Week 9 Theory of Constraints
Defining the Theory of Constraints
• Managing the rate at which the organisation converts raw materials into sales revenue o Focus on the rate at which a system generates money o Resources need to be managed according to their affect on throughput o There will always be a constraint
• TOC focuses on three variables o Throughput is the rate at which the system generates money through sales and is managed measured as sales less unit-level variable costs such as direct materials, power used in operating equipment etc o Inventory is all the money that the system has invested in purchasing things that it intends to sell. It is measured as the depreciated value of PPE and inventories valued at direct material cost o Operating expense is the money the system spends to turn inventory into throughput measured as all salaries, utilities, supplies, taxes etc
• The aim of an enterprise, under TOC is to increase throughput (sales – direct material cost), whilst reducing inventory and operating expense o However it is always possible to reduce operating expense by increasing inventory and vice versa o The trick is to minimise (effectively manage) both
Traditional cost world orientations vs. the global goal (TOC)
• In the cost world, the assumption is that by controlling department costs, management can maximise the difference between company revenues and expenses o However this emphasis on reducing operating expense has two major limitations
 Benefits are limited – operating expenses can only be reduced so much i.e down to 0
 Trade off between revenue generation now and in the future – An undue emphasis on cost reduction can encourage managers to “cut too deep” o TOC emphasises the generation of revenue rather than minimisation of cost, overcoming the two major limitations of cost orientation
 Inventory is not an asset it is the outcome of unsynchronised manufacturing
Constraints
• An organisational constraint is any element that prevents the organisation from achieving the goal of making more money o There is always one constraint termed the binding constraint which determines maximum performance and profitability
• Types of constraints o Market (supply>demand) o Supply (lack of raw materials) o Internal (demand>capacity) o Material (production processes starved of materials)
Managing the Binding Constraint
• The binding constraint is the most “harmful” constraint, the weakest link in an organisation’s value chain which may also be referred to as a bottleneck
• One option to manage the constraint is to remove the constraint by purchasing an additional resource however this may be risky as it