Chapter 10: Miscellaneous Topics - Methodologies

THEORY OF CONSTRAINTS (TOC)

Every organization that wishes to achieve significant improvement with modest capital investment must address five critical questions:

1. What are the key areas within the organization for competitive improvement?

2. What are the key technologies and techniques that will improve these key competitive areas at least cost to the organization?

3. How do these improvement and investment opportunities relate (i.e., how can they be applied in an integrated, supportive and logical manner)?

4. In what sequence should these opportunities be addressed?

5. What are the real financial benefits going to be?

Certainly, many other questions must be dealt with, but these are the five issues that frequently cause the most difficulty in industrial and business planning today. So, how can the theory of constraints (TOC) help? Before we answer this, let us examine the fundamental concepts of TOC.

THE GOAL

The fundamental goal of any for-profit organization is to make money. In fact, practical experience tells us that the owners /shareholders of such organizations demand this end result performance. However, is this definition of the goal complete? The notion of continuous or ongoing improvement has proven to be extremely powerful in all aspects of life. Therefore, does the application of this notion to our definition of the goal have any important impact? Most organizations strive to improve their money-making performance year after year. So, the goal is really to make more money now and in the future. In this manner, it is impossible to make short-term decisions that bolster short-term profitability while compromising longer- term profitability without violating our goal definition.

If the owners are responsible for determining the goal of the organization, what is the role of management? Clearly, management must develop strategies and tactics that are appropriate for achieving the goal. Unlike the goal, these strategies and tactics must be flexible and responsive to changing conditions. The goal of for-profit organizations has been the same for over 1000 years and shows all indications that it will continue in good health.

Now, before an organization can develop its own customized strategies and tactics, it must first address at least one prerequisite. How would the management team of an organization know whether a particular strategy or tactic was effective (i.e., contributed to making more money)? Some set of measures would have to be used to gauge the degree of success. As a matter of fact, the implementation of a few strategic and/or tactical candidates may not be measurable. These candidates would likely not be selected for actual implementation. So, what should be the high-level measures that lead us to understand the impact of our strategic and tactical efforts on our goal?

STRATEGIC MEASURES

For TOC, three measures have become the pillars of the methodology. They are:

1. Throughput (T) ” The net rate at which the organization generates and contributes new money, primarily through sales.

2. Investment (I) ” The money the organization spends on "stuff," short-and long-term assets, which can ultimately be converted into T.

3. Operating Expense (OE) ” The money the organization spends converting I into T.

What do we really mean by these strategic measures, starting with T? T implies that no one within the organization can get a "gold star" or rest easy until the product has been sold. Simply designing or producing the product is not enough. Instead, for anyone 's efforts to count toward the generation of new money, products must not be just designed and produced but sold as well. Therefore, we are not going to allow elements of the organization to play output performance games . No longer will we allow elements of the organization to hide behind inventory profits.

With regard to I, TOC combines all the materials (e.g., short-term asset investments in raw materials, work-in-process materials, and unsold finished goods materials) captured within the organization, together with the traditional capital assets (e.g., plant, equipment, land) of the organization. It is easy to visualize how materials are converted into T, but how can these traditional capital assets of the organization be converted into T? The 1980s were known as the decade of acquisitions and takeovers. During this period, many owners sold portions of companies (e.g., plants, divisions) to someone else in return for money. In their eyes, they converted specific capital assets into T.

OE seems to possess a similar composition. In OE, we have traditionally thrown direct labor expenses, indirect labor expenses, overhead expenses, sales expenses, and general and administrative expenses into one big pot. Why? We have noticed that over the past 20 or 30 years, the direct correlation between the level of total operating expense of a typical organization versus the level of business it enjoys has gradually eroded. In fact, today it is not uncommon to find organizations whose level of business can fluctuate greatly upwards or downwards, while their true "out-of-pocket" operating expense spending hardly budges. Thus, many expenses that we traditionally view as variable (i.e., proportional to level of business activity) are no longer proportional to level of business activity.

NET PROFIT, RETURN ON INVESTMENT, AND PRODUCTIVITY

At this point, it is not unreasonable to ask the question: "How do T, I, and OE provide clear indications of the impact of our actions on the goal?" Before we can directly answer that question, we should examine T a little more closely. What did we mean in our definition of T, "new money generated and contributed primarily through sales?" Is T simply equal to sales revenue generated for each time period? If you were the proprietor of a small business, say, a dry cleaner, you would not pay yourself a monthly salary. Rather, you would pay yourself in accordance with what money was left at the end of the month after all your expenses were paid (e.g., labor, insurance, raw materials suppliers).

