TameFlow Insights: Cost of Delay (CoD) Improved via Theory of Constraints (TOC)

The notion of Cost of Delay is being adopted ever more frequently as means of making better prioritization and/or business decisions based on economic value. Don Reintertsen, Joshua Arnold and others have described Cost of Delay in excellent ways. More recently it has been adopted by SAFe.

One interesting aspect is that the practical use of Cost of Delay for decision making, involves the so called CD3 ratio, or Cost of Delay divided by Duration. This is interesting because it is a ratio wherein the denominator is time.

In the Theory of Constraints there is a similar ratio that takes the form of money / time, which is used to make similar decisions. It is known as Throughput Octane (TPO) or Finantial Throughput Rate (TH) and even other names.

While CD3 and TPO might appear similar, in actuallity they differ. This is how:

• Numerator: In CD3, the numerator is the Cost of Delay (COD) which can be quantified in various ways. In CD3, the numerator does not represent value but it is another ratio (because Cost of Delay is always defined as a ratio) that wants to capture how “an option’s potential value decays over time” Joshua Arnold. The numerator is thus a rate. In TPO the numerator is the Throughput of Throughput Accounting: Net sales minus Totally Variable Costs.

• Denominator: In CD3 the denominator is the time it takes from start to finsh of the work to be done. In TameFlow, this is known as the Flow Time. In the Kanban Method this is known as Cycle Time or Lead Time. Terminology aside, what matters is the notion that it is “the time it takes to get the thing done.” In TPO the denominator is defined more precisely: it is the time a product or service takes to be processed by the system constraint (the “Herbie”).

The TPO ratio of money / time is, in a way, a measurement of speed: the speed at which the system can generate monetary value. Thus, in a money vs time diagram, it would be the slope of the line.

Interestingly, both CD3 and TPO give the same prioritization rule: when comparing two or more options, give priority to those that have the hights ratio. In other words, it is economically more rewarding to focus on the things that can generate value faster or expose you to the decay of value for the least amount of time.

It is in essence a measure of speed of generation of value.

The brilliant part of COD, is really having called it “Cost” - thereby getting the attention of all the cost obsessed accountants! Unfortunately the same cost-obsession prevents us from seeing the larger implications in terms of positive value generation.

It is not about getting upset with precision of durations. It is really about knowing where you have the system constraint and use that knowledge to our advantage.