THEORY OF CONSTRAINTS

PREPARED BY :ARSHIA

THEORY OF CONSTRAINTS
THE THEORY OF CONSTRAINTS (TOC) DESCRIBES METHODS TO MAXIMIZE OPERATING INCOME WHEN FACED WITH SOME BOTTLENECK AND SOME NON BOTTLENECK OPERATIONS.THE TOC DEFINES THREE MEASURES :1) THROUGHPUT CONTRIBUTION EQUALS REVENUES MINUS THE DIRECT MATERIAL COST OF THE GOODS SOLD. 2) INVESTMENT EQUAL THE SUM OF MATERIAL COST IN DIRECT MATERIALS , WORK-IN-PROCESS AND FINISHED GOODS INVENTORIES,R &D COSTS, COST OF EQUIPMENT AND BUILDINGS 3)OPERATING COSTS EQUAL ALL COSTS OF OPERATIONS (OTHER THAN DIRECT MATERIAL )INCURRED TO EARN THROUGHPU CONTRIBUTION .OPERATING COSTS INCLUDE SALARIES AND WAGES ,RENT ,UTILITIES ,DEPRECIATION.

Relating TOC Measures to Traditional Measures

T = Sale Price - Direct Material Cost OE = Direct Labor Cost + Overhead

Net Profit = Return on =

T - OE
Net Profit = inventory throughput inventory ( T - OE ) / I

Investment
Inventory =

Turns

TOC Performance Measures

Throughput (T): The rate at which the

system generates money through sales. Inventory (I): All the money invested in purchasing things needed by the system to sell its products. Operating Expenses (OE): All the money the system spends, turning inventory into throughput.

OBJECTIVES OF TOC
INCREASE THROUGHPUT CONTRIBUTION WHILE DECREASING INVESTMENTS AND OPERATING COSTS.

The Theory of Constraints

The Theory of Constraints (TOC) is based on two

premises:
The Goal of a business is to make more money, in the present and in the future. A systems constraint(s) determine its output.

STEPS IN MANAGING BOTTLENECKS :STEP 1:- RECOGNIZE THAT BOTTLENECK OPERATION DETERMINES THROUGHPUT CONTRIBUTION OF THE ENTIRE SYSTEM STEP 2:- INDENTIFY THE BOTTLENECK OPERATIONS BY INDENTIFYING OPERATIONS WITH LARGE QUANTITIES OF INVENTORY WAITING TO BE WORKED IN. STEP 3:-KEEP THE BOTTLENECK OPERATIONS BUSY AND SUBORDINATE ALL NONBOTTLENECK OPERATIONS TO BOTTLENECK OPERATIONS.THE NEED OF THE BOTTLENECK OPERATIONS DETERMINE THE PRODUCTION SCHEDULE OF THE NON BOTTLENECK OPERATIONS STEP 4:- TAKE ACTIONS TO INCREASE EFFICIENCY AND CAPACITY OF BOTTLENECK OPERATION

STEP 4:- USING DATA FROM CARDINAL INDUSTRIES (CI) MANUFACTURES CAR DOORS IN TWO OPERATIONS:-STAMPIMG AND PRESSING
STAMPING CAPACITY PER HOUR ANNUAL CAPACITY(6000 HOURS OF CAPACITY AVAILABLE IN EACH OPERATION) 6000 HOURS *20 UNITS/HOUR;6000 HOURS*15 UNITS /HOUR) ANNUAL PRODUCTION AND SALES OTHER FIXED OPERATING COSTS(EXCLUDING DIRECT MATERIALS) OTHER FIXED OPERATING COSTS PER UNIT PRODUCED RS 72,00,000/90000 UNITS;RS 1080000/90000 UNITS 120000 UNITS 90000 UNITS 20 UNITS PRESSING 15 UNITS

90000 UNITS RS 7200000 RS 80 PER UNIT

90000 UNITS RS 10800000 RS 120 PER UNIT

Each door sell for Rs 1000 and has direct material cost

WHAT CAN CI DO TO RELIEVE THE BOTTLENECK CONSTRAINT OF THE PRESSING OPERATION ? DESIRABLE ACTIONS INCLUDE :-

1) ELIMINATE IDLE TIME AT THE BOTTLENECK OPERATION (TIME WHEN THE PRESSING MACHINE IS NEITHER BEING SET UP TO PROCESS PRODUCTS NOR ACTUALLY PROCESSING PRODUCTS ) 2)PROCESS ONLY THOSE PARTS OR PRODUCTS THAT INCREASE THROUGHPUT CONTRIBUTION,NOT PARTS OR PRODUCTS THAT WILL REMAI N IN FINISHED GOODS OR SPARE PARTS INVENTORIES. 3)SHIFT PRODUCTS THAT DONOT HAVE TO BE MADE ON THE BOTTLENECK MACHINE TO NONBOTTLENECK MACHINES OR TO OUTSIDE PROCESSING FACILITIES 4)REDUCE SETUP TIME AND PROCESSING TIME AT BOTTLENECK OPERATIONS (FOR EG BY SIMPLIFYING THE DESIGN OR REDUCING THE NUMBER OF PARTS IN THE PRODUCT) 5)IMPROVE THE QUALITY OF PARTS OR PRODUCTS MANUFACTURED AT THE BOTTLENECK OPERATIONS

Evaluation of TOC
Advantages
Improves capacity decisions in the short-run Avoids build up of inventory Aids in process understanding Avoids local optimization Improves communication between departments

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Evaluation of TOC
Disadvantages
Negative impact on non-constrained areas
Diverts attention from other areas that may be the next constraint

Temptation to reduce capacity Ignores long-run considerations

Introduction of new products Continuous improvement in non-constrained areas

May lead organization away from strategy Not a substitute for other accounting methods
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