Deconstructing Illusion

Powerful illusion surrounds capacity utilization in financial reporting. There is no line to show the amount of Idle invested capital on the Balance Sheet. Similarly, there are no lines on the Earnings Statement (P&L) showing the amounts of idle and under performing fixed and variable expenses.

The practice of distributing, or ‘fully burdening’ the actual units of production output with total fixed and variable expense hides idle fixed expenses and under performing variable expenses from view. See more on this subject in an excellent paper titled “Idle Capacity Costs: It Isn’t Just The Expense” by Bettinghaus PH.D, Debruine PH.D and Sopariwala PH.D. (Management Accounting Quarterly, Winter 2012).

Extending the illusion presented by financial reporting, management subscribe to a causal fiction presented within the reductionist view of operating performance. This fiction views functional (local) performance losses as unrelated to enterprise capacity utilization. Management generally believe all performance outcomes may be improved by correcting underlying local operating problems.  This isn’t true. Local performance measures reflect the local utilization of enterprise capacity.

Subject to financial reporting which doesn’t acknowledge the cost of significant idle capacity or its associated expense, and confusion over cause and effect, why should anyone wonder why operational management systems ignore capacity losses, and management behaviors and disciplines are abstracted or atrophied to the point of non-existence?

These illusions undermine Sales & Operations Planning (S&OP) tools and disciplines. Demand forecasting and resource planning tools are often redundant or ineffective because activated capacity is set to serve peak demand. This results in variable expense becoming fixed and the disciplines associated with varying resource levels in relation to changing demand are eroded. 

As a result, the inherent need to observe high operating standards is eroded. Operating standards dissolve or erode because they can. Over servicing and over engineering become entrenched as a means of ‘utilizing’ excess capacity. Standard margins are thin or undefined because underpricing is an essential means to boost ‘demand’ in order to ‘utilize’ excess capacity. The same erosion takes place with respect to a host of operational standards ranging from minimum order quantities and order lead times to safety, sanitation, training and education.  

We design and install effective customized management operating systems to optimize enterprise capacity utilization. We understand this is necessary in order to sustain improved in local (functional) performance outcomes.

Powerful illusion is maintained around capacity utilization in financial reporting. There is no line to show the amount of Idle invested capital on the Balance Sheet. Similarly, there are no lines on the Earnings Statement (P&L) showing the amounts of idle and under performing fixed and variable expenses.

The practice of distributing, or ‘fully burdening’ the actual units of production output with total fixed and variable expense hides idle fixed expenses and under performing variable expenses from view. See more on this subject in an excellent paper titled “Idle Capacity Costs: It Isn’t Just The Expense” by Bettinghaus PH.D, Debruine PH.D and Sopariwala PH.D. (Management Accounting Quarterly, Winter 2012).

Extending the illusion presented by financial reporting, management subscribe to a causal fiction presented within the reductionist view of operating performance. This fiction views functional (local) performance losses as unrelated to enterprise capacity utilization. Management generally believe all performance outcomes may be improved by correcting underlying local operating problems.  This isn’t true. Local performance measures reflect the local utilization of enterprise capacity.

Subject to financial reporting which doesn’t acknowledge the cost of significant idle capacity or its associated expense, and confusion over cause and effect, why should anyone wonder why operational management systems ignore capacity losses, and management behaviors and disciplines are abstracted or atrophied to the point of non-existence?

These illusions undermine Sales & Operations Planning tools and disciplines. Demand Forecasting and Resource Planning tools are often non-existent or ineffective. As a result, activated capacity is often set to serve peak demand. This results in variable expense becoming fixed. Disciplines associated with varying resource levels in relation to changing demand are eroded. 

As a result, the inherent need to observe high operating standards is eroded. Operating standards dissolve or erode because they can. Over servicing and over engineering become entrenched as a means of ‘utilizing’ excess capacity. Standard margins are thin or undefined because underpricing is an essential means to boost ‘demand’ in order to ‘utilize’ excess capacity. The same erosion takes place with respect to a host of operational standards ranging from minimum order quantities and order lead times to safety, sanitation, training and education.  

We design and install effective customized management operating systems to optimize capacity utilization. We understand this is necessary sustainably improve performance outcomes.

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