Throughout history, there are examples of great business leaders who, despite their best efforts, experienced poor company performance. How is this possible? Also, when employees are asked the question, “Why is your company struggling?” the top responses usually are something like “poor communications” or “departments not working together” or “our improvements don’t seem to be sustainable.” Why are these issues so difficult to address? The answer to both of these questions may be found in understanding the demand/capacity curve.
Determine Maximum Capacity
Let us start our discussion by looking at capacity. The maximum capacity of your business is defined as the amount of goods or services that the slowest point in your process can produce (also known as the process bottleneck). In a manufacturing environment, for example, the bottleneck may be the output of a unique machine on the shop floor. If Machine X is the bottleneck and can produce 10 items an hour and runs 24 hours and 7 days a week, then the total output of the plant will be no more than 1680 per week (24 hours x 7 days x 10 items per hour).
Remember to keep in mind that the bottleneck can be anywhere in the process. Maybe it is in engineering (how many drawings can be produced) or maybe it is in the supply chain (what is the output of the suppliers) or maybe it is in the customer service department (number of orders entered per day). For example, there may be a step in the order-entry process where a person is required to verify the order, check the credit status of the customer, and get a ship date from manufacturing. Let’s assume that this process step takes 10 minutes to complete per order and that each order has 2 items on it and that this person works 8 hours a day, 5 days per week. The output of this process will only be 480 items (8 hours x 5 days x 12 items). This is well below the output of our machine so in this case the bottleneck would be in the order-entry process and not in manufacturing. We can show the maximum capacity of the bottleneck on a chart as a line going forward in time at 100% (Figure 1a).
With an unstable and unpredictable process, the capacity of the bottleneck will change from day to day. For example, if the machine has unexpected downtime, the ability to make parts at the expected capacity is diminished. It gets even more difficult to track the overall capacity if the bottleneck shifts from process to process throughout the day. For instance, if a process that feeds parts to the bottleneck operation slows down due to a bad batch of material, then the bottleneck could shift to this feeder process. This reduction in output could last for just a few hours or for several weeks. So, a more accurate way to portray the capacity line for an unstable or unpredictable set of processes might look something like Figure 1b.
For purposes of this discussion, let us assume that the process is stable and predictable (Figure 1a). Some plant managers would argue that the capacity of the bottleneck can temporarily be boosted over 100% if needed. This can be done in a number of ways… schedule overtime, don’t shut the process down for planned maintenance, increase the speed of the machine over the recommended speed, etc. However, many of these boosts to capacity tend to be short lived. For example, people will only work so much overtime before productivity drops or a machine will eventually stop working altogether if preventive maintenance is not performed (Figure 1c).
Again, let us assume that the process is stable and predictable and that we have done all we can to maximize the output of the bottleneck without jepordizing its future performance (back to Figure 1a). We are now ready to add demand to our chart.
Creation of the Demand Curve
What happens when the demand for your company’s products or services is below the capacity line? This means we have plenty of extra capacity at the bottleneck operation and by definition, in every other process step as well. The people who work in operations tend to be a little more relaxed in this type of situation. They know that if something goes wrong, they can easily put things back on track by utilizing a portion of this extra capacity. So, if a part shows up late from a supplier, no big deal, we can fast track it through the factory and get it back on schedule. Or, if the person who is checking the orders wants to take half a day off, no problem… we can catch up tomorrow. The quality of the output also tends to be better, especially in a manual process, since people can take their time to do the work correctly. Also, with this lower demand, the workers are not being harassed by expeditors to get the orders completed quickly.
Imagine what a business leader staff meeting might sound like when the demand for their products or services is below the capacity line (Figure 2). The chief financial officer would probably start the meeting by saying, “Our revenue numbers are going to miss our goals for the quarter if we don’t do something quickly! The demand for our products is well below forecast and I am starting to get worried.”
