"Are you kidding me? Your people are giving product away for nothing?" the CFO grilled the marketing director. "How the hell can we make any money if your sales jerks keep driving our costs through the roof?" he bellowed in a rage.
"John, please! Calm down," urged Henry, hoping to avoid a replay of the Desert Storm campaign in his own office. "I'm sure that Bill has good justification. Give him a chance to explain," he encouraged. "Bill, what's going on?" asked Henry as he stepped between his two managers.
Raising two boys had prepared Henry well for the CEO's slot. He'd become a champ at resolving conflicts, and this job provided him with daily opportunities to sharpen those skills.
"That's what we're doing all right," responded the marketing director. "We're giving away product. But he's way off target with his conclusions," the marketing director continued. "We're not driving costs through the roof at all," he stated with confidence.
"How the fu..." John began firing again. But the CEO cut him off in mid-expletive.
"Watch your damn language in my office, OK?" Henry exclaimed with a straight face.
He needed to diffuse this encounter, if he was going to get any facts out of the discussion. Humor often served him well in these situations. Both managers were silent for a second, until they saw the corner of Henry's mouth turn upward. Both smiled in relief as they recognized the CEO's tactic for what it was.
"All right! All right!" sighed the CFO. "I'm going to sit here and not make a sound. But what I hear had better make da... er... good sense to me, or we're going to have some problems," he observed.
The marketing director prepared to explain his marketing tactics.
"OK! You know that last month I attended a course on TOC," he began. But it wasn't long before the CFO interrupted. "What the f.... Sorry! What is TOC pleeeease?" he inquired in an obviously impatient tone.
The CFO was trying to maintain control, and Bill and Henry both could see that he was trying. That was precisely what worried them.
"Sorry! TOC means the Theory of Constraint," clarified the marketing director. "It's a new management philosophy that simply makes a good deal more sense than anything we've done so far," he stated with enthusiasm.
"Bill, can you please tell us a little about this TOC thing?" inquired Henry.
"Sure!" responded the marketing director. "I'd be happy to," he continued. "It's a different way of thinking about operations, that's all. We've been thinking in terms of optimizing every aspect of our business, on the assumption that by optimizing everything we're optimizing the whole operation. But Goldratt shows why that isn't necessarily so," explained the director.
"You mean that it's wrong for me to want engineering, manufacturing, sales, and distribution to be efficient?" inquired the CFO in a skeptical tone.
"Well, yes and no," responded the marketing director hesitantly. "It depends on how we define efficiency. For example, if we define efficiency entirely in terms of engineering or entirely in terms of manufacturing, then we're making a mistake. But if we define efficiency in terms of the entire company, and if we make changes in engineering that improve the company's overall efficiency, then we're doing the right thing," he explained.
"Well, that's obvious. But we're already doing this. Why do you think we have a bottom line anyway?" asked the CFO sarcastically. "This TOC stuff isn't anything new. We're wasting our time here," he concluded.
The marketing director began to feel his steam rising. The CFO was a master at assassinating new ideas; claiming that an idea was nothing new was his most effective murder weapon. He wielded it frequently and with great skill. First he would listen to an idea, and if he wanted it its head for a trophy he'd simply claim that there was nothing new about it. So why should he bother continuing the discussion?
The marketing director braced himself in anticipation of the intellectual slaughter that surely would follow. But Henry wasn't about to let any opportunity for improving the bottom line escape him.
"Just a minute, John," said the Henry to the CFO. "I want to hear more about this. Bill, please continue," he said to his marketing director. "Tell us more about this Goldrag guy." "His name is Goldratt," observed the director. "His premise is that we can't achieve optimum efficiency at the corporate level by focusing on the efficiency measurements of individual operations. Unfortunately, that's exactly what we've been doing with our allocated cost model. We've been calculating local efficiencies, and we've been making business decisions on the basis of local efficiency measurements," observed the marketing director.
"Oh Great!" interrupted the CFO. "Now we can't calculate costs anymore, because this Goldberg guy says it's not a nice thing to do," he continued sarcastically.
"His name is GOLDRATT! And it has nothing to do with being nice or nasty," declared the marketing director. "It has everything to do with thinking clearly and effectively," he voiced adamantly as his stare penetrated to the back of the CFO's skull. "There are plenty of examples where it makes sense to measure efficiency only in terms of the whole system. Look at power plants. Trying to optimize the efficiency of the boiler, at the expense of the turbine or at the expense of the whole plant would be idiotic. The only efficiency measurement that counts is that of the entire power plant," he continued. "It's the same with a company. Trying to maximize manufacturing's efficiency measurement at the expense of some other operation's efficiency measurement is no optimization at all. It's a mirage."
"This is interesting," observed Henry. "Please keep going, Bill."
"There's far too much material for us to discuss in detail here. But there is one aspect of TOC that is very important to us, here and now," continued the marketing director. "It's the concept of a constraint. According to Goldratt, every for-profit company is nothing more than a complex, profit-generating system. As such, at any time there is only one thing keeping the system from generating more profit. That limiting factor is the constraint."
"There's nothing in our system that's keeping us from making more money," interrupted the CFO. "We just need more paying customers, that's all."
