30 November 2009

The New ERP – Part 15

Setting priorities

If you and your management team have been working along with this series on The New ERP – Extended Readiness for Profit, then you have already created your organization's CRT (Current Reality Tree) and discovered what needs to change. Also, you have determined some potential courses of action – some answers to what the change should look like and how to effect the change – based on the roots found in your CRT. Now it is time to start setting priorities between the options that lay before you.

As we pointed out earlier, your organization's "bottleneck" is the choke-point in your system that reduces the flow of Throughput (T) into your organization. If you have identified your "bottleneck" or constraint, then you should always address your constraint first. In effect, you want to strengthen the weakest link in your chain of Throughput-producing functions. However, how should you and your management team prioritize multiple improvement projects that may each lead to improvement in organization's "bottleneck"?

There are two basic formulas to apply in making such evaluations and setting priorities. For proposed initiatives that require no additional investment (I), simply comparing the Benefit value is generally sufficient, and the following formula should be applied:

Benefit ($) = delta-T – delta-OE

Where, T = Throughput (Revenues less Truly Variable Costs)
OE = Operating Expenses

Where additional Investment (I) is required to make the proposed changes, then apply this formula:

ROI = (delta-T – delta-OE)/delta-I

Where, I = Investment
(including increases or decreases in inventories)

[Also, see definitions in Part 1 of this series.]

You will undoubtedly notice that the value of "Benefit ($)" is nothing more than the top portion of the "ROI" calculation formula. Therefore, while initiative-specific ROIs may be calculated only for those changes that will require a change in Investment (i.e., delta-I is not zero), the "Benefit ($)" value for any number of change initiatives may be compared. (This is also true for the Net Present Value [NPV] of the estimated multi-year series of "Benefit ($)" calculations for an array of different proposed initiatives.)

Once your team has calculated the Benefit or ROI, or both, for the potential change initiatives suggested by the analysis stemming from your Current Reality Tree, you can then set them in priority order. Those initiatives that reap the greatest estimated "Benefit ($)" or greatest relative ROI should be undertaken first, then the initiatives that produce lesser values may be considered for action.

My recommendation, however, is that before your team takes on subsequent improvement projects, they should reassess the Current Reality Tree to be certain that changes made in prior initiatives did not have unexpected affects that change other aspects of your reality. Addressing new or slightly different roots may be required, or perhaps you will discover that having dealt effectively with one root, your system has reaped unexpected positive results in other areas, as well.

[To be continued]

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