Introduction to
Theory of Constraints
Competitive Manufacturing
Management
Where it all began
• In 1984, Eli Goldratt wrote an international
best seller on operations management -- The
Goal. In this text, which was written in the
form of a novel, he outlined his views of
operations management -- specifically,
finite capacity scheduling.
• Since it was first published, he and others
have continued to expand the systems
thinking he laid out in The Goal.
Product P
$90/unit
100 units/week
Product Q
$100/unit
50 units/week
Resource D
15 min/unit
Resource D
5 min/unit
Purchased
Part
$5/unit
Weekly OE = $6000
1 each of resources A,
B, C, & D
2400 min/week
Resource C
10 min/unit
Resource C
5 min/unit
Resource B
15 min/unit
Resource A
15 min/unit
Resource B
15 min/unit
Resource A
10 min/unit
RM 1
$20/unit
RM 2
$20/unit
RM 3
$20/unit
Base Scenario
• What is the most profitable product mix?
• How much money can be made in 1 week
given the above information?
Base Scenario
• WC
•
A
•
B
•
C
•
D
P
1500
1500
1500
1500
Q
Required
500 2000
1500 3000
250 1750
250 1750
Avail
2400
2400
2400
2400
Base Scenario
•
•
•
•
•
•
•
P
Q
Selling price
$90
$100
Materials
-45
-40
Contribution
45
60
Total Direct labor 60 min.
50 min.
CM/DL min
$.75
$1.20
therefore make Q’s first, then P’s
Base Scenario
• If we make Q’s first then P’s, we can make
50 Q’s and then 60 P’s
•
P
Q
• CM
45
60
• make *60
*50
• Profit 2700 + 3000 = 5700
•
-6000 OE
•
-300 profit
Base Scenario
• If we make P’s first then Q’s, we can make
100 P’s and then 30 Q’s
•
P
Q
• CM
45
60
• make *100
*30
• Profit 4500 + 1800 = 6300
•
-6000 OE
•
+300 profit
Base Scenario
•
•
•
•
•
P
$90
-45
45
15 min.
Q
$100
-40
60
30
Selling price
Materials
Contribution
Total Constraint
labor min.
• CM/Con. min
$3.00
$2.00
• therefore make P’s first, then Q’s
Theory of Constraints
• The constraint determines Throughput (the
rate at which a company makes money
through sales.)
• An hour lost on the constraint is an hour lost
for the system.
• An hour saved on a non-constraint is a
mirage.
Five Focusing Steps of TOC
• Identify the constraint.
• Decide how to exploit the constraint
• Subordinate everything else to the decision
made in step 2.
• Elevate the constraint.
• If the constraint is broken in step 4, start
over and do not allow inertia to become a
constraint.
Alternate scenario 1: changes to
the base scenario
•
•
•
•
Your engineer is all kinds of excited and tells you that he has found a way to
modify one of the processes -- a process is a chain of work centers -- so that it
will take now take 21 minutes to to complete rather than 20 minutes AND it
will only cost $3000 to do it.
Should you fire the guy on the spot or allow him to finish his explanation?
If you haven't fired the engineer, he continues his explaination by telling you
that the middle process can be revised such that WC B can do the job in 14
minutes if WC C works an additional 2 minutes.
What would be the result of the revision in terms of product mix and weekly
profit? How long will it take to recover the investment?
Alternate scenario 2: changes to
the base scenario
•
Your marketing department has found an alternate market for your products in
Japan. The US and Japanese markets are perfectly segmented (i.e. the sales
price in one country will not affect the sales price in the other country). The
catch is that while the Japanese will buy P and Q in the same quantities as the
US they are only willing to pay 80% of the US price -- $72 for P and $80 for
Q. Additionally, you can purchase another B machine for $100,000. You will
need to hire another person to run it for $400/week which brings weekly
operating expenses to $6400.
•
•
Should you sell to the Japanese? What about product mix and weekly profit?
How long will it take to recover the investment in new machinery?
The PQ Problem
• Now we have already solved this problem
and know that the way to exploit the
constraint (resource B) is to make the “least
profitable” product first - 100 P’s and 30
Q’s yield a $300/week profit.
