The Theory of Constraints & Throughput: Part 2 - Analysis & Management
In Part 1 of this two-part series, we learned the basic premise of Theory of Constraints (TOC), which is that in any business there will be one process which is the slowest, also known as the constraint or bottleneck. We also learned several definitions related to the Theory of Constraints. Here, we will dive into the basics of TOC analysis and explore what that means from a managing and budgeting perspective.
The basic premise of TOC analysis is that short term profits can be maximized by maximizing the throughput margin dollars through the constraint. There are 5 basic steps in the TOC analysis process:
Identify the constraint
Determine the products or services that maximize throughput at the constraint
Maximize flow through the constraint
Improve the capacity of the constraint
Redesign your processes
Identify the Constraint
While this sounds like a straight forward process, identifying the constraint can be quite difficult. One method is to look for the area that consistently backs up or delays your production. If you are a manufacturer, think of the process that always has a pile of work-in-process inventory in front of it. In a service-based firm think of the process everyone is always waiting on, for example: you are always waiting for the senior engineer's review before you can send the final report and invoice the client. This isn't guaranteed to be the constraint, since it could just be that the immediately upstream process is so efficient that it is dumping a ton of work there, but it is likely your culprit. You can also look for workstations that maintenance staff is always hanging around, which could indicate machines being run at way past their intended or designed run-rates leading to frequent breakdowns. In services industries this might look like a person who never has time to take vacations, attend meetings, or take lunch breaks. It could be an indication of a poorly performing employee, but if you know that the employee is consistently working at 100%, this is likely your constraint. Another method is if you know of one process in your system where if it goes down, your profits fall immediately. That's likely your bottleneck. A more technical approach is to analyze all your available resources and determine which phase has negative slack time - the one that doesn't have enough resources to keep up with its input. Lastly, you can force an area to be your bottleneck, which you might do if it requires highly expensive staff or equipment. By cutting back on your investment in this area, it will become the bottleneck.
It may also be that your company has plenty of capacity to produce all the orders you receive. If this is the case, your bottleneck may actually be in your sales department or outside of your company (the total market demand for your product for example). Consider reviewing your sales process, staffing levels, and incentive structures as well as your pricing and discounts. Sometimes dropping the price will increase sales volume enough to offset the drop in price with increased throughput dollars.
Determine the Products/Services that maximize throughput at the constraint
Once you've identified the constraint process, your focus in the near term is to maximize your throughput margin through the constraint. To do this you'll first need to identify the capacity at the constraint. For example, if it is a machine, how many machine hours are available in the week? If it is a person, or group of people, how many hours do they work in the week? Once you've identified this, you next need to calculate your throughput margin for each product and then divide that by the amount of the constraint process required to complete each product to get the throughput margin per unit of constraint. To maximize your profit you'll want to produce the products in order of throughput margin per unit of constraint, beginning with the highest. If this sounds confusing, let's look at an example:
In this scenario, the total demand for the products would require 85 hours of machine time, but the company only has 60 available. Therefore they will need to determine the optimal mix to produce to maximize their throughput. In this example, product B generates $160 of throughput per machine hour which is more than Product A's $90, so they would produce all 90 units of product B, consuming 45 hours of bottleneck machine time and then use the remaining 15 hours to produce 15 units of Product A.
Maximize Flow Through the Constraint
Now that we know our constraint, and our optimal product mix, we must ensure that the bottleneck operation is constantly running. Any down time will reduce our total throughput which will drop straight to our bottom line. If we have to have downtime, such as employee holidays or machine maintenance, we should make sure the two events overlap so that we minimize the overall downtime. During shift changes we should take measures to minimize change-over downtime.
For employee-based bottlenecks, ensure they are only working on the bottleneck operation. Remove as many other things from their plate as possible to make sure they are focusing solely on the bottleneck function. Delegate their non-bottleneck tasks to other employees.
Look at upstream activities to make sure they are supplying the bottleneck operation with a steady supply of work and maintaining an adequate buffer. If the upstream processes fall behind occasionally, consider increasing the capacity of those operations to improve your sprint capacity, or consider increasing the size of your buffer. You can also look at the delivery method of work in process from the upstream processes to the bottleneck. If work is sent over in batches, consider reducing the size of the batches, or deliver each part to the buffer or bottleneck as it is completed (via a conveyor belt or similar method). Do what it takes to reduce inventory buildup while ensuring the bottleneck is adequately supplied.
