03 August 2009

Companies need to start using common sense to survive, says business thinker Dr Eli Goldratt. Rebecca Ellinor distils his words of wisdom

Are we really in troubled times? No, we're just panicking, says Dr Eliyahu Goldratt. The world-renowned business management consultant and author of The Goal, which was recently included in The 100 Best Business Books of All Time, has always challenged people to think differently.

In The Goal, written 25 years ago when he was a physicist, Dr Goldratt outlined his 'theory of constraints', with the premise that the rate of goal achievement is limited by at least one constraining process. He argued that only by increasing flow through the constraint can overall throughput be improved.

Originally directed at the manufacturing industry, its central messages hold true today. He now helps organisations to apply his advice, considered so broadly applicable that when he visited the UK this spring the 130-strong audience at his seminar included child psychologists, buyers and senior managers from the public and private sectors.

SM went along to 'Securing the Future', held at the Institute of Directors in London, to see what messages Dr Goldratt had for procurement and supply chain professionals.

"I don't agree that times are challenging," he says. "I agree there is a tremendous amount of panic. I agree also that many of the patterns that existed previously have broken, so people have to rethink and use known cause and effects in order to drive new patterns to guide them."

One of Goldratt's central tenets is that too often organisations rely on false assumptions. What they should be doing, he says, is applying common sense and thinking through cause and effect by questioning and challenging things - like children do.

"Organisations that are not doing it - and unfortunately, most are not - are facing bad times, troubled times. Those that are doing it are facing the exact opposite - they are finding these are the easiest times to expand and to make money.

"Due to the scare they have reduced their inventories and changed the way they operate, so now they are ordering much smaller quantities more frequently. A manufacturer that will not change their way in order to respond to these smaller, quicker quantities will go out of business. Those that do respond will take the market."

He urges firms to consider long-term strategy and stop blaming the economy for their woes. He warns, for example, against sacking staff that may need to be rehired in a matter of months. "I'm not talking about survival - if you have no choice but to fire people to prevent the company going under, you should have taken action before. I'm talking about profitable companies laying people off to improve the bottom line. They are cutting their future, signalling to employees there is no loyalty."

LONG-TERM PROSPERITY

Goldratt says that, although the financial crisis was "unbelievably real", we are coming out of the global downturn more quickly than people realise. "I don't believe two years down the road anybody will remember the recession," he adds.

He believes the adverse effects of the current economic difficulties can be diluted or even eradicated via some common-sense changes.

"Every company that just looks at the next quarter will end up in the ditch for sure. To ensure long-term prosperity we must focus on long-term health, and to do that you must ensure smooth current performance, otherwise you'll never reach the future. For that to happen you must focus on current operations."

He challenges professionals to stop blaming the economy and focus on improving "flow" - or lead times.

"This is the primary objective and it should be translated into a practical mechanism that guides the operation, including when not to produce, to prevent overproduction.

"Local efficiencies must be abolished and instead there should be a focus on the efficiency of a company as a whole. And a process should be formally put in place that targets what must be done to improve flow."

He hopes one positive outcome of the recession is that companies will continue to order smaller quantities more frequently, which will make them more prepared for future dips.

"If they hold less inventory, when the next scare comes they will reduce their inventories but there will be less to reduce, so the whole down and up will be much shorter."

And this message isn't a new one for Goldratt. As one of the characters in The Goal says: "To reap those benefits fully, we'd have to have our suppliers increase the frequency of deliveries to us and reduce the quantity of each delivery. That's going to take some negotiating through purchasing and I'm not sure all the vendors will go for it."

In fact, purchasers get a bit of a rough ride in The Goal. "Is cost-effective purchasing the reason for the plant's existence?" he asks. "Some of the brilliant idiots in purchasing sure do act as if that's the goal. They're out there renting warehouses to store all the crap they're buying so cost-effectively."

So what should buyers be doing? "If I was a buyer I would put in place a different, more objective way to judge the quality of suppliers. And I would constantly share their scores with them because if I don't, I will continue to have a relationship where on the one hand I'm trying to squeeze the lowest prices from them, and from the other I have to defend problems with deliveries to the whole organisation. As a buyer my real enemies are internal. I am supposed to buy and if there's something missing, everybody's on my back."

He believes a purchaser's first priority is to provide an objective evaluation of quality, using a measurement he calls "dollar days". "All the time we're talking about the price we're buying - but there is another price: the price of not having the product we're buying.

"For example, what's the price of a bolt? Say it's 50p. What's the price of not having the bolt? Well, it depends, so why don't we start to measure it that way? What's the price of not having the merchandise, multiplied by how much time until I've got it? That's the real measurement of the suppliers."

END OF LOW-COST SOURCING

Goldratt also challenges the assumption that China and India are low-cost countries. He points out that wages in both nations are rising faster than their GDPs, and these countries are becoming consumers, not just producers. "China should not now be viewed as a low-cost producer - China should be viewed as the biggest market you have."

China, he says, is now buying more cars than the US. "In five years the average wage in China will be bigger than the UK. In 2005 there were 300,000 [US dollar]millionaires in China. This is in mainland China, not including Hong Kong. Macau is now surpassing Las Vegas in terms of the number of tables. A minimum bet is $12 and 90 per cent of their tables are playing Chinese, not Western games."

With regards to India he says its GDP and wages have begun to separate in the past few years, with salaries rising more quickly than the country's domestic income. And in contrast to received wisdom on the global economy, he says growth in India and China means the world is in fact facing "the biggest economic boom in the history of mankind" in the next 10 years.

Quite apart from increasing wealth in developing countries, Goldratt points out these locations are remote from most buyers, which means they're not sensible places to source from. "The lead time from order to receipt of goods is longer. It's about time you realised the amount of inventory you have to hold is in direct proportion to this replenishment time."

He says while buyers might save a tiny amount per item by going to a low-cost country producer, they must consider the wider effects.

"For every cent you've saved in direct purchasing you have paid about 10 cents through the impact of the lousy inventory terms you have.

"People say: 'Let's buy from the Far East, it's cheaper'. And 'let's close our operation at home'. Have you noticed what you've done? You've laid people off to save some money. In many cases, yes, you've bought it more cheaply but now the replenishment time is three months not two weeks, and the result is you've made much less money.

"Nobody's looking at the cause and effect so they don't see it - this is called double damage. It really drives me crazy."

However, it's not all bad news for buyers. Goldratt says SM readers are to be assured that in his next book, the hero is a purchaser.

SMaug2009