By: Debra S. Reynard
How Does It Compare with Traditional Operations Management Theories, and Where Does My Company Fall?
Many traditional approaches to operations management have fallen from favor as today’s business climate has evolved. Other more recent efforts have proven to be a “flash in the pan.” The Theory of Constraints has continued to grow in acceptance since the initial publication of “The Goal – A Process of Ongoing Improvement” by Eliyahu Goldratt in 1984. How does Constraints Management compare with other traditional theories, and how is your company currently operating?
One of the most important foundations of the Theory of Constraints is its throughput orientation. Throughput has been defined as “the rate at which a system generates money through sales.” Throughput orientation is then defined as an organization-wide focus on increasing throughput, rather than reducing operating expenses, as a means of improving financial performance, and an awareness that financial performance is limited by constraints. This throughput orientation is supported by the use of performance measurement and decision making systems that facilitate improvement of throughput through management of these constraints. The three fundamental constructs of throughput orientation (TO), then, are: 1) organizational mindset, 2) performance measurements, and 3) decision making. How do traditional operations management theories compare with the Theory of Constraints with regard to these factors?
Organizational mindset is a measure of the underlying attitudes, assumptions and beliefs of management. It involves concerns such as cost-reduction strategies, growth strategies, and the importance which management places on customer satisfaction and employee security. Constraints management (CM) acknowledges that for throughput to be improved, quality products, customer satisfaction, employee security and equitable pay are necessary conditions. These are core concepts for Total Quality Management (TQM) as well, where meeting customers’ expectations and employee empowerment are key dimensions of competitive advantage. But these are even more important in CM, which suggests the conditions should be expressly stated and met before profitability improvements are even attempted, so other management policies and practices will be consistent with them. At the other extreme is the cost-world thinking, which emphasizes reducing operational expenses as the primary means of improving performance.
The position of these management approaches on the continuum for the first construct of TO, organizational mindset, could then be represented as the following:
Low TO ORGANIZATIONAL MINDSET
High TO Cost-world thinkingTQM CM
To determine where an individual organization lies on the continuum of organizational mindset, the following questions should be considered:
- Is the primary emphasis of improvement projects on cost reduction?
- Does management believe that everyone must work hard and be efficient for the company to maximize profitability?
- Is maintaining a satisfying work environment for all employees a top priority?
- Can customers depend on the organization to provide services as promised and when promised?
- Do the employees understand the importance of satisfied customers to the organization’s success?
Performance measurements, the second construct, primarily includes accounting-based measures, such as product cost and overhead calculations. The most commonly used systems allocate overhead costs based on direct labor. In response to criticism of this approach, some firms use direct costing or variable costing, which do not allocate fixed overheads to products, for decision-making purposes. Others have adopted the activity-based costing (ABC) approach as an alternative to traditional labor-based allocation of overhead costs. ABC assigns overhead and other costs to products based on the amount of activities used in the production of the product or service. In contrast to ABC, CM uses an approach called throughput accounting, based on a set of measures which includes throughput (T), inventory (I) and operational expense (OE). This view not only rejects cost allocations, but also the concept of product cost. It also claims that direct labor is generally more accurately viewed as a fixed, rather than variable, cost and therefore should not be allocated. CM further suggests that if throughput increases, then net profit, return on investment, and cash flow will all increase, as well.
In summary, traditional cost accounting uses a simple, direct labor-based allocation, while ABC is more sophisticated, based on various factors that are believed to drive costs. Direct costing does not allocate overhead costs but does charge direct labor to products. Likewise, throughput accounting does not allocate overhead to products, but goes one step further and does not charge direct labor to products, either.
The position of various approaches on the continuum for the second construct of throughput orientation, performance measurement, could then be represented as follows:
Low TO PERFORMANCE MEASUREMENT
High TO ABCTraditionalDirectThroughput
To determine where an organization lies on the performance measurement dimension of throughput orientation, measurement practices for the following should be considered:
- Are only raw material and directly variable costs added to product costs?
- Are direct labor costs added to product costs?
- Is variable overhead added to product costs?
- Is fixed overhead added to product costs?
- Are general and administrative expenses added to product costs?
The third construct of throughput orientation, decision making, relates to the methods of work employed by business units. This includes decision-making methods used in such areas as production scheduling, capacity planning, inventory management and process improvement.
With regard to the first of these areas, production planning and scheduling decisions, there are four fundamental systems:
- max/min reorder-point systems (ROP);
- material requirements planning (MRP)-based systems (including manufacturing resource planning and enterprise resource planning (ERP) systems);
- just-in-time (JIT) systems; and
- CM-based systems such as drum-buffer-rope (DBR).
