Pinnacle Strategies

Theory of Constraints Fundamentals & Strategy

Theory of Constraints and Strategy

How to use Theory of Constraints to create and execute strategy that actually improves results.

By Mark Woeppel

The Gestalt of TOC

“Truth is ever to be found in simplicity, and not in the multiplicity and confusion of things.” – Isaac Newton

The Theory of Constraints. What kind of management strategy is that? Who calls a management approach a “theory”? And “constraints”; isn’t that the same as a “bottleneck”? If you’ve read Eliyahu Goldratt’s The Goal, you know the theory of constraints is just a dressed-up scheduling system. And a derivative one, at that.

You may have heard or thought these comments yourself.

The Theory of Constraints (TOC) might be these things, but it is more than that. TOC, while a collection of insights and procedures, is also an approach to understanding and designing systems. From its beginnings as a shop-floor scheduling system, it evolved into a holistic approach for developing and implementing strategies for organizations.

Often, the word ‘theory’ is used synonymously with ‘unproven.’ That’s not the meaning here. In the scientific realm, a theory explains how things work, as in the Theory of Relativity. A theory is only “proven” in terms of its logic and experiments, but it’s useful – until something better is found. It generally works in the real world, not just in the abstract. The Theory of Constraints explains how systems work. All systems have constraints, yet they are often unidentified, especially in complex systems where it seems the ‘Constraint’ is constantly on the move.

TOC processes apply the hard-science approach to the “soft” social sciences. They attempt to employ scientific rigor to organizational (social) problems and behaviors to better understand how systems behave and to solve long-standing problems.

In the hard sciences, the simplest solution is often the correct one. Scientists are trained to use Occam’s Razor, the principle that one should not make more assumptions than the minimum needed. It underpins all scientific theory building. In the same way, TOC searches for the “inherent simplicity” of system behavior; the fewest assumptions or causes for the most effects.

In scientific inquiry, one observes a behavior or effect, then asks “why” (“Why did that happen?”). To understand the cause, the scientist creates a hypothesis that explains the effect. To test the hypothesis, the scientist then predicts other effects that must also be present if the hypothesis is correct. If those effects are observed, the hypothesis is strengthened. This doesn’t mean it is “correct,” but only “strong.” Goldratt said (paraphrasing here) “The true test of a good hypothesis is that when the hypothesis and causal linkages are presented, the audience must say ‘It’s obvious!’”

In the same way, the Theory of Constraints is a robust theory, strengthened by numerous experiments. However, just as any theory evolves with new knowledge, so does TOC. This may be unsettling for those who are looking for a recipe. Goldratt and his fellow developers of TOC never sought a particular recipe, even though many were found. They were and are seeking something deeper. An understanding.

The germ of TOC could be found in Goldratt’s ideas for scheduling factories. He used those concepts to build software that scheduled factory production. In adopting his ideas, he ran into obstacles, finding policies that were preventing successful implementation. So he wrote The Goal to explain the ideas behind the software (the drum-buffer-rope procedure). However, even though these were successful, they were leading to the next constraint, and the next, and the next. The theory of constraints has evolved from scheduling to cost accounting, to performance management, to sales, to projects, to strategy.

The TOC approach to systems recognizes that we do not live in a world of deterministic outcomes but rather in one of probabilities – ranges of outcomes. We recognize that “Murphy” lives (statistical fluctuations) and make decisions with this in mind. Uncertainty surrounds us. There is a kind of randomness or chaos built into the universe. Therefore, our solutions and decisions must account for differing outcomes determined by circumstances beyond our control, from the random crash on the highway that makes us late to our meeting to a decision by OPEC ministers on oil production quotas that ripple through the world’s economies. We should not kid ourselves that we are fully in control of our own or our firm’s destinies. TOC provides an approach and tools to cope with that uncertainty.

There are ample documents and books on the procedures for TOC. What is not well documented is how to integrate them into a strategic framework.

Strategy is Not…

Strategy is not a new idea or a product like the new iPhone or electric cars. Nor is it a list of improvement projects to cut costs or enter new markets. It’s not an aim or mission like winning the war, being the market leader, or solving world hunger.

A strategy is a theory of the organization. It is a statement of who the customer is (a profile of the market), their needs, and the unmet needs. It defines the capabilities, products, and methods that will meet those needs. A strategy is not necessarily holistic; it can be narrowly or broadly defined, depending on the organization. It could be a strategy of product offerings—soda vs. “healthy” drinks or sedans vs. trucks. It could be strategic, creating a new segment, as Apple did with the iPhone and Southwest Airlines did with low-cost, no-frills air travel.

