THEORY OF CONSTRAINTS



Sometimes known as constraint analysis, the theory of constraints (TOC) is a systematic and iterative approach to management that emphasizes adapting business practices in order to best cope with limitations, or constraints, that stand in the way of key objectives. The goal of TOC is to maximize the efficiency of a process selectively at the most critical points and thereby maximize profitability, quality, or other corporate objectives. TOC is often contrasted with traditional cost accounting or margin contribution approaches to problem solving, which, according to TOC proponents, may not truly optimize profits and the use of resources because they tend to have a unit focus rather than a system/process focus like TOC.

TOC is related to a wider set of management philosophies that center around continuous improvement. W. Edwards Deming (1900-93) was credited with revolutionizing business in Japan by effectively introducing concepts of continuous improvement. Out of Deming's teachings, management practices such as just-in-time (JIT) manufacturing, total quality management (TQM), statistical process control (SPC), and employee involvement (El) were created. While each of these philosophies has merit, their actual benefits, as measured over time, have generally been less than what was originally assumed. This is because very few organizations that attempt to implement these various "improvement opportunities" have done so in an organized fashion that targets the operating factors with the greatest impact.

Companies should ask the following critical questions of themselves before pursuing an improvement strategy:

Although Deming has passed on, the spirit of his work remains alive and well. TQM, JIT, El, and the like influence more recent theories such as the theory of constraints.

TOC: A MANAGEMENT PHILOSOPHY

As a management philosophy, TOC focuses on a company's most critical issues (obstacles or constraints) and the effects of those constraints on the rest of the system (company). TOC allows a company to use its constraints as leverage by which it can improve its subject system. A constraint is anything that limits a company's ability to achieve a higher level of performance; usually this translates ultimately into impediments to profits.

TOC was developed by Israeli physicist Eliyahu M. Goldratt, of the Goldratt Institute in New Haven, Connecticut. After marketing a proprietary scheduling software package that scheduled tasks based on his constraint principles, Goldratt turned to educating people on those principles—TOC—so they could apply the concepts to any number of business problems. Goldratt introduced TOC in his 1984 novel The Goal, which was followed by a number of other books and articles on the subject.

At its core, TOC assumes that any company is composed of a number of subsystems. If each of these subsystems is optimized individually, overall company performance may actually be considered disappointing because such an approach doesn't take into account how the subsystems interact and what their collective limitations are in the production process. Instead, the idea is to optimize the system as a whole, even if it means certain nonessential components aren't optimally efficient. The company must identify its core problems (or constraints) first. These constraints can involve

These constraints are most likely to directly affect the company's profitability and cash flow. Such a constraint on profitability and cash flow serves as the platform for the TOC management philosophy.

TOC views an organization as a chain composed of many links (resources). The contribution of a link in the chain is heavily dependent upon the performance of its other links. The organization must be successful in its effort to synchronize the various chain links it requires to satisfy the organization's predetermined purpose, whatever that purpose may be. In order for a company to improve its performance, it must learn to identify and manage its weakest link. By doing this, the company answers a critical question tied to performance improvement: What to change? Logically, the organization must then answer, "to what should they change the constraint," and finally, "how to cause this change." This is accomplished by applying a five-step TOC process:

  1. Identify the system's constraints
  2. Decide how to exploit the constraints
  3. Subordinate everything else to the constraints
  4. Elevate the system's constraints
  5. After breaking the constraint, repeat the five-step process

OVERLAP OF TOC PHILOSOPHY.

TOC does in fact borrow from many of Deming's progressive management philosophies. TOC, however, goes well beyond Deming's approaches, and differs from them in many ways. This is what is making TOC a leading "contender" for the next generation of management theory for U.S. business, and indeed the business world abroad. Areas of TOC that overlap with other management approaches include the following:

Differences with TOC versus other management approaches include: (1) TOC focuses on identifying and exploiting constraints as the way to achieve ongoing improvement and increased profitability; and (2) it replaces cost accounting (which according to Goldratt, is "the number one enemy of productivity") with a new measurement system.

TOC maintains that cost-based management mentality invariably leads to flawed decisions, focusing on artificial targets, and masking root causes of problems.

According to chief operating officer Larry Webb of Stanley Furniture, for a company dedicated to the implementation of TOC, the biggest difference between TOC and other philosophies is that" the others basically try to fix the whole company at once, which is a physical impossibility. By focusing on the constraint, everyone in the company is allocating resources in the right place. What TOC does in a succinct way is make sure you work on the right things rather than just doing things right."

MEASUREMENTS OF TOC

To understand TOC and to apply it effectively to an organization, one must completely understand the goal of the organization (for this essay, it is assumed that organization refers to a profit-seeking entity, as opposed to a nonprofit one). Goldratt, in The Goal, emphasized that the goal of any organization is to make money. It is important therefore to create a set of measurements that honestly and accurately allow an organization to monitor its performance as it relates to its goal. Professor James Cox of Georgia University contended that the traditional cost accounting system used by businesses for nearly 70 years "doesn't lend itself to tracking the impact of decisions on revenues and profits."

