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.

Theory of constraints examples

Steelo

Steelo is a British company that specializes in 3D printing for structural steel fabrication.

The company’s level of client responsiveness is one of the best in the industry, with lead times between order placement and site delivery as short as one day.

Just as impressive is that parts are routinely delivered within a two-hour time window.

According to Steelo founder Michael Krajewski, these impressive numbers are supported by principles of automotive lean manufacturing, a bespoke IT system, and the theory of constraints. “In our theory, you want one department to be working at 100% capacity, and the rest of the business to be under capacity. This is beneficial, because if there’s a problem, it’s likely to be in the department that is working at 100%. So other departments can take up the slack,” Krajewski explained in a 2019 interview with The Construction Index.

Krajewski initially believed welding bays would be the primary source of production bottlenecks, but after deeper analysis, he realized that the company’s delivery system was its most vulnerable point.

While employee overtime or extra resources could compensate for a broken machine, time lost from a late delivery could never be made up.

This was because council restrictions only allowed Steelo to operate between 8 am and 5 pm.

To reduce or avoid irrecoverable time loss, most of the company’s production staff are multi-talented and can be diverted into other roles as necessary.

In the office, for example, designers are trained as estimators and factory floor staff are also trained in a variety of different roles.

The balance of Steelo’s workforce is also somewhat unusual among manufacturers, with 50% of employees based in the office.

Some of these employees are solely tasked with finding ways to improve operations through innovation.

Mazda

At the 11th annual conference for theory of constraints professionals in 2013, powertrain division chief engineer Mitsuo Hitomi explained how the company reached a crisis point after reporting financial losses for the previous four years.

Hitomi noted that Mazda had one chance to reverse its fortunes and survive.

This moment called on the company to develop a car that delivered a superb driving experience with an internal combustion engine that had comparable fuel consumption to a hybrid.

Critically, the new model also needed to be affordable for most consumers.

The product development cycle at Mazda was cut by half with the Critical Chain Project Management (CCPM) method where the people, equipment, and physical space required to execute tasks are emphasized.

While there were many subsequent benefits to Mazda’s project management processes, there are two which deserve mention. For one, planning transformed from a management-only task to one where developers were involved in building and creating networks.

Mazda also instituted routine reporting and status mechanisms so that problems could be identified before they were too costly to fix later on. 

These measures, among others, enabled Mazda to return to profit in 2013 after meeting performance objectives related to customer satisfaction, tech development, and more agile product development.

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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