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MANAGEMENT DYNAMICSMerging Constraints Accounting to Drive Improvement John A.. More Praise for Management Dynamics“Students of the Theory of Constraints who want a detailed review of ho

MANAGEMENT DYNAMICS

Merging Constraints Accounting

to Drive Improvement

John A Caspari Pamela Caspari

John Wiley & Sons, Inc.

More Praise for Management Dynamics

“Students of the Theory of Constraints who want a detailed review of howTOC concepts apply to accounting will not want to miss this book

Business people will benefit from insights on how to apply TOC oriented

thinking to pinpoint the real sources of waste and inefficiency in an

enterprise The Casparis have made a significant contribution to the body

of knowledge in this area; moreover, their work should stimulate furtherdiscussion and advancement!”

—Paul H Selden, PhD, President, Performance Management, Inc

“This book combines clear thinking and research into the purpose androle of accounting in organizations Coupled with a deep understanding

of Goldratt’s Theory of Constraints, the Casparis’ methodology focusesthe enormous power of practical systems thinking in organizations Thisbook finally brings together the elements needed to truly implement andsustain a genuine process of ongoing improvement Along with Elliott

Jaques’ Requisite Organization, we now have the blueprints for creating the right structure and the right operational methodology to achieve

unprecedented organizational performance.”

—Romey Ross, PMP, CPE, President, Technical Project Services, Inc

“Financial officers and accountants in profit making organizations havealways struggled to understand how I, OE, and T can be applied in theirworld This struggle of TOC accounting versus cost accounting in thefinancial record-keeping domain has inhibited many a successful TOCproject The authors have been able to lift the veil for the financialcommunity! Now let’s hope the accountants get on with it!”

—William A Woehr, Executive Partner, Delta Institute, S.A.,Board member Angel Iglesias, S.A

“The Casparis provide a step-by-step strategy for integrating the

components of Goldratt’s Theory of Constraints into a highly effectivesystem for achieving success in business The book’s roadmap describeshow to structure a high-performance business by the thoughtful

integration of the components of Goldratt’s theory I highly recommendthis valuable work.”

—John Sambrook, President, Common Sense Systems, Inc

MANAGEMENT DYNAMICS

MANAGEMENT DYNAMICS Merging Constraints Accounting

to Drive Improvement

John A Caspari Pamela Caspari

John Wiley & Sons, Inc.

This book is printed on acid-free paper.

Copyright © 2004 by John Wiley & Sons, Inc All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

ISBN 0-471-67231-9

Printed in the United States of America

10 9 8 7 6 5 4 3 2 1

In memory of our fathers,Charles Edward Caspari, Jr.

andJohn Taliesin David,who taught us about ethical behavior and fair treatment of people

Evaluating Decision Alternatives 1 Thinking Bridges Example 4

Two Paradigms 21 Constrained Environments 24 TOC Focusing Process 31 Identifying Ongoing Improvement 34

Early Throughput Accounting 41 Cost Control in a Throughput World 45 Constraints Accounting versus

Throughput Accounting 48 Complexity Divide 57

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CHAPTER 4 Motivation and the Budget 64

Motivation for a Process

of Ongoing Improvement 64 Role of the Financial Manager 74 Establishing a Budgetary Revision

and Reporting Process 81

CHAPTER 5 Constraints Accounting Terminology

Basic Financial Control Metrics 94 Capital Write-Off Methods 104 Exploitation Decisions 115

Cost-Based Pricing 133 Constraint-Based Pricing 147 Decoupling Throughput from

Operational Expense 154 Constraints Accounting Approach

to Pricing 155

CHAPTER 7 Tactical Subordination

Tactical Subordination 174 Drum-Buffer-Rope Scheduling 174 Buffer Management Reporting 177

CHAPTER 8 Tactical Subordination in Project

Common-Sense Scheduling 191 Critical Path versus Critical Chain 196 Project Management Constraints 197 Subordination Reporting in Projects 203 Critical Chain Buffer Reports 206

Current Status of Critical Chain 208 Simplified Critical Chain 210

Sales Funnels 218 Sales Commissions 228 Leveraging Constraints

to Create Compelling Offers 230

Empowerment and Respect:

