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### The Theory of Constraints

Overview of the Theory of Constraints

The theory of constraints essentially says that there is one choke point in a business that must be managed in order to control profitability. This choke point, which is also known as a bottleneck or constraint, must be carefully managed to ensure that it is operational as close to all of the time as possible. If not, then profitability will suffer.

The theory of constraints completely contravenes the more traditional view of running a business, where all operations are optimized to the greatest extent possible. Under the constraints view, optimizing all operations only means that it is easier to generate more inventory that will pile up in front of the bottleneck operation, without profits increasing. Thus, widespread optimization merely leads to the creation of more inventory, rather than more profits.

Example of a Constrained Operation

A tractor company finds that its bottleneck operation is its paint shop. Painting operations can only proceed at a certain pace, so the company can only run 25 tractors per day through the facility. If the company were to produce more engines, the engines would not contribute to more tractors being built; there would only be an increase in the number of engines in storage, which increases the cost of working capital.

The CEO of the company finds that, since the number of tractors produced per day is limited to 25, his next best activity is to cut back production in all other areas if they are producing more parts than are needed for 25 tractors. Thus, it is better to not optimize in many parts of the business, since there is no need for more parts.

Inventory Buffers

As noted earlier, it is critical to ensure that the constrained operation is running at maximum capacity, all the time. An excellent tool for achieving this goal is to build up an inventory buffer directly in front of the bottleneck operation. This buffer ensures that any shortfall in the flow of parts from anywhere upstream of the bottleneck will not impede the process flow through the constraint. Instead, the inventory buffer will merely fluctuate in size as it is used and then replenished.

The existence of upstream production problems can also be mitigated by installing extra sprint capacity in the upstream production areas, as discussed next.

Sprint Capacity

Sprint capacity is an excess amount of production capacity that is assembled in the work stations that are positioned upstream from the constraint operation. Sprint capacity is needed when the inevitable production failure occurs, and the flow of parts to the bottleneck is halted. During this period, the bottleneck instead uses parts from its inventory buffer, which is therefore depleted. The extra sprint capacity is then used to produce an extra-large quantity of parts to rebuild the inventory buffer, in preparation for the next period of production downtime.

If there is a large amount of sprint capacity incorporated into a production system, then there is less need to invest in a large inventory buffer, since the extra capacity can rebuild the buffer in short order. If there is less sprint capacity, then a larger inventory buffer is needed.

A key point in regard to sprint capacity is that a business should maintain excess capacity in its upstream work areas, rather than paring down its production capacity to a level that just meets its ongoing needs. This means that selling off what may appear to be excess equipment is not always a good idea.

Podcast

A discussion of throughput concepts is available on Episodes 43 through 47 of the Accounting Best Practices podcast.

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