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In the previous article1 Van der Merwe argued that the current state of
management accounting is contradictory, confusing, and often absurd. The
purpose of this paper is to establish the principles that will serve as the
cornerstones for the restoration of management accounting and to demonstrate
how they are integrated into an existing management accounting framework. This
integration will serve to highlight the required adjustments to the framework and
to validate the cornerstones' implementation feasibility. In part III2 Van der Merwe
recommends an evaluation framework to critically evaluate some of the
assertions related to the prevailing approaches to management accounting.
Two principles from inductive logic that provide the basis for drawing cause and
effect inferences are presented as the cornerstones of management accounting.
These include: 1) causality and 2) analogy.
Causality
Causality is recognized in philosophy as a first principle, i.e., a principle that is
self evident. It embodies the law of rational inference and is a universal principle
in inductive logic. Although the traditional management accounting definition of
causality relates to value as stated in dollars, managers need both a quantitative
model of operating cause and effect relationships as well as a value
representation of those relationships. Therefore the definition of causality that is
needed here is a correspondence definition (i.e., corresponding to the facts), or a
definition related to the quantities of the goods and services produced by the
enterprise, i.e., the real things. The dual nature of the information produced for
management is illustrated in the value chain integration graphic presented below.
The illustration above shows that the quantities of inputs and outputs are never
separated from their values as in traditional management accounting systems.
The integrity of quantity-value is maintained which allows management
accounting to support the general ledger, but at the same time to become
independent of the general ledger. The correspondence definition of causality
and the value chain integration enhances management accounting's usefulness,
separates it from external reporting, lowers the cost of sound management
accounting information, and renders the method centric approaches to
management accounting obsolete.
Analogy
Analogy is the second cornerstone proposed by Van der Merwe and is related to
making inferences based on known cause and effect relationships. Analogy
involves the application of causal information and is used in management
accounting to help analyze and understand financial results and to make
inferences related to future events.
Integration of the Cornerstones into the Existing Management Accounting
Framework
Van der Merwe begins with Shillinglaw's management accounting framework3
that includes concepts, criteria, and constraints (See the graphic below).
Concepts include cost, cost objective, and variability. Criteria refers to elements
such as the two proposed cornerstones, i.e., causality and analogy. Shillinglaw's
original framework includes causality. Constraints include what Van der Merwe
refers to as filters such as objectivity, accuracy, and materiality. His revised
framework is illustrated below.
The revised framework goes beyond product costing for external reporting and
allows for greater levels of detail. Analogy serves to limit the detail to what is
required for enterprise optimization. Under concepts, the new framework
excludes variability (traditionally the relationship between total volume and total
cost), and adds responsiveness. According to Van der Merwe, responsiveness
relates to the relationship between input quantities and output quantities. Under
constraints articulation is amended to apply only to the extent that management
accounting is required for external reporting. This is accomplished through a
separate financial accounting valuation layer as indicated in Exhibit 1, i.e., the
first graphic illustration above.
Conclusion
The cornerstones proposed in this paper are philosophically sound, customer-
centric, seamlessly integrate into the existing management accounting
framework, provide a framework for enterprise optimization and the restoration of
management accounting.
CHAPTER 2 Agency Theory
http://maaw.info/AgencyTheoryMain.htm
1. the agent's utility function is based on the utility for wealth and the disutility
for
effort, while the principal's utility function is only based on wealth.
2. the effects of both ex ante and ex post uncertainty,
3. the effects of risk where the principal is assumed to be risk neutral and the
agent
is assumed to be risk averse.
4. the effects of incentives and payoffs,
5. the moral hazard problem - not knowing the effects of the agent's effort vs.
randomness,
6. the adverse selection problem - not being able to determine the agent's skill
level.
The following graphic shows my interpretation of the the main ideas in this
section.
The authors discuss several cases, or situations related to these issues, as well
as some limitations of agency theory but indicate their belief that agency theory
provides insights related to the structure of organizations and the role of
accounting in maintaining this structure. For example, contracts between
principals and agents show which actions are observed and reported, and how
information is used to determine shares of risk and payoffs. Thus, proposed
changes in accounting methods that fail to consider contracts between principals
and agents, along with the various issues addressed in agency theory, may
receive considerable resistance.
Markets and Hierarchies
According to Tiessen and Waterhouse, the markets and hierarchies framework is
referred to as the "organizational failures framework" and emphasizes
information, structure and control. Hierarchies replace markets in determining
relationships between those engaged in transactions when the costs associated
with contracts become too high. This theory or framework goes beyond agency
theory where all transactions are assumed to be governed by contracts.
(A review of Ouchi's three control mechanisms, i.e., market, bureaucracy and
clan, might be useful to the reader at this point since the term "hierarchies" as
used by Tiessen & Waterhouse appears to have essentially the same meaning
as the term "bureaucracy" as used by Ouchi).
Non-market modes or organization, i.e., hierarchies (Ouchi's bureaucratic form)
provide a comparative advantage over markets in an uncertain or complex
environment because together with bounded rationality and opportunism, a
condition referred to as "information impactedness" is created, i.e., sufficient
information is not available for the market contracting mechanism to work. The
graphic below illustrates my interpretation of the authors' ideas is this section.
The following graphic illustrates Otley's original (1980) view of contingency theory1.
The dimensions of structure and control include authority structure and activities
structure, i.e., rules and procedures that determine the discretion of individuals. Authority
relates to social power. In the contingency model, decentralized authority is more
appropriate where uncertain environments or non-routine technology exist. Centralized
authority is more appropriate when environments are certain. The graphic illustration
below reflects my interpretation of these theoretical concepts.
________________________________
1
Otley, D. T. 1980. The contingency theory of management accounting: Achievement
and prognosis. Accounting, Organizations and Society 5(4): 413-428.
When studying MCS, one of two approaches can be taken. First, one can build on existing areas,
trying to extend overall theories. Second, researchers may choose to evaluate new and novel ideas as
they come into practice. Both types of research make important contributions. Primarily, because MCS
change over time, it is important to study the implementation and success of new managerial accounting
tools. Furthermore, as old MCS lose relevance, research on them does not have significant practical
applications. The author also warns of the dangers of studying accounting MCS in isolation.
Consideration of other organization control systems is imperative given the interactive nature of MCS
with those other systems. One suggestion is to classify organizational controls as organic or
mechanistic. Table 1 puts forth a taxonomy which classifies controls in this way.
Another potential issue in MCS research is the assignment of dependent and independent
variables. Some studies classify performance as the dependent variable, and MCS as the independent
variable. The criticism of this approach is that, given rational economic theory, organizations will always
choose the MCS that leads to the highest performance; thus nullifying meaningful results. Others look at
the contextual variables as independent and the MCS as dependent. Finally, some studies examine
implementation of MCS and link it to performance. The author cautions that prima fascia adoption does
not necessarily lead to actual use, thereby clouding the link between performance and implementation of
MCS.
The first contingent variable examined is that of the effect of the external environment on MCS.
Many studies narrow this down to uncertainty and risk assessments. However, there are many other
characteristics of the external environment which may be relevant.
The author defines technology as hardware, materials, people, software, and knowledge. The
majority of studies examine complexity, task uncertainty, and interdependence as contingent factors
related to MCS. When using complexity as a factor, the technology relates to the complexity of the
production function. There is also a focus on the complexities of the value chain and their implications for
MCS design. Overall, the more complex a process is, the more likely the MCS will be organic and less
traditional.
Task uncertainty is considered as a factor associated with functional departments. For example,
marketing departments have more task uncertainty than production departments, and thus need a
system that includes a broad scope of information (p.140).
Interdependence, as noted earlier, can affect the study of MCS. In this case, interdependence
refers to interdependence between functional areas.
The more technologies are standardized and automated, the more formal and
traditional the MCS.
The more uncertain the task, the less formal and traditional the MCS.
The more interdependent the technologies, the less formal and traditional the
MCS.
Contemporary Technology
Chenhall gives space to discuss the most recent managerial accounting technological advances.
These include JIT, TQM, and FM (flexible manufacturing). Overall, these new tools seem to work best
when in the presence of less formal, more externally focused MCS. However, there is some indication
that a hybrid MCS best serves these implementations.
Organizational Structure
Basically, in this context, organizational structure refers to the “…formal specification of different
roles for organizational members, or tasks for groups, to ensure that the activities of the organization are
carried out”(p.144). This paper looks at some studies that classify organizational structure as
mechanistic or organic. Mechanistic structures are characterized by the degree of formalization of “…
rules, procedures, openness of communications, and decision processes” (p.145).
There are also studies that classify organizational structure as centralized/ decentralized or
functionally differentiated/integrated.
Organizational Size
Size has been studied as a contextual, influential variable, however, many studies are limited
because they only examine large firms. As firms grow larger, MCS tend to become more formal and
controlling. These are primarily administrative controls and rules. In small firms, MCS focuses on
interpersonal controls.
Chenhall (p.149), gives a useful analysis of possible ways to measure size. These include:
number of employees, net assets, sales, and profits. Choice of a measurement depends on the
dimension of MCS studied.
Strategy
Strategy, at the business unit level, has been associated with MCS. As expected, for conservative
strategies, formal controls ruled. However, as seen before, a hybrid MCS was evident in entrepreneurial
strategies. Specifically, in these cases, tight controls operated together with organic communications and
decision processes. Chenhall discusses ‘build and harvest” strategies, as well as prospector strategies.
Culture
Although research in this area is limited, it remains relevant. The basic premise is that culture will impact
the development and effectiveness of MCS. This is especially relevant given the increased globalization
of corporations. Culture classifications by Hofstede (1984) are often used in these studies. This results in
some limitations. First, studies that rely on a subset of the Hofstede taxonomy may be omitting some
relevant characteristics. Second, using only the Hofstede values may limit the study and exclude other
relevant variables. Third, cultures change in response to globalization; therefore, the values assigned by
Hofstede may not be currently applicable to the country. Last, such stereotypes may not apply equally to
all individuals within a country.
Given that findings are mixed, there is only one proposition concerning culture and MCS.
Although some of the previous elements will continue to be of interest; there are
new elements to be considered. For example, there is an increased focus on
environmental reporting and control. Additionally, there is a social emphasis on employee
empowerment and fulfillment. Finally, as globalization becomes the norm, issues of size
and culture will continue to be relevant.
Various statistical and modeling variations can be used to examine MCS design. Selection
studies, interactions approaches, and systems models are all considered. Statistical approaches include
linear regression, structural equation modeling, and cluster analysis.
Causality
Care must be taken to address causality. Is the model unidirectional (context variables influence
MCS), or is it bidirectional (context variables influence MCS, which then influences context variables)?
Level of analysis
PURPOSE/MOTIVATION
The authors are motivated in the study by various methodological issues related to the
existing research in management accounting systems (MAS) utilizing contingency theory.
These issues include the use of individual data to represent organizations, non-insightful
correlations between variables, inappropriate exclusion of variables and inappropriate or
inconsistent measures of variables. The authors make two conclusions regarding the
extant literature on contingency theory: 1) that it is "rather piecemeal in nature, requiring
redirection and synthesis in order to enhance its value; and 2) the contingency framework
may have been underspecified …" (p. 64), and they state their purpose in the current work
as an effort to "integrate and interpret contingency theory research as it relates to MASs
in order to draw descriptive as well as new prescriptive insights into the design of
effective MASs" (p. 64) by reviewing the existing literature, developing a theoretical
framework and utilizing the framework and methodological issues to suggest extensions
to the research.
SUMMARY
The current study defines MAS as "those systems which support managerial planning,
evaluation, and control activity and, in a broader sense, facilitate strategic choice" (p. 65).
The use of contingency theory would suggest that organizations align their systems and
processes with their environment (external factors) and strategy (internal factors), and that
the effectiveness of MAS will depend on the extent to which the MAS’s characteristics
meet the requirements of the various contingencies faced by the organization.
The MAS characteristics studied in prior research are based on the accounting
information systems framework proposed by Gordon & Miller (see figure 1 p. 66) and
include the following: environment, technology, organizational characteristics, decision
style, systems characteristics and MAS effectiveness. Figure 2 on pg. 67 lists the most
common operationalizations of each characteristic.
Environment is defined for this study as "phenomena that are external to the organization
and which have either potential or actual influence on the organization" (p. 68).
Uncertainty is the most commonly used measure of environment in prior research.
Technology is defined as "the organizational process of transforming inputs into outputs"
(p. 68). Technology has been measured by a number of factors, with the two most
consistent being routineness and interdependence. Organizational characteristics have
most consistently been measured by structure ("the patterns and relationships that exist
among organization or work unit elements" p. 69) and strategy ("the determination of the
basic long-term goals and objectives of an enterprise, and the adoption of courses of
action and the allocation of resources necessary for carrying out these goals" p. 69).
Decision style is "the decision style used by executives to help the organization better
cope with the environment" (p. 69), and is an individual characteristic used to represent
the organization. The existing literature does not contain a measure of organizational
decision style. Systems characteristics are typically measured using "the type of data
reported by the system" (p. 70) and three data type characteristics have shown some
consistency in the existing literature: internal/external, financial/nonfinancial and ex
post/ex ante. Measuring MAS effectiveness has been problematic in the prior research.
Two approaches have been to measure either user preferences or actual usage.
Based on their review of the existing literature, the authors contend that key contingent
variables have either been ignored or measured inappropriately, contributing to lack of
generalizability of the results and an inability to draw unequivocal conclusions. Their
assessment is that the factors associated with the effective design of MAS have not been
properly specified and that an explicit framework for evaluating MAS using a
contingency theory approach has not been developed. They then propose such a
framework and refine the factors that should be examined. They also make
recommendations regarding various methodological issues.
The authors use the Gordon and Miller framework as a starting point for developing a
more explicit framework and also adapt Franz and Robey’s distinction between factor and
process research. They define factor research as follows: factor research "empirically
examines user and situational attributes to see how they relate to the outcome of system
implementation", process research "emphasizes managing the organizational change that
takes place during the development of the system" (Franz & Robey, 1987, p. 207). The
use of both factors and processes as variables of interest are needed to expand the value of
research in the design of MAS.
To expand the framework, the authors include systems change (adaptability) and
organizational decision making as processes instead of factors. Figure 3 on p. 74
illustrates the updated contingency framework and highlights the various relationships
that have been studied in prior research. The relationships between decision style,
systems adaptability and organizational decision style have yet to be examined and
represent opportunities for future research.
Decision style is a factor that has not been properly defined or measured in previous
research, as discussed in the previous section. It represents the "range of individual
variations in decision style that can be found among the decision makers within the
organization" (p. 76). Systems change (adaptability) is the ability of MAS to adapt to
changes in the organization’s internal and external environment. It is viewed as a process
in the framework. These changes include structural changes, information processing
changes, external changes and procedural changes. These changes impact the
organizations technology, people, policies and procedures and both renovation of existing
MAS and new implementations should be examined with a view towards increasing
adaptability to future changes. Organizational decision style is also viewed as a process in
the framework and is "concerned with how organizations make decisions, what
information is needed to make decisions and how those needs can be supported" (p. 76).
Use of a decision orientation allows the researcher to develop measures of systems
effectiveness that are both practical and meaningful. The value of this perspective has
been discussed in the information systems literature, but has not been examined in the
contingency literature with respect to MAS design. Factors related to the organizational
decision making process include technological complexity, overall organizational
strategy, and organizational structure.
Two methodological issues are identified as essential to the evaluation of MAS design
utilizing the contingency theory: "theoretically-based measures of effectiveness and an
adaptive mechanism through which effectiveness is achieved" (p. 77). These require
future research to address issues regarding the method and level of analysis used.
Contingency theory implies a conditional association of two or more independent
variables with a dependent outcome. This relationship cannot be evaluated using
correlation or unmoderated regression, methods commonly utilized in prior research, but
instead requires the use of analysis methods that examine fit using either a reductionist or
holistic approach. Path analysis is one such method. One other issue to be addressed is the
level of measurement. Previous studies have measured data at the individual level and
used it in aggregated form to represent organizational level data. This may lead to
inconsistent results or to inappropriate conclusions if the individual level data is not
representational of the entire organization. Data should be collected and measured at the
appropriate level for the research question being addressed.
In conclusion, the authors are "positive about the potential for contingency research in the
future", which should "specify meaningful system and organizational characteristics that
impact actual usage patterns and the capability of these systems to improve the quality,
effort or timeliness of decision making" (p. 81). They encourage further refinement of the
framework and variables, taking into consideration the constraint of increased data
requirements.
Preface
Contingency Theory
In this section of the paper the authors discuss the notion of contingency theory and what
role it has played in situating control processes and structures of organizations in the
context of managerial accounting. Contingency theory is "a theoretical perspective of
organizational behavior that emphasizes how contingent factors such as technology and
the task environment affected the design and functioning of the organizations." Based on
its historical roots of the 1950s and 1960s, contingency theory represents a fusion of
organizational theory and sociological functionalist perspectives of organizations.
Through this blend of organizational decision-making and sociological functionalist
concerns, contingency theory absorbed and took on the views of critical organizational
processes such as decision-making and control. It is this explicit concern for issues of
"coordination and control that has provided important contributions to MAR in ones
understanding of issues (design of information and control systems, budgeting and
strategic planning)."
Traditionally, the MAR utilizing contingency theory reflected and promoted the belief
that decision-making should be rational, hence the managerial accounting information
used by managers served as a quantitative terminology of organizational goals. However,
currently accounting researchers have attempted to widen the contingency arguments to
embrace the relationships between firms’ strategies and the design of their control
systems.
While current and traditional contingency theory has had an overall broad influence on
MAR, it has been criticized for representing a "deterministic, ahistorical view of
organizations which provides limited insight as to the mediating processes of
organizations."
Interpretive Perspective
Overall, the second section of this paper is concerned with the social construction and
disbursement of rationality and the way in which this rationality affects the power and
political structure of organizational functioning through a variety of organizational and
sociological theories. The organizational and sociological theories utilized are referred to
as interpretive perspectives, which also draw from the organizational decision-making
perspective. Exclusively, a number of organizational and social theories including
institutional theory, resource dependency theory, political perspectives, and the sociology
of professions are looked at to examine the relevance of interpretive perspectives. In
summary, "interpretive perspectives of managerial accounting have begun to see
managerial accounting practices and information as socially constructed phenomena with
the full implications of the power and politics of social construction rather than as a
technically rational function driven by and serving the internal operations of
organizations." Managerial accounting is seen as being implicated in the social
construction of reality rather than as being passively reflective of the reality as depicted in
contingency theory.
Critical Perspectives
The third section of this paper deals with the critical perspective. Explicitly, the critical
perspective is concerned with the role that accounting plays in relation to issues of
conflict, domination, and power as defined by the forever conflict of capitol and labor.
The critical perspective provides an even more direct view of power and politics through
organizational and sociological theories.
Labor process theorist deny that management accounting is a "neutral tool serving the
general interests, of efficiency and emphasizing its role in legitimizing partisan interests,
in contributing to the control and domination of labor, and in reinforcing the dominant
mode of production. Labor process theory is consistent with the other organizational
sociological perspectives such as contingency theory and interpretative work in the sense
that it "embeds management accounting in a wider context than more orthodox
approaches." However, labor process theory departs from these approaches by focusing
on the "structural antagonism between classes inherent in capitalist societies."
The Foucaultian perspective remains consistent with the underlying views of the critical
perspective. This perspective situates management accounting in a wider political and
social context. Management Accounting is considered as part of a larger historical trend
through which people are subjected to several disciplinary techniques. In contrast, labor
process theory appears within the context of a class divided society. This perspective
reveals management accounting as a general historical process by which people are made
calculable and governable. In addition, the Foucaultian view also considers management
accounting as a social practice rather than a technique.
Conclusion
The last section of the article provides concluding remarks in which the relationships
among the organizational and sociological theories are discussed.
SUMMARY OF CONCEPTS
2. Develops 3. Contributes to
legitimized categories the control and
domination of
labor
4. Reinforces
capitalist
production
How Management 1. Quantitative 1. A set of legitimizing 1. Class-divided 1. People are made
Accounting is expressions of organizations though society to aid calculable and
Used organizational the construction of an economic governable
goals appearance of expropriation
rationality and 2. Social practice
2. Passive efficiency 2. Social practice
reflection of the
technology 2. Socially constructed
phenomenon with the
3. Technically full implication of the
rational function power and politics of
driven by and social construction
serving the internal
operation of the
organization
Organizational Design and Accounting Information
Kaplan, S. E., and J. T. Mackey. 1992. An Examination of the
association between organizational design factors and the use
of accounting information for managerial performance
evaluation. Journal of Management Accounting Research (4):
116-130.
Summary by Michele Martinez
Ph.D. Program in Accounting
University of South Florida, Spring 2002
Preface
The purpose of this paper as stated by the authors, is to provide evidence on the
association between the use of accounting information to evaluate the performance of
production managers and factors of organization design.
Contingency Theory
In this study the authors utilize contingency theory as the theoretical basis for this paper.
Contingency theory "asserts that there is a relationship between organizational structure
and situation, and that organizational effectiveness results from this relationship. The
most effective organizational structure will depend or be contingent on the organization’s
particular situation." In reference to this particular study contingency theory was applied
to suggest an association between the use of accounting information to evaluate
managerial performance and design factors of the organization. In addition, the
contingency perspective suggests that the use of accounting information to evaluate
managerial performance will be contingent upon task uncertainty and departmental
interdependence.
Research Questions
Due to the exploratory nature of this study, research questions instead of hypotheses are
proposed. The author’s proposed the following research questions because they focus on
the relationship between specific production characteristics and the use of production cost
information to evaluate the performance of production managers.
1. Are organizations that have a flow shop more likely to use production cost information
to evaluate production managers’ performance than organizations with job shops?
2. Are organizations that use work-in-process inventories more frequently more likely to
use production cost information to evaluate production managers’ performance?
3. Are organizations that use aggregate accounting methods for set up costs less likely to
use production cost information to evaluate production managers’ performance?
Method
Sample Companies
For this study the authors’ selected the sample of companies from the Dun and
Bradstreet’s 1984 Canadian Guide to Manufacturers and the Harris Michigan Industrial
Directory, 1986. The elimination of companies from this list began with companies that
were located more than 30 miles from the authors’. Accordingly, approximately 120
organizations were contacted. Of the original 120 organizations contacted the final
sample contains the completed responses from 47 firms, representing a response rate of
39%.
Independent variables
This study includes three independent variables. The first variable, a dummy variable is
the type of production process used by the plant. The second independent variable is a
forced choice response variable, which concerns the extent to which work-in-process
inventory is used. The final independent variable is a trichotomous measure, which
concerns accounting procedures for set up costs.
Dependent Variable
The purpose for costing in production departments was the dependent variable for this
study. This variable required a 0,1 coding response.
Results
Due to the dichotomous nature of the dependent variable and the possible associations
between the independent and dependent variables and the directional research questions
Probit regression was utilized to analyze the data.
Research Question 1 (the association between the use of production cost information and
the type of production process employed) – production process was significant at
conventional levels and the negative beta coefficient indicates the results were in the
expected direction. There was a greater tendency for flow shops as opposed to job shops
to use production cost information for managerial performance evaluation.
Research Question 2 (the association between the use of production cost information and
the frequency that work-in-process inventories are used) – was marginally significant at
the .10 level. The positive beta coefficient indicates that there was a greater tendency to
use production cost information for managerial performance evaluation when work-in-
process inventories were used.
Research Question 3 (accounting method for set up costs is associated with the use of
production cost information for managerial performance evaluations) – marginally
significant and an increased tendency for production cost information to be used for
managerial performance.
The probit model correctly classified 70% of the observations as opposed to the naïve
model, which classified the observations, correct 62% of the time. In addition, the hit
rates for the probit model were 86% and 44% indicating that the model is able to greatly
improve the prediction of non-use of accounting information.
Discussion
This study is exploratory in nature and explores the association between three
organizational design factors and the use of production cost information to evaluate the
performance of production managers. There are a few limitations in this study. First, the
sample was relatively small and contained only push manufacturing organizations. Thus,
the results will not be very generalizable. Future research should examine various types
of manufacturing organizations and various types of design factors.
CHAPTER 4 Decision Theory
http://maaw.info/DecisionTheoryMain.htm
Decision Theory
Decision Theory Bibliography
Simulation Bibliography
Decision Usefulness vs. Fairness
The argument that decision usefulness lacks symmetry. He says that lack of
symmetry can be inferred by considering the implications of symmetry for some
assumptions about the accounting environment. To understand, the reader has to
systematically make a case built upon these assumptions. The following steps
start with the basic assumptions and then provide a point-by-point explanation for
his argument that decision usefulness lacks symmetry.
4. Management and the entity’s goals are congruent. Stakeholders base their
actions on
management’s actions and all parties are aware of each other.
6. Accounting data has the unusual characteristic of being a proxy for objects
that are unobservable and the numbers are the only things observable. He
says this transforms the accounting data, which is about an object, into the
object itself.
7. Because accounting data represents an object and at the same time is the
object, accounting data is not only an evaluation about the consequences, but
it is the consequences themselves.
8. The choice of accounting data can be the choice of what outcome the
decision maker wants and is unrestricted because he/she is the object of
concern.
The following model shows two viewpoints about the result of decision
usefulness.
Some say that optimal distribution of economic resources is not the focus of
accounting and is distinctly separate from efficient allocation of resources
(modeled by straight lines). They further insist that market forces will take care of
equitable distribution, which is a societal goal. Williams posits that the two are
inseparable (modeled by both straight and dotted lines) and that both efficiency
and distribution require value judgments of fairness.
MARKET JUDGMENT OF FAIRNESS
Adherents to decision usefulness base their position on their belief that the
“free market” will ensure equitable distribution and that accounting just makes
market forces more efficient. He explores the Libertarian and utilitarian
interpretations of accounting’s emphasis on efficiency and concludes “from a
decision usefulness perspective reliance on efficiency criteria and market justice
serves only to make accounting’s fairness judgments implicit, not absent.” As
such, accounting must not only consider efficiency, but also consider moral
consequences.
See also Pallot, J. 1991. The legitimate concern with fairness: A comment. Accounting
Organizations and Society 16(2): 201-208. (Summary).
INTRODUCTION
The main purpose of this article, as stated by the authors, is to review the need for
multiple performance criteria to measure long-run profitability, the potential difficulties
of using such measures, and to present the analytic hierarchy process and its potential use
in synthesizing multiple performance measures. The authors also describe a case and
apply the analytic hierarchy process to illustrate the way in which it can be used to
transform multiple criteria into a composite performance measure.
Performance evaluation has been a difficult problem for businesses that can be viewed
from several perspectives.
• The perspective of the management and supervisors as it relates to the efficient day-to-
day operations.
The authors provide an example scenario where a senior executive must decide on which
of three candidates to promote. The decision maker will compare three criteria
(leadership, human relations, and financial management ability) in pairs to develop a
ranking. The comparisons would be:
A ratio scale of 1 to 9 is added to the ordinal ranking provided by the responses to these
questions to provide the relative importance of one criterion over another. The pairwise
comparisons are summarized in a square matrix and the eigenvalues and preference
vector are then computed to determine the relative ranking of the criteria. Then each of
the candidates is compared on the basis of the criteria as follows:
1. Is candidate A superior to Candidate B in leadership skills?
The analytic hierarchy process can allow for multiple viewpoints to be incorporated into
the priority ranking by being used at many levels of the organization. Its most important
contribution to performance evaluation is that it provides a systematic approach for
weighting performance to provide a comprehensive performance measure. This measure
can be used to assess the overall performance of the organization, to rank organizations or
segments of organizations, to serve as input to incentive compensation schemes, and as
input into decisions about the organization.
