Theory of constraints provides concepts which serve as effective starting points and processes for improving performance. Application of these processes have created a wide range of generic, "best practice" solutions which can be combined and tailored to meet specific situations.

By Thomas B. McMullen, Jr.

Using the theory of constraints (TOC) management system [3, 4] involves adopting the suite of TOC principles and processes, applying proven TOC best practices, and using TOC approaches to invent new and self-documenting best practices.

The TOC financial management system differs in important ways from traditional absorption cost, activity-based, and economic value-added (EVA) financial systems. The TOC system corrects the flaws in these systems by emphasizing a more correct definition of "economic value-added." This alternative value stream is referred to interchangeably as throughput [1, 5], financial throughput, throughput value added (TVA), and TOC value added (TVA) [3].


The TOC Management System
The management system based on TOC has been used by industrial corporations, service companies, not-for-profit organizations, military and intelligence operations, and individuals worldwide. They have used TOC to improve performance, make better analyses of opponents, create better work environments, improve relationships, increase the experience of satisfaction in day-to-day living, and solve all manner of life's large and small problems.

TOC and the TOC management system serve best as an individual's or organization's primary approach to self-management. The TOC approaches may also be used in support of other approaches to improved performance.

Case studies from Avery-Dennison, Delta Airlines, National Semiconductor, Zycon Corp., ITT, Torrington Co., U. S. Air Force Medical Service, Hannah's Do-Nut Shop, Harris Semiconductor, Dresser Industries, Allied-Signal, U. S. Air Force Logistics Command, Bethlehem Steel, United Airlines, Morton International, Johnson Controls, the U.S. Navy/U.S. Department of Commerce Best Manufacturing Practices (BMP) Center of Excellence, Rockwell Automotive, Ruckels Middle School, and many more are available directly from APICS. These are in the form of published proceedings and audiotaped presentations from the annual APICS Constraints Management Symposia.


TOC: An Overview
The Theory of Constraints is a science of management [1, 2, 3] that applies the methods of science -- specifically, the methods of physics -- to the general problem of management, including within manufacturing companies.

The phrase "methods of physics" indicates the disciplines of cause-and-effect thinking. It implies an aggressive search for the minimum number of simplest concepts which provide maximum practical explanatory and predictive power.

TOC provides a structured process that invites and verbalizes intuition, thereby capturing the best of both the analytical and intuitive modes of experience.

By placing the priority of the generalist view over the specialist, and by synthesizing intuitive and analytical experience, TOC dramatically increases the range of circumstances over which practical, commonsense, and "win-win" combinations of policies and actions can be formulated and successfully implemented.

The principles and thought processes of TOC create, communicate and improve upon a common sense of any situation. With TOC, people can: agree on definitions of "improved performance," define measurements, establish scales of importance, and methodically sort out cause-and-effect relationships. This speeds identification of constraints and sharpens the focus of planning and implementation activities.

Whatever impedes progress toward an objective, or a goal, is called a constraint.

Some constraints -- those with lesser impact -- impede progress along only one or a few measures of limited importance. Other constraints -- those with greater impact -- impede progress along many lesser measures, along at least a few measures of great importance, or both. Every situation contains many relatively lower-impact constraints, but only a single or a few higher-impact constraints. The higher-impact constraints are called core problems or root causes. Since time is every company's prime constraint, maintaining an individual's or management's focus on identifying and acting on the higher-impact constraints uses scarce time effectively. Resources are focused on deep causes, not squandered repeatedly on the same symptoms. Using scarce time effectively allows individuals and organizations to do more, or do better, in less time, thereby opening up additional opportunities.

One set of TOC tools is provided for use when limited physical resources are the primary constraint on performance. This type of situation involves a physical constraint. Drum-buffer-rope and dynamic buffering approaches to finite capacity factory scheduling, buffer management methods of logistics control, and critical chain approaches to project management are examples of these TOC tools.

More importantly, TOC provides general-purpose and structured-thinking processes for use in dealing with the more subtle and complicated situations where thinking alone, in its many forms, holds back progress. These situations are said to involve policy constraints. This structured thinking process leads to high effectiveness in problem-solving, high productivity of company personnel and assets, and a deliberate series of simple and practical breakthrough solutions in support of the company's goal.

The same structured thinking tools -- the famous TOC "logic tree" processes and diagrams -- can also be organized into systems for increasing productivity in other domains of management skill. Examples include empowerment, communication and conflict resolution.

