My blog is focused primarily on the Theory of Constraints and how to use it to maximize the profitability of any company. I also discuss why integrating TOC with Lean and Six Sigma is the most dynamic improvement methodology available today.
I have had several requests to write a blog on the integration of
the Theory of Constraints, Lean and Six Sigma.In our book, Epiphanized,
Bruce Nelson prepared an excellent piece of writing in Appendix 1, so I thought
what better than to post much of what Bruce wrote in our book.The next several postings then will be
excerpts from Appendix 1 of Epiphanized.
Appendix 1:Theory of Constraints
(TOC), Lean and Six Sigma (TLS)
Over the past century there have been abundant attempts to improve
the quality of both products and services throughout the world and many
different people have contributed to this improvement movement and the body of
knowledge associated with it. If you take a moment and look back through the
years, the list of improvement ideas and acronyms would fill several pages. If
it is true that the past helps predict the future, then there will be many more
new ideas come into existence.
Currently, three principal improvement methodologies—the Theory
of Constraints (TOC), Lean, and Six Sigma—appear to dominate the subject matter
of the improvement world, and each brings its own unique perspective to the
improvement playing field. Each also has its own following of zealots and
believers. And each proclaims that their single method is the way forward,
providing the light and the truth, so to speak. It’s almost as if each
methodology is a religious experience of sorts. But does it really have to be
this way? Is there a benefit in keeping these methods separate and apart from
each other? Does each methodology have to exist in isolation from the others?
Let’s look at each methodology in a bit more detail to see if we can answer
Theory of Constraints (TOC)
In the early 1980’s Dr. Eliyahu
Goldratt introduced the world to a new way of looking at profitability through
his now famous Theory of Constraints (TOC), which was presented in his book The
Goal. In principle, Goldratt’s argued that instead of trying to save
money through cost reductions, companies would be much more profitable if
they focused instead on making money. But aren’t the two ideas
synonymous? The answer is—absolutely not! These two ideas represent very
different and divergent approaches. Saving money is not the same as making
money. And the management strategy you choose to employ to make money is very
different than the one you employ to save money.
Goldratt’s emphasis is
that the goal of for-profit companies is to make money now and in the future.
Goldratt analogized this concept using a chain. He stated that the weakest link
in a chain controls the overall strength of the chain, and that any attempt to
strengthen any link other than the weakest one will do nothing to improve the
total strength of the chain. Organizationally this means that every action or
decision taken by the organization must be judged by its impact on the
organization’s overall goal of making money. If the decision does not get you
closer to that goal, then the decision is probably ineffective.
Goldratt defined a system
constraint as anything that limits the system from achieving higher
performance relative to its goal. So if the goal of the organization is to make
money, then the systems constraint must be identified first. Goldratt
explained that in order to determine whether an organization is moving toward
its goal and not away from it, three simple questions must be asked and
1. How much money does your organization
2. How much money does your organization
3. How much money does your organization
spend to make it operate?
From his research Goldratt
developed his own simplified system of accounting that he referred to as
Throughput Accounting (TA). The basis for Goldratt’s accounting system were
three financially based, performance metrics:
This is the rate that the organization generates “new” money primarily through
sales. Goldratt further defined T as the money collected through the sale of a
unit of product minus what it pays to its suppliers and others—or Totally Variable
Costs (TVC). Therefore, T = Selling price minus Totally Variable Costs, or T =
SP – TVC. The bulk of the TVC would be raw materials, but could include any
sales commissions and shipping costs associated with products.
The money an organization invests in items that it intends to sell. This
category would include inventory, both raw materials and finished goods.
Operating Expense (OE):
All the money an organization spends to operate, including labor costs, office
supplies, employee benefits, phone bill, and electric bill and so on. All the
money spent to support the organization. What distinguishes Goldratt’s
definition of throughput from the traditional definition is that throughput is
not considered to be valuable until money exchanges hands between the
organization and its customers. At any point in time before the sale the
product is still considered Inventory, even in a finished goods status.
Basically, any product that is produced and not sold to a customer is simply
termed Inventory or Investment and it has a cost associated with it. This is a
major departure from the traditional definition of throughput, and its overall
implications are far reaching.
Goldratt expanded his TA definitions still
further by defining net profit and return on investment as follows:
• Net Profit (NP) = Throughput
minus Operating Expense or NP = T – OE
• Return on Investment (ROI) =
(Throughput minus Operating Expense divided by Investment or ROI = (T – OE)/I. With these three simple measurements (T, I and
OE), organizations are able to determine the immediate impact of their actions
and decisions on the financial performance of their organization. Does it make
sense that the superlative actions upon the system are those that increase T,
while simultaneously reducing I and OE? You might wonder why a discussion of
TOC started first with a financial definition. The relevance should become
The Theory of Constraints
operates under what Goldratt refers to as his Five Focusing Steps:
Step 1: Identify the
system constraint. The constraint is commonly considered anything within a system
that limits the system from achieving higher performance relative to its goal.
Step 2: Decide how to
exploit the System Constraint. Exploitation implies getting more from what you already have. It
requires that you understand why you are currently getting what you are getting,
and what steps are necessary to maximize the throughput of the constraint. How
do you get more from this constraining operation?
Step 3: Subordinate
everything else to the System Constraint. The subordination implies that all other
non-constraint processes activate to the same level as the constraint. It
seems contrary to popular belief, but sometimes in order to go faster, you have
to go slower.
Step 4: If necessary,
elevate the system constraint. Elevation implies more constraint capacity or resources, if the
market demand on the system still exceeds current capacity. At this point, it
may be required to spend some money to increase throughput—but only during Step
4 and not during Step 2.
Step 5: Return to step 1. When the constraint has
rolled (moved) to a new location in the system, then go back to Step 1 and
follow the sequence again.
So, you may be wondering why
these Five Focusing Steps are important to someone who uses Lean, Six Sigma or
the hybrid, Lean-Sigma. The facts are simple— without the understanding of the global
system focus provided by TOC, many of the Lean and Six Sigma initiatives will
fail to deliver significant bottom line improvement. The fundamental key to
impacting the bottom line is directly proportional to the company’s ability to
drive throughput to higher levels while at the same time reducing Inventory and
Operating Expense. The concept here is driving the system to make money, rather
than saving money. Think about it, if your financial model is based upon how
much cost you can remove from a process (reducing OE) then, your ROI has a
mathematical limit. Likewise, if your focus is only on reducing Inventory, it
too has a functional and mathematical lower limit. Throughput, on the other
hand, is devoid of a theoretical upper limit. Ponder, just for a moment, the
overall impact of simultaneously increasing T while reducing OE and I. The
crucial focus of increasing T is what drives NP and ROI!
In my nest posting we’ll discuss
the other two components of this trilogy…Lean and Six Sigma and then talk about
why they work so well together.