The Theory of Constraints

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The Theory of Constraints (or TOC as it is called) is a relatively recent development in the practical aspect of making organizational decisions in situations in which constraints exist.

Premise In every organization there is at least one constraint - anything that limits the ability of a system to achieve its goal.

Dr. Eliyahu M. Goldratt first described the theory in his novel, The Goal. In many organizations, TOC and TOC logic form major portions of that organizations philosophy of continuous improvement.

The Theory of Constraints has been used at three different levels

a) Production Management - TOC was initially applied here to solve problems of bottlenecks, scheduling, and inventory reduction.

b) Throughput Analysis - Application of TOC has caused a shift from cost-based decision making to decision-making based on continuous improvement of processes in which system throughput, system constraints, and statistically determined protective capacities at critical points are key elements.

c) Theory of Constraints Logical Processes - This third level is the general application of TOC reasoning to attack a variety of process problems within organizations.

TOC logic is applied to identify what factors are limiting an organization from achieving its goals, developing a solution to the problem, and getting the individuals in the process to invent the requisite changes for themselves.

A constraint is anything in an organization that limits it from moving toward or achieving its goal. Of course, this assumes that an appropriate goal has been defined. For most business organizations the goal is to make money now as well as in the future. There are two basic types of constraints physical constraints and non-physical constraints. A physical constraint is something like the physical capacity of a machine. A non-physical constraint might be something like demand for a product, a corporate procedure, or an individuals paradigm for looking at the world

. Problem Identification

One knows that there is a problem when,

1. Orders pile up

. Machine is available but parts are not

. Parts are available but workers are not

4. Parts and workers are available but machine is not available due to breakdown/ waiting for repair

5. Large batches run at initial stations

6. Bottleneck sometimes move around in the shop, even when order profile is not changing much

7. Orders get delayed despite lot of WIP on shop floor and station targets being achieved

. Application of TOC

The steps in applying TOC are as follows

1. Identify the systems constraints. Of necessity this included prioritization so that just the ones that really limit system progress toward the goal.

. Decide how to exploit the systems constraints. Once we have decided how to manage the constraints within the system, we decide how the majority of the resources that are not constraints should be made use of. We manage them so that they just provide what is needed to match the output of the constrained resources. We never let them supply more output than is needed because doing so moves us no closer to the goal.

. Subordinate everything else to the above decision in Step . Since the constraints are keeping us from moving toward our goal, we apply all of the resources that we can to assist in breaking them. Practically in all cases their limiting impact can be reduced or eliminated.

4. Elevate the systems constraints. If we continue to work toward breaking a constraint (also called elevating a constraint) at some point the constraint will no longer be a constraint. The constraint will be broken.

5. If the constraint is broken, return to Step 1. When that happens, there will be another constraint, somewhere else in the system that is limiting progress to the goal.

The process must be reapplied, perhaps many times. It is very important not to let inertia become a constraint. Most constraints in organization are of their own making. They are the entrenched rules, policies, and procedures that have developed over time. Most constraints in organizations today are policy constraints rather than physical constraints.

4. Some Definitions

For a manufacturing organization, with the goal being to make money now as well as in the future, TOC defines three operational measurements that measure whether operations are working toward that goal. They are

· Throughput The rate at which the system generates money through sales. This is considered to be the same as Contribution Margin (selling price - cost of raw materials). Labor costs are considered to be part of Operating Expense rather than throughput.

· Inventory All the money the system invests in things it intends to (or could) sell. This is the total system investment, which includes not only conventional inventory, but also buildings, land, vehicles, plant, and equipment. It does not include the value of labor added to Work-In-Process inventory.

· Operating Expense All the money the system spends in turning Inventory into Throughput. This includes all of the money constantly poured into a system to keep it operating, such as heat, light, scrap materials, depreciation, etc.

