Theory of Constraint and Cost

I. What is TOC?

Generally, a company is composed of complex elements of people, methods, equipments, materials, supply, customers, workforce, regulations, productions and others depending on the company. Traditionally companies manage these elements by dividing the organization into smaller divisions with the objective of making it more manageable. This also aimed at maximizing the performance of each division. Logically, in improving the performance of each division, it is concluded that it will improve the company as a whole.

On the contrary, according to Eliyahu M. Goldratt’s Theory of Constraints these divisions or variables have only small impact on the general performance of the company. In fact, only few variables have a direct significant impact on the general or global performance of the company, and these are called constraint (TOC Fundamentals, 2007). Thus, according to the Theory of Constraint, in order for a company to achieve its goal it must first identify these significant variables or constraints and then to focus and make the necessary changes in these constraints.

II. Five-step Process of On Going Improvement

For a company to be able to control these constraints, Goldratt presented a Five-step Process of On Going Improvement, which are as follows:

1. Identify the system's constraint(s)
2. Decide how to Exploit the constraint(s)
3. Subordinate everything to the above decision
4. Elevate the system constraint (If necessary)
5. Go back to Step 1, but don't let inertia cause a system constraint

1. Identify the system's constraint(s)

            No changes can be made if the company fails to identify the constraints. Identifying the constraint can help the company increase its efficiency and productivity which eventually will lead to an increase in profit. Logically, if a company concentrates on the non constraints the throughput would remain the same and not be increased in a global sense. There might be some local impact or local gains, such as removing the queue in production line, but if the product ends up in another queue, such us in distribution, the effect would be the same. Thus it is necessary to identify the system’s constraint/s.

SoPark Corp. has been lagging in until it applied the Theory of Constraint to the works at Lackawanna manufacturer (Franczyk, 2005). SoPark identified its constraint, the surface mount placement machines. The surface mount placement machines which with proper scheduling were then fixed. This therefore opened up the bottleneck of the company. The company made the necessary adjustments by having the organization move like pit car crew. Circuit board testers, even accountants, were taught and assigned (for short fill in time) task on production floor.

2. Decide how to Exploit the constraint(s)

After identifying the constraint, the next step is to focus on getting more production from the existing company’s limitations. This is called exploiting the constraint. In the example of the Goldratt’s The Goal, the machine NCX10 was identified as a constraint. Once identified it was exploited by creating shift breaks for the operators so that NCX10 could produce at all times. This created significant increase in the output of the machine which in turn affected the output of the company.

Taiichi Ohno (1978) had a very effective way of describing how to exploit the existing capacity of a work center:

Present Capacity = Work + Waste

3. Subordinate everything to the above decision

It is not enough to simply exploit the constraint. The company must assist the exploited constraints by subordinating the non constraint resources. This involves changing the current practices of the non-constraint resources. In a more practical example, if the production line is the identified problem, increasing the output of the production line is exploiting the constraint, subordinating everything means controlling or changing all the things, such as supply of raw materials, surrounding the constraint. Thus, even if the constraint has been identified and exploited, or the production line now produces good output, other non constraint resources, such as over supply of raw materials, delivery of products, etc. will still affect the global profit of the company.

To look at non-constraint capacity then is as follows (Youngman, 2003):

Present Capacity = Work + Localized Waste of Over-production + Other Wastes

4. Elevate the system constraint (If necessary)

The next step in the process now is to elevate or evaluate of the output (of the constraint) is now enough to supply the demand of the market. This is the ultimate goal of the elevating process – the removing of the constraint. In other words, to elevate means to be able to meet the demand of the market by removing the constraint or producing enough output. Once this is done or achieved, the market now becomes the constraint.

If after all the process, the company still does not produce enough to meet the demand of the market, it is now pertinent to “elevate” the constraint. The company must find ways adding capacity in production.

5. Go back to Step 1, but don't let inertia cause a system constraint

Once the constraint has been removed, the company must now find or identify the new constraint to the system. TOC stated that there will always be constraint to the system (TOC – Fundamentals, 2007).

The problem comes when the company allows itself to be controlled by the constraints. Thus a company which can benefit most from TOC is those who controls the constraints or puts them where it wants it to be, more likely where it has least effect on income. This is managing the constraints to the company’s advantage and not letting inertia cause the system constraint. The best description of inertia comes from Mark Woeppel, “How about a 43% annual ROI? Could you sit there awhile?  I know a company that did.  How about taking your order fulfillment cycle from 3 weeks to 3 hours and stalling there.  I know another company that did that. (2000)”

To address inertia, it is important to go back to step one and then continue the process all over again. This is also a never ending process for the company.