1. Return on investment.
After analyzing these indicators, they decided to reaffirm the companies goals:
Since the divisions of the organization were located in several countries, the effects of
foreign currency fluctuations had to be taken into consideration. They added six new
performance indicator measures:
4. Customer satisfaction.
To apply the analytic hierarchy process, a questionnaire was given to the division
managers and two Divisional Vice-Presidents to compare the relative importance of the
nine evaluation criteria. The results formed a 9 x 9 matrix from which the preference
vector (eigenvalues) was computed. Based on the performance vector, the nine evaluation
criteria were ranked as follows: profitability, product and technology innovation, hedging
effectiveness, operating efficiency, marketing effectiveness, customer satisfaction,
productivity, operating effectiveness, and employee morale.
After the priorities were established, the two vice presidents were asked to complete a
second questionnaire which requires pairwise comparisons between the divisions on the
basis of the actual values of each of the nine evaluation criteria separately.
The results of the analytic hierarchy process showed that one of the divisions was the best
in terms of some factors while another was the best in terms of others. It was difficult
from the information provided to determine which division has the best overall
performance. These results were different from the company’s original evaluation
scheme. The authors believe that the analytic hierarchy process experiment was
successful for this firm even though the results were different from the company’s
original three-factor weighted scheme.
____________________________________________________
Note: This study was somewhat confusing to us because the company sounds like a real
organization although Chan and Lynn include the word hypothetical after the company
name in parentheses on page 69. Kasanen, Lukka and Siitonen (1993) list this paper as a
study in which a construction is developed further, but which lacks, in one way or the
other, practical implementation. For a case study where the authors used the technique in
an insurance company, see Chan, Y. L. and B. E. Lynn. 1993. Organizational
effectiveness and competitive analysis: An analytic framework. Advances In
Management Accounting (2): 85-108. I suppose the 1993 study passes the semi-strong
market test of a managerial construction mentioned by Kasanen, Lukka and Siitonen on
page 253 of their paper mentioned above.
The formula for success at one company does not always translate into success for
another company. Yet, consultants and managers all too frequently apply the same
principles of success in every situation. It is imperative that the dynamics of the company
be examined before applying any theory.
Management must first understand what a theory is and from where it is derived. “A
theory is a statement predicting which actions will lead to what results and why” (p. 68).
Actions are not just arbitrarily taken; rather they are the result of an expectation by a
manager. Theories are important for two reasons: 1) Assist in helping individuals make
decisions; and 2) Provide guidance for understanding what is happening in the present
and why.
The three stages of theories are constantly repeated until researchers are confident enough
to make predictions about what should happen in similar circumstances. Frequently,
while repeating the process, researchers observe something in the theory that cannot be
explained or predicted, an anomaly that implies something different is occurring. It is
then imperative to revert to the second stage to re-examine the categories defined. The
presence of an anomaly allows researchers to more accurately explain how the
phenomenon should work in a variety of situations.
For example, Michael Porter saw anomalies in the theory of comparative advantage that
had for many years explained international trade. His research demonstrated that while
the traditional theory on comparative advantage was valid, other factors played important
roles in a country’s ability to increase its advantage in the global market. His theory of
“clusters” explained how a country could exploit its natural resources, but another
country lacking essential natural resources can create policies to build “process-based
comparative advantage” (p. 69).
Typically, early in the research process, categories are defined according to the attributes
that seem to be correlated with a particular outcome. However, categorization based on
correlations is actually based on the researchers uncertainty. Stating that a casual
relationship exists as a result of correlation implies that researchers do not fully
understand what causes a given result. Unfortunately, many researchers use the
correlation basis, incorrectly believing that they can increase their results using
supercomputers and databases for number crunching and regression analysis to
manufacture statistical significance.
Breakthroughs in determining causality do not come from number crunching, but from a
careful, detailed inspection of the companies to view the processes in action. For
example, it was superficially thought that Toyota’s success in manufacturing had to be
related to Japan’s culture. However, after researchers visited a Japanese plant, they
noticed more significant characteristics of the system, including minimum levels of
inventory and kanban card scheduling systems. Sadly, the researchers then equated the
attributes of the plant’s success with its results. Many wrote books and articles
encouraging managers in manufacturing plants to adopt the Toyota philosophy to
improve quality, increase efficiency, and reduce costs. More careful analysis of Toyota by
Spear and Bowen revealed that the success of the company was attributed to “four
specific rules that create automatic feedback loops, which repeatedly test the effectiveness
of each new activity, pointing the way toward continual improvements” (p. 71).
In order to be predictable, researchers have to ask, “What will cause this theory to fail?”
instead of asking, “What characteristics are associated with success?” Researchers need to
not only identify causal mechanisms, but also need to explain which situations cause the
mechanisms to fail or succeed. Elaborating on circumstances, known as circumstance
contingent, allows managers to understand when theories should be adjusted to fit their
particular environment. It also helps management recognize changes in their competitive
environment and to begin shifting in efforts to sustain success in the new environment.
Theories that are circumstance contingent help success become predictable and
sustainable.
It is essential that researchers not only understand what factors lead to success, but also
the factors that lead to failure. Simply following the “best practices” of successful
companies very often ends with disastrous consequences. For example, in 1999, Lucent
Technologies followed the management restructuring and reorganization fad. The
company divided into 11 “hot businesses” with each operating independently. Much to
top executive’s surprise, the division autonomy did not increase growth or profitability.
Instead, the reorganization made Lucent less flexible, slower to respond to customer
needs, and created new costs. The company fell victim to the remedy of the moment.
When researchers identify circumstance contingent theories, managers are better able to
diagnose the situation that they are in, and conversely, not in. Studies conducted by the
authors indicate that rarely are success theories bound by industry barriers such as
product-based versus service-based. Therefore, theories should only be trusted when they
explain how phenomenon leads to success as a company’s circumstances change.
It is important for managers to learn how to identify a good theory. Foremost, be skeptical
of articles that merely describe a phenomenon. Researchers who have formulated
circumstance contingent theories often build on descriptive accounts of causal
relationships. Second, be careful not to trust an article with a solution that cures all
business’s problems. It is very rare that new categorizations reshape established thinking.
Third, if authors categorize a phenomenon based solely on attributes, just assume that it is
a starting point for a circumstance contingent theory to be discovered. Fourth,
“correlations that masquerade as causation often take the form of adjectives. . . a real
theory should include a mechanism – a description of how something works” (p. 73). And
lastly, remember that a researcher’s test results should not be considered final. Progress is
a result of constant testing to understand which situations will lead to failure in efforts to
refine the theories.
CHAPTER 5 Deming's Theory
http://maaw.info/DemingMain.htm
In the preface Deming states that the present style of management is a modern invention
and represents "a prison created by the way in which people interact." The present system
includes competition between people, teams, departments, divisions, students, schools
and universities. Although economists have taught that competition will solve our
problems, we now know that competition is destructive. A better approach is for everyone
to work together as a system. The solution to problems comes from cooperation, not
competition. We need a transformation to a new style of management Deming refers to as
Profound Knowledge. This includes four parts: appreciation for a system, knowledge
about variation, theory of knowledge, and psychology. The purpose of this book is to start
the reader on the road to knowledge and to create a desire for more knowledge. This
book, according to Deming, is a textbook for engineering, economics and business
students, to be used to prepare students for the future.
Will best efforts bring improvement? No, Deming argues that best efforts not guided by
knowledge will dig us deeper into the pit we are in. What is needed is new knowledge.
There is no substitute for knowledge.
In order to improve living standards, people must trade with each other and the market is
the world. Trade depends on quality. In terms of the balance of trade, the U.S. is not
doing well. We have been in economic decline for three decades. What must be done?
Our problem is education and the development of a culture that places value on learning.
Your customer expects only what you and your competitors have led him to expect, but
he is a rapid learner. Customers do not know what they want. They may be satisfied and
switch. A customer may be loyal and switch. What is needed is innovation. Deming
provides several examples of companies that were doing well and lost their market to an
innovator. The question to ask is what business are we in and what will it be in the future?
How do we achieve quality? Which of the following is the answer? Automation, new
machinery, more computers, gadgets, hard work, best efforts, merit system with annual
appraisal, make every body accountable, management by objectives, management by
results, rank people, rank teams, divisions, etc., reward the top performers, punish low
performers, more statistical quality control, more inspection, establish an office of
quality, appoint someone to be in charge of quality, incentive pay, work standards, zero
defects, meet specifications, and motivate people. Answer. None of the above.
All of the ideas above for achieving quality try to shift the responsibility of management.
Quality is the responsibility of management. It cannot be delegated. What is needed is
profound knowledge. A transformation of management is required.
Although the losses from faulty management practices cannot be measured, Deming
argues that it is a myth to assume that if you can't measure it, you can't manage it. We
must learn to manage these losses and the transformation requires a system of profound
knowledge (Chapter 4).
* See the Herzberg, Kohn, and Pfeffer summaries for some related arguments about
money as a motivator.
Deming begins this chapter by saying that the prevailing style of management is a
modern invention and a trap that has led us into decline. He defines a system as "a
network of interdependent components that work together to try to accomplish the aim of
the system." A man made system must have an aim and this purpose, or aim must be clear
to everyone in the system. Deming continues by stating that "A system must be managed.
It will not manage itself." Left to themselves the components of a system become selfish
and competitive and this behavior has a destructive effect on the system.
An organization is a system if it has an aim or purpose. This purpose, or aim precedes the
organizational system and the people working in it. The system must be defined in terms
of the aim, not in terms of methods. When the whole system is optimized, everybody
wins. Any less than optimization of the whole system means eventual loss to everyone.
A system includes the future and part of management's job is to govern the organization's
future. A system cannot manage itself. It needs guidance from outside.
Managers must learn that in order to compete, they must learn to cooperate. A system
includes competitors who working together to provide better service and to expand the
market, contribute towards optimization for the entire industry. Deming argues that rather
than worry about market share, companies would be better off to work together to expand
the market.
Deming includes a diagram (used in Japan starting in 1950) that illustrates how
production is viewed as a system. The flow of information and materials from any part of
the system (from suppliers to customers) must match the input requirements of
subsequent stages. It is used for planning from the idea stage through design, production,
distribution and customer service. It also helps in making predictions of how changes in
one component will affect the other components and shows the people in the system
where their jobs are and how their work is related to the work of others in the system.
This knowledge helps people take joy in their work.
The flow diagram is a more meaningful organization chart than the usual pyramid
showing who reports to whom. The diagram shows the value chain concept described by
Porter, although Deming does not use that term. The pyramid type organization chart
ignores customers (internal and external) and contributes to the fragmentation of the
organization into individual profit centers. The terms silos and stovepipes have been used
by others who have described this problem. (See the Mintzberg & Van der Heyden
summary on developing Organigraphs).
If the components of an organization are all optimized, the organization will not be
optimized. If the whole is optimized, the components will not be optimized. "If
economists understood the theory of a system, and the role of cooperation in
optimization, they would no longer teach and preach salvation through adversarial
competition. They would instead lead us into optimization of a system, in which
everybody would come out ahead."
In a 1990 statement of the Interstate Commerce Commission (ICC), Deming states that
forcing motor freight carriers to compete on the basis of price in a zero sum game will
destroy a healthy transportation system. Deming points out that cheaper is not always
better. It is more important to increase reliability and dependability by reducing variation
in time of transit and time of delivery. He urges the ICC to take a leadership role in
promoting cooperation between the components of the industry.
At the end of this chapter, Deming describes fifteen examples of cooperation that provide
benefits to everyone. Some of these include common international measurements of time
and date, red and green traffic signals, the metric system, and standardized parts such as
batteries. Another example involves two service stations on opposite corners of an
intersection that share each others tow trucks and stay open late on alternate nights. These
companies compete with each other, rather than against each other and everybody wins.
Deming states that the prevailing style of management must undergo transformation and
this requires a new map of theory he refers to as profound knowledge. His purpose in
Chapter 4 is to describe the components of the system of profound knowledge.
The first step, according to Deming, is the transformation (more appropriately conveyed
by the Greek word metanoia or spiritual conversion) of the individual. He describes this
change as a reorientation of one's way of life to apply the principles of profound
knowledge in every kind of relationship with other people.
The system of profound knowledge includes four components as indicated in the preface,
each described briefly below.
Knowledge of Variation
A knowledge of variation includes knowledge that life is variation, knowledge of the
difference between a stable state and an unstable state, knowledge of the difference
between common and special causes of variation and knowledge of the effect of the
system on the performance of people. It also includes a knowledge of the implications of
all this for management.
Deming states that "There is no true value of any characteristic, state, or condition that is
defined in terms of measurement or observation." "There is no such thing as a fact
concerning an empirical observation." An operational definition is needed. He defines this
as a procedure agreed upon for translation of a concept into a measurement. But this
produces information and information is not knowledge. Knowledge comes only from
theory.
Psychology
A Knowledge of Psychology includes a knowledge that people are different from one
another and knowledge of how to use these differences to optimize everybody's abilities
and inclinations. It includes the concepts of intrinsic and extrinsic motivation and the
phenomenon of over justification.
People are born with intrinsic motivation that is often destroyed by various practices at
school and work. Grades cause students to work for grades, or a reward from parents for
grades, rather than to work for the purpose of learning. Rewards at work such a merit pay
cause people to work for rewards rather than for job satisfaction and to find meaning in
their work and lives. Some extrinsic motivation helps develop an individual's self-esteem,
but over emphasis on extrinsic motivation eventually destroys an individual's intrinsic
motivation and leads to detrimental effects on self esteem. Work and life eventually have
no meaning. Ranking people, even if it could be done accurately (as opposed to ranking
the effects of the system on the workers) would not improve the performance of the
people, or the system.
Chapter 5: Leadership
This is a very short chapter. Deming explains that the job of a leader is to accomplish the
transformation of his organization. A leader needs theory, obligation, a plan and
persuasive power.
Deming begins this chapter by saying that "We are living in prison, under the tyranny of
the prevailing style of interaction between people, between teams, between divisions."
We must replace the idea that we need competition between people with cooperation. He
provides a graphic illustration similar to the one below to show how present practices
squeeze intrinsic motivation, self esteem and dignity out of people over their life time.
Across the top of his illustration he lists the forces of destruction such as forced
distribution of grades, merit systems, competition between people and groups, incentive
pay, numerical goals, explanation of variances, and treating every group as a profit center.
Along the vertical axis he shows the characteristics that people are born with such as
intrinsic motivation, self esteem, dignity, cooperation, and joy in learning.
All of the forces of destruction must be replaced with new ways to manage people. The
purpose of this chapter is to examine how to do this under the new philosophy or theory
of profound knowledge.
Deming discusses the Plan, Do, Study, Act continuous improvement cycle developed
around 1950 he refers to as the Shewhart cycle. He provides an illustration showing a
circle where a plan for a change or test of a change in the process or system is developed
in the first step, the change or test of change is made below clockwise in the do step, the
results are examined in the study step, and the change is either adopted or abandoned in
the act step. This leads to the start step, i.e., next plan for change or test of a change in the
process or system, the foundation for the whole cycle.
The development of a new engine is used as an example. The secret to shorter
development times is to put more effort into the early stages and understanding the
interaction between stages. The manager's job is to manage the whole process, not to
optimize any stage. Everyone involved including marketing people, suppliers,
toolmakers, etc. should be included in the planning stage.
Current accounting practices reinforce the incorrect perception that decisions made during
the development stage are independent of the future costs related to capital expenditures,
maintenance, operations and the losses suffered by customers.
Business schools should teach the theory of a system and the theory of profound
knowledge for transformation, some economics, statistical theory, language and science.
They should teach that un-measurable damage is created by short term thinking, ranking
people, merit systems, incentive pay, management by results, and tampering.
To achieve notable improvement, the education system should abolish grades, merit
ratings for teachers, comparison of schools on the basis of scores, and gold stars for
athletics. Joy in learning comes more from learning than from what is learned. A grade is
a permanent label for opening doors or closing doors, a way to achieve quality by
inspection, rather than building in quality, a way to produce competition between people,
rather than cooperation, a way to label people as winners or losers, a way to humiliate
those at the bottom, rather than to promote their desire to learn and future achievement.
In this chapter, Deming says that he does not grade students, but gives them a "P" for
pass.
I summarized the Red Bead experiment earlier and refer the reader to that Summary.
He mentions the two mistakes, i.e., reacting to an outcome as if it came from a special
cause when it came from a common cause, or reacting to an outcome as if it came from a
common cause when it came from a special cause.
One of Shewhart's contributions was to develop control charts to minimize the loss from
the combination of both mistakes. When the chart indicates no special causes, the
process is in statistical control, or stable. In a stable system the performance of the system
can be predicted within a range of variation. The performance of an unstable process
cannot be predicted. After statistical control is achieved, the process may be improved.
An improvement is either a reduction in variation or a movement in the average, up or
down, closer to the optimum level. "The control chart is the process talking to us."
There are many potential applications of the control chart concepts, or techniques in
industry, education and government. The most important application is in the
management of people.
Some managers set specification limits where they think the limits should be. However,
there is no logical connection between control limits and specification limits. Using
specification limits based on intuition causes loss either from mistake 1 or mistake 2, but
no one could know which or the extent of the losses.
Deming discusses some examples where common causes are often confused with or
interpreted as special causes. These include accidents on the highway, fires, absenteeism,
and malpractice suits. Highway accidents arise mostly from common causes such as
drunk driving and unintelligible road signs. These, he says, are not special causes.
Malpractice suits in medicine, engineering and accounting all treat the event as a special
cause - somebody is at fault. Study and knowledge of variation leads to the conclusion
that the event could have come from the process itself. The system may be at fault.
The purpose of this chapter is to illustrate the losses that are caused by tampering with a
system or process. At the beginning of this chapter, Deming defines tampering as
management by results. Other ways to define tampering include trying to improve the
performance of a process or system based on an individual observation or result, or trying
to improve the process or system without theory.
The funnel demonstration includes a funnel, a marble and a table, preferably with a cloth
on it to record the results. A dot is drawn on the table cloth to represent the target. Then
four rules or procedures are used and the results are recorded on the cloth.
Rule 1: Hold the funnel over the target and drop the marble through the funnel 50 times
marking each spot where the marble stops. A distribution of spots or plots will occur.
Rule 2: After each drop, move the funnel from the previous position to compensate for
the last error. The last error is the basis or reference point for each new drop. Record the
spots with a different symbol. A wider distribution will occur. Deming calculates the
diameter of this rough circle will be 41% wider than the circle based on rule one. This is
tampering, i.e., trying to improve the performance of process each time based on an
individual result.
Rule 3: After each drop, adjust the funnel using the target as the reference point. The
results will be worse than before.
Rule 4. After each drop, set the funnel over the spot where the marble stops. The results
continue to spread out and are even worse than in rule 3.
Tampering with the process (Rules 2, 3 and 4) only makes things worse. Deming says
that possible improvements in this process include lowering the funnel, using a thicker
table cloth, and using a steel ball rather than a marble. A magnetic target and marble will
also improve performance of the process.
A process may be stable and produce defects and errors. To adjust the process based on a
single defect or error is tampering with the process and will make performance worse.
Improvement in a process requires studying the process to understand the capability of
the process, including the mean outcome and range of variation. If the process is stable,
then a planned change can be developed based on theory, then tested, studied, then
implemented or rejected.
Chapter 10: Some Lessons in Variation
The purpose of this chapter is to provide: 1) some easy lessons in variation including
examples of situations where common cause variations are confused with special cause
variations, and 2) some illustrations based on the concept of a loss function.
Deming explains that variation is life. Life is variation, but those who have no knowledge
of statistical theory tend to attribute every event to a special cause. One qualification
useful to anyone, and definitely needed by anyone in management, is to understand the
concept of variation. This understanding of variation will help them understand the
system and to stop asking people to explain the day to day, month to month, and year to
year ups and downs that come from the variation that is built into the system.
Loss Functions
Deming explains that a loss function shows the losses that a system suffers from different
values of some adjustable parameter. A loss function is useful to help one change from
the idea of meeting specifications to continual reduction in variation and improvement in
the mean outcome through improvement of the process or system. Each individual has a
loss function and a combination of people have a loss function. Loss functions are usually
not symmetrical but may look something like the illustration below.
Two distributions are shown in the extended graphic illustration below to convey my
interpretation of the concept Deming explains in Chapter 10. The distributions are
identical except for their means, i.e., the range of variation is the same in both
distributions. However, the one on the left creates more loss than the one on the right. The
mean of the process described by the distribution on the left is further away from the
optimum or minimum loss. The mean of the process on the right is very close to the
optimum value. Improvements in both mean and range of variation are possible for the
process on the left. Improvement in the range of variation, i.e., reduction of the amount of
variation, is possible for the process on the right.
Why was Deming critical of the zero defect philosophy?
Deming was critical of the zero defect philosophy because it is associated with the idea of
meeting specifications as opposed to continual reduction in variation and improvement in
the mean outcome through improvement of the process or system.
This point was not entirely clear to me when I read the last chapter of The New
Economics. Several articles by Albright and Roth helped to clear up my confusion (See
references below). According to these authors, there are two philosophies associated with
quality. One concept is the zero defects philosophy and the other concept is the robust
quality philosophy based on the Taguchi loss function. According to Roth and Albright,
the zero defects philosophy is associated with defining quality as conforming to
specifications where the only costs attributed to variation are those that fall outside the
specification limits. They refer to this as the goalpost view. However, the robust quality
philosophy views any variation from a target value as undesirable because it causes
unnecessary costs to be incurred by the manufacturer, the customer or society. The lost
function provides a way to estimate these costs. Deming subscribed to the robust quality
philosophy as indicated by his discussion of the loss function in Chapter 10. See the
summaries below for more on this issue.
_________________________________________
Albright, T. L. and H. P. Roth. 1994. Managing quality through the quality loss function.
Journal of Cost Management (Winter): 20-37. (Summary).
Anderson, S. W. and K. Sedatole. 1998. Designing quality into products: The use of
accounting data in new product development. Accounting Horizons (September): 213-
233. (Summary).
Kim, M. W. and W. M. Liao. 1994. Estimating hidden quality costs with quality loss
functions. Accounting Horizons (March): 8-18. (Summary).
Roth, H. P. and T. L. Albright. 1994. What are the costs of variability? Management
Accounting (June): 51- 55. (Summary).
Taguchi, G. and D. Clausing. 1990. Robust quality. Harvard Business Review (January-
February): 67-75. (Summary).
Deming Quotes
"It is a mistake to assume that if everybody does his job, it will be all right.
The whole system may be in trouble."
"Management is prediction."
"Does experience help? No! Not if we are doing the wrong things."
"If you destroy the people of a company, you do not have much left."
"We should work on the process, not the outcome of the processes."
"Build in quality."
The components of the red bead experiment include a box of 4,000 wooden beads (800
red and 3,200 white), a paddle with fifty bead size depressions, a second smaller box for
mixing the beads, six willing workers, two inspectors who make independent counts, a
chief inspector who verifies the counts, an accountant who records the counts and a
customer who will not accept red beads. The job is to produce white beads and the
standard for each worker is fifty white beads per day.
The daily production operation for each worker includes: 1) poring the beads from the
first box into the second box and then back into the first box (to mix the beads), 2)
dipping the paddle into the first box without shaking it, 3) carrying the loaded paddle to
each inspector for separate counts and then verification, and 4) dumping the day's work
back into the supply box. The six workers perform this operation four times to represent
four days' work. The results of one of Deming's experiments appear in Table 1.
TABLE 1
RED BEADS RECORDED IN ONE OF DEMING'S RED BEAD EXPERIMENTS*
Worker Day 1 Day 2 Day 3 Day 4 Total Mean
Dick 14 10 9 10 43 10.75
Pat 17 5 8 5 35 8.75
Bob 11 6 5 9 31 7.75
Steve 8 8 9 6 31 7.75
Horst 12 11 12 8 43 10.75
Dave 9 11 7 10 37 9.25
Total 71 51 50 48 220
Mean 11.83 8.50 8.33 8.00 9.17 9.17
*Conducted in a seminar in West Springfield Mass, February 6, 1985 (Walton, Chapter 4).
Table 1 reveals that each of the six workers performed differently with daily defects (red
beads) ranging from five to 17 and four day averages ranging from 7.75 to 10.75. The
first point is clear. With identical tools, tasks and abilities, performance will vary. Now,
perhaps the reader is thinking that over the long run the mean defects for each worker will
be ten. Logically, since there are 20 percent red beads in the box, the long run average
will be 20 percent, or ten. Right? Wrong! First, the beads are different. No two beads are,
or could be, exactly alike and the red beads tend to be slightly larger and heavier than the
white beads (or it could be the other way around depending on how the beads were
produced). The paddle responds to the red and white beads differently and the red and
white beads respond to the paddle differently. In addition, the depressions in the paddle
are different. No two depressions are exactly alike. The different depressions and beads
interact differently. Even though all of these differences are undetectable without
precision equipment, they affect the results. In addition, although each of the six workers
in the experiment used the same paddle, the variation in the results would be different if
each worker had used a different paddle. Deming used four paddles over the forty-five to
fifty-year period and the long-run mean defects for the four paddles were 11.3, 9.6, 9.2
and 9.4 (Deming 1993, 168). All of the variation in these experiments was attributed to
the system, i.e., incoming beads and paddles.
What is the point of the red bead experiment? There are several.
1. The experiment provides a typical illustration of bad management. There are too many
employees involved (e.g., inspectors), and the rigid procedures do not allow workers to
offer suggestions for improvement. In addition, during the experiment, Deming (who
serves as the manager) continually blames the workers for defective products that are
caused by the system.
3. Knowledge of one source of system variation, such as the proportion of defects (red
beads) in the incoming supply, cannot be used to determine the total effect of system
variation, such as the proportion of defects in the output. This is because unobservable
factors will always affect performance and there is no basis for assuming that the effects
of these factors will be equally distributed across workers.
5. There will always be some workers that are above the average and some workers that
are below the average.
6. A worker's position in the ranking may vary from one period to the next.
7. Workers should not be ranked because doing so merely represents a ranking of the
effect of the system on the workers. In the red bead experiment, 100 percent of the
variation in the workers' performances is determined by the system. Even in this
controlled experiment where the workers use the same inputs and tools, they are all
victims of the system and cannot be compared in any meaningful way.1
The red bead experiment is deceptively simple because it provides a powerful message
that is difficult for many to grasp. In summary, the misconception that workers can be
meaningfully ranked is based on two faulty assumptions. The first assumption is that each
worker can control his or her performance. Deming (1986, 315) estimated that 94 percent
of the variation in any system is attributable to the system, not to the people working in
the system. The second assumption is that any system variation will be equally distributed
across workers. Deming (1986, 353) taught that there is no basis for this assumption in
real life experiences. The source of the confusion comes from statistical (probability)
theory where random numbers are used to obtain samples from a known population.
When random numbers are used in an experiment, there is only one source of variation,
so the randomness tends to be equally distributed. This is because samples based on
random numbers are not influenced by such things as the characteristics of the inputs and
tools (e.g., size of the beads and depressions in the paddles) and other real world
phenomena. However, in real life experiences, there are many identifiable causes of
variation, as well as a great many others that are unknown. The interaction of these forces
will produce unbelievably large differences between people (Deming 1986, 110) and
there is no logical basis for assuming that these differences will be equally distributed.2
FOOTNOTES
2. Deming was critical of probability theory and central limit theory in his seminars. For
example, in response to a comment from the audience that the mean number of defects in
the read bead experiment would be ten based on these concepts, Deming said "I think it is
necessary to think and not to assume what you don't know" (Walton 1986, 49).
