Theory of Constraints, for ecommerce Businesses

Two or three decades ago, in October, I left the office at the middle of the afternoon and went to Starbucks to have a cup of coffee and think about our firm. We had fairly good year up to this point and our growth rate was respectable. But I wasn’t pleased. I wanted more, much more. Since we’re not VC funded, we didn’t have considerable amounts of money to throw at experimental approaches to grow. This made me look for a system of expansion which we can execute without much cost and without much danger.

My research took me into a hybrid system combining”Theory of Constraints” (TOC) using the”One-Page Strategic Plan.” TOC was developed by Dr. Eliyahu Goldratt, a physicist and management consultant. TOC has been largely used and written about for big businesses, mostly in manufacturing. One-Page Strategic Plan was created by Verne Harnish, an entrepreneur and teacher, and is largely applied to growing companies. Both systems focus on profitable growth, and that’s exactly what I was searching for.

I mainly used One-Page Strategic Plan as an information tool, however. So most of the post (and the next few posts) will be about TOC and how we applied it in overstockArt.com to help us develop profitably.

I’ll begin by explaining the fundamentals of TOC and why it was so appealing to me. TOC is a commonsense approach to continuous improvement. It’s been compared to”lean manufacturing” — there are similarities. Additionally, there are some significant differences. The significant difference is that TOC doesn’t seem to improve every step in your organization’s process. It focuses on the restriction. The promise of TOC is that each and every system has a restriction or a bottleneck that controls the throughput of this system. In a company, throughput equals earnings that are fulfilled to clients.

The actual energy of the system is the understanding that not everything needs to be improved. You have to concentrate only on the restriction — i.e., the actual problem of your own organization. Many managers, when searching for increases in a firm’s performance, create many developments and they can not understand why these many tiny improvements don’t translate into real bottom line benefits. The reason is they are focusing on optimizing one source but not the system as a whole. According to TOC, the throughput of this system as a whole is determined by the constraint.

While TOC employs a commonsense approach, it’s not common practice. As a matter of fact, lots of the solutions proposed by TOC originally feel wrong to most people, since the solutions require a business to operate differently than it did previously. Unfortunately, change isn’t easy for people. But if your company doesn’t change, it won’t grow.

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Principles of TOC

TOC simplifies how you examine the financial numbers of your organization. There are three financial metrics to take into account, based on TOC.

  • Throughput. “The pace at which a system generates money through sales.” Most commonly this is considered sales or gross margin, based on the particulars of the organization.
  • Inventory. “The money the system has spent in buying things that it plans to market.”
  • Operational Expense. “All the money the system spends so as to turn inventory into throughput.”

Most companies, when they would like to enhance, focus on these metrics. By way of instance, if a business is losing money a supervisor may try to cut operating expenditure by firing workers. But, in doing this, the supervisor only affected one facet positively (reduced costs), however, in doing this, he could have decreased throughput. To achieve the ideal level of operation, an organization should focus on all three dimensions: You wish to increase throughput while reducing operational and inventory expenditure, or at least not raising the past two variables by as much.

To apply TOC successfully, Dr. Goldratt developed five measures.

  1. Identify the system restriction. This can be looked at in a department or your whole organization. We started by taking a look at our production department and hunted for the bottleneck in our creation (or, order fulfillment) department.
  2. Decide how to exploit the restriction. The restriction controls your organization’s whole throughput. An improvement to the restriction is an improvement to the whole system. An improvement to other regions isn’t a real improvement to throughput.
  3. Subordinate everything into the constraint. Since the restriction controls your throughput, everything must be subordinated to this choice.
  4. If necessary or possible, elevate the restriction. In this step a company must assess the flow and functioning of the constraint and think about what investments are possible.
  5. If in the previous steps the constraint has been broken, go back to step one, but do not allow inertia to cause a system restriction. This measure I believe as the loop measure which makes this a continuous improvement methodology. Once a constraint is broken or conditions change, you must always search using the focusing steps for methods to achieve better performance for the whole organization.

Again, TOC doesn’t seem to enhance only parts of your company, but the outcome as a whole.

In his book The Target , Dr. Goldratt begins by asking,”what’s the aim of a firm?” I will finish this article by asking the readers the identical question. Please write your answer to that question, along with other remarks, below. In my next post, I will provide more details for the application of TOC.

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