How We Measure Ourselves Matters...

In my last post, I talked about the concept of creating the Theory of Constraints Production System, a method that would be a method of designing, running and improving an organization over time. Let’s continue that thought experiment by taking a look at the next level – Metrics.

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First, let’s recall our goal:

Make money by creating five-star products and services.

From a TOC perspective, we find ourselves compelled to establish Necessary Conditions and the ultimate goal. Safety, as the paramount NC, and adherence to all laws are non-negotiable. If we wish to further refine our focus, we may consider making money as the goal and a five-star product as an NC, or vice versa. The latter scenario, where making money is an NC, defines a nonprofit.

In the case of a nonprofit organization, what they deliver is more important than profit. Here, the goal is to deliver a Five-Star product.

Making Money

We also have to examine the metrics from a local optimization or system optimization perspective. Let’s start by examining the “Making money” part of our goal statement. Here, we are talking about Net Profit, ROI, and Cash Flow.

Net Profit, also referred to as net income or net earnings, is a crucial metric in the Theory of Constraints Production System. It represents the total profit a company generates after deducting all expenses, taxes, and costs from its total revenue. In our system, it is the Net Profit of the facility. We use Throughput Accounting to calculate this figure, which is a key component of our system.

ROI is a performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments, including inventory. ROI tries to directly measure the amount of return on a particular investment relative to the investment’s cost.

Cash Flow refers to the net amount of cash and cash equivalents being transferred into and out of a business. Cash Flow is typically not used in TOCPS decisions unless the organization finds that it is unable to perform a transaction because of a lack of cash.

Five Stars

The five-star rating system, while it may spark some debate, is a practical and important metric in TOCPS. Its effectiveness lies in its ability to comprehensively evaluate products and services, encapsulating a wide range of factors that contribute to overall customer satisfaction. This practicality is particularly evident when considering the six factors outlined below.

1. Quality: The product or service is made from high-quality materials or involves high standards of workmanship. It performs its functions flawlessly and often exceeds expectations in terms of durability and reliability.
2. Customer Satisfaction: Customers report high levels of satisfaction. This includes meeting or exceeding the needs and expectations of its users. Feedback is overwhelmingly positive, with minimal negative reviews and often addressed promptly by the provider.
3. Features and Benefits: It offers comprehensive features that are both innovative and useful. The benefits of using the product or service are clear and significant compared to others in the market.
4. Value for Money: Even if it is priced higher than average, a five-star product or service provides excellent value for money. Customers feel the quality and benefits justify the cost.
5. Customer Service: Exceptional customer service is a hallmark. Support is readily available, helpful, and responsive. The service aspect ensures that any issues are resolved quickly and satisfactorily.
6. Reputation and Reliability: Typically, a five-star product or service comes from a provider with a strong reputation in the industry. It is reliable and often recommended by both experts and consumers alike.

The five-star method addresses one of TOC's key criticisms: It is only about making money. TOCPS companies do not just want to make money—they want to make products that they can be proud of and often have a strong passion for producing.

Five Stars as a Useful Metric

Adding the five stars resolves that by using this one metric and defining it as “useful” for decision-making due to its ability to encapsulate a comprehensive range of factors contributing to overall customer satisfaction. Here are several reasons why it's particularly good, especially when considering the six factors outlined above:

1. Holistic Evaluation: A five-star rating system encourages reviewers to consider multiple aspects of a product or service, such as quality, features, value, and customer service. This holistic approach ensures that ratings reflect a broad perspective on the product or service's overall performance and not just one single aspect.
2. Standardized Measurement: The uniform scale (from one to five stars) provides a standardized measurement of quality and satisfaction that is easily understandable and widely recognized. This standardization helps consumers quickly compare different products and services based on their ratings.
3. Customer-Centric: The rating system is fundamentally democratic, as it aggregates feedback from a wide range of customers. This inclusivity means that the ratings consider varied user experiences and expectations, incorporating a diverse array of opinions that reflect the general population's views rather than a select few.
4. Quantitative and Qualitative Insights: While primarily quantitative, the five-star system often encourages users to provide qualitative feedback to explain their rating. This detail offers potential customers insights into the specific strengths and weaknesses of a product or service, aligned with the six key factors of quality, satisfaction, features, value, customer service, and reputation.
5. Encourages Excellence and Improvement: For businesses, achieving and maintaining a high rating motivates continuous improvement in product quality and customer service. It serves as an incentive to consistently meet and exceed customer expectations in all the areas customers deem important.
6. Adaptability Across Industries: The versatility of the five-star rating system allows it to be effectively used in various sectors—from hospitality and travel to electronics and service industries—making it a universal tool for assessing excellence.
7. Trust and Credibility: High ratings, especially when based on numerous reviews, help build trust and credibility with potential customers. Seeing a product or service that consistently receives five-star ratings across a broad customer base can significantly influence purchasing decisions.

Metrics at a System Level

Using a limited number of system-level financial metrics like Net Profit, ROI (Return on Investment), and Cash Flow offers several advantages over tracking a vast array of local-level metrics that focus on detailed cost variations and headcount Key Performance Indicators (KPIs). Here are some of the key benefits:

1. Strategic Focus: System-level financial metrics provide a clear picture of the overall health and performance of a business. By focusing on metrics like Net Profit, ROI, and Cash Flow, leaders can prioritize decisions that align with long-term strategic goals rather than getting bogged down by the minutiae of local-level operations.
2. Simplification of Decision-Making: Having a smaller set of key metrics simplifies decision-making processes. Leaders can quickly assess the financial impact of decisions without the need to dive into overly detailed data, which can often be confusing and lead to paralysis by analysis. This streamlined approach enhances agility and responsiveness in management.
3. Enhanced Communication: Communicating the financial health and goals of a company is more straightforward when using broad, impactful metrics. These metrics are easily understood by stakeholders at all levels—from executives to shareholders. This clarity improves alignment across the organization, ensuring that everyone is working towards the same objectives.
4. Resource Allocation: System-level metrics help in better allocation of resources. For instance, ROI and Cash Flow analyses can guide where to invest capital for the highest returns or how to adjust spending to improve cash positions. This is crucial for maintaining financial stability and fostering growth.
5. Performance Benchmarking: Net Profit, ROI, and Cash Flow are standard metrics that provide a basis for benchmarking against industry peers. They allow a business to measure its performance against competitors effectively, which is less straightforward with localized, detailed metrics that might vary significantly from one organization to another.
6. Long-Term Sustainability: Focusing on system-level financial metrics helps ensure that the business is viable and sustainable in the long term. These metrics reflect critical aspects of the business's financial health, such as profitability, efficiency in using investments, and liquidity, all of which are essential for long-term planning.
7. Risk Management: High-level financial metrics are instrumental in risk management. They help identify financial risks early by showing trends in cash flow, profitability, and returns on investments, allowing management to take corrective actions swiftly.

We have inched one layer deeper into our conceptual TOCPS, further refining our goal, defining the metrics we are going to use, and affirming that they will be performed at a system level. We still have to look at putting together a design, look at Little’s Law, understand how Drum-Buffer-Rope will work, etc.

We still have a lot of work to do.