The Dangerous Dichotomy—Part 2

[Continued]

In the preceding article we discussed how—all too frequently—management inadvertently creates a schizophrenic organization by assigning responsibility for increasing revenues to one part of the organization while assigning cost-cutting to another part of the organization. Usually the other part of the organization is everyone else—everyone not assigned to the task of increasing revenues.

What happens in such cases, is that the business is driven to a dichotomy that tends to pull the organization apart.

Of course, this effect of pulling the organization apart is entirely unintentional. Management wants to move the business toward greater profits and profitability. Sales and marketing—those generally commissioned with increasing revenues want the organization to succeed and grow. And, all the others, whose marching orders are to cut costs also really want the company to find success. So they are doing their best to keep costs down.

Nevertheless, seeming unreasonable demands made by sales and marketing are a nearly constant irritation to inventory and production managers. And what appears to be the simple inability of folks in purchasing, production, scheduling, warehouse and shipping to get their house in order so that sales and marketing can achieve their goals of increasing revenues is a cause of very real frustrations.

So, even though everyone in the organization really wants to move the organization toward success, it is clear that no one in it has a view of what it takes to make the whole organization—the whole “system”—move in the desired direction. Those who are instructed to “increase revenues” have no real view or interest in holding the line on costs or operating expenses. But, what is worse, those who have been instruction to “cut costs” generally have no visibility into what it might take to increase revenues. They are not privy to the “levers” that might affect increasing sales. Plus, the various departments involved in “cost cutting” are quite often, themselves, fragmented in their view of what it takes to be effective.

A simple example

Let’s take one simple example relative to supply chain thinking.

Most businesses vastly underestimate their losses from what they too frequently believe is a good thing. When they say, “Folks, we sold out of product X!” they are frequently thinking: “This is great! ‘Sold-out’ means we have lower inventories! It means we sold more than we expected to sell!” or similar thoughts.

But look at the results of out-of-stock conditions in the example above.

First, everyone needs to recognize that the things that “sell-out” are the most popular items. Second, because these are the most popular items, there is no reliable way to know how many more units the firm might have sold if they had had more units in stock. Certainly extrapolating from “average sales” is insufficient.

In our example (above), a product comes in five styles (‘A’ through ‘E’). The firm chose to stock 280 of each of these five styles and the quantities actually sold are found in the “Qty Sold” column.

In our scenario we are supplying what cannot actually be known—that is, the actual market potential (“Mkt Potential”) for each style. In this case, the firm ended up selling-out of two styles (‘C’ and ‘D’), while being overstocked on Styles ‘A’, ‘B’ and ‘E’. Extrapolating from “Average Sales” one might believe that the firm lost $5,400 in revenues. However, when calculated from “market potential” for each style, the actual amount surrendered in lost revenues due to being sold-out calculates to $12,900—more than double the estimated losses from averages.

Of course, this lost-sales number is a guess—since there is no reliable way to know the actual market demand for a sold-out item. But, what is not a guess is that when a business is out-of-stock on a popular item, it is almost certainly also losing sales on other items when customers go elsewhere for the items they are seeking. Plus, every time a customers goes shopping somewhere else, the “out-of-stock” business stands a good chance of losing the customer to another supplier.

Doubtless, reducing out-of-stock occurrences will increase revenues. That will help satisfy the sales and marketing team in our troubling dichotomy above. But, the question remains, can that be done in such a way that will satisfy what should be everyone’s goal: helping the business make more money tomorrow than it is making today?

[To be continued]

Collective Fixation on Short-Term Profits

Vivek Sehgal brings up an important point in the post Putting Your Money Where Your Mouth Is (3 March 2010) here at Supply Chain Expert Commnity. Even though, at GeeWhiz To R.O.I. I talk a lot about the the goal of business being to make more money, I generally add ...tomorrow than you are making today. Making more money "tomorrow," should not be predicated on actions that will diminish the long-term prospects for making more money. Nevertheless, a lot of companies -- especially publicly traded companies -- have a fixation on short-term profits that is damaging to the long-term health of the enterprise.

W. Edwards Deming diagnosed this issue early and brought it to our attention about 30 years ago. He called it "paper entrepreneurialism." The investing relationship of real entrepreneurs looks like this:

Entrepreneurs sitting in this relationship have a vested interest in the ability of the firm to produce profits over the long term. Such investor-entrepreneurs seldom intentionally make decisions to reap short-term profits at the expense of the long-term prospects for the business.

Speculative investors have a slightly different relationship with the firm(s) in which they take stock. That relationships looks like this:

The most connected investors are those that hold a relationship similar to that of the real entrepreneurs. They invest in shares directly with the company (or at least have an more intimate relationships with the firm and knowledge of its management, even if they must make their stock acquisitions through a broker). However, most of the investors agreed to buy stock in the specific firms based on the advice of their broker. They may know little or nothing about the firm or the firm's management directly. They trust the advice of their broker.

