The Theory of Constraints (TOC) is a management philosophy that identifies the constraints limiting an organization from achieving its goals and focuses on restructuring processes to better exploit constraints. The key steps are to identify the system's constraints, decide how to best exploit each constraint to maximize throughput or productivity, and subordinate all other decisions and processes to supporting the constraint. TOC uses linear programming to determine the optimal product mix and production levels given capacity constraints. The goal is to keep constraints fully utilized to maximize profits in the short-term.

1. 1
Theory of Constraints
Short-term Capacity Optimization

2. 2
Theory of Constraints
 Significance of bottlenecks
 Maximum speed of the process is the speed of
the slowest operation
 Any improvements will be wasted unless the
bottleneck is relieved
 Bottlenecks must be identified and improved if the
process is to be improved

3. 3
Theory of Constraints
 Purpose is to identify bottlenecks or other
constraints and exploit them to the extent
possible
 Identification of constraints allows management to
take action to alleviate the constraint in the future
 Reduce cycle time
 Time from receipt of customer order to shipment
 Improve manufacturing cycle efficiency (MCE)
 Processing time / total cycle time

4. 4
Theory of Constraints
 Assumes current constraints cannot be
changed in the short-run
 What should be produced now, with current
resources, to maximize profits?
 Question cannot be answered by traditional accounting
methods

5. 5
Theory of Constraints
 Management tool, not an accounting tool
 Not used to determine inventory values
 Not used to allocate overhead to inventory
 Does not comply with GAAP
 Does indicate how to use available resources
most effectively

6. 6
The Need for TOC
 Standard costing
 Can promote undesirable behavior
 Work to keep people busy
 Local optimization
 Inventory is produced regardless of need
 Does indicate what it should cost to produce a
product

7. 7
The Need for TOC
 Does not indicate which products will maximize
profits given the constraints
 Doesn’t take constraints into account
 Does not consider the demands each item places on
limited resources

8. 8
The Need for TOC
 Absorption costing
 Can promotes undesirable behavior
 Production costs are assets until sold
 Accumulation of inventory keeps costs off the income
statement
 Illusion of profitability
 Does indicate what it costs to produce a product

9. 9
The Need for TOC
 Does not indicate which products will maximize
profits given the constraints
 Doesn’t take constraints into account
 Absorption cost does not consider the demands each
item places on limited resources

10. 10
The Need for TOC
 Variable (direct) costing
 Identifies the incremental costs of producing a
product
 Identifies product that provides the greatest
contribution margin, or contribution margin per unit of
constrained resource
 Cannot deal with more than one constraining
resource at a time

11. 11
The Need for TOC
 Traditional definition of variable cost doesn’t hold
in the short-run
 Labor, variable overhead aren’t really variable
on a day-to-day basis
 Some costs are truly variable in the short-run
 Material, commissions, delivery costs, out-of-
pocket selling costs, etc.
 Each additional unit produced or sold causes
more of the cost to be incurred

12. 12
The Need for TOC
 Theory of Constraints
 Uses linear programming to determine best use of
limited resources
 Indicates what should be produced and in what
quantities

13. 13
Theory of Constraints
 Constraining resource must be maximized
 All other operations must be geared toward this
goal
 May require suboptimization in other areas
 Upstream operations must provide only what the
constraint can handle
 Downstream operations will only receive what the
constraint can put out

14. 14
Theory of Constraints
 Constraint must be kept operating at its full
capacity
 If not, the entire process slows further
 Focus is on maximizing throughput
 Sales – totally variable costs
 All other costs treated as fixed operational
expenses
 Cannot vary much in the short-run

15. 15
Theory of Constraints
 Based on the concepts of drum, buffer and
ropes
 Drum
 Output of the constraint is the drumbeat
 Sets the tempo for other operations
 Tells upstream operations what to produce
 Tells downstream operations what to expect

16. 16
Theory of Constraints
 Buffer
 Stockpile of work in process in front of constraint
 Precaution to keep constraint running if upstream
operations are interrupted
 Rope
 Sequence of processes prior to and including the
constraint
 Want to “pull” the rope at the maximum speed
 Speed of the constraint

17. 17
Steps in the TOC Process
 Internal
 Process constraints
 Machine time, etc.
 Policy constraints
 No overtime, etc.
 External
 Material constraints
 Insufficient materials
 Market constraints
 Insufficient demand
 Identify the system constraints
 How is a constraint identified?

18. 18
Steps in the TOC Process
 Decide how to exploit the constraint
 Produce the most profitable product mix
 Want it working at 100%
 How much of a buffer?
 Holding costs
 Including risk, quality costs
 Stock-out costs

19. 19
Steps in the TOC Process
 Subordinate everything else to the preceding
decision
 Plan production to keep constraint working at
100%
 May need to change performance measures to
conform upstream activities to the “rope” speed

20. 20
Steps in the TOC Process
Product 1 Product 2
Demand per month 1,000 600
Price per unit 900$ 1,500$
Material cost per unit 400$ 800$
Test components 0.25 0.40
Assemble components 1.00 1.50
Install electronics 0.50 0.50
Final inspection and test 1.25 1.00
Package and ship 0.10 0.10
Identify the constraint
Product 1 Product 2 Total
Hours
available
per month
Slack
hours
Test components 250 240 490 640 150
Assemble components 1000 900 1900 2240 340
Install electronics 500 300 800 800 0
Final inspection and test 1250 600 1850 1760 (90)
Package and ship 100 60 160 160 0
Hours required per unit

21. 21
Steps in the TOC Process
Identify the best use of the constraint
Price per unit $900 $1,500
Material cost per unit $400 $800
Throughput per unit $500 $700
Constaint time per unit 1.25 1.00
Throughput per hour $400 $700
Identify the most profitable product mix
Total demand 1,000 600
Units produced in best mix 928 600
Unmet demand 72 -
Throughput generated
Units produced 928 600
Throughput per unit 500$ 700$
Total throughput 464,000$ 420,000$ 884,000$

22. 22
Steps in the TOC Process
 Alleviate the constraint
 Determine how to increase its capacity
 Repeat the process
 Always a new constraint

23. 23
Evaluation of TOC
 Advantages
 Improves capacity decisions in the short-run
 Avoids build up of inventory
 Aids in process understanding
 Avoids local optimization
 Improves communication between departments

24. 24
Evaluation of TOC
 Disadvantages
 Negative impact on non-constrained areas
 Diverts attention from other areas that may be the next
constraint
 Temptation to reduce capacity

25. 25
Evaluation of TOC
 Ignores long-run considerations
 Introduction of new products
 Continuous improvement in non-constrained
areas
 May lead organization away from strategy
 Not a substitute for other accounting
methods