What is your organization trying to accomplish? What is its goal?
In a business, the financial goal will typically be to make more money, now and in the future. Of course, organizations have additional goals:to hire and retain the best people, to be competitive in their industry, and to bring innovative products to market. But operationally, the financial goal will be to make more money, now and in the future.
Lisa Scheinkopf explains that we connect our metrics to our goal by measuring the primary process of the organization—the inputs, the transformation of inputs into outputs, the outputs—in a way that connects to the goal.
A premise: organizations convert money into more money by adding value
The process begins when we buy inputs from vendors. This is money that we put into the system so that we can convert the money we spent into more money.
We convert this money by transforming the inputs and selling the result to customers at a higher price than the cost of our inputs.
This knowledge allows us to define “value added” as the difference between the amount that customers pay us for the outputs of our system and the amount we paid vendors for the inputs.
If we generate more “value added” than the amount we pay for the ongoing operation of the system, then we make a profit.
The Theory of Constraints defines the fundamental financial components of an organization in this way:
- Throughput: The rate at which the organization adds value to the system by generating money through sales.
- Inventory: The money spent on purchases from vendors that the organization will turn into throughput.
- Operating Expense: All of the money that the organization spends to do the work of turning inventory into throughput. This includes everything spent to run the enterprise—wages and salaries, buildings, equipment, insurance and taxes.
The constraint holds organizations back from increasing their throughput
When we look for the constraint in the system, we are searching for the element in the system that is holding us back from increasing the rate of throughput.
The constraint could be anything in the system that limits better performance in relation to the goal. Improvements that reduce the constraint are measured as increases in throughput.
If we talk to people in the different functions of the company, we are likely to be given a long list of possible constraints. Everyone has their perception of the important problems in the company.
But if we change our view to the system as a whole we can see that the organization is composed of an interdependent collection of resources. Throughput flows through this chain at a given rate. That rate is determined by the constraint in the system.
Like a chain that can be no stronger than its weakest link, the throughput in the system can be no faster than what the constraint permits.
Find the constraint, improve its throughput, and you improve the throughput of the entire system.