The following four measurements are used to identify results for the overall organization

Net Profit = Throughput - Operating Expense

Return on Investment (ROI)= (Throughput - Operating Expense) / Inventory

Productivity = Throughput / Operating Expense

Turnover = Throughput / Inventory

Some of the major constraints identified are,

a) Demand Constraints

A demand constraint is a constraint on output. Symptoms include large amounts of final product inventory, or a production line running at a fraction of full capacity production. It means you have excess capacity given the demand for your product. You either have a problem with marketing (your customers dont know about your high quality product); you have a low quality product, undesired by customers, regardless of the marketing effort; or you have an obsolete product, undesired by customers, regardless of the marketing effort. Solution to this problem involves finding which of the above three problems (or combination thereof) it is, and doing something about it. This is why a relationship with ones customers is so important in TQM-you get some lead time on solving this problem.

b) Production Constraints

Production constraints are generally of three types policy constraints-company or union policies or practice create the constraint and impede its long-term solution; machine capacity constraints-a single (or small number of machines) on a line form a bottleneck; labor constraints-insufficient labor (either a skilled operator) or the general labor pool are sufficient to run a line to full capacity, including extra shifts if needed. In-process inventories between production steps are often a symptom of a production constraint.

c) Raw Material Constraints

Raw material constraints include shortages in the short or long term of one or more essential ingredients necessary to making the product. This is why a relationship with ones vendors is so important in TQM.

Sadly, the most frequent constraint is the policy constraint. The cycle in many businesses goes something like this

1. A problem arises

. A policy is created to solve the problem

. The situation changes eliminating the original problem

4. The policy remains and causes a constraint on production

5. Change is emotionally difficult and therefore the policy is lived with and worked around

5. Advantages of TOC

a) Employees can make local decisions by examining the effect of those decisions on the organizations overall Throughput, Inventory, and Operating Expense. A decision that results in increasing overall Throughput, decreasing the overall Inventory, or decreasing the overall Operating Expense for the firm will generally be a good decision for the business.

b) The Theory of Constraints does away with much of cost accounting. It is clear that application of cost accounting principles (primarily the allocation of costs in order to make decisions at the local level) leads to poor management decisions at the department as well as in upper levels of the organization.

c) TOC virtually eliminates the use of Economic Order Quantities (EOQ), production lot sizes, deriving product costs, setting prices, determining productivity measures, and the use of performance incentives.

d) TOC is truly applicable to any process in any organization. This includes universities, hospitals, service providers of all varieties, government and, of course, manufacturing. Although it is true that the Theory of Constraints provides us with simple examples in the manufacturing environment, its applications are not restricted to that environment.

6. The relationship between TQM, TOC and JIT

Each of the three major management movements of the eighties and nineties, Just in Time (JIT), Total Quality Management (TQM), and Theory of Constraints (TOC) claim to be THE answer to solving existing management problems. The three are really different facets of the same management philosophy.

The foundation of modern total quality management is W. Edwards Deming. In his book, Out of the Crisis, Deming demonstrates that a TQM management philosophy is really the use of the concept of a system, systems thinking, process measurement and a never ending cycle of process improvement. TOC is really a focused methodology for performing systems thinking on the business entity as a whole to focus changes to be made on constraints that are directly limiting better total-system profitability. JIT (or MRP) with its emphasis on inventory reduction and resource scheduling is really just a specific application of TOC to one area of the business. Thus, JIT and MRP are subsets (or consequences) of TOC that is a subset of TQM.

7. Easing Resistance to Change

Remarkably, both TQM and Goldratt come to amazingly similar conclusions about instituting progressive change within an organization. Both philosophies view employees as the key to change. Both philosophies agree that the employee group must internalize the solution to a problem.

The TQM Solution to Initiating Change

In total quality management, root cause analysis, in teams, is a major method for initiating and creating essential change-to solve a problem or to improve a process. Not only does the problem get analyzed and solved, but the solvers of the problem are also typically those who implement the solution to the problem. Thus, the inertia of the system is overcome. The workers solve the problem. Management does not have to change worker attitudes prior to implementing the solution to the problem. By having the workers solve the problem, buy-in is assured.

Goldratts Solution to Initiating Change

Goldratt proposes what in essence is a dual concept solution to the problem of initiating change in an organization. The first concept is the use of the Socratic method - a teaching strategy employed by the Greek philosopher, Socrates, with his pupils. In the Socratic method, a questioner-typically the teacher-attempts to have the students create or induce a solution to a question or problem by asking them questions that lead them in the direction the answer or solution. This process continues until the student finds the answer. When this method is successful, the person implementing the solution has found the solution for himself or herself. Buy-in is assured.