REFERENCES
Deming, W. E. 1993. The New Economics for Industry For Industry, Government &
Education. MA. Massachusetts Institute of Technology Center for Advanced Engineering
Study. Chapter 7. (Summary).
Walton, M. 1986. Deming Management Method. New York, NY: The Putnam Publishing
Company.
____________________________________
* Deming, W. E. 1993. The New Economics for Industry For Industry, Government &
Education. Cambridge: Massachusetts Institute of Technology Center for Advanced
Engineering Study. Chapter 6. (Summary).
Beginning in 1995, colleagues within Pratt & Whitney Rocketdyne (PWR) in Canoga
Park, California (then a division of Rockwell International) created the concept of "A
Thinking Roadmap" as a means to formally integrate their classroom education efforts
(both seminars and workshops), all with the aim of leading a thinking transformation,
both individual and organizational. The need for the thinking transformation is to foster
better thinking about sub-systems, psychology, variation, knowledge, and their
interactions - elements recognized as the basis of W. Edwards Deming's R20;System of
Profound Knowledge (SoPK)". In seeing the vast opportunities for simultaneously
improving the thinking skills of the entire enterprise, including employees, suppliers, and
customers, Rocketdyne's Enterprise Thinking Network was formed to lead a thinking
transformation, with a Thinking Roadmap as a means to create awareness of the thinking
of Russell Ackoff, Edward de Bono, W. Edwards Deming, Tom Johnson, and Genichi
Taguchi, to name a few of the thinking pioneers whose writings and teachings they have
incorporated into their roadmap.
Discussion Questions
Deming's theory of profound knowledge includes four components: I. Appreciation for a
system, II. Knowledge about variation, III. Theory of knowledge and IV. Psychology.
Questions related to component 1:
1. What does Deming mean by appreciation for a system? (See the summaries of The
New Economics Chapter 3 and Chapter 4, Mintzberg & Van der Heyden, and Castellano,
Young & Roehm).
2. Why does Deming say the parts cannot manage themselves? (See the summaries of
The New Economics Chapter 3 and Stevens). (See the summary of Senge's description of
The Beer Game for the same idea).
3. Why is Deming against management by objectives? (See the summaries of The New
Economics Chapter 2 and Levinson).
5. What does he mean by knowledge about variation? (See the summaries of The New
Economics Chapter 4 and Castellano, Young & Roehm).
6. What is the red bead experiment and why did Deming use it? (See the Red Bead
summary).
7. Joiner and Gaudard indicate that there are four causes of variation: common, special,
tampering and structural. What is tampering? How do we know it is tampering? (See the
summaries of Joiner & Gaudard and The New Economics Chapter 9).
8. How is the funnel experiment used to illustrate the concept of tampering? (See the
summary of The New Economics Chapter 9).
9. What is structural variation? (See the Joiner & Gaudard summary and MAAW's
Chapter 3 Class problem 2).
10. Do you think there are four types of variation or just two? Explain.
11. Explain why Deming was opposed to ranking people from the variation perspective?
(See the summary of The New Economics Chapter 2).
12. What does Deming mean by the theory of knowledge? (See the summary of The New
Economics Chapter 4).
13. Deming said that you do not find knowledge in a dictionary. What did he mean by
this? (See the summary of The New Economics Chapter 4).
14. According to Deming, information is not knowledge. Why not? (See the summary of
The New Economics Chapter 4).
15. Why does Deming say that experience teaches nothing without theory? (See the
Deming quotes and the The Beer Game summary for some ideas).
17. What does Deming mean by psychology? What motivates people? (See the
summaries of The New Economics Chapter 4, Herzberg, Levinson, Katzenbach &
Santamaria and Amabile).
18. Why do organizations need to drive out fear? (See the summary of The New
Economics Chapter 4, Herzberg, Levinson, Katzenbach & Santamaria and Amabile).
19. What did Deming learn at the Hawthorne plant lighting experiment?
20. Why was Deming opposed to ranking people from the behavioral and system's
perspectives? (See the summaries of The New Economics Chapter 4 and Chapter 6).
(Also see the summaries of Pfeffer, Stevens, Herzberg, Amabile and Kohn).
21. What is wrong with exhortations such as "Do it right the first time"?
22. What does he mean by lack of constancy of purpose? (See the short summary).
23. Which diseases and obstacles are related to accounting? (See the summary of The
New Economics Chapter 6 and the short summary).
Other questions:
24. Deming did not use, or even recognize, the term total quality management. Why do
you think Deming was opposed to this term?
25. From Deming's perspective, what is wrong with managing by results? (See Deming
quotes and the Collingwood, Healy & Wahlen, Dechow & Skinner and Chow, Kato &
Merchant summaries).
26. Compare Deming's concept of a leader with the traditional American management
concept of a leader. (See the summaries of The New Economics Chapter 6 and Spear,
Sobek, Stevens).
27. Do you disagree with any of Deming's arguments? Explain.
28. Deming said "We are being ruined by best efforts." What did he mean? (See the
Deming quotes and The Beer Game).
29. There is a popular saying, "If you can't measure it, you can't manage it." Deming
disagreed. Why?
30. From Deming's perspective, what should be the role of government? (See the Stevens
summary).
31. Deming was not a fan of the ISO 9000 series of international standards. Why
not? (See the ISO website and the Stevens summary).
32. Deming was critical of the Malcolm Baldrige award. Why? (See the Malcolm
Baldrige National Quality Award and the Stevens summary).
33. Although Deming was a consultant for some of the largest organizations (e.g.,
General Motors, Ford, Xerox, Procter and Gamble, and of course Japan), he was not a
rich man. He lived in a relatively small two story brick house in Washington D.C. and
worked in the basement. What do you think is the reason for Deming's modest lifestyle?
(See the Herzberg, and Amabile summaries).
34. Bazerman, Loewenstein & Moore (BLM) and Healy & Palepu make some
recommendations related to auditing. BLM argue that the problem is unconscious self-
serving bias in the client-auditor relationship. Are they blaming the auditors or the
system? Discuss their recommendations in relation to Deming's views on leadership and
solving problems.
35. Read the Joke on American management. Can you relate this to Deming's criticisms
of American management?
36. Dr. Deming taught that companies should compete with each other, not against each
other. What did he mean ?
3. Why are control charts developed using sample means? (See Chapter 3 Part II).
4. Why do we need both X-bar and R control charts? (See Chapter 3 Part II).
5. Does an observation (i.e., sample mean) plotted outside the control limits
necessarily indicate a special cause? Explain. (See Figure 3-11 for an example). Do
observations plotted inside the control limits necessarily indicate a common cause? (See
Francis & Gerwels and Walter, Higgins & Roth).
6. How do confidence intervals developed around a regression line differ from the upper
and lower limits of a control chart?
7. Discuss the two types or errors connected with the use of control charts. What type do
you think managers tend to make more often? Why? (See Chapter 3 Part II and Deming
Chapter 8).
8. To say that a system is stable means that the performance of the system is predictable
within a specified range. Explain this statement. (See Figure 3-11 for an example and the
Dog in the Yard illustration).
9. Does a stable system mean that the system is efficient? Explain. (See Chapter 3 Part
II).
11. Think of some practical applications of the control chart you could use to monitor
your health, the performance of your car, or the performance of some other system you
come in contact with in your daily life. (See the Walter, Higgins & Roth summary).
12. Is the control chart methodology a top down or a bottom up approach? Explain. (See
Chapter 3 Part II).
13. Does the traditional standard cost system recognize the concept of variability that is
the basis of the statistical process control methodology? Explain. (See the Roehm,
Weinstein & Castellano, Reeve & Philpot, Francis & Gerwels and Reeve 89 summaries).
15. Compare the SPC control concept with the accounting standard cost control
concept. (See the Roehm, Weinstein & Castellano, Reeve & Philpot, Francis & Gerwels
and Reeve 89 summaries).
16. Is the variation within the upper and lower limits of a control chart considered to
be controllable or uncontrollable? Explain. (See the Dog in the Yard illustration).
17. Is the variation within the upper and lower limits of a control chart considered to be in
control or out of control? Explain. (See the Dog in the Yard illustration).
18. Is the variation within the upper and lower limits of a control chart considered to be
predictable or unpredictable? Explain. (See the Dog in the Yard illustration).
19. Is the variation outside the limits of a control chart considered to be controllable or
uncontrollable? Explain. (See the Dog in the Yard illustration).
20. Is the variation outside the limits of a control chart considered to be in control or out
of control? Explain. (See the Dog in the Yard illustration).
21. Is the variation outside the limits of a control chart considered to be predictable or
unpredictable? Explain. (See the Dog in the Yard illustration).
22. GE's Jack Welch developed a program at General Electric referred to as Six Sigma.
What is a sigma and what does six sigma mean? (See the Six Sigma summary, the Lucier
& Seshadri summary and GE's Six Sigma site).
23. How does GE's Six Sigma program different from the SPC concept? (See the Lucier
& Seshadri summary and GE's Six Sigma site).
24. What was the main idea or purpose of GE's "Work-Out™" program started by Jack
Welch ? (See the Lucier & Seshadri summary).
25. The SPC concept is a prerequisite for understanding Deming's Theory of Profound
Knowledge. Explain. (See the Deming category to begin).
Economies of Scale
The graphic illustration below (based on Figure 11-12) shows the short-run average cost
curve for a specific size plant based on increasing then decreasing productivity. The
average cost decreases as productivity increases, then increases after the point of
diminishing returns is reached. See Chapter 11 for more on these relationships. An
important point to grasp is that the short run average cost curve is U-shaped because of
the phenomenon known as diminishing returns.
Economies of Scale versus Diminishing Returns
The concept of economies of scale is based on the long-run average cost (LRAC) curve as
indicated in the graphic illustration below. The LRAC curve is derived from the short-run
average cost (SRAC) curves represented by alternative plant sizes. The U-shaped
function drawn tangent to the various short-run cost curves represents the long-run
average cost curve and illustrates the concept of economies of scale. An important point
to grasp is that the long-run average cost curve is U-shaped because of the phenomenon
known as economies of scale.
In the MIT video Friedman talks about the first three chapters of the book. In the first
chapter he describes how he developed the idea for the book. From the realization that the
global economic playing field is being flattened came the title "The World is Flat".
Friedman tells the audience that there have been three stages or eras of globalization
including the following:
1. The first era involved countries globalizing from around 1400 to 1800.
2. In the second era companies or multinationals were globalizing from 1800 to 2000.
3. The third era is when the world became flat as individuals and small groups from all
nationalities began globalizing themselves after 2000.
While we were sleeping, the world changed dramatically when the third era of
globalization began. The world flattened in all kinds of ways. Some of these ways are
mentioned in the video, e.g., what's going on in China and India.
In the second chapter, Friedman describes how the world became flat. According to Tom
this phenomenon came about because of ten flatteners as follows:
1. The fall of the Berlin wall in 1989 was the beginning along with the introduction of
Microsoft Windows.
2. Netscape's web browser brought the internet to life in 1995 by bringing the web to
average folks, not just technical types.
3. The dot com boom and investment in a "glut of fiber optic cable" made it possible for
everyone to communicate for free.
4. Workflow - Software applications were developed that allowed connecting workflow
which created multiple forms of collaboration.
5. Outsourcing - a new form of collaboration was created.
6. Off shoring - another form of collaboration.
7. Open sourcing - more collaboration, e.g., Firefox was developed by two people who
never met.
8. Supply chaining - Walmart's system provides an example.
9. Insourcing - the UPS/Papa Johns connection provides an example.
10. Steriods - File sharing and ...
In chapter 3 Friedman describes how all ten flatteners converged to create a tipping point
or platform. (See The Tipping Point summary).
After some additional comments about chapter 3, Friedman answers some interesting
questions like What is the effect of this phenomenon flattening on third world countries?
The day after I put my notes about Friedman's book on the web I got the following e-mail
message from Scottie Jacob of Meghan-Kiffer Press.
Thomas Friedman’s recent New York Times bestseller, The World is Flat, asserts that the
international economic playing field is now more level than it has ever been. As popular
as it may be, some reviewers assert that by what it leaves out, Friedman’s book is
dangerous.
“The world isn’t flat as a result of globalization,” say Ronald Aronica and Mtetwa
Ramdoo, business analysts and authors of a critical analysis of Friedman’s book. “It’s
tilted in favor of unfettered global corporations that exploit cheap labor in China, Indian
and beyond. Today’s global corporations go to the ends of the earth to employ factory
workers for 20 cents an hour and PhDs in science and technology for $20,000 a year,”
add Aronica and Ramdoo. In short, “Globalization is the greatest reorganization of the
world since the Industrial Revolution,” says Aronica.
This epic change has shaken up the way the world does business, and Americans are
reluctantly facing a shift of wealth and power to the East. Across the country, a growing
number of Americans fear that they could be replaced by someone from a developing
country. Recent polls indicate that millions of Americans are preoccupied with the
outsourcing of American jobs and the threat of global economic competition. From
boardrooms to classrooms to kitchen tables and water coolers, globalization has become a
hot topic of discussion and debate everywhere. But by what Friedman’s book ignores or
glosses over, it misinforms the American people and policy makers.
Aronica and Ramdoo’s concise monograph, The World is Flat?: A Critical Analysis of
Thomas L. Friedman’s New York Times Bestseller, brings clarity to many of Friedman’s
stories and explores nine key issues Friedman largely disregards or treats too lightly,
including the hollowing out of America’s debt-ridden middle class. To create a fair and
balanced exploration of globalization, the authors cite the work of experts that Friedman
fails to incorporate, including Nobel laureate and former Chief Economist at the World
Bank, Dr. Joseph Stiglitz.
Refreshingly, readers can now gain new insights into globalization without weeding
through Friedman’s almost 600 pages of grandiloquent prose and bafflegab. “It’s of
utmost urgency that we all learn about and prepare for total global competition. If you
read Friedman’s book, and were awed, you really should read more rigorous treatments of
this vital subject. Globalization affects all our lives and will be of even greater
significance to our children and grandchildren,” says Ramdoo.
Aronica and Ramdoo conclude by listing over twenty action items that point the way
forward for America and other developed countries. They provide a comprehensive, yet
concise, framework for understanding the critical issues of globalization. They paint a
clear and sometimes alarming picture of the early twenty-first century landscape, and
present timely information needed by governments, businesses, and individuals
everywhere.
The video below is an interesting presentation by Hans Rosling illustrating the economic
development of 200 countries over the last 200 years. Life expectancy is placed on the
vertical axis and income per person is represented on the horizontal axis. Life expectancy
ranges from 25 years to 75 years while income per person ranges from $400 to $40,000.
According to Rosling, the series of graphics illustrated represents 120,000 numbers
plotted to show the changes in life expectancy and income per person from 1810 to 2010.
Each country is presented as a circle or bubble, and the size indicates the relative size of
the country's population. The colors of the bubbles indicate the country's location. Blue is
Africa, Red is Asia, Orange (he calls it brown) is Europe, Yellow is the Americas, and
Green is the Mid-east. The 2010 graphic (see below) shows what Rosling refers to as a
converging world where all countries are moving up from the condition of poor and sick
toward a condition of rich and healthy. A couple of other screen captures show the
changes since 1948.
Perhaps this illustration represents an argument for trickle down economics, but see my
note on the Universal law of wealth.
___________________________________
To see the entire 200 years develop see the Gapminder World Tool
The purpose of this article is to describe a universal law of wealth based on a network
effect that appears to have some important implications for economic policy.
According to Buchanan, the universal law of wealth is simply stated in the following
way. Each time you double the amount of wealth, the number of people involved falls by
a constant factor to form a Pareto curve, e.g., in the U.S. approximately 80% of the
wealth is held by 20% of the people. In some other countries it might be 90% of the
wealth held by 20%, or 95% held by 10%, but the point is that in any society a small
percentage of the people always own a large proportion of the wealth. This Pareto curve
distribution of wealth appears to be based on a network effect that is applicable across
societies and has little to do with differences in backgrounds, talents, and the education of
an area's citizens.
However, a network model developed by two physicists, Bouchaud and Mezard, shows
how Pareto's distribution of wealth can be influenced. Their model shows that the greater
the amount of money flowing through the economy, and the more often it changes hands,
the greater the equality in the economic system. The model also provides some test of
political justifications for various policies. For example, recent economic policy
dominated by the free market ideology and government deregulation has been promoted
using the argument that wealth will trickle down to the poor. The network model suggests
the opposite in that increased investment without an increase in the flow of funds between
people will lead to an increase in inequality - and that is exactly what happened over the
past 30 years. Wealth distribution in the U.S. has become much less equitable. The model
also indicates that income taxes will tend to produce a more equitable distribution of
wealth if those taxes are redistributed to society in an equitable way. On the other hand, a
decrease in taxes without an increase in the flow of funds between people will lead to an
increase in wealth inequality.
The concept of competitiveness has been a hot top, as well as a controversial topic for
several years. Two organizations publish annual competitiveness reports. The World
Economic Forum (WEF) has published the The Global Competitiveness Report since
1979. The International Institute For Management Development (IMD), has published a
similar report referred to as the The World Competitiveness Yearbook since 1989. The
Global Competitiveness Report was originally published jointly by the WEF and the
IMD, but according to a note in the Economist1 differences over how to define and
measure competitiveness (originally titled the competitiveness index) caused these
organizations to split and produce separate reports. The World Economic Forum defines
competitiveness as "the ability of a country to achieve sustained high rates of growth in
gross domestic product (GDP) per capita". On the other hand, the IMD defines
competitiveness as "the ability of a country to create added value and thus increase
national wealth by managing assets and processes, attractiveness and aggressiveness,
globality and proximity, and by integrating these relationships into an economic and
social model." Other differences include which factors to include in the competitiveness
index and how to weight these factors.
There are two main indexes and several sub-indexes. The two main indexes prior to 2003
were the Growth Competitiveness Index and the Current Competitiveness Index. The
2003 report uses the terms Growth competitiveness Index and the Microeconomic
Competitiveness Index.
The WEF's growth competitiveness index (referred to as the Competitive Index prior to
2000) is based on estimates of each country’s ability to grow over the next five to ten
years. These estimates were based on each country’s economic conditions and institutions
including 155 related criteria aggregated into eight factors determining competitiveness.
The eight factors are as follows:
According to the executive summaries by Porter, Sachs and McArthur2, the growth index
is based on three sub-indexes including:
For 21 innovating (core) economies, the GCI weights technology 1/2 and public
institutions and macroeconomic environment 1/4 each. For the non-innovating (non-core)
economies, these measurements are weighted 1/3 each. There are numerous sub-indexes
underlying these three indexes.
The current competitiveness index (first presented in 2000 and renamed microeconomic
competitiveness index for 2002) is based on the current levels of productivity in the 80
economies now covered by the report. This is an aggregate measure of current
competitiveness. There are two sub-indexes including:
The amount of free information made available by the World Economic Forum varies
from year to year, but the main index rankings and executive summary are available on
the WEF website or click on the links below for the information available on Amazon's
website.
2006- 2007-
Country 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
07 08
7 13 17
Hong Kong 2 2 2 3 10 12
(16) (18) (19)
10 7 3
Taiwan 9 8 6 4 5 13 14
(21) (21) (16)
6 3 8
Canada 8 4 5 5 12 13
(11) (11) (10)
15
Switzerland 6 6 8 6 9 (5) 6 (5) 7 4 2
(5)
Luxembourg 5 11 10 7 NA NA NA 25 25
12 11
U.K. 15 7 4 8 8 (8) 15 2 9
(7) (3)
15
Netherlands 17 12 7 9 3 (4) 8 (3) 12 11 10
(7)
4 11 24
Ireland 26 16 11 10 22 22
(22) (22) (20)
11 7
Australia 12 17 14 12 5 (9) 10 16 19
(10) (14)
19 10 16
New Zealand 3 5 13 13 14 21 24
(19) (20) (22)
20 21 13
Japan 13 14 12 14 11 5 8
(14) (15) (11)
15 6 9
Norway 7 10 9 15 9 17 16
(20) (19) (21)
24 30 27
Malaysia 10 9 17 16 19 21
(30) (37) (26)
13 14 10
Denmark 11 20 16 17 3 3 3
(6) (8) (8)
23 11 12
Iceland 27 38 30 18 8 20 23
(17) (16) (17)
12
Sweden 21 22 23 19 9 (6) 5 (6) 4 9 4
(7)
17 18 18
Austria 19 27 20 20 18 15
(13) (13) (12)
27 27 20
Chile 18 13 18 21 27 26
(26) (29) (31)
28 23 21
Korea 20 21 19 22 23 11
(27) (28) (23)
21 20 30
France 23 23 22 23 15 18
(15) (12) (15)
16 19 25
Belgium 25 31 27 24 24 20
(12) (14) (13)
14 17 14
Germany 22 25 24 25 13 7 5
(3) (4) (4)
26 22 22
Spain 32 26 25 26 29 29
(23) (23) (25)
22 25 23
Portugal 34 30 26 27 43 38
(28) (31) (36)
18 24 19
Israel 24 24 29 28 14 17
(18) (17) (18)
35 32 35
Mauritius NA NA NA 29 55 57
(38) (52) (49)
30 33 31
Thailand 14 18 21 30 28 28
(40) (38) (35)
42 42 45
Mexico 33 33 32 31 52 49
(42) (51) (55)
43 36
Lithuania - - - - - 39 36
(49) (40)
40 39 33
China 36 29 28 32 35 34
(44) (47) (38)
36 48 61
Philippines 31 34 33 33 75 67
(46) (54) (61)
37 35 43
Costa Rica 28 43 34 34 68 59
(43) (50) (39)
29 26 39
Italy 41 39 41 35 47 43
(24) (24) (24)
47 55 54
Peru 38 40 37 36 78 80
(49) (63) (66)
56 66
Romania - - - - - 73 70
(61) (67)
43 64 67
Indonesia 30 15 31 37 54 51
(47) (55) (64)
25 28 29
Hungary 46 46 43 38 38 44
(32) (26) (28)
29 26
Estonia - - - - - 26 27
(27) (30)
31 28
Slovenia - - - - - 40 37
(32) (27)
Czech 31 37 40
35 32 35 39 31 33
Republic (34) (35) (34)
Trinidad & 38 37
- - - - - 76 78
Tobago (34) (44)
46 45 47
Jordan 28 43 34 40 46 46
(35) (44) (53)
46 42
Uruguay - - - - - 79 71
(46) (62)
47 44
Latvia - - - - - 48 40
(42) (45)
33 36 38
Greece 39 48 44 41 61 61
(33) (43) (43)
44 49 63
Argentina 37 37 36 42 70 79
(45) (53) (65)
Dominican 50 52
- - - - - 93 88
Republic (59) (41)
34 41 51
Poland 44 50 49 43 45 48
(41) (41) (46)
39 54 69
Turkey 42 36 40 44 58 50
(29) (33) (54)
Slovak 38 40 49
NA 35 48 45 37 39
Republic (36) (39) (42)
49 58 57
El Salvador NA NA NA 46 53 63
(51) (64) (63)
32 34 32
South Africa 43 44 42 47 36 41
(25) (25) (29)
52 60 65
Vietnam NA 49 39 48 64 64
(53) (62) (60)
61 59
Sri Lanka - - - - - 81 66
(57) (47)
41 51
Egypt 29 28 38 49 NA 71 73
(39) (45)
52 60
Jamaica - - - - - 67 74
(40) (59)
53 50
Panama - - - - - 60 56
(48) (50)
53 62 68
Venezuela 47 47 45 50 85 90
(54) (66) (72)
45 44 46
Brazil 48 42 46 51 66 68
(31) (30) (33)
48 57 48
India 45 45 50 53 42 45
(37) (36) (37)
58 68 73
Ecuador NA NA NA 53 94 94
(57) (72) (77)
51 65 56
Columbia 40 41 47 54 63 65
(48) (36) (56)
66 70
Guatemala - - - - - 91 81
(69) (73)
50 67 78
Bolivia NA NA NA 55 100 96
(58) (75) (79)
57 59 62
Bulgaria NA NA NA 56 74 75
(55) (68) (68)
55 75 79
Zimbabwe NA 51 51 57 112 120
(50) (65) (70)
56 69 77
Ukraine NA 52 53 58 69 69
(56) (60) (69)
70 76
Honduras - - - - - 90 77
(74) (78)
71 74
Bangladesh - - - - - 92 98
(73) (74)
72 72
Paraguay - - - - - 108 112
70) (76)
73 75
Nicaragua - - - - - 101 102
(71) (75)
74 71
Nigeria - - - - - 95 87
(67) (71)
54 63 64
Russia 49 53 52 59 59 55
(52) (58) (58)
58
Croatia - - - - - - 56 54
(52)
80
Haiti - - - - - - ? ?
(80)
55
Morocco - - - - - - 65 60
(48)
53
Namibia - - - - - - 72 82
(51)
34
Tunisia - - - - - - 33 32
(32)
41
Botswana - - - - - - 57 72
(57)
Some of the
recently
listed
countries
Kuwait - - - - - - - - - - 30 30
Qatar - - - - - - - - - 32 31
UAB - - - - - - - - - - 34 35
Bahrain - - - - - - - - - 48 40
Barbados - - - - - - - - - - 41 47
Cyprus - - - - - - - - - 49 52
Malta - - - - - - - - - - 51 53
Kazakhstan - - - - - - - - - - 50 58
Azerbaijan - - - - - - - - - 62 62
See recent
reports for
- - - - - - - - - -
other
countries
- - - - - - - - -
Information related to the IMD's current competitiveness rankings can be found on the
IMD website or click on the links below for the information available on Amazon's
website.
SOME THOUGHTS
One of the most interesting facts revealed in the data and discussion related to these
reports is the size of the U.S. and Japan in relation to the world economy. In 1998 the
U.S. economy (GDP) was $8,511 billion, while Japan, the second largest economy, was
$3,784 billion.3 Based on this data, the Japanese economy is 44.5% as large as the U.S.
economy, or the U.S. economy is 125% larger than the Japanese economy. According to
a related discussion on the IMD website (August 2001), the U.S. and Japan account for
46% of the world GDP.
FOOTNOTES
1
1996.The C-word strikes back. Economist (June 1): 76.
2
Porter, M. E., J. D. Sacks and J. W. McArthur. 2002 and 2003. Executive Summary:
Competitiveness and Stages of Economic Development.
3
Sacks, J. D. and A. M. Warner. 1999. Year in review. WEF website.
CHAPTER 7 Expectancy Theory
http://maaw.info/ExpectancyTheoryMain.htm
Expectancy Theory Bibliography
An application of expectancy theory
Monetary incentives, expectancy and other theories
What is expectancy theory?
Griffin, L. and A. Harrell. 1991. An empirical examination
of managers' motivation to implement just-in-time
procedures. Journal of Management Accounting
Research (3): 98-112
MOTIVATION/PURPOSE
Foreign competition has prompted manufacturers in the United States to adopt
new methods and technology, such as the Just-in-Time (JIT) concept. When a
firm implements the JIT concept, major physical, psychological, and
organizational changes occur in the organization’s work environment. The firm
develops more intimate relationships with suppliers, significantly reduces its
inventories, and implements simplified manufacturing procedures.
Several individuals within the firm may be reluctant to adopt the JIT concept. For
example, management accountants may not be aware of the benefits associated
with JIT, because they received limited coverage of JIT while completing their
undergraduate accounting program. Managers and supervisors may not be
motivated to implement JIT because the JIT concept seeks to eliminate the slack
used by middle managers and supervisors as a cushion against difficulties
caused by defective raw materials, production errors, and irregular supply and
demand schedules.
The authors propose that the expectancy theory can be used to examine the
motivation of middle managers and supervisors to implement JIT procedures.
Management accountants are not sampled in this study.
