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May 07, 2012

The Theory of Constraints and the Supply Chain

A white paper published by the AGI- Goldratt Institute reports, "The core constraint of virtually every organization AGI - Goldratt Institute has worked with over the past 20+ years is that organizations are structured, measured, and managed in parts, rather than as a whole." ["The Theory of Constraints and its Thinking Processes: A Brief Introduction to TOC," 2009] For years, I have been writing about the pitfalls of traditional business silos and how they create barriers to better information sharing and corporate alignment. The AGI- Goldratt Institute white paper details a few of the challenges that result from corporate silos:

"The results of this are lower than expected overall performance results, difficulties securing or maintaining a strategic advantage in the marketplace, financial hardships, seemingly constant firefighting, customer service expectations being rarely met, the constraint constantly shifting from one place to another, and chronic conflicts between people representing different parts of the organization, to name a few."

The theory of constraints, which is the main focus of the white paper, takes a holistic (or system of systems) approach to managing an organization. The underlying assumption of the theory is that a system can be no stronger than its weakest parts -- they represent constraints to the organization as a whole. Wikipedia defines "constraints" in this theory as follows:

"A constraint is anything that prevents the system from achieving more of its goal. There are many ways that constraints can show up, but a core principle within TOC is that there are not tens or hundreds of constraints. There is at least one and at most a few in any given system. Constraints can be internal or external to the system. An internal constraint is in evidence when the market demands more from the system than it can deliver. If this is the case, then the focus of the organization should be on discovering that constraint and following the five focusing steps to open it up (and potentially remove it). An external constraint exists when the system can produce more than the market will bear. If this is the case, then the organization should focus on mechanisms to create more demand for its products or services. ... The concept of the constraint in Theory of Constraints differs from the constraint that shows up in mathematical optimization. In TOC, the constraint is used as a focusing mechanism for management of the system. In optimization, the constraint is written into the mathematical expressions to limit the scope of the solution (X can be no greater than 5)."

The five focusing steps mentioned in that explanation (as provided by the AGI- Goldratt Institute white paper) are:

1. Identify the constraint.

2. Decide how to exploit the constraint.

3. Subordinate and synchronize everything else to the above decisions.

To improve the performance of that same value-chain, continue:

4. Elevate the performance of the constraint.

5. If in any of the above steps the constraint has shifted, go back to Step 1.

Proponents of a strong sales and operations planning (S&OP) process, whether they know it or not, are also proponents of the theory of constraints. A good S&OP process helps break down silos and improves information sharing and corporate alignment -- which are also goals that emerge from the theory of constraints. The AGI- Goldratt Institute white paper likens the theory of constraints to the diagnostic and treatment program used in medicine. Before you begin treating the patient, you have to diagnose what's wrong with them, design a plan for treating the ailment, and then execute that plan. According to the white paper, TOC is used to improve the health of an organization.

In many ways, the theory of constraint parallels the Enterprise Resilience Management Methodology™ (ERMM) pioneered by Enterra Solutions a number of years ago in collaboration with Carnegie Mellon University's Software Engineering Institute. ERMM helps organizations identify their critical assets (that is, those assets that if lost would cripple the business), assess how well those assets are currently being protected, and develop a course of action to cover any shortfalls. Just as ERMM tries to establish reality in an organization, the AGI- Goldratt Institute white paper notes TOC begins by building "a Current Reality Tree" that identifies organizational constraints that holding a company back. Once those constraints are identified, an action plan for overcoming those constraints can be developed and then implemented. But the white paper also discusses an interim step, constructing "a Future Reality Tree" that established objectives that can guide planners in designing the right course of action. After all, as the old adage goes, if you don't know where you are going, any road will take you there.

The Wikipedia article on TOC identifies a few types of (internal) constraints, including:

  • Equipment: The way equipment is currently used limits the ability of the system to produce more salable goods/services.
  • People: Lack of skilled people limits the system. Mental models held by people can cause behavior that becomes a constraint.
  • Policy: A written or unwritten policy prevents the system from making more.

