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

ReducingScrap

From To

AnnualCost

SavingsInvestment

NeededThe CostJudgment

8% 2%

2% 0.5%

0.5% 0.1%

$60,000$15,000

$4,000

$20,000$20,000

$20,000

The Cost World Perspective: Cost and Inventory Turns

IncreasingInventory

Turns

AnnualCost

Savings*Investment

NeededThe CostJudgment

3 6 $2M $2M6 12 $1M $2M12 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 inIncreased 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: $10WIP value per unit: $20Finished Goods value per unit: $35Sale Price per unit: $50

Other Operating Expenses: $4 Million in 1996; $3.75 Million in 1997

1996 1997

Beginning WIP Inventory (1000 units) 50 50

Beginning FG Inventory (1000 units) 40 40

Raw Material (1000 units) 400 330

Sales (1000 units) 400 400

Ending WIP Inventory (1000 units) 50 10

Ending FG Inventory (1000 units) 40 10

The Income Statement

1996 1997

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 $)

20,000 20,000

1,000 1,000

1,400 1,400

Product Costs

How do we calculate a company’s profit?

Net Profit = p Revenuep - c 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

How to determine product cost accurately? Standard Costs:

Activity Based Costing (ABC)

Net Profit = p Revenuep - p Expensep

= p (Revenuep - Expensep)

Allocate! If we can allocate costs correctly:

Product Costs At National Pumps

National Pumps, Inc. has obtained the standard cost for one of its pumps:

Direct Material $500Direct Labor $100Overhead Allocation $400

Standard Cost $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 system’s 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 company’s 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 ConstraintsA constraint if thought process or culture of the

organization blocks design & implementation of measures & methods required to achieve goals.

Measures ConstraintsA constraint if they drive behaviors that are

incongruous with organizational goals.

Methods ConstraintsA 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: $40,000Beetles: $20,000

Which product will the sales person push?

Suppose the profit margins areCadillac: $1,500Beetle: $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 system’s 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

Net Profit = T - OE

Return on = Net Profit = ( T - OE ) / I Investment inventory

Inventory = throughputTurns inventory

T = Sale Price - Direct Material Cost

OE = Direct Labor Cost + Overhead

The Throughput World: The Five Step Focusing Process of TOC

Step 1: Identify the System’s Constraint(s)

Step 2: Decide how to Exploit the System’s Constraints

Step 3: Subordinate Everything Else to that Decision

Step 4: Elevate the System’s Constraints Step 5: If a Constraint Was Broken in

Previous Steps, Go to Step 1

Identifying Constraints

Identifying Physical Constraints:A Typical WIP Inventory Profile:

Ave

. WIP

Inv

ento

ry

R1 R2 R3 R4 R5 R6

How can we get the most from Physical Constraints?

Techniques for optimizing capacity constraints:Eliminate periods of idle timeReduce setup time and run time per unitImprove quality controlReduce the workloadPurchase additional capacity

Is there anything else we can do?

An Example:A Plant Producing Two Products

Purchased Part$5 / unit

RM1$20 per

unit

RM2$20 per

unit

RM3$20 per

unit

$90 / unit100 units / week

$100 / unit50 units / week

P: Q:

D15 min.

D5 min.

C10 min.

C5 min.

B15 min.

A15 min.

B15 min.

A10 min.

Time available at each work center: 2,400 minutes per weekOperating expenses per week: $6,000

A Production System Manufacturing Two Products, P and Q

Can We Meet The Demand?

Perform a Capacity Analysis

Product A B C DP 15 15 15 15

Q 10 30 5 5

Processing Requirements (all times in minutes)

Available time / week on each resource: 2400 min.

Can We Meet The Demand? Resource requirements for 100 P’s and 50 Q’s are:

Resource A: 100 x + 50 x = minutes

Resource B: 100 x + 50 x = minutes

Resource C: 100 x + 50 x = minutes

Resource D: 100 x + 50 x = 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 = min. on B.

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

Each unit of P requires minutes on B. So, we can produce units of P.

If we produce and sell 50 units of Q and units of P each week, we get 50 x $60 + x $45 = $ per week.

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 company’s 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 minutes on B. So, we can produce units of Q.

By producing 100 units of P and units of Q, we get 100 x $45 + x $60 = $ each week.

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 New PriorityFirst: OE TSecond: T IDistant Third: 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 constraintDecide how to exploit it

Drum-Buffer-Rope (DBR) technique.

A Troop Analogy

WORK-IN-PROCESS

RAW MATERIAL

FINISHED GOODS

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

That’s 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 doesn’t have anything to do,

let’s 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

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

RAW MATERIAL

FINISHED GOODS

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

The drum is held by marketing demandsResult:

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

RAW MATERIAL

FINISHED GOODS

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

RAW MATERIAL

FINISHED GOODS

A rope tying the gating operation to the bufferTime Buffer

Major Capacity Constraint

The 5 Focusing Steps (Contd.)

What is Step 4? Elevate the System’s ConstraintsHow 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?

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

Product Costs and Profits

Product SellingPrice

Manufg.Cost

Profit perunit

P (domestic) 90 45 45 Q (domestic) 100 40 60 P (Japan) 72 45 27 Q (Japan) 80 40 40

Maybe We Should Not Sell in Japan?

Right now, we can get at least $ per constraint minute in the domestic market.

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

So, should we go to Japan at all?

Recovering Our InvestmentProdType

UnitProfit

$/constminute Plan A

$45 3.00 $4,500(100)

$60 2.00 $1,800(30)

$27 1.80 -

$40 1.33 -

OE $6,000

Profit $300

QD

PD

PJ

QJ