As a small business proprietor, you may encounter periods of time where business is so bad that you not only do not make a profit (i.e., no money left over at the end of the month to pay yourself), but you do not have enough money to pay all your expenses. What do you do? Well, you probably carefully ration the money you did generate that month. Which expenses will you pay first? Normally, you are not excited about the prospect of asking your suppliers to wait for their payments. If presented with this situation, they may elect to no longer service you. So, you will probably pay them first.

It is interesting to notice that the types of expenses that you would pay first are directly proportional to the level of your business. In other words, the quantity of raw materials and component parts you purchase from your suppliers, together with the level of subcontracting services you buy from your subcontractors , go up when business levels go up and vice versa. Expenses that clearly demonstrate variability proportional to level of business activity can be thought of as the true variable expenses.

Once you have paid these true expenses from the money your business generated through sales, you can use the money left to cover your own internal recurring and fixed operating expenses. Therefore, the money left after all these expenses are covered is contributed back to the company to cover its OE. Anything left over at this point is pre-tax net profit. In summary:

T = sales - true variable expenses (TVE)

Net profit (NP) = T - OE

The net profit generated per period in relation to the total investment base of the company employed is an important relative measure. This relative measure is frequently thought of as return on investment and can be summarized as follows :

Return on Investment (ROI) = NP/I = (T - OE ) / I

Finally, how could we strategically measure the productivity of the organization? The traditional definition of productivity compares the value of the output generated to the money spent in the generation process. From the T, I, and OE perspective, this would lead us to the following conclusion:

Productivity = T/ OE

In other words, the productivity of the organization can be described as simply the T dollars generated for each OE dollar spent.

MEASUREMENT FOCUS

It has often been said that if you focus on everything, you will end up focusing on nothing. So in this context, which of the three strategic measures (T, I, or OE ) should an organization focus its improvement efforts on? Before we answer this question, it may be helpful to determine which measure typical organizations traditionally have focused on. It is our experience that traditional focus is on OE . Why? Here are some popular reasons:

• OE is perceived to be the easiest to control.

• It is thought that OE changes can be made quickly.

• OE is where all of our "people" costs reside.

• Productivity improvement justifications usually focus on OE reduction.

• Traditional product costs are partially derived by allocating OE to the per product level.

Now that we have a perspective as to why conventional improvement efforts are commonly focused on OE, is this the proper focal point for the modern, lean, quick-response enterprise? In order to answer this question, we should first examine the desired improvement trends for T, I, and OE from the perspective of long-term continual improvement:

From this perspective, reducing I and OE while increasing T would have positive impact on NP and ROI. However, how far can we go in our efforts to reduce I and OE ? From a pure academic perspective, our I and OE improvement efforts are bound by zero, and in reality, we cannot go below some non-zero threshold without driving the enterprise out of business. Also, each step we take closer to our I and OE practical reduction limits, the more energy, effort, resources, and time it usually takes to generate real financial benefits. In other words, long-term I- and OE -focused reduction efforts are prone to the laws of diminishing returns.

On the other hand, T appears to have no obstacle in the path of its long-term continual improvement. Thus, it would appear that over the long term, our improvement efforts should be focused primarily on T. Now, does this imply that I and OE are unimportant? Of course not. First, the net profit and ROI relationships rely heavily on I and OE . Therefore, we cannot implement any T improvement opportunity without first understanding its impact on I, OE, and therefore, net profit and ROI. Second, obvious opportunities for real and meaningful I and OE reduction should always be pursued. However, this also implies that our efforts to identify improvement opportunities will not be preoccupied by I and OE. Rather, we will marshal and focus our efforts on identifying and implementing T improvement opportunities.

Now, what is the implication of shifting continual improvement focus from the traditional OE perspective to the more modern perspective of T? Another analogy may aid our investigation. Assume you can go to your local optician and purchase a pair of "OE" glasses. When you get back to your company and put these glasses on, you are able to clearly, easily, and rapidly identify and prioritize opportunities for OE reduction, and as a result, you amass a list of OE reduction projects (A, B, C, D, and E). A few days later, you return to that same optician and purchase a pair of "T" prescription glasses. Upon returning to your company, you put on your new T glasses and are able to clearly, easily, and rapidly identify and prioritize opportunities for increasing T. Using your instincts , do you think the list of T projects would be the same or different from OE reduction project list? Over the past five years and thousands of respondents, the answer has unanimously been "different." In other words, our instincts tell us that perspective is critical in guiding continual improvement efforts. Therefore, viewing the organization "through the eyes of T" may be the most effective method of driving continual improvement within the modern, lean, quick-response enterprise.

