How to use the Theory of Constraints to control and scale your business.
A guest blog post by Business Coach, Eric Gregory of Gregory Business Coaching.
The goal of every business and its’ owners is to create consistent, predictable and controllable profit, year in and year out. Sure, you might like to have some fun along the way and maybe feel a sense of satisfaction from what you do, yet, if your business doesn’t provide a return on investment above and beyond your wage, in the form of profit, what you’ve really done is built yourself a job as opposed to a company, which is probably not why you originally went into business in the first place.
Thankfully, there are some key disciplines and strategies to help you make sure your business consistently produces your desired profit levels ensuring the time and effort you’ve invested into your business returns you more than just a wage.
1. Brief outline of The Theory of Constraints
In 1984, Eliyahu M. Goldratt introduced the ‘Theory of Constraints’ in his book ‘The Goal’ which is designed to help organisations achieve their goals and was very much geared towards operational plants and manufacturing. The theory states that a companies’ output is only as good as its throughput. If there are any constraints within the business workflow, the total output will be limited by that constraint. It is very similar to the old idiom “A chain is only as strong as its’ weakest link”.
2. Quantifying and clarifying your ‘Business Assembly Line’
The system my company uses to coach businesses is called ‘10 Keys to a Profitable Business’, those keys are: Capital, Strategy, Leadership, Team, Systems, Marketing, Sales, Delivery, Finance, Admin. Within those ‘10 Keys’ is a section that we call ‘The Business Assembly Line’, this is your version of a factory, those keys are: Marketing, Sales, Delivery, Finance and Admin.
Every business in the world must do those five things well to have a functional business workflow. Marketing must produce the right number and type of leads, Sales must convert the right number and type of customers from those leads, Delivery must deliver what was sold to the customer and do it on-time, on-budget and to the standards outlined in the sale while maintaining margins, Finance must manage the money throughout the process (cash flow, AP AR etc…) and Admin supports those areas throughout this process and is the glue that keeps your office running. Imagine those five keys from left to right just like a traditional factory, sitting above those keys are systems and team, your team must run the systems within those five keys to make sure everything runs smoothly, effectively and efficiently.
The challenge for most SME businesses is that most never reach a point of thinking about their business this way (they stay far too reactive) and far fewer ever get around to doing anything about controlling and managing the constraints within their business.
Without going into too much detail here, the best way for you to quantify your ‘Business Assembly Line’ and making a start at identifying what your current true capacity might be, do the following:
- Work out what you believe your total sales per annum can potentially be, start with your tradesmen in Delivery, this will usually give you a good indication of how many billable hours you potentially have and if you have subbies, factor those in as well, but remember that subbies need managing too, so better to be conservative
- Let’s assume for a moment that your total estimated sales capacity for the year is $3 Million, next step is quantify what that looks like in terms of total customers, how many, what types etc.
- Now that you have total customer numbers, work out what your established returning base of customers is, the difference between your returning base and total capacity target is your new customer target (some companies will have a need for 100% new clients every year, others much fewer)
- Next, quantify your conversion rates from leads to meetings to quotes to customers and sales
- What you have effectively done now is established (at a given total sales point per annum), what needs to happen across all 5 Key functional areas of your ‘Business Assembly Line’ or what each area needs to be able to consistently ‘output’ to play its part in producing the total ‘output’ which is your total estimated sales for the year at capacity
- Finally, with this information in hand, look at your systems and your team and mentally assess whether they are ready and capable to handle the workload associated in each of those five areas
3. What does working ‘ON’ your business really mean and how you can apply it
Every business owner I speak with agrees with the statement ‘work on your business as opposed to getting caught working in it’. However, when I ask them what that means, most people have difficulty giving an effective definition, they agree with the idea, but don’t have any real way of defining or applying it.
At any given point, a business must be able to understand its break-even point and its capacity point (as discussed above in point two). Before you begin down the path of new growth, commit to mastering your current capacity point. In other words, make sure your ‘Business Assembly Line’ of Marketing, Sales, Delivery, Finance and Admin can consistently produce the outputs needed to generate the total revenue figure at your capacity point (without adding any additional resources).
Relentlessly refining your business model until you fix all of the constraints in your ‘Business Assembly Line’ is what we define as working ‘ON’ your business… the end result will be that you have the right team to run the systems that prescribe the way your ‘Business Assembly Line’ runs at your realistic capacity.
Finally, when you want to grow, the next step will be to repeat this process, however, as you grow, new constraints will present themselves that weren’t present at the previous capacity level which will need refining and improving. Having said that, with each step, your overall business model will become more and more efficient and effective and eventually you’ll reach a stage of automated predictability and control and with each new growth phase the amount of refining and fine-tuning will reduce dramatically, not to mention the fact that you should by that point be in a much more stable financial position and have your own internal capital which will give you the ability to control and fuel the growth even more.
4. Try to avoid trading profit for growth
Ok, so let’s assume you are now working ‘ON’ your business as described above in point 3, make sure, at this point, to avoid one of the mistakes far too many businesses make which is to try to grow too quickly or before they are ready (the business doesn’t yet have the ability to maximise capacity). What tends to happen if this is the case is that the company may grow but they end up sacrificing profit for growth, sales may indeed increase but not to the level required and the business may end up with less profits than before they started to grow and the company ends up in a more precarious position than it started from.
The lesson? Master capacity at your current level, ensuring your ‘Business Assembly Line’ has no constraints and is ready to be scaled and then grow to the next level. If you’re not profitable at your current capacity level, growth may be the last thing you want to try to attempt.
5. Passing this thinking onto your team so it becomes a habit of your company
Your team are a vital key to making all of this happen. You need to make sure you find, keep and grow the right team members. Once you have the right team members, one of the best ways to ensuring you keep them and they grow with your business is to include them in the working ON your business (make sure they still maintain their roles of working IN the business but also include them in the overall thinking about and working ‘ON’ your business as well… eventually your business will grow to a size where you can have a team of senior leaders who are employed to do this almost exclusively). By doing this, your team will be more engaged, have more purpose to their work and ultimately, it’s almost impossible for you to achieve your capacity without them, get everyone involved.
simPRO plays a massive part in ensuring your ‘Business Assembly Line’ has the ability to run at full capacity, it is one of the key ‘Systems’ that your business will need to keep your workflow running smoothly, allowing your team to run it for you in an automated, controllable, repeatable and profitable way. This is what we call having a ‘Well-oiled, Systematic, Profitable Business Machine’.