Oct 13, 2020 | BLOG
Taking the Theory of Constraints to the Next Level
The Theory of Constraints has been a factor in the manufacturing community since the 1980s. Today, there is a large community of consultants that advises manufacturing firms to focus on their ‘constraint operation.’ They base their approach on the work of the late Israeli physicist Eliyahu Goldratt and see his model as one the most important tenets of lean manufacturing.
Clearly, this group has identified an important truth regarding manufacturing productivity, however, we believe they are not taking their idea far enough. Let’s take a look at the theory and see where we can expand upon it to achieve far more benefit for manufacturers.
The central idea behind the Theory of Constraints is that a manufacturing process can be greatly improved when system constraints or bottlenecks are identified and improved. From this idea, a whole methodology has emerged for identifying and systematically resolving limiting constraints within manufacturing operations.
Essentially, the theory says that in a series of process steps, you need to find the one that’s the constraining operation and fix it so that your products are able to flow smoothly. If you do that, you will have addressed a problematic roadblock to your success and everything will be wonderful.
But there is a fatal flaw to this logic that neither Goldratt nor his followers have ever been willing to address. The issue is this: What if you address your system constraints and push things through your manufacturing plant more efficiently, but the market is not particularly interested in buying those things? Won’t you just end up with a big pile of inventory?
The answer to this question from the Theory of Constraints crowd is typically along these lines. “It’s not our problem if the market isn’t big enough. Then you have an external market constraint.”
At Profit Velocity, we have a different take on this challenge. We don’t just pay attention to the speed and efficiency with which you’re able to manufacture products. We also don’t just focus on the price your products generate per unit. We help you understand which products you make where you are able to do BOTH things well at the same time, thereby achieving high margins at high speed.
Once you’re able to rate how well all of your products do at producing margins at speed, the whole game changes. For the first time, you’re able to high-grade your product mix by shifting your focus to your most highly successful products. This is precisely what our analytics platform allows you to do.
Goldratt did not feel like a lot of financial analysis or accounting was necessary. For him and many of his followers, it’s all simply a matter of resolving the issue of the system constraint in your operations in order to increase manufacturing productivity. In our view, however, an ability to inject a financial perspective into the formula takes things to another level.
We believe there is a bigger issue at stake here. Unless you convert the physical flow rate of products being manufactured into dollars and cents, you are not able to communicate to the sales organization to focus on the products that are the most profitable. Our software enables us to make this call because it shows which product are generating the highest profits per hour. This is how we solve the disconnect between production and sales.
It’s worth pointing out that we are able to identify products that have high margins, but are not particularly interesting due to their slow production times. We call these ‘false profits.’ Likewise, we can identify products that we call ‘hidden winners’ because they have low margins but are in fact extremely worthwhile due to their fast production rate.
In our view, the means of communication from the production side to the sales side has to come from the finance organization. If you’re not actually providing detailed information in dollars and cents as to what is profitable and what is not profitable, you will always have a disconnect between what is going on in production and sales.
Sales and production organizations are vastly different. They are comprised of different types of people with very different backgrounds. They rarely see each other and when they do, they often do not see eye to eye. This is why it’s so important that finance be the intermediary between these two groups. Because money talks with both sales and production. And knowing which products are generating money fastest is critical information.
The Theory of Constraints is familiar to people in production because they focus on manufacturing productivity. Our goal is to elevate their message and extend it to the finance and sales teams as well. This is only possible when you broaden the conversation to talk about margins in addition to manufacturing efficiency. Once your finance and sales teams are able to see which products are yielding the highest margins at the highest speed, they will understand the supreme importance of adjusting your mix strategy to focus on creating and selling those products that have the biggest impact on your bottom line.
When you’re finally able to translate the lessons of the Theory of Constraints into financial metrics that are based on margins per hour instead of just production per hour, you’ll be able to get your whole team speaking the same language – and focusing on what matters most for growing profits across your company.