Theory of Constraints- A Proven Methodology in increasing profitability


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How Theory of Constraints can help increase profitability

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Theory of Constraints- A Proven Methodology in increasing profitability

  1. 1. Advanced Manufacturing Consultancy Sdn. Bhd. Theory of Constraints A proven methodology of increasing profitability J. Ramesh Victor Sr.Consultant and Director, Advanced manufacturing Consultancy Sdn. Bhd. 1. What is the Theory of Constraints? The theory of Constraints (TOC) is a highly effective process of ongoing improvement, always focusing all efforts towards the system’s goal. The theory was founded by the Israeli physicist, Dr.Eliyahu Goldratt in the early 70’s and made popular through his book, The Goal in the early 80’s. TOC stresses that a system with a goal will always have a limitation or a constraint which prevents it from achieving higher results. Identifying this and focusing improvement efforts on the constraint gives a leverage point to achieve higher performances towards the goal. Dr. Goldratt has identified a 5 steps approach in TOC which will allow any business to do just that: 1. Identifying the system’s constraint 2. Decide how to exploiting the constraint 3. Subordinating everything else to the above decision 4. Elevate the constraint 5. Go back to step 1. But avoid inertia to cause a system constraint William Dettmer in his book ‘Breaking the Constraints to World-Class Performance’, describes TOC as “…the application of the scientific method to the challenges of managing complex organizations” TOC describes a system (a manufacturing organization is also a system) as being similar to chains or network of chains. Each chain has links differing in strength, size and capability. In any independent chain, there is one link that is weaker than the rest; this is the weakest link. The weakest link determines the maximum performance of the chain – it is the constraint to system performance (Fig.1). Applying the 5 steps approach as describes above, an organization is able to: 1. What out what is the weakest link to their performance 2. Focus improvement actions on the constraint 3. Use leverage force the constraint has on the system (it determines maximum performance of the system) to improve the system performance within a very short period of time Figure 1 This chain analogy can be seen in a manufacturing environment through the following example. In a production line where there are several resources through which raw material flows through, not all resource can produce a part at the same speed or volume at any given time. The capacity, like the link in the chain varies in size, strength and reliability. There will be one resource or station which will form the weakest link- this will be the constraint of the production line Let’s assume Resource A can produce 450pcs/hr (Refer to Fig. 2), Resource B 460pcs/hr, Resource C 430pcs/hr and the last Resource D can produce 500pcs/hr. In this production line Resource C is the constraint process. It determines the output of the whole line; that is 430pc/hr. If this system were to make more money out of sales (assuming there is demand) the only way is to build more by increasing the capacity of the constraint (E.g. from 430pcs/hr to 440pcs or 450pcs) Manufacturing and business solutions towards increased profitability 2009 Advanced Manufacturing Consultancy Sdn. Bhd. All rights reserved
  2. 2. Advanced Manufacturing Consultancy Sdn. Bhd. Figure 2 Process A Process B Process C Process D 450pcs/hr 460pcs/hr 430pcs/hr 500pcs/hr In a non TOC environment companies tend to balance the line and keep equal capacities in all process. Balancing the lines assumes that there is very little variation in performance at each resource. This is not the actual case in real life scenario. Secondly when there is a need to increase capacity the organization has to equally spend effort or investment on all resource to meet new volume targets rather than focusing on one point-which is the constraint. This in fact is a more expensive and slower approach to managing capacities. An organization which uses the TOC approach would improve its performance using the five steps approach: 1. Identify Constraint: It will use diagnostic tools to calculate and identify the constraint as Resource C 2. Exploit the constraint: It will focus all attention and improvement tools in the arsenal of its team to increase the capacity of Resource C without adding new machines. Examples will be running the machine during break hours, Doing Quick-Changeover activities on Resource C, Improving Cycle time of Resource C and introducing material management concepts to ensure that Resource C always has the right Inventory in front of it to produce output 3. Subordinate other operations: It will decide that other operations produce only what the constraint (Resource C) can consume. Producing more will not go through the constraint but will increase Inventory cost. Producing less than the constraint capacity could starve the constraint for parts thus creating a capacity loss that cannot be recovered 4. Elevate the constraints: If the demand continues to grow then the organisation will decide to invest on adding machine at Resource C. Since it did not balance the line it need to only invest on Resource C rather than at every station 5. Go back to step 1: After breaking a constraint the organisation will look for its next constraint, which may be Resource A or it could be something else-probably a market constraint or policy constraints. Focus will then be given to this constraint Our example above illustrates the use of TOC in a simple production line scenario. This is TOC applied in its simplest form. However even though it looks logical and simple many organizations do not use this method of managing their production. In my visits to hundreds of factories all over Asia and also in the USA very few organizations actually practice these five steps even though it is commonly agreed by the management team as simple logic. The main reason I have noticed, for them not practicing it is because of the lack of detail hands-on knowledge on the different Tools needed to carry out each of the 5 steps of TOC. At each step the practitioner has to use proven methods and techniques to carry out effectively the improvement cycle while always focusing on improving and achieving system goals. 