Has there been any writing by Austrian or other free market economists about running a business? I’ve been wondering about this, since it could potentially open up a new field, like a micro-microeconomics.
Some people who come to mind are Bill Bonner, Gary North, Peter Klein, and Jim Rogers.
Any specific papers, essays, books, or treatises you suggest?
I doubt this guy is libertarian or Austrian but when I was getting ready for management it was a huge help. I am wondering if you have heard of him.
Thomas Gilbert, he is most known for his work at a management, production, manufacturing level improving business efficiency.
Human Competence: Engineering Worthy Performance
I read this before I started managing at my place. It gave me a much different perspective on how to encourage and look for performance amongst co-workers in my team. I would recommend it and if you do decide to check it out I’d like to know what your thoughts are on it.
Here is his model in a nutshell. Identify exemplars in a given organization. Identify the different behaviors of the exemplar and attempt to replicate.
Manufacturing company has 5 employees producing widgets. Their daily widget performance is
- PersonA: 5
- PersonB: 6
- PersonC: 4
- PersonD: 9
- PersonE: 4
The survey can go across hundreds of employees or across several plants but my example keeps it simplified. Lets say the Manufactguring plant has already undergone expensive training sessions for its employee’s and the productivity gained out of the training has not justified its costs.
Gilbert recognizes that there is not always a change in behavior just because there is an increase in knowledge. Instead what Glibert would do is survey the team and identify an ‘Exemplar’. In this case PersonD out performes everyone else signifigantly.
He identifies the exemplar in the group and than will attempt to ascertain what behavior specifically this person is doing that gives him/her such a performance advantage. He formulates his potential for improved performance as follows. (PIP)
Average Production: 5.6
Exemplar: 9
So the potential for improved performance is 3.4. Obviously not everyone may be able to theoretically produce 9 widgets a day. the Exemplar really just ends up being a goal for other employees. Once Gilbert identifies what specific human behavior is occuring with the exemplar he attempts to replicate this action out to all workers.
The ultimate result is, rather then giving employee’s arbitrary training which may or may not be beneficial he identifies efficient human behavior and attempts to replicate it. He finds that exemplars know their job extremely well and have taken the time to find key shortcuts or skills that benefit their job. He seeks to identify these skills and replicate them out. If it works well new Exemplar’s may be made and the strive to improve performance never ends. It gives a clear metric however to management on how they can improve their bottom line.
For management it improves the performance of all their employees. As an employee it provides easy access on improving your own skill set making you more marketable in general depending on the behavioral knowledge gained.
I have a few business consultant friends who employ similar technique’s and they say it’s always met with success. They do obviously have to sell their product.
This may be too specific for what you were looking for but thought I’d toss it out there. Cheers!
I can suggest looking in to the Theory of Constraints. They come from a different approach. They focus primarily on Manufacturing companies. TOC is related to management accounting.
Similar to the Austrian School, they’ve noticed several problems.
One is the idea of objective value. Manufacturing companies, primarily due to US regulations I suspect, view inventory as a real valuable asset. Austrians and TOC knows that only things that can be sold has value. There is no value in producing something that has buyer.
Two is that actors in the economy need to be aligned. According to the Austrian school the price system helps aligns the actors in the marketplace. According to TOC the actors in a firm need to be aligned and are often misaligned because false or conflicting measurements of performance are used.
Three is that sunk costs aren’t always recognized as sunk. In TOC sunk costs can include short term labor - you’re going to pay the employees anyway in the short term. Sunk costs form your pool of capital that is to be exploited to create as much money as possible. They can’t be minimized, but you can get a return on them.
These areas interlink in TOC. TOC aligns the goals around making money. You make money by producing goods that can be easily sold or better yet are already contracted for. You run business processes to maximize the dollar profit throughput per unit of process time.
Read The Measurement Nightmare and The Goal for more details. Amazingly a lot of business practices make the wrong assumptions - e.g. value is objective / inventory has value, different people/areas have different unaligned performance measures, sunk costs are treated as variable costs.
I think it would be worth creating Austrian School approaches to business and finance.