With TOC, the "cost world" is replaced by the "throughput world," which is driven by these three key components:

  1. Throughput: The rate at which the system generates new money through sales.
  2. Inventory: Money the system has invested in things it intends to sell, which would include plant, property, and equipment.
  3. Operating expense: The money spent to convert inventory into throughout.

Using these measurements in combination with TOC "scientific" problem-solving methods allows management to focus on critical issues and root causes rather than symptoms of problems.

A major difference in the cost world and the TOC throughput world is that the cost world focuses on reducing operating expenses as the primary means to improvement, whereas the throughput world views cutting operating expenses as the least important of the three key improvement measurements. The throughput world emphasizes increasing throughput, reducing inventory, and reducing operating expenses.

Tradition in the cost world indicates that, to save money or reduce costs, a company must explore laying people off as downturns occur. A TOC-driven company, however, will not view layoffs as an option, as they would rather seek alternatives than to disrupt employee morale and loyalty.

TOC emphasizes reducing inventory as a way to expedite response time. In the throughput world, inventory is seen as a liability, not as an asset (as it is viewed in the cost world). Common-sense reasoning suggests that if a company reduces its inventories, the following occurs:

TYPES OF CONSTRAINTS

Constraints limit the ability to improve throughput. In TOC, a constraint can take various forms. These include capacity constraint (bottleneck or physical), market constraint, policy constraint, logistical constraint, and behavioral constraint.

A capacity constraint is simply a situation where market demand for a product exceeds the amount of the product that the system is able to supply. Some general examples of capacity constraints include skewed investment policies toward a specific type of unit production process, "cost world" focus, traditional manning practices, and personnel hiring guidelines. The reverse of capacity constraint is considered a market constraint whereby an organization is capable and willing to sell more products than the market is willing to buy. Market constraints include pricing based upon product standard costs, sales commission policies, product technology development guidelines, and market segmentation practices. When a company issues a "no-overtime" policy, it is placing a policy constraint upon the system.

Perhaps the easiest constraint to illustrate is a physical constraint (bottleneck). Physical constraints are resources, either human or mechanical, whose capacity is less than or equal to the demand placed on them. The challenge therefore becomes to identify and utilize physical constraints to control the flow of product through the plant or store into the hands of the consumer. TOC proves that physical constraints control the pace of any system, so therefore an hour gained at the physical constraint is an hour gained for the entire system. An hour gained elsewhere, at a nonconstraint, is therefore meaningless.

TOC holds that investments made to support a nonconstraint are unwise. The TOC manager must ask herself if an investment made will (1) be directed at a constraint; (2) increase throughout; (3) reduce inventory expense; and (4) reduce operating expense.

EXAMPLES OF TOC IN PRACTICE

TOC is practiced in many different industries, including automotive, computers, telecommunications, furniture, retail food, consumer goods, and apparel. Practitioners have ranged from Fortune 500 companies like Procter & Gamble Co. and General Electric Co. to small local businesses.

In a widely cited small business example, Kent Moore Cabinets of Bryan, Texas, used TOC in the late 1980s to address employee turnover caused by the seasonal nature of its business. The company's main production and selling season was spring through fall, when the construction industry is most active, and thus winter was its slow season. Previously the company laid off some of its employees during the winter, but found it was hard to attract the better workers year after year when lay-offs were always imminent. Using TOC, the company identified seasonality as its biggest constraint. Throughput analysis suggested that the company could maximize profits and fight worker turnover by keeping a full staff year round and offering builders an incentive (a 20 percent discount) to buy cabinets during the winter. The strategy succeeded and the new orders generated more than enough revenue to cover the additional labor during the winter. The company credited TOC with helping boost revenues by two-thirds in just two years.

More recently, many larger companies have sought to unite TOC concepts with the newer cost accounting methods known as activity-based costing (ABC) or activity based management (ABM). Similar to TOC, these accounting techniques examine production costs from a process standpoint, e.g., marking which steps of a production process (activities) require the largest investments and which contribute the most profit.

Many other companies continue to see the benefits that the TOC management approach can provide. It is not considered an overnight process, although in certain manufacturing environments, companies may enjoy quick, short-term results. TOC is rather a long-term approach to how an organization, or a system, operates. As Deming's work revolutionized management practices, so too does the theory of constraints continue the transition.

SEE ALSO : Critical Path Method

[ Art DuRivage ]

FURTHER READING:

Bushong, J. Gregory, and John C. Talbott. "An Application of the Theory of Constraints." CPA Journal, April 1999.

Cooper, Robin, and Regine Slagmulder. "Integrating Activity-Based Costing and the Theory of Constraints." Management Accounting, February 1999.

Gardiner, Stanley C., John H. Blackstone Jr., and Lorraine R. Gardiner. "The Evolution of the Theory of Constraints." Industrial Management, May/June 1994.

Osten, Sam, and Mike C. Peterson. "A Theory of Constraints Fable," parts I and 2. Industrial Management, March/April 1996; May/June 1996.



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