CONTRIBUTION
The expectancy theory variables (valence model and force model) can provide an
appropriate conceptual framework for understanding how an organization can
gain the support and cooperation of middle managers and supervisors in the
implementation of JIT procedures. Both models have the strong ability to explain
variations in individual motivation levels.
THEORY
Expectancy theory is a theory of motivation based on the belief that people's
efforts to achieve depend on their expectations of reward. Vroom’s formulation of
expectancy theory involves two models, the valence model and the force model.
Expectancy-Valence Model:
D ependent Variable: Attractiveness
Independent Variables: (1) Second Level Outcomes and (2) Strength of the
Instrumentality (relationship) between the first-level outcome and associated
second level outcome.
The expectancy-valence model depends on the person's expectations of reward.
People's motivation to achieve something depends on the product of their
estimation of their chance of success (perceived probability of success) and the
value they place on success (incentive value of success).
Force Model:
Dependent Variable: Motivational Force
Independent Variables: (1) Valence of First Level Outcome and (2) Expectancy
Two forced models are tested: additive and multiplicative
The force model depends on both the valence and the expectancy. When both
valence level and expectancy are high, motivational force is high. The force
model implies the motivation of a middle manager or supervisor to implement JIT
procedures is explained by the valence (attractiveness) of implementing JIT
procedures and the expectancy (probability) that some particular level of effort
will result in implementation.
PROPOSALS
Proposal 1: The valence model will predict the valence (attractiveness) of
implementing JIT procedures to middle managers and supervisors.
Proposal 2: The force model will predict the motivation of middle managers and
supervisors to implement JIT procedures
Proposal 2a: Most individuals will employee additive information processing
procedures (the additive model), rather than the multiplicative information
processing (the multiplicative model)
As expected, the typical individual reached a greater motivational force decision
for higher expectancy levels than for lower expectancy levels. This increase is,
however, relatively modest when the wide change in expectancy (from 10 percent
to 90 percent) is considered, indicating the typical individual placed less weight
on expectancy than upon valence in reaching motivational force decisions.
METHOD
The judgment analysis approach for expectancy research was used to examine
whether the valence and force models can predict the motivation of middle
managers and supervisors to implement JIT procedures. This approach uses
individuals’ decisions as operational measures of valence and motivation.
Each participant was given 1 of 32 cases that described a unique hypothetical JIT
implementation status. A regression model was obtained for each participant and
the average values (i.e. adjusted R2 and beta weights) for each group were
reported.
SAMPLE
70 participants in Group One were middle managers and supervisors (or
individuals who had previously held supervisory positions), who were enrolled in
an evening MBA program. Group Two consisted of 35 mangers that were
attending a one-day JIT seminar. Group Three participants were 50 middle
managers and supervisors who were employed by one of the nation’s leading
textile manufacturers.
RESULTS
Proposal 1: The valence model will predict the valence (attractiveness) of
implementing JIT procedures to middle managers and supervisors.
The typical participant in all three groups placed the greatest valence upon the
fourth second-level outcome, the rewards associated with increased productivity
in the new work environment. The typical participant found employment security
and the more challenging production standards and output goals associated with
the new work environment to be the second and third most attractive second-
level outcome and placed the least value upon the greater coordination of
departmental activities outcome.
The adjusted R2 values obtained from the person-by-person regression
analysis provided an indication of the ability of the valence model to explain
variations in the participants’ valence decisions.
Proposal 2: The force model will predict the motivation of middle managers and
supervisors to implement JIT procedures.
The adjusted R2 values obtained from the person-by-person regression
analysis provided an indication of the ability of the force model to explain
variations in the participants’ motivational force (or effort level).
Proposal 2a: Most individuals will employee additive information processing
procedures (the additive model), rather than the multiplicative information
processing (the multiplicative model).
o The results indicate the additive version of the force model performed well,
even for those participants who actually did employ the multiplication information
processing procedures. Even for these participants, the additive model explained
over 95 percent of the total explainable variance in the participants’ effort-level, or
motivation. These findings are in consonance with prior expectancy theory
studies, which employ the judgment modeling within-persons approach used in
this study.
PRACTICAL IMPLICATIONS
These finding provide guidance for accounting researchers who may wish to
employ expectancy theory to examine the motivational aspects of implementing
new procedures and systems in organizations. In a practical sense, the results
provide some knowledge of the valences individuals place on second-level
outcomes, which are associated with the implementation of JIT implementation.
This suggests management accountants who advise senior executives regarding
appropriate incentives for motivating the implementation of JIT procedures might
advise publicizing the productivity rewards and employment security result from
implementation, for these outcomes were highly valued by the members of all
three groups of participants.
FUTURE RESEARCH
The wide range of valence values obtained across individuals implies the need
for research aimed at explaining these differences. A possible explanation is
suggested by Klien (1989), who proposes the attractiveness of outcomes differs
for individuals who have different values and intrinsic needs. Accounting
researchers might, therefore, examine whether differences in individuals’ intrinsic
needs influence the valences they associate with the various outcomes within the
context of expectancy theory.
Future research, which employs expectancy theory to examine the
implementation of JIT procedures, is also desirable. The various departments of
a firm are usually affected differently by the implementation of JIT procedures, so
future research might be focused at the department level.
Behavioral Issues and Culture
Behavioral Issues Bibliography
How to Manage Yourself & Other Advice
Social Networks Bibliography
ABKY Chapter 10 Summary
Accounting and Culture Summary
Herzberg on Motivation
Hidden Bias or Implicit Association Tests
What is the Tipping Point?
2. Using a mix of balanced measurements, i.e., balance short term and long
term,
quantitative and qualitative measurements etc.
3. Empowering employees.
3. ETHICAL ISSUES
Developing a code of ethics is important to help motivate ethical behavior. ABKY
discussed beliefs systems and boundary systems in Chapter 1. These combined
systems or concepts provide a comprehensive code of behavior for employees.
As Simons points out, effective control in "an age of empowerment" also
requires diagnostic control systems to insure that employees follow the code of
conduct. (Simons summary)
A Hierarchy of Ethical Principles
ABKY discuss a hierarchy of ethical principles that provide general guidelines for
understanding and addressing ethical problems. These include:
1. Legal rules.
2. Societal norms.
3. Professional memberships. (Links to the IMA, AICPA and other ethics sites).
4. Organizational or group norms.
5. Personal norms.
Problems arise where an employee's personal code of ethics conflicts with the
other levels within the hierarchy. The In-Practice note at the top of page 399
makes an interesting point. According to the note, 55% of the executives
surveyed admitted cheating at golf. The point: Golf cheats and job cheats are
highly correlated.
A Whistle-Blower's Choices
ABKY list and discuss nine choices for a whistle-blower on pages 399-400
ranging from reporting unethical behavior and refusing to act unethically to doing
nothing. They point out that the control system should include a way for
employees to report inconsistent ethical behavior without fear of retribution. They
suggest the internal audit function as a possible answer.
Elements of Effective Ethical Control
4. Dimensions of Motivation
This sub-section (page 402) provides three dimensions of motivation:
1. Direction, or focus.
2. Intensity, or effort.
3. Persistence, or duration.
Controls to guide direction include:
2. Task control. Follow standard procedures. Applicable when there are legal
requirements or precious assets involved, and there is no need for judgment.
Two types of task controls:
a. Preventive control.
b. Monitoring, or surveillance as with croupiers (dealers) in gambling
casinos.
6. EMPLOYEE EMPOWERMENT
Employee empowerment involves two elements:
1. Delegating the authority to employees to make decisions, and
2. Employee education to support the decisions.
Employee empowerment benefits may include:
1. Higher employee morale and job satisfaction.
2. Increased productivity.
3. Increased potential for improvement.
7. INCENTIVE SYSTEMS
Intrinsic and Extrinsic Rewards
Intrinsic rewards come from within the individual and reflect "joy in work" to use
Deming's term. The idea that employees derive pleasure from work is consistent
with McGregor's Theory Y concept.
Extrinsic rewards are frequently in monetary terms such as bonuses, but can
also be non-monetary such as recognition, employee of the month etc.
Controversy Over Pay as a Motivator
The literature on compensation systems is very controversial. Some researchers
have questioned the idea that pay is a motivator. Herzberg, Kohn and Deming
provide some notable examples in this area.
Herzberg identified a number of myths related to motivation and developed a
motivation-hygiene theory. Herzberg's research findings support the view that
factors involved in producing job satisfaction (and motivation) are different from
the factors that lead to job dissatisfaction (hygiene). Intrinsic factors (e.g., job
enrichment) motivate people while extrinsic factors (e.g., salary, bonuses) are
mainly related to hygiene or dissatisfaction avoidance (See summary).
Kohn argues that incentive plans cannot work and provides six reasons for the
failure of reward systems: 1. Pay is not a motivator. 2. Rewards punish. 3.
Rewards destroy cooperation. 4. Rewards ignore the reasons for problems and
the possible causes of improvement. 5. Rewards discourage creativity and risk-
taking. 6. Rewards undermine interest in work. (See summary).
Deming argued that pay is not a motivator and placed most pay related schemes
in the category of deadly diseases, e.g., employee annual performance reviews,
ranking employees, management by objectives and merit pay. Deming argued
that most of the variation in any system is caused by the system, rather than the
people working in the system. Ranking people, simply ranks the effects of the
system on to the people. (Deming's perspective on the Effects of Ranking
people) and (MAAW's section on Deming).
(Some other article summaries related to motivation include: Amabile,
Katzenbach & Santamaria and Levinson).
ABKY point out that most organizations ignore the role of intrinsic rewards and
rely on extrinsic monetary rewards to motivate performance (p. 413). It is possible
however, that for most people, the absolute amount of money is not the
motivator, but instead people respond to how much money they earn relative to
others. One major problem with pay schemes and rewards is that they tend to
promote competition between employees rather than cooperation and teamwork.
Incentive Compensation
Pay-for-performance can be based on absolute measures or relative measures.
Absolute measurement schemes include piece-rate systems and pay based on
the organization's results such as profitability, stock share price or other
performance.
Relative measurement schemes include rewards for meeting a target, or
provide a percentage of a bonus pool, or are based on performance in relation to
an average.
Six Attributes of Measurement Systems
1. Employees must understand the system and believe it measures what they
control.
8. QUESTIONS
1. What are the four major behavioral considerations in MACS design?
(See the introduction above).
2. What is the scientific management view of motivation? (See item 2 above).
3. What is the human relations movement view of motivation? (See item 2
above).
4. What is the human resources model view of motivation? (See item 2 above).
(The Caplan summary is also related to questions 2-4).
5. What are the four requirements of ethical conduct by which certified
management accountants
(CMAs) have to abide? (See the ethics links page).
6. What are some choices that individuals can make when ethical conflicts arise?
(See item 3b above).
7. What is an ethical control system, and what are its key elements? (See item 3c
above).
8. What are the three key dimensions of motivation? (See item 4 above).
9. What is goal congruence? (See item 2 above).
10. How does task control differ from results control? (See item 4 above).
11. List and explain the two categories in task control. (See item 4 above).
12. List three quantitative financial measures of performance in a manufacturing
organization of
your choice. (See table above).
13. List three quantitative financial measures of performance in a service
organization of your
choice. (See table above).
14. List three quantitative nonfinancial measures of performance in a
manufacturing organization
of your choice. (See table above and MAAW's Chapter 8).
15. List three quantitative nonfinancial measures of performance in a service
organization of your
choice.
16. List three qualitative measures of performance.
17. What is gaming? (See the Collingwood summary).
18. What is data falsification?
19. What is a balanced scorecard? (See item 5 above).
20. What are the four measurement perspectives in the balance scorecard?
(See perspectives under item 5 above).
21. What are two essential elements in employee empowerment? (See item 6
above).
22. What is an intrinsic reward? (See item 7 above and the Deming summary).
23. What is an extrinsic reward? (See item 7 above).
24. What is incentive compensation? (Look under item 7 above).
25. What are six attributes of effective performance measurement systems? (See
item 7b above).
26. What type of organization is best suited to incentive compensation?
(See the Kohn summary).
27. What is a cash bonus? (See item 7c above).
28. What is profit sharing? (See item 7c above).
29. What is gainsharing? (See item 7c above).
30. What is a stock option plan? (See item 7c above).
Additional Questions:
1. Is there a difference between ethical problems and systems problems? If so,
what is the
difference?
2. Can the problem of unethical behavior be solved with the proposed ethical
systems outlined
in this chapter? Discuss the issues. (See item 3c above, and the summaries of
Simons,
Bazerman, Loewenstein & Moore, and Collingwood). (Some other article
summaries related to
behavioral problems (e.g., gaming, earnings management etc.) include Healy
& Wahlen and
Dechow & Skinner).
CHAPTER 8 Fayol's Theory
http://maaw.info/Fayol'sTheoryMain.htm
According to Crainer (2000), Henry Fayol (1841-1925) was a French mining
engineer who recognized management as a legitimate discipline. Fayol is
perhaps the first author to define the functions and objectives of management.
Managers, according to Fayol, plan, organize, command, coordinate and control.
Fayol extended these basic concepts by defining fourteen principles of
management as follows: (Crainer, p. 4).
1. Division of Work.
2. Authority & responsibility.
3. Discipline.
4. Unity of command.
5. Unity of direction.
6. Subordination of individual interest to general interest.
7. Remuneration of employees.
8. Centralization.
9. The scalar chain.
10. Order.
11. Equity.
12. Stability of personnel.
13. Initiative.
14. Esprit de corps.
Fayol's lectures were published in book form in 1925 and translated into English
in 1930. The following comment by Fayol appears in Chamber's Accounting
Thesaurus (1995):
"Accounting activities - This group is the visual organ of business. It must throw
up at any moment, present position and future trend, must afford accurate, clear
and precise information about the economic position of the concern. An efficient
accounting system, clear and simple, giving an accurate idea of the firm's
condition is a powerful managerial instrument".
See the references below. A Google search of the web provides a great deal of
additional information related to Fayol's theory of management.
"Contrary to what happens in politics and religion, in business circles there are so
many gurus competing for followers that no one of them can dominate the minds,
let alone the emotions, of potential followers."
Educators stand in sharp contrast to gurus. Educators do not try to bring thinking
to a halt but to initiate it. They want their students to extend and expand the ideas
they present and students are encouraged to question and modify without
constraint. Educators want their solutions to be treated as beginnings, not ends.
Gurus lead into; educators lead out of. Gurus provide ready-made solutions but
educators provide ways of finding individualized solutions."
"An educator tries to transmit a way of thinking and a way of conducting inquiries.
And he does not pretend that these are the only ways. Among other things, he
recognizes that differences in personality lead those with different personalities to
select different ways of thinking and behaving."
"I find that business schools tend to avoid the important complex strategic
problems that corporate management is currently involved with. Not too long ago
at a meeting of the deans of business schools I identified the set of six or seven
corporate problems on which I was working. I asked them if any of them had
courses that addressed such problems - not a single one of them was covered."
"Managers are not confronted with problems that are independent of each other;
but with dynamic situations that consist of complex systems of changing
problems that interact with each other. I call such situations messes....Managers
do not solve problems, they manage messes."
Koontz, H. 1961. The management theory jungle. The
Journal of the Academy of Management 4(3): 174-188.
(JSTOR link).
The purpose of this article is to identify the various schools of management
theory, indicate the source of the differences, and to provide some suggestions
for disentangling the management theory jungle. Koontz describes six schools of
management theory as follows.
1. The Management Process School
The management process school views management as a process of getting
things done with people working in organized groups. Fathered by Henri Fayol,
this school views management theory as a way of organizing experience for
practice, research and teaching. It begins by defining the functions of
management.
2. The Empirical School
The empirical school views management theory as a study of experience. Koontz
mentions Ernest Dale's comparative approach as an example which involves the
study and analysis of cases. The general idea is that generalizations can be
drawn from cases that can be applied as guides in similar situations.
3. The Human Behavior School
The central thesis of the human behavior school is that since management
involves getting thing done with people, management theory must be centered on
interpersonal relations. Their theory focuses on the motivation of the individual
viewed as a socio-psychological being.
4. The Social System School
The members of the social system school of management theory view
management as a social system. March and Simon's 1958 book Organizations
published by Wiley is used as an example, but Koontz indicates that Chester
Barnard is the spiritual father of this school of management. The social system
school identifies the nature of the cultural relationships of various social groups
and how they are related and integrated. Barnard's work includes a theory of
cooperation which underlies the contributions of many others in this school.
Herbert Simon, and others expanded the concept of social systems to include
any cooperative and purposeful group interrelationship or behavior.
5. The Decision Theory School
The decision theory school of management concentrates on the rational
approach to decisions where alternative ideas or courses of action are analyzed.
This school is believed to have grown from the theory of consumer's choice
associated with Jeremy Bentham and tends to by oriented toward economic
model construction and mathematics. The decision is the central focus.
6. The Mathematical School
The mathematical school of management views management as a system of
mathematical models and processes. This includes the operations researchers
and management scientists. But Koontz points out that in his view mathematics is
a tool, not a school.
The Major Sources of Mental Entanglement that create the Management
Theory Jungle
Five sources of entanglement or confusion include the following:
1. The Semantics Jungle - There is no agreement on the meaning of the words
management, organization, leadership, communication, and human relations to
give a few examples.
2. Differences in the Definition of Management as a Body of Knowledge -
What is management? Who is a manager? If everything is management and
everyone is a manager, how can management theory be regarded as a useful or
scientific?
3. The a priori Assumption - Ignoring the work of Fayol, Mooney, Brown,
Urwick, Gulick and others on the grounds that they are universalists.
4. The Misunderstanding of Principles - For example, confusion over the
validity of principles such as unity of command, and span of control.
5. The Inability or Unwillingness of Management Theorists to Understand
each other - The roadblock to understanding is unwillingness.
PURPOSE OR SCOUT
CONCEPT FACTORY
FUNCTION TROOP
The
DRUM Sets the pace Slowest scout
Constraint
Inventory in
BUFFER Protects the pace Slack in the rope front of the
constraint
Some type of
Rope tied
pull system,
Enforces the between first
ROPE e.g., kanban
pace scout and
type or OPT
slowest scout
schedule
Prelude
It begins on Jan 24, 1998, and within a period of 16 months, Eli Goldratt
spins a tale of the implementation of a production delivery system in a large scale
environment, based on the principles of the Theory of Constraints (TOC). Within
this span of time, the implementation leads to significant problems for other units
of the organization such as distribution and sales. The story unfolds around
Pierco, a large manufacturing company that delivers a wide variety of products to
market, and the investment it made in a new computer system developed by
BGSoft, and implemented by KPI, a subsidiary of BGSoft.
The players are Scott and Lenny, the masterminds behind BGSoft, Maggie,
the head implementer for KPI, Gail, VP of Sales for BGSoft, and Craig, the CEO
of Pierco, Brian, a Pierco division manager, and a cast of supporting characters.
Through an interesting and easy to understand story, Eli Goldratt is able to
explain and justify, no exemplify, that implementation of TOC concepts into real
business application can lead to 20, 30 even 40% quarterly increases in the
production, distribution and sales for a production company. He also ardently
defends implementing a change in “the rules”, in the cultural makeup of a
company at the same time when it implements a data driven system that will give
it those statistical increases.
Chapter 1
We begin the story by meeting Scott Duncan, head of BGSoft, one of the
most successful software companies in the world. Scott is lecturing one of his
account managers, discussing “the global picture” for which his vision becomes,
apparently, visionary. Scott believes strongly that a company’s success is based
on more than just a good product. Early on his strategy focused on what made a
good product for the customers system at hand, not just in how well it worked.
And it has worked well for him. His company has been the leader in setting
the standards for the computer industry, and it has led to change in the way
things are looked at. The factor to determine the value of his company, based on
the profit it generates, is higher than the normal standard by 75%. This is the key
to its rapid growth. BGSoft is driven not by the parameter of profit, but
maintaining its growth rate. This is also the dilemma, because the company
cannot continue this growth rate…trouble is lurking ahead.
Chapter 2
One month later. Here we meet Lenny Abrams, brash, often icy, number
two at BGSoft, who met Scott while they were both in graduate school. Scott had
come up with the idea that computers would revolutionize business, and Lenny
challenged him to act on it. Well, here it was 20 years later, and Lenny is facing
an ever increasingly hectic schedule, and has grave concern about the future
growth rate of his business. Too many of the implementations they have installed
are getting their clients the results they said they would get, but nobody really
knows why. The software works, the modules are getting through the bugs, but
the bottom line of the clients hasn’t changed. And there are problems, problems
that aren’t getting solved by his people in the field. It’s time for a meeting of the
minds to discuss the problems.
Chapter 3
Here we meet Maggie, head of KPI, prime implementation consultant for
BGSoft, and are immediately introduced to her problem – the current system is
deteriorating. The response time from BGSoft’s tech-support centers has
decreased by over 80%. The general consensus is that BGSoft’s key product
Enterprise Resource Planning (ERP) has become too complex, which has
serious ramifications for BGSoft. But it’s not just this delay, it’s a broader
problem – the computer system is “just one component in the game. There is
also the company that implements it, and its clients. To find a solution, they must
look at the global picture.” (p. 31) Here again we are led to “the global picture”
which will become a mainstay of thought through out the novel.
Chapter 4
Three months from start. We meet Gail Collins, VP of Marketing and Sales
for BGSoft. At a company sales force bar-b-que, Lenny has introduced a new
architecture for ERP, which has gotten all the sales people excited. For the first
time in years Gail was worried about BGSoft not meeting its forecast. She
predicts that they will be short, and that this will trickle into the next quarter. It
appears that they are not losing their market position, but instead they have
saturated their market of large companies who have or are willing to implement
their software. They need to figure out how to expand into the mid-size market.
But, to compound the problem, it isn’t any easier to sell to a mid-size company
than a large one. To top it all off, they are having serious quality assurance
issues. Lenny must go to the company’s plant in India, where most of their code
is written and packaged.
Chapter 5
Five months from start. Scott and Maggie have been called to visit Pierco,
one of their largest clients. Craig has been grilled by his Board of Directors,
particularly a new, young, aggressive fellow, who has questioned the huge
investment Pierco has put into BGSoft, and wants to know what do they have to
show for all the money they spent. Craig didn’t have an answer. He assumes
that no real savings has occurred regardless of how many cents or fractions of
cents have been saved, because no lay off had occurred. “No head-count
reduction means no real cost reduction, no impact on the bottom line.” (p.48) So,
Maggie, Scott and Craig discuss what would be bottom line examples: 1) sales
information from Pierco’s warehouses is now streamlined to its production plants.
Such information is available to plants on the same day of the sale. (p. 50) This
leads to improved production forecasting and planning according to market
consumption. Faster response from the plants mean losing fewer sales to
competition, because fewer shortages in distribution mean more sales. “And
more sales is more money,” Craig concludes – real bottom line impact. (p. 51)
2) Better distribution leads to less unneeded inventory, which also has an impact
on the bottom line.
BGSoft gets excited about concentrating on the bottom line instead of cost
reduction. But they realize that they have been talking the wrong language – the
computer system’s language – and not the language of the clients’. Lenny’s
insight runs the deepest. He realizes there are three languages to contend with:
1) the computer system’s, 2) the client’s language, and 3) the top managers
language – bottom line. That is the most important. With this in mind they also
continue to see the ever increasing, unnecessary complexity that is creeping into
ERP.
Chapter 6
Five months from start. In a nod to Deming, Goldratt suggests that to the
sales people of BGSoft, salaries are not the most important things. They thrive
on intrinsic values like challenge and the thrill of overcoming each obstacle. (p.
60) Maggie is lamenting the fact that it has become increasingly difficult to find
the right talent. The rate of implementation has stretched her work force thin, and
she is bearing the brunt of current clients dissatisfaction. She reminds herself
that “the customers are not always right, but they are always customers.” (p. 61)
Through this, she can barely stop thinking about what Craig has said to them,
and wonders if all her clients will start to demand real bottom line justifications.
“Does this mean the rules are changing again,” she wonders (p. 61) It seems as
though the industry is experiencing perpetual change.
Chapter 7
Six months from start. “We’re just a herd of animals stampeding towards
the cliff,” is this chapter’s opening thought from Scott (p. 65) and he believes
everyone else in the industry is acting like the cliff doesn’t exist. His main market
is saturated, and its limits are beyond his control. On top of that, the increasing
difficulties of his product put it in real danger of becoming too complex to handle.
And they don’t know what to do about it. Goldratt provides a bigger picture of the
high tech industry here. Not only is this happening to BGSoft, but also its
competitors. Some will even report negative growth this quarter. The
assumption is that this will lead to greater scrutiny from Wall Street analysts,
whom will demand proof that BGSoft is not heading towards the same fate, and if
he can’t his stock will nose dive. (p.68) He can’t get past the problem of selling to
mid-size companies, still faced with the same complexities involved in
implementing the system to a large-scale company, and not reaping the same
incentive/reward.
Scott goes back to the basics. Neglecting the bottom line has led to a large
number of meaningless features being added to the software because the client
demanded it, which drastically increased the systems complexity. But he can’t
link this to the long sales cycle they experience in the mid-size market. If he can
answer that, he believes he will establish the link between the two dilemmas –
satisfying customers while simplifying the product, and finding new markets. (p.
70)
Chapter 8
Six months from start. Maggie is holding a meeting with Gail and another
team member George to finish up their bottom line justification presentation to
Pierco. The team encountered trouble from the start, trying to agree on what
should be considered a measurable benefit. After a slow start, Maggie
impatiently gets to the point – what is it about their software leads to either a
decrease in cost, or an increase in revenue? (p. 73) She believes that what
needs to be shown is economic benefit, not catchy phrases like system
optimization, or greater operations visibility. George begins discussing that since
ERP was implemented, invoices are correct the first time, an improvement over
the old system (legacy system) which means the customer gets its money faster
which means improved cash flows – a bottom line answer. Another key savings
is identified in material-cost reduction – an ongoing annual benefit. And there
has been impact on inventory reduction, which will free up cash reported on the
balance sheet. Fewer stock outs are mentioned, which correlates to higher
sales. The savings identified by these features mean that Pierco is basically
getting its new ERP system for free, and have a slew of ongoing benefits. What
is significant to the group isn’t so much the savings they have identified, but by
focusing on the bottom line, they have discovered that of the key justifications
BGSoft lists as its benefits, only 3 out of 20 made it onto the list of being a benefit
to the bottom line.
Chapter 9
Still six months later. The important theme that Goldratt is suggesting is
that in order for these companies to succeed, they must keep maintaining their
growth rate, which more and more seems like an impossible predicament. (p. 81)
Once again Lenny is lamenting that of all the new features that he has authorized
of late, not one of them contribute to the client’s bottom line. But the client’s
demand it, so therefore they must provide it. But Scott disagrees. He has just
seen the true value of his system to a large company, stripped of all the
“admiration of technology,” and it boiled down to four items: 1) reduction in the
days of outstanding receivables, 2) reduction in material costs, 3) reduction in
inventory, and 4) increase in sales. (p. 83) Here we begin to see where Goldratt
will eventually lead us. Scott believes that a shift must occur in the company’s
business paradigm. If they continue to focus on their current features, the
backbone of their sales tactics, then they will continue to offer very little real value
to their clients. Therefore, they must sell value. (p. 85) This elicits a barrage of
debate. “It’s one thing to state that (one) must provide a product that brings
value, but a totally different story to do it,” exclaims Gail (p.86) She doesn’t
believe that they have a clue how to do it. Scott decides the answer is to
investigate adding a new Advanced Planning and Scheduling (APS) module to
the software. Apparently, all the marketing of the leading APS companies is
based on the claim that they will significantly decrease inventory and lead to an
increase in sales – the key to impacting the bottom line. This is going to mean a
paradigm shift in BGSoft’s own sales tactics, and Gail is uncomfortable. The
group decides to visit one its smallest clients who is their best bottom line
reference, Stein Industries.
