THEORY OF CONSTRAINTS

ACCT 7320October 8, 2014

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What is the “Theory of Constraints” all about?

Developed by Eliyahu Goldratt in the mid 1980’s with his business novel The Goal.

Has a close relationship with other modern techniques (more about this later):

Just-in-Time Manufacturing Resource Planning Quality Management, Six-Sigma Activity-Based Management.

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Goldratt’s Biography Born in Israel in the late 1940’s. Bachelor’s degree in Physics. Masters and Doctorate degrees in Philosophy. Founder of a production scheduling software

company. Has helped many companies such as: GM, RCA,

Kodak, Westinghouse, Philips, etc. Wrote several books:

The Goal. The Race. What is this thing called TOC? Critical Chain.

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Eliyahu Goldratt’s “The Goal” Brief overview:

Midsize company having difficulty shipping products on time. Managed by a plant manager desperate to turn things around. With the help of a Physicist, the plant manager is able to locate

the bottleneck and find a solution.

Symptoms noted in the book: Obsolete inventory. Low inventory turnover and high amount of inventory in storage. Idle workers or machines. Machine breakdown. A large amount of scrap pieces. A large amount of retooling and rework needed.

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What is the “Theory of Constraints” all about? Looks at the entire supply chain and synchronizes the

chain to achieve ultimate performance.

Based on two assumptions: Every organization has a set of processes working together

to achieve a common goal. Every process has a [single] constraint that limits it from

higher performance.

Typical constraints: Time, Capacity, Materials, Human Resources, Capital Resources, Financial Resources

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Implementation of the Theory of Constraints Step 1: Identify the bottleneck(s)/constraint(s).

Look at your production plan as a whole and determine which resource is preventing you from achieving better performance.

Look at the cause (old machine, untrained employee, long setup times, machine breakdown).

According to Goldratt, an entire plant’s throughput (productivity) is limited to the bottleneck’s productivity.

Step 2: Exploit the bottleneck(s). All process efforts should be focused primarily on the constraint to

maximize throughput.

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Implementation of the Theory of Constraints

Step 3: Subordinate everything else to the bottleneck(s). According to the theory, other activities must be subordinated to the

actions taken to fix the bottleneck in hand.

Step 4: Elevate the bottleneck(s). At this point, management has to decide whether to purchase

additional capacity (new machine, better trained employee)

Step 5: Evaluate whether solving the current bottleneck(s) created other bottlenecks. Do not allow inertia.

The production plant has to be monitored carefully as to whether other constraints now exist and to monitor the progress of the old constraint.

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Common Terms in Theory of Constraints

Throughput: processing another unit of output

Emphasis on Increasing Sales, Productivity, and Market Demand

Throughput contribution: Sales-(Material and any other directly variable Costs).

Bottlenecks: limited resource that prevent the supply chain from achieving ultimate performance

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Benefits of implementing TOC Reduction in inventory. More productive machines. Ability to meet shorter lead times. More flexible. Better customer service. Better product mix. Better customer relationship.

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Shortfalls or Criticisms of TOC Focus on short-term goals as opposed to long-term with

ABC. Main emphasis on increasing sales and volume, not

quality. May lose overall picture when only looking at specific

constraints. Focuses on the push approach as opposed to pull

approach of JIT.

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The “Theory of Constraints” and Other Concepts

PROS CONS

J IT Emphasis on customer, flexibility, and low inventory costs.

Reliance on suppliers could be costly if your needs cannot be met.

MRP Reduction in inventory costs, storage costs, and better efficiency.

Focuses primarily on materials management and not overall supply chain management. Limited in scope.

ABC Dynamic optimization of resource supply, product design and mix, and pricing.

Emphasis on cost-cutting initiatives. Mostly used for accounting purposes.

TOC Optimization of productivity and customer satisfaction.

Primarily focuses on short-term profit maximization.

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Lean Accounting A practitioner-based movement Not much in accounting textbooks and courses Is it a fad? According to one recent research article*…

Lean manufacturing is a complete business system that combines advanced manufacturing techniques including

Just-in-time (JIT) Total quality management (TQM Total preventative maintenance (TPM).

Lean accounting seeks to Reduce steps in transaction processing Eliminate standard costs in favor of actual costs Discontinue cost allocations

Lean control practices re-focus the performance measurement system

Emphasize social and behavioral controls.

Frances A. Kennedy & Sally K. Widener, “A control framework: Insights from evidence on lean accounting.” Management Accounting Research 19 (2008) 301–323

http://www.leanaccountingsummit.com/

Another article…

LEAN MANUFACTURING PRINCIPLES eliminating waste, producing only to meet customer demand. typically require a company to move from a functional division of

work to work cells where all of the processes needed to manufacture a product or line occur next to each other in sequence.

IN THIS ENVIRONMENT… Accountants have begun to realize many traditional cost

accounting practices no longer make sense. A growing number of businesses are implementing lean

accounting concepts to better capture the performance of their operations.

ADHERENTS PROPOSE A NEW WAY of looking at the numbers.

Rather than categorizing costs by department, organize them by value stream, which includes everything done to create value for a customer the company can reasonably associate with a product or product line.

July 2004 article

http://www.journalofaccountancy.com/Issues/2004/Jul/TheLowdownOnLeanAccounting.htm

Key points about LA, cont’d. NEW ACCOUNTING CONCEPTS NOT A

PANACEA Difficulty accurately pricing products and

determining profitability when they analyze performance by value stream rather than by individual product.

The approach also may emphasize speed and quality almost to the exclusion of cost concerns.

SOLUTION MAY BE to supplement the company’s standard financial statements with additional information

Report improvements from efficiency Be aware of GAAP requirements

Velocity World- The Conference on TOC, Lean and Six Sigma

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Questions?

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