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.

Connected Business Matrices

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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.
eisenhower-matrix
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).
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tows-matrix
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ge-mckinsey-matrix
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.
bcg-matrix
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.
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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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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a 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 The FourWeekMBA Flagship Book "100+ Business Models"