Normally, one thinks in terms of people, processes, and technology (which together fully cover the above types of constraints). The AGI- Goldratt Institute white paper concludes:

"Once the barriers that block [disparate parts of an organization] from working together as an integrated system are removed, significant and sustainable improvement in each and every problem [area] is the result. What blocks organizations from tearing down these barriers? Organizations are often so consumed by the pressures to achieve their shortterm performance targets, that taking the time to plan for the future is a luxury they can’t afford. Or, they have plans for the future, but are faced with the difficulties of balancing the risks of change with the opportunities they create – 'if it ain’t broke, don’t fix it!'"

Change management is always difficult. To read more about the difficulties associated with change management, read my post entitled Change Management: On the Cusp of a Revolution? Dale Houle, chief technology officer at AGI-Goldratt Institute, told the staff at SupplyChainBrain that "misalignments in the many linkages of the supply chain lead to variability in delivery performance or in demand" but that "the theory of constraints can help nullify the effects of that variability." ["Plan, Source, Make & Deliver Using the Theory of Constraints," 5 April 2012] The article continues:

"The theory of constraints, or TOC, looks at organizations as systems and addresses them as such. Similarly, it looks at activities or processes the same way. Accordingly, a supply chain is a 'system of systems' governed by cause and effect, says Houle. Under the TOC lens, plan, source, make and deliver are not viewed as independent actions but as interdependent processes that must be integrated into the overall planning process. However, for the desired results of that plan to materialize, execution in supporting areas needs to be managed to maintain alignment with the overall plan."

As I noted above, that kind of talk should sound familiar to anyone involved in a company's S&OP process. As those involved in S&OP know, it's easier said than done. The article continues:

"Practically speaking, what does all that mean? Houle says you must clarify your objective first. That means being responsive to the needs of the customer, considering lead time, delivery availability and price while lowering overall costs and improving return on investment. 'This is demand-driven performance.' When considering integration and alignment, often it helps to go back to basics, says Houle. 'The supply chain is best analogized to the physical chain, in that it has links and linkages. The links would represent businesses, organizations, functions, industries, manufacturing, suppliers, 3PLs, planning, transportation, etc. The linkages are much more governed by policies that link the measures they use and what basis they use for information exchange. Then the resulting linkages themselves will enable either greater or lesser degrees of organizational alignment. The more misalignments there are organizationally, the greater the variability in the performance of the links in the supply chain.'"

Although the linkages that Houle describes are better analogized to a network than a chain, his main points remain valid. You can't achieve the type of alignment he is suggesting without being able to securely share information (i.e., have good supply chain visibility) and then work together to achieve complementary objectives (i.e., collaborate). The article continues:

"However, it isn't necessary to correct all misalignments before there can be significant supply chain improvement. The most important impact on supply chain performance is in variability, whether in delivery performance or in demand. Variability causes expediting, out-of-stocks, poor fill rates, overstocks, longer lead times, late deliveries, lost sales, more overtime and other negative effects on business. What to do? You can focus either on addressing variability or on nullifying its effects, Houle says. 'Given that it's very unlikely you will totally eliminate variability, organizations often are better off starting by nullifying the effects and then using that information to then identify and address subsequent causes. In this way, the supply chain actually gets the best improvements in performance.'"

Most analysts agree that in order to reduce supply chain variability much better supply chain visibility is required. As Lora Cecere often points out, you must be able to have visibility from your supplier's supplier to your customer's customer (if you are a manufacturer). One of the reasons that many businesses are excited about Big Data is that they believe that the insights and actionable intelligence they can obtain by analyzing it will help reduce variability and headaches that come with it (i.e., things like the bullwhip effect). If the theory of constraints can help get businesses on the road to a true demand-driven supply chain, then it may be worth taking a look at.

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