THROUGHPUT VERSUS COST WORLD

A great deal of attention has been paid to the comparison between cost world and throughput world decision making. Let us take time to simply examine this relationship from the perspective of strategic or organization-wide productivity (T/ OE ).

Generally, the traditional focus on OE reduction generates a consistent degradation in T. However, the rate of OE reduction is greater than the resulting rate of T decrease, thus leading to a misleading improvement in productivity. Obviously, this false sense of security and improvement cannot be sustained for a prolonged period of time. In addition, most organizations are capable of maintaining productivity levels even in the midst of significant T losses. These are classic symptoms of what has become known as the death spiral.

On the other hand, in the situation where throughput world T, OE, and T/ OE condition in which T will typically increase steadily while OE increases at a slower rate or is held constant, the result is increased organization-wide productivity performance. The attention is clearly being paid to increasing T, even if OE must be increased as well. The best financial arbitrator of such improvement options is incremental ROI.

OBSTACLES TO MOVING INTO THE THROUGHPUT WORLD

When information is passed from the bottom of the organization to the top, it rarely gets there without significant interpretation and summarization along the way. Some may even say that information rarely gets to the top of the organization without distortion. Likewise, as policies flow down the organization from the top to each lower level, rarely are these policies not interpreted prior to their implementation.

This distortion, some may say, also occurs to policies as they cascade down the organization. Why does this distortion occur? Usually, individuals and departments at each level of the organization's pyramid will interpret information flowing up or policies cascading down to their own best advantage. So, what perspective or framework do they use in determining how to perform this interpretive process? There is an old saying that goes, "Tell me how you will measure me, and I will tell you how I will behave." Therefore, the manner in which each group within the organization is measured directly impacts that group 's actions.

To see how this phenomenon occurs, let us examine a hypothetical organization with sales, finance, manufacturing, product development (PD), and quality departments within that organization:

Typical measurable characteristics are:

Finance

• Cash flow management

• Return on assets

• Return on investment

Sales

• Volumes

Product development

• Development budgets

• Development schedules

Quality

• Defect rates

• Returns

• Scrap rates

• Warrantee claims

Manufacturing

• On-time delivery

What do you notice about these individual department or local measures? First, many of them exist. Second, they are all different. But there is something else. Let us say that I manage manufacturing and my on-time delivery is getting worse . Such local measures as on-time delivery are important to me; they are like my professional report card. So I conclude that in order for me to improve my local measure, I need to add production capacity by purchasing and installing a new piece of equipment.

However, when I take my recommendation to the finance people, they veto the proposal not because they are inherently nasty people, but because the proposal will make their return on assets local measures worse. So I rethink my strategy and conclude that I could improve on-time delivery by simply speeding up my production equipment. However, when I do that, the quality manager reacts negatively, to say the least, because the defect rate local measure gets worse. It appears that frequently my efforts to improve those measures for which I am held accountable hurt other local measures for which others in the organization are held accountable. In other words, our traditional local measures are frequently in conflict with one another.

In the quick response, lean, modern organization, can such a fundamental conflict be allowed to continue? Most believe it cannot. Can we overcome this situation? The simplest solution would be to measure all departments and functions with the same measures. What measures come to mind first? How about T, I, and OE ?

Of these fundamental measures, which should take precedence within the quick-response, lean, modern enterprise? We concluded earlier that T provided the best perspective regarding continual improvement. Therefore, we are not suggesting that we treat each department within the enterprise as an enterprise unto itself focusing on its own T. Instead, we are suggesting that "each local area be measured on its effort and how those efforts contribute directly to improving the global T of the entire enterprise."

THE FOUNDATION ELEMENTS OF TOC

When we view organizational opportunities for improvement through the eyes of T, we are really asking ourselves a simple question, "What limits our ability to improve the T of our organization?" This simple question leads quickly to the conclusion that the typical organization is nothing more than a system composed of tightly interlinked or interdependent subsystem components (e.g., departments and functions). A common analogy describing a system is that of a chain. Each link in the chain represents individual organization departments and/or functions. Each department is dependent upon the succeeding and preceding departments or links. The overall performance of the chain is usually described in terms of tensile strength. Therefore, when the question, "What limits our ability to improve the overall performance of the chain?" is asked, the answer becomes obvious: its weakest link.