The intervention of the broker/brokerage house makes buying and selling of stocks easier, and the brokers are typically incented to produce results (return on investment) for their customers (the shareholders) over both the short-term and long-term. The focus of the broker and the guidance given to the investors will vary based on personal preferences. Nevertheless, it is easy to see that the investors are abstracted from their investments by the borkers and management at the publicly held companies must satisfy the short-term expectations of the brokers or, in the interest of their customers, the brokers are likely to shift investment away from companies performing poorly in the short-term in favor of those with better short-term returns on investment.

Paper entrepreneurs are even further abstracted from their holdings as shown in the following diagram:

With the introduction of mutual funds and government-incented retirement plans, more capital has moved into the markets, but at the price of having the investors abstracted from the companies in which their dollars are invested by three or four layers, which layers tend to be focused entirely on short-term performance and profitability. By a huge factor, a majority of the investors in today's capital markets do not even know the names of the companies in which they hold stock. How can they be anything but "paper entrepreneurs"?  They seek the highest return on their investments without any concern for the long-term viability of the companies providing the returns.


Consider that the mutual fund manager. He care not one whit for the companies in which the fund he manages invests beyond the companies' ability to provide solid growth for the mutual fund over the next reporting period. He will gladly shift millions from company A to company B at the hint that company B's short-term return will outstrip company A's performance.

Next in line come the brokers and the brokerage houses. They are willing to recommend mutual fund C over mutual fund D on the basis of their likelihood of producing short-term returns to the investors. The brokers and brokerage houses are incented to provide this kind of advice without consideration for the long-term survivability of the companies which their investments ultimately reside.

Then, of course, for the vast majority of investors, there are the corporate retirement and pension fund managers. They, too, have only one incentive: to see good performance in the funds they manage. They, like the investors themselves, quite often have no knowledge -- ultimately -- about the companies in which their investments ultimately are put to use.

All of this leads to the boards of directors in publicly-held companies providing incentives to their chief executives to provide short-term profitability so as to keep market capitalization up -- which is almost entirely based on stock prices. So, how do CEOs and CFOs react to all of this? They are willing to sacrifice the long-term prospects of their own organization for short-term performance during the particular CEO's or CFO's term in office -- and their successors will do the same.

This constitutes a grave danger to publicly-held companies in the U.S.  What is the answer?

Contact me!

The danger of "We know!" - Part 2

In Part 1 of this series, I discussed how many executives and managers fail to reap benefits from new methods and ideas -- especially if these new methods and ideas arrive in the form of a "consultant" -- simply because these executives and managers believe that the already know what can be known about their organizations and their industries. This prevents many organizations from growing to their full potential.

W. Edwards Deming put it bluntly: "Information is not knowledge. Knowledge comes from theory."

Unfortunately, what far to many executives and managers have is a lot of information about their businesses and their industries. What they desperately lack is "theory" by which to interpret and understand the information at their disposal.

G. K. Chesterton put it this way in Tremendous Trifles (Beaconsfield, Britain: Darwen Finlayson, 1968): "One of the four or five paradoxes which should be taught to every infant prattling on his mother's knee is the following: that the more a man looks at a thing the less he can see it, and the more a man learns a thing the less he knows it. The Fabian argument of the expert, that the man who is trained should be the man who is trusted would be absolutely unanswerable if it were really true that the man who studied a thing and practised it every day went on seeing more and more of its significance. But he does not. He goes on seeing less and less of its significance."

Think of Sir Isaac Newton and the story of his having begun his development of the theory of gravity because he had seen an apple falling from a tree. Surely there had been tens of thousands of individuals that had witnessed objects falling to the ground under the influence of gravity for several millennia prior to Sir Newton's experience. Yet, no one understood "gravity."

It has only been since Isaac Newton put a "theory" around gravity that men could take what they had experienced with gravity and put it into a framework -- a theoretical context -- that made the experience understandable to them. Furthermore, the framework (the "theory") gave men the opportunity to predict outcomes of certain actions relative to the gravitational affects. This meant that men could plan and execute with some real certainty as to the results they would obtain under "gravity."

Precisely the same is true of business.

Executives and managers have all manner of data in their hands relative to the performance of their enterprises. What they lack is a "theory" by which that data may be abstracted and understood for the purposes of effective management. A framework that will help them bring simplicity out of the complexity before them.

In all too many cases, the missing "data" for beginning the process of ongoing improvement is to be found within the organization at all. The missing component for executives and managers is quite often this simple point: there is a simple method available to help organizational leadership logically analyze what they already know internally.

