Theory of Constraints

Introduction

Jindal Steel & Power Limited

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 Index
▪ Fundamental TOC Beliefs
▪ Organizational Goal
▪ Goal measurements
▪ TOC measurements
▪ Concept of constraint
▪ Five focusing steps – POOGI
▪ Constraint identification
▪ Implementation case studies
 Fundamental TOC Beliefs/ Paradigm

Traditional Belief/Paradigm TOC Belief/Paradigm

1. Inherent Constraints 1. Inherent Potential
2. Inherent Complexity 2. Inherent Simplicity
3. Inherent Conflict 3. Inherent Win/win
4. Inherent Uncertainty &
4. Inherent Certainty &
“Good Enough”
Optima
5. Inherent Good People
5. Inherent Bad People with Bad assumptions
 The Goal?

What is the Goal of your organization?

1. Some organizations state that their Goal is to be a

World Class Quality Company. Stated differently
they would like to delight their customers now as
well as in future.
2. Many other organizations say that their Goal is to
keep their employees happy now and in future.
3. A few organizations declare that their Goal is to
make money now and in future!
The Goal?

Is there any conflict between the three Goals stated or

a hierarchy of Goals?
The Goal?

▪ For example, let us choose that our Goal is to delight

customers now and in future.
▪ In order to achieve our chosen Goal i.e., to delight
our customers now and in future, it is necessary to
keep our employees happy now and in future.
▪ Similarly, it is imperative to make money now and in
future in order to continue to keep our employees
happy.
The Goal?

▪ Now let us decide that our Goal is to keep our

employees happy now and in future.
▪ In order to achieve our chosen Goal, it is absolutely
necessary to make money now and in future.
▪ It is impossible to make money now and in future
unless we continue to delight our customers now
and in future.
The Goal?

▪ Now if we decide that our Goal is to make money

now and in future, is it really possible to achieve it
without delighting our customers now and in future!
▪ And can we satisfy our customers without keeping
our employees happy now and in future!
The Goal?

▪ In reality there is no conflict between the three

different Goals.
▪ Choose any of the three Goals, the other two
become the necessary conditions for achieving the
chosen Goal!
▪ In fact, they have to co-exist for long term
sustainable results.
▪ Since the measurement of profit is easy to monitor
and track, we will take the Goal as: making more and
more money now as well as in future.
Measures for the Goal - Making Money

Generally accepted measures are

▪ Profit
▪ Return on investment
▪ Cash flow

We do not question the validity of these measures.

However, we do question the usefulness of these
measures as operational measures for day-to-day
decision making!
Five levels of financial health

1. Unable to meet financial commitments

2. Meeting financial commitments but not making
profits
3. Meeting financial commitments, not making losses,
but profits fluctuating
4. Profits increasing continuously period after period
5. Return On Investment (ROI) / Return On Capital
Employed (ROCE) increasing continuously
What measurements should we use?

▪ For the average employee, seeing the effect that any

given action has on Net Profit (NP) or Return On
Investment (ROI) is almost impossible.
▪ As a result, we have created local measures like
efficiency & utilization because we believe that they
are linked to NP or RoI.
What measurements should we use?

New Operational Measures

▪ Throughput (T)
▪ Investment (I)
▪ Operating Expense (OE)
 Flow of Money

Cash in bank

TVC
- + S

I -

OE
Throughput (T)

▪ The rate at which Contribution Rupees are coming

into organization
▪ T = (Net sales – All truly variable costs ~ TVC)
▪ TVC: All costs that would be saved if we sell or
produce one unit less
Investment (I)

▪ All the money currently tied up inside the system

▪ All the inventory in raw material, WIP, or in Finished
Goods
▪ Money blocked in plant and machinery
▪ Receivables are also part of “I”
Operating Expense (OE)

▪ All the money that system spends on converting

inventory into throughput
▪ All the expenses are clubbed together as “OE” and
are thought as fixed
▪ All employee expenses are part of “OE”
Financial Links

Is there any link between the new Operational

Measures “T”, “I”, & “OE”, and conventional measures
as “P”, “ROI”, & “Cash Flow”?

