A Guide to Implementing the Theory of Constraints (TOC)





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Please note.  This is an older page that has been superseded by one called Evaluating Change.  This older page remains on-line because it is still referenced by other pages.

Financial Navigation

Imagine for a moment that you are a passenger on a plane with a competent pilot, but with a slightly dysfunctional navigation system.  Sometimes the navigation system guides you to your chosen destination, but sometimes it does not.  Maybe that is alright for fair-weather flying when our competent pilot can use some visual reality checks, but is that good enough for all-weather flying?

In a way, management accounting in its current form is like a slightly dysfunctional navigation system.  Sometimes it guides us to the right destination, sometimes it doesn’t – and it is at exactly that time that we depend upon the experience and intuition of the management to do the reality checks.  Certainly this is not an ideal system.  What if we aren’t in a fair-weather situation?  What if the management believes implicitly in the authenticity of the accounting guidance?

However, there is a deeper issue here.  Why do we use accounting as the guidance system at all?  We saw in the previous pages that operations managers already have a systemic and systematic method of evaluating decisions and choosing the correct one to guide us in our chosen direction.  Why then does accounting second guess these decisions?  The reality seems to be that we accept that accountants should not only measure and report the financial results; but that they should also make and measure the individual management decisions along the way that are the perceived drivers of the financial results.  If we are going to insist on this, then let’s make sure that we provide everyone with the right tools for the right job.

Financial Accounting & Management Accounting

It is apparent then that there are two jobs that accounting wishes to perform;

(1)  Financial Accounting – external reporting to regulatory authorities (the Government).

(2)  Management Accounting – internal reporting to superiors (the boss).

And for these two jobs there are currently two toolsets;

(1)  Absorption costing – product/process cost

(2)  Variable costing – product/process contribution.

Financial accounting is governed at national and sometimes international levels by a code of generally accepted accounting practice (GAAP).  In fact the Japanese have a term for this – generally accepted U.S. accounting practice!  GAAP is absorption and accrual based.  Even if some of the assumptions and methods are arbitrary and historical, GAAP presents a consistent and level playing field.

Management accounting however is more variable.  Historically, it is governed by the concept of absorption costing – a direct transfer of financial accounting practices into management accounting.  Here decisions are based upon a construct called the “product cost.”  However there are variations that are direct or variable costing based.  Here decisions are based upon a construct called the “product contribution.”  We can more realistically know the product contribution than we can the product cost.  We have used product contribution in the measurements section to guide our decisions, this we might think of as throughput decision analysis.  If we extend these concepts to a management accounting level then and call this throughput accounting then at “a conceptual level, throughput accounting is indistinguishable from contribution margin” and “at the conceptual level there is no difference between throughput accounting and variable costing (1).”

Define Throughput Accounting Then

At an accounting level throughput accounting is a cash-based non-allocation method.  It is conservative in revenue generation (as sale isn’t a sale until it is sold), raw material is valued at it purchase value.  A sale means a sale to outside of the system, in this day and age of supply chain management means channel stuffing is still accepted practice in many places.  Therefore throughput accounting is similar to a small business cash-based accounting system.

“The basic difference between throughput accounting and full-absorption accounting is the treatment of fixed manufacturing overhead expenses.  Throughput accounting expenses overhead in the period the product is produced (i.e. current period expense) vs. full-absorption, which assigns overhead to the product to be carried as part of the inventory valuation until the period the product is sold (I.e. expensed as cost of sales when the product is sold (2).  As a cash-based accounting system, throughput accounting can be reconciled to full-absorption based accounts at period end (2).

Direct labor unless it is contract or piece-rate is not considered to be a variable cost, but is instead a part of operating expense.  The rationale for this is explained in detail later in this section.

The ultimate difference between throughput accounting and other less extreme forms of variable costing is that local decisions are based upon the role of the constraints and the relative and absolute contribution due to the constraints.

Horses For Courses

It is a kind of “horses for courses” situation.  If GAAP was used exclusively for financial accounting (because we have no choice) and throughput decision analysis was used exclusively for management accounting there would be no problem.  However, this isn’t the way the world works at the moment (apart from some particularly effective companies).  Generally, absorption costing is used for both financial accounting and management accounting.