Chapter 10
Stein Industries is a company that has grown from $50 million to over $250
million in three years. Maggie, Scott and Lenny are paying a visit to Gerald Stein,
CEO, to find out the details of his success using ERP. After some jovialities and
sparring, Gerald admits that although the system worked as advertised, he didn’t
get the benefits that he presumed would occur – a reduction in lead-time. What
was happening was that a project would come out of one unit 2 weeks ahead of
schedule, but would get stuck at the first bottleneck. There the work would pile
up, forcing the managers of that unit to make more and more decisions,
incorporating more opportunity for error. Eventually all the allotted time was fully
used. So Stein introduced the Drum-Buffer-Rope method, a method that “chokes
the material release according to the due date of the order” (p. 96) delaying the
release of work orders until the actual lead time necessary to meet the final due
date. This seemed to be counter intuitive. This led to connecting the entire
project progress to the bottleneck, and for Stein they did this inside BGSoft’s ERP
system. By focusing on the bottleneck, they could improve its performance. This
led them to another concept, Buffer-Management, a follow-on step to Drum-
Buffer-Rope. Whenever anyone has product waiting in line, they look at the
developed buffers to make their decision about what to do next.
Scott and Lenny leave the meeting thinking that they have found their first
connection to how they can tap into the mid-size market. By introducing Drum-
Buffer-Rope into their software package, they are still focusing on value, and
believe have an answer for the mid-size company. But what they don’t see is
that to implement such changes entails more than just implementing new code; it
means changing what actually gets measured. By synchronizing the release of
materials to the bottleneck schedule, the efficiencies of the workers who man the
non-bottlenecks suffer, but local efficiencies are a standard benefit to be
measured. This led them to the first conclusion that what was needed was a
change in culture, and the answer lay in bringing value. (p. 103)
Chapter 11
Lenny is paying a visit to Intelogic, one of the best APS companies. The
visit is not going well. Lenny is being fed the standard sales pitch, but he came to
look at possibly buying the company. He finally gets hooked up with the VP of
Engineering and Intelogic’s top programmer, and begins discussing the concept
behind its algorithm – providing the best practical schedule. This idea is the key
to Intelogic’s product. The planning of the Master Schedule will tell you in
advance what problems the various units are going to face, so that enough time
can be buffered into the schedule to take corrective action. But what Lenny
discovers is that the meaning of an optimized schedule has to be redefined. A
reality to schedule optimization is that “the same amount of safety time when
inserted in one stage of the process can help much more than if it is inserted in
another stage.” (p. 115) But, the bottlenecks may move, and it is very difficult to
forecast the potential bottlenecks. Therefore, Lenny concludes that a better way
to protect the schedule would be to use safety capacity, not time. The user
decides on capacity only after the disruption occurs, so the amount used is
exactly the amount needed. (p. 116) This could be of value to any plant. Lenny
leaves thinking he is drawing near to an answer on how to tap the mid-size
market.
Chapter 12
Lenny believes he has figured out how to add something to their ERP
system that will cause the system to generate more bottom line value, even for
mid-size companies. After his visit to Intelogic, he spent the next week meeting
with Intelogic’s successful clients. What he discovered at each plant is very
surprising. He learned that at each plant, they had to re-think the entire way they
run their operations. (p. 123) As he is relaying this Scott, Scott acts as if he has
already figured it out. Scott leads off their meeting. “When does a new
technology bring value?” he asks. It will bring benefits when it surpasses an
existing limitation. The paradox is that when we deal with a new technology, it
defines that we have been living with an existing limitation for a while. So, we
install a new technology to surpass the existing limitation, but we continue to
operate with the old rules – the rules that assume the existence of the limitation.
In that case, the rules themselves impose a limitation. (p. 125) Here again we
see where Goldratt is drawing us. Technology is a necessary condition, but it is
not sufficient. To get the benefits of the new technology, we must also change
the rules that recognize the limitations of what it replaced. One way of doing this
is to confine optimization to only the constraint. By doing more, you destabilize
the schedule. Here Goldratt introduces us to a lesson from Deming – “trying to
optimize the noise within a system doesn’t help, it hurts. As long as the system is
vibrating within the limits of its noise, any tampering just increases the
fluctuations.” (p. 129) Lenny and Scott conclude the chapter by figuring that their
biggest obstacle is not the market or their product – it’s them, it’s how they have
been thinking about the problem. They too must consider a cultural change
within their own company structure.
Chapter 13
Seven months from start. Craig and Maggie are enjoying a round of golf
during Pierco’s top executive retreat. There is no better opportunity for a golf
game than an executive retreat. (p. 133) They are soon joined by Brian and
Stan, two of Pierco’s division vice presidents. One of the strongest arguments in
BGSoft’s ERP justification was an expected increase in sales, which would have
been reflected as a substantial increase in net profit. But it hasn't materialized.
Their sales have remained flat. Inventory has gone down, shortages went down,
but sales went down too. What we’re seeing here is the intricate connection the
implementer of new technology faces when even after successfully installing the
new technology (and getting the product to work according to spec), it still doesn’t
deliver the essential bottom line value. When this becomes apparent, who is to
blame? Brian has come to the same conclusions that Scott and Lenny have
been arriving at, that in order for his division to meet its forecasts and deliver
more value, Brian understands that he must abolish the traditional way of running
a plant and change his fundamental measurements of success. (p. 142) He
understands in order to do this he must get everyone on board, from the plant
manager to machinist – everyone must be educated in regards to the new
paradigm, and your company culture must be on board. Based on the ensuing
discussion it is agreed that BGSoft will develop a Drum-Buffer-Rope module for
the ERP system, and KPI will begin working on the re-education of Brian’s
division.
Chapter 14
Eleven months from start. It’s the end of the year, and BGSoft has
completed the best year in its history. But Scott’s earlier predictions are
beginning to come true: their main competitor has announced negative growth
for the quarter, another has announced a 600-person layoff, and share prices are
plummeting. Wall Street is getting antsy, and is looking for some hard answers
about the future of the industry. “Is this just the separation of the chaff from the
wheat, or has the industry reached its growth limits?” (p. 144) The answer is
important, because if the first point is true, then BGSoft is emerging as a true
leader, but if the second point is true then shares could be dropped like a hot
potato. Lenny and Scott are debating about what the clear message to radiate
about BGSoft’s success should be. They are at the crossroads, because they
know they cannot continue to maintain their current growth, but they still can’t
quite see what will get them over the hurdle. Scott is convinced that it is in their
hands. He believes the answer lies in the decision to change the way they do
business. By doing this, he believes that growth is unlimited. (p. 145) It is here
that Scott consummately declares that BGSoft has to switch from selling
information technology to selling value. But what does selling value entail?
Determining and focusing on results is the real target. That’s what the Drum-
Buffer-Rope method does, it focuses your efforts. It tells you what’s really
important. ERP has used this to focus on increasing capacity and increasing the
flow in production, without increasing costs. New capacity is unearthed each
week in Brian’s division. Now it has been spread to five other plants. Here
Goldratt sings the praises of TOC, because its logic is so addicting. He labels it
“comprehensive, practical, and still common sense.” (p. 153) Based on Goldratt’s
scenario, all indications show that the theory does work.
However, what still seems to be looming in the background is the fact that a
major change has occurred in only one function of the organization. Up to this
point, we have not been shown what this change may be doing to the other
interconnected units of the organization. Here we are given an inkling into this
connection by the foreboding of Lenny, who at the end of the chapter is far from
relaxed.
Chapter 15
Thirteen months from start. The chapter starts out with Maggie and her
people at KPI totally swamped and frazzled. They are working 90 hours a week,
and still can barely keep up with the demand. Things are getting out of hand. (p.
161) Staffing for new projects is increasing by 60 people per day. BGSoft has
instituted a new module which implements a TOC paradigm, and they have
retrained their staff to identify that what is important to the client is making sure
that relevant information will be available for the right people at the right time so
that bottom line results will be guaranteed. This represents a paradigm shift for
the system integrators. It’s a madhouse, but they prefer it to the fear they had
just a month ago when their market appeared to be drying up.
Chapter 16
We are introduced to the first sign that all is not right in paradise. The
chapter opens with a picture of the time it takes to unload a truck at the
warehouse. Inventory has been piling up at the warehouse – yet several
products are experiencing shortages, while others have almost six months
capacity. At this rate, the warehouse manager Fred concludes that his space will
be filled to capacity within one month. He whips off a strong email to the division
VP (Brian) and all the plant managers. The warehouse managers are claiming
that the plants are making and shipping things that the warehouses don’t need,
and they want more of a say on what gets shipped to them. The plant managers
defend themselves, as their records show that production is only triggered by an
urgent need from at least one of the warehouses. But, the problem we see is that
when a plant produces a product, it produces it for more than one warehouse. In
order to fix the problem of increased set-up time due to small batch production,
they produce the quantity needed for the entire network. The plant managers,
however, feel that the ERP system is providing them with to-date data about
actual inventories. They don’t guess about what to ship. They do not understand
why there are so many products with excess inventory.
We meet Harrison, plant manager in Brian’s division. He has been
studying the problem since receiving Fred’s strong email. As he studies the
problem, Harrison uncovers a huge discrepancy in the ERP system: the sales
forecasting is being increased and decreased based on other factors, but this
information is not tied into production or distribution. And inventories continue to
rise. (p. 175)
Brian has also noticed the increase in inventories. Since the
implementation of the Drum-Buffer-Rope method, there has been a huge release
of much hidden capacity in the plants. But what is also discovered is that it is
virtually impossible to accurately forecast sales for a product in a single region.
Brian believes the answer lies in a better forecast. But BGSoft doesn’t agree with
him. Once again we are led into the notion that something else has to change,
not just the technology. We cannot continue to think that technology will solve
the problems. This example is amply detailed in this chapter.
Chapter 17
The problem identified in chapter 16 has led to a company wide
presentation by BGSoft at Pierco. Craig has gathered together all of his division
VP’s, plant managers, distribution managers, and support staff. Scott starts off
by identifying that the production application of the TOC in all plants has been
successful beyond expectations. Without adding any machines or manpower,
each plant is able to produce at least 40% more than before. But this
improvement in production has had nasty side effects on other units. Inventory is
increasing in the distribution warehouses, whom have no control over the
problem. So Scott and Brian introduce a solution: adopt the TOC application for
distribution. This leads us to the idea of rather than producing products based on
impossible forecasts and shipping the inventory to the distribution centers, the
inventory should be held in the place where the relevant forecast is the forecast
for the entire network – a far more accurate forecast. That place is identified as
the plant. The idea is that if a product is ordered from one distribution center, the
plant will produce five times as much, ship what the warehouse needs and store
the rest, because it shouldn’t take long before another warehouse demanded the
same product. (p. 191) And then they take this concept one step further – in
order to eliminate the need for plants to produce small quantities, which eat into
their set up time, produce a 3-week inventory that is held at the plant. This tied
into a 3-week inventory held in the warehouses means that the plants can
produce larger batches, and will always have sufficient inventory to keep the
warehouses stocked. Since the plants will know which products need to be
replenished, this can lead to Pierco offering service levels that the industry is
unaccustomed to, thereby increasing sales significantly. (p. 194) This should
lead to a huge release of cash, while putting an end to cross shipments and
shortages – a win-win proposition for the plants and distribution. Of course, once
again this brings up the reality that for an organization to succeed it cannot only
rely on implementation of new technology, it has to reorganize its fundamental
philosophy on how it operates its business. In this case, Pierco implemented
technology that did improve production, but led to problems in distribution. But
once it implemented the same application in distribution, which involved a
significant change in the way they did business by holding inventory at the plants
instead of relying strictly on the warehouse to define its inventory, the problems
virtually disappeared because now the right source was deciding how much
product needed to be produced.
Chapter 18
Fifteen months from the start. The new system has been implemented for
2 months. Not only has it changed the way Pierco did business, it has led to a
shift in the way that BGSoft does business. BGSoft has deduced that changing
the rules is key to success in its implementation of its ERP. But there are new
problems – not enough TOC experts to lead the charge. (p. 205)
Chapter 19
Lenny, Scott, Gail and Maggie are meeting to discuss the new direction
that Scott and Lenny have been cooking up for BGSoft. Once again they are
bringing up the concept of selling value rather than technology. “It’s not just the
software, it’s the frame of mind,” says Scott. (p. 208) The ERP system brought
the ability to do things that were not possible before. Now data can be quickly
transferred between different units of an organization, and the relevant
information can be quickly retrieved from the oceans of data collected and
inputted. But what BGSoft has learned is that while its ERP system has led to
significant improvements and diminished major limitations of its client’s, it ignored
the rules that resulted from the existence of those limitations. Those were left
unchallenged. (p. 211) So when ERP was installed, the old rules were still used.
Again Scott confirms what he had earlier deduced: “ To realize value, bottom line
value, technology is necessary but not sufficient.” (p. 211) Now, BGSoft has hit
upon the same idea it is selling to its client’s – it can no longer play by the same
rules. It cannot remain as just a purveyor of technology, but as a company that
will provide everything that is needed to get potential value, “even if it means
doing things that a software company is not supposed to do.” (p. 211) And that
means forcing its prospects to change their old management rules. What BGSoft
has also discovered in this is that by focusing on these concepts, it also has led
to a simplification of the code necessary for its system to be optimized.
But switching from selling technology to selling value means a
synchronized change in all units of an organization. And it means that a new
function must be introduced, the TOC agent. (p. 214) But what BGSoft learned
was that their success also became their bottleneck. And the only way to
overcome it was to reinvent its organizational rules.
Chapter 20
Sixteen months from start. Craig from Pierco has invited Maggie and Scott
to dinner to discuss Pierco’s success story, but he also has a bombshell to drop.
What Craig has realized is that his organization’s success is just the beginning.
What they have done so far is good, but he has an idea to see it move to a new
level. Even though Pierco has become more agile, this agility isn’t making its
way to the end customer. And as long as the end customer doesn’t see it, Pierco
isn’t reaping the biggest reward they expected, which is an increase in sales. (p.
220) The reason behind this is based in the vendor chain. If Pierco wants to win,
it must look beyond the limits of itself, and look at its entire supply chain. (p. 221)
Craig asks BGSoft to consider selling the TOC concept to its supply chain, which
includes hundreds of businesses, most small to mid-size companies. BGSoft
instantly recognizes the opportunity laid before it – finally, the way to capitalize on
the mid-size market that has so far alluded them. Scott is ecstatic. Here lies the
opportunity to institute fundamental changes in the operations of hundreds of
business. Connecting all the businesses in the supply chain will force each
individual link to act like a chain.
Scott sees this as the answer he has been thinking did not exist. This
solution solves the problem completely. It will provide a constant stream of
clients and income. It can provide incredible stability (p. 230) And it will increase
everyone’s rate of growth. But this means a drastic change in the way BGSoft
does business - the paradigm shift that BGSoft has been requiring of its clients.
Goldratt ends by suggesting “The end…or just the beginning.”
Conclusion
In Necessary but not Sufficient, Eli Goldratt leads us to a startling
conclusion: In order for today’s high tech industry to succeed, they cannot afford
to simply look at themselves as simply purveyors of technology, but they must
show how their new technology will bring real value to their clients, bottom line
value, because that is the cornerstone of business – what bottom line value is
delivered to the shareholder. And they must also consider that once the
operational limitations have been overcome by implementation of new
technology, the limitations of the mind must be overcome. Business must
redefine the rules that were put into place because of the old limitations that
technology is now erasing. Goldratt clearly suggests that technology is
necessary, but alone it is not sufficient. It must be incorporated with a shift in the
business paradigm. And Goldratt suggests that the application of the Theory of
Constraints as the foundation for this new paradigm fits well for re-educating
business to work differently by focusing on different measurable benefits. I think
Goldratt’s analysis presents a good argument, but in the context of this book it
was somewhat oversimplified. What I saw throughout the story were the
difficulties that new technology companies face in selling their new technology,
and the difficulties companies face when implementing new technology and
figuring out the changes that it creates in the way they do business. Alone they
each have limitations, but together Goldratt suggests the possibilities are
endless, and the opportunity for growth virtually limitless. A tall order for any
industry.
All data is given. All data precise. No excuses. Can we answer the question
now, "What is the maximum net profit we will earn next week?" Do we have
enough information? To solve this problem you will begin to see information in a
whole new light.
13. Demonstrating the difference between the Cost World and the Throughput
World
Most people would solve the previous chapter’s question like this:
P: 100 units X ($90-$45) = $4500
Q: 50 units X ($100 - $40) = $3000
NP = ($4500 + $3000) – ($6000 “operating expense”) = $1500
Wrong. This calculation neglects the first step “IDENTIFY THE SYSTEM
CONSTRAINTS.” Look at the load forecast for each resource. For A, the load
placed by Product P per week is 100 units times 15 minutes per unit (1500
minutes). Product Q places an additional load on resource A of 50 units times 10
minutes (500 minutes). The load is a grand total of 2000 minutes and the
availability of resource A is 2400 minutes per week. No problem.
Resource B—after doing the same calculations is shows that the demand for
Resource B is 3000 minutes. This is a constraint. Note: The demand for C and D
after doing the same calculations falls far below the system availability.
We cannot satisfy the entire market potential. Hence the wrong answer above.
We must make a choice as to which products in which capacities to make. Most
managers approach the problem from three angles: profit per unit, cost per unit,
or time/effort per unit. If we examine each product per those criteria, we might
decide to make more Q’s than P’s. We can sell 50 Q’s per week (1500 minutes).
We have 900 minutes left over to make P’s. That gives us a NP formula of (50
X$60) + (60 X $45) = $5700. Subtracting operating expense ($6000)…we find
out that we will loose $300 per week. That puts us in a position of promising NP
of $1500 (first formula) and actually losing $300 per week.
This won’t do! We must go to the second step “DECIDE HOW TO EXPLOIT THE
CONSTRAINT.” This forces us to offer P to the market first. The new product mix
formula is (100 X $45) + (30 X $60) = $6300. Subtract out operating expenses
($6000)…we have a NP of $300.
The key impact of this throughput thinking is not in the world of production. They
could care less how much they produce and when. The sales department will
care if management makes them sell P’s ahead of Q’s. Sales (normally on
commission) earn less for P’s…they favor selling Q’s. This is how “systems
thinking” is a real life dynamic.
14. Clarifying the confusion between data and information—some fundamental
definitions
What is data and what is information? Resource B is a constraint—data or
information? For production—it is information. For the sales force…it is data.
Sales would consider “Push P and only then Q,” as information.
Information is not simply the data NEEDED to answer the question…it is the
ANSWER itself. More so, information is the answer to the QUESTION ASKED.
Data can be further separated into “data” and “required data”—an important
distinction.
Information is arranged in a hierarchal way. At each level, information is deduced
from the data. Two conditions must be met to acquire information: data
availability and decision process validity. The decision process will follow the five
focusing steps introduced in Chapter 11.
Some working definitions:
INFORMATION: An answer to the question asked.
ERRONEOUS INFORMATION: A wrong answer to the question asked.
DATA: Any string of characters that describes something about our reality.
REQUIRED DATA: The data needed by the decision procedure to derive
the information.
ERRONEOUS DATA: A string of characters that does not describe reality
(might be a residual of an erroneous decision
procedure).
INVALID DATA: Data that is not needed to deduce the specific desired
information.
15. Demonstrating the impact of the new decision process on some tactical
issues
We have come to the conclusion that we will Produce 100 P’s and 30 Q’s. That
brings us to SUBORDINATE EVERYTHING ELSE TO THE ABOVE DECISION.
What happens (in reality) if we ask our production managers to make 100 P’s and
30 Q’s? The result is idle time. It takes 15 minutes to make P’s and 10 minutes
per Q. That is a total of 1800 minutes used out of 2400 minutes available. Our
production manager won’t want to stay idle for 600 minutes. So, produce more?
NO. The excess made won’t add to throughput…It’ll just become finished goods
down the line (unused inventory).
Subordinate everything else to the above decision forces us to look beyond the
results of local decisions to the impact a decision has on the system. Further, our
work ethic seems to be “If a worker does not have anything to do, find him
something to do.” Subordination as a concept runs counter to our normal way of
thinking. We are familiar with the saying, “Tell me how you measure me and I will
tell you how I will behave.” But, without fully understanding how the subordination
concept works and explaining it to workers/managers, the new saying might well
be, “Change my measurements to new ones, that I don’t fully comprehend, and
nobody knows how I will behave, not even me.”
Goldratt offers an illustration of local measurements in terms of elevating the
system’s constraints. He shows that in the cost world, a manager that offers a
suggestion that increases processing time by 1 minute per part and costs $3000
to implement (buy a new fixture) would be fired. But under throughput world
thinking, the manager who makes this suggestion really understands elevating
the system’s constraints. How? Because if the manager (who in fact is in charge
of a non-constraint) implements a change that makes his resource go slower, but
frees up time on the system’s constraint (and increases overall throughput), he or
she is a genius! The other aspect of this example is true as well…if the same
manager wasted their time finding “cost reductions” for the non-constraint, the
impact to the total system would still be meaningless. But, isn’t that how
managers are rewarded today???
16. Demonstrating inertia as a cause for policy constraints
Moving on, we now see our system’s constraints and we subordinated and
elevated as needed. Our next step was to go back to step 1 and (at the same
time) not let inertia cause policy constraints. There is a complex example of
taking our products to Japan.They want just as many P’s and Q’s as we sell in
America. All the costs of production are the same as in America, but the
Japanese want us to sell for 20% less per each unit. Should we?
We can look at selling all the P’s we can make. Since we see that this new
market will bear all we can make, maybe we should buy a new machine to make
P’s. That eliminates the previous constraint (constraint broken). After all the
calculations, we find that NP is just about $800 per week. But, have we let inertia
take us in the direction of producing P’s (the most profitable product)?
Reexamined, we see that if we increase production for domestic sales rather than
sending so much to Japan…we can still have about 400 idle minutes on
Resource A…and that will result in $1500 per week NP. That’s almost double the
NP than if we simply bought the new resource and sent all the P’s over to Japan!
The moral of the story is to go back to Step 1 when you break a constraint, but
when you get to step 1, look at the system as a brand new system. Avoid the
temptation to simply build on previous assumptions and let inertia create new
problems. Ask, “which product contributes more, through the constraint?”
PART II (THE ARCHITECTURE OF AN INFORMATION SYSTEM)
17. Peering into the inherent structure of an information system—first attempt
Information—the answer to the question asked. The most needed information
relates to questions that cost accounting was supposed to answer. There is a
missing link between data systems and information systems. This lays the
groundwork for the discussion ahead.
Information is arranged in a hierarchal structure, where information at higher
levels can be deduced from lower levels using a decision process. If we didn’t
use a decision process, our needs would only be data. Our current data systems
lack decision processes, or at least are based on erroneous decision processes
from the cost world.
We reserve the term information system for those that are able to answer the
question asked using a decision procedure. To construct an adequate information
system, we must build the relevant decision process. We have already identified
the five focusing steps. This is our starting point in building an information
system.
A discussion follows about a simple inventory and ordering system for 2 products
with different demand schedules, ordering schedules, and vendor lead times. In
building the information system to address this issue and determine raw material
levels, three major factors have to be considered--Frequency of delivery, the
unreliability in consumption levels, and vendor reliability. Of course, a need for
numerical evaluation must be built in as to the system as well.
18. Introducing the need to quantify “protection”.
One of the pieces of the information system that Goldratt is discussing
concerning inventory he calls “level of paranoia consumption.” This sounds much
like the concept of Safety Stock from Operations Management theory.
In any case, to formulate this information, we will go through the five focusing
steps. We will Identify the System’s Constraints, decide how to Exploit them, and
Subordinate to them. Our first action will be to decide the procedure to get us to
the five focusing steps. Is the process as generic as our five focusing steps (that
is, work in any situation)?
We look at a make versus buy decision from the throughput world instead of the
cost world and we see very interesting differences in the results. Product cost is
NOT the way to make this decision. We Identify our constraints. Then we Exploit
them—in this case, we do that by making the part in-house. The next step is
Subordination. But what does that mean?
In Subordination, attention is focused on the stronger links in the chain. What this
boils down to is simply what is the difference between protective capacity and
ordinary excess capacity. The first, as Goldratt illustrates in this chapter, is
desired to account for Murphy, or unexpected production outages on non-
constraints. The second is waste. To fully capture this distinction in our operation,
we must mandate our information system not only Identify and Exploit the
constraints—but also distill for the actual events in our company some means for
determining the level of Murphy.
19. Required data can be achieved only through scheduling and quantification of
Murphy
Any information system that lives up to its name must be able to answer all the
“what if’s” we have discussed in previous chapters. Unfortunately, much of this
information is unavailable. So, to help build this information, we need to
distinguish between 2 types of missing data:
1. Knowledge of what are the company’s constraints
Current and future…physical not policy…found in incremental phases
2. The ability to simulate future actions—scheduling
Who should do what, when, and in what quantities?
So how can we measure Murphy? Possibly, it can be measured only through an
examination of the aggregate impact of the local perturbations. This is better
termed Buffer Management because the few places where Murphy’s actions
aggregate is in the inventory (safety stock) that sits in front of non-constraints.
20. Introducing the time buffer concept
We have established that one way to protect against Murphy is to build in
inventory to keep non-constraints running—and allowing us to fully exploit the
constraint. Is this the only way? No. Another way is to use time to our
advantage. For instance, we can start an order earlier (when possible) and if
Murphy happens, we have some flex time in the system. Once the problem is
resolved, we can continue operations—without excess inventory on hand. The
interesting point is that either way of protecting involved an “early start”…you
either pre-build inventory or pre-start a job order.
We are simply protecting the constraint. In our effort to exploit the constraint—
make the most out of it—we find that excess inventory and early starts are
equivalent. For this reason, the proper way to express the protection of the
constraint is in TIME. We now refer to the excess capacity that is desirable as
TIME BUFFER—the interval of time that we release the task prior to the time that
we would have released it if we assumed that Murphy did not exist.
What determines the length of a buffer? We know disturbances will happen, just
not when and for how long? The following graphs approximate the function of
discrepancies.
These graphs (particularly the second) show clearly that any disturbance can be
overcome depending on the length of time we want to build in (size of time
buffer). That length is a management decision. It involves a cost-benefit tradeoff
in levels of time-related inventory (work in progress and finished tasks), future
throughput, and operating expenses (expediting and control). It also effects
throughput in our track record for delivery dates.
Who should make this decision? Top management??? No! The decision on the
length of the buffers MUST be in the hands of the people directly responsible for
the overall performance of the company.
21. Buffers and buffer-origins
More detailed statistical data does not necessarily help us get to the core
problem—the need for protection from Murphy. There are 2 types of disruptions
—one where there is an unexpected change (worker absent, tool breakdown,
etc.) and another called Non-Instant Availability. This second type is when a
resource is being used to do something else when we need it.
To establish buffer origins, we must look at the components of processing time.
For almost every product, processing time is almost 100% buffer time.
Processing time is actually negligible. So, Murphy accounts for virtually all of the
buffer time needed. Is one type of Murphy longer than another? That’s unclear…
So how do we insert buffers into our plan? This begins the discussion of buffer
origins. To determine our release schedule, we must measure backwards from
the consumption of constraints to get our time buffers. The points in time for
consumption of constraints is called the buffer origins. Again, these are simply
time intervals connected to physical locations where protective inventory
accumulates.