Theory of Constraints
The Goal
The goal of the organization is to make money. Theory of Constraints or TOC is designed to help align the people in an organization with the goal of making money. Often individuals and departments use measurements for performance and decision making that are misaligned with the goal.
The goal is to make as much money as possible using the available resources. One wants to increase cash flow, ROI, and profits. To do this one needs to measure Throughput, Operating Expenses and Investment. Throughput is Sales minus TVC / total variable cost of production (i.e. raw materials), operating expense are maintenance and fixed overhead (e.g. rent, utilities, etc.), and Investment is money tied up in supplies, capital, inventory, etc.
Reaching the Goal
Therefore one must ask about each decision - does this decision:
- Increase throughput? How?
- Reduce investment (inventory) (money that cannot be used)? How?
- Reduce operating expense? How?
The answers to these questions determine the effect of proposed changes on system wide measurements:
- Throughput = Sales – Total Variable Cost (raw materials = S - TVC
- Net Profit (NP) = Throughput - Operating Expense = T-OE
- Return on investment (ROI) = Net Profit / Investment = NP/I
- TA Productivity = Throughput / Operating Expense = T/OE
- Investment Turns (IT) = Throughput / Investment = T/I
(Here is a link to a simulator)
http://www.tpacc.com/1/main/tacalc1.htm
The Constraint
There is, by definition, something constraining profit Throughput. In some case the constraint on Throughput is in the marketplace – production capacity is higher than can be utilized. In many cases the constraint on Throughput is in production. Production can not crank out enough units to meet the demand for immediate profitable sales, in many cases production may also be producing units that don’t increase Throughput but for example go in to inventory.
In any production system there must be one area which is the constraint or bottleneck (just like on a basketball team one player is always the shortest.)
In order to maximize throughput one must make sure this constraint is as productive as possible, otherwise you’ll lose production of additional profitable units.
Managing the Constraint
- IDENTIFY the constraint (the resource/policy that prevents the organization from obtaining more of the goal)
- Decide how to EXPLOIT the constraint (make sure the constraint’s time is not wasted doing things that it should not do)
- SUBORDINATE all other processes to above decision (align the whole system/organization to support the decision made above)
- ELEVATE the constraint (if required/possible, permanently increase capacity of the constraint; “buy more”)
- If, as a result of these steps, the constraint has moved, return to Step 1. Don’t let inertia become the constrain
Theory of Constraints and Austrian Economics
Introduction
If anyone has investigated the working of large firms, one will notice a kind of internal socialism present. The same problems of information, management and resource allocation that Mises and Hayek described in relation to socialist calculation will crop up.
While many people think that firms exist to make money, in many cases they make money in order to exist and perpetuate themselves. This is in part because markets permit organizations that function just well enough to avoid bankruptcy to perpetuate themselves. Market discipline acts as a check on the expansion of badly managed firms, but it doesn’t magically guarantee results. That is up to the firm itself.
There are in fact economic fallacies which disrupt firms and cause them to perform less efficiently. Two examples we’ll encounter in this essay are the labor theory of value and empiricism / pure induction. The largest problem is that the price system that enables cooperation in the market place does not always function as effectively as possible within firms. There is an entrepreneurial opportunity here for people to apply the lessons of Austrian Economics to firms and enhance their growth. It may also show people how Austrian Economics helps people understand not just how government policies make them poorer, but also how Austrian Economics can help directly improve their life.
In short there is a great opportunity here for Austrian Economics to be applied in business.
In this essay we’ll discuss an approach to making firms more profitable called Theory of Constraints or TOC. While this is not associated with the , it is similar and parallel to it.
Similarities between Austrian Economics and TOC
Austrian Economics is a unified theory that helps people make sense of a wide variety of complex social phenomena and explain coordination and distortions in the marketplace. Theory of Constraints or TOC was designed to help members of firms, especially manufacturing firms, make sense of their own complex internal social phenomena and enable coordination and cooperation. TOC has detected certain flaws in the way actors in firms think, and their fixes for these flaws are congruent with the insights of Austrian Economics. Similarly the flaws within business thinking appear to be in part confusion but also erroneous ideas from economics that Austrian Economics and TOC corrects.
