Outline

 What is Statistical Process Control

 Variability
 Control Charts
 Process Capability Cp
 Measuring Instruments
 Repeatability & Reproducibility
Statistical Process Control (SPC)
 Invented by Walter Shewhart at Western
Electric
 Distinguishes between
 common cause variability (random)
 special cause variability (assignable)
 Based on repeated samples from a
process
Statistical Process Control (SPC)
 A methodology for monitoring a process
to identify special causes of variation
and signal the need to take corrective
action when appropriate
 SPC relies on control charts
Variability 8
7
 Deviation = distance between 10
8
observations and the mean (or average) 9

Emmett

Observations Deviations
10 10 - 8.4 = 1.6
9 9 – 8.4 = 0.6
8 8 – 8.4 = -0.4
8 8 – 8.4 = -0.4
7 7 – 8.4 = -1.4 Jake
averages 8.4 0.0
Variability
 Deviation = distance between
observations and the mean (or average)
Emmett

Observations Deviations
7 7 – 6.6 = 0.4 7
7 7 – 6.6 = 0.4 6
7 7 – 6.6 = 0.4 7
6 6 – 6.6 = -0.6 7
6 6 – 6.6 = -0.6
6 Jake
averages 6.6 0.0
Variability 8
7
10
 Variance = average distance between
8
observations and the mean squared 9

Emmett

Observations Deviations Squared Deviations

10 10 - 8.4 = 1.6 2.56
9 9 – 8.4 = 0.6 0.36
8 8 – 8.4 = -0.4 0.16
8 8 – 8.4 = -0.4 0.16
7 7 – 8.4 = -1.4 1.96 Jake
averages 8.4 0.0 1.0
Variance
 Variability
 Variance = average distance between
observations and the mean squared
Emmett

Observations Deviations Squared Deviations

7 7
7 6
7 7
6 7
6
6 Jake
averages
 Variability
 Variance = average distance between
observations and the mean squared
Emmett

Observations Deviations Squared Deviations

7 7 - 6.6 = 0.4 0.16 7
7 7 - 6.6 = 0.4 0.16 6
7 7 - 6.6 = 0.4 0.16 7
6 6 – 6.6 = -0.6 0.36 7
6 6 – 6.6 = -0.6 0.36
6 Jake
averages 6.6 0.0 0.24 Variance
Variability
 Standard deviation = square root of variance

Emmett

Variance Standard Deviation

Emmett 1.0 1.0
Jake 0.24 0.4898979

Jake
Variability
The world tends to be bell-shaped

Even very rare Most outcomes Even very rare

outcomes are occur in the outcomes are
Fewer Fewer
possible in the
middle in the
possible
(probability > 0) “tails” “tails” (probability > 0)
(lower) (upper)
Variability
Even outcomes that are equally likely (like dice),
Here is why: when you add them up, become bell shaped
“Normal” bell shaped curve
Add up about 30 of most things
and you start to be “normal”

Normal distributions are divide

up into 3 standard deviations
on each side of the mean

Once your that, you know a lot

about what is going on
Causes of Variability
 Common Causes:
 Random variation (usual)
 No pattern
 Inherent in process
 adjusting the process increases its variation
 Special Causes
 Non-random variation (unusual)
 May exhibit a pattern
 Assignable, explainable, controllable
 adjusting the process decreases its variation
3 Sigma and 6 Sigma Quality
Lower Upper
specification specification

1350 ppm 1350 ppm

1.7 ppm 1.7 ppm

Process
mean
+/- 3 Sigma

+/- 6 Sigma
Statistical Process Control
 The Control Process
 Define
 Measure
 Compare
 Evaluate
 Correct
 Monitor results
 Variations and Control
 Random variation: Natural variations in the output of
a process, created by countless minor factors
 Assignable variation: A variation whose source can
be identified
Sampling Distribution
Sampling
distribution

Process
distribution

Mean
Normal Distribution

  Standard deviation

   