Use of the TOC principles and thinking processes gave rise, among other things, to the policies and procedures known as the TOC financial management system, and to the TOC manufacturing systems solutions now being employed throughout industry.


TOC Financial Management System
A manufacturing enterprise must create value for its stakeholders. Many procedures have been proposed and used to guide and measure the creation of value. Examples include allocation-based absorption cost accounting (traditional management accounting), activity-based costing, activity-based management, and the so-called "economic value-added" (EVA) system.

All of these procedures have been useful; in other words, they each delivered certain advantages over predecessor technologies and each continue to deliver at least a subset of what an appropriate financial system should provide. However, none of these still-popular systems have provided all of the features which would constitute the correct solution for manufacturing decision-support and financial control. By the term "correct solution," I'm indicating an optimum combination of concepts and processes which delivers the maximum amount of the most necessary benefits with the least unintended negative consequences and the least consumption of scarce resources.

The TOC financial management system for manufacturers is formed from the following concepts and processes:

• The manufacturing enterprise is viewed as a system, with owners who determine its goal and stakeholders who influence establishment of necessary conditions
• for continued system operation.
• For most operational purposes, the goal of the company is established as making money now and
• in the future.
• In the context of decisions concerning potential improvements, the goal of the company is established as making more money now and in the future.
• The word "money" is understood primarily to mean the economic value added by the operations of the firm.

TOC Value-Added (TVA)
Of the many competing definitions of "value," the TOC value-added (TVA) is defined as: All the money the system generates through sales. This means TVA is calculated as sales, less any sales discounts, less any true variable costs. Accountants will recognize that the TVA portion of the TOC financial system is similar to direct margin analysis, with two exceptions. First, direct labor is treated as period (vs. variable) cost. Second, TOC companies treat this as gospel and actually do it, as opposed to treating variable costing as an academic exercise learned in school.

TOC value-added was introduced as "throughput," as in the throughput of a system, by Dr. Eliyahu M. Goldratt, the inventor of TOC [1, 5]. Goldratt demonstrated the importance of organizing management financial systems around the correct definition of "economic value-added." These new TVA terms simply place new labels on Goldratt's initial formulation in order to improve efficiency of communications. The new terms bring the reader's thinking more quickly into the financial arena. They remove the need to repeatedly clarify for many audiences that the term "throughput" is a financial and management accounting term and not a reference to the units of physical throughput of some machine, department or company. Throughput, financial throughput, TOC value-added, throughput value-added, and TVA are all different names for the same underlying flow of money.

TVA is the economic value available to satisfy legitimate demands of all the company's stakeholders, not just the shareholders. By contrast, the primary shortcoming of the EVA system is that it measures and emphasizes the wrong portion of value that is added, overemphasizing the claims of shareholders at the expense of effects which can be observed among customers, employees, and other stakeholders in the firm.


Making the Pie Bigger
A management system based around TVA makes the economic "pie" bigger, without interfering with -- and, in fact, supplying the funds for -- any reengineering or other programs to reduce relative or absolute asset or expense expenditure levels, as appropriate during the life cycles of a company, product or process. With the economic pie growing, these reductions in expenditure levels can be made while maintaining high levels of employment stability, without cutting corners on legal or other established obligations, and while gaining the economic, moral and societal respect advantages of satisfying the legitimate needs of all the company's established stakeholders.

The pie does not grow by itself. People must focus on it, plan it, do it and succeed in their efforts. To fail to focus every day on growing the pie is eventually to back the management team into the self-defeating corner of cost-cutting without growth, and to force them -- in order to appear as successes in their careers -- to persuade others that such cost-cutting is the hallmark of superior management. It isn't. Only cost-cutting within the context of growing the pie, and while delivering a reasonable degree of employment and operations stability, is superior management. Only by focusing a disproportionate amount of management attention on the economic value entity pointed to via the concept of TVA will get the right thing done.

TVA focus leads to effective balance in combined marketing, product development and expenditure control programs.

Build your management system around TVA, deal logically with operating expense and investment reduction as priorities two and three, and superior employment stability, loyalty, legitimacy, respect, return on investment and EVA will all come along in the process.


Scale of Importance Issues
The TOC scale of importance principle states that not all measurements are to be treated with equal priority.