If we know that absorption costing is relatively slow and sometimes leads to the wrong management decisions, and we know that throughput decision analysis is quick and effective and so far has never given rise to an incorrect decision, then why don’t we use throughput accounting?  We know that we must use GAAP for external reporting – we have no choice.  But does this mean we can’t use throughput decision analysis for internal decision making?  In fact;

“... no matter what costing method a company uses, at the end of the year you will have the same cash, assets, liabilities, workforce, and market.  But, the method you use will lead you to very different (and opposite) strategic decisions.  If the decisions are opposite, then only one of them can be optimal, and it is dependent on the company-specific environment, the environment reflected by the company’s constraint (4).”

Let’s investigate this further.

Debra Smith presents this as a cloud (4).  It’s redrawn here.

It would appear that most people see the conflict as “either/or.”  And as GAAP absorption costing is required by law for financial reporting, it becomes by default the decision analysis process for management accounting as well.  However, as you know by now, assumptions seem to be made for us to break.  Smith breaks these assumptions.  Most importantly by suggesting the use of both absorption accounting and throughput accounting – absorption accounting for external parties and throughput accounting for internal parties without imposing an “either/or” solution.  We will follow that logic here.

Our cloud will now look like this;

Smith argues that “Even beginning management texts emphasize not using GAAP-compiled numbers to make management decisions.  All management accounting texts made the following statement: A company will profit maximize when it makes and sells the product with the highest contribution margin per unit of its scarce resource (4).”  Why then don’t we heed this advice?

There seems to be two answers to this;

(1)  Most people are unaware of the pivotal role of constraints.

(2)  A strong pre-existing belief that financial accounting is management accounting.

We then are in a much better position, we are aware of the pivotal role of constraints and we aware that absorption-based costing does not always lead us to making correct decisions.

Let’s have a look then at throughput accounting and then, later, a brief look at a more recent development – constraints accounting.

Throughput Accounting

Small Businesses/Large Businesses

Businesses have two choices.  Firstly they could keep all accounts as throughput accounts and converting to GAAP accounts for financial reporting at period end.  That way all decision analysis is throughput based and two sets of accounts don’t have to be kept.  Smith details a procedure for the reconciliation of throughput accounting to full-absorption accounting at period end (2).  This is likely to appeal to smaller businesses.  Secondly, larger businesses with a full GAAP financial accounting system will mostly likely want to run a throughput accounting decision analysis system along side the financial system and not use the management information derived from the financial accounting system.

Internal Decision Analysis

In the measurements section we introduced and developed the concept of throughput (T), inventory (I) and operating expense (OE) as the fundamental operational measures.  With knowledge of the role of the constraints we can use these measures to drive maximal process profitability if that is our goal.

In comparing a decision – either between different potential outcomes, or the current situation and different potential outcomes – we are doing so against the bottom line measures that we first saw in the measurements section.  Here, however, we are interested in the differential generated.

For the change in net profit, positive values are good – we generate more throughput than the additional expense of producing it.  For return on investment, the highest ratio is best – we generate the greatest profit for the least additional investment (5).

Of course we can only determine the throughput necessary for these decisions by knowing the volume and the rate at which throughput is generated per unit of scarce resource.  Let’s call this T/cu.  And to know this, of course, we must know where the constraints are.

In fact we had the opportunity to experience all of the throughput decisions as we worked through the answers to the P & Q analysis in the measurements section.  Schragenheim and Dettmer summarized the decisions and actions required as a flow diagram (5).  Let’s distil this down to just two rules.

Whenever we make a decision we must evaluate the consequences based upon where the constraint is now (internal or external) and where it will be next (same place or another place).

We can summarize this as two basic rules;

Rule 1: when a constraint is internal we must evaluate the throughput generated per unit time on the constraint (T/cu).

If a new product is introduced on an existing constraint we must calculate the new T/cu and reprioritize the sequence of all other products produced on the constraint.  If the constraint moves internally we must recalculate the T/cu for all the products produced on the constraint.  If the constraint moves externally then rule 2 applies.

Rule 2: when a constraint is external any throughput above totally variable cost is a positive contribution to the system.

Adding new products in this case has no effect so long as they don’t cause the constraint to shift internally.  If they do rule 1 applies again.

Why must we do this each time?  “You see, in the ‘cost world’ almost everything is important, thus changing one or two things doesn’t change the total picture much.  But this is not the case in the ‘throughput world.’  Here, very few things are really important.  Change one important thing and you must re-evaluate the entire situation (6).”