Mean
95.44%

99.74%
Control Limits
Sampling
distribution

Process
distribution

Mean

Lower Upper
control control
limit limit
SPC Errors
 Type I error
 Concluding a process is not in control when
it actually is.
 Type II error
 Concluding a process is in control when it is
not.
Type I Error

/2 /2

Mean

  Probability LCL UCL

of Type I error
Observations from Sample
Distribution
UCL

LCL

1 2 3 4
Sample number
Control Chart
 Control Chart
 Purpose: to monitor process output to see if
it is random
 A time ordered plot representative sample
statistics obtained from an on going process
(e.g. sample means)
 Upper and lower control limits define the
range of acceptable variation
Control Chart
Abnormal variation Out of
due to assignable sources control
UCL

Mean
Normal variation
due to chance
LCL
Abnormal variation
due to assignable sources

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Sample number
Control Charts in General
 Are named according to the statistics
being plotted, i.e., X bar, R, p, and c
 Have a center line that is the overall
average
 Have limits above and below the center
line at ± 3 standard deviations (usually)
Upper Control Limit (UCL)
Center line

Lower Control Limit (LCL)

Histograms do not take into
account changes over time.

Control charts can tell

us when a process
changes
Control Chart Applications
 Establish state of statistical control
 Monitor a process and signal when it
goes out of control
 Determine process capability
Commonly Used Control Charts
 Variables data
 x-bar and R-charts
 x-bar and s-charts
 Charts for individuals (x-charts)
 Attribute data
 For “defectives” (p-chart, np-chart)
 For “defects” (c-chart, u-chart)
Developing Control Charts
 Prepare
 Choose measurement
 Determine how to collect data, sample size,
and frequency of sampling
 Set up an initial control chart
 Collect Data
 Record data
 Calculate appropriate statistics
 Plot statistics on chart
Next Steps
 Determine trial control limits
 Center line (process average)
 Compute UCL, LCL
 Analyze and interpret results
 Determine if in control
 Eliminate out-of-control points
 Recompute control limits as necessary
Limits
 Process and Control limits:
 Statistical
 Process limits are used for individual items
 Control limits are used with averages
 Limits = μ ± 3σ
 Define usual (common causes) & unusual
(special causes)
 Specification limits:
 Engineered
 Limits = target ± tolerance
 Define acceptable & unacceptable
Process vs. control limits
Distribution of averages
 Variance
of Control limits
Specification limits
averages
<
variance
of
individual
Distribution of individuals
items
Process limits
Variables Data Charts
 Process Centering n

 X bar chart X i

 X bar is a sample mean X i 1

 Process Dispersion (consistency)

 R chart
 R is a sample range R  max( X i )  min( X i )
X bar charts
 Center line is the grand mean (X double
m
bar)
 Xj
 Points are X bars  x   / n j 1
X
m
UCL  X  z x LCL  X  z x
-OR-

UCL  X  A2 R LCL  X  A2 R
R Charts
 Center line is the grand mean (R bar)
 Points are R
 D3 and D4 values are tabled according
to n (sample size)

UCL  D4 R LCL  D3 R
Use of X bar & R charts
 Charts are always used in tandem
 Data is collected (20-25 samples)
 Sample statistics are computed
 All data are plotted on the 2 charts
 Charts are examined for randomness
 If random, then limits are used “forever”
Attribute Charts
 c charts – used to
count defects in a n

c
constant sample c i 1
m
 centerline

size
LCL  c  z c

UCL  c  z c
Attribute Charts
 p charts – used to
track a proportion
(fraction) defective
m

p x n

x
p j 1
  centerline
i
ij p 
i
i 1
n
m nm

p(1  p ) p(1  p)
UCL  p  z LCL  p  z
n n
Control Charts for Variables
 Mean control charts
 Used to monitor the central tendency of a
process.
 X bar charts
 Range control charts
 Used to monitor the process dispersion
 R charts
Variables generate data that are measured.
Mean and Range Charts
(process mean is
shifting upward)
Sampling
Distribution

UCL

x-Chart Detects shift

LCL

UCL

Does not
R-chart
detect shift
LCL
 Mean and Range Charts

Sampling
Distribution (process variability is increasing)

UCL

x-Chart Does not

LCL
reveal increase

UCL

R-chart Reveals increase

LCL
Control Chart for Attributes
 p-Chart - Control chart used to monitor
the proportion of defectives in a process
 c-Chart - Control chart used to monitor
the number of defects per unit

Attributes generate data that are counted.

