close to breakeven, and that is just a forecast!

The sales force got instructions to come up with additional sales – offering lucrative deals to potential clients, as long as there were no concerns for cannibalization. If intuition says some negative impact on other sales might happen, it should be part of the proposed change and the T and load calculations should reflect it. It turned out that early negotiations seemed good. Several new options were brought before management.

The graph of the predicted load looked like that:

Each row presents the relative load versus capacity of one critical resource. The Blue/Violet part shows the regular sales. The new special sales contribution to the load is represented by the pink part. The Dye, the current ‘weakest-link’, is now loaded to about 91% of its available capacity.

The financial state is depicted by this table:

It seems the additional load uses only available capacity. Even the Dye resource does not penetrate the 95% line, which represents the limit for the protective capacity of the weakest link. There is no need for any delta(OE).

The meaning is that by pushing the sales force the company succeeded to increase its predicted bottom-line from $465 to $45,965.

This means that realizing the amount of truly excess capacity in Operations should lead to putting pressure on Sales to come up with more opportunities. Of course, we require that the new opportunities should generate higher overall T, taking into account that sometimes new sales cause reduced sales of other products.

Another requirement is to make sure that the capacity profile is valid for delivering all the sales according to the market requirements. That means having enough protective capacity on all resources.

Looking at the improved situation for Company G reveals that even with the additional sales the management of that company should continue to push their salespeople to bring more sales.

The weakest-link, the Dye Resource, has still 3-4% of load to reach its protective level. All the rest have much more. Sales of products that require more capacity of the other critical resources than from the Dye might be lucrative depending on their T.

The main concern is that the additional sales might create too much load.

When we reach this stage then two different actions should be contemplated:

1. Using the capacity buffer to increase available capacity. The financial calculations should consider the delta(OE) making sure it is smaller than delta(T).
2. Reducing some other sales that yield less T relative to the capacity of the overloaded resources.

Suppose that after checking the above additional sales and realizing there is still room for more, additional ideas were checked, but then the following problematic capacity profile emerged:

The management of G realized they cannot promise delivery to all their potential sales with this overload. So, something had to be done about it, giving up some sales and being ready to pay more for additional capacity, under the condition that eventually the profit would be significantly higher.

Going carefully through both types of actions. Reducing some sales, where the VP of Sales confirmed it did not disrupt any commitment, and also using some additional capacity, which caused delta(OE), the final capacity profile, using fast computerized calculations, looked valid:

And the financial table became:

In other words, pushing Sales to come up with new opportunities, coupled with careful analysis of the capacity.  Then reducing some opportunities that required too much capacity of the overloaded resources. Then also using additional capacity to provide valid capacity profile, the bottom line went up from mere $465 to $130,065!!!

When Sales, Operations and Finance key executives sit together in a mutual-decision meeting to plan their activities for next month, or quarter or even a year, supported by fast computerized calculations, superior decisions with huge impact on the business are made.

Linkages, differences and the strategic impact

It is impossible to match capacity to demand!

The above is a major TOC realization, which is the key for challenging all current cost-account methods.  In a previous post on “Non Linear Behavior of the Cost of Capacity” I have stated the three main causes for being unable to use (drawing value from) all available capacity.  The first cause is the need to maintain protective capacity to ensure adequate delivery in the face of dependencies and statistical fluctuations.

What dictates the right amount of protective capacity?

TOC does not have a formula to answer the question!  When the protective capacity of just one resource is penetrated then some time later the amount of red-orders would go up sharply. So, looking back to the recent load could identify the amount of excessive load that threatens the stability of the delivery performance.  The intuition of the production manager, being exposed to such cases, should be used to assess the practical limit on the load that will be used for operations planning.

What impacts the level of protective capacity?

Three critical factors:

• The acceptable response time in the market.
• The level of fluctuations of demand within the acceptable response time.
• The size of time or stock buffers used.

The impact of maintaining the appropriate protective capacity on the global performance of the organization is very significant. It impacts the following issues:

1. Establishing the service level that matches the commitment of the organization to its customers.  This match should be part of the organization global strategy.
2. The vast majority of I and OE of the organization is spent on maintaining adequate capacity to support sales.  The protective capacity is crucial in deciding how much capacity to maintain.
3. The short-term planning of Sales and Operations has to consider the limit imposed by the protective capacity.

While we cannot match capacity to demand, we like to draw the most of the available capacity to generate high throughput relative to I and OE levels.

My insight is that Operations has to recognize two different protective capacity levels:

1. For the weakest-link resource!  Even when the weakest-link is an active CCR, being able to satisfy the market is still a must that forces leaving certain protective capacity on the CCR, providing flexibility to deal with Murphy  and urgent requests.
2. For all the other resources, making sure they have more protective capacity to support the CCR and all the other urgent needs. In other words, properly subordinate to the exploitation planning.

Definition: Capacity buffer are all the fast means to increase capacity for a cost.

Overtime, extra shifts at night and/or during weekends, using temp manpower and outsourcing are included in the capacity buffer.  The main objective is to protect from peaks of demand.