“We have to evaluate the impact, not of a product, but of a decision.  This evaluation must be done through the impact on the system’s constraints.  That’s why identifying the constraints is always the first step (7).”

The case where the constraint remains internal to the process is straightforward.  However if the constraint is in the market or moves to the market then a new logic emerges.  Essentially any additional revenue that exceeds total variable cost makes a contribution to increased profit.  However, in general, firms don’t chase such small margins.  There are two reasons for this.  Firstly, we don’t want to start a price war within our existing market, and secondly many of our other potential markets are not sufficiently segmented or we don’t know how to properly segment them to stop a price war “leaking” over to our existing market.

We mentioned that we must also consider total volume.  Just as we would have liked only business class passengers to fill our aircraft in the example in the measurements section, we know that isn’t going to happen.  We are quite happy to fill most of the aircraft with economy class passengers because overall they make a substantial contribution – it’s just that it is not the best contribution possible.

So, we are really making decisions based more like this;

Throughput = SSales - STotally Variable Costs

We need to sum all of the different products and their different totally variable costs, indeed also the same products if their sales prices are different (8, 9).  In fact, this is exactly what we did in the P & Q analysis.  We had two products; P & Q.  But later we also had two markets, domestic and export.  The export market would take P’s and Q’s but at a discount.  We called the products to the new market P’ and Q’.  The throughput that they each generated was different to the domestic products.

Here is the table we used to present such data.  Thus we can see the location of the constraints (Q and Q’ are market constrained, P and P’ are resource constrained), throughput and volumes.








Weekly Demand







Selling Price





















Units Supplied







Resource A







Resource B, B’







Resource C







Resource D







Weekly Throughput







Weekly Operating Expense




Weekly Net Profit




Of course much of the data for the non-constraints in reality is redundant.  We only need accurate data for the constraint and any emergent constraints.  Buffer management should tell us where the emergent constraints are.  The only thing missing from this table is our measure of T/cu.  Let’s add that for completion.






Throughput/min Resource A





In fact this format is particularly well suited for using with “Solver,” the Excel add-in module for linear programming.  If you would like to see how to assign cells for this particular example using solver, please have a look here.

In the P & Q analysis we didn’t calculate the return on investment between different decisions; however, there are a series of pro-forma examples allowing for sales mix, additional operating expense, and investment that can be used to make these evaluations (10).  Familiarity with these will allow you to tackle all throughput decisions.

Strategic And Tactical Decisions

We saw that decision analysis revolves around two questions;

Essentially we are asking by how much did we increase our profit, and by how much did we increased our return on investment.  However, we can also examine these from another viewpoint.  Net profit is largely a tactical decision – how can we best maximize the return on our current assets.  Return on investment is largely a strategic decision – how can we best maximize the return on any additional assets.

Now that we are also explicitly aware of the 5 focusing steps, we can place these decision analyses in a broader framework of strategic or tactical significance (11).

Let’s consider the steps exploit and subordinate.  During this stage of an implementation we don’t expect to make investment to increase output.  We expect our exploitation activities to cause output to rise.  Inventory, especially work-in-process may remain neutral or it may go down.  Operating expenses may remain neutral or it may go down.  It may go down for instance if significant overtime was required in the past to meet due dates or to enable rework to be done (hidden or otherwise).

When we elevate a constraint we must bring additional investment into the system, usually the purchase of additional capacity.  We may also need to increase operating expense in order to utilize the new capacity.  Thus inventory (investment) will increase and operating expense will most likely increase also, if only due to the increased depreciation of the new investment.

This brings us to an interesting point concerning our definition of productivity;

Our productivity might increase markedly if we have additional investment because we must apportion capital to operating expense at some predetermined rate according to the economic life of the investment.  The assumption is that the investment is repaid at a consistent but low rate over the life of the investment.  But Theory of Constraints isn’t like this, we make investment decisions on the basis of;

(1)  Fulfilling a necessary condition.

(2)  Increasing throughput.

In the first instance there might be a case for discount rate based upon economic life.  However, in the second instance we are making an investment on the basis that income will jump and payback will be quick.  We expect rapid and substantial increases in throughput and hence should be able to convert the investment to operating expense at a commensurate rate.  Constraints accounting addresses this more fully that throughput accounting.