Use of p-Charts
 When observations can be placed into
two categories.
 Good or bad
 Pass or fail
 Operate or don’t operate
 When the data consists of multiple
samples of several observations each
Use of c-Charts
 Use only when the number of
occurrences per unit of measure can be
counted; non-occurrences cannot be
counted.
 Scratches, chips, dents, or errors per item
 Cracks or faults per unit of distance
 Breaks or Tears per unit of area
 Bacteria or pollutants per unit of volume
 Calls, complaints, failures per unit of time
Use of Control Charts
 At what point in the process to use
control charts
 What size samples to take
 What type of control chart to use
 Variables
 Attributes
Run Tests
 Run test – a test for randomness
 Any sort of pattern in the data would
suggest a non-random process
 All points are within the control limits -
the process may not be random
Nonrandom Patterns in Control
charts
 Trend
 Cycles
 Bias
 Mean shift
 Too much dispersion
Typical Out-of-Control Patterns
 Point outside control limits
 Sudden shift in process average
 Cycles
 Trends
 Hugging the center line
 Hugging the control limits
 Instability
Shift in Process Average
Identifying Potential Shifts
Cycles
Trend
Final Steps
 Use as a problem-solving tool
 Continue to collect and plot data
 Take corrective action when necessary
 Compute process capability
Process Capability
 Tolerances or specifications
 Range of acceptable values established by
engineering design or customer
requirements
 Process variability
 Natural variability in a process
 Process capability
 Process variability relative to specification
Process Capability
Lower Upper
Specification Specification

A. Process variability
matches specifications
Lower Upper
Specification Specification

B. Process variability
Lower Upper
well within specifications Specification Specification

C. Process variability
exceeds specifications
Process Capability Ratio

specification width
Process capability ratio, Cp =
process width

Cp = Upper specification – lower specification

6

57
Improving Process Capability
 Simplify
 Standardize
 Mistake-proof
 Upgrade equipment
 Automate
Taguchi Loss Function

Traditional
cost function
Cost

Taguchi
cost function

Lower Target Upper

spec spec
Limitations of Capability Indexes
 Process may not be stable
 Process output may not be normally
distributed
 Process not centered but Cp is used
Process Capability
 The ratio of process
Text Text Text Text Text Text

variability to design Natural data

specifications spread
Title

The natural
-3σ -2σ - µ +1σ +2σ +3σ spread of the
1σ data is 6σ
Lower Upper
Spec Spec
Empirical Rule

-3 -2 -1 +1 +2 +3

68%

95%

99.7%
Gauges and
Measuring Instruments
 Variable gauges
 Fixed gauges
 Coordinate measuring machine
 Vision systems
Examples of Gauges
Metrology - Science of
Measurement
• Accuracy - closeness of agreement
between an observed value and a
standard
• Precision - closeness of agreement
between randomly selected individual
measurements
Repeatability and Reproducibility
 Repeatability (equipment variation) –
variation in multiple measurements by
an individual using the same instrument.
 Reproducibility (operator variation) -
variation in the same measuring
instrument used by different individuals
Repeatability and
Reproducibility Studies
 Quantify and evaluate the capability of a
measurement system
 Select m operators and n parts
 Calibrate the measuring instrument
 Randomly measure each part by each
operator for r trials
 Compute key statistics to quantify
repeatability and reproducibility
Reliability and Reproducibility
Studies(2)
M easurement (M ) made by
Operators (i from 1 to m) on
Parts (j from 1 to n) in
Trials (k from 1 to r)
 
