Thus, the question becomes: is there a well-defined and proven flow-based operational model that can scale to the multi-echelon enterprise level? Chapter 4 will focus on that model—the Demand Driven Operating Model.
Prerequisite #4: Flow-Based Metrics
If flow of relevant information, material, and services becomes the common focus for decision making in day to day operations and throughout the organization, then we need an appropriate suite of metrics for each of the relevant time ranges to support that focus. Appropriate metrics will allow us to maintain organizational coherence to that ROI objective now and in the future. Flow-based metrics should neither be a source of variability nor exacerbate variability.
Force fitting or failing to remove non-flow-based metrics in the deployed metrics suite will directly lead to conflicts and distortions throughout the organization—it will obscure what is relevant! Obscuring what is relevant directly leads to more variability, which in turn directly inhibits the flow of relevant information, materials, and services. Worse yet, when we do this, we are doing it to ourselves; it is self-imposed variation that directly hurts our ROI performance and causes great stress to the organization’s personnel.
Any suite of flow-based metrics must consider three additional prerequisites:
These four prerequisites for relevant information define what it means to think, communicate, and behave systemically—the only way to protect and promote flow. If an organization and its personnel do not have this thoughtware installed, then the flow of relevant information and materials will always be impeded to varying degrees, leading directly to poorer ROI performance. Thus, before companies invest significant amounts of money, time, and energy into new hardware and software solutions, they must first consider investing in the proper thoughtware in order to gain visibility to what is truly relevant. Technology can only provide value if it addresses a limitation that the company is facing in terms of achieving its objective.
Convention’s Failure with the Four Prerequisites
Now that the four prerequisites for relevant information are established, let’s turn our attention to the failure of convention to establish and properly use these prerequisites. First, let’s describe what the typical conventional approach looks like.
The conventional approach to managing a company involves strategic, tactical, and operational perspectives. Strategy is deployed to the organization by a Sales and Operations Planning (S&OP) process. The S&OP process balances supply availability and demand requirements resulting in a Master Production Schedule (MPS). The MPS is essentially intended to be a tactical dampener to prevent the forecast variability from driving MRP directly due to the imbalance of load against capacity. In the process of preparing the MPS, S&OP integrated reconciliation performs a rough-cut capacity check. The only bidirectional interaction between the MPS and S&OP is an “aggregation—disaggregation” process in which disaggregated demand forecasts are rolled up from the item level to the product family level to create the new forward-looking production plan. Then the production plan is rolled down into item level requirements by date, and this is used as the gross requirements line for MRP calculations.
In summary, the MPS is a statement of what can and will be built recognizing available capacity. The MPS sends this forward-looking plan for the planning horizon to Material Requirements Planning (MRP). MRP calculates the necessary supply order generation dates and quantities necessary to synchronize to that plan through a level by level explosion. Orders are then released when required by a date that has been calculated precisely from this multi-level explosion process. Figure 2-1 illustrates the conventional approach.
FIGURE 2-1 The conventional approach
Now we will turn our attention to the failure of convention regarding the four prerequisites to relevant information.
Convention and Relevant Ranges
The conventional approach clearly supports the need for relevant ranges. Figure 2-1 clearly shows a top-down linear approach that recognizes strategic, tactical, and operational emphases. The problem with convention, however, is that it improperly manages these ranges. This will be demonstrated through two examples that are devastating to relevant information and flow.
Our first example is conventional planning’s reliance on forecasting item level demand for the planning horizon. Obviously, predicting market behavior and conditions is a necessary component for successfully managing any business. The better our forecasts, the better leadership can define and manage a company’s path to success—there should be no doubt about that. However, bringing those predictions into the immediate operational range by tightly synchronizing order generation directly with a demand signal containing known error creates an immense amount of distortion and waste. There are three rules about forecasts:
Despite these well-known facts, convention continues to drive actual supply orders to forecast and then attempts to make corrections as better information is available. This means that capacity, capital, materials, and space are committed to signals that have significant rates of error associated with them. This is the very definition of irrelevant or at the very least distorted information and is one reason why forecasts are irrelevant in the short range. This is a clear mismanagement of the short term relevant range, demonstrating a lack of comprehension of this critical concept. Readers wishing to know more about this issue should consider reading the book Precisely Wrong—Why Conventional Planning Fails and How to Fix It (Ptak and Smith, Industrial Press, 2017).
Our second example of improperly managing relevant ranges is the use of fully absorbed unitized cost metrics for operational decisions. Fully absorbed unit cost means that all manufacturing costs, fixed and variable, are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, labor, and overhead costs.
Direct materials are variable costs. Variable cost is tied to unit volume, not resources. Variable costs rise and fall with unit volume but do not change on a per unit basis. Labor and overhead are fixed costs. Fixed costs are not affected by volume changes in activity level within the operational relevant range (a specific short-range period). Using fully absorbed unit cost related metrics directly creates the false impression that fixed costs can and will vary within the short range. They do not; that is why they are called fixed costs. The unitized cost equation obviously improperly mixes relevant ranges. This causes significant distortion in relevant information at the operational level and directly relates to disruptions in coherence and flow. Once again, this is a clear mismanagement of relevant range, demonstrating a lack