Neither tactical nor strategic decisions should be passive – determined by the next accidental emergence of a new constraint.  They should be the result of active analysis of where we want the constraint to be.  After all, the location of the constraint dictates the way in which our firm will make money – and where our capital investment, product development, marketing and sales efforts will be.

The subdivision of whether something is tactical and strategic based upon external investment is useful, but often substantial improvement can be obtained without additional investment at all.  In fact during this tactical phase questions of strategic importance can occur.  So, let’s not be mislead into believing that constraints are only broken by elevation, often, especially in the early stages of an implementation, proper exploitation may be all that is required to break a constraint and move the new constraint somewhere else in the system.

Let’s draw this

Once a constraint is identified, and exploited, that action alone may in a short period reveal another constraint in the system – before we have really made much improvement.  Our loop is very short; identify-exploit-identify.  Of course this is excellent.  We have jumped the system output in the process.  We then set out to exploit the next constraint and so on.

We can also break an apparent constraint simply by proper subordination.  Consider in manufacturing where non-constraints may be regrouping separately scheduled process batches together again – insubordination (pun intended).  This will actually slow the whole process down and if it occurs in one area – maybe near the gating operation for instance then it may appear as an apparent physical constraint somewhere else.  The other extreme might be when sprint capacity is beginning to be eroded due to increased output, constraints will appear to be “breaking out” in various places – however the solution is to increase the buffer size.

Really the constraint in both cases is in the inertia of our subordination policies.  We can “short” the loop once again; identify-exploit-subordinate-identify.  So we don’t have to go through the process in a linear fashion from start to end, reality is far more messy and interesting than that.  We can break a constraint at any point, and then we must go back to the first step and identify where the constraint has moved to (but usually it is fairly obvious).  In fact normally buffer management will have warned us where the emergent constraints are likely to be.

Static And Strategic

If the location of the constraint dictates the way in which our firm will make money or our organization will make output, we may in fact have a preferred place for the constraint to be.  It may remain in the same place for long periods of time; both static and strategic.  Too often we are confused by the notion that bottlenecks “wander” or “pop up.”  We can control the process if we want to – that is what buffer management allows us to do.

The premier example of wandering bottlenecks must be winter respiratory admissions to hospitals.  Every year almost without fail, batches of patients besiege public hospitals.  It isn’t the bottlenecks that wander (capacity constraints) it is the large batches of patients that wander.  If you can imagine a cartoon of a python having eaten a rodent you will understand wandering bottlenecks.  And every year without fail hospitals don’t load-balance non-medical non-acute procedures to accommodate these waves (you don’t understand we are not manufacturing we are different).  In fairness more recently public health officials have learnt that a free flu vaccination subordinates the batch size to the constraint and lowers the overall cost.  In fairness also, public health monitoring of general practitioners offers a kind of buffer management of impending holes in the buffer.

We saw on the process of change page how the focusing process can be reworded to accommodate this strategic perspective (12).

(1)  Select the leverage points.

(2)  Exploit the leverage points.

(3)  Subordinate everything else to the above decision.

(4)  Elevate the leverage points.

(5)  Before making any significant changes, Evaluate whether the leverage points will and should stay the same.

The key words here are; select and evaluate.  We select where we would like the strategic constraint to be, if not now then sometime in the future, and we then evaluate our exploitation procedures against this decision.

This strategic view requires a more focused approach to non-constraints and near-capacity constraints.  Near-capacity resources must be removed (12), therefore we must;

(1)  Identify near-capacity constraints.

(2)  Evaluate their significance.

(3)  If necessary, remove their impact.

Essential this is a type of “subroutine” loop for near-capacity constraints running within the subordination step above.

In practice this means that some current non-constraints and all current near-capacity constraints must be evaluated and steps taken to ensure that they can continue to correctly subordinate to the strategic constraint.  If demand or product mix changes so that they have insufficient protective capacity then they must be elevated prior to the elevation of the strategic constraint and elevated sufficiently at that time relative to the future capacity of the strategic constraint that they do not inadvertently become the constraint themselves.  The identification of near-capacity constraints is a function of buffer management.  The identification of the strategy and strategic constraint is the function of the leadership.

Let’s modify our diagram to reflect this more strategic view.

