Theory of Constraints: How To Increase Operational Profitability For Manufacturers

Posted on February 22, 2018

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When you have multiple products, how do you know which one drives the most profit? Conventional wisdom would send you to cost accounting for the answer, where profitability is determined by subtracting cost from the per unit sales price to arrive at a per unit cash margin. Subtract operating expenses and you arrive at net profit. Simple, right? Yes, but not necessarily the best way to make decisions for your operation. Cost per unit fails as a standard against which to measure the most profitable product. Why? Because an operation’s cash generation is directly tied to how efficiently the most profitable products move through the primary bottleneck resource. And to know that metric, you have to take time into account – the one variable that matters most to manufacturers when it comes to profit-based decision making.

Enter the Theory of Constraints (TOC) developed by Eli Goldratt, which claims that any manageable system has a very small number of constraints that limit it from fully achieving its goals.[1] Using a focusing process to identify these constraints, organizations can restructure the rest of their operations around them. There is always at least one constraint, thus there is always a mechanism to improve the likelihood of success. TOC adopts the common idiom, "A chain is no stronger than its weakest link." Find the weakest link, and you find the lever to pull that will increase Economic Spread.

As Goldratt notes, cost accounting was a powerful solution to a significant problem when it was invented. But, like all solutions, it is not the ultimate solution. In a dynamic environment, yesterday’s solutions become tomorrow’s problems. TOC can serve as the solution for tomorrow’s challenges and is available today. For asset-intensive/complex manufacturing organizations with a significant number of products, what was once complex now becomes simple. To capture value, shift the focus from a “margin per unit” to a “dollar per minute” or “margin per minute” measurement. Follow the constraint; increase the profit.

Sustainably increase your Economic Spread and reduce your working capital—all without making a material change to your capital expense. By applying the Theory of Constraints – this simple, yet powerful, concept – to your operations, your company will experience these benefits.  Contact Venetia Partners to find out how your company can leverage TOC today.

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[1] Goldratt, E. M. 1990. The Haystack Syndrome: Sifting Information Out of the Data Ocean. New York: North River Press.