Understanding Operations Management through ‘The Goal’ by Eliyahu M Goldratt — Part 1

We generally classify books into two — fiction and non-fiction. I was mostly into the former during my childhood days except for a few ones that crossed paths with me occasionally. Then there are subject books which we are forced to refer when burning the midnight oil a day before an exam or deadline of a coursework. What if there is a book that belongs to all these categories ?!

I do agree with Yuval Noah Harari in Sapiens where he brilliantly articulates the historic relevance of storytelling in shaping human civilization. It started from gossiping around the fire in an old cave and now stands at gossiping by descendants of the same in social media. There are stories that stand the test of time, and some that don’t. There are some things which you don’t even perceive as a story in the first place. For example, how would you feel if I told Differential Calculus is a story ? You may frown at first but start reading Calculus by Lev Tarasov and you may start agreeing with me ! Tarasov presents the book as a freely flowing conversation between the author and the reader. Basically the ideas are connected in the form of a story rather than figments of complicated theorems spread widely apart. We will talk more about Calculus another time, now I want to bring your attention towards another book that falls in the same genre.

Operations Management

This is not something alien for a mechanical engineering or B-School graduate (If you happen to know it despite being neither, Cheers !). I am not going with any textbook definition of this, but drawing inspirations from experiences and all the definitions I know of, I prefer to see it simply as “The Science and Art of achieving a Goal”. This blog is all about taking a walk through the very basics of Operations Management using its Bible — The Goal written by management guru Eliyahu M Goldratt, subsequently reaching this definition that seems very broad at first but useful and devoid of any technical jargons. This is also not a book review but more of a detailed analysis pertaining to the key ideas discussed in the book, which can be helpful for those who have already read the book, and to create intrigue in people who haven’t read it yet.

I prefer to adapt a Three Act Structure in explaining the core ideas of the book (after all I am a movie and drama enthusiast !).

Act I

Act I introduces us to our protagonist Alex Rogo (everyone call him Al) who is currently working as Plant Manager of a company named UniCo. He is shown rushing to a meeting with Bill Peach, the vice-president of his department and it doesn’t seem good. Turns out that the vice-president himself came over to the plant to enquire about a customer order which is already 7 weeks late. To make things worse, the ordered part is not even close to being shipped. Bill makes a scene with the shop floor employees as many parts are stacked, waiting to be assembled as some parts are missing that delays the assembly even further… but he doesn’t care about all this and wants to get that customer order shipped immediately. As the plot unfurls further, we understand that Bill’s meeting with Alex is not only about the delayed customer order, but a lot more than that.

Alex’s plant hasn’t been making any money, which makes Bill answerable to the management. That brings Bill to a deal breaker with Alex, either turn things around in 3 months time or else he will have to give a proposal of shutting the plant down to the management. Now our hero has a mission impossible task in front him and he has 3 months to get it done. What next?

Jonah the Saviour

Subsequently we are introduced to another important character, Jonah. He can be seen as someone who is to Alex just like what Morgan Freeman is to Jim Carrey in the movie Bruce Almighty ! Jonah is an old teacher of Alex who is a physicist and now more into doing consulting for manufacturing companies. Sometime back, they randomly happen to meet at an airport and have a casual chit chat about Al’s current work. But that casual chit chat seemed to be an eye opener for Alex which prompted him to get back to Jonah after the new mission set to him by Bill. What was that casual talk about ?

Before that, let’s analyse two scenarios which prompt you to think. Say company ABC purchases a new lathe machine which results in an increase in productivity by 40% in the particular area which it is installed in. Do you think it was a good bet to install that machine from the company’s perspectives ? Well…yea come on, increase in productivity means increase in output with the same input so why not ?!

Well, maybe or maybe not, let’s ask a couple of follow-up question to that. Did installing that machine made the company make 40% more money than it did previously ?! Or did that enable the company to reduce its expenses by any significant measure ?! These are the same questions that Jonah asked to Alex when he explained excitedly about how the new Robots installed in two of their departments increased productivity by 36%.

So what is productivity ? Is it just merely output upon input, yes but it is even more. In the words of Jonah,

“Productivity is the act of bringing a company closer to its goal”.

So what is a company’s goal ?

Well, Alex stumbled upon this question, so its quite natural that we get stuck on this as well. But Alex did manage to get to it in a few days. He realised that the basic goal of a company or a business is to “make money”. This doesn’t imply that a business should focus only in making money and forget all the ethical aspects that comes with it, but if it needs to be sustainable in all aspects for long term, it should have cash flowing through it. Hence all other aspects such as minimising cost, improving efficiency, etc directly or indirectly contribute towards the basic goal which is making money.

Metrics to express the Goal

Excited about realising the actual goal of the company, Al get back to Jonah to share his finding and he turns out to be correct! Now Alex is worried about measuring this goal. As quoted by management thinker Peter Drucker, “If you can’t measure it, you can’t improve it”. How do we measure our goal here ? Alex comes up with many useful measurement such as Net Profit, Return of Investment (ROI) and Cash Flow. All these are pretty useful in expressing the goal, and these measurements are indeed related to each other. Increasing Net Profit while simultaneously increasing ROI and Cash Flow does translate into making money.

While Jonah does admit that these are useful in evaluating performance, he comes up with three metrics which is better to use in the context of daily manufacturing operations. These are Throughput, Inventory and Operational Expense. Sounds really familiar doesn’t it ?! But it might be new to revisit it definitions from the perspective of Jonah. (All definitions quoted exactly as in the book).

Throughput — Rate at which the system generates money through sales.

Inventory — All the money that the system has invested in purchasing things which it intends to sell.

Operational Expense — All the money the system spends to turn inventory into throughput.

So the common FAQs that can arise from these definitions can be:-

1. Is rate of production equivalent to throughput ?
   No. For example, if a company is able to product 50 units every day but only able to sell 25 units per day. That means that the other 25 units goes into the inventory, not sales, which means the company’s throughput is only 25 units per day.
2. Is labour cost accounted as inventory?
   It might be tempted to assume labour cost as inventory but it is easier and better to consider them as expenses and not inventory because that would make it easier for us to classify investments and expenses. It can be better understood by taking two examples. Imagine a company purchased a machine, this is an investment because it is assured the company gets money whenever it sells a unit of what is produced in that machine. So this investment remains the same whether the machine produces 50 units a day or 100 units a day because that cost is already accounted for in its selling price. But when it comes to labour expense, that is highly variable. For instance, consider two options, if the throughput of the company is 50 units per day with a unit price of £ 10. That means the company is making £500 per day. Imagine two workers are employed who has a productivity of 50 units per day per worker and his daily wage is £ 50. That means that the company is only able to sell 50 units of it even though the worker keeps producing 100 units. If only one worker was employed, that means he produces 50 units per day and the company is able to sell all of that is produces which results in a cost cutting of £ 50 per day. In simple words, operational expenses are controllable elements whereas investments are not.

Scenario 1 in which 2 workers are employed

Scenario 2 in which only 1 worker is employed

So in simple terms, we can say that the money coming in is throughput, money inside the system is inventory and money paid for making throughput happen is operational expense.

Now that we understand the very basics of what these terms mean, maybe now you can see the famous Little’s formula in a new perspective.

Work In Process (WIP) = Throughput × Lead Time

Here Work In Process (WIP) translates into Inventory or the money in the system. So the very basic principle is to manage the dynamics of a plant by controlling the money in the system (inventory) by varying the variables that control it subsequently achieving a balanced plant (where all resources are exactly matched with market demand) which is the dream of every manufacturer.

Now Alex got something to start with, what will he do next ? We will find that out in Act II. (To be continued…)