P = T – OE
ROI = P/I = (T – OE)/I
FCF (Free Cash Flow) = T-OE-ΔI
What happens to P, ROI & cash flow when we improve
either T, I or OE, keeping other two as constant?
Measurement Priorities

• Throughput (T) must improve period after

Priority 1 period (Incremental increase in T must be
more than incremental increase in OE)

• Operational productivity (T/OE) should

Priority 2
improve period after period

• Capital productivity (T/I) should also

Priority 3 improve period after period
Constraint for making money

What is that limits your organization to achieving more

of its Goal - to make more and more money?
 Theory of Constraints (TOC)

▪ The core idea in the Theory of Constraints is that

every real system such as a profit-making enterprise
must have at least one constraint that limits the
system to achieving its Goal.

▪ Every ‘for profit organization’will have a constraint in

Supply, Operations, or Market. Current constraint
may shift, but there cannot be any situation when
there is no constraint. Had it been so, its profit would
have been infinite!
 Organization as a chain

▪ An organization can be compared to a chain.

▪ The activities that constitute a business are
‘chain’of dependent events.
▪ For example, we do not dispatch products unless they
are tested and certified, and we do not test & certify
until they are manufactured.
 Organization as a chain

▪ The output of the organization is achieved through

the synchronized efforts of various functions.
▪ The output is limited by the weakest area.
▪ The strength of the chain is determined by the
strength of the weakest link.
▪ What should be done to improve the output of an
organization?
 Organization as a chain

▪ Should we improve all functions or all links?

▪ Or should we strengthen the weakest function or the
weakest link?
▪ It is common sense that unless we improve the
weakest link, the organizational output or chain
strength would not increase at all.
▪ Is it possible that overall organizational effectiveness
is reduced by improving performance in one
department ?
 Organization as a chain

▪ The global improvement is not the sum total of all the

local improvements.
▪ Often organizations spread their energies thin in all
areas in order to improve the output.
▪ In the TOC world optimizing a sub-system would sub-
optimize the whole system.
How does TOC help companies?

1. Focusing improvement efforts where it will have the

greatest immediate impact on the bottom line.
2. Providing a reliable process that ensures Follow
Through.
Process Of On Going Improvement
(POOGI)
1. Identify the constraint.
2. Decide how to exploit the
constraint
3. Subordinate all policies, decisions
and procedures to exploiting the
constraint.
4. Elevate the constraint. If we need
still more output from the
constraint, elevate it.
5. Avoid inertia. If in a previous step
constraint shifts, start the cycle
once again.
POOGI: Step 1

Identify the Constraint.

▪ The constraint can be internal or external to your
organization. Internal constraint is preferable.
▪ The constraint could be orders, operations, suppliers,
or CASH
▪ Though the apparent constraint could be any one of
the above, in reality the policies of the decision
makers are the ones that create or decide
constraints!
POOGI: Step 2

Decide how to exploit the Constraint.

▪ Get the most possible out of the existing capacity of
the constraint.
▪ Utilization at the constraint is critical.
POOGI: Step 3

Subordinate all decisions to exploiting the constraint.

▪ All policies and measurements must be designed to
get the most out of the constraint.
▪ Utilization and efficiency at the non-constraint
resources must not be measured. However, this
does not imply that there are no measurements for
non-constraint resources.
▪ This step is often missed, and thereby the majority of
financial benefits of TOC is lost. This is the toughest
step.
POOGI: Step 4

Elevate the constraint.

▪ If more capacity is required after steps 2 &3 to meet
the market requirements, increase it through capital
investment, outsourcing, or off-load the constraint
by defining alternative routings, processes or design.
Capital investment should not be the first option.
▪ Often, Exploitation and Subordination are sufficient
to reach the needed output. Do not increase the
investment too soon.
POOGI: Step 5

Avoid Inertia.
▪ If in a previous step the constraint is broken,
go back to Step 1. Do not let inertia be the
system constraint.
▪ Often times when a new constraint is
identified, it is necessary to change the
policies you have just made!
POOGI: Step 5

Avoid Inertia. (Choose)

