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What is Theory of Constraints?

The bigger and more successful a firm is, the more vulnerable it can be to disruption! But the good news is that by exploiting “hidden” capacity in production and “untapped” demand in the market, a company can flourish by constantly increasing gross contribution without inflating Operating Expenses and without any capital risk.

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What is Theory of Constraints?

  1. 1. Are we facing a crisis in management, as a body of knowledge?
  2. 2. Average Life Span of Companies in US S&P 500 has come down in last 5 decades* In last 5 decades, the average life span of human beings has gone up** 33 24 12 0 5 10 15 20 25 30 35 Average Tenure of Companies (yrs) 1964 2016 2027 (projected) 50 69 75 0 10 20 30 40 50 60 70 80 Average Human Lifespan (yrs) 1964 2016 2027 (projected) Source: *https://www.innosight.com/insight/creative-destruction/ **http://www.geoba.se/population.php?pc=world&type=015&year=2027&page=1 We can claim, progress in field of health science. Can we claim the same about management science?
  3. 3. Source: https://hbr.org/sponsored/2017/07/digital-transformation-is-racing-ahead-and- no-industry-is-immune-2 The bigger and more successful a firm is, its ability to disrupt the industry deteriorates 52% of the firms in fortune 500 have either become bankrupt, ceased to exist or got acquired Management as a body of knowledge can only explain the above phenomenon BUT cannot prevent it ! (outsiders saw the obvious, the incumbent firms just couldn’t see it until it was late)
  4. 4. About 70%* of large transformation projects fail in organizations Source: * https://hbr.org/1995/05/leading-change-why-transformation-efforts-fail-2 **https://www.forbes.com/sites/brucerogers/2016/01/07/why-84-of-companies-fail-at-digital-transformation/ 84%** of the companies fail in digital transformation We just do not know how to transform a company !
  5. 5. * Can grow sales consistently year on year AND can grow profits year on year AND maintain a ROI of minimum 25% The crisis! If the body of knowledge of management is all about creating successful (ever-flourishing) organizations, we seem to have made no progress at all! To be successful is a rare event. Only 3 companies meet the criteria of Ever flourishing Companies* as per BSE Sensex What is the point of studying management ?
  6. 6. LET US NOT GIVE UP To get a clue on the potential of a new body of knowledge, let us investigate how companies die! • Creeping increase in costs, to deal with inflation – this does not increase capacity. • At same time markets tend to get saturated or get reduced for established products. • Unviable business ! The Aging related Death • Very high investments made in capacity and markets. • Future does not materialize as envisaged • The company runs out of cash The Accidental Death Let us not give up
  7. 7. The only way to keep surviving and flourishing, is to find out ways to keep increasing the rate of gross contribution as compared to rate of increase of OE, without taking risks on capital deployment. Cost(s) Time Operating Expenses Gross Contribution (Sales – Truly Variable Costs) The decouple - graph Decouple operating costs from sales One of the reasons why the above curves are not decoupled is because managers EXPAND on assets before EXPLOITING THEM
  8. 8. Is there a way out? The only way out is to maintain the decouple - graph trend which can be done by
  9. 9. Get more out from existing capacities before you expand capacities 60-80% 40-20% Exploited capacity Hidden Capacity Hidden capacity  Producing what is not required  Unplanned set up  Expediting and priority changes  Rework Symptoms of Hidden Operational Assets  Non-uniform output across time periods – skew in efforts and output close to target period  High level of expediting and priority changes 1. To exploit hidden operational assets
  10. 10. 20- 30% 70- 80% Real Sales Non-Sales Get more share from existing products and markets before you expand into new products and categories Do organizations really have wasted capacities in sales team and hidden opportunities in the Market ? Non Sale Activities  Follow up for material, receivables, documents etc.  Travel time  Waiting for meet schedules, approvals, etc.  Making quotations, Order entry, Tendering etc. Market assets  Unaddressed customers  Reach gaps in market  Unaddressed enquiries  Narrow definition of market Current Market Share Potentials Customers 10% 90% 2. To exploit market assets
  11. 11. Bandwidth should not used up in running after short term issues & targets (rather than working on the long term plans which secure the firm, and not get disrupted) Hidden Managerial assets  Capacity used up in short term issues , conflicts , endless meetings – nothing left to work on long term  Each role seems to do work of level below or another role in org!  No capacity available to even think and ponder about issues Short Term Conflicts  Unending meetings  Intervention to meet short term goals  Doing work of sub ordinates  Doing work of colleagues 10-20% 80-90% Strategic Initiavtives Short Term Conflicts 3. To exploit top management assets We will continue to have lots of meetings till we find out why no work is getting done!
  12. 12. WHAT CAUSES CAPACITY WASTAGES • If every resource is busy, then we get higher overall more productivity Corollary: If we stretch more ( more the WIP), more is the likely output! • If we improve every where, the net outcome will be additive improvement • If every manager meets their individual budgeted targets, we will meet the company wide budgeted numbers • If we have many improvement projects, more is the level of improvement LOCAL OPTIMA THINKING is the guiding mantra of management! What causes capacity wastages?
  13. 13. Local optima thinking Why does local optima thinking creates wastage of capacity ?