57. The Theory of Constraints

Question 1

Describe the three basic problems with inventory (cost, quality, timeliness).

Answer 1

• Cost: Economic holding costs occur because of money tied up in unsold inventory; out-of-pocket costs are incurred to move, store, and secure the inventory; and shrinkage cost exists if inventory is lost, damaged, or becomes obsolete.
• Quality: Quality problems are hidden in the inventory pile, and continue until discovered when the inventory is used.
• Timeliness: In addition to production time, inventory must also “sit in line” waiting for production, which results in delayed or lost sales

Question 2

What is the core difference between theory of constraints (TOC) and just-in-time (JIT) management systems?

Answer 2

The core difference is that TOC identifies the bottleneck in the organization and uses it as the focus to coordinate the whole system. Optimizing the system is based on being sure that the bottleneck operation is always working at full capacity. Part of the optimization process includes keeping a buffer of inventory in front of the bottleneck. In contrast, JIT seeks to remove all inventory everywhere.

Question 3

Briefly describe the three parts of the drum-buffer-rope system used by the theory of constraints (TOC).

Answer 3

• Drum: The drum indicates the current pace of the bottleneck to downstream processes so that output from the bottleneck is anticipated and handled as perfectly as possible.
• Buffer: The purpose of buffer inventory is never to let the bottleneck stand idle waiting for upstream operations to catch up.
• Rope: The rope represents constraints placed on upstream operations so they don’t overwhelm the bottleneck operation with so much inventory that cost, quality, and timeliness problems become an issue.

Question 4

What is the five-step TOC process to optimize the organization’s true capacity and create throughput value by focusing on the bottleneck?

Answer 4

• Identify the constraint. Determine whether the constraint is an internal process, internal policy, external material, or external market constraint.
• Determine how to exploit the constraint. Maximize bottleneck’s moneymaking capacity by prioritizing on most valuable products.
• Subordinate all other operations to the constraint. Coordinate efforts to keep the constraint operating at full capacity.
• Elevate the constraint. Increase the capacity of the constraint.
• When the constraint is broken, go back to Step 1. Shift focus to the new bottleneck once the constraint shifts.

Question 5

Briefly describe the three critical accounting terms (throughput, inventory, and operational expense) as they relate to throughput accounting.

Answer 5

• Throughput: Throughput is computed as revenue minus extremely variable costs.
• Inventory: Inventory represents all the money tied up in the production system. Labor and overhead costs are not allocated to inventory, but are immediately expensed to the income statement.
• Operational expense: Operational expense represents all costs other than raw materials that are used to convert inventory into throughput, including labor costs. These costs are treated as fixed expenses and are immediately expensed to the income statement.