The "throughput world" financial policies (I'll call them policies of the TVA financial system) state that protecting and increasing TVA should always be treated with higher priority than reducing investment or reducing operating expense. Cause-and-effect thinking processes and diagrams should be used to ensure investment and operating expense levels are understood at appropriate levels of detail. Investment and operating expense levels should be controlled and, where appropriate, reduced -- whenever such reduction activities don't interfere with efforts to increase current or future TVA. Reductions in the relative levels of operating expense and investment, as expressed by the ratios of operating expense to TVA (OE/TVA), and investment to TVA (I/TVA), should be aggressively pursued as additional desirable effects automatically coming from the programs to increase TVA.

Global (companywide) measures take priority over local (departmental or product) measures. Therefore, once the global TVA and operating expense are known for a specific manufacturing business plan or decision scenario, the effort to calculate allocation-based product costs is a waste of time that creates confusion and wrong decisions.

To be aware of cause-and-effect relationships affecting how consumption rates of staff (and other resources represented in period operating expense) vary with changing assumptions in the business plan is a good and important thing to do; to translate that awareness into allocations of overhead, to form a fictional math entity called allocation-based product cost, is a bad, wasteful and dangerous idea. A company can "know its costs" in excruciating detail and know exactly where it stands and is going economically -- without ever allocating a bit of overhead to form a single allocation-based "product cost." Think about that.

Where factory department efficiency and utilization measures conflict with maintaining and increasing global TVA, the global TVA must take priority.

In contrast to the competing activity-based and other allocation-based cost accounting systems, the TOC financial system is clear and persuasive to industrial employees ranging from factory machine operators to chief executive officers. It is easier to use, less prone to mistakes and less costly to administer.


TVA's Advantages Over EVA
With respect to the so-called "economic value added" (EVA) system, the TVA system's advantages include:

• a superior definition of "economic value added" (EVA is a subset of net profit, which is a subset of profit before taxes, which is a subset of direct margin, which is a subset of that expression of true economic value added -- TVA.)
• a more effective framework for accomplishing growth and maintenance of the company's revenues and cash flows
• a greater ability for inculcating loyalty, legitimacy and productivity in the employer/employee relationship via more logical workplaces and greater employment stability
• a greater ability to fund and balance activities which meet appropriate requirements of all established stakeholders
• greater comprehensiveness
• an avoidance of unnecessary and counter-productive conceptual and process complexity.

TOC Manufacturing Systems
Traditional planning systems are built around an implicit, but functionally very real assumption of infinite resource capacity in the departments of the company.

TOC manufacturing systems provide manufacturing companies and the professionals who serve them with a means for upgrading the traditional computing systems based on assumptions of infinite work center capacity [4, 6]. As public domain constraints-based computing concepts [7, 8] are adopted by an increasing number of systems vendors, they present manufacturing companies with an attractive menu of choices: the traditional "closed-loop" suite of systems, and a well-integrated generation of newer TOC manufacturing systems. Having both technologies "on the menu" enables manufacturers to set their own pace in migrating to public domain TOC finite capacity systems architectures, and to avoid the extensive semi-custom internal development and integration efforts which, in some plant environments, has been required to gain access to the benefits of TOC systems [6].

The TOC computing systems, as described in [7], were created to support the TVA emphasis of the TOC Financial Management System; in other words, to create the right solution to the long-standing problems presented by traditional management accounting. The breakthrough solutions in logistics control, scheduling and focusing of improvements were unavoidable and very valuable by-products invented along the way.


References

1 Goldratt, E.M., "The Goal: A Process of Ongoing Improvement," (1992, APICS bookstore item #03201).

 

2 Goldratt, E.M., "It's Not Luck," (1994, #03291).

 

3 McMullen, T.B., "Introduction to the Theory of Constraints (TOC)," (1997, #03521).

 

4 McMullen, T.B., TOC: The Infrastructure of Agile Manufacturing, "APICS 1996 Conference Proceedings," (#04018; Also included in #05021).

 

5 Goldratt, E.M., 1983. Cost Accounting: Public Enemy Number One of Productivity, "Selected Readings in Constraints Management," (1996, #05021).

 

6 McMullen, T.B., The Systems Industry is Giving MRP (and ERP) Implementors a Choice: Traditional and TOC Systems, "Selected Readings in Constraints Management," (1996, #05021).

 

7 Goldratt, E.M., "The Haystack Syndrome: Sifting Information from the Data Ocean," (#03125).

 

8 Stein, Robert, "Reengineering the Manufacturing System: Applying the Theory Of Constraints," (1996, #03480).

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