Don’t know what’s holding your company back? Theory of Constraints might give you the answer

Economic Times, December 16, 2011, Mumbai

In the concrete sprawl of the Godrej manufacturing facility in Vikhroli, Mumbai, the locks division office stands out, it’s gleaming white walls, glass panes and cheerful interiors a study in contrast from its surroundings. But the interiors are only a byproduct of larger changes. The division, which makes 700 different stock keeping units (SKUs), has transformed over the past three years. Everything is automated, wastage has plummeted, inventory turns have nearly doubled and its operating profit-to-sales ratio is one of the highest in the group. Shyam Motwani, executive vice president & business head (Locks Division), Godrej & Boyce says that from the supplier to shop floor workers to retailers, everyone now ‘speaks the same language’.

The language they speak is TOC, short for (Theory of Constraints , a management philosophy discovered (he was careful never to say invented) by Israeli management guru Eliyahu Goldratt, who first outlined it in his 1984 book ‘The Goal’. The TOC approach takes a cause-and-effect route towards establishing and exploiting the ‘weakest link’ (‘constraint’) within an organisation that prevents it from reaching profitability and efficiency levels well beyond its ken. Dr Goldratt believed that it was possible for an organisation to convert its topline sales into bottomline profits in 4 years or less. It may sound ambitious to the point of being delusional, but it’s worked for Godrej.

Up until three years ago, Godrej Locks was caught in a trap commonly experienced by manufacturers everywhere. Sales predictions, no matter how meticulously collected, never fully represented what the customer really wanted. This led to overproduction – often of the entirely wrong units — which would then lie idle for months. Consequently, the distributor’s capital was locked and he couldn’t buy more from the company.

At the end of the year, the factory was saddled with huge inventory that the sales teams had to ‘push’ into the market, with incentives that hurt operating profits. It was an arrangement where everyone lost; and it should have been obvious – and yet, no one was aware of the problem prior to TOC implementation.

Following TOC, the team, along with the consultant, came up with a great way to meet the forecasting constraint. An array of seemingly baffling colour codes is now used to relay real-time information to factory workers. Red is the highest priority and yellow or green implies that sufficient quantities of a particular unit have been produced. This code applies to everyone, from delivery men who pick up raw materials to, now, the retailer who hands the final product to the customer.

Since 2008, the code has guided Godrej Locks and 600 of its distributors towards incremental savings by replacing its sales forecasting system with one based on technology that captures real-time sales and relays it to departments like production, purchase and warehouse. “We’re only making what we’re selling,” Motwani says simply, “In hindsight, it all seems so obvious.”

“In most companies, departments work at cross-purposes,” explains Sanjay Ghoshal, director at Avenir Management Services, which continues to work with Godrej on TOC implementation. He quotes the example of the telecom sector. “The collection department is only concerned with getting outstanding payments, while the sales people don’t care whether you’ve paid your bill or not as long as you buy more services. Everyone’s concerned with optimising their own department.”

Supply unchained

Another TOC convert is Bharat Bijlee, whose motor division was facing a problem of constant stock-outs, with demand exceeding supply. The constraint turned out to be insufficient levels of global optimisation across the value chain and high levels of local optimisation at each point of the value chain. “When every department has differing objectives, everyone pushes for their own targets and ends up compromising others,” says Sunil Mistry, VP (Motors) at Bharat Bijlee.

For most companies, TOC means a realignment of senior management vision. Pradeep Kapse, former CEO of Eicher Motors, was earlier heading a division of the company called Eicher Demm. Based in Thane, Maharashtra, Eicher Demm (now Eicher Engineering Components) makes gears for heavy vehicle OEMs. However, a prolonged recession from 1997 till 2002 saw the division floundering and operating well below capacity. “We were wondering whether to hold or sell that division off,” recalls Kapse, who is currently technical advisor at VE Commercial Vehicles.

Kapse, a long-time manufacturing and operations man, had plenty of career experience in turning around sick units and was well versed in ‘lean’ principles. But even then, he and his team found it tough to deal with the situation at Eicher Demm. “We blamed the market and slow demand, not ourselves,” he says.

In 2003, the division hired Ravi Gilani, founder and managing consultant, Goldratt India, to diagnose the problem. At the time, the company needed revenues of Rs 24 lakh a month to break-even, but was making just Rs 10 lakh. The first thing Gilani wanted to know was the division’s ‘on time and in full’ (OTF) delivery rate. “To our shock, it was around 4%,” Kapse says. That revelation shed light on a series of home truths. The team realised they had a dismal OTF rate because they weren’t receiving raw materials on time. The reason – they didn’t pay their suppliers on time.

That, in turn, was because getting cash from Eicher’s corporate office was a lengthy and difficult process. Therefore, the real constraint was cash, not the market.

The immediate step was to remove this obstacle. “Our receivables from customers were high, since they paid us when their customers paid them,” explains Kapse, “So we gave them a 3% discount on immediate cash payments, which they passed on to their clients. The cash we got, we passed to our suppliers who in turn, sent us raw materials on time.”

Then came the challenging part.

The company made OTF and Sales its two main priorities, with every team from operations to finance, HR and quality, getting targets that were reviewed every week. Senior management’s variable pay was linked to these twin parameters. Kapse says, “We didn’t invest anything and concentrated instead on sweating our existing resources to the fullest. For examples, key machines that would be switched off during lunch and other breaks were manned in shifts. And we only manufactured whatever we were selling; no surplus inventory that had to be pushed.”