Let’s complete this idea with an example – Valmont Industries (13, 14). This is an example of a firm that has expanded hugely and profitably for over a decade with throughput increasing from $8.5M in 1986 to $46.5M in 1996.  A decade is a reasonable amount of time for a business, don’t you think?  They did this while managing a strategic constraint and growing the firm within an industry sector that is was not growing itself.

The strategic nature of the 5 focusing steps – our plan of attack – is important.  If you are especially comfortable with this concept, or more so if you are especially uncomfortable with this concept, then click here for an extended discussion.

Subordinating The Tactics To The Strategy

In determining a desired future strategic constraint we may come up against a small dilemma.  It is expressed at two levels.

(1)  We must subordinate a current tactical constraint to a future strategic constraint.

Consider for example a tactical constraint that is the paint booth in a small engineering shop, and we want the constraint to eventually move to the assembly area of that shop.  In order to do so, we may have to forgo maximum financial throughput per unit time on the current tactical constraint in order to build the correct business for the future desired financial throughput on the chosen strategic constraint.

We can step this up to the next level.

(2)  We must subordinate a current strategic constraint to a future strategic constraint.

Imagine for example a successful regional airline that decides to change market focus from short-haul and build its long-haul traffic.  In fact, we don’t need to imagine examples.  We can see exactly this in Toyota today as that company develops hybrid engine technology and brings it to market ahead of perceived demand (15).  The development of the Cummins Engine Company and the philosophy of the Irwin-Sweeny-Miller families is another exceptional example of this process (16).  Both of these firms are examples of leveraging on the present to create the future.  The leveraging results in lower current profit than would otherwise be possible – and a greater future (and total) profit than would otherwise be possible.

In fact we could step back a little to contemplate how Toyoda Spinning and Weaving – a very successful firm in its own right evolved into an auto manufacturer.  If this is too recent and singular then we are reminded that Mitsui was once a drapery shop, then money lender, then a mining and manufacturing enterprise – originating in the mid-1600’s.  Sumitomo started out in 1590 as a copper casting shop, then moved into trading, and then mining, then manufacturing, followed by banking and chemicals (17).

Caspari and Caspari capture this dilemma which occurs whenever such a new strategic constraint is selected.  The dilemma is presented very nicely as a short-run versus long-run cloud (18).  Let’s have a look at this cloud – here inverted.

Everything that we need to know to describe the situation is there, but let’s reword this cloud slightly before we look more closely.

No one would doubt that in order to have a process of on-going improvement we must have good tactics.  This, after all, is what operations management – in fact any management – is all about.  We might call this the direction of the solution.  On the other hand, no one would doubt that in order to have a process of on-going improvement we must also have good strategy.  This, after all, is what good leadership is all about.  We might call this the direction of the company.

A conflict arises however from the extension of these needs.  In order to have good tactics we must exploit the current constraint – otherwise what was the point of having a constraint in the first place.  Also in order to have good strategy we must move the system towards the future desired strategic constraint – otherwise our leadership decisions will not be implemented.  And herein lies the dilemma; we can not both exploit the current constraint and not exploit the current constraint (move the system towards the strategic constraint).

How can we break this dilemma?  Let’s see.

We must sometimes subordinate the short-run to the long-run if we want to undertake a process of on-going improvement.

In fact, if we substitute “long-run” for “good strategy” and “short-run” for “good tactics,” then I think that we can see a generic cloud that covers many more system and personal situations than just this one.

On-The-Fly Conversion From GAAP To Throughput Accounting

All firms will have a set of GAAP financial statements.  These will allow you to have quick look at the health of the system.  In order to do so we need to rearrange the numbers as per the following table.







Full Absorption Costing

Conventional Variable
 (or Direct) Costing

Throughput Accounting


















- Costs of Goods Sold

- Variable Mfg Costs

- Totally Variable Costs








   Direct labor

   Direct labor




   Variable mfg overhead

   Variable mfg overhead




   Fixed mfg overhead


   Sales Commissions










= Throughput








- Stock Movement

- Stock Change

- Inventory Change



   Opening - Closing

   Opening - Closing

  Opening - Closing









= Manufacturing margin










- Variable Selling & Admin





  Sales Commissions









= Gross Profit

= Contribution Margin









- Operating expenses

- Period Expenses

- Operational Expenses



   Selling expenses















   Administration expenses

  Fixed selling & admin





  Fixed mfg overhead






   Manufacturing overhead





   Direct labor








= Operating Income

= Operating Income

= Operating Income








- Income Taxes

- Income Taxes

- Income Taxes








= Net Profit

= Net Profit

= Net Profit







Sales commissions become a part of totally variable expenses, manufacturing variable and fixed overhead becomes an operational expense.  Direct labor becomes an operational expense.  Inventory is valued at the raw material value and operational expenses are increased by the portion previously “allocated” to stock.

