Theory of Constraints And Why It Matters In Business

The Theory of Constraints was developed in 1984 by business management guru Eliyahu Goldratt in his book The Goal. The Theory of Constraints argues that every system has at least one constraint that hinders high-level performance or profit generation. Fundamentally, the theory advocates identifying constraints and then eliminating them or at the very least, reducing their impact. 

Understanding the Theory of Constraints

The Theory of Constraints was developed in 1984 by business management guru Eliyahu Goldratt in his book The Goal

In the book, Goldratt uses the chain metaphor to argue that every business system is only as strong as its weakest link. Here, the weakest link is a constraint that limits the extent of profitability. Since there can only be one weakest link, Goldratt suggests that this is where businesses should focus their efforts to institute significant change.

This change is achieved via throughput accounting, which emphasizes selling more of something to generate higher profits. This approach differs from traditional accounting methods that focus on reducing expenses to generate profit.

However, the capacity to reduce expenses is limited once an expense reaches zero. That is, the ability to increase profits is constrained

Conversely, the emphasis on increasing sales revenue via throughput accounting has no such constraint. This is because – at least in theory – there is no limit to the amount of sales revenue a business can generate.

Throughput accounting is comprised of three parts:

  • Throughput – or the rate of sales revenue generated by a product or service. 
  • Inventory – or money that is tied up in physical things such as raw materials, equipment, distribution facilities, and goods awaiting sale.
  • Operating expense – or the money a business spends creating throughput to maintain a desired level of capacity. This may include payroll, depreciation, and utility expenses.

The five steps of the Theory of Constraints

1. Identify the constraint

Which part of the system constitutes the weakest link? Remember, there can only be one.

2. Exploit the constraint

Use available resources to make rapid improvements to the constraint. Reduce or eliminate where possible to avoid expensive wholesale upgrades or process changes.

3. Subordinate the remaining links

The unconstrained (strong) links in a process must be altered so they maximize the output of the weakest link. At this point, the process should be evaluated to determine if the constraint has simply shifted to another location on the chain.

If the constraint has been eliminated, the business can move to step five. Otherwise, they should proceed to step four.

4. Elevate the constraint

If the second and third steps have not been successful, take whatever action necessary to eliminate the constraint. This includes a major overall of an existing system.

5. Beware of inertia

Once a constraint has been removed, avoid becoming complacent. 

Understand that the Theory of Constraints is a cyclical process that stresses the importance of improving one constraint and then moving on to the next. Complacency, which Goldratt calls “inertia”, is a significant barrier to profit generation through increased production.

Key takeaways:

  • The Theory of Constraints is a management philosophy stating that any system is prevented from achieving its full potential by one or more key constraints.
  • The Theory of Constraints focuses on constraints in the context of their ability to reduce profits. As a result, the theory focuses on throughput accounting and its core principle of increasing production capacity to generate revenue.
  • The Theory of Constraints is a five-step, cyclical process that businesses must consistently use to avoid becoming complacent.

Connected Business Matrices

The SFA matrix is a framework that helps businesses evaluate strategic options. Gerry Johnson and Kevan Scholes created the SFA matrix to help businesses evaluate their strategic options before committing. Evaluation of strategic opportunities is performed by considering three criteria that make up the SFA acronym: suitability, feasibility, and acceptability.
The Hoshin Kanri X-Matrix is a strategy deployment tool that helps businesses achieve goals over the short and long term. Hoshin Kanri is a method that seeks to bridge the gap between strategy and execution. Strategic objectives are clearly defined and the goals of every level of the organization are aligned. With everyone moving in the same direction, process coordination and decision-making ability are strengthened.
The Kepner-Tregoe matrix was created by management consultants Charles H. Kepner and Benjamin B. Tregoe in the 1960s, developed to help businesses navigate the decisions they make daily, the Kepner-Tregoe matrix is a root cause analysis used in organizational decision making.
The Eisenhower Matrix is a tool that helps businesses prioritize tasks based on their urgency and importance, named after Dwight D. Eisenhower, President of the United States from 1953 to 1961, the matrix helps businesses and individuals differentiate between the urgent and important to prevent urgent things (seemingly useful in the short-term) cannibalize important things (critical for long-term success).
A decision matrix is a decision-making tool that evaluates and prioritizes a list of options. Decision matrices are useful when: A list of options must be trimmed to a single choice. A decision must be made based on several criteria. A list of criteria has been made manageable through the process of elimination.
An action priority matrix is a productivity tool that helps businesses prioritize certain tasks and objectives over others. The matrix itself is represented by four quadrants on a typical cartesian graph. These quadrants are plotted against the effort required to complete a task (x-axis) and the impact (benefit) that each task brings once completed (y-axis). This matrix helps assess what projects need to be undertaken and the potential impact for each.
The TOWS Matrix is an acronym for Threats, Opportunities, Weaknesses, and Strengths. The matrix is a variation on the SWOT Analysis, and it seeks to address criticisms of the SWOT Analysis regarding its inability to show relationships between the various categories.
The GE McKinsey Matrix was developed in the 1970s after General Electric asked its consultant McKinsey to develop a portfolio management model. This matrix is a strategy tool that provides guidance on how a corporation should prioritize its investments among its business units, leading to three possible scenarios: invest, protect, harvest, and divest.
In the 1970s, Bruce D. Henderson, founder of the Boston Consulting Group, came up with The Product Portfolio (aka BCG Matrix, or Growth-share Matrix), which would look at a successful business product portfolio based on potential growth and market shares. It divided products into four main categories: cash cows, pets (dogs), question marks, and stars.
In the FourWeekMBA growth matrix, you can apply growth for existing customers by tackling the same problems (gain mode). Or by tackling existing problems, for new customers (expand mode). Or by tackling new problems for existing customers (extend mode).

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