THEORY OF CONSTRAINTS

Theory of Constraints is a broadly applicable approach to managing business operations

within an organization. Basically, the theory of constraints is a management philosophy
designed to help organizations achieve their goals.

The idea is to identify the goals of the organization, identify the factors that hinder the
achievement of those goals, and then improve the business operations by continuously
striving to mitigate or eliminate the limiting factors.

The limiting factors are called bottlenecks or constraints. At any given time, an
organization is faced with at least one constraint that limits business operations. Typically,
as one constraint is eliminated another constraint will arise. The organization should then
focus its attention on the new constraint. And this process repeats itself continuously.

According to the theory of constraints, the best way for an organization to achieve its
goals is to reduce operating expenses, reduce inventory, and increase throughput. The
theory of constraints includes three core principles, six steps for implementation, and a
five step thinking process.

The theory of constraints was formalized and introduced by Dr Eliyahu Goldratt in the
1980s in his book The Goal. Goldratt subsequently published other books and gave
seminars and workshops on the theory of constraints. Also, other papers and books have
been written about the theory of constraints by other authors.

Theory of Constraints Core Principles

The theory of constraints has three principles. These three principles are: convergence,
consistency, and respect.

The convergence principle implies that a complex system is simpler to manage because
an adjustment or correction to one aspect of the system will impact the whole system.
The consistency principle implies that any internal conflict must be the result of at least
one flawed assumption. And the respect principle implies that humans are inherently
good and deserving of respect even when they make mistakes.

Theory of Constraints 6 Step Implementation

There are six steps for implementing the theory of constraints. The first one is to identify a
measurable goal. This is typically defined as throughput, or the amount of products or
services produced and sold to customers. Basically, the goal is some concrete objective
that involves the company’s success and profitability.

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The second step is to identify the bottleneck. This is any constraint that limits the
production process. The constraint can be internal, such as a flaw or shortcoming in the
production process, or it can be an external hindrance, such as a competitor or some
other influential market force.

The third step is to exploit the bottleneck. This means making sure the bottleneck is being
put to its most profitable use. If the bottleneck is some slow machine that cranks out two
types of products, a very profitable product and a less profitable product, you should
make sure the machine is always working on the more profitable product.

The fourth step is to subordinate all other factors in the operation to the bottleneck. This
means optimizing the production process to the pace of the bottleneck. If the production
process involves three machines, one can crank out 10 products per hour, another can
crank out 20 products per hour, and the third can only crank out 3 products per hour,
then you must operate the first to machines so they produce only 3 products per hour to
keep pace with the bottleneck machine. This reduces excess inventory.

The fifth step is to increase the capacity of the bottleneck. For example, referring to the
previous paragraph, if the bottleneck can only produce 3 products per hour, then you
should try to increase that output rate. Perhaps by outsourcing that phase of production,
or by purchasing two more of those machines to increase output. Basically, you’ve
identified the constraint, and this is the step where you mitigate or eliminate it – alter the
process so this factor is no longer a constraint.

And the sixth step is to start the process over with the next bottleneck. There is always at
least one factor limiting the process. When you successfully manage that factor, another
bottleneck will arise as the constraint. Implementing the theory of constraints method of
process improvement is a never-ending endeavor.

TOC Six Steps

Below is the TOC six steps:

1. Identify the goal

2. Identify the constraint
3. Exploit the constraint
4. Subordinate operations to the constraint
5. Increase constraint capacity
6. Repeat with a new constraint

Theory of Constraints Thinking Process

The theory of constraints also includes a 5-step theory of constraints thinking process
designed to organize the thought process involved in approaching a bottleneck and
trying to resolve the problem relating to the constraint.

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The five steps are as follows:

First, the people involved must agree on the problem. That is, they must all agree which
factor is the bottleneck.

Second, the people involved must agree on what sort of solution is required. This could
be something like increasing the output of machine number three in the production
process.

The third step is to get everyone to agree that the solution will resolve the problem. That
is, the proposed solution is the correct action for eliminating the bottleneck in question.

The fourth step is to look past potential negative ramifications of the process.

Finally, the fifth step is to overcome any hindrances to the implementation of the solution
to the problem.

Theory of Constraints Benefits

There are several benefits to Goldratt’s theory of constraints. It is an organized way to

approach a business operation and to try to improve it. TOC takes the analytical and
diagnostic process and lays it out into a step-by-step procedure.

Also, the theory of constraints allows the managers involved in the process to focus on
the constraints in the process. It is a way to galvanize efforts and energies and to focus
attention on a single aspect of the process with the intention of correcting a clear
problem to arrive at a clear solution.

Also, the organization that adopts and implements the theory of constraints will be
continuously striving for process improvement. This is a way to ward of inertia and
complacency and will most likely result in operations that continue to get more efficient
and more productive and more profitable over time.

Theory of Constraints Criticisms

Some criticisms of Goldratt’s theory of constraints include the idea that Goldratt himself
treats the theory as a product to sell and he acts as a salesman. Also, some say Goldratt’s
theory of constraints borrows ideas and concepts from previous studies and theories, but
Goldratt does not acknowledge these contributions to his theory.