Capacity buffers are critical for growth where instead of investing in much more available capacity the organization is ready to pay-per-usage of extra capacity. It should definitely be an integral part of the Strategy of the organization.

Capacity buffers can be used as protective capacity.  It allows 100% utilization of the resource and when additional capacity is required the capacity buffer is used.  It does impact T,I and OE calculations because any usage of a capacity-buffer causes additional truly-variable-cost (TVC) and by that reduce the Throughput-per-unit.  I think, by the way, that it is much more practical to treat those additional TVC as delta-OE, but that is another discussion for a different post.

Maintaining capacity buffers has to be part of the strategy planning and buffer-management should be used to monitor their consumption.  Any capacity buffer has a limit.  Thus, when too much of the capacity-buffer is used a red-signal should be raised.  As long as the organization does not exhaust a specific capacity buffer no red-orders are created by it, but once it is exhausted then it is question of time until red and black orders would appear and then it is too late to quickly fix the situation!

The concept of capacity buffers is new to TOC.  It impacts our understanding of what is an active capacity constraint (CCR), and it has a big impact on Throughput Accounting.

Any comments, questions or reservations?  Please, let’s talk about it.

A recent discussion on what is the appropriate TOC definition for ‘constraint’ leads me to state some historical facts that highlight the development of Goldatt’s approach to constraints.

Prior to the Theory of Constraints (TOC) the breakthrough idea was to distinguish between bottlenecks and non-bottlenecks.  The definition of a bottleneck was simple: “The load placed on the resource is more than what the resource is able to do.” Thus, a bottleneck is always a resource.

The term ‘constraint’ was defined “Anything that limits the system versus its goal”.  It was conceived to answer three significant limitations of the term ‘bottleneck’.

1. When all resources have enough capacity to process all the demand then there is no bottleneck. However the system is able to do more.  Thus, looking on the market demand as a ‘constraint’ is quite valuable.  It allowed managers to understand that there is no excuse not to ship everything on time.

2. Being a bottleneck does not ensure being a constraint. There might be another bottleneck with even more load.

3. We might have a true resource-capacity-constraint (CCR) that is not a bottleneck.  While on average there are idle times, in other times the queue behind the CCR is so long that some potential demand is lost.

It was realized from the start that the constraint limits the throughput (T) of the organization.  Goldratt even played with the idea of introducing the term of ‘inventory constraints’ referring to trouble-makers that force the organization to maintain more WIP.  He backed off this term to keep the simplicity.

The real power of the term ‘constraint’ came through the paradigm that an organization cannot have many constraints.  Dependencies coupled with statistical fluctuations do not allow interactive constraints in the chain. This realization led to the conclusion that the shop-floor can handle only one constraint without creating chaos.  In 1989 Goldratt wrote The Haystack Syndrome and presented a rather complicated algorithm to handle multiple constraints.  The whole development of the ideas was set around capacity constraints.  The chain analogy, where there has to be one, and only one, weakest link in the chain was widely used. Thus, the default for a constraint was lack of enough capacity of a resource.

Limited capabilities, like being unable to produce top quality products, were not considered constraints.  Limited capabilities are less exposed to statistical fluctuations.

The wide definition of the term constraint did cause problems.  People used to say that the constraint lies between the eyes of the CEO.  Flawed policies, especially policies concerning efficiency, were called ‘policy constraints’.  So, the idea was that the system is limited by a capacity constraint, and failing to exploit it is due to policy constraints.

The full set of TP (thinking processes) was developed in 1990. Effect-cause-effect trees and the cloud existed before (even before the 5fs) but not the other tools we know today.  The definition of the CRT raised the notion of the core problem – the conflict (cloud) that causes all the undesired-effects.  Resolving the conflict by challenging a basic assumption behind the conflict would push the organization to a new level of performance.

So, is the core-problem the real constraint?

It remained an open question for a while.  Core problems touched upon local versus holistic thinking, but also on behavioral patterns and opened the door for re-evaluating the value the organization brings to the market.  The core-problem could also challenge the paradigm why do we exploit a CCR rather than immediately elevate it.

Fact is: we did not ask ourselves these questions in the 80s.

Goldratt publicly regretted calling flawed policies “policy constraints” sometime in the 90s, explaining that policies should be eliminated and not exploited and subordinated to.

A major development in the TOC thinking came around 2003 with the idea of the Viable Vision.  Suddenly the way to improve an organization did not come through elevation of a capacity constraint and even not through challenging the conflict behind a policy-constraint.  With the term “decisive-competitive-edge” the TOC thinking has realized the need to challenge the value the organization offers to its customers.  The core idea was to answer a need of the customer in a way no other competitor can.

Explaining how come the VV did not care what is the constraint, Goldratt spoke about two different changes.  One is minus-minus – you identify something that is not right (minus) and you change it (minus of the minus) and a plus-plus change where you take a big step towards the “pot-of-gold”.  When such a step is taken one needs to carefully re-think all the conditions that would be sufficient to bring the organization to growth along the “red curve”.  Lack of capacity of a specific resource becomes a triviality that needs to be eliminated.  Many other potential constraints would be elevated long before they become constraints.

Food for thought?