• This is true because we focus on and exploit
the constraint.
Product A
Product B
$50
Y
Product C
$50
6 min/unit
$5
Y
$55
8 min/unit
$10
Y
Product D
Y
$52
5 min/unit
$10
$5
Z
10 min/unit
$5
Z
$10
$5
20 min/unit
Y
10 min/unit
5 min/unit
Which Product Should be Made?
Product Price - Materials - Labor cost/unit =
PROFIT MARGIN
A
B
C
D
$50 - $20
50 - 25
55 - 25
52 - 20
- (36 min. X $10/hr) = $24.00
- (38 min. X 10/hr) = 18.67
- (35 min. X 10/hr) = 24.17
- (35 min. X 10/hr) = 26.17
The Accounting Perspective:
Product D
profit = revenue - material expense - labor expense
=($52 X 16u) - ($20 X 16u) - (2 wkrs X 8 hrs X $10)
= $352 / day
Your accountant would recommend making product
D for a daily profit of $352. If the firm makes only
product D, then in an 8 hour day, since 30 minutes
per product are required in work center Z, 16 units
(8 hours/30 minutes) can be reproduced.
The Marketing/Sales Perspective:
Product C
profit = revenue - material expense - labor expense
=($55 X 16u) - ($25 X 16u) - (2 wkrs X 8 hrs X $10)
= $320 / day
Marketing in many instances is measured by the
revenue generated and since product C generates
$55 per unit, it is the logical choice. Second,
salesmen commissions are generally based on a
percentage of selling price, C again is the logical
candidate.
The Operations Perspective:
Product B
profit = revenue - material expense - labor expense
=($50 X 24u) - ($25 X 24u) - (2 wkrs X 8 hrs X $10)
= $440 / day
From the plant manager’s point of view, product B
is the logical choice. It gives a 90% utilization of
work center Y and a 100 % utilization of work
center Z.
Traditional Performance
Measures: Limitations
• Standards and Variances, Direct Labor
productivity, and Machine Utilization place
emphasis on achieving goals in and of
themselves.
• Overhead Allocation by direct labor
investment is also inappropriate. When this
method was developed, DL comprised most
of a product’s cost; now the percentage is
usually less than 10%.
Traditional Performance
Measures: Limitations
• Traditional measures also tend to:
– ignore inventory status and lead time;
– be organized by functional silos;
– and, emphasize past and near-future (short-term)
results.
• Many of the tools and processes we have
discussed this term tend to increase (rather than
decrease) costs in the short-term, but the longterm benefits are undeniable.
Enlightened Measures:
Productivity
• Traditional measures tend to separate OH (IL)
and DL, causing managers to focus on DL
reduction. As world-class companies embrace
empowerment, etc., many IL duties are shifted to
DL employees.
Enlightened Measures:
Principles
• Competitive Focus
• Emphasis on Clear, Common Sense Measures
• Emphasis on Trends and Long-Term
Improvement
Aligning Functional Decisions
with Organizational Goals
• At the organizational level, companies use three
main types of measures: profitability, returns, and
solvency. Often companies use Net Profit, ROI,
and Cash Flow. All three should increase (or at
least not decrease.
• The impact of decisions made at lower levels in
the organization on these three measures is not
readily apparent, so companies use other
measures (e.g. commissions, utilizations, etc.)
Company President
Firm
Income Statement
Balance Sheet
Funds Flow Statement
Net Profit, ROI
Cash Flow
President
-net profit bonus
Plant Manager
Plant Profit and Loss
Statement
Purchasing Dept.
$ Saved
-volume discounts
-variances
-make vs. buy
Vendors
-quality
-cost
-delivery
Production Dept.
