PowerPoint Presentation

Why Management Cant See Excess Capacity

A Case of Mistaken Identity.Copyright 2016 We Engage LLC DBA Productivity Step Change. All Rights Reserved

In this presentation, we are going to explore a serious case of mistaken identity. We are going to conclude that most measures of operating performance are really measures of just one thing. That thingis capacity utilization. We will discuss how a functional view of organizations has obscured a holistic view and how this has resulted in disconnecting capacity utilization from operating performanceand why management should repair the misconception. 1

AcquiredCapacity168 UnitsDemand84 UnitsCopyright 2016 We Engage LLC DBA Productivity Step Change. All Rights ReservedWhat happens to EXCESS CAPACITY ?

In our example, the organizations capacity will be given as 168 units per calendar week (one per clock hour). Demand from the customer will be given as 84 units per weekor just half the acquired capacity. So the question we must answer is What happens to the excess capacity? Does our perspective really matter?2

AcquiredCapacity168 unitsDemand84 units

So, knowing we have a full 84 units of excess capacity, what are the ways in which it can be discarded? The first and possible most obvious way is to simply leave the acquired assets lying idle.right? Turn off the lights and dont activate or use the assets. What could be easier? Indeed, putting aside fully automated production processes which produce power or commodities, its hard to find any company these days, which would be planning to operate their operating assets 168 hours every week. So, in the context of our example, lets just say that we leave 10% of the 84 units or hours of weekly capacity IDLE. Where else can we discard the remaining 67 excess units? Keep in mind, there is no demand for these additional units.3

AcquiredCapacity168 UnitsDemand84 Units

The next big opportunity to discard excess capacity is found when we wish to operate production assets, but find they are not available. This may be because they are brokenor because we dont have the workers or skills required at the timeor because of power outagesor because the equipment is being maintained or overhauled. So lets say we discard 15% of the time that was not left idle. That would mean that we had almost 23 units or hours lost to downtime for one reason or another. However, we are still left with almost 40 units or hours of activated capacity, which we cant use to make product. It must be discardedbut where and how?4

AcquiredCapacity168 UnitsDemand84 Units

Moving to the next big opportunity to discard excess capacity, we find that its always possible to just slow down the operating assets to run at a speed which is well below their achievable run rate. In our example, we are given that 20% of the remaining 40 or so units of excess capacity are effectively discarded by doing exactly thatrunning the assets slowly.5

AcquiredCapacity168 UnitsDemand84 Units

With about 20 units or hours of excess capacity remaining, another way of discarding that excess capacity is to produce goods or services which dont meet the quality expectations of the client and which cant then be offered for sale after a first pass through the production process. So lets say we discard 10% of the efficient output by producing quality defects. Thats another 10 units or thereabouts which wont see a customer. However, we still have 10 units left to discard. So what means remain?6

AcquiredCapacity168 UnitsDemand84 Units

One way of discarding excess capacity is to store it, by turning it into product, and then holding it as inventory. Obviously, this cant be done with services. In fact, we can store product during one reporting period and then, in some subsequent reporting period, we can totally write off the economic value of the inventory as it never existed. We may do this because the product has been superseded in some technical context, or because the passage of time makes it worthless. This is often the case for electrical or computer related goodsand also for food, beverage, chemicals and pharmaceuticals. So, by sending 5% of our excess capacity to inventory and then writing it off, we are able to discard another 5% of our excess capacity. That leaves us with just 5% left to dispose of...so, what can we do to get rid of it? 7

AcquiredCapacity168 UnitsDemand84 UnitsCopyright 2016 We Engage LLC DBA Productivity Step Change. All Rights Reserved

Finally, there is one very common means of discarding excess capacity which remains. Sometimes it is used to jettison vast amounts of production capacity. However, in our example, we will use it to discard the final 5% of our excess. This is accomplished by selling the product at a loss. We do this by pricing it in order to deliver a unit loss, or failing to recover the total of both fixed and variable unit costs of production. Demand is significantly distorted when customers find they can stonewall prices increases and when salespeople are prepared to discount and rebate until available capacity is filled. Selling products and services at a loss is just another way of discarding excess productive capacityno matter the title given to the strategy invoked to justify such losses.8

Total Organizational Effectiveness (T.O.E.)X

What percentage of Efficient Capacity meets Quality specifications on the first pass?