Within a month, Eicher’s on-time, in-full delivery went to 25% and kept rising in the two years Gilani worked with the firm. Today, the figure is between 95% and 98%. And its OTF rates improved, the company became premium suppliers to its customers, since its competition was struggling. Today, the business unit has grown to four factories now, with combined annual revenues of Rs 300 crore.

It all sounds very straightforward, and that is what consultants say is the best part of TOC. “My wife asks me, ‘Why do people pay you for this? This is common sense’. I reply that it may be, but it is not common practice!” says Gilani.

Fleetguard Filters is a case in point. Having grown sales four-fold in the last five years, the Pune-based manufacturer of air, fuel and oil filters for the auto sector is one of India’s biggest TOC success stories. Yet, it had to overcome initial skepticism to arrive where it is today. SS Pandit, executive chairman says, “I’d heard about TOC earlier, but my view was, ‘If its common sense, why should we pay someone to do it?'”

A visit to Barcelona and a meeting with Eliyahu Goldratt in 2006 changed everything and made a believer of Pandit. Ironically, when he requested Goldratt to help with TOC implementation at Fleetguard, the latter refused. “Dr. Goldratt told us our market wasn’t big enough. But I was so convinced that we resolved to become Eklavya and do it nevertheless!” Pandit says. Fleetguard then went to a local firm called Vector Consulting Group, which took on the project as a challenge.

“In most organisations, it’s fairly obvious what needs to be tweaked — erroneous sales forecasting systems, wastages, low IT usage are common to almost all organisations we work with,” says Kiran Kothekar, director of Vector Consulting Group. Adds cofounder Satyashri Mohanty, “To paraphrase Archimedes, TOC says that if you have a leverage point, you can move the earth. Once we deduce the obstacles that prevent the natural flow of value through the organisation, we work with managements to subordinate everything else towards making that lever work.”

Vector worked with Fleetguard to create systems that enabled their OEM buyers to pick up any part, any time they needed it. The company also improved distributor inventory turns by going for a pull-based distribution system, similar to Godrej. In addition, Pandit says that one major lever was the company mindset. He says, “We had to accept that all people are inherently good. If a department is not performing, there was probably a systemic obstacle in the way. For example, if there is a policy to buy low-cost raw material, we are more likely to face rejections.

Similarly, if someone was working longer hours, we started investigating whether they were overloaded or inadequately trained. Making these changes called for reviews of existing policies.”

From promotion and remuneration to responsibilities and priorities, Fleetguard totally realigned its policies towards greater efficiency. “We created avenues for people to learn principles of TOC related to their field. We also linked profit growth to management compensation,” he says. In addition, Fleetguard worked more actively with suppliers to increase their profitability. The result – Fleetguard’s sales have grown by 250% over the past four years. Its main constraint is no longer production or delivery. “We are now using TOC to develop new products; essentially to grow market demand,” Pandit says.

While TOC has worked on many smaller organisations, will it work on larger firms? While the Vector team is bullish, Gilani of Goldratt India isn’t. He recalls a recent interaction with executives from an MNC. “They told me, that as per their policy, they would make losses for the first 12 years. I can’t work with people like that. That’s why I only work with owner-driven, loss making units because they’re the ones who feel the pain most acutely,” he says.

Bharat Bijlee’s Mistry says that the company had the advantage of being family-owned, which meant that there was ‘stability in thinking’. “Getting buy-in was not difficult, and that assurance of management commitment helped tremendously.”

It was the same at says Paharpur 3P, a packaging company that according to Gaurav Swarup, MD, Paharpur Cooling Towers was not making any reasonable profit before TOC implementation. “The margins in packaging are wafer thin and there weren’t enough long-run orders to enable us to scale up fixed assets.” The company decided to give TOC a try and went through intense management training sessions organised by Gilani. “I was told that come what may, I had to attend at least once a month,” says Swarup.

During the training sessions, the senior management realised that if short-run orders were the norm, they’d be better off accepting it. “No one has to tell us what to do — the answer was waiting to be found; and that’s what TOC does,” Swarup says. Like Eicher, Paharpur 3P too decided to improve its OTF rates and inventory. Machines were utilised more efficiently so that instead of 3 hours, short-run orders could be completed in 30 minutes. “It was all about reaching our potential. And the best part is, we never had to invest anything in the beginning. It was only after output doubled at the end of two years, that we started a new plant,” Swarup says.

Compared to other philosophies like Six Sigma and Lean which are used across industries, the lesser-known TOC is still primarily rooted in the manufacturing supply chain. And it differs from other mainstream approaches like Lean or Six Sigma, in a couple of ways. One, TOC is logic-focused, not data-focused. Sunny Banerjea, head — management consulting, KPMG in India says, “Approaches like Lean or Six Sigma work in a services environment where data is continuously generated – like in the IT-ITES sector. TOC isn’t as metrics-intensive and uses logic more to identify and exploit the dominant constraint as a lever for maximising the throughput”

Secondly, while TOC consultants tend to link their fees to the profits achieved, others like KPMG do not. “When an approach is still nascent, organisations will link payouts to the benefits. But once it’s tried and tested, this will not be the case and it is more viewed as a set of enabling mechanisms available to chose and apply,” says Banerjea. About 70% of KPMG’s management advisory clients in India are IT companies, with a small percentage from manufacturing. But while there are differences, KPMG doesn’t see TOC clashing with other philosophies like Lean or Six Sigma. “TOC being a logical approach can be used to identify ‘where’ one is falling short, while Lean and Six Sigma can be used as tools to improve it,” Banerjea adds.

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