Strategy is not a Plan

A strategy differs from a strategic plan in that the strategy focuses on the outcomes, while the plan outlines how to achieve them. It helps an organization focus the energy, resources, and time of everyone in the organization in the same direction toward a common goal. It provides focus and impetus to move from idea to action. It is the formalized road map that describes how your organization executes the chosen strategy; the plan is not the end; it is the means to the end. It’s a map.

Strategy is…

Often, the term ‘strategy’ is synonymous with ‘plan’. Porter posits that strategy is a verb: the creation of a unique and valuable position that involves a different set of activities. This serves as the guidance for all of the organization’s activities. Action, supported by solid arguments.

We can boil a reasonable interpretation of strategy down to one thing: doing the things that increase value for the entity, however the organization defines ‘value’.

Criteria for a Good Strategy

In view of this, we can conclude that a “good” strategy:

  • Drives the organization closer to its goal. There is enough “meat on the bones” to push the organization into action toward achieving the organization’s goals.

  • Provides security for the people in the organization; the strategy should strengthen the firm’s position and security, and thus the security of its people.

  • Provides satisfaction for other stakeholders. Any strategy that violates stakeholder terms cannot be sustained and thus fails the first criterion. Customers must be satisfied with the product or service. The community should be enhanced, or at least not harmed.

  • Promotes sustainable results; it should build on the organization’s strengths and be self-sustaining

  • Is robust – allows growth even during periods of volatility in the company’s domain or market

TOC verbalizes these criteria in this way:

  • Build a decisive competitive edge (DCE). Decisive in that the competitive advantage is far superior to other firms’ abilities or capacities. This implies that other firms cannot or will not duplicate this unique facility. It is similar to the traditional concept of competitive advantage, except that the DCE is based on solving significant customer problems created by suppliers. For example, brands dictating a minimum order quantity or full truckload shipment policies that require large order quantities.

  • And the capability to capitalize on it. A DCE is based on operational excellence (i.e., fast delivery, high quality, low cost, etc.), but that is not enough. One must have or build the policies, systems, and processes to leverage these capabilities in the marketplace. You don’t have to look far to see great products undone by poor marketing.

  • On big enough markets. Not to be too obvious here, but we hope that if we go to the trouble of the previous two items, we would have a large enough market to make it worth our while.

  • We don’t want to exhaust the company’s resources. We don’t want to “bet the farm” on any strategy unless we must. We must leverage our existing resources, shifting them to the DCE strategy almost without effort.

  • And without taking real risks. We could substitute the word “real” with “big.” The strategy should ensure stability through volatility; it should remain profitable even during market downturns. There should be no sacrifice of critical resources (no mass layoffs – low-cost sacrifices) or selling off assets. It should ensure asymmetrical rewards (strong profits during growth, limited losses during downturns).

A TOC Strategic Approach

A ‘TOC strategy’ is built around the organization’s constraint(s). The strategy would explicitly acknowledge the current constraint and include elements to either break or elevate it, including the emergence of and breaking new constraints during the execution of the strategy. For example, if the constraint is the market, we would build the strategy around growing sales and navigating the (planned) changing location of the Constraint (i.e., internal capacity, distribution, back to the market, etc.).

Secondly, a TOC strategy is built on the idea that the organization’s performance should be constantly rising. Improvement is a way of life for the organization, not bursts of change but constant change. This gives rise to the concept of the Ever-Flourishing approach.

The Ever-Flourishing Organization

An ever-flourishing organization is one that is constantly growing and improving (always relative to its purpose). The idea is often presented as two lines on a graph, with performance on the y-axis and time on the x-axis. TOC practitioners have posited that there are two paths, a red curve with rapid, almost exponential growth, and a green curve with more linear improvement.

A high-growth environment (red curve) is perilous, so stability of profit growth (green curve) is a primary consideration when formulating a strategy. The goal is the red curve—a situation where the rate of improvement INCREASES. But for an ever-flourishing firm, you need BOTH. The strategy resolves these incongruities.

Problems with Strategy

A successful strategy has at least three problems to solve: choosing the “right” objectives, developing a plan to achieve them, and executing that plan successfully.

There is a significant amount of research showing that many strategic initiatives do not bear the fruit envisioned. Almost half of all strategic initiatives undertaken fail.