  M ijk 
 
xi   j k  average for each operator
nr
xD  max ( xi )  min ( xi ) difference (range) of operator averages
i i

R ij  max ( M ijk )  min ( M ijk ) range for each part for each operator
k k

 
  Rij 
 
Ri   j  average range for each operator
n
 
  Ri 
R  i  average range of all
m
Reliability and Reproducibility Studies(3)

Control limit of ranges Rij  D4  R

Use number trials (r) for n in table. Check
for randomness of errors.
Repeatability or Equipment Variation
EV  K1  R K1 is a constant tied to # of trials
Reproducibility or operator (appraisal) variation
 EV 2 
AV  K 2  xD     K 2 is a constant tied to # of operators
2

 n  r 
Repeatability and Reproducibility
R&R  EV 2   AV 2

Results are in actual units measured. Customary to express

as percentages.
Under 10% - Acceptable
10 - 30% - ? based on importance and repair cost
Over 30% - Unacceptable
R&R Constants

Number of Trials 2 3 4 5

K1 4.56 3.05 2.50 2.21

Number of Operators 2 3 4 5

K2 3.65 2.70 2.30 2.08

R&R Evaluation
 Under 10% error - OK
 10-30% error - may be OK
 over 30% error - unacceptable
R&R Example
 R&R Study is to be conducted on a
gauge being used to measure the
thickness of a gasket having
specification of 0.50 to 1.00 mm. We
have
x  0.830
1

x  0.774
three operators, each taking
2

xmeasurement
3 0.829 on 10 parts in 2 separate
trials.

R1  0.037
R2  0.034
R3  0.017
Calibration
 Calibration - comparing a measurement
device or system to one having a known
relationship to national standards
 Traceability to national standards
maintained by NIST, National Institute of
Standards and Technology
Calibration Quiz

 Calibration - comparing a measurement

device or system to one having a known
relationship to national standards
 Traceability to national standards
maintained by NIST, National Institute of
Standards and Technology

Click the Quiz button to edit this quiz

Outline
1. Introduction to Constraints
2. Five Steps Of Theory of Constraints
3. Drum Buffer Rope
4. Issues with TOC
5. Measurements & Financial Issues
Constraints
 Any system can produce only as much as its
critically constrained resource

Constraint

60 units 70 units 40 units 60 units

Per day Per day Per day Per day

Maximum Throughput = 40 units per day

Significance of Bottlenecks
 Maximum speed of the process is the
speed of the slowest operation
 Any improvements will be wasted unless
the bottleneck is relieved
Theory of Constraints
 Purpose is to identify constraints and
exploit them to the extent possible
 Identification of constraints allows
management to take action to alleviate the
constraint in the future
Theory of Constraints
 Assumes current constraints cannot be
changed in the short-run
 What should be produced now, with current
resources, to maximize profits?
○ Question cannot be answered by traditional
accounting methods
Theory of Constraints
 Based on the concepts of drum, buffer
and ropes
 Drum
○ Output of the constraint is the drumbeat
 Sets the tempo for other operations

 Tells upstream operations what to produce

 Tells downstream operations what to expect

Theory of Constraints
 Buffer
○ Stockpile of work in process in front of
constraint
 Precaution to keep constraint running if upstream operations are
interrupted

 Ropes
○ Limitations placed on production in upstream
operations
 Necessary to prevent flooding the constraint
Do we really want or need another new theory?

“The significant problems we face today

can not be resolved at the same level of
thinking we were at when we created
them.”
- Einstein
What is the Theory of Constraints?

“The core idea in the Theory of Constraints

is that every real system such as a
profit-making enterprise must have at
least one constraint”.
What is TOC? (continued)

“There really is no choice in the matter.

Either you manage constraints or they
manage you. The constraints will
determine the output of the system
whether they are acknowledged and
managed or not”

Noreen, Smith, and Mackey, The Theory of Constraints and its Implecations for Management Accounting (North River Press, 1995)
How does TOC help companies?