III. Layers of Resistance

In making the necessary changes in implementing new ways or process to the human system the company will definitely face resistances. This resistance must be overcome to effect the necessary changes. The Theory of Resistance provided the foundations for overcoming the resistance to change in its 6 Layers of Resistance or the 6 Steps to Buy-In. Another layer, Layer Zero, was added to the original six although it is a step preceding the six.

Layer Zero - "We/I don't have a problem."

This is the resistance encountered on people who perceives that there is no problem and therefore there is no reason to listen to the suggestion that change should be implemented. The way to overcoming this resistance is to clarifying the problem to the person.

Layer 1 – “You don’t understand my/our problem(s)”.

Here, the resistance is found on “we have different problems here”. One of the main reasoning encountered is: The solution may have worked well with other companies, but here we are different. To address this problem, TOC gave the generic cloud and current reality tree of the TOC Thinking Process.

Layer 2 – “…we don’t agree on the direction of the solution.”

Presenting the reality is difficult. Often, companies resist by saying that they are quite aware of the problem and are really not sold on the need to change or on the way change must be implemented. For example, in increasing production the general accepted principle is to hire more people. In TOC, the solution would be to find the bottleneck and find a way to solve this (TOC Fundamentals, 2007).

To overcome this layer of resistance, the evaporating could of the TOC Thinking Process is the suggested tools in making companies accept the suggested solution.

Layer 3 – “…your solution can’t possibly produce the level of results you say it can.”

Here, the solution or change must clearly demonstrate that all the negatives or problems identified will be solved and turned into positives. TOC Thinking Process’ future reality tree can best show that the proposed changes will directly solve the problem/s.

Layer 4 – “…your good solution is going to cause some bad things to happen.”

After making the company see that the proposed changes will definitely bring good to the company the resistance now will come in the form of whether the good will outweigh the negatives brought by implementing the change. Of course in implementing changes, there will be unintended but unavoidable consequences. These are like side effects of a good medicine. 

To convince the company that the proposed change is more vital than avoiding the side effects, the negative branch reservation of the TOC Thinking Process is a useful tool.

Layer 5 – “…there are some significant obstacles that prevent the implementation.”

Similar to Layer 4, here the company may now agree to implement the change but enumerate all the things “why it cannot be done”.  Here, unlike in Layer 4, the company presents concrete and realistic obstacles that must be overcome. This may come in the form of budget, top management will not approve, etc.

The prerequisite tree of the TOC Thinking Process addresses the way of going around these obstacles.

Layer 6 – Unverbalized Fear.

Here, after overcoming all the previous layers, the company may still feel apprehensive. It may not be able to fully communicate its worries and may ambiguously say “I agree with everything but l I still feel this will not work”. If this is the case, it is pertinent to backtrack to all the previous layers. An unidentified and unverbalized fear means something in the previous layers have been missed. There is not tool that can overcome this except in going back to the previous layers.

However, before going back thoroughly from the beginning Goldratt suggested assessing the character of the person at the top. He may simply be the kind of person who is resistant to change.

IV. TOC Thinking Processes

The Evaporating Cloud, Generic Cloud and Current Reality Tree assess the situation, provide the present reality and identify the core problem.

1. The Evaporating Cloud identifies the unconventional starting point in establishing the problem. It is a construct of necessity logic that takes the form (The TOC Thinking Processes, n.d.):

               B) Requirement <-----  D) Prerequisite

              /                              ^

             /                               |

            v                                |       

A) Objective                                 |/| -- conflict

            ^                                  |     

             \                                 |    

              \                                v

               C) Requirement <-----  D') Prerequisite

and is read:

In order to have objective A, we must have requirement B...
In order to have requirement B, we must have prerequisite D...
In order to have objective A, we must have requirement C...
In order to have requirement C, we must have prerequisite D'...
But prerequisites D and D' are in conflict...

            2. The Current Reality Tree (CRT)

The Current Reality Tree is basically a cause and effect based relationship. It is composed of  “if…, then…”, or “if… and if…, then…” statements (The TOC Thinking Processes, n.d.)

3. The Future Reality Tree (FRT)

The Future Reality Tree turns undesirable effects into desirable outcomes. This is the same in a way to the Current Reality Tree except here there is now a presentation of proposed outcome, as exemplified in the following diagram (The TOC Thinking Processes, n.d.):

A CRT:                    

          I have           

          a fire           

            ^                    

           /|\            

          / | \        

         /  |  \         

        /   |   \           

       /    |    \       

      /     |     \      

     /      |      \      

I have   I have    I have 

 fuel   ignition   oxygen 

AN FRT:         

          

        I don't have         

           a fire         

            ^        

           /|\           

          / | \      

         /  |  \     

        /   |   \      

       /    |    \       

      /     |     \       

     /      |      \      

I have   I have    I don't have

 fuel   ignition   oxygen in contact

                   with the fuel

            4. The Negative Branch Reservation (NBR)

            The Negative Branch Reservation makes the whole situation complete by adding the necessary things or adjustments needed to steer away from the unintended negative consequences.  The following simple negative branch demonstrates how to avoid the negative consequences of the action by replacing lack of understanding of a policy with education of the policy (The TOC Thinking Processes, n.d.):