2. Theory of Constraints Applied in Different Areas of the System Principles of TOC go beyond the production shop-floor as we have seen in the simple example above. TOC can be applied to Finance, Supply Chain Management, Project Management, Change Management and Decision Making and every other area of a system. While in this article we shall touch as an overview, how TOC applies in varied areas of a system requires a detail study on each of the topic TOC in Finance & Decision Making Process Concepts of TOC are very effectively used in measuring business performance and directing actions which always have an effect on bottom-line figures, namely profitability. The TOC measurements are known as Throughput accounting. Throughput Accounting is a method of simplifying and measuring what matters most in an organisation so that these measurements always, without error point out whether or not the business organisation is working towards higher profits and improved cash flow. Throughput Accounting is a necessary way of looking into the health of the organisation by the Finance group of that system. Manufacturing and business solutions towards increased profitability 2009 Advanced Manufacturing Consultancy Sdn. Bhd. All rights reserved
  3. 3. Advanced Manufacturing Consultancy Sdn. Bhd. Dr. Goldratt expounded the Throughput Metrics because of the serious disconnect Cost Accounting showed between Finance Reporting and actual decision making in the organisation. Dr. Goldratt once said that “Cost Accounting is productivity’s public enemy number one” While Throughput Accounting deserves a lengthy treatment of its own I will summarise what it is about and how it can help point towards increased profitability and better decision making. As Goldratt has pointed out in numerous places in his writings, especially in his book ‘What is This Thing Called the Theory of Constraints and How Should It Be Implemented’: “before we can deal with improvement of any section of a system, we must first define the system’s global goal; and the measurements that will enable us to judge the impact of any subsystem and any local decision, on this global goal” In general terms we shall assume that the global goal of a business organisation is to make more money now and in the future. To see if the company is achieving its goal it needs to answer 3 simple questions: 1. How much money is my company generating? 2. How much money is actually captured by my company? 3. How much do I spend to operate my company? In Throughput Accounting these questions are turned into formal measuring definitions, namely: 1. THROUGHPUT (T): the rate at which the system generates money through sales 2. INVESTMENTS (I): the money the system invests in buying items it intends to sell (mostly Raw Material; either in Raw, WIP or Finished Goods not yet sold) 3. OPERATING EXPENSES (OE): the money the system spends in turning it’s Investment into Throughput We could formularise this and make financial sense: T = SR – VC (T is Throughput, SR is Sales Revenue & VC is Variable Cost) I = All money invested in Raw Material OE = All Fixed Expenses ( Overhead, Labour and any other expense which will incur even if no parts are produced) NP = T – OE and ROI = T – OE / I (NP is net profit, T is Throughput, OE is Operating Expense and I is Investments) If this system’s goal is to be achieved (see Fig. 3): THROUGHPUT MUST INCREASE INVESTMENTS MUST REDUCE OPERATING EXPENSES MUST REDUCE Figure 3 THROUGHPUT INVESTMENTS OPERATING EXPENSE Any decision that helps achieve the above trend will have a positive impact on profitability A link is created between bottom-line finance results and day to day decision making Manufacturing and business solutions towards increased profitability 2009 Advanced Manufacturing Consultancy Sdn. Bhd. All rights reserved
  4. 4. Advanced Manufacturing Consultancy Sdn. Bhd. TOC in Change Management & Project Management TOC principles have proven to be very valuable in managing effective Organizational Change. Very often the constraint in an organization is not a physical machine which has a limitation in capacity. More often than we realize constraints which limit performance of an organization is either not changing the course of direction towards actions which increase profitability or having policy constraints. To address this TOC suggests that the first 4 steps of the 5 step approach be consolidated into three fundamental items to be determined: 1. What to Change? This is the stage of identifying the area that needs change to realize the goal or to identify a policy which is constraining the system 2. What to Change to? Here two aspects are analyzed before deciding if the new cause of Change is something which will bring result. i) Will this action/change bring about the actual realization of my global goals? ii) What side effects will I see? Several tools including the Throughput Measurements are used to simulate answers to these questions. 