theory-of-constraints

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.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here