TOC Principles

The starting hypothesis of TOC is that any system must have a constraint that limits its output. If there were no constraint, system output would either rise indefinitely or go to zero. Therefore, a constraint limits any system with a nonzero output. Figure 8.1-1 shows that limiting the flow through any of the arrows can limit the total output of the system. The downward-pointing arrow identifies the system constraint. Sometimes it helps to think of the constraint in physical systems as a bottleneck, a constriction limiting flow through the system, as when a highway narrows down from three lanes to two. All organizations have a constraint that limits their ability to deliver projects. TOC provides a way to discover and use that constraint to improve the overall system throughput.

In What Is This Thing Called Theory of Constraints, Goldratt (1990) states, "Before we can deal with the improvement of any section of a system, we must first define the system's global goal; and the measurements that will enable us to judge the impact of any subsystem and any local decision, on this global goal."3

W. Edwards Deming noted in The New Economics for Industry, "We learned that optimization is a process of orchestrating the efforts of all components toward achievement of the stated aim."4

TOC poses the theory that for any value chain (at any time), only one constraint limits throughput. This is easier to see for a single project, where a project plan can have only one longest path (or, if more than one, they must be exactly the same length). The constraint may not be evident for a portfolio of projects. Even for a sin-

Figure 8.1-1 TOC Limits the Output of a System by a Constraint

Raw Material from Suppliers

System Throughput Limited by a Constraint

Production Functions

Products to

Customers gle project, the constraint (longest path) often seems to shift due to fluctuations in project activity performance. But at any time (with rare exception), only one path controls the actual time to complete the project.

Business accounting systems trace back to the turn of the twentieth century and aside from automation have changed little. (This is about twice the history of modern project management systems.) Their development includes assumptions (no longer listed) about the design of business enterprises. One significant assumption, for example, is to treat people as expenses rather than assets. Another is to treat work in progress as an asset rather than an expense.

At the turn of the twentieth century, big business (which defined cost accounting) consisted primarily of large production plants with very large capital investments, for example, resource industries, steel, railroads, and, a little later, automobile manufacturing. The large production plants cause large fixed cost. At that time, things were tough for labor: labor was a variable cost. It was mostly applied to unskilled jobs and therefore plentiful and easy to replace. Consequently, it was easy to vary the workforce with demand.

Today the skilled workforce is much less variable, and the traditional fixed costs are much less fixed. The concept of allocating costs to labor or products always requires many assumptions. These assumptions, often long forgotten, influence the business decisions made using the cost accounting practices.

TOC considers the focus on present accounting systems as cost world thinking, because it operates on the assumption that product cost is the primary way to understand value and make business decisions. Cost world thinking requires the allocation of many expenses to products through elaborate product cost schemes, such as activity-based costing. These schemes are full of assumptions and often lead to erroneous understanding and decisions.

TOC applies throughput world thinking, which focuses on flow and rests on three definitions:

Throughput(T): All of the money you make from selling your product (revenue minus raw material cost).

Inventory (Investment)(I): All of the money you have tied up in fixed assets to enable the throughput. A primary difference between TOC and conventional cost accounting is that TOC combines fixed assets (often called investment) and work-in-progress inventory into one category. This can cause confusion when we consider return on investment for a project. To align better with conventional terminology, this chapter will use the word investment for all of the money spent on a project.

Operating Expense (OE): All of the money spent to produce the throughput.

Major accounting authorities around the world have endorsed the TOC method, but TOC accounting has yet to cross the chasm into common terminology.

Throughput thinking focuses all decisions on the goal of the company: to make money now and in the future. All decisions and measures relate to the global goal. For example, in the cost world, managers measure operating efficiencies of local workstations. Financial people count inventory as a company asset. If they do not need workers to produce product for customer need, then they produce product for inventory, increasing efficiency to make themselves and their local plant look good. Unfortunately, the plant does not make money on inventory. Inventory costs money to make (raw materials) and to store, so it hurts cash flow and reduces disposable cash at the plant. Present accounting systems count inventory as a good thing (an asset), but it is bad for business. Earned value extends this thinking to projects, claiming value has been earned based on the estimated cost for work items. In reality, most projects are worth nothing (or have a negative value due to potential project terminations costs) until the project is complete and in operation.

An effective way to evaluate the meaning of the dilemma facing managers is to apply one of the thinking process tools invented by Goldratt: the evaporating cloud. Figure 8.1-2 illustrates the throughput world/cost world evaporating cloud. Block A represents

Figure 8.1-2 The Throughput World/Cost World Evaporating Cloud Exposes the Manager's Dilemma

Figure 8.1-2 The Throughput World/Cost World Evaporating Cloud Exposes the Manager's Dilemma

a common objective all managers share. Blocks B and C are requirements to achieve the objective. You read the cloud, "In order to manage properly, managers must control cost." You read the lower branch, "In order to manage properly, we must protect throughput." So far so good.

Focus on throughput requires understanding and controlling the whole system to optimize throughput. The most important effect of throughput world thinking is that it requires focus on throughput as the much preferred path to system improvement. Looking at how T, I, and OE affect net profit and return on investment leads to an immediate conclusion that T is the most important variable. Improvements in throughput are unbounded, while improvements in OE and I are limited (from the present value to zero).

Cost world thinking leads to a piecemeal view of each part of the production system. Costs add algebraically. The cost world leads to focus on OE. You can reduce OE in any part of the system, and the sum of the OE reductions adds up. This thinking leads to entity D, with the logic, "In order to control cost, managers have pressure to manage according to the cost world." Some ask, "Why hasn't everyone adopted throughput accounting and thinking?" TOC experts answer, "Inertia."

I have witnessed and read about many alleged cost savings improvements projects that purport to save cost through piecemeal cost reductions, including saving money by reducing parts of people. Of course, one can only reduce whole people, not parts, so it is no surprise that such proposals fail to achieve the intended return on the investment. One interesting example I reviewed recently was a several million dollar project performed by a company wishing to reduce printing and mailing cost. The idea was to make electronic forms accessible to many agencies throughout the country over the Internet versus purchasing them centrally and mailing them to the agencies. The project completed successfully in that it produced the electronic forms. There were even some who appreciated having the electronic forms available. However, there was no return on the investment, or, more correctly said, the return was negative. The cost to have forms printed centrally was usually a fraction of a cent per page. The cost of mailing was not saved because some material still had to be mailed to the agencies, and the additional forms not mailed did not reduce mailing expense or warehouse and printing expense. Worse, printing the forms in the field cost from ten to thirteen cents a page. This is one typical story, by no means exceptional.

Throughput reasoning extends to the conclusion that a system operating with each step at optimum efficiency cannot be an efficient system. Most people intuitively believe that operating each part of a system at maximum efficiency causes the system to operate at maximum efficiency. You can see that an optimum system has to feed the bottleneck at its capacity and process the downstream parts at the bottleneck's average processing rate. This means that, on average, every nonbottleneck process must operate at lower efficiency than the bottleneck in order to have reserve capacity to make up for fluctuations.

This understanding is a major reason that TOC is able to make such an immediate impact once people understand it. Managers design and operate most current systems without the critical understanding of TOC. They work to cut costs everywhere, including the capacity of the constraint (because they have not identified it). They work to improve efficiency everywhere, including workstations upstream of the constraint that may cause the constraint to work on things that do not translate to short-term throughput. Once they understand the theory, identify the constraint, and improve its throughput, the system throughput increases immediately.

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Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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