Every entry in the absorption costing is also represented in the throughput costing and the net result is the same.  However, now we can see at a glance whether we are making a profit – does throughput exceed operational expenses – is our operating income positive.  Of course this doesn’t allow us to drill down to the drivers, to do that we would need knowledge of the location of the constraints.

Such a quick conversion also allows us to evaluate the consequences of increases in throughput and decreases in pricing.  Goldratt’s consistent admonishment is not to decrease prices (19).  However, it certainly happens and it often happens without consideration for the amount of increased sales necessary to maintain the pre-existing equilibrium (“the market demanded it”).  It also happens without consideration for the other non-price penalties the firm already inflicts upon its market – late orders, long lead times, poor product quality, and frequent out of stock for example.  We will examine these a little more in the section on supply chain.

Cash Flow

Increasing productivity in a healthy business will, as we saw in the section on bottom line, increase profitability substantially.  The ensuring robust cash flow should allow the business to grow even further.  But what of companies that are not so healthy to begin with, maybe companies that are at the other end of the spectrum facing commercial recovery or turnaround?  For such companies cash flow and perhaps even the timing of cash flows is of critical importance.

Goldratt and Fox characterize cash flow as; ”… an on-off measurement.  When we have enough cash, it is not important.  When we don’t have enough cash, nothing else is important.”  Cash flow is a survival measurement (20)!

Be that as it may, there is little discussion of cash flow within the constraint management literature (21, 22).  However, Stein mentions how to use a constraint schedule and Throughput Accounting to effectively manage cash flow in situations where this is imperative (23).

Let’s repeat the definition of cash flow from the measurements page;

Cash Flow = Throughput - Operating Expense + Inventory Change

Note however, that when there are stock movements;

Net Profit = Throughput - Operating Expense - Inventory Change

This is especially important for absorption-based accounts because the stock has overhead attached to it.  Therefore;

(1)  When stock increases, then profit increases, but cash flow goes down.

(2)  When stock decreases, then profit decreases, but cash flow goes up.

When overall inventory is small, or if overall inventory is large but period to period changes are small these factors are not particularly significant.  However, in the initial stages of an implementation where there might be a substantial reduction of work-in-process or more importantly finished goods, then it is important that this effect on the accounting position is known and understood beforehand.

In the situation of a turnaround getting old work-in-process out the door as fast as possible it will bring much needed cash into the system.

Direct Labor As Operating Expense And Strategic Implications

For many people transferring the discounts and sales commissions of absorption costing from indirect expenses to the variable expenses of variable costing is OK, but transferring direct labor from cost of goods sold of variable costing to operating expense of throughput accounting is difficult to sanction.

Part of this undoubtedly arises from the fact that direct labor is the variable against which indirect costs are allocated to products to obtain a “product cost.”  That is, unless, a more “sophisticated” approach such as activity based costing is being used.

There are two interrelated reasons why it is essential to move direct labor to operating expense.  They are;

(1)  Technical Considerations.

(2)  Philosophical Considerations.

Let’s deal with the technical aspects first.

Inherent in the assumptions of absorption costing and variable costing is that direct labor is an avoidable cost.  You can reduce direct labor.  This may have been so in the past when absorption costing was developed and most direct labor was on piece-rates.  Then, in fact, almost all direct costs were indeed variable costs.  These days this is not so, and to make decisions based up this assumption will lead to contrary results.  The damage caused by companies that “…still use the same cost accounting and management control systems that were developed decades ago for a competitive environment drastically different from that of today” is well documented (24, 25).

Moreover, even if direct labor could be considered as a totally variable expense, in most western countries even if it is legal it is neither particularly acceptable nor easy to lay-off staff.  In Europe and Japan there are strong governmental regulations and social norms that make this almost impossible.  It seems that our accounting system is suffering from inertia.

