The Theory of Constraints

The Theory of Constraints

Eli Goldratt, a physicist.
OPT: a scheduling package. The Goal and the Theory of Constraints. Goldratt challenges the conventional

approach to managing organizations.

Traditional Decision Making

How are investment decisions usually made?

The Cost-World Perspective Consider how such a perspective affects the push towards parts per million (PPM) quality and Zero inventory.

The Cost World Perspective: Cost and PPM Quality

Annual Cost Investment The Cost Savings Needed Judgment 8% 2% $60,000 $20,000 $20,000 2% 0.5% $15,000 $20,000 0.5% 0.1% $4,000 Reducing Scrap From To

The Cost World Perspective: Cost and Inventory Turns

Increasing Annual Inventory Cost Investment The Cost Turns Savings* Needed Judgment 3 6 $2M $2M 6 12 $1M $2M 12 24 $0.5M $2M
* Assuming starting inventory of $15M and 25% carrying cost

The Real Cost of Inventory

Inventory adversely affects all the factors

that give you a competitive edge (Price, Quality, and Delivery). It results in
Increased costs due to obsolescence, storage costs, overtime, etc., Defects not being detected soon enough, Longer lead times and poorer delivery performance.

Assume the following data

Raw Material cost per unit: WIP value per unit: Finished Goods value per unit: Sale Price per unit: $10 $20 $35 $50

Other Operating Expenses: $4 Million in 1996; $3.75 Million in 1997 1996 Beginning WIP Inventory (1000 units) Beginning FG Inventory (1000 units) Raw Material (1000 units) Sales (1000 units) Ending WIP Inventory (1000 units) Ending FG Inventory (1000 units) 50 40 400 400 50 40 1997 50 40 330 400 10 10

The Income Statement

Sales (1000 $) Beginning WIP Inventory (1000 $) Beginning FG Inventory (1000 $) Raw Material Purchase (1000 $) Other Expenses (1000 $) Ending WIP Inventory (1000 $) Ending FG Inventory (1000 $) Cost of Goods Sold (1000 $) Profit (1000 $) 1996 20,000 1,000 1,400 1997 20,000 1,000 1,400

Product Costs
How do we calculate a companys profit?

Net Profit =

Sp Revenuep - Sc Expensec.

Note: first summation is on product types, second summation is on categories. So, how can we use this information to, say,
decide on launching a new product?

Product Costs
Allocate! If we can allocate costs correctly:
Net Profit = Sp Revenuep -

= Sp (Revenuep - Expensep)

Sp Expensep

How to determine product cost accurately?

Standard Costs:
Activity Based Costing (ABC)

Product Costs At National Pumps

National Pumps, Inc. has obtained the

standard cost for one of its pumps:

Direct Material Direct Labor Overhead Allocation Standard Cost $500 $100 $400 $1,000

This pump sells in the US for $1,250.

Plant is currently running at 80% capacity

Product Costs At National Pumps

There is a big demand for this pump in the

Asian market.
Should National Pump cut its selling price to penetrate the Asian market? If so, by how much should it discount its price?

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 systems constraint(s) determine its output.

Types of Constraints
Physical Constraints
Physical, tangible; easy to recognize as constraint. Machine capacity, material availability, space availability, etc.

Market Constraints
Demand for companys 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.

Local Performance Measures: The Sales Department

A 1% sales commission: 2 products:

Cadillacs: $40,000 Beetles: $20,000 Which product will the sales person push?

Suppose the profit margins are

Cadillac: $1,500 Beetle: $2,500 Which product will the CEO want you to push?

Conflicting goals (local and global).

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 systems 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 =

Investment
Inventory =

Net Profit inventory

= ( T - OE ) / I

Turns

throughput inventory

 Step 1: Identify the Systems Step 2: Step 3:

The Throughput World: The Five Step Focusing Process of TOC

Constraint(s) Decide how to Exploit the Systems Constraints Subordinate Everything Else to that Decision Elevate the Systems Constraints If a Constraint Was Broken in Previous Steps, Go to Step 1

Step 4:
Step 5:

Identifying Constraints
Identifying Physical Constraints: A Typical WIP Inventory Profile:
Ave. WIP Inventory R1

R2

R3

R4

R5

R6

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

Is there anything else we can do?

An Example: A Plant Producing Two Products

P: $90 / unit 100 units / week Q: $100 / unit 50 units / week D 5 min. C 5 min. B 15 min. RM2 $20 per unit B 15 min. A 10 min. RM3 $20 per unit Purchased Part $5 / unit D 15 min.

C 10 min.
A 15 min. RM1 $20 per unit

Time available at each work center: 2,400 minutes per week Operating expenses per week: $6,000 A Production System Manufacturing Two Products, P and Q

Can We Meet The Demand?

Perform a Capacity Analysis
Processing Requirements (all times in minutes)

Product P Q

A 15 10

B 15 30

C 15 5

D 15 5

Available time / week on each resource: 2400 min.

Can We Meet The Demand?

Resource requirements for 100 Ps and 50 Qs are: Resource A: 100 x Resource B: 100 x Resource C: 100 x Resource D: 100 x

+ 50 x + 50 x + 50 x + 50 x

= = = =

minutes minutes minutes minutes

Any Bottlenecks?
B is a bottleneck. A, C, & D are not bottlenecks. They all have

spare capacity at desired production levels..

We cannot achieve desired levels of production

due to the capacity constraint on B.

So, what production levels do we set for P & Q?

