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Theory of Constraints Max Profit #9 – Sales Backlog Problems?

by Dr Lisa on December 27, 2013

Theory of Constraints Sales Backlog – Is your backlog too low or too high?

Theory of Constraints DiscussionBrad: “It is common for business owners and managers to keep a close eye on the size of their Sales Backlog. It is a barometer of how things are going. Usually it is expressed in dollars. It is also expressed as a ratio, like ‘our backlog is 4 weeks’.”

Dr. Lisa: “Yes, and below or above a certain point, people really start to get nervous. This time of year, it can get way out of whack. If receipts of new orders have been slow coming in, the Sales Backlog dwindles. If production has slowed due to fewer workdays in November and December and a lot of vacation days taken, then the Sales Backlog goes up – often as sales goes down.”

Brad: “Here is a trick question – would you recommend a Sales Backlog that is bigger or smaller?”

Dr. Lisa: “Trick question, indeed. But let’s discuss it. This is a very important topic. And the size of the Sales Backlog directly relates to the health and profitability of a company.”

Brad: “The case for a bigger Sales Backlog is that it provides a predictable buffer of work ahead. It shows that the sales team has done their job. Everyone in production wants something to do, and everyone gets really nervous when the backlog is ‘too small’.”

Dr. Lisa: “The case for a smaller Sales Backlog is that the company can be more responsive to the market. The size of the backlog is a direct reflection of the current lead time. ‘Too big’ of a backlog and lead times go up. Way up. And since there is pressure to ship ‘on time’, there is a lot of expediting on the shop floor.”

Brad: “But when the Sales Backlog is ‘too small’, production may slow while milking the backlog that is available. So shipments go down. And because this operational slowdown occurs, the company does not benefit from the opportunity to be more responsive.”

Dr. Lisa: “We cannot consider the size of the Sales Backlog in isolation. We must consider the size of the Sales Backlog in relation to company’s rate of shipments and to that industry’s competitive lead time.”

Brad: “Variability in a company’s rate of shipments is a real problem. It dramatically lowers predictability. If the rate of shipments goes down, the size of the Sales Backlog (as expressed in weeks), is relatively bigger and lead times are longer. At the same time, overall profitability is suffering.”

Dr Lisa: And as I teach in Velocity Scheduling System, the rate of shipments should be fairly consistent regardless of what’s happening with your backlog if you’re scheduling correctly. The only time your rate of shipment should change is if your capacity changes. Rate of shipments should have NOTHING to do with your backlog unless your backlog gets so low that there is not enough to ship.

Dr. Lisa: “On the other hand, if the rate of shipments goes up, the size of the Sales Backlog is relatively smaller (as expressed in weeks) and lead times are shorter. Profitability will go up in the short run until the backlog is less than your rate of shipments.”

Brad: “That’s why there is fear when the Sales Backlog is too small.”

Dr. Lisa: “Yes and this fear is often misguided. A lower Sales Backlog is only an issue IF your rate of sales and rate of shipments have also gone down. If your rate of sales and rate of shipment have also increased then the only thing to fear is more profits.”

Dr. Lisa: “TOC is all about challenging assumptions. Let’s think holistically – about the company as a whole. What is it that we want?”

Brad: “Higher dollar profits; a higher return on sales; and more and more sales, consistently, week-in and week-out, month-in and month-out.”

Dr. Lisa: “Okay, to grow sales, what size of Sales Backlog do you want? “

Brad: “Smaller, of course, to leverage having a shorter lead time than the company’s direct competitors. Customers want it when they want it, reliably. Buyers will notice if we are more responsive. Buyers will notice even more if we can handle emergencies with ease.”

Dr. Lisa: “Correct, this is an important decisive competitive edge that can be used to create an ‘unrefusable offer’, or what we call in the TOC community call a ‘Mafia Offer’. “

Dr. Lisa: “But what about production? What are you going to say to them about only having a small, measly backlog?”

Brad: “I’m going to say they need to improve the rate of shipments so we can maintain the competitive advantage. Once the Sales Backlog goes back up, our actual lead times are the same or maybe even worse than our competitors.”

Dr. Lisa: “Yes, and for production to successfully reduce lead times and increase the rate of shipments, operational changes must be made. Production cannot be managed conventionally. It must be managed for flow, not local efficiencies. That is what the Velocity Scheduling System is all about. It is reasonable to assume that productivity can increase by 10% to 50% after implementing VSS, meaning the same people and machines can ship 10% to 50% more.”

Dr. Lisa: “And what are you going to say to sales?”

Brad: “That we need to feed the machine. Sales must consistently bring in more and more new orders. The rate of shipments trumps the perceived need for a bigger Sales Backlog. The sales funnel process must be managed well.”

Brad: “And with the lower Sales Backlog and shorter lead times, the sales people have something they can REALLY sell.”

Dr. Lisa: “Great. We have synchronized marketing, sales, and production functions of the company holistically. The company is making more and more money and all with a smaller Sales Backlog (as expressed in weeks). “

Dr. Lisa: “And after you’ve improved productivity and your rate of sales, and then your Sales Backlog starts to grow again – it’s time to add capacity.”

Brad: “As a former business owner, a smaller backlog still makes me nervous.”

Dr. Lisa: “Get over it.”

Check out Max Profit #8, Max Profit #7


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