Applying the Theory of Constraints (TOC)

Something is holding back your company’s productivity. What is it? The Theory of Constraints, introduced by Dr. Eli Goldratt in his book The Goal, asserts that there is typically a single bottleneck that limits productivity. While it’s common sense that a process is “no stronger than its weakest link,” the Theory of Constraints emphasizes that it’s far more practical to work with your weak spot than to eliminate it. That weak spot provides a clear focus point, around which the most valuable improvements to your system can be made.

The Five Focusing Steps

Identify

Start by identifying the constraint. You need to understand your production process, and be able to name its single most significant limitation. This may be a limitation of equipment or space, a company policy or attitude, or even an external constraint like a lack of customers. What one thing is holding your system back from being more productive? After each change to your system that you make in the later steps, see if the constraint has changed. If so, come back to this step and start the process again.

Exploit

Next, find ways to exploit the constraint - that is, to get the most use out of what is already there. There are probably several small adjustments that can be made right at the point of work. These are “quick wins” that should be implemented as soon as possible. You’ve identified the limiting element; what about that element needs to change in order for it to work at its best?

Subordinate

After making decisions around the constraint itself, it’s time to subordinate the rest of the production system to those decisions. This can be counter-intuitive at first, because non-constraint elements of your production system may not need to function at their “most productive” level. Instead, each part of the process should support the full exploitation of the constraining element. What other elements need to change to keep the constraint as productive as possible?

Elevate

At this point, your production process is using the constraint as effectively as it can. The next step is to elevate the constraint itself – that is, increase the productivity cap the constraint imposes. This step may involve changing equipment or processes dramatically, and may prompt more in-depth planning and research. The core question is simple: what can you do to change your limitation?

Repeat

You’ve made it to the last step! Go back to the first step and repeat the process. If the same constraint is still in effect, what else can you do to improve your system? If you’ve overcome the original limitation, “breaking the constraint,” then what is the new constraint to focus on? Applying the Theory of Constraints is an ongoing process; it only stops when you don’t want to make more money. Don’t let complacency become the new constraint!

Throughput Accounting

Steps 2, 3, and 4 of the Five Focusing Steps require some operational decisions. How should you choose the best approach in each step? The Theory of Constraints includes a specialized framework to inform these choices, called Throughput Accounting. In Throughput Accounting, there are three core measures: Throughput, Investment, and Operating Expense. With these core measures, you can make well-informed decisions about new investments and system changes.

Throughput

The rate at which value is created is called Throughput. Usually, this is the rate of income from sales, after the costs of materials. You could also think of this as “net productivity.” In effect, this is what your business is all about - what your company actually does.

Investment

Sometimes called “Inventory,” Investment refers to the value that your business has tied up in physical objects, like product inventory, equipment, and real estate. Some investment is required for businesses to function, but very few companies make money on the products that stay in the warehouse. Investment is not part of Throughput.

Operating Expense

Your Operating Expense could also be called your “ongoing cost of business,” because it refers to the costs involved in simply maintaining the system. Most of the time, these expenses are relatively stable and predictable. They allow your company to function, but otherwise they don’t contribute to Throughput.

When you look at your business process through the lens of Throughput Accounting, your Net Profit is equal to your Throughput minus your Operating Expense:

(Net Profit) = (Throughput) - (Operating Expense)

…and your Return On Investment is the Net Profit divided by your Investment:

(Return On Investment) = (Net Profit) / (Investment)

When you’re deciding on a new purchase or system, compare the Net Profit and the Return on Investment from each of your options, including the status quo. It will be immediately clear which way is the best way. With the Five Focusing Steps guided by Throughput Accounting, your business stands to gain significant benefits from applying the Theory of Constraints.