We don't really        We may get stuff

get the good stuff     worse than we have

we expect              now 

                ^             ^ 

                 \           /

                  \         /

Desired good     The policy may

stuff happens    be misinterpreted

     ^                  ^^

     |                 / | 

     |                /  | 

     |    ___________/   | 

     |   /               | 

     |  /             Not everyone 

     | /              in the organization 

We put a new          understands the 

policy into           rationale for the

place                 policy

            5. The Prerequisite Tree (PRT)

            The Prerequisite Tree transforms obstacles into a plan by collecting or identifying the “intermediate objective” (IO) that would make the obstacles debatable or disputable. By building a plan as a group the team will have a synchronized knowledge or understanding of the task and how each of them fits in the plan.

            6. The Transition Tree (TRT)

            The Transition Tree is based on an “if and then” parameter previously presented to the company. It now includes the need for action, the action, the rationale for the action, that desired, expected result (or intermediate objective - IO), and then reason for the next need in as demonstrated in the diagram (The TOC Thinking Processes, n.d.):

Result 

       (IO) 

       ^ ^ ^

      /  |  \

     /   |   \

Action  Need  Rationale

         ^ ^

         |  \

         |   \

      Result  Reason for

       (IO)   next need

       ^ ^ ^

      /  |  \

     /   |   \

Action  Need  Rationale

V. Conventional measurements vs. TOC measurements

Generally measurement is the method of accounting for the results of actions being taken by the company or organization (TOC Fundamentals, 2007). Therefore they are the “output” of the whole system or organization. Traditionally managers and employees based the company’s general performance or status on this “output”. Thus from being “output” measurement can now be used as “input” wherein it can influence the efficiency of the organization.

Taking both of these in consideration, in TOC, measurements may cause the system to go into chaos if they (measurements) are not clearly or fully understood. In TOC examining the measurements of the company or organization is important and done as follows:

In conventional measurement or conventional accounting companies focus on measurements such as Net Profit, Return on Investment, etc. This practice is generally good and appropriate for the company since they clearly indicate the company’s success or failure. However looking into these measurements and using it for forecasting or for making the decisions for the company makes it impossible for the management to see clearly the day to day operation of the company. This is like steering the company into a destination by looking on where it has been. 

By this process the company will create local measurements which are connected to the net and gross profit, ROI, etc. These local measurements will eventually lead the management to make poor decisions. Therefore what is needed is to create local measurements that are not based on “reading” the conventional measurements but rather on what are actually linked on or what actually affect long term global measures of profit, ROI, etc. These measurements are throughput, inventory and operating expense. These measurements are throughput, inventory and operating expense. In other words these measurements should be used to make changes in the gross profit, net profit, cash flow, etc. and not vise versa as is the traditional method.

For instance, in inventory, if there is a new investment needed, let’s say for raw material, the inventory cost will definitely be increased in accordance with the amount of the raw materials. In operating expense, the cost of labor is immaterial but what has an impact on the company is whether there is a need to pay for the overtime. In throughput or the rate at which money comes into the system through sales, the impact can be measured by determining the selling price minus totally variable costs, times the volume of sales (TOC – Fundamentals, 2007). This will allow the company to reliably predict how the local action will have on profit, cash flow, ROI, etc.

VI. Application

The Theory of Constraints was first introduced in Goldratt’s book “The Goal”. The book focuses on implementing TOC logistical solution for production control called the Drum/ Buffer/ Rope. Then it was followed by the sequel “It’s Not Luck” which gave logistical solutions for suppliers (replenishment) and marketing solutions for customers (unrefusable market offer). Then Goldratt followed this with the third book Critical Chain for critical chain project management. The three books demonstrated the application of the Theory of Constraints.

1. Production/ Operations

Deviating from the traditional idea that an increase in efficiency causes reduction in cost, “Drum-Buffer-Rope” gives a new approach to production/operation control. The Drum is the operation which should “march to its beat”; the time “Buffer” protects the drum from disruptions by discharging the material before they are due; and the “Rope” is connection or communication between the drum and the gateway which ensures that the materials are not stored at the workstations or discharged earlier than necessary. As a general rule, it is bad practice for workstations not having available materials for processing. However TOC argues that with the right “Buffer management” the materials should be available when it is needed and the negative effects of having low or high supply of materials can be avoided.

2. Distribution/Supply Chain

According to TOC the constraint of the supply chain is to have the product at the right place, at the right time and at the right price. Supply chains are faced with the conflict of having the right amount of inventory for their production. Most of them are torn between the practice of having more inventory, which results in high holding cost and having obsolete materials, or low inventory, with the risk of lost sales.  