1. Focusing improvement efforts where

they will have the greatest immediate
impact on the bottom line.

2. Providing a reliable process that

insures Follow Through!
Five Steps Of TOC
1. Identifying the constraint

2. Decide how to exploit the constraint

3. Subordinate everything else to the

decision in step 2

4. Elevate the constraint

5. Go back to step 1, but avoid inertia

 Theory of Constraints
2. Identify the 3. Use bottlenecks
bottlenecks properly

1. Identify the 4. Synchronize all

appropriate other processes to
measures of value the bottlenecks

6. Avoid inertia and 5. Increase the

return to Step #1 bottleneck’s capacity
Steps in the TOC Process
Identify the system constraints

 Internal  External
 Material constraints
 Process constraints
○ Insufficient materials
○ Machine time, etc.
 Market constraints
 Policy constraints
○ Insufficient demand
○ No overtime, etc.
Steps in the TOC Process
 Decide how to exploit the constraint
 Want it working at 100%

 How much of a buffer?

Steps in the TOC Process
 Subordinate everything else to the
preceding decision
 Plan production to keep constraint working
at 100%
 May need to change performance measures
to “rope” upstream activities
Steps in the TOC Process
 Elevate the constraint
 Determine how to increase its capacity

 Repeat the process

 Always a new constraint
Drum Buffer Rope
 Drum-Buffer-Rope for Process Control
 Drum: The Pace Setting Resource - constraint
 Buffer: The amount of protection in front of the
resource
 Rope: The scheduled staggered release of
material to be in line with the Drum’s schedule.
A Pull System Buffer

60 70 40 60

Rope Constraint
(Drum)
Lean: How DBR Supports it
Fundamentally, Don’t Build Until Needed

 Overproduction avoided because DBR is “pull”

system
 Inventory minimized because only buffer at
constraint
 Transportation reduced because “unbuilt material”
doesn’t move
 Processing waste minimized because “unbuilt
material”
 Unnecessary Motion decreased because don’t build
unneeded
 Waiting is eliminated at the constraint –only place
that counts
 Defects avoided because of “small lot”, non
conformance, and corrective action
Issues with TOC
 Constraining resource must be
maximized
 All other operations must be geared toward
this goal
○ May require suboptimization in other areas
Issues with TOC
 Upstream operations must provide only what
the constraint can handle
 Downstream operations will only receive
what the constraint can put out
 Constraint must be kept operating at its full
capacity
○ If not, the entire process slows further
Issues with TOC

 Advantages
 Improves capacity decisions in the short-run

 Avoids build up of inventory

 Aids in process understanding

 Avoids local optimization

 Improves communication between departments
Issues with TOC
 Disadvantages
 Negative impact on non-constrained areas
○ Diverts attention from other areas that may be
the next constraint
○ Temptation to reduce capacity
Issues with TOC

 Ignores long-run considerations

 Introduction of new products
 Continuous improvement in non-constrained
areas
 May lead organization away from strategy
 Not a substitute for other accounting
methods
Financial Issues: Finding the Goal

Before a company can properly focus,

one necessary condition is that they
answer the following question:

 What is the Goal of a for profit enterprise?

The Goal?

 To make more money now and in the

future!
The Goal
Some would argue that the goal of their
company is to…

 To satisfy customers now and in the

future!
Or to..
 Provide satisfying jobs now and in the
future!
The Goal
TOC recognizes that only the “owners” of a company can choose THE
goal. However, once chosen, the other 2 become conditions necessary
to achieving the goal.

Make money now

and in the Future

Satisfy customers Satisfy employees

now and in the future. now and in the future
The Goal
That is…
 If your goal is to satisfy customers, it is
absolutely necessary that you make
money and that you satisfy employees…
 Likewise, if your goal is to satisfy
employees, you also have to make
money and satisfy your customers…
…or you won’t be in business in the
future!
The Goal

The choice is yours, choose any of the

three as the goal of your organization.