The Production Decision

Which product has higher profit margin?

Product P: Product Q: Which product requires less effort? Product P: Product Q: So, it looks like is the star and is the dog. We will first offer the star to the market. If we still have residual capacity, we will offer the dog. Makes sense, does it not?

What Is The Net Profit?

Consider the bottleneck, B. To produce 50 units of Q we

need 50 x
This leaves

min. on B. min. available on B, for producing P.

Each unit of P requires

produce

minutes on B. So, we can units of P.

units of P each per week.

If we produce and sell 50 units of Q and

week, we get 50 x $60 +

x $45 = $

When we factor in operating expense ($6,000), we find we

Do We Shut The Plant Down?

Wait! We are not adopting the

throughput world perspective are we? We worked with product profits. In the throughput world, there is no such thing as product profit, is there? Only companys profit. What is the second focusing step? DECIDE HOW TO EXPLOIT THE CONSTRAINT.

Exploiting The Constraint

Each unit of Q brings $

to the company. How many minutes of B do we use for one unit of Q? minutes. So, by promoting Q, we receive $ per constraint minute. Each unit of P brings $ to the company. How many minutes of B do we use for one unit of P? minutes. So, by promoting P, we receive $ per constraint minute.

Throughput World vs Cost World

The throughput world perspective indicates

that we should first focus on producing product .

The cost world perspective had indicated

that we should first focus on producing product .

Which Perspective Is Correct?

If we focus on P first, we can sell 100 Ps / week,

requiring minutes of B. That leaves minutes available on B to produce Q.

Each unit of Q requires

can produce

minutes on B. So, we units of Q. units of Q, we each week.

By producing 100 units of P and

get 100 x $45 +

x $60 = $

After subtracting $6,000 for operating

expenses, we obtain a net profit of

Cost World or Throughput World?

So, what product will you focus on?

Shifting Paradigms
Current Priority First: OE Second: T Distant Third: I New Priority T I OE

Cost World

Throughput World

Moving to the Throughput World

If you move to the throughput world, you

have a competitive advantage, since most of your competitors are still in the cost world.
How do you shift the perspective to the throughput world?
How do you effect the change?

Implementing TOC In The Shop Floor

How do we implement a scheduling

technique in the shop floor in line with the 5 focusing steps of TOC?
Recall the fundamental steps: Identify the constraint Decide how to exploit it Drum-Buffer-Rope (DBR) technique.

A Troop Analogy
FINISHED GOODS RAW MATERIAL

WORK-IN-PROCESS

Spreading troops = high inventory. Closely

packed troops = lower inventory. How can we prevent troops from spreading?

A Troop Analogy
Put the slowest soldiers at the front and the

strongest ones in the rear.

A Troop Analogy
In other words, restructure your factory so

that the most loaded machines (the capacity constraints) are at the first operations, and place the machines that have a lot of excess capacity downstream.

A Troop Analogy
Put a drummer at the front to set the pace.
Have sergeants constantly urge the soldiers

to close any gaps.

A Troop Analogy
Thats common practice now:
The sergeant is the expeditor and the drummer is the material management system assisted by a computer But can the soldiers follow the drum beat?

A Troop Analogy
If a worker doesnt have anything to do,

lets find him something to do.

As long as this mentally exists, each soldier will proceed according to his potential and not according to the constraints of the troop. Do efficiencies, incentives and variances allow your workers to follow the drum beat?

A Just-In-Case System
FINISHED GOODS RAW MATERIAL

A push system. The drum beat is set by

the gating operation: it is the rate at which the first machine executes.
Result:
Inventory is high Current throughput is protected Future throughput is in danger

A Troop Analogy
Henry Ford: The assembly line.
Taiichi Ohno: Kanban system
Rate of production regulated by Kanbans. Workers are instructed to Stop work when kanbans are full!

A Just-In-Time System

FINISHED GOODS

RAW MATERIAL

The drum is held by marketing demands Result:

Inventory is low Current throughput is in danger Future throughput is increased

Just-In-Time Systems & Kanbans

Work is synchronized.
Inventory is low But any significant disruption will cause the

entire system to stop.

A Troop Analogy
Since the weakest soldier dictates pace: To prevent spreading, tie weakest soldier to the front row. To protect overall pace, provide some slack in the rope.

Synchronized Manufacturing The Drum-Buffer-Rope Way

FINISHED GOODS Major Capacity Constraint Time Buffer

RAW MATERIAL A rope tying the gating operation to the buffer

The 5 Focusing Steps (Contd.)

What is Step 4?

Elevate the Systems Constraints How does it affect us here?

The Marketing Director Speaks Up :

Another constraint in our company. It is the market

A Great Market in Japan!

Have to discount prices by 20%

Do We Try To Sell In Japan?

Product P Q A 15 10 Processing Times B C 15 15 30 5 D 15 5

Product Costs and Profits Selling Price P (domestic) 90 Q (domestic) 100 P (Japan) 72 Q (Japan) 80 Product Manufg. Cost 45 40 45 40 Profit per unit 45 60 27 40

Maybe We Should Not Sell in Japan?

Right now, we can get at least $

per constraint minute in the domestic market.

So, should we go to Japan at all?

Okay, suppose we do not go to Japan Is there something else we can do?

Recovering Our Investment

Prod Type Unit $/const Profit minute Plan A

PD
QD

$45
$60

3.00 2.00 1.80 1.33

$4,500 (100) $1,800 (30)

PJ
Q
J

$27
$40

$6,000 $300

OE Profit