Theory of Constraints (TOC)

Maximizing Throughput

The Theory of Constraints is an organizational change method that is focused on profit improvement. The central theme of TOC is that every organization must have at least one constraint. A constraint is any factor that limits the organization from getting more of whatever it strives for. At the production system, constraint is created by a process that limits the total output of the system. In non-manufacturing environment, the examples of constraints are market demand or a sales department’s ability to translate market demand into orders.

The Theory of Constraints defines a set of tools that change agents can use to manage constraints, thereby increasing profits. Most businesses can be viewed as a linked set of processes that transform inputs into saleable outputs. TOC conceptually models this system as a chain, and advocates the familiar adage that a "chain is only as strong as its weakest link."

The originator of TOC, Dr. Eliyahu M. Goldratt defines a five-step process that a change agent can use to strengthen the weakest link, or links. In the book “The Goal”, Goldratt proves that most organizations have very few true constraints. Since the focus only needs to be on the constraints, implementing TOC can result in substantial improvement without tying up a great deal of resources, with results after three months of effort.

Dr. Goldratt also provides a foundation for achieving change through TOC by defining a set of three essential measurements that drive the change process. He realized that conventional accounting systems do not support TOC, or lean-based efforts. Goldratt proposes replacing all traditional measures derived from the "product cost" accounting paradigm. The following measures are the only way to increase profit through TOC:

Throughput
The rate at which the entire organization generates money through sales for a product or service. Throughput represents all the money coming into an organization.

Inventory
All the money the organization invests in things it intends to sell. Inventory represents all the money tied-up inside an organization. Goldratt’s definition includes facilities, equipment, obsolete items, as well as raw material, work in process, and finished goods.

Operating Expense
Operating Expense is all the money an organization spends turning Inventory into Throughput. It represents the money going-out of the organization. Examples include direct labour, utilities, consumable supplies, and depreciation of assets. All three of these measures are interdependent. This means that a change in one will result in a change in one or more of the other two. Therefore, to improve your organization using TOC, you as the change agent would adhere to the following formula:

Maximize Throughput while Minimizing Inventory and Operating Expense

These measures are the key to relating local decisions to the performance of the entire system. Goldratt advocates that all improvement opportunities should be prioritized by their effect on the three measures, especially Throughput, for which the only limit on how high it can be increased is market size.