Theory of Constraints — A Concise, Expert Management Briefing

The low end of a TOC Business Case based on the manufacturing application is typically massive. Literally hundreds of published case studies provide the average data. The high end is an order of magnitude beyond the low end.

Putting Dollars to the Theory of Constraints

The business case for an implementation of Critical Chain project management, or of the Sales solution in isolation of other applications, or a workshop on the Thinking Processes ... each would naturally have an entirely different business case.

However, a Drum-Buffer-Rope implementation in a manufacturing business, in combination with the minimum of sales elevation to keep the plant busy, is the single most common Theory of Constraints implementation and the one I shall use for a base model.

Assumptions:

1. The company has sales revenues of $10 MM per year.

2. Material costs represent 35% of the Revenue figure.

3. 20% additional Throughput can be achieved from the company's resources following the implementation. This might take the form of 20% additional products produced and sold for the standard selling price, for example.

Note: 10% is ALWAYS achievable, almost effortlessly. I do not know when a minimum 20% improvement has not been recorded. 30% is often recorded. And 40% and more is not unheard-of.

The outcomes of the implementation will typically be a lead time reduced by 50% or more. On time delivery in the high 90% level. And the increase in productivity that generates the additional Throughput ... a 20% increase in Throughput for this example.

From a financial perspective:

The additional revenues will be 20% X $10MM = $2MM for the first full year.

The added expenditure on materials to produce the additional revenues will be 35% X $2MM = $700,000.

The additional Operating Expense needed to generate the additional revenues (beyond the investment in the implementation) will be zero, or negligible. Occasionally some increase in Operating Expense is necessary; it is always trivial relative to the scale of the added Throughput.

Therefore, the additional Net Profit from the plant in this first year is $1.3 MM.

If we choose (for the sake of example) an earnings multiple of 3.5, the value of this business has just increased by $4.5MM ...
provided the performance can be maintained.

There is an assumption in the above that the additional production can be sold; that is rarely an invalid assumption when the company is able to take the new lead time and on-time delivery performance to the marketplace. However, if the improved performance could not easily be translated into added sales, the Unrefusable Offer comes into play as a way of creating such a clear competitive edge that added sales are inevitable.

The Unrefusable Offer (Market solution) also becomes the basis for the higher level of Business Case. The Market Offer, perhaps being applied with the distribution and supply chain solution or the project management solution and presented using the sales solution, positions the company with a competitive edge that supports extremely aggressive sales growth. This is the premise for Eli Goldratt's new program, the Viable Vision, where companies can use the TOC solutions to grow such that Net profit in 4 years equals or exceeds Revenues today.

If this $10MM Revenue company grew to record $10MM Net Profit per year ... it takes little mathematical skill to understand the scale of the new valuation of the business; recognizing also that, the earnings multiplier in the face of such performance would no longer be 3.5, it would be substantially increased.

This represents the upper scale of the Business case for improving the Theory of Constraints Drum-Buffer-Rope application.