For the duration of this presentation, we

will assume that the goal is:
 To make more money now and in the
future!
Measuring Progress

Once the Goal is identified, one

necessary condition to success in
achieving the goal is to identify which
measurements will be used to judge
progress.
Measurements
Conventional Wisdom
 Net profit?
 Efficiency?
 Utilization?
 Return on Investment?
 Cash Flow?

“Are you using the right measurements?”

Jonah in The Goal
Measurements

TOC Wisdom
 Throughput
 Inventory
 Operating Expense
Throughput (“T”)
The rate at which the system generates
money through sales. (Or, the money
coming into the organization.)
 Building inventory is not throughput
 Only $ generated by the system get
counted; e.g., raw materials and
purchased parts are not throughput.
 T = Selling Price - Materials
Inventory (“I”)
All the money the system has invested
in purchasing things which it intends to
sell.

 Inventory is a liability (not an asset)

 Raw materials, work in process, finished
goods and scrap are “I”
Operating Expense (“OE”)
All the money the system spends in
order to turn inventory into throughput.
(Or, the money coming into the
organization.)
 All employee time is “OE” (direct,
indirect, operating, etc.)
 Depreciation of a machine is “OE”
 Operating supplies are “OE”
Financial Links
“Wait a minute” someone exclaims. “If I
monitor Throughput, Inventory, and
Operating Expense in the short term,
how can I be sure that I will have a
Profit, with a reasonable Return On
Investment in the long term, and
maintain a positive Cash Flow?”
Financial Links (continued)

Question 1: If we can increase “T” while

maintaining level “I” and level “OE, what
will the impact be on Net Profit, ROI and
Cash Flow?
If…
T I OE
Then...
NP ROI CF
Financial Links (continued)

Question 2: If we can decrease “I” while

maintaining level “T” and level “OE”,
what will the impact be on Net Profit,
ROI, and Cash Flow?
If…
T I OE
Then...
NP ROI CF
Financial Links (continued)

Question 3: If we can decrease “OE” while

maintaining level “T” and level “I”, what
will the impact be on Net Profit, ROI, and
Cash Flow?
If…
T I OE
Then...
NP ROI CF
Financial Links (continued)

 So the answers to these 3 questions

show that by determining the impact that
an action will have now on Throughput,
Inventory, and Operating Expense we
will know the future impact on Net Profit,
ROI, and Cash Flow.
Financial Links (continued)
Question 4: What about Inventory?
Because it has no direct impact on Net
Profit, it would seem to be less powerful
at impacting the bottom line.
Even though when…
I
There is no Direct impact on...

NP
Financial Links (continued)
However, reducing Inventory levels does
also reduce some operating expenses.

If… Then...
Carrying
I Costs
Financial Links (continued)

And…

If… Carrying
Costs
Then...
NP ROI CF
Financial Links (continued)
Therefore, there is an indirect link…
If… Then…
I NP
And since we already saw that a reduction
in inventory causes a direct increase in
ROI and Cash Flow, we can see that
reducing inventory has a significant
financial impact.
Financial Links (continued)
 Throughput, Inventory, and Operating
Expense are valuable operational
measures that can be used to guide our
decisions.

 The next question must be: Which of

these 3 is the most important -- or do
they all have equal weight?
Where should we focus?

 Increasing Throughput

 Decreasing Inventory, or

 Decreasing Operating Expense?

Traditional vs JIT, TQM and TOC
Traditional Ranking JIT, TQM and TOC

 Operating expense  Throughput

 Throughput  Inventory or Assets

 Inventory or Assets  Operating expense

All Three methods attack the underlying assumption that crated a problem related
to inventory levels. They ask:

WHY DO WE NEED INVENTORY TO PROTECT THROUGHPUT ?

Why do we need inventory to
protect throughput ?
 We need inventory to protect
throughput, because there are
statistic fluctuations ( variations ) and
dependent resources
TOC, TQM and JIT
 All 3 methods attempt to reduce variation and
recognize the interdependencies.