There are significant obstacles to strategic success. Planners often have incomplete information, including what buyers “truly” desire and their motivations. Entire industries are devoted to these 2 questions alone! Even among the experts, the strategic information is still imperfect, rife with wishful thinking and bias. I’m reminded of Henry Ford’s quote, “If I had asked people what they wanted, they would have said faster horses.”

Many strategies fall short because it’s difficult to understand what influences system behavior. The customer, the competitors, and even the organization itself are hard to analyze because the number of variables and their relationships are difficult to identify and quantify.

Planners themselves are subject to bias and wishful thinking. They create strategies based on untested assumptions and overlook geographical and cultural differences. They cling to the past when they should be embracing the future. Think of Kodak’s reliance on film, even though it invented digital photography. Or Chevrolet’s introduction of the Nova in Mexico, where Nova literally means no go (No-Va). We are all subject to “blindness” and bias. Recognizing it is the difficulty.

Further, strategy failures are tied to the lack of a theory of implementation. To successfully execute an organization’s strategy, it must have a singular focus on the people (every person?) in that organization. A strategy is incomplete unless there are mechanisms to create, monitor, and reward that focus as it is expressed. Critical implementation questions such as “How do we know if we’re on track?”, “Who is responsible for each element?”, and “When should we intervene or reevaluate the strategy?” must be answered.

Complex systems obscure the relationships that matter to a successful strategy. Planners and executives are often domain experts, but sometimes lack an understanding of how the “system” works. For example, they may not understand how a firm interacts with its competitors or why its products are chosen over competitors’ products. There aren’t many people who can provide a detailed operational map of how a firm delivers its strategic choices to the customer. And understanding how these two systems interact? Most planners rely on intuition, not rigorous analysis.

The Project Management Institute and others give a lot of attention to the execution side of things. Often, the skills needed to implement the strategy are absent from the strategy itself. It’s hard to know what you do not know, so strategies sometimes fail because of a lack of rigor in implementation planning.

Finally, no strategy can succeed when there are cross-functional conflicts in the organization. Any strategy that has one silo “win” at the expense of another is doomed. Conflicting standards for performance, compensation, and rewards (informal and formal) will break any strategy.

What TOC Offers to Strategists

TOC offers a framework that overcomes many of the obstacles that derail most strategic initiatives, along with a set of tools to overcome many of the obstacles to creating and delivering a good strategy. Whether they are “correct” is a matter of judgment.

The approach to strategy, with operational excellence as the foundation and a focus on the problems (undesirable effects) inherent in the “standard” way of doing business, offers a fresh perspective on arriving at a strategy that will lead to success.

With the Thinking Processes (TP), you can analyze and deepen your understanding of complex system behavior, highlighting cause-and-effect relationships and revealing hidden assumptions. This can go a long way toward overcoming the complexity obstacle, both in understanding the existing system’s behavior and in predicting its future behavior, and in identifying risks in new strategies. Further, a significant feature of the TP is its ability to identify and resolve cross-functional conflicts and to establish congruent standards of performance.

To identify a “right” strategy and its potential outcomes, TOC recommends a rigorous market analysis using the thinking processes of the Current Reality Tree, Evaporating Cloud, and Future Reality Tree.

Using the Strategy and Tactics tool provides a theory of implementation and a roadmap for developing the supporting tactics to successfully implement a strategy.

The most important feature of a TOC-based strategy is its focus on the most critical issues—the Constraint(s) and the uncertainty that affects them. The only strategy worth implementing is one that overcomes the limitations that constrain higher performance and systematically drives the organization toward its goal.

Bibliography

Cooper, Marjorie, TOC handbook (2010), Traditional Strategy Models and the Theory of Constraints

Goldratt, Eliyahu, TOC handbook (2010), Introduction to TOC- My Perspective

Spender, J.C., Business Strategy (2014), Oxford Press

Michael E. Porter (2000), What is Strategy, Harvard Business Review

Goldratt, Eliyahu, The Gestalt of TOC (2010), YouTube https://www.youtube.com/watch?v=DQoO8y3En3w

Boston Consulting Group, (2014), Strategic Initiative Management: The PMO Imperative

Goldratt, Eliyahu, (1996), My Saga to Improve Production

Goldratt, Eliyahu, (2011), Building a Blue Ocean Strategy, http://toc.tv

Goldratt, Eliyahu, (2011), Goldratt Satellite Program Marketing – Unrefusable Offers and Market Segmentation

Rumelt, Richard, (2011), McKinsey Quarterly, https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-perils-of-bad-strategy

Edinger, Scott, (2012), Three Cs of Implementing Strategy, http://forbes.com