Aligning Authority, Responsibility, and Long-Term Commitment 236 Personnel Employment Decisions 241 Mixed Messages 252

Successful Constraint Management 262

Brief History of Cost Accounting 273 Cost and Revenue Flows 281 Constraints Accounting Similarities

and Departures 289

Reconciliation

Practitioners of the theory of constraints (TOC) have been waiting for thisbook for a long time Many of you reading this now have had substantialexposure to TOC and perhaps even experience with it Those who havenot will benefit by knowing a little background

TOC, as a management approach, has been around for almost twodecades, and its creator, Eliyahu M Goldratt, has been applying the basicprinciples even longer than that Consultants have been expending a lot

of effort in helping their clients use TOC to effect real change—quantumimprovements—in the performance of their organizations Visionary peo-ple within client organizations have been trying to apply what they havelearned about TOC toward the same end For both groups, the resultshave been mixed For every success, there have been more failures (Fail-ure can be defined as TOC producing “underwhelming” results, beingabandoned altogether, or the organization reverting to the way things

were before the change.) The question is: Why?

Interestingly, that basic question—Why?—is at the heart of TOC

it-self The thinking process created by Goldratt is designed to answer “why”types of questions And when the “why” question is posed about an unde-sirable system outcome using the thinking process, the inevitable an-swer—whatever that may be—is the system’s core problem, or critical rootcause So what is the critical root cause behind the failure of organizations(those that have tried and failed) to realize the tremendous benefits thatTOC has to offer? I would suggest it’s a missing element

So what is that missing element? The answer is inherent in the

para-digm shift that the Casparis talk about in Chapter 2: the transition—onemight say a giant leap of faith—from cost-world thinking to throughput-world thinking And that transition—or the absence of it—is what makes

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the difference between theory and successful rubber-meets-the-road agement.

man-Nearly every company is heavily imbued with cost-world thinking.TOC challenges that thinking by requiring its practitioners to abandonthe “old-time religion” of the cost world that virtually every executive (andchief financial officer) has grown up with

In the movie Indiana Jones and the Last Crusade, Jones finds himself

facing a chasm he feels he can’t possibly jump over safely Yet the tions for him to reach his goal call for a “leap of faith.” It’s a life-or-deathsituation, so he steels himself, takes that leap, only to discover that there

instruc-was a solid, dependable bridge beneath his feet after all But Indiana

Jones is a fictional character Risk-takers in the business world are few, andrisk-averters abound So, tempted as they might be by the Holy Grail onthe other side of the chasm, many (most?) chief executives and chief fi-nancial officers are loath to step off the security of the platform they cur-rently stand on, make that leap of faith, and try to reach the performanceimprovement that TOC promises They intuitively know that throughput-world thinking is the right thing to pursue, but they can’t bring them-selves to turn loose from the comfort zone provided by their cost-worldhistory In the vernacular of the bashful country girl at her first dance,

“I’m gonna dance with the one what brung me.” Cost-world thinking gotthem where they are today, so why mess with a winning formula?

A big reason why they’re reluctant to tinker with the existing digm is that they can’t see the invisible bridge that Indiana Jones discov-ered—but only by taking a huge risk—and they won’t take the risk that

para-Jones did because for most of them it’s not a life-or-death situation.

And therein lies an important point: even among the normally averse decision makers, some will make that leap, even though it runscounter to their normal thinking, behavior, or desires—but only under aparticular set of circumstances: when the danger of not surviving is sogreat that they see risk-taking as the least undesirable option In otherwords, when the survival of the company, or the executive in his or herjob, is clearly at stake, decision makers will often do things they would oth-erwise eschew Some, of course, will dither and fail to decide to leap untilit’s too late W Edwards Deming said it best: “It is not necessary to change;survival is not mandatory.”

risk-Wouldn’t it be better, however, if organizations didn’t have to be in alife-or-death situation in order to be willing to embrace a new way of fun-damental thinking about how their systems should operate? Executiveshave such a difficult time letting go of cost-world thinking because, like In-diana Jones, they can’t see the invisible bridge to the throughput world

But as in The Last Crusade, that bridge is there They just need a way to

make it visible, so that they can have the confidence to do what’s required

to shift their paradigms to the throughput world That bridge might becalled reconciliation.