What percentage of Available capacity is Efficient?

What percentage of Activated capacity is Available for production?

What percentage of Acquired capacity is Activated or manned for production?

80%95%95%50% 90%=XXX

T.O.E. is an Enterprise wide measure of system Capacity Utilization.

What percentage of fully valued Capacity is sold at prices which realize a unit profit?

What percentage of Quality Capacity is not written down to a value below its variable unit cost?

X85%90%=Capacity UtilizationActivatedCapacityAvailable CapacityEfficient Capacity

QualityCapacity

Valued Capacity

Economic Capacity

e.g.Total Operational Effectiveness (T.O.E.)

Unproductive capacity (O.E.E).Total Organizational Effectiveness (T.O.E.)Idle Capacity.Uneconomic capacity.

Copyright 2016 We Engage LLC DBA Productivity Step Change. All Rights ReservedThe Holistic View of PerformanceOperating Problems Related by Cause

Up until now, weve characterized each performance measure as being simply a different means of discarding excess production capacity across the entire production system. As a matter of fact, all of the means of discarding excess capacity may be factored to produce one product which represents an aggregate measure of capacity utilizationas you see here. Its easy to dojust change the unit of measure to reflect the amount of productive capacity which is lost. But thats not how the typical organization sees operating performance and cause. In a typical organization, every measure of operating performance has a different unit of measure. Each performance loss has a unique and unrelated set of causes. Every performance loss may be repaired locally without reference to capacity utilization.9

Copyright 2016 We Engage LLC DBA Productivity Step Change. All Rights Reservedmissing toolspoor maintenancelong set-upspoor sales skillspoor market intelligenceno standard marginsA Reductionist View of Performance:Operating Problems Unrelated by Cause

SALES FUNCTIONPRODUCTION FUNCTION

In the reductionist or functional view of the organization, every type of performance loss is caused by special problems which are not related to having to discard excess capacity. Each performance loss has a unique set of operating problems as a cause. For example, the loss of profit to low pricing isnt caused by the need to dump excess capacity from the organization as a whole. Its caused by a lack of policy, or poor data and skills. And more importantly, in this reductionist view, these problems can be fixed from within the functional scope in which they are imagined to have been created. But the holistic math of the organization stands in the way. Excess capacity must be discarded. Performance marks only the different means. The cause is shared. It is the presence of excess capacity. Truly this amounts to a case of mistaken identity. It turns out that capacity utilization is equivalent to aggregate operating performance. It also turns out that operating problems are caused by the need to discard excess capacityand they can be solved by reducing the amount of excess capacity.10

What is the level of capacity utilization in our system as a wholeand how much are you planning to lift it in this program? Copyright 2016 We Engage LLC DBA Productivity Step Change. All Rights Reserved

In the reductionist or functional view of the organization, every type of performance loss is caused by special problems which are not related to having to discard excess capacity. Each performance loss has a unique set of operating problems as a cause. For example, the loss of profit to low pricing isnt caused by the need to dump excess capacity from the organization as a whole. Its caused by a lack of policy, or poor data and skills. And more importantly, in this reductionist view, these problems can be fixed from within the functional scope in which they are imagined to have been created. But the holistic math of the organization stands in the way. Excess capacity must be discarded. Performance marks only the different means. The cause is shared. It is the presence of excess capacity. Truly this amounts to a case of mistaken identity. It turns out that capacity utilization is equivalent to aggregate operating performance. It also turns out that operating problems are caused by the need to discard excess capacityand they can be solved by reducing the amount of excess capacity.11