Theory of Constraints

What is the Theory of Constraints?

The Theory of Constraints is an organizational change method that is focused

on profit improvement. The essential concept of TOC is that every organization must have at least one constraint. A constraint is any factor that limits the organization from getting more of whatever it strives for, which is usually profit. The Goal focuses on constraints as bottleneck processes in a job-shop manufacturing organization. However, many non-manufacturing constraints exist, such as market demand, or a sales department's ability to translate market demand into orders.

The Theory of Constraints defines a set of tools that change agents can use to manage constraints, thereby increasing profits. Most businesses can be viewed as a linked set of processes that transform inputs into saleable outputs. TOC conceptually models this system as a chain, and advocates the familiar adage that a "chain is only as strong as its weakest link." Goldratt defines a five-step process that a change agent can use to strengthen the weakest link, or links. In The Goal, Goldratt proves that most organizations have very few true constraints. Since the focus only needs to be on the constraints, implementing TOC can result in substantial improvement without tying up a great deal of resources, with results after three months of effort.

The Five Steps of the Theory of Constraints

1. Identify the System Constraint

The part of a system that constitutes its weakest link can be either physical or a policy.

2. Decide How to Exploit the Constraint

Goldratt instructs the change agent to obtain as much capability as possible from a constraining component, without undergoing expensive changes or upgrades. An example is to reduce or eliminate the downtime of bottleneck operations.

3. Subordinate Everything Else

The non-constraint components of the system must be adjusted to a "setting" that will enable the constraint to operate at maximum effectiveness. Once this has been done, the overall system is evaluated to determine if the constraint has shifted to another component. If the constraint has been eliminated, the change agent jumps to step five.

4. Elevate the Constraint

"Elevating" the constraint refers to taking whatever action is necessary to eliminate the constraint. This step is only considered if steps two and three have not been successful. Major changes to the existing system are considered at this step.

5. Return to Step One, But Beware of "Inertia"

Goldratt cautions practitioners about becoming complacent. TOC is an on-going process, and the inertia that can build up after a change occurs can actually serve to prevent continuous improvement.

Goldratt also provides a foundation for achieving change through TOC by defining a set of three essential measurements that drive the change process. He correctly realized that conventional accounting systems do not support TOC, or lean-based efforts. Goldratt proposes replacing all traditional measures derived from the "product cost" accounting paradigm. The following measures are the only way to increase profit through TOC:

Throughput

The rate at which the entire organization generates money through sales for a product or service. Throughput represents all the money coming into an organization.

Inventory

All the money the organization invests in things it intends to sell. Inventory represents all the money tied-up inside an organization. Goldratt's definition includes facilities, equipment, obsolete items, as well as raw material, work in process, and finished goods.

Operating Expense

Operating Expense is all the money an organization spends turning Inventory into Throughput. It represents the money going-out of the organization. Examples include direct labour, utilities, consumable supplies, and depreciation of assets.

All three of these measures are interdependent. This means that a change in one will result in a change in one or more of the other two. Therefore, to improve your organization using TOC, you as the change agent would adhere to the following formula:

Maximize Throughput while Minimizing Inventory and Operating Expense

These measures are the key to relating local decisions to the performance of the entire system. Goldratt advocates that all improvement opportunities should be prioritized by their effect on the three measures, especially Throughput, for which the only limit on how high it can be increased is market size.

How Does Lean Thinking Compare to the Theory of Constraints?

Lean thinking is an organizational change method that is also implemented with the objective of increasing profit. Lean thinking originated in Japan, and is best exemplified by the Toyota Production System. Constraints placed on the Japanese manufacturing industry after the second world war lead Taiichi Ohno of Toyota to pioneer a new type of production system that was so different, and so much better, than mass production, as to warrant a new type manufacturing. Lean production is a method of organizing production using half the effort, space, inventory, and product development time compared with mass production. It also achieves fewer defects, and larger product variety. These improvements should result in increased sales, which is the key to re-deploying freed-up resources. Lean thinking codified and expanded upon the Toyota Production System to include non-manufacturing organizations, as well as product development efforts.

The objective of lean thinking, as with TOC, is to increase profit. This is achieved by focusing on reducing costs using the following simple equation:

Profit = Selling Price - Cost

Toyota realized that selling price is dictated by the market and cannot be increased. Therefore, the only way to increase profit is to decrease cost. Note that although Goldratt attempts to move away from cost reduction by focusing

on throughput improvement, the net effect is the same: profit increases because cost decreases.

Lean thinking achieves the objective of cost reduction by employing a system-view of an organization that