"Exactly!" declared the marketing director. "As I found out during the TOC course, the limiting factor that Goldratt calls the constraint can be either before the system, within the system, or after the system. An example of having a constraint before the system would be a supplier who can't deliver components fast enough to meet our manufacturing needs. But for us right now, the constraint is after the system. It's the market," continued the marketing director. "That's why we have to focus on improving market conditions. That's also why I've instructed our sales people to offer free samples to potential new customers at every opportunity, so long as the free samples don't interfere with the orders of our current customers."
"You're freaking nuts!" declared the CFO. "Do you know what each of those samples costs us?" he demanded. "As it is, our margins are thinner than the hair on a gnat's ass. Our product cost is $12.50 per unit, and our wholesale price is $13.75 per unit. Every time you give away one of your samples you're wiping out the profit that we make from ten sales. You're nuts!" announced the CFO.
"I have to admit it Bill," interjected Henry. "John does have a point. If the members of the board find out that we're giving away our profit, I'll have a tough time explaining to them that we aren't."
"But we aren't!" stated the marketing director. "We're not giving away much at all. Look! Are we firing anybody?" he asked.
"No, we aren't," admitted Henry. "But if this continues much longer we'll have to resort to drastic measures just to survive."
"I understand," stated the marketing director. "But right now we're not firing any one. So our operating expenses are relatively fixed, aren't they?"
"Yes, I'd have to say that they are. Our payroll represents the bulk or our operating expenses, and we're not firing any one. So our operating expenses are relatively fixed." "Good!" stated the marketing director. "We're making progress."
"We're making progress toward the poorhouse. That's what we're doing," added the CFO. "But go ahead. You're doing a good job of burying your own argument, so don't stop now," he urged.
The marketing director ignored the gratuitous comment as he continued.
"We also have excess capacity, right now. Isn't this true?" he asked.
"Yes, of course we have excess capacity," agreed Henry. "That's the whole problem. Where are you going with this?"
"Well! If we have excess capacity, and if our operating expenses are relatively fixed, then what's our real cost for producing a little more product than our customers are buying right now?"
"I told you what our product cost was. Are you deaf?" interrupted the CFO.
The marketing director tried hard to not react to the CFO's verbal assault, but his patience was wearing very thin.
"That's not the real cost of producing the extra products that we're giving away as free samples," responded the marketing director. "If we don't produce the samples, then our operating expenses are x dollars per month. If we do produce the samples, then our operating expenses are still x dollars per month. The only additional cost that we incur by producing the samples is the cost of the additional raw material that we use in the samples. That's all," he declared. "What's the raw material content of our product?" he asked of the CFO.
The CFO paused briefly, trying to recall the information. "Most of our product cost is labor," he responded. "We don't have much raw material content in the product. It's about $1.50," said the CFO.
"Then we're giving away $1.50 every time that we give away a free sample. We're not giving away $12.50, which is what you said earlier," reminded the marketing director.
"Bill, I'm a little confused," said Henry as he requested clarity. "We have a high labor content in our product. Yet you're telling me that we're giving away only the raw material cost with every sample. Aren't we paying for labor?"
"Of course we are," agreed the marketing director. "That's precisely the point. We're paying for some labor and for some resources that are not producing product for our current customers. That labor and those resources and the operating expense that they represent are with us no matter what. We're paying for them if they produce the samples, and we're paying for them if they don't produce the samples. That's why we're not driving costs through the roof. That's also why we're not giving away the equivalent of the fully allocated product cost with every sample," explained the marketing director. "The incremental cost of making the samples is only the cost of the additional raw material that we use," he continued.
"Well, what if our orders pick up, and we have people making your free samples?" asked the CFO. "What are we going to do then, hire more people? Won't that increase our operating expenses?" he asked.
"That's the whole point, you stupid bastard!" nearly responded the marketing director before catching himself. It took enormous effort to maintain his control as he spoke.
"The market is our constraint right now," he said in an obviously controlled tone. "We want to give away free samples to potential new customers, so that our orders will pick up. When they do, we'll stop making the free samples, and we'll make only the products that we sell for a profit," said the marketing director.
"Bill, now you calm down, please!" pleaded Henry, who had heard the strain in the marketing director's voice. "I think I understand," he continued. "So long as we're not interfering with customer orders, we can use any excess capacity that we have to produce samples for the sales people to give away. I can see why this won't increase our operating expenses," added Henry. "But what happens if our current customers find out that we're giving away product? What's to prevent them from asking for free samples too?" worried Henry.
"That could happen," admitted the marketing director. "If our sales people gave samples away to everybody, or at random, then some of our current customers might ask for them regularly, forcing us effectively to offer discounts. But I've issued clear instructions to avoid this. The samples are to be given only to prospective new customers. I've also required that we track who gets the samples. That way we can keep the free samples program from corrupting our current markets. The idea is to develop new markets, not to offer discounts within our current markets," explained the marketing director.
"Good!" exclaimed Henry. "I like it. Let me know how it works," he said to his director. "Now let's break for lunch while the cafeteria is still open," he suggested.
As the three of them left the executive wing, Henry turned to the CFO.
"So tell me, John," he said. "Why haven't we heard about this Goldridge guy before?"
"Goldratt!" exclaimed the marketing director. "His name is Eli Goldratt. He's really a nice guy. You should meet him."
(C) Tony Rizzo, 1996. rizzo@hogpb.att.com
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