 Statistical process control is emphasized in the

quality area to help identify ways to reduce
variations.

 Cells are used to reduce the dependencies „..U cell

configurations , where one worker is moving with the
processed piece from one machine to another“

 Predetermined schedules, in TOC, reduce both

statistical fluctuation and dependent resources.
The “Cost World”
 Decreasing “OE” is definitely #1 because
we have relatively high control of our
expenses.
 Increasing “T” is always important, but it
ranks #2 because we are at the mercy of
the marketplace and have less control
over sales.
 Inventory tends to fall into a “grey area”
that we don’t know exactly what to do
about; it is a “necessary evil” that must be
lived with to protect sales.
The “Throughput World”
 Increasing “T” is unquestionably #1
because it has the greatest potential
impact on the bottom line.
 Decreasing “I” is #2 because excess
WIP and finished goods jeopardize
future throughput.
 Decreasing “OE” is #3 because
significant reductions (workforce
reductions) usually jeopardize future
throughput.
Financial Issues
 TOC is a management tool, not a financial
tool
 Not used to determine inventory values
 Not used to allocate overhead to inventory
 Does not comply with GAAP
 (Generally Accepted Accounting Principles)

 Does indicate how to use available

resources most effectively
Financial Issues
 Standard costing promotes undesirable
behavior
 Work to keep people busy
○ Local optimization

○ Inventory is produced regardless of need

Financial Issues
 Does indicate what it should cost to
produce a product
 Does not indicate which products will
maximize profits given the constraints
 Doesn’t take constraints into account
 Standard cost does not consider the
demands each item places on limited
resources
Financial Issues
 Traditional absorption costing promotes
undesirable behavior
 Production costs are assets until sold
○ Accumulation of inventory keeps costs off the
income statement
○ Illusion of profitability
Financial Issues
 Does indicate what it costs to produce a
product
 Doesn’t indicate which products will
maximize profits given the constraints
 Doesn’t take constraints into account
 Absorption cost does not consider the
demands each item places on limited
resources
Financial Issues
 Variable (direct) costing identifies the
incremental costs of producing a product
 Identifies product that provides the greatest contribution margin, or
contribution margin per unit of constrained resource

○ Cannot deal with more than one constraining

resource at a time
Financial Issues
 Traditional definition of variable cost
doesn’t hold in the short-run
 Labor, variable overhead aren’t really variable on a day-to-day
basis

 Some costs are truly variable in the

short-run
 Material, commissions, delivery costs, out-of-pocket selling costs
Profit
 Profit is defined in terms of throughput
 Sales – totally variable costs
 All other costs treated as fixed operational expenses

○ Cannot vary much in the short-run

TOC Question...

How do you manage a company in a world

where increasing Throughput is the #1
priority, reducing Inventory is #2, and
reducing Operating Expense is a tactic
only after serious efforts at #1 and #2?
TOC Summary

The theory of Constraints is about 2 things

 Focus
 Follow Through
TOC Summary: Focus

 A company must first know its Goal

 Then it must identify the thing(s), the
constraint(s), that are limiting the level of
achievement of that goal.
TOC Summary: Follow Through
The Process Of On Going Improvement
1. Identify the constraint
2. Exploit it
3. Subordinate all other operations to
the necessity to exploit the
constraint.
4. If after #2 and #3 more capacity is
needed to meet market demand,
Elevate the constraint.
5. Go back to #1, but don’t let inertia
become the system.s constraint.
 Quiz

Click the Quiz button to edit this quiz

Conclusion
 Viewing an organization from the operation
expense world perspective causes one to
believe that almost everything is important –
that the organization is composed of
independent variables.

 But viewing the organization from throughput

world perspective forces the realization that
the organization is a collection of dependent
variables and that the artificial barriers
between these variables, or functions, must be
eliminated.
Conclusion

 In the throughput world, constraints

become the main tools of management
and the previous tool, product cost, can
be discarded.