Basic principles in Theory of Constraints (TOC)

Throughput contribution, inventory, operational expenses, and the drum-buffer-rope system are the principal concepts underlying the TOC.

1- Throughput contribution

known as throughput margin or simply throughput

Throughput contribution is a TOC measure of product profitability.

Throughput contribution = sales revenue – direct material costs

Throughput contribution assumes that, the material costs include all purchased components and material handling costs. TOC analysis also assumes that labor is a fixed cost, not a direct and variable cost.

Throughput contribution is the rate at which the entire system generates money through sales of a product or rendering a service (throughput contribution is money coming in).

”The world is not interested in the storms you encountered. But did you bring in the ship?”

2- Inventory

Inventory refers to all the money the system invests in things it intends to sell (inventory is
money tied up inside).

Inventory refers to all the money the system invests in purchasing items it intends to resell.
Typically, this refers to all physical inventory items but is now more broadly defined to include all assets.

Inventory = (direct materials costs, work-in-process, and finished goods inventories) + (R & D
costs) + (costs of equipment and buildings)

3- Operating (operational) expenses

Operating expenses: All the money the system spends turning inventory into throughput
(operating expenses are money going out)

In the TOC, operating (or operational) expenses refer to the money the system spends to convert inventory into throughput. Operating expenses include expenditures such as direct and indirect labor, supplies, outside contractors, interest payments, and depreciation. Employees are responsible for turning inventory into throughput.

4- Drum-Buffer-Rope (DBR) System

The drum-buffer-rope (DBR) system is a TOC method for balancing the flow of production
through the constraint.

The drum connotes to the constraint.

The rope is the sequence of processes prior to and including the constraint, and

The buffer is the minimum amount of work-in-process input needed to keep the drum busy.

The objective of the drum-buffer-rope system is to keep the process flow running smoothly through the constraint by careful timing and scheduling of the processes in the rope leading up to the constraint.

Drum-buffer-rope (DBR) system (related to TOC)

1. DBR system attempts to minimize build-up of inventory at a bottleneck and at the same time keep bottleneck producing at all times, thus non-bottleneck operations are not permitted to produce more output than can be processed by the bottleneck, because this creates excess inventory and doesn’t increase throughput contribution.
2. The constrained process (bottleneck) is the drum. There are different steps in managing
   bottleneck operations through the use of the theory of constraints (TOC) analysis.
3. The sequence of processes prior to and including the constraint is the rope. The objective is to balance the flow of production through the rope by timing and scheduling activity for all processes leading up to the drum.
4. The buffer is a minimum amount of work-in-process inventory waiting for completion by the constrained process (just enough to ensure that the constrained process is busy at all times.

Throughput contribution (T), inventory (I), and operating expenses (OE) relationship

• In the theory of constraints, throughput contribution (T), inventory (I), and operating expenses (OE) link operational and financial measures.
• Net profit increases when throughput goes up or operating expenses go down. Throughput contribution can go up by increasing sales revenues or reducing variable costs of production.
• Measures that increase net profit increase ROI as long as inventory remains the same.
• If inventory can be decreased then ROI will increase even without an increase in net profit.
• Cash flow increases when either throughput contribution goes up or the time to generate
  throughput is reduced, assuming the time save is applied toward generating more throughput.
• TOC attempts to maximize throughput contribution while decreasing inventory and
  operational expenses. Unlike traditional performance measures, which focus on direct labor efficiency and unit costs and how efficiently the company must produce a product, TOC emphasizes how efficiently an organization must manufacture products for optimum market success. The flow of product is dictated by market demand, not by the forces influencing traditional mass productioncheap sources of materials, machine efficiencies, or low direct labor. Stated another way, T, I, and OE measurements enable a company to understand how much money it is making and how to best leverage capabilities to improve profitability