Challenges in the PSTS Sector

Some challenges that are endemic to manufacturing and distribution do not carry the same weight in PSTS. For instance, TOCG strives to minimize inventory because it's an expensive investment that limits flexibility and all-to-often becomes obsolete before it's sold. In PSTS, however, there are virtually no inventories. Services are consumed as delivered, so there's no way to produce them in advance.

In that context, any solution that minimizes physical inventory is a solution in search of a problem. Nevertheless, as will be seen later, the principles underlying TOC apply to services as well as goods-based businesses and, with some adaptations, TOCS can address several challenges facing the PSTS sector.

Some challenges facing PSTS are the same as those facing enterprises in other service sectors: New entrants have radically different business models.

Work seeks the lowest level worldwide via outsourcing and offshoring.

Legislation, regulation, and intellectual property rights can work for you or against you.

New technology levels the playing field, but old technology is hard to replace.

There are, however, challenges afoot that hit the PSTS sector especially hard: Knowledge is expanding, which makes expertise harder to attain.

The half-life of information is getting shorter, which makes expertise harder to sustain.

Clients want results, not just advice.

Demand is inherently unpredictable, so clients want to shift that burden.

Clients want their projects completed better, faster, cheaper.

Clients want their processes to accommodate unpredictable swings in demand easily.

Competitors are observant, so competitive advantages tend to be fleeting.

Fortunately, TOC can address several of these challenges.

What TOC Has to Offer

Challenges facing PSTS are formidable enough to motivate some managers to seek alternatives to conventional wisdom. Fortunately, TOC has much to offer PSTS.

First, TOC establishes flexibility instead of pushing for predictability. That is, rather than striving for more accurate forecasts over longer horizons, TOC manages buffers that anticipate predictable changes in demand or supply. When something unpredictable happens, the enterprise is not locked into lengthy commitments. When you are nimble, rogue waves matter less.

Second, TOC speeds up projects and processes. When correctly harnessed, speed not only makes an enterprise nimble, it pleases clients because they can get their services on demand. Delivering services on demand, rather than as capacity is available, creates competitive advantage that's hard for competitors to match. When you are speedy, everyone else has to play catch-up.

Third, TOC focuses management attention on the constraint. Literally dozens of other concerns can fade into the background when the constraint becomes the center of attention. Moreover, the constraint then becomes a leverage point because relatively modest changes there can generate sizable benefits elsewhere-both for the service provider and its clients. When you manage constraints, noise fades away.

Finally, TOC rearranges management priorities. The top priority for most managers is cost control, but TOC shows how this emphasis is misplaced when it makes growth difficult. In contrast, when managers adopt TOC, their top priority switches to maximizing cash from sales minus truly variable cost, which is called Throughput. When you maximize Throughput, growth comes naturally.

Every TOC implementation has to answer these fundamental questions: (1) What to change?, (2) What to change to?, and (3) How to cause the change? Answers to these questions for TOC in PSTS are provided next.

What to Change

Pain points would seem to be an obvious way to decide what to change. If you ask managers about their pain points, they can easily reel off long lists. This is in fact the way many process improvement programs actually start. Unfortunately, that sets those programs off in the wrong direction because pain points are symptoms, not causes. Just as treating the symptoms of a disease provides temporary relief rather than a cure, treating pain points provides temporary relief while allowing the core problem to fester.

When applying TOC, undesirable effects (UDEs) are the starting point for figuring out what to change. For example, shipping orders late is an UDE of pushing too many jobs into and through a factory. A corresponding UDE in PSTS is finishing client projects late by starting more projects than the service provider can handle at once. Arbitrarily starting fewer jobs or projects isn't the answer, however, because the number of jobs or projects is a symptom, not a cause. Unless you know which jobs or projects to start-and how to manage their constraints-you haven't really solved the problem.

