amounts of money, time, and energy into new hardware and software solutions, they must first consider investing in the proper thoughtware in order to gain visibility to what is truly relevant. Technology can only provide value if it addresses a limitation that the company is facing in terms of achieving its objective.
Convention’s Failure with the Four Prerequisites
Now that the four prerequisites for relevant information are established, let’s turn our attention to the failure of convention to establish and properly use these prerequisites. First, let’s describe what the typical conventional approach looks like.
The conventional approach to managing a company involves strategic, tactical, and operational perspectives. Strategy is deployed to the organization by a Sales and Operations Planning (S&OP) process. The S&OP process balances supply availability and demand requirements resulting in a Master Production Schedule (MPS). The MPS is essentially intended to be a tactical dampener to prevent the forecast variability from driving MRP directly due to the imbalance of load against capacity. In the process of preparing the MPS, S&OP integrated reconciliation performs a rough-cut capacity check. The only bidirectional interaction between the MPS and S&OP is an “aggregation—disaggregation” process in which disaggregated demand forecasts are rolled up from the item level to the product family level to create the new forward-looking production plan. Then the production plan is rolled down into item level requirements by date, and this is used as the gross requirements line for MRP calculations.
In summary, the MPS is a statement of what can and will be built recognizing available capacity. The MPS sends this forward-looking plan for the planning horizon to Material Requirements Planning (MRP). MRP calculates the necessary supply order generation dates and quantities necessary to synchronize to that plan through a level by level explosion. Orders are then released when required by a date that has been calculated precisely from this multi-level explosion process. Figure 2-1 illustrates the conventional approach.
FIGURE 2-1 The conventional approach
Now we will turn our attention to the failure of convention regarding the four prerequisites to relevant information.
Convention and Relevant Ranges
The conventional approach clearly supports the need for relevant ranges. Figure 2-1 clearly shows a top-down linear approach that recognizes strategic, tactical, and operational emphases. The problem with convention, however, is that it improperly manages these ranges. This will be demonstrated through two examples that are devastating to relevant information and flow.
Our first example is conventional planning’s reliance on forecasting item level demand for the planning horizon. Obviously, predicting market behavior and conditions is a necessary component for successfully managing any business. The better our forecasts, the better leadership can define and manage a company’s path to success—there should be no doubt about that. However, bringing those predictions into the immediate operational range by tightly synchronizing order generation directly with a demand signal containing known error creates an immense amount of distortion and waste. There are three rules about forecasts:
Despite these well-known facts, convention continues to drive actual supply orders to forecast and then attempts to make corrections as better information is available. This means that capacity, capital, materials, and space are committed to signals that have significant rates of error associated with them. This is the very definition of irrelevant or at the very least distorted information and is one reason why forecasts are irrelevant in the short range. This is a clear mismanagement of the short term relevant range, demonstrating a lack of comprehension of this critical concept. Readers wishing to know more about this issue should consider reading the book Precisely Wrong—Why Conventional Planning Fails and How to Fix It (Ptak and Smith, Industrial Press, 2017).
Our second example of improperly managing relevant ranges is the use of fully absorbed unitized cost metrics for operational decisions. Fully absorbed unit cost means that all manufacturing costs, fixed and variable, are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, labor, and overhead costs.
Direct materials are variable costs. Variable cost is tied to unit volume, not resources. Variable costs rise and fall with unit volume but do not change on a per unit basis. Labor and overhead are fixed costs. Fixed costs are not affected by volume changes in activity level within the operational relevant range (a specific short-range period). Using fully absorbed unit cost related metrics directly creates the false impression that fixed costs can and will vary within the short range. They do not; that is why they are called fixed costs. The unitized cost equation obviously improperly mixes relevant ranges. This causes significant distortion in relevant information at the operational level and directly relates to disruptions in coherence and flow. Once again, this is a clear mismanagement of relevant range, demonstrating a lack of comprehension of this critical concept.
Convention and Tactical Reconciliation
In convention, tactical reconciliation is not bidirectional—it is essentially a one-way street in an assumed linear predictive world. This oneway direction limits the ability to drive any meaningful adaptation and additionally, any attempt at periodic reconciliation is incredibly painful. For example, every MRP run results in massive cascading schedule changes as date and quantity changes at higher levels affect all connected lower level components. This is an effect called nervousness and leaves most companies in a huge dilemma about how often they run MRP and how much they can actually trust its output, causing planners to export data to spreadsheets in an attempt to find the truth.
At a higher level, monthly S&OP updates create massive shifts at the beginning of every month that are then compounded by new MRP runs. Planning personnel struggle to stabilize the requirements picture and plans only to have the new version of the prescribed future reality dropped into their laps at the beginning of the next month. In convention, this makes tactical reconciliation more akin to a constant and repetitive cycle of tactical demolition and reconstruction; both are incredibly messy, wasteful, and cause great confusion.
Convention and Flow-Based Operating Models
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