ENVIRONMENTAL MANAGEMENTACCOUNTING

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Introduction

Environmental management accounting (EMA) focuses on the efficient use of

resources, and the disposal of waste and effluent.

The importance of considering environmental costs

If a company is wasteful in its use of resources, or alternatively causes pollution, then this
impacts inthree ways:

(1) there is the direct cost to the company of spending more than is needed on
resources, orhaving to spend money cleaning up the pollution

(2) there is the damage to the reputation of the company – consumers are
becoming more andmore environmentally aware

(3) there are possible fines or penalties as a result of breaking environmental regulations.

For all of the above reasons it is important for the company to attempt to identify and
to managethe various costs involved.

Typical environmental costs

The cost that comes to the mind of most people immediately are those relating to
dealing with waste. However there are many other costs that are likely to be just as
important. For example:
The amount of raw materials used in production. A publisher should consider ways of
using less paper (or recyclable paper) as a way of saving costs for themselves as
well as helping the environment.
Transport costs. Consideration of alternative ways of delivering goods could perhaps
reduce costsand reduce the impact on the environment.

Water and energy consumption. EMA may help to identify inefficiencies and wasteful practices
and, therefore, opportunities for cost savings.

Different methods of accounting for environmental costs

Although you cannot be required to perform any calculations for this section of the

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syllabus, youshould be able to explain briefly four methods that have been suggested
as ways of accounting forenvironmental costs.
(a) Inflow / Outflow analysis
This approach balances the quantity of resources that is input with the quantity that is
output either as production or as waste. Measuring these in physical quantities and
in monetary terms forces the business to focus on environmental costs. (Resources
includes not simply raw materials but also energy and water. i.e. all resources)

Flow cost accounting

This is really inflow/outflow analysis (as described above) but instead of applying
simply tothe business as a whole, it takes into account the organisational structure.
Resources inputinto the business are divided into three categories:
Material: the resources used in storing raw materials and in production
System: the resources used in (for example) storing production and quality control
Delivery and disposal: resources used in delivering to the customer and in disposing
of any waste.
As in (a), the aim is to reduce the quantities of resources used, which saves costs for
the company and leads to increased ecological efficiency.
Lifecycle costing
This has been discussed earlier. The relevance to EMA is that it is important toinclude
environmentally driven costs such as the costs of disposal of waste. It may be possible
to design-out these costs before the product is launched.
Environmental Activity Based Costing
Activity Based Costing has been discussed in an earlier chapter. Its application
to environmental costs is that those costs that are environment-related (e.g. costs
related to asewage plant) are attributed to joint environmental cost centres.
As with ABC in general, this focusses more attention on these costs and potentially
leads togreater efficiency and cost reduction.

KAIZEN COSTING

Definition: Kaizen is a Japanese term which means “continuous improvement” on which

Lean Manufacturing System is based. It refers to the continuous improvement and
examination program constantly going on in the organization that stresses on the
effective waste management, during the manufacturing process, as a result of which
costs is further reduced below the initial standards stipulated at the time of designing the
product.

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In this technique, incremental improvements are made to the product undergoing
production process, continuous reduction in production cost and constant improvement
in designing and developing the product.

In finer terms, the Kaizen Costing is the sustenance of existing cost levels for the products
under the manufacturing process by way of collective efforts to attain the intended cost
level.

Kaizen Costing aims at eliminating wastes and losses in the process of production,
assembly and distribution, along with removing the unnecessary steps during these
processes and implementing economic re-designs for the product. Thus, it reduces extra
costs at each stage.

Kaizen Costing Principles

1. Continuous improvements in the present situation, at an agreeable cost.

2. No limits to the improvement level that has to be implemented.
3. Advocates collective decision making and knowledge application.
4. Concentrates on waste or loss elimination, system and productivity improvement.
5. Establishing standards and then continually working on improving them.
6. Participating all employees and covering every business area, i.e. all the levels,
departments and units.

The primary assumption behind Kaizen Costing is that nothing is perfect, so there is always
a room for improvements and reductions in the variable costs. So, slight, additional
changes are regularly applied and maintained during the production stage of the
product life cycle, over a long period, leading to substantial improvements.

Types of Kaizen Costing

 Asset-Oriented or Organization-oriented: Kaizen costing activities are planned

and directed as per the requirement of the firm or deal.
 Product-Oriented: Kaizen costing activities are undertaken in specialised projects
with great focus on value analysis.

Kaizen Costing is laid out to redo many value engineering steps until the production of
the product continues and constantly working on upgrading the process and thus
eliminating the extra costs. However, the cost reduction arising from Kaizen costing is
quite less than those attained with value engineering.

Nevertheless, Kaizen Costing is still essential for the organization as competitive pressures
will force the firms to reduce the price of the product over time and any possible savings
in the costs facilitate in achieving the intended profit margins while continually working
on reducing cost.

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Hence, in Kaizen Costing method ensures production of a product while meeting the
desired quality, usability, customer satisfaction and reasonable price, to maintain its
competitiveness.

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