And that’s what the Casparis have in this book: they have reconciledthe apparent dichotomy between cost-world and throughput-world think-ing Only someone with John Caspari’s thorough understanding of bothparadigms—and his penchant for independent thinking—could have con-ceived of that reconciliation

The big knock on throughput accounting, as Goldratt conceived it,has always been that, although it has “accounting” in the name, it isn’ttruly a functional accounting system It’s more of a decision support sys-tem It can’t fully substitute for generally accepted accounting principles(GAAP) in the business world because, for one thing, it isn’t rigorousenough in the details But that criticism is based on an erroneous underly-ing assumption: that the existing way of calculating and reporting finan-cials must be replaced in order for TOC to succeed Clearly, that would be

an extremely “hard sell” under any circumstances But even harder to sell

is the idea that costs are irrelevant and only throughput matters That’s anerroneous impression that many people come away with after their firstexposure to TOC And that’s unfortunate because not even Goldrattwould maintain that costs are irrelevant—only that they should not be thefirst, or even the most influential consideration

The Casparis have done the TOC community, and the business munity at large, a great service in writing this book In presenting the con-cept of constraints accounting, they reveal the relationship—the bridge, ifyou will—between the cost world and the throughput world It’s thisbridge that distinguishes true constraint management from the theorythat led to it And the authors make it clear that succeeding at TOC andembracing a throughput orientation does not require giving up tradi-tional accounting systems The same data are collected and compiled;they’re just interpreted in a new way for the purposes of sound opera-

com-tional and strategic decision making—in other words, for effective

con-straint management The Casparis explain all this, with liberal use of

exam-ples, in a way that identifies the faulty assumptions—and explains whythey’re faulty—underlying traditional use of financial numbers to guidemanagement behavior

Perhaps best of all, in this book the Casparis have put “bean ing” in the proper context of the entire organization and its activities.They relate throughput and cost financial metrics to the people of the or-ganization and their activities Most financially oriented books don’t dothis How does constraints accounting relate to product pricing? to manu-facturing production decisions? to project management? or to sales? How

count-do financial measures affect people’s motivation and priorities in count-doingtheir jobs? All of these issues are addressed here Pay special attention to

their unique concept of a bonus plan for reinforcing a process of ongoingimprovement (POOGI Bonus Plan).

So what are you waiting for? You didn’t pick up this book becauseyou wanted to know what I think about the constraint management andthe relationship of constraints accounting to success An intriguing intel-lectual journey awaits you start reading!

H William Dettmer

Port Angeles, Washington

April 9, 2004

In their quest for success, some organizations seem to dip their hands into

a bag of programs, hoping that the one they extract will bring themglowing results that turn up on the bottom line After the first few months

of implementing the new flavor, optimism is high, bottom-line results areglowing, and sighs of relief are felt rippling through the organizations—and the accolades of analysts can be heard throughout the land Thensuddenly Murphy strikes with back-to-back home runs—suppliers are latewith a shipment, computers crash, the economy goes into a nosedive Theaccolades give way to critical analysis of the problems, grave doubts aboutthe financial health of the organization, and loss of confidence in topmanagement’s ability to take control and lead the organization back torobust health Financial numbers are crunched, manipulated, massaged,and sometimes put into hibernation People are downsized, right-sized,tossed into the roiling ocean of unemployment And when favorable resultsare slow to reappear on the bottom line, the roar and accusations of theanalysts become deafening and the leadership door revolves

The new leadership, wanting to achieve bottom-line results thatwill not be just a flash in the pan, eagerly reach into their own bag offlavorful programs, choosing one, which they are confident, will bringlasting results Another day at the office begins

With this scenario playing over and over like a broken record inour minds, our journey began First, we needed to make sense out of ourthoughts If a robust process of ongoing improvement is a desirable statefor any organization to be in, why does it seem so hard to achieve? Second,

we devoted ourselves to making words out of our sense and finally actionsout of our words This book is an in-depth, step-by-step analysis of ourjourney What we discovered was the amazing consistency of the logical

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