Key linkages of Austrian Economics and TOC
What is The Goal?
According to Austrian Economics the goal of market transactions is to make money and profits. The social function of the price system is to coordinate the different actors in the economy. According to TOC the goal of an organization is to make money, to profit. This goal must be used to coordinate the different actors within an organization. The Goal is also the title of the first book explaining TOC, and was written by Goldratt an Israeli Physicist.
While one might think that obviously organizations make money, we have to remember that lots of businesses don’t make money, or very much of it. Many people within an organization have their own goals which aren’t necessarily aligned with the goal of making money. The organization just muddles through and often eventually goes out of business. Internally many organizations are run like bureaucracies or quasi socialist institutions. The organization needs a system to help coordinate everyone the way that the price system coordinates the market.
TOC helps an organization align with the goal of making money. Just like the profit system helps actors in the economy align, TOC and the goal of making money can help employees in an organization align their efforts. The question is - how to make that coordination happen?
The price system sends simple and clear signals across the marketplace. The goal of TOC was to figure out how to do create simple and clear signals for organizations. This would make coordination possible. The market system helps prevent the cascading effects of supply and demand variability. Similarly TOC helps prevent these effects within an organization. Many organizations in fact have serious difficulties meeting demand and buy excessive raw materials to prevent supply issues and experience cascading disruptions throughout the organization.
Key Intellectual Errors
Two key intellectual errors Rothbard cites in his history of economic thought are the Labor Theory of Value and Empiricism / Pure Induction. Similar errors seem to have infected business thinking in firms. These are also key errors that TOC seeks to address.
Labor Theory of Value
Accounting practice often treats inventory as assets that necessarily have economic value based on the value of labor input and the value of material. However as we know from Austrian Economics market value is based on there being a buyer available in the marketplace. Goods that can’t be sold don’t have value and aren’t an asset. In fact they destroy value. Inevitably firms who have unsold inventory eventually take a loss and write off the inventory, despite the inventory being valued as an asset. In the short term valuing inventory as an asset distorts production
Accounting systems encourage many firms to produce goods at the lowest cost. This is often done by producing large batches of goods. Because the goods produced are seen as having some sort of inherent value, firms systems often do not consider whether there is an immediate buyer. (Individuals at firms of course do see this is an issue, but the firms system don’t reflect this.) Additionally firms may buy large quantities of raw materials that can’t be immediately used in order to get a lower per unit cost. The raw material in inventory ties up scarce capital and may even be written off. In both cases what is in fact a cost – wasted inventories of raw and finished materials – is often seen as asset or way to save money. By contrast, TOC helps firms to devote all their production and buying towards producing for the market and what can be immediately sold.
Empiricism / Pure Induction
As Rothbard pointed out pure induction does not work. One does not simply sift through all the data to come up with conclusions.
Goldratt, the author of The Goal and creator of TOC, points out that scientists view the data with the aid of a hypothesis, which is an IF THEN or statement. They don’t just sift through the data, they use the data to check their hypothesis and see if the data explains it.
However many management system do not take in to account theory. They assume that collection of data is sufficient. TOC helps organizations understand what data is important and relevant.
Accounting Systems
Traditional accounting systems are also set up to deliver historical reporting. They allow firms to see over all what performance was historically. This is particularly useful for the state who wishes to collect taxes, and is useful for creditors. However accounting practices are not focused on helping entrepreneurs make decisions and deal with the future. These accounting systems think of inventory as assets and try to account for costs. However entrepreneurs are often dealing with costs that in the short term can be divided in to sunk costs and variable costs, but accounting system when historically reporting lump them together. This is explained in much detail in the TOC book The Measurement Nightmare by Debra Smith.
Key Ideas of TOC related to Austrian Economics
Entrepreneur
The role of management in TOC is similar to that of Mises Entrepreneur. The Entrepreneur must determine what is the highest present use or investment of the capital available to him. This investment capital includes a variety of sunk costs as well as money available for investment. Entrepreneur uses the price system to help rank or value the different alternative courses of action available to them. TOC similarly helps people within the firm rank or value the different alternative courses of action available to them.
