MEL751: Module on Theory of Constraints

Opening remarks about “Theory of Constraints” Developed by Eliyahu Goldratt in the mid 1980’s with his business novel The Goal. Has a close relationship with other modern techniques Just-in-Time Manufacturing Resource Planning Quality Management, Six-Sigma Activity-Based Management.

Brief abut Goldratt Born in Israel in the late 1940’s. Bachelor’s degree in Physics. Masters and Doctorate degrees in Philosophy. Founder of a production scheduling software company. Has helped many companies such as: GM, RCA, Kodak, Westinghouse, Philips, etc. Wrote several books: The Goal. The Race. What is this thing called TOC? Critical Chain.

Goldratt’s “The Goal” Brief overview: Midsize company having difficulty shipping products on time. Managed by a plant manager desperate to turn things around. With the help of a Physicist, the plant manager is able to locate the bottleneck and find a solution. Symptoms noted in the book: Obsolete inventory. Low inventory turnover and high amount of inventory in storage. Idle workers or machines. Machine breakdown. A large amount of scrap pieces. A large amount of retooling and rework needed.

Brief about “Theory of Constraints” Looks at the entire supply chain and synchronizes the chain to achieve ultimate performance. Based on two assumptions: Every organization has a set of processes working together to achieve a common goal. Every process has a [single] constraint that limits it from higher performance. Typical constraints: Time, Capacity, Materials, Human Resources, Capital Resources, Financial Resources

Types of Constraints Physical Constraints Market Constraints Physical, tangible; easy to recognize as constraint. Machine capacity, material availability, space availability, etc. Market Constraints Demand for company’s products and services is less than capacity of organization, or not in desired proportion. Policy Constraints Not physical in nature. Includes entire system of measures and methods and even mindset that governs the strategic and tactical decisions of the company.

Policy Constraints Mindset Constraints Measures Constraints A constraint if thought process or culture of the organization blocks design & implementation of measures & methods required to achieve goals. Measures Constraints A constraint if they drive behaviors that are incongruous with organizational goals. Methods Constraints A constraint when procedures and techniques used result in actions incompatible with goals.

Theory of Constraints Significance of bottlenecks Maximum speed of the process is the speed of the slowest operation Any improvements will be wasted unless the bottleneck is relieved Bottlenecks must be identified and improved if the process is to be improved

TOC and Systems Thinking TOC promotes “Systems Thinking”: global optimization (not local optimization). The performance measures advocated by TOC are global measures.

The Theory of Constraints The Theory of Constraints (TOC) is based on two premises: The Goal of a business is to make more money, … in the present and in the future. A system’s constraint(s) determine its output.

TOC Performance Measures Throughput (T): The rate at which the system generates money through sales. Inventory (I): All the money invested in purchasing things needed by the system to sell its products. Operating Expenses (OE): All the money the system spends, turning inventory into throughput.

Relating TOC Measures to Traditional Measures T = Sale Price - Direct Material Cost OE = Direct Labor Cost + Overhead Net Profit = T - OE Return on = Net Profit =( T - OE ) / I Investment inventory Inventory = throughput Turns inventory

The Throughput World: Process of TOC Step 1: Identify the System’s Constraint(s) Step 2: Decide how to Exploit the System’s Constraints Step 3: Subordinate Everything Else to that Decision Step 4: Elevate the System’s Constraints Step 5: If a Constraint Was Broken in Previous Steps, Go to Step 1

How can we get the most from Physical Constraints? Techniques for optimizing capacity constraints: Eliminate periods of idle time Reduce setup time and run time per unit Improve quality control Reduce the workload Purchase additional capacity

Steps in the TOC Process Identify the system constraints Internal Process constraints Machine time, etc. Policy constraints No overtime, etc. External Material constraints Insufficient materials Market constraints Insufficient demand How is a constraint identified?

Steps in the TOC Process Subordinate everything else to the preceding decision Plan production to keep constraint working at 100% May need to change performance measures to conform upstream activities to the “rope” speed

Steps in the TOC Process Alleviate the constraint Determine how to increase its capacity Repeat the process Always a new constraint

Theory of Constraints Purpose is to identify bottlenecks or other constraints and exploit them to the extent possible Identification of constraints allows management to take action to alleviate the constraint in the future Reduce cycle time Time from receipt of customer order to shipment Improve manufacturing cycle efficiency (MCE) Processing time / total cycle time

Theory of Constraints Assumes current constraints cannot be changed in the short-run What should be produced now, with current resources, to maximize profits? Question cannot be answered by traditional accounting methods

Theory of Constraints Management tool, not an accounting tool Not used to determine inventory values Not used to allocate overhead to inventory Does indicate how to use available resources most effectively

The Need for TOC Standard costing Can promote undesirable behavior Work to keep people busy Local optimization Inventory is produced regardless of need Does indicate what it should cost to produce a product

The Need for TOC Does not indicate which products will maximize profits given the constraints Doesn’t take constraints into account Does not consider the demands each item places on limited resources

The Need for TOC Theory of Constraints Uses linear programming to determine best use of limited resources Indicates what should be produced and in what quantities

Theory of Constraints Constraining resource must be maximized All other operations must be geared toward this goal May require suboptimization in other areas Upstream operations must provide only what the constraint can handle Downstream operations will only receive what the constraint can put out

Theory of Constraints Focus is on maximizing throughput Constraint must be kept operating at its full capacity If not, the entire process slows further Focus is on maximizing throughput Sales – totally variable costs All other costs treated as fixed operational expenses Cannot vary much in the short-run

Theory of Constraints Based on the concepts of drum, buffer and ropes Output of the constraint is the drumbeat Sets the tempo for other operations Tells upstream operations what to produce Tells downstream operations what to expect

Theory of Constraints Buffer Rope Stockpile of work in process in front of constraint Precaution to keep constraint running if upstream operations are interrupted Rope Sequence of processes prior to and including the constraint Want to “pull” the rope at the maximum speed Speed of the constraint

Evaluation of TOC Advantages Improves capacity decisions in the short-run Avoids build up of inventory Aids in process understanding Avoids local optimization Improves communication between departments

Evaluation of TOC Disadvantages Negative impact on non-constrained areas Diverts attention from other areas that may be the next constraint Temptation to reduce capacity

Evaluation of TOC Ignores long-run considerations Introduction of new products Continuous improvement in non-constrained areas May lead organization away from strategy Not a substitute for other accounting methods

Challenges Identifying goals? Identifying bottlenecks? How to apply this theory to service context? How to extend the logic to unorganized sector, say , especially in India?

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