Utilization
Efficiency
Workers
-keep busy
-absenteeism
-grievances
-safety
Sales Dept. Manager
-revenues generated
Transportation Dept
$ Saved
-transportation
-warehousing
Truckers
-costs
- $ damaged
Salesmen
-commissions
Customer Satisfaction
-product
-price
-quality
-time
A simplified manufacturing organization chart illustrating the
performance measurement dilemma
Product A
Product B
$50
Y
Product C
$50
6 min/unit
$5
Y
$55
8 min/unit
$10
Y
Product D
Y
$52
5 min/unit
$10
$5
Z
10 min/unit
$5
Z
$10
$5
20 min/unit
Y
10 min/unit
5 min/unit
What We’ve Already Seen
• Accounting would choose to make Product D
yielding a profit of $352/day.
• Marketing and Sales would choose to make
Product C yielding a profit of $320/day.
• Operations would choose to make Product B
yielding a profit of $440/day.
What about Product A?
A
B
C
D
SP
50
50
55
52
RM
20
25
25
20
T
30
25
30
32
Z min
20
20
30
30
=T/CM 1.5
1.25
1.0
1.06
From a Theory of Constraints perspective,
Product A is best.
profit = revenue - material expense - labor expense
=($50 X 24u) - ($20 X 24u) - (2 wkrs X 8 hrs X $10)
= $560 / day
Throughput, Inventory and
Operating Expense
• Goldratt suggests three measures:
• Throughput - the rate at which a company makes
money through sales (Cash coming in should
increase)
• Inventory - all things purchased by the company
which might be resold (Cash going out should
decrease)
• Operating Expense - the money a company spends
turning Inventory into Throughput (Cash going
out should decrease)
How do T, I, and OE Relate to
Net Profit, ROI and Cash Flow?
• Net Profit = T - OE
– As T increases so does profit
– As OE decreases profit increases
• ROI = (T - OE) / I
– As T increases so does ROI
– As OE and/or I decreases ROI increases
• Cash Flow = T- I - OE
– As T increases so does Cash Flow
– As OE and/or I decreases Cash Flow increases
How do T, I, and OE Relate to
Net Profit, ROI and Cash Flow?
Net Profit
increase
ROI
increase
Cash Flow
increase
T
increase
I
decrease
OE
decrease
Prioritizing TIOE
•
•
•
•
First, increase Throughput.
Second, decrease Inventory.
Third, decrease Operating Expense.
This is the opposite of what most companies
will do.
• Two other TIOE measures:
– Throughput-dollar-days
– Inventory-dollar-days
Paradigm Shifts
• Cost accounting and T, I, OE are different
paradigms. You should be able to see the
world through both. You will certainly
encounter cost accounting where you work,
and you should know how to tell when it is
misleading.
A Setup Example
Resource V
20 min/unit
Resource U
20 min/unit
We could minimize total
setup time per week by
executing only one per week;
however W can make
444/week and U (or V) can
only make 120/week.
Inventory increases.
Or we could examine the
constraint(s) U & V. Forgetting
Resource W
Resource W setup time; what percent of the
5 min/unit
5 min/unit
time must W run to keep both U
(3 hour setup)
(3 hour setup) & V busy?
If the market will take all that we Since W only needs to run 50%
can make, how many units should of the time, the other 50% can be
spent in setup - run 3 hours then
Resource W run on each setup?
setup for 3 hours - 36 units.
Resource A
25 min/unit
Resource B
5 min/unit
A Make/Buy Example
Purchased part
$5/unit
Option 1: You could make the
part for 5 minutes of “A” time
and a $3/unit raw material.
The cost to make the part is
$4/unit.
This is your current process
(a greatly simplified
example). You have two
resources A & B. You
currently purchase a part
that costs $5/unit.
Option 2: You could make the
part for 15 minutes of “B” time
and a $4/unit raw material. The
cost to make the part is $7/unit.
Which is the better decision?
Resource A
25 min/unit
Make/Buy: Option 1
Resource A
5min/unit
Resource B
5 min/unit
Raw Material
$3/unit
Given that Resource A is the
constraint, the true cost to make must
include the impact on T -- which
would be lower. You would be better
off buying the part for $5/unit.
You could make the part for
5 minutes of “A” time and a
$3/unit raw material; given
that you pay workers
$12/hour, the cost to make
the part would be less than
the purchase price.