Marginal Costs and Profits
In order to maximize profits TOC looks for those activities which can increase marginal profits today and over time. TOC refers to Throughput, which is marginal profit, or the price of the goods sold minus total variable cost (i.e. raw materials.) This emphasis on Throughput or marginal profits helps firms avoid activities that aren’t related to market demand. As we showed above, often companies will act in order to ‘decrease costs’ and not to increase profits.
Time
Production takes time and passes through various stages, each taking time
This is a key point in Austrian Economics and in TOC. TOC focuses on stages of the production process and making sure that activities coordinate over time. As a corollary, it helps individuals understand the highest value action to take at each specific time.
Many production processes are uncoordinated with disruptive shortages and surpluses at different stages of the production process. Firms are often at a loss as to how to deal with them because the different stages of the production process are not aligned. TOC helps firms align themselves.
Profit Maximization and Sunk Costs
A key idea is to maximize profits with the resources available to you. The available resources include sunk costs, like your machinery, buildings etc. as well as the labor, overhead, and vendor services which you’re going to pay for anyway at least in the short term. Your goal is to maximize your return on this investment by making the highest possible use at any given time. Therefore with TOC you want to maximize the use of resources, especially labor which you’re going to pay for anyway. It doesn’t help increase profits to ‘decrease costs’ on paper by using less of your resources on hand, just to decrease costs. Those resources are still there and their cost isn’t going away just because they weren’t used. Instead one should maximize the profitable utilization of the resources on hand. Unfortunately many firms don’t view sunk costs as sunk, and try to save on those costs, even though the costs are sunk.
Profit Throughput and costs
One key idea is to look at your profit throughput per unit resource time. For example if you have a production line, how much money are you making per day or hour should be maximized.
Often there is the temptation to reduce the cost of production by inappropriately minimizing the labor input, when in fact adding labor can sometimes radically increase the profit throughput. Sometime there is a huge opportunity cost to reducing a cost. In firms what is seen can trump what is unseen
Profit Throughput also looks at the difference between your marginal cost of producing an additional good and the sales price of the good.
This helps answer - How do you prioritize production decisions?
Companies who implement Theory of Constraints focus on selling and producing the highest value items. The highest value items are those items that have a ready buyer and produce the highest profits per unit of production time. Profit means the difference between the marginal cost and only the marginal cost of producing an additional good and the sales price of the good. This has the happy effect of increasing cash flow.
This implies that if easy to produce low margin products have higher profit throughput than slow to produce high margin products, one should produce the low margin products. Producing high margin low labor products are not necessarily the best products for a firm to produce. Yet often companies assume that this is always the case.
The Constraint
TOC points out that in any production process there is a constraint or bottleneck. (Just as any basketball team always has shortest player.) This constraint limits profit throughput. Until the constraint moves, the organization must focus on the constraint. This helps coordinate everyone.
The coordination system is fairly elegant and simple, just like the price system.
Focus on maximizing profit throughput (which creates cash flow.)
If the firms understand what actions and products maximize cash flow, this help coordinate everyone in the firm.
Find the constraint in the business processes which if not running at peak performance will disrupt profit throughput. Focus on the constraint. This will help increase profit throughput.
Don’t worry about other areas unless they’ll prevent from the constraint from running at peak performance. Other areas by definition aren’t the bottleneck and can pick up the slack.
When the constraint moves to another place in the business process, focus on the new constraint.
Conflict Management
Debra Smith points out repeatedly in The Measurement Nightmare that actors within firms are often in conflict because the system sets up conflicting goals for different actors. Each person is trying to do the best job they can, but the system has given them conflicting goals. While the price system helps align firms, the system breaks down within the firm.
Similarly Mises Liberalism talks about the importance of Liberalism because it is a social system that aligns the individual and society. Under the Liberal system there is no structural conflict between the individual and society, and the price system is key part of Liberalism. Theory of Constraints works to set up a structure or way of thinking within the firm that aligns individuals and removes conflict.