Goldratt suggests that this be done by using a second concept, that of the effect-cause-effect method of proof. In the development of every science, three distinct stages exist

1. classification

. correlation (or theory)

. effect-cause-effect

Goldratt proposes an useful analogy that points out the parallel between the development of astronomy and economic relationships that exist within a business enterprise. The following discussion closely parallels Goldratts discussion

In astronomy, for example, the ancient Greeks classified the stars in the sky according to their position in the heavens-creating the Zodiac-still used in astrology. The stars that moved around and violated this classification system (these were the planets) were called moving stars. Thus, they provided a classification system for the stars-the first stage.

Nearly a thousand years later Ptolemy in Egypt first postulated the first correlation on planet movement--that they travel in a circle path whose center moves along another circle whose center is the Earth. Almost a thousand years later, Copernicus added power to the theory of heavenly body movement by suggesting that the Sun should be the center, rather than the Earth. Five hundred years later Kepler suggested that the orbits were elliptical rather than circular.

The entire theory or correlation was developed by observation. No one had yet suggested WHY the heavenly bodies moved as they did.

Sir Isaac Newton was the first scientist to develop an answer to the question Why to the heavenly bodies behave as they do? His explanation was gravity-that bodies attract each other in proportion to their masses and inversely proportional to the distance between them squared. At that point, one can explain the behavior of all types situations, both new and old. Newtons theories were the guiding physics behind artificial satellites and space travel. Astronomy had reached the effect-cause-effect stage.

About 0 years ago, both in the United States and in Japan, production scheduling was systematized with the use of MRP (Manufacturing Resource Planning). For the first time, a systematic approach was taken to shop floor scheduling-bills of material, routings, inventory files, work-in-process files, and order files were all organized into a single data base. This was really the first stage-classification.

The United States took many years to accomplish and assimilate the first stage. The Japanese moved almost immediately to the second stage-correlation. Dr. Taichi Ohno, Executive Vice President of Production at Toyota discovered the correlations or theories called the Toyota Production System and the Kanban approach which in the U. S. we combine under the name of Just-In-Time (JIT). Dr. Ohno never asked the question WHY? He is reputed to have said, My system does not make sense at all but, by God, its working.

The effect-cause-effect level for the organization provides a working theory that if the goal of an organization is to make money through sales, and we properly measure Throughput, Inventory, and Operating Expenses, we can use the resulting information to make correct decisions that improve bottom line performance.

Effect-Cause-Effect methodology, then is the speculation of a cause for a particular effect, then predicting (and verifying) another effect from the same cause. The more effects that can be predicted from the theory, the more powerful the theory and the more light is shed on the potential root cause problem.

This has never been shown true for decision making by the use of cost accounting. The challenge is to cause a paradigm shift in management thinking-from cost-based decision making to one that is based on a theory that has been shown to explain behavior.

8. Prescribing Simple Solutions to Problems

Once the root cause of the problem is identified, having the relevant group identify a methodology to remove the problem becomes the next challenge. Goldratt never talks about solving problems at this level, but rather he talks about causing the problem not to exist. This is consistent with his view of constraints and constraint removal. His reasoning is that constraint removal is not consistent with compromise, and that problem solving in business is typically a compromise. Compromise does not generally eliminate a root cause problem, but rather works around it. Typically, the compromise is some course of action between the real solution or constraint elimination and a conflicting policy or personality. This is an easier political choice than taking on the more difficult course of both eliminating the real problem and handling the resulting political problem.

. Applying the Theory to Problems a summary

Applying Theory of Constraints to problems has two stages

Stage 1

1. Identify the systems constraints

. Decide how to exploit the systems constraints

. Elevate the systems constraints

4. If in the previous step a constraint is broken, return to Step 1, but never allow inertia to cause a system constraint.

Stage

1. Determine what to change

o Pinpoint the core problems using appropriate method

. Determine what to change to

o Construct simple, practical solutions and eliminate problems

. How to make the change

o Induce the appropriate people to invent the solution and use different methods to guide them toward the solution

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