Capacity Has Value – Part 1

In manufacturing companies, the term “capacity” typically refers to the aggregate production capabilities of your factory.  It’s a bit like your factory’s bandwidth … it defines how much manufacturing can your operations support in a given period of time.  Understanding your production capabilities lets you project the capabilities of your resources (or “capacity”) into the future.

But, beyond knowing WHAT capacity you have, when you break this down into HOW you are using it, you should get the best information you need to measure the effectiveness of your resources,  know how you can make adjustments to best advantage, how to redeploy your capacity effectively, and how to make decisions that will critically affect how well you can achieve your company’s strategic goals.

In this in this and my next blog I will be showing you a different way to think about your capacity, and I’ll demonstrate a better way to understand how much money you can make with Lean. First, let’s establish the traditional context for thinking about capacity.

Capacity & Traditional Methods

Traditional manufacturing companies use software – MRP (Material Requirements Planning) in conjunction with CRP (Capacity Requirements Planning) – to calculate and plan their total capacity.

It works something like this: a production forecast is input into the software. Then the system uses data such as perpetual inventory levels, bills of material, routings and production run rates to calculate how much material you need and  how much machine and people resources you need to manufacture the scheduled products. The resulting schedule for materials goes off to purchasing; the capacity schedule goes to the shop floor (in the near term often in the form of a bunch of work orders.)

The forecast of capacity requirements is important information for you, the CFO. If you are using standard costing, you use the total hours required to determine the manufacturing production costs for financial forecasting purposes.

Moreover, companies using such traditional methods measure the effectiveness of their resources in three ways.  After month end figures are complete, they will look at:

  • The efficiency of labor,
  • The utilization of machines and
  • How much overhead production absorbs.

This information comes from comparing how operations actually performed with respect to standard costs.  Typically you want to measure whether operations is beating the “standard” production rates set up in the system.

Labor resources are considered “efficient” if they produce at a rate faster than the standard and producing more than planned. Machines achieve favorable “utilization” if actual run times are greater than planned. And all resources are considered to be doing well if absorption is greater than planned.

From a financial standpoint then, what you are looking for are “favorable” variances as described above.  The more favorable the efficiency, utilization and absorption the better the profits and vice versa. Of course,  as the CFO, you pay close attention to these numbers because they have a tremendous influence on your financial statements and often times are discussed more than actual operating numbers.

If you have ever been a CFO or controller of a manufacturing company using standard costing, you now what a headache these numbers are.

So far, I haven’t told you much that you don’t know already.

Now here is the good news! When you become a lean company you can throw these numbers away, because (IMHO) they are meaningless to lean operations.

Capacity & Lean Manufacturing

First, I want to make something very clear. Efficiency, utilization and absorption measures do not work in lean companies.

They work just fine for traditional manufacturing because they are designed to support traditional manufacturing assumptions.  But efficiency, utilization, and absorption  totally conflict with Lean operating principles. For a mind map that shows the 5 Principles of Lean have a look here on the BMA web site.  As a Lean CFO you have a tall order:

  • Job #1 for you is to banish these measures forever from your company;
  • Next  you have to ensure the integrity of the actual data used to calculate capacity; and
  • Lastly, you have to integrate Lean capacity information into business analysis and decision-making.

We’ve learned so far in my earlier Lean CFO blogs that the total resources that a lean company requires are based on a combination of actual demand and the productivity of the resources available to supply that demand.  Lean Flow, with other effective lean practices,  gives operations what they need to maintain productivity levels regardless of the level of demand. This is the reason why Lean companies are less concerned about the total amount of capacity and more concerned with constantly measuring the productivity of their capacity.

Lean companies measure the effectiveness of their capacity based on the effectiveness of lean practices being used. In a Lean company, resources can perform two types of activities – productive or nonproductive.  Lean companies look at capacity  from the customer’s viewpoint, not from an internal viewpoint. This is a major difference between traditional thinking and Lean thinking.  It’s pretty simple:

  • Productive activities are those activities required to deliver customer value. These are the activities customers are paying you to do.
  • Nonproductive activities are everything else.  These break down into:
    1. Pure waste (such as scrap, downtime, waiting, etc.) which  needs to be eliminated.
    2. Other necessary activities, i.e., activities that you must perform to support the productive activities (think purchase raw materials) or run the company (think accounting).  Customers won’t pay you more money if you have best-in-class purchasing and accounting.  But they sure will complain if an order is late because your were late getting raw materials in, or if their invoice is incorrect. It’s up to you to use Lean practices everywhere for all necessary activities  just as you do in your value streams.

Measuring capacity in lean companies is really about measuring the amount of time resources spend on productive and nonproductive activities, then showing this on the Lean Box Score.  The best part about measuring capacity this way? The information needed is already on the value stream map.

Here’s a picture that illustrates where you find this data on a value stream map of a typical non-Lean production process.

Next time, I’ll spend some time on the issues that can make or break a Lean understanding of capacity.