It is important to note too that you should maximize quality product flow through the constraint. If you have products that make it through the constraint process and are later scrapped, you've wasted valuable bottleneck time. Consider a quality review immediately upstream of the bottleneck process to ensure all materials processed by the constraint are acceptable prior to processing.
In general, when considering short-term to mid-term alterations to the system, if the decision will increase throughput more than the incremental cost, it is a viable option to consider. Rush delivery payments might make sense compared to the throughput lost from shutting down the bottleneck. The cost of overtime pay may likewise be justified.
Improve the capacity of the constraint
The medium-term solution for improving your operation is to increase the capacity of the constraint. There are a few methods to do this. Obviously investment in more equipment or employees is one method. In the short-to-midterm, another method would be to consider offloading excess work from the bottleneck to a back-up operation. Even if the back-up is less efficient than the main operation it might still make sense if it increases your throughput. You can sometimes borrow employees from other operations that are not the constraint to fill in on a back up operation, You'd be paying them normally anyway there is no incremental cost and it can generate a large amount of additional throughput. In the same vein, you could consider putting old equipment back to work as a backup to the bottleneck. Again, it might not be as efficient, but it can serve to increase the capacity.
Redesign your process
A long term solution to improving your operations is to review and redesign your processes and products to ease production. Consider how new technology could improve your throughput. Review product lines and drop those that require too much effort. Review your products using value engineering concepts which seeks to balance production costs of features with the features that most valued by your customers.
Capital Budgeting with TOC
The traditional form of capital budgeting is done without regard for the Theory of Constraints. Individual managers look at their departments and decide if they need to replace or add equipment. They then put together a request and often are required to justify the investment using an analysis showing that the increase cashflows generated by the investment will exceed the companies required rate of return. Then a review committee looks over the requests and approves them in order of highest forecasted return. This neglects the insights provided by the Theory of Constraints: investing in areas that are not the bottleneck will not improve overall output of your firm. As we discussed before, it is wasteful to improve the efficiency or capacity of processes that are downstream of the bottleneck if they can already keep up with the bottleneck production. Improvements upstream may make sense, from an increasing sprint capacity perspective, but too much investment will be wasted because the company-wide output is still limited downstream by the bottleneck.
Capital budgeting using the TOC involves primarily investing in initiatives or resources that improve the bottleneck operation. Investment opportunities are evaluated by considering the incremental addition to throughput generated by the investment and any related changes in operating expenses. Another item to consider when looking at capital budgeting for the throughput operation is risk. For example, installing a large, fully automated machine at the bottleneck might improve the throughput, but consider that if you only have one machine and it goes down, all throughput is halted. Installing multiple machines with less individual capacity will reduce your risk of this. Also, generally more complex equipment is also more complex to repair, meaning more down time when it does breakdown. Remember if the bottleneck operation goes down, your output grinds to a halt. This is not an area where you want to increase your risk.
If you receive a request for an investment that doesn't affect the bottleneck, you should not automatically deny it, but you will want to review it very carefully. Consider requiring additional analysis for requests such as this. Interview the individual or team that submitted the request as to why they need it, review the investments impact on the entire system, etc. Investments that help reduce risk, reduce operating expenses, etc. may merit investment. To help you better analyze investment requests, consider placing an industrial engineer on the committee that reviews these investment requests. Finally, if you notice throughput is suffering right now because of lack of a key investment, but there wasn't an budgeted amount for required investment, make the investment anyway and quickly. Don't lose those throughput dollars by waiting around for the next budgeting cycle.
By keeping the TOC in mind during your capital budgeting process, you may actually end up reducing overall investment while still increasing output, even in the long term. If you've invested in excess capacity either upstream or downstream, you will be able to replace these investments with appropriately sized investments when the current ones wear out at less cost than the originals since they'll have less capacity.
As we've seen throughout this two part series, the theory of constraints is essential for understanding how your organization functions and how to maximize its productivity. Ignoring this can lead to sub-optimal profitability and inefficient capital investment. However, by intelligently viewing your organization through the lens of TOC you'll be able to create more profit more efficiently and more strategically invest your limited capital.
If you would like to learn more, or think your company could benefit from working with Augelli Consulting, LLC please contact us for a free initial consultation at email@example.com