Generally, rather than having lost sales supply chains end up with having high inventory. This practice forces them to “push” their products into the market by having preseason discounts, year end fire sales, etc. which does not actually create good profit. In TOC the solution is not to “push” but to “pull”. This means that instead of pushing the goods to the customers, the company holds only relatively small amounts of inventory at the point of purchase and then developing a system of replenishing the retail outlets with the product (CIRAS – TOC, 2007). This allows for low inventory at the supply chain while improving retailing.

3. Marketing

Goldratt described marketing as like spreading corn on the ground to attract ducks while sales is the equivalent of shooting a sitting duck (CIRAS – TOC,. 2007). The conflict between sales and marketing then is the customer’s perception of value (what they are willing to pay for the product) versus the producer’s perception of value (the cost of the product plus profit margin) (CIRCAS – TOC, 2007). To solve the conflict, according to TOC, is to create an “unrefusable” offer to the customer. This is a customized offer done by understanding how the customer uses the product and thereby creating “value” in their lives. In short this is making the product significant in the customer’s lives and then offering it to them.

4. Project Management

Successful project management meets all of its commitments such as due date, budget, quality, scope, etc. However project managers find it difficult to meet all the commitments and are forced to sacrifice one for the other. TOC’s Critical Chain Project Management (CCPM) accepts that managers are faced with making decisions and taking actions based on individual commitments. In TOC’s CCPM project managers must make sure that delivery and reliability are both meet and this can be assured by implementing Critical Chain Scheduling, or scheduling the chain of dependent events which accounts also for the task and resources conflicts, and Buffer Management. These are done by identifying and protecting what is vital from the inevitable uncertainty and thereby avoids the Parkinson’s Law (at task level) while accounting for Murphy’s Law (at project level). Thus individual compromises or tasks are completed at the same time the whole project is completed on scheduled.

Another practice which may also affect the whole completion of the whole project is multi-tasking. Multi-tasking results in multiplying the time to complete a task and therefore creates delay in the project as demonstrated in the diagram (Patrick, 1999):

            This is explained as: if one employee has different task then the one waiting for a completed task will wait longer. Therefore as a whole the project will take longer to complete.

VII. TOC in Future Applications

 With the use of TOC coupled with other theories, most of the healthcare colleges now claim to offer the best training possible for healthcare. Imperceptibly, they hope to capitalize on application of these theories thereby getting more enrollees, spelling profit for these universities. This is best exemplified by HealthEast Woodwinds Health Campus.

HealthEast Woodwinds Health Campus after introducing a new process management system saved $32,000 and improved its rate of mistakes by 38% (Wilbert, 2006). HealthEast Woodwinds learned this “Lean-Flow” method from St. Paul St. Paul College’s Customized Training & Consulting division. It is a combination of process management system from Lean, TOC and Flow. St. Paul College aims to stand out from other colleges by its Lean-Flow method. It plans to carve a niche in college training programs by concentrating on health care system and the method is one of its most effective tools so far.

The same can be said of the software development industry. The main application of TOC here is in the production line, but of course, with cost and profit as the bottom line. In a recent article published in the Agile Journal it was identified that in the software development there is now much talk about applying the principles of Theory of Constraints (ToC) and Lean Product Development (Lean). It was hoped that by using elements more business can be delivered with less effort. According to the report, TOC shall be the base or backbone, with Lean and Agile injected in the whole process. For TOC this involves the principles of finding the bottleneck, exploiting the bottleneck, making all the steps of the process subservient to the bottleneck’s maximum capacity, pulling work and improving the capacity of the bottleneck (Elssamadisy & Mufarrige, 2007). In improving the capacity, Agile comes into application. Lean’s “Flowing” and “perfect hand-off position” were also used in steps 3 and 4.

The diagram shows this simple sequential process, illustrating the use of Lean and TOC. 

Each step has a speed (50, 30, 60, 80, and 100).  Inventory builds up between two steps when they are of mismatched speed - therefore because step A is faster than step B, an excess product of A waits to be processed by B (Elssamadisy & Mufarrige, 2007).

According to the article this three theory application hopes to meet the increasing demand in software development industry.

Works Cited

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Retrieved 24 August 2007 from

http://www.ciras.iastate.edu/library/toc/applications.asp

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http://www.ciras.iastate.edu/library/toc/whatisthegoal.asp

Elssamadisy, Amr & Mufarrige, John. 2007Theory of Constraints, Lean, and Agile Software

Development. Delivering More Business Value Where Needed. Agile Journal

Retrieved 24 August 2007 from

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http://triangle.bizjournals.com/buffalo/stories/2005/09/05/story5.html?page=2

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http://triangle.bizjournals.com/twincities/stories/2006/12/04/story4.html

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St. Lucie Press, pg 41

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