Saturday, September 17, 2011

Theory of Constraints - What is this thing called the Theory of Constraints?

Theory of Constraints

“There is Nothing as Practical as a Good Theory” – Kurt Lewin, 1952

What is the Theory of Constraints?

Focus! The core of the Theory of Constraints (TOC) is to focus correctly, on those few critical things that prevent your organization from achieving more of your goal.

In fact, one can identify a goal and two necessary conditions. The goal might be to make money now and more in the future. To do that a business must satisfy their clients* sufficiently (now and in the future) and at the same time their employees must also be sufficiently satisfied (now and in the future). Any one of these three can be the goal; the other two will always be necessary conditions that must be fulfilled!

If you look around your company there are many, many things that can be improved. Organisations use the Theory of Constraints to find which of the possible improvement activities will have the greatest impact on their chosen bottom line. Since Eli Goldratt’s first book ‘The Goal’ TOC has been used to make very significant improvements in many different areas, from production to health care, from project management to distribution, marketing and sales and many more.

Organizations, even those in deep (financial) difficulties find it very difficult to focus their energies on what really counts. Managers and people act but base their actions on erroneous assumptions or paradigms – will these actions really have an impact on the bottom line. A lot of good work gets done, but too little of the effort finds its way to a significant bottom line effect.

To focus an organisation is not easy. Organisations are broken down into departments or divisions and every one of these departments has a target to improve – sales to increase revenues, production to minimize cost (and investment) etc. Management’s working assumption seems to be - if every part of the company is optimal, then the entire organisation will also be optimal. This is never so. An action by the sales organisation can very easily disrupt the factory’s efforts to minimize cost and inventories. Actions in production and the supply chain can easily cancel good sales efforts.

Optimizing all the parts does not result in a global optimum because a business lives in a World of high uncertainty coupled with many dependent events necessary to produce a product or service. The two factors ensure a local optimum can only be achieved in one (or a very few) place(s). Focus must determine where this place is and how it should be exploited.

This leads to the Five Focusing Steps of TOC.

1. Identify the constraint. In the economic environment of 2009 it is quite easy to determine that there is not enough demand from our markets. Businesses need to sell more to be profitable and to have satisfied employees. In many businesses there is something blocking clients from buying more. That something could be customer demand, but it can also be our company not doing things it should be doing or doing things it should not be doing. It is too easy to place the blame on the financial crisis.

2. Decide how to exploit the constraint. This simply asks the question – ‘what should we do in order to maximize the constraint’s performance?’ In today’s World, what would cause clients to buy much more from our company? To what should we change our offering so that our clients (and potential clients) buy much more from us? To lower prices is not the answer!

3. Subordinate everything else to the above decision. This is a difficult step. It says that all resources other than the constraining resource must subordinate (often to sub-optimize their operations) in order to get the absolutely maximum from the constraint. If every department is charged with optimizing their part, then other departments cannot support the constraint properly. The business as a whole will suffer, and consequently so will employees and clients.

4. Elevate the constraint. If the first three steps have been successfully implemented the organisation may find that the constraint has still not been removed. If this is the case, then the time has come to expand the constraint’s capacity. These first four steps help prevent unnecessary investment and when an investment is made it will be done in the correct place.

5. Go back to step 1. BUT do not let your own inertia become the system’s constraint!

The Mafia (or Un-Refusable) Offer

In most industries all competitors are more or less equal – products and service are so equal that significant market share swings do not happen – at least not very often**. Since many industries are well established there is also relatively little market growth. The only way for a business to grow rapidly and at a significantly higher rate than its competitors is through some sort of decisive competitive advantage and therefore market share gains.

While a fantastic new product is always possible, in many industries these are unusual and if they are possible they take a long time to develop and many times they can also easily be emulated. Fortunately products are not everything your clients desire or need. Clients have business problems of their own and, if your offering can solve or significantly reduce your client’s key business problems, then it is possible to achieve a decisive competitive advantage.

A Mafia Offer must meet the following criteria to succeed:

  1. The market must perceive that the value of the company’s products and services (the offering) are sufficiently high.
  2. To be sufficiently high the perceived value of the company’s offering must be much higher than that of any competitor’s offering.
  3. The actions taken to achieve the necessary advantage must be difficult for competitors to copy.
  4. The targeted market(s) must be far larger than the company’s capacity.

