Theory of Constraints – A tool for Identification and optimum utilization of resources

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Introduction:
The manufacturing industries across the world utilize multiple resources like man-power, machines and raw materials vis-à-vis production. Although these resources are limited in supply, but one of them may pose a greater constraint in comparison to others. This constraint will be the bottleneck resource and the limiting factor. It prevents the optimum utilization of other available limited resources. If the resource is required in the production of more than one product, a decision has to be taken as to its allocation. The production management demands the optimum utilization of all the resources in generating maximum profits. It begins with identifying the bottleneck activity and scheduling the production, with focus on bottleneck activity and optimum utilization of bottleneck resource.
 
The “Throughput Accounting” which emerges from the “Theory of constraints”, helps in taking the optimal decision regarding production and product-mix.   

What is theory of constraints?

The understanding of theory of constraints was given by “Goldtratt and Cox”. It is applicable in the short run. It assumes that, material cost is the only variable cost, associated with sales and labour is also considered as fixed costs in the short run. The aim is to improve the profits of the organization by increasing the throughput of the plant by optimizing the bottleneck activity. There are three key operational measures used in theory of constraints:
 
1. Throughput (Sales – Material cost)
 
2. Operating Expenses (labour costs, other fixed and variable factory and other overheads) and 
 
3. Investments (facilities used in converting material into throughput such as building, plant and machinery, inventory etc. and research and development expenses). 

The aim is, to increase the throughput, minimize the investments and decrease operating expenses.

Key Measures in theory:

The theory of constraints focuses on three key measures:

1. Throughput: 

 

It is the rate of generating money in an organization through sales. The direct labour cost is used as fixed unit level expenses and is not included in the variable cost.

2. Investment: 

 

This is money associated with turning materials into throughput and do not have to be immediately expensed. 

3. Operating Expense: 

 

Money spent in turning investment into throughput and therefore, represent all other money that an organization spends.

Steps in theory of constraints:

This purpose of theory is achieved by the following steps.  1. To identify the bottleneck activity. 2. Ranking the products on the basis of contribution generated per unit use of bottleneck resource and to plan the product mix on the basis of this ranking.   3. Utilize all other resources subject to the bottleneck activity or resource, as per the production plan set in step 2 (supra). These other resources will remain idle and should be left so. If utilized to the fullest, work-in-progress inventory will pile up, thereby increasing the investments, which is not desirable.

4. Try to elevate the bottleneck resource or increase bottleneck efficiency and capacity. This may lead to some other constraint or resource now becoming the bottleneck resource of the system.
 
5. Repeat the process as a new constraint emerges as the bottleneck resource in the system. 
 
Product image
 

  Example:-  Malabar industries manufactures two products, Product X and Product Y. Both the products require processing over two Machines, Machine 1 and Machine 2. The total hours available for Machine 1 is 500 hours and that of Machine 2 is 650 hours. The demand for the products X and Y are 100 units each. The following table shows the selling price, contribution per unit and the no. of machine hours required of each machine in manufacturing one unit of the product.

Product

X

Y

Selling price per unit  (Rs.)

30

50

Contribution (Rs.)

10

15

Machine 1  (Hour per unit)

5

2

Machine 2  (Hour per unit)

2

5

Step 1: Identify the bottleneck activity/Resource:

 

 

M/c 1

M/c 2

Hours required

700

(5 × 100 + 2×100)

700

(2 × 100 + 5×100)

Hours available

500

650

Ratio

700/500

140%

700/650

107.69%

 

This shows that Machine 1 is the bottleneck activity.
 

Step-2: Ranking the products as per Machine 1:

 

 

Product X

Product Y

Contribution

10

5

Hours of M/c 1

5

2

Ratio

10/5

= 2

15/2

= 7.5

Rank

II

I

 

Step-3: Schedule the production of X and Y:

 

Since product Y is ranked 1, 100 units of Y will be made and the balance 300 hours will be utilized for making product X. Hence, 60 units of X can be manufactured. 

The hours utilized of machine II will be:100×5 +60 X 2 = 620 therefore 30 hrs of machine 2 will be idle.

 
Step-4: Elevate the hours of Machine 1 by say, for example 180 hrs. 
 
This can be done by installing additional smaller machine 1 or any other manner.
 
Identify the bottleneck activity/Resource once again:
 

 

M/c 1

M/c 2

Hours required

700

(5 × 100 + 2×100)

700

(2 × 100 + 5×100)

Hours available

680

650

Ratio

700/680

102.94%

700/650

107.69%

Now Machine 2 will be bottleneck. Step-5: Reschedule the production as per Machine 2. And optimize the production.

 

Disclaimer: The content/information published on the website is only for general information of the user and shall not be construed as legal advice. While the Taxmann has exercised reasonable efforts to ensure the veracity of information/content published, Taxmann shall be under no liability in any manner whatsoever for incorrect information, if any.

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