In the absence of a "tool set" that helps management bring forth "knowledge" from their "information," executives and managers tend to continue "tinkering" with their businesses. They make changes here or there to see if the change helps.

Sometimes such change seems to help, other times the change actually makes things go worse than before. Still other times, the change is made and their is no perceptible affect on the organization at all.

This is no way to run a business -- or any other kind of organization!

Executives and managers are yearning -- sometimes without even recognizing what is lacking -- for a simple, effective tool to help them gain control of their enterprises once again.

[Next time: Gaining Control]

Contact me!

...

Government-Induced Economic Discontinuity

There is considerable upheaval in the U.S. economy right now, and your business could be in jeopardy if you do not have a framework and method by which to come to grips with the discontinuity that is likely to be introduced by federal government actions over the next several months.

Consider these facts:

1. Over the last 50 years, the federal government has controlled about 20% (+/- 2%) of our gross domestic product (GDP). They have done so through some direct controls as well as through the letting of government contracts for defense and so forth. However, with Congress pushing for a plethora of new programs, the drive toward a nationalized health care system, and the results of various so-called "economic recovery" actions being the virtual "nationalization" of some segments of some industries, we may see the federal government directly or indirectly involved in up to 50% of GDP in the near future.
   
   
2. Since about 1948, the federal deficit has hovered around 2% of GDP. Now, however, with so-called "recovery" bills pending and acts that have already been passed that run into the trillions of dollars, we could easily see the federal deficit leap to 15%, 18% or even 20% of GDP.
   
   
3. For nearly 30 years the Federal Reserve has grown the money supply at about 4% a year. That has changed dramatically! The Federal Reserve has doubled the money supply between October 2008 and January 2009 alone.

In essence, the U.S. may rapidly become "Europe" if politicians in Washington have their way -- and it is likely that this is largely unstoppable at this time. If we use for comparison Germany and France as "typical" Euro-zone nations, we find that in these countries the national government controls 40 to 60% of GDP and that these nations are dominated by massive social programs.

What are the results for business economics?

• Slower growth - the economies in these nations grows at a rate equal to about one-half or two-thirds that of the U.S. economy

• Higher inflation -Euro-zone inflation is about 10% higher than that of the U.S. over the last 20 or so years

What does all this mean for you and your business?

This government-induced economic discontinuity means that you and your business will find that "the rules have changed." You will discover that management tactics that may have worked before may no longer have the same positive effect.

In revolutionary times like these, my very best advice is for you to be sure that you and your management team have a sound framework of understanding by which to analyze and interpret the new reality in which you find your enterprise. I strongly recommend the application of the highly rational and easily understood "Thinking Process" tools as developed by Eliyahu Goldratt.

Contact me!

(c)2009, 2010

World Class Manufacturing -- Really?

I found this quote on a Web site which will remain unidentified in this article:

World Class Manufacturing - A definition
World Class Manufacturers are those that demonstrate industry best practice. To achieve this companies should attempt to be best in the field at each of the competitive priorities (quality, price, delivery speed, delivery reliability, flexibility and innovation). Organisations should therefore aim to maximise performance in these areas in order to maximise competitiveness. However, as resources are unlikely to allow improvement in all areas, organisations should concentrate on maintaining performance in 'qualifying' factors and improving 'competitive edge' factors.... The priorities will change over time and must therefore be reviewed.

The author here identifies six "priorities":

1. Quality
2. Price
3. Delivery speed
4. Delivery reliability
5. Flexibility
6. Innovation

I would contend, however, that none of these 6 priorities may be achieved without setting the organization's primary focus on making money -- making money both today and in the future. Without making profit the first priority, there is no money to spend on improving quality; there is no money to spend on improving the speed or reliability of delivery; and there is no money to spend on improving flexibility or innovation.

One might say, "Well, if we improve quality, we will make more money." But unless the framework for the planning and focus of the organization has demonstrated by a rational method that improving quality will lead to improved profits, then that statement remains only a "hope" and not a plan or a true "goal." The same may be said for the other five "focus" points in the article.

If the manufacturer has no sound framework by which to determine precisely what steps it must take beginning today to increase its profitability -- to make it more effective at making money -- there is a chance it may not survive long enough to work on any of the six "priorities" listed above.

"Without theory there is no knowing." -- W. Edwards Deming

Having a valid theory -- a consistent "framework" -- by which to evaluate all that transpires within your business is critical to constancy of purpose and effective leadership by management.

Contact me!

(c)2008 Richard D. Cushing

Increasing Your Cash Velocity

Cash velocity is related to cash flow and in tough economic times, nothing -- and I mean nothing -- is more important to the health of a business than cash flow. Most organizations cannot survive if they run out of cash. In essence, an organization with a good cash flow is a healthy organization and an organization with a bad or declining cash flow is at risk.