▪ The long term strategic application of TOC does not
call for continuous removal of all constraints. In any
case all constraints cannot be removed!
▪ Rather, the idea is to choose where the constraint
should be in order to best exploit the market
opportunities, and then keep it there!
Constraints: Identification

▪ Every system will always have only one

weakest link at any given time-
Constraint
▪ Constraint is in market if market share >
50% of world market
▪ Constraint is orders if On Time in Full
(OTIF) > 90%
Constraints: Identification

▪ Supply is constraint if material availability <

95% despite payments being on time
▪ Suppliers if consumption is > 50% of world
consumption
▪ Supplier policies if consumption < 50% of
world consumption
Constraints: Identification
▪ Constraint is operations when OTIF < 90%, and
material availability > 95%
▪ Equipment if OEE (Overall Equipment
Effectiveness) for at least one
equipment >90% on 24X7 basis
▪ Operational policies if OEE < 90%
Cash Constraint
There is Cash Constraint if and only if there are
▪ sufficient orders i.e., OTIF < 90%
▪ manufacturing capacity i.e., OEE < 90% for all
equipment
▪ right suppliers
▪ there are raw material shortages as suppliers are
refusing to supply unless paid upfront
▪ additional cash cannot be easily arranged
▪ Cash shortage does not necessarily imply cash
constraint.
▪ However, if cash shortage is not managed
properly, it will lead to cash constraint
 Case study 1: Capital goods
manufacturer
▪ Background
▪ Capital goods manufacturer for refractory equipment
▪ It was losing money for 2.5 years
▪ Constraint: Cash (Financial health: level 1)

▪ Actions
▪ Stopped measuring machine utilization
▪ Stopped measuring local performance parameters to
prevent bad multi tasking
▪ Focus on cash generation with weekly review

▪ Results
▪ Turned around in 100 days
▪ Turnover increases by 30 times in 5 years
 Case study 2: Auto component
manufacturer
▪ Background
▪ Manufacturer of automotive gears
▪ Losing money for last 5 years
▪ Constraint: Operational policies (Financial health: Level 2)

▪ Actions
▪ Stopped measuring “Tons”
▪ All functional heads Key Result Areas (KRAs) abolished
▪ Started measuring OTIF (On time in full)
▪ Focus on throughput instead of sales with weekly review

▪ Results
▪ Throughput increases by 70% within 2 years
 Case study 3: Refractory manufacturer

▪ Background
▪ Manufacturer of refractories for steel and cement
industry
▪ Inconsistent profits
▪ Constraint: Orders (Financial health: Level 3)
▪ Actions
▪ Stopped measuring “Tons”
▪ Started measuring “Throughput loss”
▪ Focus on throughput instead of sales with weekly
reviews
▪ Results
▪ Throughput increases by 25% within 3 months
 Case study 4: Garment Exporter
▪ Background
▪ One of the largest garment exporters in India
▪ Not making profits
▪ Constraint: Cash (Financial health: Level 1)
▪ Actions
▪ Stopped purchase of expensive input (fabric) as the first
item & ordering fabric in one go for different shipments of
the same order
▪ Improved end to end planning
▪ Focus on money credited & throughput instead of sales on
a weekly basis
▪ Results
▪ Sales increased by 25% & Receivables reduced by 45%
▪ Inventory is reduced by 40%
▪ Positive EBIDTA from negative EBIDTA
Summary

▪ Organizational Goal- Making More and More Money

▪ Making More & More Money is also an index of
Customer satisfaction & Employee satisfaction
▪ Five levels of financial health
▪ Most organizations do not achieve their Goal of making
More & More Money
▪ Conventional measures of making money (Profit, return
on Investment, & Free Cash Flow) are not easily
understood by most people in the organization
▪ Throughput, Investment & Operating Expenses are easy
to understand and correlate well with conventional
financial measures
Summary

▪ Systems output is not governed by the output of

various subsystems. Rather it is determined by the
output of the weakest link – constraint of the
organization
▪ Five steps of POOGI-identify, exploit, subordinate,
elevate, and start all over gain
▪ Constraint identification steps
▪ Indian case studies
▪ Improving cash flow by shrinking working capital,
increasing throughput and controlling OE
 Thank You

Measurements Drive Behavior!

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