THEORY OF CONSTRAINTS

ACCT 7320
October 8, 2014

What is the Theory of

Constraints all about?

Developed by Eliyahu Goldratt in the mid

1980s with his business novel The Goal.

Has a close relationship with other modern

techniques (more about this later):

Just-in-Time
Manufacturing Resource Planning
Quality Management, Six-Sigma
Activity-Based Management.

Goldratts Biography

Born in Israel in the late 1940s.

Bachelors degree in Physics.
Masters and Doctorate degrees in Philosophy.
Founder of a production scheduling software
company.
Has helped many companies such as: GM, RCA,
Kodak, Westinghouse, Philips, etc.
Wrote several books:

The Goal.
The Race.
What is this thing called TOC?
Critical Chain.
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Eliyahu Goldratts The Goal

Brief overview:
Midsize company having difficulty shipping products on time.
Managed by a plant manager desperate to turn things around.
With the help of a Physicist, the plant manager is able to locate
the bottleneck and find a solution.

Symptoms noted in the book:

Obsolete inventory.

Low inventory turnover and high amount of inventory in storage.

Idle workers or machines.

Machine breakdown.

A large amount of scrap pieces.

A large amount of retooling and rework needed.

What is the Theory of

Constraints all about?

Looks at the entire supply chain and synchronizes the

chain to achieve ultimate performance.

Based on two assumptions:

Every organization has a set of processes working together

to achieve a common goal.
Every process has a [single] constraint that limits it from
higher performance.

Typical constraints: Time, Capacity, Materials, Human

Resources, Capital Resources, Financial Resources

Implementation of the Theory of

Constraints

Step 1: Identify the bottleneck(s)/constraint(s).

Look at your production plan as a whole and determine which

resource is preventing you from achieving better performance.
Look at the cause (old machine, untrained employee, long setup
times, machine breakdown).
According to Goldratt, an entire plants throughput (productivity) is
limited to the bottlenecks productivity.

Step 2: Exploit the bottleneck(s).

All process efforts should be focused primarily on the constraint to

maximize throughput.

Implementation of the Theory of

Constraints

Step 3: Subordinate everything else to the bottleneck(s).

Step 4: Elevate the bottleneck(s).

According to the theory, other activities must be subordinated to the

actions taken to fix the bottleneck in hand.

At this point, management has to decide whether to purchase

additional capacity (new machine, better trained employee)

Step 5: Evaluate whether solving the current bottleneck(s)

created other bottlenecks. Do not allow inertia.

The production plant has to be monitored carefully as to whether

other constraints now exist and to monitor the progress of the old
constraint.
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Common Terms in Theory of

Constraints

Throughput: processing another unit of output

Emphasis on Increasing Sales, Productivity, and

Market Demand

Throughput contribution: Sales-(Material and

any other directly variable Costs).
Bottlenecks: limited resource that prevent the
supply chain from achieving ultimate
performance

Benefits of implementing TOC

Reduction in inventory.
More productive machines.
Ability to meet shorter lead times.
More flexible.
Better customer service.
Better product mix.
Better customer relationship.

Shortfalls or Criticisms of TOC

Focus on short-term goals as opposed to long-term with

ABC.
Main emphasis on increasing sales and volume, not
quality.
May lose overall picture when only looking at specific
constraints.
Focuses on the push approach as opposed to pull
approach of JIT.

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The Theory of Constraints and

Other Concepts
PROS

CONS

J IT

Emphasis on customer, flexibility,

and low inventory costs.

Reliance on suppliers could be costly if

your needs cannot be met.

MRP

Reduction in inventory costs,

storage costs, and better
efficiency.

Focuses primarily on materials

management and not overall supply
chain management. Limited in scope.

ABC

Dynamic optimization of resource

supply, product design and mix,
and pricing.

Emphasis on cost-cutting initiatives.

Mostly used for accounting purposes.

TOC

Optimization of productivity and

customer satisfaction.

Primarily focuses on short-term profit

maximization.

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Lean Accounting

A practitioner-based movement
Not much in accounting textbooks and courses
Is it a fad?
According to one recent research article*

Lean manufacturing is a complete business system that

combines advanced manufacturing techniques including

Lean accounting seeks to

Just-in-time (JIT)
Total quality management (TQM
Total preventative maintenance (TPM).
Reduce steps in transaction processing
Eliminate standard costs in favor of actual costs
Discontinue cost allocations

Lean control practices re-focus the performance

measurement system

Emphasize social and behavioral controls.

Frances A. Kennedy & Sally K. Widener, A control framework: Insights from evidence on
lean accounting. Management Accounting Research 19 (2008) 301323

http://www.leanaccountingsummit.com/

Another article
July 2004 article

LEAN MANUFACTURING PRINCIPLES

IN THIS ENVIRONMENT

eliminating waste, producing only to meet customer demand.

typically require a company to move from a functional division of
work to work cells where all of the processes needed to
manufacture a product or line occur next to each other in
sequence.
Accountants have begun to realize many traditional cost
accounting practices no longer make sense.
A growing number of businesses are implementing lean accounting
concepts to better capture the performance of their operations.

ADHERENTS PROPOSE A NEW WAY of looking at the

numbers.

Rather than categorizing costs by department, organize them by

value stream, which includes everything done to create value for a
customer the company can reasonably associate with a product or
product line.

http://www.journalofaccountancy.com/Issues/2004/Jul/TheLowdownOnLeanAccounting.htm

Key points about LA,

contd.

NEW ACCOUNTING CONCEPTS NOT A

PANACEA

Difficulty accurately pricing products and

determining profitability when they analyze
performance by value stream rather than by
individual product.
The approach also may emphasize speed and
quality almost to the exclusion of cost concerns.

SOLUTION MAY BE to supplement the

companys standard financial statements with
additional information

Report improvements from efficiency

Be aware of GAAP requirements

Velocity World- The Conference on

TOC, Lean and Six Sigma

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Questions?

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