The concept of an organization as a collection of interdependent subsystem components whose improved performance is based upon its single weakest link is fundamental to systems thinking and is critical to our effort to view the organization through the eyes of T. TOC calls the organization's weakest link its constraint. The organization's constraint is that element of the organization that limits its ability to improve performance relative to T.

Therefore, the two fundamental concepts of TOC are:

1. View the organization through the eyes of T.

2. Develop a common performance measurement system derived from T.

These two elements are related to design for the six sigma (DFSS) methodology because:

1. Design engineering knows the critical features of the products that are processed through the specific manufacturing process A.

2. Manufacturing engineering knows the critical manufacturing process steps performed by the specific manufacturing process A.

3. Integrating the above two insights (the essence of DFSS) frequently allows the joint design/manufacturing engineering team to offload a few non-critical process steps now performed by process A to some other non-constraint manufacturing process such as process B.

THE THEORY OF NON-CONSTRAINTS

Most managers in their everyday life quantify their daily projects in the following prioritization scheme:

• Tier I ” most important projects to a particular department

• Tier II ” moderately important projects taking priority after Tier I projects

• Tier III ” low-priority projects that are scheduled but rarely addressed

First, let us examine how these lists would be constructed from the traditional management perspective. What type of projects would make it into Tier I for manufacturing process (MP) #1 department? Obviously, process improvement projects focused primarily, if not exclusively, at MP #1 department. How about MP #3 department? The same. And MP #5, #6, and so on? The same. By looking at the organization's various lists of Tier I process improvement projects, can we determine where the leverage point of the organization is located? Can we determine what the organization's key improvement thrust is? No! In fact many, many different issues are key to the organization. It appears that the organization is focusing on everything.

Now, from the T perspective, what type of projects would make it into Tier I for MP #1 department? Obviously, process improvement projects focused primarily, if not exclusively, at MP #4 department. How about MP #3 department? The emphasis is also focused primarily on process improvement projects at MP #4 department. And for MP #5, #6, and so on? The same. By looking at the organization's various lists of Tier I process improvement projects, can we determine where the leverage point of the organization is located? Can we determine what the organization's key improvement thrust is? Yes! In fact, it appears that the organization has been able to synchronize the process improvement efforts of all of its non-constraint resources from the T perspective.

If any logistical system's T performance is limited by its constraint resource and there can only be one constraint resource within a system at a single point in time, then the rest of the organization's resources must be non-constraints. Therefore, in terms of sheer numbers , non-constraints dominate the organization. From this perspective coupled with the Tier I process improvement example above, we have discovered that we may have made a mistake naming this methodology the theory of constraints. In reality TOC is not primarily about the poor overworked people in the constraint department. TOC is not primarily about whether the constraint people can invent a 25th hour in the day or an eighth day in the week. Rather, one of the most powerful elements of TOC is the synchronization of the organization's non-constraints so as to improve the T performance of the entire system.

THE FIVE-STEP FRAMEWORK OF TOC

A great deal of ground has been covered in this section. Let us summarize the lessons derived in this section by listing the five-step implementation process known as The Five-Step Framework of the Theory of Constraints (TOC):

1. Identify the organization's constraint.

2. Develop plans to exploit the organization's constraint (e.g., squeeze out as much T performance improvement as possible from the existing constraint resource).

3. Subordinate the actions of non-constraint resources to the implementation of step #2 (e.g., ensure that all non-constraint functions support and are synchronized in the implementation efforts of #2).

4. Elevate the organization's constraint (e.g., augment the constraint).

5. Once the constraint has been broken, go back to Step #1, but beware of organizational inertia (e.g., be sure to clearly communicate to the entire organization that it is time to search for the next constraint).

This common-sense process of improvement is neither complex to understand nor difficult to implement. In fact, practical implementation experience tells us that TOC logically integrates many of the traditional tools in the improvement toolbox in an effort to improve the T performance of the entire organization. Such tools as 8D, design of experiments, and work team now become more effective in their application when used through the eyes of T.

Finally, the power of TOC in the DFSS process is the understanding of constraint and the action that must be taken to remove the constraint. In essence, TOC is a viable methodology to eliminate the hidden factory from a design perspective.