The Cash Velocity value measures how rapidly your business generates cash. The Cash Velocity of your organization is a good one-stop metric on your business' health because it includes so many important factors.

Here is the way we would recommend that you calculate your Cash Velocity (CV):

CV = Throughput / Cash-to-Cash Cycle Time

where:

• Throughput = Revenues minus TVC (truly variable costs)
• TVC or Truly Variable Costs are those costs that are directly proportional to your revenues and, in a manufacturing operation (for example), would typically include raw materials and outside processing costs, but would not include labor or overhead since labor and overhead do not vary directly with the number of units produced.
• Cash-to-Cash Cycle Time is the average number of days it takes from the time you pay out cash to a vendor or supplier for raw materials or outside processing until you collect from your customer for a resulting finished good. The chart below shows how this cycle may be understood.

The Cash Velocity metric is, as a result, stated in terms of "Throughput-dollars per day."
As stated above, this consolidated metric is influenced by a number of factors upon which management may take action for improvement:

1. Increasing Throughput - This may be done by either increasing revenues or reducing truly variable costs. Revenues may be increased in the aggregate (more sales) or by increasing prices (where the market will bear it and the net result will not actually be reduced aggregate revenues).
   
2. Decreasing the Cash-to-Cash Cycle Time - This, too, may be addressed in multiple ways:
   
   a) Reducing Inventories will mean that goods will sit a shorter period of time in either raw materials, WIP, or finished goods inventories before they are shipped to your customers.
   
   b) Changing the terms of your sales (reducing the days between shipment and receipt of payment from your customers where the market will bear such a change).
   
   c) Accelerating collections (if you have a significant number of customers that delay payment beyond your terms).
   
   d) Shortening your manufacturing cycle time (if possible).
   

This metric may be further refined so that you are not evaluating your organization as a whole. Instead, you may look at Cash Velocity by product line, for instance, if there are significant differences in how your product lines behave. There is a big difference between a product line that produces $1 million in Throughput on a 300-day cash-to-cash cycle ($3,333 Throughput per day) and another product line that produces $800,000 in Throughput with a 90-day cash-to-cash cycle ($8,889 Throughput per day). Clearly, the latter is "healthier" for your business even though the total revenues may be lower.

Email me.

©2008 Richard D. Cushing

Information Is Not Knowledge

"Information is not knowledge. Knowledge comes from theory."
-- W. Edwards Deming

When Sir Isaac Newton was conked on his head by the falling apple (as the story goes), he had information. The information was, "apples fall from trees" or, put more generically, "things fall to the earth."

However, Newton still had no "knowledge."

Newton's comprehension of the facts did not provide "knowledge" that would be useful in any significant way. After all, people had known for centuries that things fall to the earth and, if one didn't want them falling to the earth, one must be certain that the objects are held securely in their present location.

Once, however, Newton began to construct "theory" around the fact that things fell to the earth, valuable "knowledge" began to spring from the "information" at hand.

For example, based on the "theory" that gravity was a force that always acted in precisely the same way, experiments could be set up to measure just how gravity functioned. From these experiments and calculations, we now know that the gravity of the earth accelerates objects at ~ 32.2 feet per second-squared.

This principle applies in business as well.

Having worked in the world of business management and computers since the time of the introduction of the personal computer (PC) in the early 1980s, I have found that many, many business people -- from owners, to CEOs, to CFOs, to middle managers, and on down the line -- confuse "information" with "knowledge". In fact, a very common fallacy is the belief that more "information" will lead to better management which will, in its turn, lead to better results.

Therefore, organization spend a considerable amount of some very limited resources (namely, time, energy, and money) acquiring or creating systems to give them more "information."

When all is said and done, however, these business folks often are not significantly better off than they were before they spent their precious time, energy and money, simply because, like the world before Newton, they have no "theory" by which to interpret the information they have. Without this theoretical "framework" in which to fit their body of information, many of their management actions are not much more than flailing at the wind. Some of their efforts work and some do not, but they generally cannot tell you (specifically or accurately) why one initiative worked and another similar one failed.

There are three required steps to gathering what one needs to take timely and effective action:

1. One must take the data (the raw, undigested facts -- perhaps line upon line of numbers) and convert the data into "information."

2. "Information" is data "digested" and put into a form (i.e., a chart, a graph, summed, analyzed statistically) that allows the user to quickly assess the essential implications of the underlying data.

3. The resulting "information" must be placed into a theoretical context -- a "framework" -- whereby the potential outcomes of any actions that might be indicated by the information may be fully comprehended.

Without these three steps, your organization may drown in data or become infatuated with "information" and, yet, never be able to move effectively when times are the most challenging.

©2008 Richard D. Cushing