“Yeah, the sales team needs to get their act together and start doing what we pay them to do,” says the director of operations. “My factory is starving for work!”
“Hey, our sales folks are working their tails off, but our prices are too high compared to the competition” says the vice president of sales.
“Well, things are running very smoothly in operations. Our on-time delivery to our customer is the highest it has been in a while. We are also experiencing fewer quality issues, so our customers should be happy. Our overtime costs have come down quite a bit as well,” brags the director of operations.
“Hold on a minute,” chimes in the CFO. “Your operations team is not off the hook either. I have noticed that the labor and machine utilization metrics have been steadily declining. Maybe it is time to consider laying some people off. Also, since we are selling fewer products, our overhead costs per product sold are out of whack. We might need to start cutting overhead!” He of course says this while looking at all of the overhead sitting around the table.
“Calm down everyone,” the chief operations officer finally says. “We can work this out long before we need to start thinking about laying anyone off. It sounds to me like we can afford to lower our prices in order to fill up our factories. I know in the short term, this will eat into our profit margins, but we need to get our volumes up. You folks in sales also need to take advantage of the improved performance in operations. Maybe some sort of guarantee that we will ship it out on time. That should make our customers happy.”
After the business leaders conclude their meeting, the vice president of sales convenes a meeting of his top sales people. “Those operations folks are making us look bad! They claim that we are not doing our job. So, let’s do an across-the- board price reduction and start advertising that we will guarantee that the products will be shipped out on time.” The sales folks leave the meeting satisfied since many of them are paid on commission, and they want to push as much product to the customer as possible. Due to these incentives, the demand begins to increase and the gap between demand and capacity begins to close (Figure 3a).
We now reach a point on our chart where the demand curve crosses the maximum capacity line. But remember, the capacity line represents the maximum output of our bottleneck operation. So, as we approach the 100% line, the only part of the process that begins to feel the heat is the bottleneck. All of the other process steps are still doing fine. A chart that shows the number of individual process steps that compares the demand vs. capacity might look something like this: (Figure 3b)
The chief operations officer, at the next business leaders meeting, is understandably pleased. “The sales team is really kicking things into high gear. Congratulations on getting our sales back on track. I know we had to give away a bit of our margins, but no one can argue with the results. If sales continue to grow, maybe we will actually hit our goals for the year.”
“I hate to throw a wrench into this celebration,” comments the director of operations, “but we are starting to see a few issues in our ability to keep up with all of this new demand. Most of our processes are not having any problems. However, we are starting to experience a few shortages and our need to work overtime is starting to increase. Nothing too bad yet, but I am starting to get a little worried. Our quality defects and on time delivery is also starting to slip a bit as people are getting maxed out.”
“Hmmm… Let’s look at your utilization percentages,” pipes in the chief financial officer. “It looks to me like the average machine and labor utilization is somewhere around 75%. That sounds to me like we still have quite a ways to go before there is an issue. You all in operations are always making things sound worse than they really are.”
“Good. So, we are in agreement that I have the green light to keep the pressure on the sales team,” says the vice president of sales. So, demand continues to grow (Figure 4a).
“The wheels are completely falling off!” shouts the director of operations at the next business leaders meeting. “We are experiencing multiple shortages throughout the plant. The repair areas are full of quality-related issues to the point where we are putting product outside as we wait for repairs. Our on-time delivery is now an embarrassment. We have everyone on mandatory overtime working every hour we can squeeze into the week and we are still unable to keep up. This extra demand is going to kill our business!”
“Wait a minute,” chimes in the VP of sales with a smug look on his face. “Earlier this year, you were bragging about how great your operations team was doing. Now, we give you some solid sales and you start complaining! You operations folks are never satisfied. Your plant’s performance is really starting to take a toll on our customers’ trust in our company. Dealing with the quality and delivery complaints is consuming a great deal of our sales force time. We have to give steep discounts to keep our customers from leaving us and that is not even working!”