href="#u42c3e166-6b49-5593-a727-9aab7642b7b7">Appendix B.
• Expenses. When flow is poor, additional activities and expenses are incurred to close the gaps in flow. Examples would be expedited freight, overtime, rework, cross-shipping, and unplanned partial ships. Most of these activities are indicative of an inefficient overall system and directly cause cash to leave the organization. These types of expenses are described later in this chapter (see Figure 1-8) in relation to the bimodal distribution.
• Cash. When flow is maximized, the material that a company paid for is converted to cash at a relatively quick and consistent rate. This makes cash flow much easier to manage and predict. Additionally, the expedite-related expenses previously mentioned are minimized, limiting cash leaving the organization.
What happens when revenue is growing, inventory is minimized, and additional or unnecessary ancillary expenses are eliminated? Return on investment (ROI) moves in a favorable direction! In fact this relationship between flow and ROI can be easily depicted by the equation in Figure 1-3. This depiction first appeared in the book Demand Driven Performance: Using Smart Metrics.6
FIGURE 1-3 Connecting flow to return on investment (from Smith and Smith7)
Explaining this equation requires us to first define the elements and then show how they relate to each other:
• Flow is the rate at which a system converts material to product required by a customer. If the customer does not want or take the product, then that output does not count as flow. It is retained in the system as investment (captured money).
• Cash velocity is the rate of net cash generation: sales dollars minus truly variable costs (aka contribution margin) minus period operating expenses.
• Net profit/investment (captured money) is the equation for ROI.
The deltas and yield arrows in the equation explain the relationships between the components of the equation. Changes to flow directly yield changes to cash velocity in the same direction. As flow increases, so does cash velocity. Conversely as flow decreases, so does cash velocity. As cash velocity increases, so does return on investment, as the system is converting materials to cash in a quicker fashion.
When cash velocity slows down, the conversion of materials to cash slows down. The organization is simply accomplishing less with more. This scenario typically results in additional cash velocity issues related to expediting expenses. Period expenses rise (over time) or variable costs increase (fast freight, additional freight, and expedite fees). This directly reduces the net profit potential within the period and thus further erodes return on investment performance.
A “River” to ROI
We can make a simple analogy to this equation using the manner in which a river works. Water flows in a river as an autonomous response to gravity. The steeper the slope of the riverbed, the faster the water flow. The fewer number of obstructions in the river, the faster the water runs.
In supply chain management, materials flow through the supply chain like water through a river. They are combined, converted, and then moved to points of consumption. The autonomous response of this flow is demand. What else could it or should it be? The stronger the demand, the faster the rate of flow. And like rivers, supply chains have obstructions or blockages created by variability and limitations in the “riverbed.” Machines break down, critical components are often unavailable, yield problems occur, choke points exist, etc. All these issues are simply impediments to flow and result in “pools” of inventory called queues with varying depth.
With this analogy we begin to realize that flow is the very essence of why the Operations component of manufacturing and supply chain companies even exists. Operations is typically divided into functions, each of which has a primary objective that it is responsible for and held accountable to. Figure 1-4 is a simple table showing typical Operations functions and their primary objective.
FIGURE 1-4 Typical functions in Operations
All the objectives in Figure 1-4 are protected and promoted by encouraging flow. In fact if flow is impeded, so are these primary objectives. Thus, if Operations and its functions want to succeed in being truly effective, there is really only one thing to focus on—flow.
Let’s expand this view to the organization as a whole. An organization is typically divided into functions, each with its own primary objective. Figure 1-5 is another simple table showing the typical functions of a manufacturing and/or supply chain–centric company.
FIGURE 1-5 Typical organizational functions
All the functional objectives in Figure 1-5 require flow to be promoted and protected. When things are flowing well, shareholder equity, sales performance, market awareness, asset utilization, and innovation are promoted and protected.
Additionally, flow is a unifying theme within most major process improvement disciplines and their respective primary objectives:
• Theory of Constraints (Goldratt) and its objective to drive system throughput
• Lean (Ohno) and its objective to reduce waste
• Six Sigma (Deming) and its objective to reduce variability
All these objectives are advanced by focusing on flow. When considered with Plossl’s first law of manufacturing, the convergence around flow is really quite staggering. There should be little patience for ideological battles and turf wars between disciplines. It is a waste of time and counterproductive to bicker—they all need the same thing to achieve their desired goal. Among these disciplines, flow becomes a common objective from a common strategy based on simple common sense grounded in basic physics and economic principles.
The concept and power of flow is not new. It powered the rise of industrial giants and gave us the corporate management structure in use today. Leaders such as Henry Ford, F. Donaldson Brown, and Frederick Taylor made it the basis for strategy and management.
And yet what about “cost”? The calculation of standard unit cost attempts to assign a cost to an individual product or resource based on volume and rate over a particular time period. When things flow well over a given period, cost performance will be favorable. Thus, emphasizing flow should even work for the cost accountants’ objectives! This critical realization will be explored in more depth in Chapter 6 as well as in Appendix D.
Returning to the specific function of planning, Plossl’s law, while incredibly simple, should not be taken lightly. This one little statement has always defined the way to drive return on shareholder equity, and it was articulated by one of the main architects of conventional planning systems. Thus, the real reason
