MEL751:

Module on Theory of
Constraints

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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.

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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.

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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.

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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

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 Types of Constraints

 Physical 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
 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

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 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  External
 Process constraints  Material constraints
 Machine time, etc.  Insufficient materials
 Policy constraints  Market constraints
 No overtime, etc.  Insufficient demand

 How is a constraint identified?

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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

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Steps in the TOC Process

 Alleviate the constraint

 Determine how to increase its capacity

 Repeat the process

 Always a new constraint

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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

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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

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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

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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

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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

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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

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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

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Theory of Constraints
 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

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Theory of Constraints

 Based on the concepts of drum, buffer and

ropes
 Drum
 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

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Theory of Constraints
 Buffer
 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

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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

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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

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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

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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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Thanks

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