Contrary to conventional wisdom, behind even the most complicated web of symptoms there is usually just a single core problem. It accounts for the multitude of pain points. If there are too many jobs in the factory, the core problem could be the factory's constraint isn't being managed. If there are too many services projects in progress, the core problem could be the service provider's constraint isn't being managed. The pain points associated with rework, overtime, missed shipments or milestones, employee morale, and customer dissatisfaction can be traced back to this core problem. In addition, mandates to eliminate rework, cut overtime, ship on time, meet milestones, reassure employees, and satisfy customers invoke considerable effort to treat symptoms, not the core problem.

Once the core problem is identified, however, it's usually the result of a conflict. For instance, if senior management complains that utilization is too low, more jobs get pushed into the factory or more services projects get launched. However, the crush of new work and the confusion sown by expediting slow down work on previous commitments, which further depresses utilization. By now, the conflict is in full swing.

The question then should be how to stop the cycle. Conventional wisdom says the way to resolve conflict is compromise. For example, picking an optimal utilization target and setting an optimal production schedule seems like a sensible solution. Unfortunately, universally high utilization and high overall productivity are an inherent conflict, and no amount of compromise will make it go away. Indeed, what often happens is senior management scrutinizes utilization until production becomes unacceptable. Then scrutiny shifts to on-time delivery until utilization becomes unacceptable. Then the cycle repeats. TOC practitioners know, however, that whenever they see an enterprise oscillating this way, its managers are probably compromising on a conflict. Oscillation takes many forms: centralize versus decentralize, hire versus fire, acquire versus divest, and build versus buy, to name a few.

In contrast to conventional wisdom, TOC teaches the way to resolve conflict is to eliminate the conflict itself. For example, the quest for universally high utilization is rooted in the belief that every resource that isn't fully utilized represents a lost opportunity for production. However, if the non-constraints produce more than the constraint can, work just piles up ahead of the constraint even though non-constraints downstream from the constraint are sometimes starved for work. And if work is released into production just to keep workers or machines busy, it eventually leads to excess inventory. The services equivalent occurs when people bill projects for tasks that could be done better another way, or that don't necessarily need to be done at all to complete the project successfully, but that do contribute to resource utilization.

TOC resolves this conflict by maximizing utilization of the constraint, while minimizing utilization of everything else that isn't required to keep the constraint busy. In other words, the goal is not utilization; the goal is Throughput via saleable products and billable services. Once utilization targets are recognized as the cause of UDEs, no compromise is required to eliminate the conflict-just measure utilization of the constraint, and nothing else.

Not only can service providers use this technique to improve their own enterprise, they can use it to help clients improve theirs. Indeed, the TOC approach to marketing and sales depends on this specific capability. Of course, the TOC approach can be applied to more than just marketing and sales of services. What to change throughout PSTS is covered next.

Expertise and Assets

Every enterprise in the PSTS sector depends on expertise. It's how sales are made and reputations maintained. Missteps here have condemned to oblivion some trusted professional service firms, cutting-edge research organizations, and high-flying technology start-ups.

If a PSTS enterprise is labor-based, having the right professionals, scientists, or technicians is a critical success factor. Each professional practice, research lab, and technology group needs to have the right skills in the right amount in the right place at the right time.

Conventional approaches include hire-to-plan, which requires a forecast, and hire-to-deal, which requires clients who are patient enough to wait, if necessary. Of course, forecasts are notoriously inaccurate, and clients have less and less patience. Consequently, oscillating between too few and too many resources is a common conflict in PSTS enterprises.

If a PSTS enterprise is asset-based, expertise still plays a vital role. However, the experts put more of their effort into assets that clients value and less effort into serving clients directly. Those assets may be physical capital, such as architectural models, research laboratories, or data centers. Alternatively, the assets may be intellectual capital, such as legal databases, engineering designs, computer patents, or consulting methodologies.

To the degree that assets serve more clients than the experts could without assets, the enterprise gets leverage from its investment in assets. Thus, it might seem that assets lessen the need for experts, but the opposite can be true because a shortage compromises service to multiple clients. For example, a service outage of just a few minutes can provoke howls from all the clients who have come to rely on the service provider's assets.