There is more than one type of buffer origin. There are Resource Buffers—right in
front of the resource constraint that contain work in process inventories. There
are Shipping Buffers—the shipping dock or finished goods warehouse. There are
also Assembly Buffers—that contain pre-released parts from non-constraints to
guarantee that other needed parts from the system constraint do not arrive at the
assembly point and wait (the second type of Murphy).
22. First step in quantifying Murphy
We need to quantify disturbances. Our method will be to devise a mode of
operation that takes into account that at any given time, Murphy exists. And that
our struggle with Murphy is a continuous one. Let’s look at which problem should
we attack first, then next, then after that—in order of their impact (Pareto
analysis)?
We choose to buffer only when something more important (throughput) would be
lost had a disturbance occurred. Buffers are expensive (increased inventory,
e.g.). How can we reduce the price of protection? We all know that if a process
normally takes a week, we can expedite it in the case of an emergency. But to
expedite everything creates chaos. Can we systematically use expediting? Sure.
This gives us the Expediting Zone. Refer back to the second graph. The
Expediting Zone is an area where we can speed up the arrival rates of resources.
We choose to pick those that already arrive at a 90% rate to the buffer-origin.
Note that the curve is relatively steep up to 90% probability. To get additional
probability that a resource will get to the process—you must drastically increase
lead-time. Anyway, choosing 90% means 10% of our tasks to a given resource
will be expedited—very manageable. The result? Lower buffers, shorter lead
time, and a more favorable trade-off between protection against Murphy and
costs of doing so. Now that we have a way to concentrate the protection where it
is really needed, maybe we can find a way to concentrate our efforts to reduce
the need for protection.
23. Directing the efforts to improve local processes
We want to reduce the price paid for protection, we have to concentrate on the
tasks that will arrive latest to the buffer-origin. Managing the buffers provides us
with several benefits. It enables us to better determine the required length in
accordance with the level of existing disturbances. It enables us to systematically
and methodically to expedite tasks to shrink overall lead times. Then, tracking the
locations where the delayed tasks are found and prioritizing according to the
number of times each resource appears on that list (probably with an appropriate
weighting factor) provides us with the desired Pareto list—the list that should be
our productivity improvement guide. There is one other—even more important--
benefit.
Maybe a resource pops upon our list and it has a superb process. This is
because it does not have enough protective capacity. Quantifying Murphy is
quantifying the buffer’s length and the amount of required protective capacity.
We now have a way to monitor the expediting efforts—not in fire-fighting mode,
but in a constructive way, geared to reduce overall lead time of all tasks. We
might refer to this properly as Control—a crucial component to a good information
system!
24. Local performance measurements
Measuring local performance (as we do now) by efficiencies and variances is
counter-productive. We must find a better way. The answer is not in “non-
financial measurements,” as some guru’s suggest. Remember the goal of any
organization is to make more money now and in the future—so financial
measures are imperative.
Also, remember that human nature is, “tell me how you measure me and I will tell
you how I behave.”
Control is to know where things are versus where they should be and who is
responsible for any deviation—measured via a procedure that continuously
attaches a numeric value to each one of the areas responsible for execution.
Local performance measures should not judge the end result, but rather the
impact the local area being measured has on the end result of the entire system.
By this rationale—local measures are related to deviations to the enterprise plan.
There are two types of deviations: not doing what was supposed to be done and
doing what was not supposed to be done. The first impacts throughput and the
second impacts inventory.
The unit of measure for deviations, which are clearly liabilities, is DOLLAR-DAYS
or more accurately THROUGHPUT DOLLAR-DAYS because it relates to that
system measurement versus the others (inventory and operating expense).
Multiplying the number of days that have passed since a corrective action should
have started by the dollars lost in sales gives a pretty accurate assessment of a
deviation’s impact in financial terms. The measure works for the first type of
deviation and in just about every business.
It makes sense to assign the resulting measure to the business unit where the
process is stuck. At first, this seems unfair because they may not be responsible
for the lateness—but the result to the system is exactly what we want. The center
that inherits the problem will, in effect, expedite the resource like a “hot potato” to
get it out of their department. This shows they are conscious of the Dollar-Days
measure and the whole system benefits—not just a local department.
Will this behavior cause sloppy work as department push the “hot potato” out of
their world and into someone else’s area of responsibility? Maybe we should
assign a corresponding dollar-days measure to the quality control department. No
doubt inferior products will be reported and sent their way. As the trend shows
itself, it will be their job to remedy the situation (and guard against other
departments shifting poor quality products out the door just to manipulate their
dollar-days measure). The minute quality control sees a department simply
passed off a poor product…they return the product to that department…along
with the corresponding dollar-days. This actually defines TQM…Quality at the
Source.
We still must deal with the second type of deviation (inflating inventory) and take
on a local measurement that relates to operating expense. Those interested in
these topics are directed to Theory of Constraints Journal, Volume 1, Number 3.
25. An Information System must be composed of Scheduling, Control and What-
If modules
A sort of review chapter…
Data is every string of characters that describes anything about reality.
Information is the answer to the question asked. Data needed to derive the
needed information is “required data.”
We must deduce information from the required data and any good information
system will be able to integrate this decision process. Data Systems are those
that supply readily available information while the term Information Systems is
reserved for only those that supply information that cannot be achieved unless
through a decision process.
A comprehensive information system must be built in a hierarchal structure. The
top of which must be geared toward answering managerial questions that elevate
constraints or prevent the unnecessary creation of new constraints. This level is
referred to as the What-If stage.
We know now that we must first generate data on Identifying the System’s
Constraint(s). We cannot start to identify constraints until we understand the
scheduling aspect of an organization—hence the second stage of an information
system, the Schedule stage.
Much of what we concern ourselves with in the Schedule stage relates to what
Goldratt called Control. This concept refers to our desire to quantify Murphy
(whatever can go wrong, will). We want to get a handle on the trade-off between
inventory and protective capacity. Then we can answer What-If questions. We
also can answer where to focus our efforts to improve processing and establish
local performance measurements.
Thus far, we have 3 building blocks for an information system: What-If, Schedule,
and Control. What-If is related to Schedule and Control as we have just
described. But how are Schedule and Control related? There is a relationship
between the Schedule and Control in that Control cannot be used until Schedule
is functional. Remember, Control tells us where things are with respect to where
they should have been. We control to limit deviations from the strategic plan…
thus the schedule must exist first.
Deviations that impact throughput and deviations that impact inventory are
deviations from our business plans. Our plans must include allowance for
Murphy. Our Schedule block must predetermine an estimation of Murphy. Only in
this way can the information system provide some realistic way of scheduling and
controlling. The discussion thus far has laid the groundwork for us to build on for
the rest of the text.
PART III (SCHEDULING)
26. Speeding up the process
Time to outline the approach to the scheduling phase. The “MRP” has been
considered a scheduling tool for some 30 years—it is not one, though. An MRP is
a very good database though. But, they are very time consuming to establish.
Does the time it takes to make a schedule render it worthless at some upper
limit?
How can we shrink the run time of an MRP? We must look at every step—even
the way the data is handled. Why does an MRP run take so long—computers
are fast, right? Most manufacturing experts agree that the way our MRP
applications work, most of the process is “shuffling data internally” characterizing
MRP’s as “totally I/O bound.” The reason for that is related to technological
limitations, Goldratt claims, that no longer exist. Programmers had no choice but
to shuffle data between mainframes and smaller computers because of storage
and processing capabilities. Since PC’s can more than handle the workload
nowadays, you might see the continued MRP run process as one example of
letting inertia cause a constraint…
27. Cleaning up some more inertia—rearranging the data structure
Product structure is usually broken down into 2 separate categories: Bill of
Materials (BOM) and Routings. Both are descriptions of the journey that materials
have to go through and have come about because of the problems we have had
scheduling the material journey.
The first MRP’s ran on magnetic tape. The diagram below shows how a simple
Sub Assembly and 2 Finished Products might be related. Sub Assembly A is
required for both (Product A and Product B). Old magnetic storage tapes used
when MRP’s were first constructed held one copy of the Sub Assembly. For
each product that used Sub Assembly A, the tape would have to be “searched”
through for the file. Very, very time consuming and inefficient.
Another way to do it was to detail the Sub Assembly every time it was needed
(for Product A and Product B, for example). Very labor intensive and inefficient as
well. What happens if a change occurs in some part of the Sub Assembly…? All
the Sub Assemblies must be updated.
The creation of BOM’s and Routing has alleviated much of these problems. In
picture form, they look like this:
But they weren’t perfect. And while magnetic tapes gave way to floppy disks and
vast hard drives of random access storage media, MRP structure stayed
relatively static since BOM and Routing.
Goldratt examines another factor toward shrinking MRP run time in merging
separately held “work-in-process inventory” and stores inventory.” Key to this
concept is that computers execute instructions far faster than they “reach for
disks.” Further, we must convert from the multi-file structure (BOM, Routing, etc.)
to a suggested uniform, “task-structure net.” The idea is that the computer would
only access the disks at the beginning of the run and hold all data in memory.
An information system helps managers at all levels answer “what-if” questions.
They, and their specific data must be made available on a distributed,
disseminated basis. A data system must be centralized, however, and
information systems—fed from a single data bank—must be decentralized. We
need not restructure the existing data banks to convert the data format. We must
concentrate on the structure of the subset of data format and file layout that must
become available for our information system.
28. Establishing the criteria for an acceptable schedule
Where to start? A good schedule must be realistic. Our system must be able to
carry it out—or IDENTIFY OUR CONSTRAINTS. Also, a realistic schedule
should not conflict between the system’s constraints (it will be immune from
disruption). When we identify constraints, we must check thoroughly that there
aren’t any conflicts between the id’d constraints. Since the conflicts were
unrecognized before, we can guess that the data required to resolve them is not
clearly specified.
The information system, then, must:
Reveal the conflicts
Highlight the minimal actions needed to resolve the conflicts
Stop and Demand the user make a decision (unless clear guidance is available)
Linear programming (and dynamic programming) do provide conflict resolving in
scheduling—ignoring the lack of data and failing to highlight where the conflicts
were encountered. Further it fails to protect against disruptions, in fact
disregarding them. Still the method has been the cornerstone of operations
research for the last 20 years.
The scheduling method of JIT—the KANBAN method—pushes the subject of
conflicts from the scheduling phases to the execution phase. No guidance is
available for selecting the number and content of the various cards to be located
between workcenters—the full load of making the schedule work is placed in the
floor personnel. MRP has given up on being realistic—it employs “infinite
capacity.” Both JIT and MRP account for disruptions to the extent that they build
in time to allow for them—more time than need to carry out the actual task itself
(without disruptions). In short, each tries to immunize the schedule instead of the
result of the schedule.
The need for a schedule to be protected against disruption is simply to ensure it
is predictable…nothing more. There is one more (and most important) criteria of
schedules. It must be measured (judged) by the same criteria we use to measure
results—throughput, inventory, and operating expenses.
The end performance that the schedule indicates is judged by whether or not
maximum throughput is achieved—exploitation of a company’s constraints.
Second, the level of material inventory should be present only to guarantee the
throughput. The schedule can only use overtime (Operating Expense) to protect
throughput. If the information system does all this and if the user customizes the
system contrary to these conditions—judge the end schedule accordingly—not
the information system.
29. Identifying the first constraints
Here’s where our scheduling should start. We must start by identifying something
that is definitely a constraint—no guessing and hoping “buffer management” will
save us. We are better off overlooking a constraint than choosing a non-
constraint as a constraint. So, what can we identify as a constraint with a high-
degree of probability to get us started?
Starting with a material constraint is risky. We need the detailed knowledge of the
schedule we are trying to create to accurately identify them. Vendor constraints
are likewise risky because in many, many cases—vendors are not the constraint.
Resource constraints are not good first choices to target because most
“bottlenecks” turn out to not be real bottlenecks and we need time to really decide
whether a resource is a constraint or not…again, we need the schedule we are
trying to create.
So, the only category left is market constraints—client orders. So, let’s use them.
The only thing limiting us from making more money is the market demand. It is
safe to assume that even if we do have internal constraints, we can still have
market constraints. This is true is we have bottlenecks and where we have
capacity constraints due to lack of sufficient protective capacity. Neither of these
conditions will mask our market constraints and invalidate our process.
The only time the market is not a constraint is when we do not have to specify
delivery dates to customers. Does that ever happen? Maybe if we only produce
one product that is immediately grabbed by the market…very rare.
Next we need to exploit the constraint (the market). In this case, we need to
simply meet our delivery dates. So, we move to the next step, subordinating
everything else to client orders (the constraint). In this chapter—Goldratt
chooses to circumvent this process and actually go back and look for additional
constraints before subordinating to the market constraint because (in this
example) the exploitation phase is inadequately illustrated.
To help us find bottlenecks (that by definition are time-dependent), we will set an
arbitrary time interval of present date to the most remote due-date of our client
orders. These due-dates are defined as the “schedule horizon.” From this we
need to look at the workload for resources based on the schedule horizon. This
can be misleading data…but we can’t give up. Let’s just concentrate on all orders
whose due date is earlier than the scheduling horizon plus a shipping buffer. We
will account for all the set-ups, size of the batches, etc. After all the needed
calculations are accomplished for our resources, we can compare that to our
schedule horizon. If the load placed on any resource is greater than its availability
—we do have at least one bottleneck.
30. How to work with very inaccurate data
What if we collect all the data and we find we have a constraint—but it is really
not? What if it is, but our data says it isn’t? In one instance, the first—it is
dangerous to identify a non-constraint as a constraint. In the second case, the
only harm is some computer processing time lost—in this day and age, not a big
concern. The real question is how can our data show we have a constraint when
we really do not?
A closer look at the data shows that of all the resources that seem to not have
enough capacity, one resource (the one that takes 2 hours to process—the
others take just 1) is most likely our resource constraint. But, this little bit of
insight does not fully prove anything. If we are right, we have a conflict between
the market constraint and the resource constraint. By definition, any resolution of
this conflict will yield a degradation in the company’s performance. Is our
conclusion based on erroneous data? We know it is almost impossible to keep
accurate process times data for ALL processes. But, we can verify just a few…
but which few?
For resource constraints, we based our calculation on computation of resource-
type availability and on their required load. The availability was based on the
calendar (usually uniform for entire organization) and on the data of number of
units available from this resource. The number of resource units can be very
inaccurate. Let’s assume we checked this data and found it all to be accurate.
We move to the data we used to calculate the load. We concentrate only on the
process times that are required by this particular resource. This may seem
obvious. But usually, when data accuracy is questioned, the normal response is
to “clean the data to 95% accuracy.” Any system that goes in that direction
misses the point of an information system to highlight clearly which data elements
(out of the entire maze) should be checked, narrowing it down to a feasible
amount to verify.
Our system (per this example) should display to the user a chart dealing with
which tasks are absorbing what percent of the availability of our suspected
constraint. We now need to match this up against our “big load tasks” (client
orders). Avoid the temptation to store all these calculations. How much of it will
be accessed later? Remember that computer speed in calculating is much faster
than in storing/retrieving. Recalculate instead of storing intermediate results.
Once we pass the stage of verifying the very few data elements that caused us to
suspect the existence of a resource constraint, we are ready to sort out apparent
conflicts between the company’s constraints. Here comes the real test of our
information system. Narrow the conflict down to its roots. Give the users clear
alternatives so that they have no real difficulty choosing using just intuition.
31. Pinpointing the conflicts between the identified constraints
Identifying a bottleneck (constraint) means that we cannot satisfy all orders on
their respective dates—not enough capacity at least on one resource. Our
information system does not have the required data to make the appropriate
decision. Who should we short? By how much? What are the other alternatives?
We need our information system to focus on the conflict AND allow the managers
to make the decisions—not the computer.
We go to our five focusing steps. We have identified our constraint(s) and the
conflicts (the market is one). We exploit that resource by making sure every order
is one-time. Now, we must subordinate. Subordinating means ignoring any of the
resources own limitations and concentrating on finding out exactly what we would
like that resource to do to satisfy the constraint.
During this phase, you may be tempted to go into a “sophistication” process
where you input, collect, and retrieve large, detailed data sets that may have very
little meaning or relevance to the outcome. Avoid this temptation. We must deal
with only the data we need. In our market constraint example—we allocate our
stock based only on due-date. The ones with early due dates take precedence
over later due dates—simple as that.
Next we want to know WHEN the resource is to perform. We know the due-date
of the order and we know the shipping buffer. We should “release” the task from
the resource constraint a “shipping buffer” before it’s due to be shipped. If we do
that, we may find that many tasks conflict—we expect that. Maybe we should
find which tasks conflict (relatively simple computer code based on the calendar
of tasks) and adjust. On first blush, let’s take the conflicting tasks and merely
push their processing start dates earlier. We will increase inventory—but that’s
OK given the example. Having pushed the processing dates earlier, we reduce
our conflicts—but create and infeasible solution with some processing start dates
becoming yesterday. To fix this, we can adjust our processing dates forward to
ensure all dates are future starts—again simple coding for today’s computers. In
the end, we acknowledge the arbitrary nature of moving the start dates. Some
tasks will be high-risk for Murphy. However, we have adjusted our focus to a
manageable level—only a few tasks will require managers to pay close attention
to disruptions.
32. Starting to remove conflicts—the system/user interplay
At this point we have to make some distinction as to where an information system
stops and user intuition must take over. In looking at our processing blocks, the
information system will certainly guide us through a valid decision process, but
human intuition is needed to avoid pitfalls. As the discussion in this chapter
articulates and Goldratt’s series of Socratic type questions demonstrate, the point
comes where the user must look at each “red block” and decide in what order to
resolve them.
For instance, as we require our information system to forecast and attribute
various set-up costs/times, it becomes apparent that without human sanity
checks, we would end up with a resource constraint that spends most of its time
in set-up, not production. The system user (in this example) must decide which
blocks to “glue together” and combine steps.
Have we now removed the conflicts? Nope…we may have reduced them. It’s
time for a bigger gun (overtime).
33. Resolving all remaining conflicts
Our information system should give guidance for allowing overtime per resource
based on certain parameters, under rare circumstances, and ONLY to increase
throughput. Overtime instructions are obeyed by the system without additional
intervention from the user. From our present discussion, we have tried to reduce
set-up time to free up capacity on our identified constraint. Once that attempt
failed, we may look at overtime to accomplish what we need.
Overtime may help the task we desire it to. However, it also will help other tasks
relative to their due dates. Depending on when we insert the overtime, if we cut it
too close to the due date, there may be no effect on the task we targeted—but
the tasks downstream are sped up. This relates to the idea that inserting overtime
as far in advance as possible increases the likelihood it will work for the tasks it is
intended to help. The balance is that you certainly do not want to insert overtime
as a first resort, though. Note that one hour of overtime (if it does have an effect)
will have the same effect on all resources.
Now we must insert overtime into our schedule at all points earlier than the first
“red block” or task in danger of not being met. We insert until all the tasks are
clearly feasible. If we keep inserting tasks and never get to a point where we can
satisfy all tasks…then we get to a point where overtime fails to fix our resource
constraints—then we need more drastic measures.
Now the user becomes the driver. He/She has to manipulate our information
system to off-load a particular task to another resource, split the task and remove
part of it to be done at a different time, or decide on a bigger, one-time shot of
overtime. Regardless, any action taken for any task by the user will (remember)
have major effects on all the tasks downstream. So a constant watch is needed
as each individual action is taken.
In the end, the user can give up. Maybe they will have to live with some late
orders. There may be nothing else they can do. The information system must be
able to do this as well. It will do this by setting a new due date equal to the ending
time of the latest among the “red block,” plus a shipping buffer. Missing a due
date is bad enough…What we must not do is miss a due date without warning
the customer.
We now have the first attempt at a “master schedule.” It’s a first attempt because
we can’t be sure we have found all the constraints yet. It differs from the
generally accepted concept in that it is created not only from data regarding
orders, but also from data regarding the detailed schedule of the resource
constraint.
The next step is to Subordinate everything else to the above decision. The
actions of all other resources will need to be derived, so that they will safely
support what we have already decided. At this stage we come across the concept
of the DRUM. We have set the timeline for the schedule which sets the tone for
how the process “marches along,” like to a drum.
When a second resource constraint is found—a new concept called RODS
appears. Now is as good a time as any to define the concept. The length of a rod
is one-half the resource-constraint buffer. When a resource constraint feeds itself
through operations done by other resources, we need to protect the second
(later) operation by inserting these rods. In a picture:
The movement of one block may cause the movement of many. The next
segment of our journey is the subject of subordination.
34. Manual subordination: the drum-buffer-rope method
The due dates for the orders and the exact dates for the resource-constraint
operations have already been fixed. We do not have to worry about any
mismatch between the dates. Any order is guaranteed to be processed by at
least its shipping buffer (in emergencies, half the buffer). Now we have to fix the
dates for all other activities.
First, determine the dates of release for materials. Our rule is that they should be
released a resource buffer before the date they are to be consumed by the
resource constraint. Subtract the resource buffer from the dates that have already
been established at the drum.
For intermediate operations, we want the inventory they create to accumulate
before the constraints—nowhere else. Only there does it serve its purpose as a
protection against disruptions.
We are not telling non-constraint resources, “Do it on a certain day.” We are
telling them to, “Do it as soon as you can, preferably the minute the material
arrives, but if the material arrives before the specified date, please wait, don’t
work on it, someone has made a mistake.
The resource constraints must rigorously follow the schedule. We also want
those operations that use common parts to also follow the schedule very closely
so they don’t push inventory to non-constraints that aren’t ready. For the other
non-constraints, the schedule really tells them, “don’t do it before….” Not exactly
a rigid command.
We have constructed the “drum” by pushing our tasks within the schedule
backward and forward until they made sense according to the calendar. We have
covered the operation feeding a resource constraint. We have covered the
operations feeding free orders. And we have covered the operations between the
blocks and orders. The only scenario left is operations that are not between
blocks and orders and do not feed a free order. For these, we should follow the
corresponding order by using the assembly buffer.
The schedule of an action should be derived according to the constraint date the
operation feeds. This, and the chapter’s examples, describes the “drum-buffer-
rope” procedure. We have now finished subordination—what clashes with reality
will now occur?
After all the discoveries we have made, we may be at a point where the only
thing to do is to postpone the corresponding instructions on the drum—postpone
an order. How can it be that we are faced with a choice to remove conflicts only
by decreasing throughput. Further, how can it be that we can increase inventory
and operating expenses and still not fix the problem? Are our assumptions
correct to begin with?
35. Subordinating while considering non-constraints’ capacity—the conceptual
approach
The subordination process seems to be simply subtracting the various buffers
from the dates already set by the drum. We also use the info on the length of the
buffers. Does capacity have anything to do with the length of the buffers? Yes!
Remember “non-instant availability of resources?” Sometimes, when work
arrives, a resource may be busy doing something else and the work must wait a
little while—not because of a bottleneck. Maybe we can get a handle on when
these are going to occur.
To do so, we need to construct our schedule with an emphasis on moving
backward in time. Reconsider the example of moving tasks (blocks) backwards
and then forwards again to subordinate everything to our constraint. We need to
build our scheduling system to do that. Doesn’t MRP do that already? No. At
best, it resembles a zig-zag pattern over time—with a strong tendency to move
forward over time.
36. Dynamic time buffers and protective capacity
We are tempted to start with the latest thing we are going to do (the latest order).
More precisely, the latest order that is earlier than the horizon date plus a
shipping buffer. We shouldn’t—we should start by allocating the stocks and
based on due dates (the drum).
One dominant reason for a tasks lead-time is non-instant availability of non-
constraint resources. Queuing phenomena results as people release material
even earlier than the buffer dictates. Determining queues is very difficult. Most
people use an “average queue time.” However, due to the inherent random
nature of queues, this is a very misleading number. In using time buffers rather
than queuing times—we improve considerably.
We can predict expected fluctuations in the workload. We can time the release of
materials according to the expected load fluctuations. We wanted a mechanism
to identify constraints—we got that and a significant reduction in inventory.
We rely on our information system to determine variable time buffer—we supply
the fixed portion. We are basically going to use DYNAMIC BUFFERING.
A resource needs to have protective capacity to restore the damages caused by
disturbances—not just at that resource but all the activities feeding it. The
constraint is protected only by the content of the material residing in the buffer-
origin. Note: we don’t protect just any inventory—only that which will be
consumed by our constraint.
When we subordinate, we have to be careful that a resource is not running for too
long before we enforce unscheduled time on it.
37. Some residual issues
Three chapters from the end…can we start to construct the subordination
procedure, yet? No. First we have to spend some special attention on the
“peaks” we’ve created by moving them backwards in time—that are the result of
activity on the “red lane.” This type of situation will occur only when there is no
“slack”—when the date of the block is not earlier than the date of the order minus
the shipping buffer. With the right amount of slack—the red lane peak is not a
problem. Not enough—we have to deal with the peak.
We can live with only half the buffer. Remember that the length of the buffer is
key. For every hour above the available capacity on the date of the peak will
cause the disruption to penetrate another hour into the buffer-origin. Let’s
consider some overtime. Doesn’t work, let’s contact the user. They can authorize
more overtime (the system suggests how much) or they can decide to off-load
the task to another resource (the system will tell the minimum quantity) or
postponing the date (the system must tell to what date).
What cam the user do if these don't work? Do we have an additional constraint?
The resource exhibiting this peak should be considered a constraint. We’ve done
our job and now the system must resolve the conflicts between the already
identified constraints.
Next open point. How do we take into account the time required to actually
perform an operation? It’s the time to do a batch, found by multiplying the
process time per unit by the number of units required, adding the set-up time, and
then summing the results along the sequence of operations needed to do the
task. If we do that, what happens?
We get a ridiculous result. We have to include the possibility of overlapping the
batches between different operations. In the final analysis, the direct contribution
of process times is even less than we stated earlier. If no problem of resource
availability exists, as in a line, and Murphy does not exist, then the time it takes to
complete the order is almost equal to the time required to complete the order at
just one work center. Compared to non-instant availability and Murphy—this
value is ridiculously small.
Is this the right formula? The direct contribution of the actual process time to the
overall lead-time is the time to process the batch on the longest operation, plus
the time required to process the batch at operations that cannot be overlapped,
plus the time to process one unit at all the other operations. Let’s ignore set-up
time because saved set-up is saved time, not money. If we find set-up time is
limiting a resource, we will identify it as a constraint. But it is irrelevant to our
discussion right now. Under these conditions, set-up time doesn’t affect
throughput. In fact, reducing it increases inventory at non-constraints if we are not
careful. It has no effect on operating expense—in our example, only overtime has
that effect.
Now can we start to build the subordination mechanism?
38. The details of the subordination procedure
We have all the tools needed to build the subordination process. The chapter
describes a very technical procedure. There is one important guideline—to be
very consistent in moving ONLY backward in time.
First, the system must be concerned with “current date.” It doesn’t want to “leave
anything behind”—i.e. move from the current date without a very good reason.
What makes us move? Each operation.
We need an interval of time to represent the sensitivity of the system. Anything
less than this interval can be ignored as a reason for moving forward. Our
example lends itself to a one-daytime interval (based on due dates).
This gives us 3 categories that will necessitate a move in time: the drum, the
buffers, and the peaks of overload. We need to install “reminder lists” in our
system. It should contain the entire drum—the due-dates of the orders and the
ending time of the resource constraints’ blocks.
The subordination process…start with the highest entry on the list (likely an
order) and dive from there. Go to the feeding operations, subtract out shipping
buffers. Identify the operations that directly feed the order and put the
corresponding notes on our reminder list.
Follow these steps and eventually, we’ll pick an operation, not just an order from
the list. Calculate the load that it represents and adjust accordingly the current
available capacity of the resource which is supposed to perform that operation.
As we continue to dive down, we will encounter one of 3 situations:
• Reach a material—most common situation. Jump back to nearest higher
assembly and dive down additional legs if they exist.
