versus the money it takes to start and maintain that system. Thus, the output of the equation is called return on investment. The higher the rate of return on investment (both in the short run and the anticipated long run), the more valuable the shareholder equity.
Of course, a full DuPont analysis would provide a more detailed perspective incorporating profit margin, asset turnover, and financial leverage. The above equation is simply a conceptual shortcut that can be used to make a crucial connection between flow and return on investment via Plossl’s Law.
Hopefully, that connection is now readily apparent. The previously mentioned benefits of flow (perhaps with the exclusion of taxes) are all direct inputs into the ROI equation. This makes flow the single biggest lever in determining the objective of a for-profit organization. This can be expressed as the equation in Figure 1-4. This depiction first appeared in the book Demand Driven Performance–Using Smart Metrics (Smith and Smith, McGraw-Hill, 2014, p. 71).
FIGURE 1-4 Connecting flow to return on investment (ROI)
Explaining this equation requires first a definition of the elements and then how they relate to each other.
The delta 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 more quickly.
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 (overtime) 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.
The River Analogy
The simple analogy to this equation is the manner in which a river works. Water flows in a river as an autonomous response to gravity. The steeper the slope of the river bed, the faster the water flows. Additionally, the fewer number of obstructions in the river, the faster the water runs.
In service and supply chain management, materials and/or services flow through the network like water through a river. Materials are combined, converted, and then moved to points of consumption. Services are offered, scheduled, and delivered to customers. The autonomous response of these flows is demand. What else could it or should it be? Ideally, the stronger the demand, the faster the rate of flow of materials and services. And like rivers, service and supply chains have obstructions or blockages created by variability, volatility, and limitations in the “river bed.” Machines break down, critical components are often unavailable, yield problems occur, choke points exist, capacity bottlenecks exist, etc. All of these issues are simply impediments to flow and result in “pools” of inventory with varying depth. A river without flow is not a river, it is a lake. Operations with out flow is a disaster.
With this analogy we begin to realize that flow is the very essence of why the Operations subsystem of manufacturing and supply chain companies even exist. The Operations subsystem is typically divided into functions, each of which have a primary objective for which they are responsible and accountable. Figure 1-5 is a simple table showing typical Operations functions and their primary objective.
FIGURE 1-5 Typical functions in operations
All of these objectives are protected and promoted by encouraging flow. Under what scenario does a cost-based focus enable you to synchronize supply and demand or sequence activity to meet commitments? In fact, a cost-based focus most often leads to the exact opposite of these objectives. Thus, if Operations and its functions want to succeed in being truly effective, there is really only one focus–flow. Flow must become the common framework for communications, metrics, and decision making in Operations.
Let’s expand this view to the organization as a whole. An organization is typically divided into many subsystems, not just Operations. Each subsystem is typically tasked with its own primary objective. Figure 1-6 is another simple table showing the typical subsystems of a manufacturing and/or supply chain-centric company.
FIGURE 1-6 Typical organizational functions
All of these functional objectives require flow to be promoted and protected to drive maximum effectiveness. When things are flowing well, shareholder equity, sales performance, market awareness, asset utilization, and innovation are promoted and protected and costs are under control. This was discussed extensively earlier in this chapter. Thus, flow must become the common framework for communications, metrics, and decision making across the organization.
Additionally, flow is also a unifying theme within most major process improvement disciplines and their respective primary objectives.
All of these objectives are advanced by focusing on flow first and foremost. This should not be surprising since we have already mentioned these thought leaders regarding systemic coherence. When considered with Plossl’s First Law of Manufacturing, the convergence of ideas around flow is quite staggering. There should be little patience for ideological battles and turf wars between these improvement disciplines; it is a complete waste of time. All need the same thing to achieve their desired goal: flow. Among these disciplines, flow becomes the common objective from a common strategy based on simple common sense grounded in basic physics, economic principles, and complex systems science.
The concept and power of flow is not new, but today it seems almost an inconvenient afterthought that managers must, if pressed, acknowledge as important. It powered the rise of industrial giants and gave us much of the corporate structure in use today. Leaders such as Henry Ford, F. Donaldson Brown,