Service Delivery

Every enterprise in the PSTS sector generates Throughput via projects or processes. Although these terms are sometimes used interchangeably, making a distinction is useful when applying TOC.

A project is a set of finite-duration tasks that must be performed in a specified sequence to produce the desired result within a prescribed time and budget, such as designing, building, and implementing an information system. Every project is therefore unique, even if based on a standard methodology with known deliverables.

A process is a set of activities performed continuously or on a frequently recurring schedule, such as doing legal research, repairing equipment, and processing purchase orders. Every process is therefore highly repeatable, and the output of processes is typically measured in terms of service levels, such as the percentage of service requests completed within a specified period.

If a PSTS enterprise is project-based, it has to execute individual projects, of course. However, it also has to manage a portfolio of projects for multiple clients. Moreover, those projects compete for resources, so project management and resource management are complementary. TOC has traditionally treated resources as relatively fixed, and has managed projects according to the prevailing resource constraint. This approach can be quite acceptable in an enterprise that does internal projects as an adjunct to its main business, such as when it performs engineering projects in support of its manufacturing business.

Although PSTS enterprises also do internal projects, such as those to build their assets, they often do more external projects as their main business. And letting a resource constraint dictate what the service provider can produce may or may not be consistent with its strategy. Indeed, when a service provider adopts a strategy to deliver services on demand, resources should not be its constraint. Thus, to make TOC workable on such services projects, it cannot be based on the presumption that resources are relatively fixed.

If a PSTS enterprise is process-based, it likewise has to execute individual processes, as well as manage a portfolio of processes for multiple clients. Moreover, those processes compete for resources, not just with other processes, but also with projects. For instance, if the service is employee benefits processing for multiple clients and the service provider is simultaneously building an asset to automate employee benefits processing, then the benefits experts are likely pulled in several directions at once.

Clients engage service providers to perform processes on their behalf for various reasons. Expertise is an obvious one. So is reduced cost from economies of scale. Perhaps less obvious is the expectation that the service provider has global reach, can handle higher processing volumes, or will be able to react to a wider range of demands. The latter point is notable because it requires the service provider to be nimble. The ability to dial processing capacity up and down with demand differentiates services on demand from services as available. Capacity management requires measurements to drive it.

Measurement

Every enterprise in the PSTS sector requires measurement. Of course, the finance and accounting functions are major sources of measurements.

The prevailing measurement method in PSTS, cost accounting, is the same method used in the vast majority of enterprises, regardless of whether they produce goods or deliver services. Despite its widespread use, however, cost accounting is controversial. Many accountants are well aware of its shortcomings, but they are trapped in a professional conflict that obligates them to use it anyway.

When direct labor costs dominated product costs, allocating overhead was straightforward. However, now that direct labor no longer dominates product costs, allocation creates distortions that mask the true profit contribution of each product. Some products may appear profitable, when actually they are not. Consequently, manufacturers relying on cost accounting make product mix decisions that are far from optimal.

The same dilemma afflicts service providers who rely on cost accounting. Even in labor-based services, cost allocation masks the true profit contribution of service offerings. Some may appear profitable, when they are not. Consequently, service providers relying on cost accounting make service mix decisions that are far from optimal. Moreover, service providers who bid on jobs with cost-plus pricing are more prone to over- or under-price their bids relative to what the work is actually worth to clients.

Another insidious effect of cost accounting is Cost-World Thinking, which is the TOC name for making cost reduction the top management priority. Relentlessly driving costs down can have the unintended consequence of driving down revenue, customer satisfaction, and employee morale as well. This is just as true in PSTS as in manufacturing.

Marketing and Sales

Every enterprise in the PSTS sector has to pursue marketing and sales, even if its practitioners are on retainer. Moreover, marketing and sales depends on expertise and intellectual capital that clients value. Here are typical marketing pitches for PSTS.