• Reach an operation of the drum. No action needed. Simply return to the
nearest highest assembly if it exists.
• Try to adjust the availability of the corresponding resource and we find its
current availability is already zero. Go back to the reminder list, since this
means we are going back in time.
When no conflict has been observed at the end of subordination, we will repeat
the entire last round of subordination and finalize the schedule. We will continue
to follow this basic process and use the special guidelines developed in the last 2
chapters to deal with the special cases.
39. Identifying the next constraint, and looping back
We probably have some resources that are overloaded after the first day, since
we’ve completed the subordination stage. There may be a lot of mountains of
overloads at our resources and we might be tempted to misidentify new
constraints. We must be patient. First, we need to go back and try and minimize
the overload by using set-up savings, permitted overtime, and half-buffer, forward
shoveling—sound familiar? Then consider the magnitude of the overload based
on its effect on the overall system. Again, the user can take steps to overcome an
overload…so be careful when trying to identify new constraints. Remember
identifying a constraint means an increase in inventory (additional protection).
If we do identify a new constraint, the issue becomes the relationship between
the first constraint we found and the new one we found. Goldratt refers to the new
blocks and the old blocks (the jobs feeding the new constraint and the jobs
feeding the old constraint). We have a need to define “time rods” to understand
what to do next.
Time rods are equal to the length of half a resource buffer, and are sensitive to
the date of the old block. The date for a time rod is what an iron wall is for a
regular rod. Now we can find any possible conflicts between constraints.
The system for finding the conflicts between constraints as described several
times in the text, happens over and over until all the overloads on the first day are
resolved—all the constraints have been identified, exploited, and subordinated to,
and no known conflicts have been left for the floor personnel to resolve.
Goldratt as a caution against thinking that what we have done so far ends the
discussion offers a corollary situation. In sum, there are situations where a firm
has one resource constraint feeding another resource constraint and it still may
be in a system without any interactive resource constraints. As we have used
market constraint as our first constraint, we have to realize the constraint may act
on each resource differently and thus show the caution of Goldratt as having
merit. In fact, we need to encourage this situation because it leads to increased
throughput.
We have now finished the first phase of our information system—the scheduling.
But we are by no means ready to move on to automating the control mechanism
though.
40. Partial summary of benefits
Original Inventory valuation More accurate Reduce waste & Improve scheduling
purpose and matching & product costs for increase efficiency in a job shop
overall profit management
decisions
Emphasis on Assumes a static Not addressed by Kaizen to reach 5 step method based
improvement set of constraints to ABC, but extends to perfection using the on identifying
optimize within, not activity analysis Plan-Do-Check-Action constraints
improvement technique
Short or long Short run emphasis Long run variable Long run Short run emphasis
run orientation with long run costs improvement with long run
implications implications
Main focus or Production and Cost tracing to The whole system: Making money by
concept value added by provide accurate interdependence, increasing
production costs & profits by cooperation & throughput,
departments cost object, e.g., synergy decreasing assets
products etc and operating
expenses
Production Push system with Not addressed Pull system using Demand pull using
control or emphasis on labor kanban authorizations the drum-buffer-rope
emphasis efficiency & to produce concept
production volume
Overhead cost Allocate using Trace to activities, Assign costs based No cost allocations
allocation production volume then to products on cycle time in the
emphasis & based drivers using various drivers cells
drivers
Product costs Not accurate - Fairly accurate Fairly accurate Product costs do not
accuracy distorted exist
Capacity focus Labor & machine Measure unused Measured by cycle Balance the flow of
utilization, capacity costs to time. Emphasis on work but do not try to
production volume manage capacity balancing capacity & balance plant
variances the flow of work capacity
Relation to Consistent with the Not addressed. Consistent with team Many similarities to
framework individualistic Potentially okay with or communitarian the communitarian
concepts either concept concepts concepts, but TOC is
not as broad
TOC Problems
TOC Problems & Introduction to Linear
Programming
TOC Problem 1: Find the Constraint & Product Mix needed to Maximize
Throughput
TOC Company produces two products, Y and Z that are processed in four
departments, A, B, C and D. Product Y requires three types of materials, M1, M2
and M4. Product Z requires two types of materials, M2 and M3. The company's
production process is illustrated in the following graphic adapted from Ruhl's
Exhibit 1.
The requirements for each product are summarized in the table below.
Each department has 2,400 minutes of available time per week. The Company's operating
expenses are $30,000 per week. Based on current demand, the company can sell 100 units
of product Y and 50 units of product Z per week. Sales prices are $450 for product Y and
$500 for product Z. All four materials are available in sufficient quantities. The needed
workers are also available.
Required:
1. Determine the company's constraint.
2. Determine the throughput per unit for each product.
3. Determine the throughput per minute of the constrained resource for each
product.
4. Determine the product mix needed to maximize throughput, i.e., the number of
units of Y
and Z that should be produced per week.
5. Determine the maximum net income per week for TOC Company.
6. Suppose the company broke the current constraint by doubling the capacity of
that
resource. What would become the new constraint?
Solution
The following approach is useful when there are only two products and there is
only one binding constraint in addition to demand. However, a different approach
is needed when there are overlapping constraints, i.e., more than one binding
constraint. Linear programming is needed to solve the more difficult problems
involving multiple products with multiple binding constraints.
1. Determine the company's constraint.
Time requirements to meet demand for each department are calculated as
follows :
Total Time
Department Product Y Product Z
Required Per Week
A (15 min)(100 units) (10 min)(50 units) 2,000 minutes
B (15 min)(100 units) (30 min)(50 units) 3,000 minutes
C (15 min)(100 units) (5 min)(50 units) 1,750 minutes
D (15 min)(100 units) (5 min)(50 units) 1,750 minutes
Each machine center has only 2,400 minutes of available time per week. B is the
constraint because it does not have enough capacity to process 100 units of Y and 50
units of Z per week.
Throughput per unit for each product is needed so that we can determine how to use
the
constraint to maximize throughput. Throughput per unit is as follows:
3. Determine the throughput per minute of the constrained resource for each product.
Throughput Per Unit
Product Throughput Per Minute
Minutes required in B
Y $235 ÷ 15 $15.67
Z $300 ÷ 30 $10.00
4. Determine the product mix needed to maximize throughput, i.e., the number of units of
Y
and Z that should be produced per week.
Maximizing throughput requires producing as much of the product with the highest
throughput per minute of the constrained resource as needed to meet demand. So the
company should produce 100 units of product Y. This requires (100 units)(15 minutes) =
1,500 minutes of time in the constraint department B and leaves 2,400 - 1,500 = 900
minutes for the production of 30 units of product Z, i.e., 900 minutes ÷ 30 minutes per
unit = 30 units of Z.
Graphic Analysis
The following graphic analysis provides a general approach for solving simple product
mix problems that is also applicable when there are overlapping constraints.
First, plot the constraints to find the feasible solution space. The B constraint is 15Y +
30Z = 2,400 so Department B could produce 160 Y's (i.e., 2,400/15) or 80 Z's (i.e.,
2,400/30), or some combination of Y and Z indicated by the constraint line connecting
those two points on the graph. The department B constraint and demand constraints
define the feasible solution space indicated by the mustard colored area on the graph.
2. Check the solution at each corner point, or plot the objective function and move it to
the right as far as possible in the feasible solution space. The objective function is to
maximize throughput where Throughput = 235Y + 300Z. Checking the corner points we
find that 100 Y and 30 Z provides the greatest amount of throughput.
If we plot the objective function 235/300 (i.e., it takes .7833 of a Z to produce as much
throughput as 1 Y), we can locate the solution by moving it to the outer most point in the
feasible solution space as illustrated below. The first objective function shows that 100
Ys would produce the same throughput as 78.3333 Zs. This is an iso-throughput line
indicating that any point on the line represents a combination of Y and Z that produces
$23,500 of throughput. The point indicated by 100 Y and 30 Z is the last point the
objective function touches in the feasible solution space as we move it up and to the right.
This point indicates the solution to our product mix problem.
5. Determine the maximum net income per week for TOC Company.
Sales:
100 units of Y = (100)($450) $45,000
30 units of Z = (30)($500) 15,000 $60,000
COGS:
100 units of Y = (100)($215) $21,500
30 units of Z = (30)($200) 6,000 27,500
Throughput 32,500
Less Operating expense 30,000
Net income $2,500
6. Suppose the company broke the current constraint by doubling the capacity of that
resource. What would become the new constraint?
Doubling the capacity of Department B would allow the company to produce 60 units of
product Z in addition to the 100 units of product Y. Since only 50 units of Z are
demanded, the company would have unused capacity in all departments. Therefore,
external demand would become the constraint. Of course the new solution would be at the
intersection of the demand constraints, i.e., 100 Ys and 50 Zs.
__________________________________________________
Ruhl, J. M. 1997. The Theory of Constraints within a cost management
framework. Journal of Cost Management (November/December): 16-24. Ruhl's
illustration is based on an example discussed by Goldratt in Chapters 12 and 13
of The Haystack Syndrome. See Goldratt, E. M. 1990. The Haystack Syndrome:
Sifting Information Out of the Data Ocean. New York: North River Press.
(Summary).
TOC Problem2: Determine the Optimum Product Mix with Overlapping
Constraints
Hart Furniture Company produces two products, End Tables and Sofas that are processed
in five departments, Saw Lumber, Cut Fabric, Sand, Stain, and Assemble. End tables are
produced from raw lumber. Sofas require lumber and fabric. Glue and thread are plentiful
and represent a relatively insignificant cost that is included in operating expense. The
specific requirements for each product are provided in the table below.
The Company's operating expenses are $75,000 per month. Based on current demand, the
company can sell 300 End Tables and 180 Sofas per month. Sales prices are $300 for End
Tables and $500 for Sofas.
Required:
3. Determine the product mix needed to maximize throughput, i.e., the number of
End Tables and Sofas that should be produced per month.
4. Determine the maximum net income per month for Hart Company.
5. Suppose Hart Company broke the current constraint resource. What would become
the new constraint?
6. Solve the Hart Company product mix problem assuming that only 3,000 board feet of
lumber can be obtained rather than 4,300 board feet.
Solution
As indicated in the first example, the following approach can be used to solve a simple
product mix problem when there is only one binding constraint, i.e., no overlapping
constraints.
Resource requirements to meet demand for each department are calculated as follows:
Total Amount of
Activity & (Quantity
End Table Sofa Resource
available per month)
Required Per Month
Lumber (4,300 board
(10 board ft)(300) (7.5 board ft)(180) 4,350 board feet
feet)
Fabric (2,000 yards) - (10 yards)(180) 1,800 yards
Saw (16,800 min) (30 min)(300) (20 min)(180) 12,600 minutes
Cut &Trim (8,400
- (20 min)(180) 3,600 minutes
min)
Sand (16,800 min) (30 min)(300) (10 min)(180) 10,800 minutes
Stain (8,400 min) (20 min)(300) (30 min)(180) 11,800 minutes
Assemble (42,000
(60 min)(300) (90 min)(180) 34,200 minutes
min)
The Stain activity is the binding constraint because it does not have enough capacity to
process 300 End Tables and 180 Sofas per month.
2. Determine the throughput per minute of the constrained resource for each product.
First we need to determine the throughput per unit for each product so that we can
determine how to use the constraint to maximize throughput.
Throughput per unit is as follows:
Then we can determine the throughput per minute of the constrained resource for each
product as follows.
3. Determine the product mix needed to maximize throughput, i.e., the number of End
Tables and Sofas that should be produced per month.
Maximizing throughput requires producing as much of the product with the highest
throughput per minute of the constrained resource as needed to meet demand. So the
company should produce 300 End Tables. This requires (300 units)(20 minutes) = 6,000
minutes of time in the constraint and leaves 8,400 - 6,000 = 2,400 minutes for the
production of 80 Sofas, i.e., 2,400 minutes ÷ 30 minutes per unit = 80.
Graphic Analysis
The following graphic analysis provides a general approach for solving simple product
mix problems that is also applicable when there are overlapping constraints.
First, plot the constraints to find the feasible solution space. The staining constraint is
20ET + 30S = 8,400 minutes, so staining could produce 420 ETs (8,400/20) or 280 Sofas
(i.e., 8,400/30), or some combination of ETs and Sofas indicated by the constraint line
connecting those two points on the graph. The Staining constraint and demand constraints
define the feasible solution space indicated by the green area on the graph. The lumber
constraint is 10ET + 7.5S = 4,300 so the company could produce 430 ETs (4,300/10) or
573.33 Sofas (4,300/7.5) with the available lumber. Plotting the lumber constraint shows
that it is not a binding constraint, i.e., it does not limit the feasible solution space on the
graph.
Next, check the amount of throughput that could be obtained at each corner point, or
plot the objective function 200 ET + 250S and move it up and to the right as far as
possible without leaving the feasible solution space. The first objective function is plotted
to indicate the slope of the function (200/250 = .8 means that it takes only .8 of a Sofa to
produce as much throughput as 1 ET) and shows that 250 ETs produces the same
throughput as 200 Sofas, i.e., (250 ETs)($200) = (200 Sofas)($250) = $23,500. Either
approach (checking the corner points or using the objective function) reveals that 300 ETs
and 80 Sofas is the optimum solution.
4. Determine the maximum net income per month for Hart Company.
Sales:
300 End Tables = (300)($300) $90,000
80 Sofas = (80)($500) 40,000 $130,000
COGS:
300 End Tables = (300)($100) $30,000
80 Sofas = (80)($250) 20,000 50,000
Throughput 80,000
Less Operating expense 75,000
Net income $5,000
5. Suppose Hart Company broke the current constraint. What would become the new
constraint?
Breaking the Stain activity constraint would cause Lumber to become the constraint
resource because 4,350 board feet are needed and only 4,300 board feet are available per
month.
6. Solve the Hart Company product mix problem assuming that only 3,000 board feet of
lumber can be obtained rather than 4,300 board feet.
Where there are overlapping constraints as in this case, the solution obtained using the
first approach indicated above is not recommended. The graphic approach is more
reliable.With only 3,000 board feet of lumber, the company can produce 300 ETs
(3,000/10) or 400 Sofas (3,000/7.5), or some combination of the two as indicated by the
new lumber constraint line on the graph.
The feasible solution space is smaller than before and is now defined by lumber and
staining as well as product demand as indicated in the graph below.
The solution can be found by examining the potential throughput at each of the corner
points 1, 2, 3, and 4.
Corner Point Throughput
1. 300 ETs and zero Sofas (300)(200) = 60,000
2. 180 ETs and 160 Sofas (180)(200) + (160)(250) = 76,000
3. 150 ETs and 180 Sofas (150)(200) + (180)(250) = 75,000
4. Zero ETs and 180 Sofas (180)(250) = 45,000
Point 2 provides the solution because it provides the greatest amount of throughput.
The solution can also be found by using the objective function. If we plot the objective
function we can locate the solution by moving it to the outer most point in the feasible
solution space as illustrated below. The point indicated by 180 ETs and 160 Sofas is the
last point the objective function touches in the feasible solution space as we move it up
and to the right. This point indicates the solution to our product mix problem. The
objective functions in the graph are iso-throughput lines indicating that any combination
of ETs and Sofas on the line produces the same amount of throughput, i.e., $23,500 of
throughput for the lower function and $76,000 for the function indicating the solution
point.
The graphic solutions to the Hart Company problem and the TOC problem are both fairly
simple. For problems with multiple products and multiple constraints there is no graphic
equivalent, but these simple problems provide a conceptual view and introduction to more
realistic product mix problems and are useful for introducing both TOC and the linear
programming technique.
__________________________________________________
__________________________________________________
Blocher, E. J., K. H. Chen and T. W. Lin. 2001. Cost Management: A Strategic
Emphasis, 2nd edition. Irwin McGraw-Hill.
Buffa Company produces two products, X and Y that are processed in two departments,
A and B. The requirements for each product are provided in the table below.
Required:
1. Assume that the company can sell as much of X and Y as it can produce. Determine
the number of units of X and Y that should be produced per week to maximize
throughput.
2. Now assume that Weekly demand is 12 for Product X and 14 for Product Y.
What would be the new product mix needed to maximize throughput?
Solution
Question 1: Where there are no demand constraints. The Department A constraint is 2X +
4Y = 80 so the company can produce 40 units of X (80/2) or 20 units of Y (80/4) or some
combination of X and Y on the line connecting those two points on the graph. The
Department B constraint is 3X + 2Y = 60 so the company can produce 20 units of X
(60/3) or 30 units of Y (60/2) or some combination of X and Y on the line connecting
those two points on the graph.
We can find the solution by checking the throughput at each of the corner points.
The last point represents the solution since it produces the greatest throughput.
Another way to find the solution is to plot the objection function. The objection is to
maximize throughput = 60X + 50Y. It takes 1.2Y (60/50) to generate as much throughput
as 1X, i.e., (1.2)(50) = 60. The first objective function plotted is 12Y and 10X. Moving
the objective function up and to the right, parallel to this function indicates the solution
point on the graph at 15 units of Y and 10 units of X.
Question 2: Where the demand constraints limit the solution space. We can see that the
solution space becomes smaller after plotting the demand constraints and the original
solution is no longer feasible.
Using the objective function also shows that the point where Y = 14 and X = 10.67 is the
solution point since that is the last point within the solution space that the objection
function touches as we move it up and to the right.
As indicated in previous illustrations, graphic solutions are only useful for solving simple
introductory problems. A technique such as linear programming is needed for more
realistic product mix problems. Linear programming and many other techniques are
illustrated in operations management and quantitative methods textbooks.
__________________________________________________
Buffa, E. S. 1963. Models for Production and Operations Management. John
Wiley & Sons. Chapter 12.
Discussion Questions
Questions related to the Theory of Constraints
What do Deming's New Economics, Senge's Fifth Discipline, Baker's Scoring a
Whole in One, and Goldratts What is this thing called the Theory of Constraints?
have in common? (See the Castellano, Young & Roehm summary).
1. What is the goal? (See MAAW's Chapter 8) or (See the Ruhl summary).
2. What prevents an organization from achieving the goal? (See the Ruhl
summary).
3. What is a constraint? (See the Ruhl, Atwater & Gagne, Rezaee & Elmore and
Huff summaries. Question 1 in the TOC Company problem is also relevant).
4. How is a bottleneck defined in TOC? (See the summary of The Goal Chapter
18).
5. Why does Goldratt condemn placing emphasis on the efficiency of non-
constraints? (See MAAW's Chapter 8).
6. How is net profit defined in TOC? (See MAAW's Chapter 8 Exhibit 8-6
alternative).
7. What is throughput? Provide a conceptual definition as well as a calculation.
(See MAAW's Chapter 8 or the Ruhl summary and graphic view). (See summary
of The Goal Chapter 8 and Chapter 10). (For an example of throughput in
healthcare see the Kershaw summary).
8. What is inventory in the theory of constraints? (See MAAW's Chapter 8 or the
Ruhl summary and graphic view). (Also see the summary of The Goal Chapter 8
and Chapter 10).
9. How is net profit increased in TOC? (Three ways.) (See the Ruhl summary).
10. What is the order of importance of the three methods of increasing net profit
in TOC? (See the Ruhl summary).
11. In reference to question 10, what is the order of importance in traditional cost
accounting? (See the Ruhl summary).
12. How is the TOC measure of ROI = (T-OE)÷I = NI÷I different from Dupont’s
measurement, i.e., (Margin)(Turnover) = (NI÷Sales)(Sales÷Investment) = NI÷I?
(See Comparing Dupont's ROI with Goldratt's ROI).
13. Goldratt argues that traditional accounting mixes controllable and
uncontrollable costs in cost of goods sold. What does he mean by this?
14. Goldratt argues that accounting measurements (either traditional absorption
costing, direct costing, or ABC costing) all rely on a poor, or invalid assumption
about value added. What does he mean by this? When is value added in TOC?
(For some ideas, see the Ruhl and Baggaley& Maskell summaries).
15. Goldratt argues that throughput accounting produces the most conservative
and objective income statements and balance sheets in the context of GAAP.
What does he mean by this and what do you think?
16. Does Goldratt confuse book value with market value in his arguments, i.e.,
questions 15&16?
17. What is a balanced plant? (See Step 3 in MAAW's Chapter 8 and the
summary of The Goal Chapter 11).
18. What is Goldratt’s match bowl experiment designed to show? (See the Match
Bowl note and Summary of The Goal Chapter 14).
19. Does JIT attempt to balance the plant? It so, how?
20. What does Goldratt mean by balancing the flow? (See Step 3 in MAAW's
Chapter 8).
21. What is the difference between activating and utilizing a resource? (See
Rules for scheduling in MAAW's Chapter 8).
22. Why is time saved at a non-constraint resource or non-bottleneck an illusion?
(See Rules)
23. What is Goldratt’s prescription for increasing throughput? (See Chapter 8).
24. What is the drum-buffer-rope method? What do the drums, buffers and ropes
represent? (See Drum-Buffer-Rope System and the Huff summary).
25. According to Goldratt, what is wrong with the concept of a cost center? (See
the summary of Westra, Srikanth and Kane).
26. Why does Goldratt advocate placing a quality control emphasis in front of a
bottleneck?
27. In traditional absorption costing, what happens to NI when the product
inventory (i.e., work in process and finished goods) increases? Why? (See the
Pop Company problem for questions 27-30).
28. What happens to NI when the product inventory decreases in absorption
costing? Why?
29. In throughput costing, what happens to NI when the product inventory
increases? Why? (See the Pop Company problem for questions 27-30).
30. What happens in throughput costing when the product inventory decreases?
Why?
31. Does ABC encourage, or discourage product diversity? Why?
32. Does TOC encourage or discourage product diversity? Why?
33. Goldratt argues that there is no such thing as a product cost and wants to
purge the term "product cost" from our vocabulary? Why? (See Goldratt 90
summary).
34. Compare Goldratt’s five step approach to the Deming-Shewhart PDSA
cycle. (See MAAW's Chapter 8 for TOC Steps, the PDSA graphics and the
Kershaw graphic).
35. Goldratt argues "don’t think cost, think throughput". Why? (See the Goldratt
92 summary). If product costs are not determined in TOC, how are products
priced? (See the Baggaley & Maskell summary).
36. Is the goal in TOC too narrow? Discuss the issue. (See the Handy 2002
summary).
37. What are some ways to exploit a constraint? (See Step 2 in MAAW's Chapter
8 and the Kershaw summary).
38. What does it mean to break a constraint?
39. What is a floating bottleneck? What causes this to occur? (See the Match
Bowl note and the summaries of The Goal Chapters 18 and 19 and Chapters 11-
14).
40. Why is Goldratt opposed to compromise? (See Goldratt 90 summary).
41. Discuss TOC in relation to JIT. Is there a conflict between the philosophies
and the various practices associated with each? (See the Comparison and see
the Goldratt 92 summary).
42. Goldratt is critical of the JIT emphasis on non-financial measurements of
performance. What is his argument? (See Chapters 10 and 24 of the Haystack
Syndrome summary).
43. Discuss the concept of variability in relation to TOC and JIT.
44. Some authors argue that TOC and ABC can be integrated. What is the main
argument related to this view? (See the summaries by Holmen, Huang, Coate
and Frey, Demmy & Talbott, Kee, MacArthur 93, Campbell 95 and Campbell,
Brewer & Mills).
45. Other authors argue that accounting professionals cannot agree with both
TOC and ABC and that those who discuss integration focus on the wrong issue.
What is the relevant issue according to these critics? Discuss this opposing
viewpoint. (See the ummaries of Louderback & Patterson, Corbett, Westra,
Srikanth & Kane and Goldratt 92).
46. What is the Evaporating Cloud Method? What is the purpose and how does it
work? (See the Goldratt 90 summary).
47. What is the Effect-Cause-Effect Method? What is the purpose and how does
it work? (See the Goldratt 90 summary).
48. What is the Socratic Method? Why does Goldratt advocate using the Socratic
method? (See the Goldratt 90 summary).
49. What is the goal of the product mix decision in TOC? See the TOC Problems.
50. How is the product mix determined in a TOC system? See the TOC
Problems.
CHAPTER 11 What is a theory?
http://maaw.info/ArticleSummaries/ArtSumChristensenRaynor03.htm
Christensen, C. M. and M. E. Raynor. 2003. Why hard-nosed executives should care about management
theory. Harvard Business Review (September): 67-74.
Summary by Kelly Brummett
Master of Business Administration Program
University of South Florida, Fall 2003
The formula for success at one company does not always translate into success for another company. Yet,
consultants and managers all too frequently apply the same principles of success in every situation. It is
imperative that the dynamics of the company be examined before applying any theory.
Management must first understand what a theory is and from where it is derived. “A theory is a statement
predicting which actions will lead to what results and why” (p. 68). Actions are not just arbitrarily taken;
rather they are the result of an expectation by a manager. Theories are important for two reasons: 1)
Assist in helping individuals make decisions; and 2) Provide guidance for understanding what is
happening in the present and why.
Theories are the product of a three-stage process. First, a phenomenon to be investigated must be
described. The first stage is very important because the phenomenon needs to be carefully observed,
taking note of its breadth and complexity. In the second stage, aspects of the phenomenon are classified
into useful, relevant categories. This categorization allows researchers to organize complex information
into meaningful distinctions. Finally, during stage three, researchers can develop a hypothesis of cause
and effect relationships of the phenomenon.
The three stages of theories are constantly repeated until researchers are confident enough to make
predictions about what should happen in similar circumstances. Frequently, while repeating the process,
researchers observe something in the theory that cannot be explained or predicted, an anomaly that
implies something different is occurring. It is then imperative to revert to the second stage to re-examine
the categories defined. The presence of an anomaly allows researchers to more accurately explain how
the phenomenon should work in a variety of situations.
For example, Michael Porter saw anomalies in the theory of comparative advantage that had for many years
explained international trade. His research demonstrated that while the traditional theory on comparative
advantage was valid, other factors played important roles in a country’s ability to increase its advantage
in the global market. His theory of “clusters” explained how a country could exploit its natural resources,
but another country lacking essential natural resources can create policies to build “process-based
comparative advantage” (p. 69).
Typically, early in the research process, categories are defined according to the attributes that seem to be
correlated with a particular outcome. However, categorization based on correlations is actually based on
the researchers uncertainty. Stating that a casual relationship exists as a result of correlation implies that
researchers do not fully understand what causes a given result. Unfortunately, many researchers use the
correlation basis, incorrectly believing that they can increase their results using supercomputers and
databases for number crunching and regression analysis to manufacture statistical significance.
Breakthroughs in determining causality do not come from number crunching, but from a careful, detailed
inspection of the companies to view the processes in action. For example, it was superficially thought
that Toyota’s success in manufacturing had to be related to Japan’s culture. However, after researchers
visited a Japanese plant, they noticed more significant characteristics of the system, including minimum
levels of inventory and kanban card scheduling systems. Sadly, the researchers then equated the
attributes of the plant’s success with its results. Many wrote books and articles encouraging managers in
manufacturing plants to adopt the Toyota philosophy to improve quality, increase efficiency, and reduce
costs. More careful analysis of Toyota by Spear and Bowen revealed that the success of the company
was attributed to “four specific rules that create automatic feedback loops, which repeatedly test the
effectiveness of each new activity, pointing the way toward continual improvements” (p. 71).
In order to be predictable, researchers have to ask, “What will cause this theory to fail?” instead of asking,
“What characteristics are associated with success?” Researchers need to not only identify causal
mechanisms, but also need to explain which situations cause the mechanisms to fail or succeed.
Elaborating on circumstances, known as circumstance contingent, allows managers to understand when
theories should be adjusted to fit their particular environment. It also helps management recognize
changes in their competitive environment and to begin shifting in efforts to sustain success in the new
environment. Theories that are circumstance contingent help success become predictable and
sustainable.