[Calculated as follows:
($12/hr * .083 hr + $3/unit)
= $4/unit to make].
Shouldn’t you make the
part?
Resource A
25 min/unit
Make/Buy: Option 2
Resource B
15 min/unit
Resource B
5 min/unit
Raw Material
$3/unit
Given that you are already paying
someone to man Resource B and it is
not the constraint, the only variable cost
to make is $4/unit of raw material. You
would be better off making the material
-- T would increase.
You could make the part for
15 minutes of “B” time and a
$4/unit raw material; however,
given that you pay workers
$12/hour, the cost to make the
part would be greater than the
purchase price. [Calculated as
follows: ($12/hr * .25 hr +
$4/unit) = $7/unit to make].
Shouldn’t you buy the part?
Constraint Management
• The constraint determines Throughput (the
rate at which a company makes money
through sales.)
• An hour lost on the constraint is an hour lost
for the system.
• An hour saved on a non-constraint is a
mirage.
How do we Exploit the
Constraint on the Shop Floor?
• We now know that the constraint must run
at 100% efficiency to make the most money.
• Question: Should the non-constraints be
required to run at 100% capacity?
• The answer is: NO! If non-constraint
resources run at 100% capacity, then WIP is
increased.
Drum-Buffer-Rope
• Production scheduling system following
TOC principles.
• It is a hybrid push/pull system.
• The purpose DBR is to exploit the
constraint.
The Drum
• The constraint determines the throughput of
a plant.
• If we have an internal resource constraint,
how do we maximize throughput?
– Manage the constraint closely.
• If the constraint has such a significant effect
on our operations, shouldn’t we consider it
when we prepare the master production
schedule (MPS)?
The Drum (con’t)
• The pace of the whole plant is determined
by the pace of the constraint
• Therefore, we base the MPS on maximizing
the constraint.
• Where do we want to minimize setups?
• We may want to try to group similar batches
on the constraint to save setups
• We can use lot-for-lot (LFL) on nonconstraints
Buffers
• We want to protect the throughput of the
system from inevitable variability
• Inventory is a form of buffer, as is time.
• Location of buffers is critical
– What points in the system need protection?
Buffers
1
2
3
Required processing time:
Scheduled lead time:
Shipping due date:
4
5
40 hours
40 hours
40 hours
What happens if an operation is disrupted?
Buffers (con’t.)
Let’s add 20 hours of safety inventory
as follows:
1
2
4 Hrs
3
4 Hrs
4
4 Hrs
5
4 Hrs
4 Hrs
What happens if there is a 10 hr. delay at Op. #1?
A 10 hr. delay at op. #5?
Buffers (con’t.)
A better way to arrange our 20 hours of safety
inventory might be:
1
2
3
4
5
20 Hrs
Now what happens if there is a 10 hr.
delay at Op. #5?
Buffers (con’t.)
What if operation #3 is a constraint and our
safety inventory is in front of shipping?
1
2
3
4
5
20 Hrs
If operation #3 is a constraint, a disruption at
operation #1 or #2 will reduce T for the system
Buffers (con’t.)
A better way to arrange our 20 hours of
safety inventory would be to protect both
the constraint and the shipping schedule:
1
2
3
10 Hrs
4
5
10 Hrs
The Rope
• The constraint acts as the Drum setting the
pace for the whole system
• Inventory Buffers protect the shipping
schedule and the constraint
• What else do we have to do to operate the
system?
– Have to tell everyone else what to do.
• Material release points and non-constraints
The Rope (con’t.)
• What do we have to tell material release
points?
• To ensure that material gets to the constraint
when needed, material release points need a
schedule of:
–
–
–
–
What material to release
The quantity to release
The time to release it
The Rope ties material release to the constraint
Other Control Points
•
•
•
•
•
Divergence points
Assembly points
These operators also need a detailed schedule.
What do we have to tell operators of non-constraints?
If material release points only release material at a rate
to keep the constraint busy, non-constraints will have
some idle time (no queues or short queues)
• => Operators of non-constraints just need to be told to
work on things as they come in, FCFS