Further
Hopefully this helps show how applying better and more economic concepts to the firm can help increase firm performance. This essay is only scratching the surface.
Two book which can help explain Theory of Constraints are
The Goal: A Process of Ongoing Improvement by Eliyahu M. Goldratt and Jeff Cox
The Measurement Nightmare: How the Theory of Constraints Can Resolve Conflicting Strategies, Policies, and Measures by Debra Smith
The Goal is an easy to read novel which introduces reader to concepts using the Socratic method. It is the book that started it all. The Measurement Nightmare is a much more technical and slower work which analyzes the structural issues firms face and the TOC solution, especially those relating to accounting.
Anders this is great. I think it could apply to more than just manufacturing. Any good textbooks?
I’ve only read these.
The Goal: A Process of Ongoing Improvement by Eliyahu M. Goldratt and Jeff Cox
The Measurement Nightmare: How the Theory of Constraints Can Resolve Conflicting Strategies, Policies, and Measures by Debra Smith
The Measurement Nightmare is along the lines of a textbook. The Goal is a great introduction to TOC and is the start of the school of though. It is a novel and uses the Socratic method to teach the reader.
Anders,
Your post got me interested in TOC, and after reading some papers I must say than it is nothing more that Linear Programming for dummies. That is of course very welcome, for normally linear programming calculations require specific softwares or copious amount of time (I almost failed LP in college), while TOC is much less complex, yet it is no “new “ management theory, and ads nothing to the manager’s horizon’s at all. It’s an production engineer’s tool.
But more generally, I originally got very interested to this topic because I know of no way in which Austrian prescriptions can apply to managment, with Mises himself highlighting this point on every occasion he got. Management, like entrepreneurial activities, is all about “pure instinct”, and no mathematical trick will help with that.
Thus, the similarities mentioned by you between the TOC and Austrian Methods are superficial and clearly general: every business management theory shares the same similarities! They all try to maximize efficiency, maximize profits, coordinate activities, get the firm close to a “internal free market”, etc. They only differ in regard to the techniques proposed, with TOC addressing only some of these issues (HR, wages, hours, organizational structure are all left out as these too can be decide only by instinct, not numbers).
All told, I must say that:
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Austrian prescription are of no value at all to entrepreneurs qua entrepreneurs. Only their instinct will help them.
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Managers, as Mises rightly said, aren’t entrepreneurs, and their duties differ form those of capital allocation. Thus, managers are just employees, although high-ranking ones, and as such have even less to gain form Austrian methods in their professional faculty.
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Managing a multinational conglomerate, say Royal Dutch Shell, is impossible, as Rothbard stated, because no mater how hard anyone tries, no “simulated internal price mechanism” can work (if not, the USSR would never have fallen). Big firms are just so damn inefficient. They only arise if a)subsidized, b)in short periods in a newly free market where production structure is evolving form conglomerates to SME-s, the real champions of business or else c) when fixed costs are such that large firm are preferable (but note that they are still inefficient, they’re simply the only alternative)
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Austrian prescription are, if properly understood, tautologies and are only useful (and massively so!) in tying together long string of tautologies (and a few assumptions made for practicality purposes), and thus building new, simpler, (quasi)tautologies. Strictly speaking they add nothing new, just make what we should already know more visible.
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By contrast, entrepreneurs and managers need new information, not tautologies, and as such have no use at all for Austrian prescription in their professional capacities.
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If not, rest assure that there would be no Mises Institute, for Mises himself, Rothbard, Rockwell, Hoppe, Tucker, Murphy and all these guys understanding Austrian Economics would just become CEOs, guard the theory carefully as a secret (or at least not insist so much in everyone understanding Austrian economics), and make tons of money with which it would be possible to bribe the State into submission. But as we can see, this hasn’t been the case at all.
I’m sorry, but there can be no “Austrian friendly” management theory. Otherwise a great discussion.
Dear Merlin, didn’t Anders just point out a few useful fallacies, that the Austrian School explicitly demonstrates to be wrong (subjectivity of value, etc), and how they have applications in the end for both enterpreneurs and managers?
