Previously in this blog series, we have discovered that improved flow drives improved ROI and the missing element for improved flow is relevant information. There are four prerequisites for relevant information; an understanding of relevant range, a flow-based operating model, flow-based metrics and bi-directional tactical reconciliation. This blog will explore how conventional planning supports these concepts.
The conventional approach to managing a company involves strategic, tactical and operational perspectives. Strategy is typically set by a Sales and Operations Planning (S&OP) process. S&OP feeds a forecast to a Master Production Schedule (MPS) which is essentially a tactical filter to prevent the forecast from driving MRP directly. The MPS is a statement of what can and will be built recognizing available capacity. The MPS then sends planned orders to Material Requirements Planning (MRP) for supply order generation involving date and quantity synchronization through a level by level explosion.
Convention and Relevant Ranges
The conventional approach definitely understands the need for relevant ranges but fails to manage them properly. One clear example is using fully absorbed unitized cost metrics for operational decisions. Fully absorbed unit cost means that all of the manufacturing costs 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 changes in activity level within a relevant range. Using fully absorbed unit costing metrics creates the false impression that fixed costs vary within the short range. They do not and that is why they are called fixed costs. This causes a significant distortion in relevant information.
Another example is conventional planning’s reliance on forecasting. Predicting market behavior and conditions is a necessary component for guiding any business to success. Bringing those predictions into the immediate operational range, however, creates immense amount of distortion and waste. There are three rules about forecasts:
- They start out wrong.
- The more remote in time the forecast is extended the more wrong the forecast will be
- The more detailed the forecast is then the more wrong the forecast will be
Despite these well known facts, convention continues to use forecasts to drive actual supply orders. This means that capacity, capital, materials and space are committed to signals that have significant rates of error associated with them.
Convention and Flow-Based Operating Models
There are no shortages of flow based operating models that have been proposed within the last fifty years. The very essence of Material Requirements Planning (MRP) is to perfectly synchronize supply and demand while netting inventory to zero. Lean proposes a flow based model utilizing kanbans, supermarkets and heijunka boards. Theory of Constraints advocates yet another flow based model using drum-buffer-rope scheduling and time, capacity and stock buffering. Yet these flow-based models tend to have many tenuous, even conflicting assumptions, limiting each from fully achieving expectations. There are known cases where planners use spreadsheets to work around the formal planning system (MRP/ERP/APS) to determine what to really order and when. Many Lean and TOC implementations are isolated to specific areas of an organization and constantly struggle against imposed corporate metrics and policies as well as the legacy system. It is fair to say that convention has been lacking a practical, sustainable and adaptable flow-based operating model that meets the needs of all operational players.
Convention and Flow-Based Metrics
Make no mistake, there are important flow-based metrics in use in conventional approaches. Metrics like on-time delivery, perfect order, and fill rates are flow-based. Their use, however, is countered with conflicting cost-based metrics. These conflicting metrics obscure what is relevant and introduce self-imposed variability within organizations as personnel oscillate between protecting flow and protecting cost performance. Ironically, when flow is promoted and protected, costs are under control. The inverse, however, is not true.
Convention and Tactical Reconciliation
In convention tactical reconciliation is not bi-directional – it is a one way street. This limits the ability to drive any meaningful adaptation in the system and additionally, reconciliation is incredibly painful. Every MRP run results in massive cascading schedule changes as date and quantity changes at higher levels effect all connected lower level components. Monthly S&OP updates create massive shifts at the beginning of every month that are compounded by the MRP run. In convention this makes tactical reconciliation more akin to a cycle of tactical demolition and reconstruction.
This brings us to the real problem statement regarding a company’s inability to embrace flow:
We lack an effective organizational model, metrics and communication system that enables the ability to implement, sustain and evolve flow-based operating models at the complex enterprise level.
This problem has become more acute with the increasing level of complexity, uncertainty and volatility in today’s supply chains and the continued drive to keep attempting the acceleration and optimization of old and inappropriate rules. We must have a framework to utilize the appropriate thoughtware.
Companies need an operating model, smarter metrics and a communication system that promotes visibility to the relevant information for the promotion and protection of flow and maintenance of coherence at the enterprise level. They need a blueprint and a step by step path to install appropriate the thoughtware. The Demand Driven Adaptive Enterprise model was designed as a result of this need and will be the subject of the next blog.