This seems to be a very tall order – something almost impossible to achieve. However tools (logical cause-effect-cause analysis) exist to analyse markets in order to discover what a supplier could change to achieve an offering that fulfils the above four points. Generic Mafia Offer templates have been developed and implemented for some typical business issues as product availability, shorter reliable lead-times and others. These have to be adapted to specific environments.

Examples of possible Mafia Offers:

Product availability: Clients want a product when they need it - immediately. Distributors and clients often have to deal with unreliable supply because their own forecasts are poor, replenishment lead-times are (often) too long and suppliers are often not reliable enough. To secure supply, distributors and clients hold too much stock – their investment in materials and components is too high and from time to time they still cannot get what they need.

Would distributors and clients buy more from a company if products were always available when needed? If the supplier guarantees availability with a penalty and he lives by his promise wouldn’t clients prefer him to others? If penalties were high enough, would competitors dare to copy the offering?

New Product Development: Most businesses develop new products continuously – technologies advance. If a business achieves the capability to deliver more new developments in a shorter space of time to much more reliable due dates and without having to add additional resources***  - would such a company gain a significant advantage over its competitors? There are an increasing number of companies achieving such an advantage.

These are just two (unsubstantiated) examples that could lead to a significant competitive advantage. There are more and probably many others yet to be developed

Why are these Scenarios Possible?

We are all programmed to believe that, “A resource standing idle is a major waste.” If a resource is not working, a manager will make sure that it has something to do. Employees also feel the same pressure – with little to do they feel they may not be needed and look for more work. There is the added pressure of, ‘the sooner we start, the sooner we will finish’. Many things are started far too early resulting in significant traffic jams in production and project environments.

Little’s Law****  proved that the flow of goods is much faster when there is LESS work in process (WIP). Our experience tells us that with less work in process, a factory will get shorter lead times and is able to produce at least as much as it did with high amounts of WIP. In many factories one can easily cut lead-times in half by cutting WIP by the same amount. Cutting lead-times can lead to a significant competitive advantage. However the suggested change goes against common practice and is often difficult for production management to accept!

In projects the situation is not much different. Project times can be cut by 25% while due date performance increases to about 90% while any late project is much less late.

Cutting work in process is just one simple tactic. There are several more that enhance these results. Several of them fly in the face of common practice*****  – but they are just common sense.

Why are such Solutions Difficult to Copy?

The simple explanation is that the changes necessary, while they are very much common sense, go almost 100% in the opposite direction to common practice.

It is usually very difficult for a production manager to accept to have some of his resources standing idle. It goes so much against the grain that competitors will not copy changes such as those suggested above – at least it will take quite a long time until they do. Offering high enough penalties increases the hurdle for competitors.

The Impact

The current economic crisis has forced many companies to resort to short workweeks. This practice is a transfer of funds from employees and the population as a whole to support companies in difficulty. The cost of such operations must be repaid sometime in the future and will be borne by the country, through higher taxes (or inflation) or by postponing other needed expenditures – for education, infrastructure, healthcare etc.

If what has been indicated is true, then companies could weather the storm of many economic crises without having to resort to short workweeks or the reduction of their workforce. They will have prepared for such an event by their focus on those few but essential things rather than trying to improve everything. A company can soften the blow by finding those effective strategies and tactics that give it a decisive competitive advantage.

*Clients include those to whom products are sold plus the other external stakeholders like the social, political and physical environment.

** A competitor with a significant competitive advantage must gain market share rapidly – at least until the other competitors have caught up.

*** And the quality of the development work does not suffer!

**** John Little is a professor at MIT, USA http://web.mit.edu/sgraves/www/papers/Little's Law-Published.pdf

*****  Lean and 6-sigma are two commonly used improvement methodologies. What we are proposing here is a focusing technique that together with Lean and 6-Sigma makes them far more powerful. The combination of the Theory of Constraints, Lean and 6-Sigma has been shown to be far more powerful than any one on its own.

Goldratt's book "What is This Thing Called Theory of Constraints and How Should It Be Implemented?" is available at Amazon and other bookstores.

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