Isn’t this what pretty much all science and education does - “adding nothing new, just making what we should already know more visible”? Because, if we don’t know those useful things, there may just be some value in applying the teachings of this school to this area.
Indeed, but TOC has nothing to do with either of these two fallacies. It just shows that one has to calculate the close obstacle to higher profits, then minimize that obstacle, and finally overcome it. It can be seen as a simple restatement of Ricardo’s law or calculus: where marginal values die, the parent value is minimized/maximized.
The theory has nothing to do with either value theory of labor or “strict” empiricism. And if you think about it, any manager which would have to be shown those two fallacies to be false would have the IQ level of toddlers. For current accounting practices do no expound the labor theory of value in per se, but use that as an approximation useful to avoid revaluating assets on a hourly basis (wich would make calculation nearly impossible). Profits/losses due to this approximation are incurred, not avoided (which is what would happen if accounting where really based on LTV), at most they get moved up be a few years.
As for “strict” empiricism, the human mind is incapable of even contemplating this process to its logical limits, let alone implement it. “Cognito, ergo sum”
But please refer to http://www.grafix9000.com/documents/CCI_Scheinkopf.pdf and you shall see what I’m talking about here.
If that were the case, we would never se “paradigm shifts” in most sciences. Tautologies do not change with added facts. Strictly speaking, “science” is either empiricism (physics, chemistry, biology, etc.) or logic (math, praxeology). Thus, empiric sciences can add value and have practical effects. Who could have known, back in ancient rome, that enenrgy equates to mass? On the other hand, a gifted individual could heve inferred praxeology or methematic since day 1, although no one is that intelligent.
How do you convince the exemplary employee to share these key shortcuts and skills with management and other employees? Wouldn’t they often want to keep these to themselves in order to advance their careers beyond those of the other employees?
You recognize their value and give them a bonus or higher wages.
Merlin,
I think you make good points, which I agree with.
But you also missed the main points of my posts.
A. Yes it is in part a process engineer’s tool. That is the constraint. But it is also an organizational tool. The market organizes independent actors - so how do you organize a firm?
B. You say
Entrepreneurship is separate from management. It is an art, but management is open to analysis. Mises always points out that value judgements help to determine what kind of house to build, but economic analysis can help us build that house more cheaply.
B.2. TOC was designed to help firms fill orders on time and with as little expense as possible - meeting the goal of making money. Firms actually have problems doing this. TOC does also address what to do if the constraint is in the marketplace - you don’t have enough orders. TOC primarily suggests you find the constraint in your customers business or life and help with that. Here’s an example. A firm making pipe connectors analyzed how their customer used them. Building contractors would connect the pipes, and it would take a long time to install each one, and you’d have to tighten lots of bolts. So a new design was created that took a fraction of the time to install and was compatible with the pipes contractors install. Contractors would now be much more productive. The manufacturer could charge a premium. In many areas of b2b you can improve entrepreneurial activities by applying analysis.
C. If the management theories which management actually practices contradict economics - isn’t that worthy of note? TOC seems consistent with the Austrian school even though it comes from a different direction.
D. TOC shows in great detail how companies misalign. TOC shows you how to use the price and profits and loss system to better align parts of an organization. Isn’t the price and profits and loss system exactly what aligns the parts of the economy?
In replay to point 5.
See point D. above. If Entrepreneurs and Managers aren’t getting the information they need and aren’t aware they need it, this is a huge proglem. The information they so often need relates to prices and profits and losses. TOC talks about the information that people are missing and what needs to be measured in order to give everyone the information they need to be aligned and making the right decisions.
A good example is inventory. If management views unsold inventory as an asset that is bad information and bad thinking. They’ll start producing goods that end up in inventory in preference to goods that there are orders for today. An Austrian School economist analyzing a business firm would point out to them that there’s no such things as objective value and that the should be producing to fill orders and make money, not to fill up their warehouse with valuable inventory.
Again, if business firms are engaging in improper analysis and uneconomic thinking, then there is room for Austrians to help.