3. How to cause the change? How to turn this into reality-actions, strategies and re-engineering TOC has established a set of proven tools to answer these fundamental questions to achieve the results required (E.g. The Reality Tree, Cause Effect Tree etc.) The above three questions are also critical in Managing Projects. Very often problems faced in projects are: 1. Projects which have blown the budget 2. Long Lead times of projects 3. Fire Fighting and burning-out resources to complete projects on time All these have a very expensive price to pay. It can even lead to lost contracts and loss of market share due to delays in New Products and not meeting Time to Market requirements. TOC approaches Project management by answering the above three questions and also by using the TOC method of Critical Chain Scheduling and Buffer Management. In summary TOC Critical Chain method does two main things to projects : 1. Shifting focus from assuring the achievement of task estimates and intermediate milestones to assuring the only date that matters -- the final promised due date 2. A project buffer is located between the end of the critical chain and the projects final due date.(this protects the project from execution variability Critical Chain project management methods can reduce project completion Lead time by 25% to 30% in normal scenarios 3. TOC & Other Methodologies Many companies today have adopted some type of Performance Improvement methodology. These include Total Quality Management (TQM), Continuous Process Improvement (CPI), Just In Time (JIT), Lean Manufacturing, Total Productive Maintenance (TPM) and Six Sigma to name a few. How does TOC differ or is similar to these methodologies? Let’s first look into the similarities. All methods attempt to reduce variation and recognise the interdependencies. Statistical process control is emphasized in the quality area to help identify ways to reduce variations. The difference or the advantage TOC has over the other methodologies is as follows. Other methodologies place an emphasis on process improvement. That means improvement is carried out in a number of areas at once. Very often it is carried out throughout the plant or organization. In TOC improvement is focused on the constraint. This has two distinctive advantages: 1. Resource is not spread throughout the organization. They are focused at the constraint. This actually brings faster results. 2. Improvement in non-constraint areas cannot bring an impact to the whole system’s performance. It is the constraint which determines the maximum performance of the whole system. Therefore spreading resource across the system while not bringing a system-wide improvement could also become a more expensive affair Manufacturing and business solutions towards increased profitability 2009 Advanced Manufacturing Consultancy Sdn. Bhd. All rights reserved
  5. 5. Advanced Manufacturing Consultancy Sdn. Bhd. 4. TOC Successes Companies who have moved into TOC have significant improvement seen within a period of anywhere between one month to about 3 months. This is because of the 5 step approach which forces a team to work on the right area aiming for the right bottom-line results. From my involvement in helping organizations going into improvement at their manufacturing and also service environment using TOC the following results have been seen • 70% reduction in Inventory (using TOC Drum Buffer Rope Material management Methods) • 30% increase in bottleneck machine performance without adding capital (within about 2 weeks) • 40% more tools completed at Tool Rooms using TOC project management and 5 step approach • On-Time-Delivery improved from 65% to 98% within 3 months • Capital avoidance amounting to an average of more than US$3,000,000.00 (average of the various companies) And the list could go on. 5. Conclusion As Debra Smith put it in her book ‘The measurement Nightmare’: “Theory of Constraint is the Evolution of a Revolution” It brings quantum benefits to those who practice it within a very short period of time. The way the 5 steps approach is lined up is planned as a method to be used continuously to repeat these gains until one can say that I have achieved all my goals. But is there an organization that wants to stop making more improvement? No! But the way the improvement activities are organized and implemented in most of the organizations today seem to suggest otherwise. The improvement actions are slow, results seen are not seen in bottom-line financial figures, no sustainability in the methodologies employed. Millions of Dollars spent on embarking of new initiatives with results not seen for years The main reasons for this state as I have observed are: 1. Not moving into TOC concepts in their improvement programs. TOC can complement and fine tune existing methodologies but very few organization heads realize this and move towards it 2. A lack of understanding of the TOC concept and the various tools in it 3. Limited competent TOC practitioners in this region (Asia) to get consulting service and external help from 4. Lack of an effective monitoring measurements and methods to ensure they have achieved what they want TOC is not something a company has to spend millions of Dollars to embark on. It starts with the 5 steps approach. Once the constraints have been identified several tools are at the disposal of the organization to improve itself. While external help is limited it is not unavailable. TOC is proven to have brought results wherever it has been used. It aims to achieve only one result: If your organization has a goal (with the assumption tat your organization’s general goal is to make more money now and in the future) what limits its achievement or slowing down its achievement? If this notion makes sense then THE THEORY CONSTRAINTS has the answer to break that limitation and achieve higher profitability for the organization. Advanced manufacturing Consultancy Sdn. Bhd. is a consultancy firm specializing in: • Consulting and Training in Theory of Constraints • Consulting and Training in Lean Manufacturing • Lean Sigma development • Certification programs in Lean & LEANSIGMA • LeanSigma for Operational Cost Reduction in Service, Healthcare & Manufacturing Industries • Factory audits and assessments Website: Email: Fax: +605-526 1090 Manufacturing and business solutions towards increased profitability 2009 Advanced Manufacturing Consultancy Sdn. Bhd. All rights reserved