MRP and ROP share some characteristics, such as lot-sizing techniques based on economic order quantities (EOQ). Today, MRP is often used for dependent-demand items, with ROP only being used for independent-demand items. Both approaches attempt to minimize inventory levels by placing orders as late as possible while still meeting requirements. Both also have a strong emphasis on high utilization of equipment and labor, which causes the release of material to production and orders to vendors in excess of current requirements. Master production schedules are created with limited schedule feasibility tests. JIT, in contrast, focuses on matching the flow through production with demand. Small lots are delivered frequently from vendors based on fixed schedules that are strictly adhered to. DBR also attempts to balance production flow with demand, but it recognizes that the flow is limited by the system’s constraint.
This constraint has a primary role in determining the master production schedule to insure capacity feasibility, so material is released to production only as fast as the constraint can process it.
To summarize, in the area of production planning and scheduling, the focus of ROP and MRP is on minimizing the costs of carrying inventory and of idle equipment and workers, and is clearly aligned with cost-world thinking. The planning and scheduling aspects of JIT and DBR are, in contrast, focused on ensuring that throughput meets customer demand. A distinction between these latter two is that JIT still has an extreme emphasis on cost-reduction, resulting in high efficiency and balanced capacity throughout the operation. DBR discourages balanced plants and focuses everything on the system’s constraint.
Regarding capacity management decisions, ROP assumes unlimited capacity, while MRP, JIT and DBR are based on varying views of capacity and how it should be managed. MRP does capacity checks at several levels to ensure the production schedule is capacity feasible and all resources are fully utilized. At the other extreme, JIT incorporates under-capacity scheduling to allow time for preventive maintenance and to absorb fluctuations in demand. DBR has an intermediate position between MRP & JIT, since it focuses on maximum utilization of the constraint, but recognizes that non-constraints will have excess capacity and allows them to not be fully utilized. Both JIT and DBR do, however, reflect a focus on throughput, while MRP concentrates on maximizing capacity utilization and minimizing costs.
For inventory management decisions, the four systems have different views of the importance of inventory to operations. ROP and MRP control inventory levels by ordering as late as possible while still meeting due date requirements. However, these approaches often result in high inventory levels due to their reliance on EOQ-based lot sizing. Their process batches and transfer batches are generally equal in size, and MRP additionally depends on fixed lead times. So, both of these approaches can be considered high inventory systems. A primary focus of JIT, on the other hand, is to drive inventory to the lowest possible levels needed to operate by reducing set-up times, travel distances, variability, etc. It is, ideally, a “zero-inventory” system. DBR, in contrast, incorporates an inventory management system referred to as buffer management. This system supports the maximization of throughput by placing buffers in strategic locations, especially in front of the constraint to protect its throughput, as well as in finished goods to protect the shipping schedule. But inventory at other points in the system is low, with short or nonexistent queues, so DBR can be considered a low-inventory system.
Finally, with regard to process improvement decisions, ROP and MRP do not adopt a process of continuous improvement. JIT, on the other hand, attempts to eliminate all waste, including overproduction, waiting time, transportation, and inefficient processing, and it is closely associated with TQM. The distinction from CM, however, is that JIT and TQM do not target these efforts where they will have the greatest impact, but rather attempt to improve everywhere at once. CM, in contrast, uses five focusing steps to target improvements on the constraint, where they will have maximum holistic impact.
Taking these four areas of decision making into account, the position of the four systems on the continuum for the third construct of throughput orientation would then be represented as follows:
|Low TO||DECISION MAKING||High TO|
To determine where an individual organization lies on the continuum of throughput orientation decision making, some of the questions which should be considered include the following:
- Is the production process best described as flow production or batch production?
- Is the production system best described as a “push” system (material is pushed from one operation to the next) or a “pull” system (material is pulled from the final customer through each preceding operation)?
- Is the master production schedule based on the schedule of the most constrained resource or operation?
- Are economic batch quantities used to determine batch sizes?
- Is capacity requirements planning used?• Is input/output control used?• Is TQM used?
- Are process batches (i.e., the batches worked on at each operation between setups) the same size as the batches transferred from one operation to another?
Constraints Management’s organizational mindset focuses on increasing throughput, i.e., generating more money with current resources, rather than on minimizing costs. Accordingly, a CM firm will be more likely to adopt an accounting system that measures organization-wide progress toward making more money, rather than a system that that supports minimizing costs as a means of improving profitability. The organizational mindset and performance measurement systems in turn are both related to organizational decision making in that, given the throughput-focused nature of the first two, it is more likely that the organization’s decisions will be based on the impact of local actions on global results, rather than attempting to optimize resources locally. These factors work together to enable Constraints Management to deliver the highest degree of organizational performance.
IDEA is ready to show you how.
– Adapted from Lynn Boyd and Mahesh Gupta, “Operations and Production Management”, International Journal of Operations & Production Management, Vol. 24 No. 4, 2004