It is essential that researchers not only understand what factors lead to success, but also the factors that
lead to failure. Simply following the “best practices” of successful companies very often ends with
disastrous consequences. For example, in 1999, Lucent Technologies followed the management
restructuring and reorganization fad. The company divided into 11 “hot businesses” with each operating
independently. Much to top executive’s surprise, the division autonomy did not increase growth or
profitability. Instead, the reorganization made Lucent less flexible, slower to respond to customer needs,
and created new costs. The company fell victim to the remedy of the moment.
When researchers identify circumstance contingent theories, managers are better able to diagnose the
situation that they are in, and conversely, not in. Studies conducted by the authors indicate that rarely
are success theories bound by industry barriers such as product-based versus service-based. Therefore,
theories should only be trusted when they explain how phenomenon leads to success as a company’s
circumstances change.
It is important for managers to learn how to identify a good theory. Foremost, be skeptical of articles that
merely describe a phenomenon. Researchers who have formulated circumstance contingent theories
often build on descriptive accounts of causal relationships. Second, be careful not to trust an article with
a solution that cures all business’s problems. It is very rare that new categorizations reshape established
thinking. Third, if authors categorize a phenomenon based solely on attributes, just assume that it is a
starting point for a circumstance contingent theory to be discovered. Fourth, “correlations that
masquerade as causation often take the form of adjectives. . . a real theory should include a mechanism
– a description of how something works” (p. 73). And lastly, remember that a researcher’s test results
should not be considered final. Progress is a result of constant testing to understand which situations will
lead to failure in efforts to refine the theories.
CHAPTER 11.1 Changing Minds - Academic Theories
Links http://maaw.info/TheoryLinks.htm
This is the deepest level of information on this site, covering lots of academic theories that are relevant to
changing minds.
• Alphabetic list of Theories: All the theories in one big alphabetically-sorted list!
Grouped by type:
• Motivation: Basic systems that get us going (and keep us going).
• Belief: What and how we believe.
• Meaning: How we make sense of the world and infer meaning.
• Emotion: Affect and what we feel as emotion.
• Memory: Memorizing and recall.
• Attention: How we pay attention to things around us.
• Understanding ourselves: How we perceive ourselves.
• Understanding others: How we make sense of other people.
• Discomfort: How we handle discomfort.
• Attribution: How we attribute cause.
• Forecasting: How we forecast what will happen.
• Decision-making: How we make decisions.
• Decision errors: Mistakes when we make decisions.
• Conforming: Conforming with social rules.
• Being contrary: Acting differently or in non-conforming ways.
• Helping others: Sometimes we are just very helpful.
• Persuasion: Changing the minds of others.
• Resistance: Resisting attempts to persuade.
• Trust: Building trust of others.
• Leadership: Leading followers.
• Lies: Telling things that are not true.
• Power: Being able to achieve our goals.
• Friendship: Making friends with others.
• Behavior: General behavioral responses.
• Groups: How groups think and act.
There is also:
• Clusters: All theories in clusters of meaning (similar to above).
SEE ALSO
Psychoanalysis, Critical Theory
CHAPTER 11.2 CONTINGENCY MANAGEMENT THEORY
Management History
Provides an overview of management theory history. Describes the benefits of systems and contingency
theory in integrating managerial techniques. ollie.dcccd.edu
Overview of Contemporary Theories in Management
Briefly describes the principles of Contingency and Systems theory in the context of modern
management systems. www.managementhelp.org
Fiedler's Contingency Theory of Leadership
Details Fred Fiedler's Contingency Theory of Leadership and its contribution to knowledge management.
www.stfrancis.edu
Sponsored Links
MIT Executive Programs
Providing managers with the skills to lead successful organizations mitsloan.mit.edu/execed
Contigency Theory
Search for Contigency Theory Find Contigency Theory
Ask.com
Contingency Definition
Look Up Contingency Now Fast Definitions with Free Toolbar
Dictionary.alot.com
Contingency management theory asserts that there is no one best way to manage an organization
because external factors, known as contingencies, are always influencing the activities and outcomes.
The structural contingency theories that emerged in the 1970s have had a major impact on many other
contemporary management theories.
Get to know the contingency management theory basics by investigating the following:
1. Learn how contingency theory fits into other management theories currently in use;
2. Use contingency management theory to evaluate and understand decision-making;
3. Discover how contingency theory is used to understand individual leadership.
Action Steps
The best contacts and resources to help you get it done
One important feature to keep in mind when using contingency management theory is the idea that all
activities and actions are based within a certain context. Contingency management theory helps
businesses take into account the contexts of their work in order to understand their company
environments and increase effectiveness.
Learn how to best implement contingency theory in your organization using the following steps:
1. Investigate Vroom's contingency theory models and software for discovering leadership type;
2. Use Fiedler's LPC scale to assess leadership behaviors using contingency theory;
3. Implement contingency theory through project and contingency planning models.
Action Steps
The best contacts and resources to help you get it done
Fred Fiedler is a theorist whose Contingency Trait Theory was the precursor to his Contingency
Management Theory. Fiedler believed there was a direct correlation to the traits of a leader and the
effectiveness of a leader. According to Fiedler, certain leadership traits helped in a certain crisis and so
the leadership would need to change given the new set of circumstances. Fiedler's Contingency Theory
proposes the following concepts:
1. Fiedler's Contingency Theory says there is no one best way to manage an organization.
2. Fiedler's Contingency Theory of leadership says that a leader must be able to identify which
management style will help. achieve the organization's goals in a particular situation
3. The main component of Fiedler's Contingency Theory is the least preferred co-worker (LPC) scale
which measures a manager's leadership orientation.
Action Steps
The best contacts and resources to help you get it done
FRED FIEDLER
Fred Fiedler is the main theorist who developed the idea of contingency management. His theories focus on
the leader and the way that the leader relates to the employees that he or she manages.
I recommend: You can learn more about Fred Fiedler and his theories in the book Great Writers on
Organizations by Derek Salman Pugh and David J. Hickson.
LEAST PREFERRED CO-WORKER SCALE (LPC)
The least preferred co-worker scale, or LPC, asks leaders to rate people with whom they do not enjoy
working. The results of this 'test' show what type of leader he or she is. Those with a high LPC score
focus on relationships when leading; those with a low LPC score focus on tasks when leading.
I recommend: ChangingMinds.org describes the least preferred co-worker scale.
VROOM-YETTON-JAGO NORMATIVE DECISION MODEL
The Vroom-Yetton-Jago Normative Decision Model allows leaders to ask a series of questions about a
project, which in turn shows them the best way to manage a particular project. For example, some
projects require a higher level of participation from the leader.
I recommend: Learn more about the Vroom-Yetton-Jago Normative Decision Model, including a diagram,
from College of St. Scholastica.
GARBAGE CAN MODEL
The garbage can model states that an organization is similar to a garbage can in that people dump many
different types of problems and solutions into it.
I recommend: 12 Manage gives a more thorough description of the garbage can model.
SITUATIONAL CONTROL
Situational control is how a leader maintains control over a particular situation. Different types of situations
require different methods and levels of control, and the leader's style should be suited to the project.
I recommend: Learn more about situational control from Situational Control and a Dynamic Theory of
Leadership.
LEADER-MEMBER RELATIONS
Leader-member relations are the ways that leaders and employees interact with each other. Good
interactions are an important part of an organization's success.
I recommend: The article Leader-Member Relations as a Function of Rapport Management discusses
leader-member relations. Download the entire article to learn more.
Directory Listings | Web Listings | Advertise With Us
CHAPTER 11.3 MANAGEMENT THEORIES
CHAPTER 11.4 BOB JENSEN'S THEORY PAGE
CHAPTER 12 Links http://maaw.info/TheoryLinks.htm
http://maaw.info/StrategyRelatedMain.htm
MANAGEMENT AND ACCOUNTING WEBMANAGEMENT AND ACCOUNTING WEB
=MANAGEMENT AND ACCOUNTING WEB
Strategy Related
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CHAPTER 13 (or new issue?)
Strategy and other Graphic Illustrations
Causal Models, Strategy Canvases, Strategy & Value Stream Maps
(Strategy Related Main)
Strategy Canvases
Causal Models Strategy Maps Value Stream Maps
& Value Curves
Fast Food Body Shop Balanced Scorecard Sales Order Value Stream
Sears Borders and Barnes & Noble Fannie Mae
EFS Mobil NAM&R
Formule 1 Store 24
Quicken
Southwest Airlines
Causal Models
Fast Food Strategy Map
Baggaley, B. and B. Maskell. 2003. Value stream management for lean companies, Part I. Journal of Cost
Management (March/April): 23-27.Summary by Hsin-Yi Chen
Master of Accountancy Program
University of South Florida, Fall 2004
The main purpose of this article is to explain the systems and controls that are best suited to the lean
company. According to the authors, there are three major lean management issues that need to be
considered:
1. Developing an appropriate management focus,
2. Organizing by value stream, and
3. Costing by value stream.
This article (Part I) covers only the first two issues concerning the steps related to organizing the enterprise
by value stream.
Developing an Appropriate Management Focus
A lean company places emphasis on creating value for customers. Value is added through many different
processes rather than by one specific process such as production. For example, in the case where a
customer places an order, value is added from taking the order, manufacturing products, shipping goods,
collecting payment and after-sales services. The chain of these processes would become a value stream
for sales (See Exhibit 1). A lean company recognizes the connections along the entire stream of the
work performed in order to achieve a smooth flow of the product to satisfy customers; in other words, to
create value for its customers.
This is the key difference between the management focus of the lean company and the traditional company.
The traditional management concept focuses on organizing or managing the company by production
departments. Thus, each department is designed to be efficient rather than to produce a smooth flow of
work to serve the next process or department. According to the authors, the primary purpose of
management in a lean company is to identify the value stream in order to improve the flow of work
required to meet customer needs.
Organizing by Value Stream
When lean manufacturing matures within the company, there is a need to manage the value stream. Thus a
manager would be assigned with the profit and lost responsibility related to the value stream. The
growth and improvement strategies revolve around the value stream because it provides the visibility for
managing continuous improvement.
The Simplicity of Value Stream Organization
The lean company strives for simplicity of operation. Thus within a lean organization there would be only
three or four value streams with a clear cut line of responsibility. A traditional organization would have a
complex organization chart, hundreds of cost centers and thousands of transactions to keep track of
people. It is obvious that managing with the value stream perspective really simplifies management.
Value Stream as the Focus for Improvement
For each value stream there would be a continuous improvement (CI) team to review the value stream
performance measurement and make improvements on time. The CI team within the value stream can
see the entire flow of the work, thus the improvement benefits the whole system rather than a single
process.
Implementing the Value Stream Organization
Implementing lean manufacturing can include implementing value stream management at the same time.
Basically, there are three stages in the progression (see Exhibit 2).
At stage 1, lean manufacturing is first introduced and a pilot lean cell is implemented. There is no need to
change the original organization chart in the short term.
At stage 2, lean manufacturing widely spreads in the plant and product groups, crossing organizational lines
within the plant as each lean cell is linked into the value streams. At this stage it is necessary to manage
by value stream and assign both production and support people to each value stream. Support people
are important to the value stream because they make sure that the services are there to maintain the
rate of production. The authors provide an example of support functions that need to be more available
to a lean value stream:
1. Production Control – to manage the size and number of kanbans required to achieve value stream target
rates of production.
2. Transportation – to ensure that the right materials and tooling are at the right cells and at the right time.
3. Procurement – to ensure that materials are received from suppliers in the right quantities and on time.
4. Manufacturing Engineering – to ensure the focus on continuous improvement.
5. Maintenance – to limit equipment downtime, especially in a constraint resource.
There may be a problem of assigning people to value streams due to a shortage of people. It may be
necessary to have a person serving in many value streams for the short-term, but for the long-term cross
training would become necessary to solve this problem.
It might appear that implementing lean manufacturing with the value stream concept would require additional
people, e.g., several production planners rather than a single production planner. However, this potential
problem can be solved in two ways by:
1. Eliminating unnecessary administrative tasks, for example, production planning would not be needed
when an effective pull system is in place.
2. Cross training can help in providing support skills in every value stream. Thus, no additional people would
be needed and each value stream would have all the required skills.
For complex organizations, they may find that a matrix management structure (people still report to their
functional bosses, but are assigned to work in particular value stream teams) is a convenient way to
adopt lean manufacturing without disrupting the organization. A medium or small size business can
simply forego its original structure and adopt a new one to reflect value stream management.
Conclusion
In conclusion, the authors provide some rules of thumb as guidelines:
1. When implementing lean manufacturing and value streams, move ahead step-by-step.
2. A value stream should contain between 25 and 100 people. When the stream contains too many
people, it will not be able to maintain the small-team focus required. When there are too few people, it
will not be able to maintain an effective operation.
3. A value stream should represent a significant part of the business. A business usually has three major
value streams and a fourth one to combine all the other functions that do not fit in.
4. A key idea of value stream management is to have the majority of people working in the major streams,
with only a few additional supporting departments to maintain the smooth operation of the business.
__________________________________________
Note: The second article in this set is Baggaley, B. and B. Maskell. 2003. Value stream management for lean
companies, Part II. Journal of Cost Management (May/June): 24-30. (Summary).
Strategy Maps
Balanced Scorecard Generic Strategy Map
Organigraphs
According to the authors, traditional organizational charts are outdated. The concept of a
chain of command, with top management is not necessarily an accurate illustration of the
manner in which a company operates. If someone were to look at the organizational chart
of a company, he or she may not obtain a good grasp of the organizational structure of a
company. Thus, the authors suggest organigraphs in response to the changing structure of
business and its management today.
The most conventional types of organigraphs are the set and the chain. Both of these
models are somewhat antiquated. The set is a “collection, a group, or a portfolio.” These
sets share common resources and often are unrelated to one another. An example of a set
would be a salesperson that has his unique set of customers and products. A car salesman,
for example, would only be able to sell one make of car to his repeat clients. There would
be no cross sales between salespersons. From a management perspective, a set has
managers at the top of the set. These managers do not get involved in the actual business
process, but rather supervise from a distance.
The second model is the chain. These show a connection between different events in a
company. Combined, these events create a business process. Assembly lines and supply
chains are two examples of the chain. Each chain in an organization has a manager. They
oversee the entire process. Chains are fairly common in business today and companies
would not exist without them.
Two other types of organigraphs are becoming common. The first is the hub. The hub
serves as a central checkpoint, or coordinating center, for all process activities. This is the
point through which “people, things [and] information move.” From a management
perspective, the person at the center of the hub becomes the manager, or coordinator. The
coordinator may not necessarily be in a “management” position. For example, a nurse
may be a hub coordinator for patient care, rather than a doctor or hospital administrator.
Chains may become hubs by transforming from a small process to a large operation. For
example, a supply chain may become a hub for a manufacturing process. The chain is the
hub for a larger process.
Another newer type of organigraph is the web. In a web structure, the company has
several “nodes” that all communicate with each other, without going through a central
coordinator. Webs allow for “open-ended communication and continuous movement of
people and ideas.” There is no single manager for a web. Rather, all individuals may act
in a management capacity. “Managers have to be everywhere.” Management structure
may be loose or undefined.
While the organigraph is somewhat novel, companies have been using the concepts in
their organizational structures for a long time. Other types of structures exist. The four
discussed above are the most popular. However, any structure can be designed if it better
depicts the organization of the company’s business processes. The more complex the
company, the more complex the organigraph is.
An organization is not restricted to one type of organigraph. It may have several business
functions each represented by the different structures. As discussed before, a chain could
be a hub for another, larger process. Also, companies may shift between the different
types of organigraphs. It may begin as a more traditional set, move to a hub structure, and
then transform into a web. If a company reorganizes, it may change the design of its
organigraph.
A new idea exists, related to the core competencies of a company. A core competency is a
group of “knowledge, skills or resources” that form a foundation for the structure of a
business process. These competencies can be diagrammed as the hub of an organization.
From this hub, all activities and processes of the company stem.
Organigraphs are not meant to replace the organizational chart. Instead, they provide for a
new view of the organization. Organizational charts can still illustrate the authority of
official management, but they do not represent the actual management of a company's
business processes. In order to obtain the best understanding of a company’s operations, it
would be to one’s advantage to look at both the organizational chart and the organigraph.
See more illustrations below.
Some Questions & Additional Graphic Illustrations
1. What is an organigraph?
An organigraph is a drawing, picture, or map of the way people and work are organized
within an organization. It shows the connections and the interdependences to help
managers see critical relationships and competitive opportunities. An organization chart,
on the other hand, puts management at the top and treats everything and everyone as an
independent box.
2. How do the different forms of organization (i.e., sets, chains, hubs, and webs) differ in
terms of how they are managed?
The authors point out that management is the servant of the organization, not its purpose
and that management needs to be put in its proper place. The relatively new forms of
organization (e.g., hubs and webs) require a different form of management that is very
different from the older form that emphasized control. If companies are to prosper in
today's economy, management needs to fit the organization whether at the center as in a
hub or throughout as in a web.
Overcoming the stovepipe organization
Today, most businesses are moving from a narrow functional (stovepipe) view of the
organization to a cross-functional (holistic) view of the organization. Moreover, models
with a functional focus, still exist in many organizations and conflict with the current
organizational focus of continuous improvement and being "world class." Thus, process
model integration, an organization-wide view, which integrates existing models within
different functions, has become the focal point of many organizations. Model integration
is consistent with activity-based management and not the function-specific approach that
currently prevails.
A company has the following models developed independently of each other (thus,
having a functional focus):
Econometric marketing model- forecasts demand in terms of sales volume for a product
for the next fiscal year,
Financial model- determines the revenues and net income from sales of the product
given demand volume, manufacturing and distribution expenses, and product price.
However, these currently existing models, built in isolation of each other, are unable to
provide management with useful answers to questions such as:
What effect will developing islands of automation in the manufacturing process have
on net income?
What will happen to revenues if demand for our product softens as a result of decreased
spending by Department of Defense?
What baseline price do we need in order to provide for customer needs while
maintaining long run profit goals?
Thus, by integrating these models where the outputs of one serve as the inputs of another,
the company is able to achieve global optimization instead of local optimization. An
integrated example of the above models is presented below.
Nevertheless, to develop such a highly integrated model in a stovepipe organization
presents many obstacles including:
Moreover, the key to model integration is data integration. An organization must be able
to develop a shared data management philosophy in order to support cross-functional
model development.
IME is a quick and easy way to support the integration of existing models developed
within different functions. IME supports the overall life cycle for specific model
development and also facilitates the composition of models from two or more existing,
constituent model components. The latter process is known as model integration. Model
integration, however, requires a shared view of the strategic goals of an organization, the
business processes necessary to realize those goals, and the mathematical models required
to support those business processes. This, in turn, requires an information system
infrastructure that promotes the sharing of data and the models, which use the data. IME
is the component of this infrastructure, which supports the development, integration, and
maintenance of mathematical models compatible with an organization’s goals.
Further, a necessary requirement for model integration is that all models be expressed
using a single, consistent representation ("schemata" in IME terms). Representations
come in many forms like mathematical, graphical, narrative, and as computer programs.
An example of a representation is Structured Modeling (SM) that offers different forms of
viewing models that are customized as per user’s interest and technical capability.
Another advantage of SM is that it supports and facilitates model integration.
The other dimension of IME, besides the schemata, is the library of model solvers (i.e.
software, algorithms, etc.), which manipulates the model schema and solves particular
model instances. IME is thus, also used as a tool to convert data from the model schema
data structure to the particular format desired by solvers (i.e., SAS, Simscript, GAMS,
Spreadsheet, etc.). Such "grand scale" IME models however, are not in existence today
and are only a hope for the future.
Use cross-functional design teams: Include representatives from providers to, and
customers of, the function and choose team-members with great care. Also, it is important
to ensure sufficient availability of resources and the creation of an environment that is
supportive of the cross-functional team;
Make the user the leader of the design-team: Although technicians are organizationally
"above" the users, the technicians should be assigned to work and take direction from the
user;
Develop the model within an IME: Use model schema representation like Structured
Modeling (SM). The achievement of this third objective, however, is contingent upon
successful implementation of the first two recommendations.
Convert the model to the IME: Develop appropriate schemata. To do this however,
"reverse engineering" may be necessary.
For existing models, "reverse engineering" is necessary to convert them to the IME. This
requires developing the appropriate schema. As this is usually a time-consuming and
costly process, an organization may want to choose only the most critical models to be
reverse engineered and leave the rest untouched. Thus, a cost-benefit analysis may be
needed to identify which models are most critical. However, in conducting such analyses,
both quantifiable costs and benefits and qualitative impacts must be considered. By
performing such an analysis, an organization is able to promote a cross-functional
awareness and focus. Thus, in this process, the organization is able to evolve
incrementally towards an integrated modeling environment.
Conclusion
In order to achieve a cross-functional focus a change is necessary not only on the "shop
floor but also in the models used to support decision making, and by implication, changes
in information resource policies" (p. 211). Further, successful implementation of model
integration requires a high level of coordination and cooperation than before. Moreover,
"model integration is not an answer to modern management problems, it is simply one of
many tools that will help today’s managers make more informed decisions and maintain a
competitive market position" (p. 211).
Introduction
Activity Management
Business Strategy
Gosselin uses the Miles and Snow typology for classifying businesses by strategy.
The defining characteristic is the rate at which the organization changes its products and
markets. Prospectors exhibit the fastest rate of change. Defenders are the exact opposite
of prospectors; they “compete aggressively on price, quality, and customer
service”(p.108). Analyzers fall somewhere between prospectors and defenders. Reactors
do not have a defined strategy.
Given that ABC is considered an innovation; and past studies have demonstrated
that prospectors are better able to incorporate change into their organizations, the
following hypothesis is proposed:
H1: A prospector strategy is positively associated with the adoption of an AM
level.
Organizational Structure
Gosselin posits that certain organizational structures will facilitate the diffusion of
innovation better than will others. Two theories are examined: dual-core model and
ambidextrous model.
Methodology
Three categorical variables were created to test each of the three hypotheses.
Results
The hypotheses are tested preliminarily through a Chi-Square analysis, and then
using a logistic regression approach. H1 is supported: prospectors were found to more
frequently adopt AM than analyzers and defenders. H2 was also supported; however,
only for one of the three variables, vertical differentiation. It was determined that firms
with higher levels of vertical differentiation (mechanistic firms), were more likely to
adopt ABC. Finally, H3, which proposes a link between implementation of ABC and
strategy/structure, was supported for centralization and formalization, but not for vertical
differentiation.
This article examined both strategy and structure, and their effect on adoption and
implementation of AM innovations. It was found that adoption of AM was related to a
prospector strategy. Further, mechanistic firms were more likely to adopt the highest level
of AM, ABC; and they were also more likely to implement ABC. Further analysis of the
structure measures and their relationship to the adoption and implementation of ABC is in
order.
In this article, O’Reilly and Tushman examine what happens when contemporary
businesses try to expand outside of their existing market and products. The
authors discovered that the successful companies are those that separate new
exploratory units from exploitive traditional units, but still keep a tightly linked
executive team to manage the organizational separation. This type of company is
referred to as an “ambidextrous organization”.
Managers are expected to be able to explore new opportunities while also
making steady improvements to what already exists. Most companies are
successful making steady improvements, but cannot succeed at innovation at the
same time. The authors utilize Kodak as an example. Kodak has been successful
with traditional photography, but has not been able to compete strongly in the
digital camera market.
Exhibit 1 illustrates what the authors refer to as “A Map of Innovation”. The type of
innovation as well as the target market can be plotted on this matrix. Companies that
pursue modest incremental innovations would be plotted on the lower left while
breakthrough innovations would be plotted in the upper right area of the matrix.
Exhibit 1
A MAP OF INNOVATION*
Incremental Architectural Discontinuous
Innovations Innovations Innovations
New
Customers
Existing
Customers
The authors use two organizations, USA Today and Ciba Vision, as examples of
how companies can renew themselves with breakthrough products without
harming its existing business. Both companies were struggling to compete in their
respective markets until they became ambidextrous organizations. The following
are a few managerial and organizational characteristics of ambidextrous
organizations such as USA Today and Ciba Vision (in addition, see Exhibit 3
below):
Exhibit 3
INTRODUCTION
Michael Dell founded Dell Computer Corporation in 1984 with a plan for selling
custom-built PCs directly to the customer. By using this simple concept, Dell can
best understand their customers needs, and efficiently provide the most effective
computing solutions to meet those needs. The concept became known as the
direct business model.
The direct business model had a valuable benefit that Michael Dell didn’t
anticipate. It enables the company to have an actual relationship with customers.
This provides essential information that is used to leverage relationships with the
suppliers as well as customers.
Dell uses this information along with technology to eliminate the boundaries in the
value chain among its suppliers, manufactures, and customers. Michael Dell
describes this process as virtual integration. Technology has allowed
coordination between the company’s individual segments such as strategy-
customer focus, supplier partnerships, mass customization, and just-in-time
manufacturing. This helps to achieve new levels of efficiency, productivity, and
remarkable returns to investors.
Dell is continually refining the direct business model through virtual integration,
which relies on information technology to improve the value chain of suppliers
and customers.
SUPPLIERS
The few suppliers of Dell are the equivalent of partners. They are treated as if
they were actually part of Dell. The partnership will last as long as the partner
maintains their leadership in technology and quality.
The suppliers of Dell are told exactly what the company’s daily requirements will
be. This is made possible from the free flow of information that is shared between
Dell and the supplier. Technology enhances the economic incentives of this type
of collaboration because it speeds time to market and creates value that is
shared between buyer and seller.
This type of collaboration posses the challenge of change of focus from how
much inventory there is to how fast it’s moving. This is measured by inventory
velocity, which has Dell working with suppliers to continually reduce inventory
and increase speed.
Customers
Dell serves a wide variety of customers. They range from governmental
institutions to individual buyers. To handle this complex market, Dell benefits from
segmenting its customers. Dell is better able to understand their customer needs
in a more intimate way. This type of relationship allows Dell to obtain access to
information that is critical to their direct model strategy. Without this information,
Dell could not successfully forecast what their customers need and when they are
going to need it.
There are a vast array of information links between Dell and their customers. The
ability to sell directly allows Dell to keep track of a company or individuals total
PC purchase, country by country. This is information that can ultimately be feed
back to them. For example, when a computer isn’t working properly for a
company, the IT people don’t have to waste time figuring out the type of
configuration of hardware and software the computer has.
The close relationships that Dell has formed with its customers have allowed
them to extend the value they deliver to those customers. This value can be seen
through the ability of Dell to routinely load the customer’s software in the factory.
Dell has also set up Platinum Councils to ensure the free flow of information with
their customers on a continual basis. At these forums, Dell’s senior technologists
share their views on where technology is headed and provide an overview of
product plans over the next two years. Groups are then set up to focus on
specific product areas and discuss solutions to problems that may not necessarily
have anything to do with the commercial relationship with Dell. The ratio of Dell
people to customers at the forums is 1:1. The council allows Dell to demand
forecast.
Dell believes that its customers are in control, and that Dell’s job is to combine all
the technology available and apply it in a useful way to meet the needs of their
customers. Dell has to stay on top of what the customers’ need, as well as
monitor and understand the innovations in the material science world.
Virtual integration lets Dell meet customers’ needs faster and more efficiently
than any other model.
Conclusion
The direct business model is a unique concept that separates Dell from others in
the industry. Virtual integration relies on information technology to improve the
value chain of manufactures, suppliers, and customers. The benefits it produces
are coordination and focus. These attributes make virtual integration an
organizational model on the horizon for the information age.