We should do it for you because you don't have the necessary expertise in-house (for example, independent auditing, architecture, or intellectual property law).

We can do it for you because it's not your core competency and we can do it better, faster, cheaper (for example, technical support, procurement, or market research).

We can do it with you because you have insufficient capacity, need to share risk, require physical facilities, or lack specific skills (for example, joint scientific research).

We can help you do it yourself by providing assets (for example, information technology, knowledge bases, or patents).

Although it might seem that these marketing pitches, as well as the services they encompass, have little in common, when enterprises in the PSTS sector market such services, they almost always start with cost-plus pricing. That is, they base their bids on standard billing rates, which in turn are based on standard costs plus a standard margin. This, however, assumes that there is only one fair price that all clients ought to be willing to pay.

Of course, standard rates have nothing to do with the business value that clients perceive in a service offer. Two clients receiving identical services may derive substantially different business value because their needs are different. Consequently, negotiations that take place during the sales cycle of large contracts move the provider and the client toward a mutually agreeable price for a given scope of work. How far the provider will negotiate is nevertheless strongly influenced by the margin between standard cost and bid price, which keeps the provider anchored on cost rather than value. Consequently, providers often have no other way to decide whether they are under- or over-pricing their services.

Something similar happens on smaller contracts, which can include high volumes of services too small to negotiate separately. In that case, the service provider may have discounts based on volume or customer loyalty-and premiums based on local market conditions. Nevertheless, standard rates and margin analysis still lie behind the discounts and premiums, even when there is no overt price negotiation.

The upshot of this is to the degree that standard cost is fallible, the resulting standard rates and gross margin do not maximize Throughput. Furthermore, the nature of the services themselves affects what clients will buy. When every service provider is proposing fundamentally the same services, marketing and sales gravitate to price as a differentiator. This, of course, opens the door to new competitors with different business models that not only change pricing, but also what value clients get for their money.

Strategy

Every enterprise in the PSTS sector tends to have the same fundamental strategy as its competitors. That may sound like a bold statement, but consider this: A typical PSTS strategy says, "the enterprise will provide a given set of services in its fields of expertise to particular types of clients for standard charges-or a negotiated price (within limits based on cost)." It doesn't matter whether the field is a profession, science, or technology-the strategy is the same.

From the service provider's perspective, expertise is the primary differentiator, and the tasks are to maintain the firm's reputation while managing cost, protecting gross margin, and winning new contracts. From a client's perspective, however, price is the primary differentiator because expertise is essentially unmeasurable. Clients thus ask themselves, "Am I willing to pay a higher price when I cannot objectively evaluate expertise, or can I get reasonably comparable service elsewhere for a lower price?"

This disparity in perspectives opens the door to new entrants who are able to compete only on price. Then the entrenched firms seem to have few choices. They can begin serving different clients with the same services, or existing clients with new services, either of which can shift the battleground to more favorable terrain. Alternatively, they can stand their ground on reputation and hope that their clients are sufficiently risk-averse to low-cost competitors, which means the firm's rainmakers have to cement the firm's relationship with its client base. On the other hand, those entrenched firms can join the price war sparked by the new entrants and watch the market race to the bottom.

There is, however, another possibility: Alter strategy to pursue client value rather than price. The shift from labor-based to asset-based services is one way to do this. It's harder for new entrants to compete on price if they have to build assets comparable to ones the entrenched firms already have. In addition, clients may enjoy the benefits of higher functionality and reliability with asset-based services.

The prevailing PSTS strategy outlined above thus may have made sense when professions were sparsely populated, science was in its heyday, and technology was a novelty. However, with professionals, scientists, and technologists facing competition as never before, an undifferentiated strategy is a huge exposure.

The question then becomes, "Does TOCS enable service providers to change the game in any way besides shifting from labor-based to asset-based services?" The answer, as we shall see, is yes.