According to the Goal: How Eliyahu Goldratt Helps Organizations Examine Their Processes to Achieve Maximum Results
Eliyahu Goldratt’s Business Model
Eliyahu Goldratt’s The Goal: The Process of Ongoing Improvement was first printed in 1984. Since it was published the book has sold more than one million copies. In 2004, it was released in its third edition. When Goldratt introduced the book it created a minor earthquake in the manufacturing world. Goldratt attacked some of the most basic procedures in manufacturing plants all over the United States and other parts of the world. Suddenly, a guy from Israel comes along and tells manufacturing industries that cost accounting is profoundly flawed. He claimed that managers should refrain from using performance incentives, economic order quantities (EOQ) should be thrown out, and productivity and product cost are really not what they seem (Sytsma, 1997). It seems as if those 2 years in business school and that M.B.A. on the wall are worth nothing according to Goldratt’s commonsense approach. The following will examine and contrast Goldratt’s business model with the way we traditionally look at manufacturing businesses.
Goldratt’s business model is based on two principles. The first principle defines three ways to measure whether or not businesses are achieving the goal of making money. These three measurements are interrelated and easy enough to apply to any process. The three measurements are throughput, or “the rate at which the system generates money through sales;” inventory, or “all the money that the system has invested in purchasing things that it intends to sell;” and operation expense, or “all the money the system spends in order to turn inventory into throughput” (Goldratt & Cox, 1992). The second principle of Goldratt’s model relates dependent events and statistical fluctuations to the manufacturing process. Dependent events are processes that must first take place before other ones can begin (Goldratt & Cox, 1992). An example would be a car assembly line. Before the engine is put into the car, the frame must be finished and the steering wheel cannot be attached until the steering column is put into place, and so on. Statistical fluctuations occur when one is unable to precisely predict events or quantities (Goldratt & Cox, 1992). The book presents an excellent example illustrating this principle. Alex and Jonah sit in a restaurant and Jonah points out that they are able to precisely predict the capacity of the restaurant by counting the available seats. On the other hand, they are unable to predict how long the waiter will need to fulfill their order (Goldratt & Cox, 1992). This uncertainty is referred to as statistical fluctuations.
Using these two principles we are able to apply them to the traditional business model. This model relies on forecasting and efficiencies. In this system, it is constantly the goal to reduce cost of production and keep processes running at maximum efficiency. In many cases, this model is on a microlevel because it accounts for specific areas of the system instead of focusing on the entire system. For example, it is most efficient to have every worker and all machines running constantly at 100%. If this is the case, a company gets the most out of its investment in the labor force. Companies realize that 100% is a utopian figure and scale it to an acceptable range of 85% to 95%. This efficiency rating is then used to forecast how long it will take for processes to occur and a production schedule can be determined. Oftentimes this schedule is inaccurate and companies miss out on opportunities to make money. Instead of focusing on the actual capacity of the entire system, capacities are determined for individual stages, limiting the company’s ability to make money.
The business model illustrated in The Goal: A Process of Ongoing Improvement can remedy this situation. In 1992, Goldratt titled his model the Theory of Constraints after a book he wrote with the same title. It suggests that companies should scale their entire production to the process within the system with the lowest capacity; the bottlenecks. This will make the system appear less efficient, because areas in the factory may stay idle if they have a much higher capacity than bottleneck areas. However, implementing this approach will directly add to the bottom line. The Theory of Constraints uses dependent events and statistical fluctuations as its base.
Using the three measurements, we can see why limiting production to traditionally inefficient rates actually increases the bottom line. The starting point to understand this concept is throughput. Every time throughput increases, the company’s sales increase, which directly adds to the bottom line. Throughput can only increase if the area of lowest capacity increases its rate of throughput. Running areas of the factory that have higher capacities at 100% will not increase the overall throughput of the system, and sales do not increase. The measure that increases is inventory, because the factory produces parts that cannot be assembled into finished goods until the area of lowest capacity produces enough parts. Inventory is an investment of money and thus subtracts from the bottom line. Keeping large amounts of inventory will further subtract from the bottom line, because warehouse space is costly. Lastly, running every worker and machine at 100% seems efficient but does not help the bottom line by reducing operational expense. The worker has been paid regardless if he or she works at all times. Machines have also been obtained and operational expense does not decrease when the highest efficiency rating is reached. In fact, running every machine at 100% can increase operational expense for machines, because they lose lifetime hours and consume energy. Every machine/worker must adjust its throughput to the throughput of the area with lowest capacity. This assures that operational expense and inventory stay at a desirably low figure. In fact, Goldratt suggests that this is the most efficient way to run any manufacturing business, regardless of what the percent-efficiency rating is of any area.
In The Theory of Constraints, Goldratt introduces mathematical formulas to help organizations further judge their processes. These formulas are:
• Net Profit = Throughput – Operational Expense
• Productivity = ___Throughput_____
• Turnover = ____Throughput______
The formulas can aid us further in understanding the benefits of Goldratt’s model. For instance, we can identify that throughput is very important because it influences each of the four additional measurements. The formulas also describe why plants running at 100% efficiency do not function well. According to the Theory of Constraints, these plants are highly unproductive. As described earlier, throughput does not increase in this scenario while operational expense does. Goldratt’s formula for productivity will yield a lower value in this case. Using the same analogy, net profit decreases and excess inventory is created, which will decrease return on investment. While inventory increases, throughput remains constant, which then will decrease turnover. According to Goldratt, it is wrong to run plants at their highest efficiency rating, a concept that clearly shocked U.S. manufacturers.
Another advantage of Goldratt’s model is that it can be applied on the local plant level. Every worker can apply the three basic measures of throughput, inventory, and operational expense. If they are trained to identify that inventory and operational expense cannot be increased unless throughput increases, it will enable them to make good decisions directly on the local level, without using complicated cost accounting terms (Sytsma, 1997).
Professor Sid Sytsma of Ferris State University goes as far as hypothesizing that Goldratt’s Theory of Constraint could be applied to any business and any organization. This is due to the fact that constraints do not have to be physical. This point is valid and many organizations function under this model without even realizing it. Universities only offer as many courses as are necessary and courses offered are limited to the building and labor force capacities. It makes me wonder why many manufacturing plants needed Eliyahu Goldratt’s book to learn about the Theory of Constraints.