The Mises Institute spends tons of time talking about wrong government policies. What if there were more Mises people showing firms how their policies are wrong, and charging a ton and making the firms more profitable? That would be exciting.
I should also re-iterate that the book The Measurement Nightmare gives a lot of detail about accounting and business practices that violate economics and common sense.
I work for a living helping companies get more visibility in to their costs. I know companies all the time are forced to make sub optimal decisions because they don’t have the information they need to make a better one. This is a talk I gave on the subject.
http://www.berlinpacific.com/docs/Visibility.ppt
Bloomberg is so rich because he realized that by giving entrepreneurial people better information on what’s going on in markets they would make more money and be happy to pay him money.
Depends on their work environment. If it’s competitive that may be so but thats an incentive issue that can easily be corrected.
I believe you are right in as far as we discern that a manager has so many functions, unlike the entrepreneur who must only allocate capital to different ventures (and across time) in order to be considered such (that of course doesn’t mean that an entrepreneur can’t also be a manager).
Thus, TOC is truly helpful for a manager in his production managing function: managing production, schedules, inventories, purchases, etc. I really enjoyed the theory and found it very helpful in this respect.
What TOC doesn’t, is that it can’t’ help the manager mimic the price system inside his company. A short example: if a Megacorporation has as much as 500 manufacturing plants all over the world, how to make sure that the manager of each plant does his outmost to ensure the profitability of business? Can the CEO expect to find, one fine day, a letter ion his desk form one such manager asking to be fired or demoted since his plant can’t make money and should be closed?
Of course not, people put their interest before everything else. in a free market the competitive price system allows for individual and “collective” interests to converge, within a firm this is impossible. So, putting ourselves in the shoes of the Ford CEO, how can TOC help me overcome THAT difficulty? For that is what “applying Austrian prescriptions to management” would amount to. Or is this view to narrow?
NOTE: I don’t think the above problem can ever be solved. Intelligent individuals will invent something to keep the firm going well enough, but no single answer, such as those provided by praxeology in the field of human action, can be given to this issue. It is, I believe, inherently unsolvable. Else a socialist government could very easily use TOC to function well enough.
I believe this is more of an approximation than a way of thinking. Inventory will either be sold in full, sold with lower prices or entirely written off. When managers end up with a surplus of product, they assume that this surplus can be sold and all they need to do is curtail production in the future. So, I don’t think anyone thinks that inventories are inherently sellable. It is just based on experience that they know that using its historical cost will result in a smaller error of valuation along an extended period of time(the same goes for accounting practices in general).
There might be, of course, guys who just trust accounting principles a such, but most intelligent managers do, I believe, see these practices as a mere approximation.
Socialism doesn’t work because the price system isn’t allowed to function. If the price system functions properly then it isn’t socialism, it is free enterprise.
You don’t mimic the price system. You institute a measurement system so you can better see prices and profit and losses. With TOC any observer can see with each plant / production line how they’re performing.
- Throughput = Sales – Total Variable Cost (raw materials = S - TVC
- Net Profit (NP) = Throughput - Operating Expense = T-OE
- Return on investment (ROI) = Net Profit / Investment = NP/I
- TA Productivity = Throughput / Operating Expense = T/OE
- Investment Turns (IT) = Throughput / Investment = T/I
Many manufacturing plants do not maximize profit throughput. They often try to decrease the ‘cost of goods’ instead of getting as many marginal dollars as possible for each available unit of production time. They improperly use prices and profit and losses.
Actually TOC shows you how to better align everyone. Most conflicts in a firm emerge because of misalignment management assigns conflicting goals to employees.
Several companies I’m familiar with used TOC so all employees can now tell what to do. If they’re in sales they sell the highest profit throughput products first. If they’re in production they make the highest throughput products first. Without TOC they wouldn’t know what they have to do in order to perform.
Obviously yes entrepreneurship and art is needed. But entrepreneurs require a functioning price and profit and loss system. If their company doesn’t have a functioning price and profit and loss system how can they succeed? Some good form of management accounting is needed.