Given these technical considerations, there are also deeper and much more important and powerful philosophical considerations.

Superficially we know part of this already.  Ask yourself, what would happen if you had a successful improvement program, found some spare capacity – people – and then laid them off?  What would be the chance of another improvement program within that organization within the next 5 years?

What about the next 10 years?  And we saw ourselves in the section on bottom line effects that improvements based upon cost reduction suffer diminishing returns – so even if the people remaining will co-operate then “bang per buck” gets less and less each time.  And of course people will co-operate but every problem will be external and beyond their control.

Now consider also what would happen if you raised productivity and profitability (and we know this can be done), you now have an open ended improvement process – peoples’ security is enhanced and their desire to contribute is improved.  This is why one of the pivotal necessary conditions for a process of on-going improvement is; provide employees with a secure and satisfying workplace now and in the future.

But deeper than this are some underlying values.  Jones and Dugdale consider that in the foundation of Goldratt’s work there are humanitarian concerns that are the moral framework for his management theories.  “For Goldratt, … and other advocates of TOC, …, the treatment of labor as a fixed cost is a moral and political statement that pays more than mere lip-service to the interests of employees (26).”  Jones and Dugdale develop this point further and compare and contrast Theory of Constraints with activity based costing.  They conclude that; “ABC and TOC represent not only different socio-technical systems but also different moral systems.”

Being part of a different moral and socio-technical system is not a liability.  In fact it is just the opposite; it is a definite strategic advantage.  Hurst has also raised similar important issues about Toyota’s just-in-time system (27).  He makes a case for this to be a substantial competitive advantage.  This is a concept that we will return to and examine in more depth in the page on strategic advantage.

The experience with job security in kaizen in Japanese corporations is actually no different from that of Theory of Constraints; “There is an important precondition that must be met …that the shop floor has the ability to perform kaizen, and that no jobs will be lost as a result of kaizen.”  Moreover, “the maintenance of this precondition is the key foundation for independent kaizen (28).”  In fact it almost becomes circular.  In order to improve we must be secure, in order to be secure we must improve.  Lean implementations in the United States of America have also found that guarantees of job security are an important part of the improvement process (29).

Maybe Deming said all of this much more succinctly; “Drive out fear (30).”

Limitations Of Throughput Accounting

Some people of reductionist/local optima persuasion consider that throughput accounting has limited strategic capability.  Hopefully the previous discussion on strategic issues has helped.  Schragenheim best summarizes this situation as follows.  “The TOC approach may remind people of the marginal costing method, but the similarity is very superficial.  TOC objects to any allocation of fixed costs, but is not going to ignore them.  Moreover, TOC is system oriented and by that a different logic emerges.  TOC looks for the marginal costs for the whole system rather than the marginal costs associated directly with the decision at hand (31).”  So it seems that the limitation is more to do with a reductionist/local optima mind-set than a failure of the systemic/global optimum environment in which this accounting should be executed.

Let’s use our system model once more to illustrate this.  Let’s draw the reductionist/local optima view first.

And below is the systemic/global optimum model.

If the reductionist/local optima view of the world is as we have drawn and the reality is more like the systemic/global optimum model – then we can’t expect those of reductionist persuasion to fully understand the implications of the systemic view.  We can only repeat that Theory of Constraints is system oriented and by that a different logic emerges.  To use an analogy, it would be like asking 1980’s American manufacturers to believe that there is no dumping or for that matter that cost can go down as quality goes up.

Takashi Kawase sums up this problem best.  “Paradigm shifts are not born out of existing evaluation standards (especially not from economic calculations), but from the pursuit of ideals and convictions.  This is because it is not possible to predict the merits and demerits of a revolutionary new process accurately (32).

However, within systemic/global optimum practitioners there is awareness that throughput accounting is not perfect.  “The remaining hurdle is to restate financial statement profit to best align executive strategy and decision making with both short- and long-term results (33).”  This brings us to the concept of constraints accounting.

Constraints Accounting

Caspari and Caspari are practitioners who are aware that throughput accounting is not perfect; essentially we are trying to evaluate a global-throughput paradigm with an existing local efficiency costing paradigm and calling it throughput accounting.  Caspari and Caspari borrow a term from computing jargon to describe the situation; throughput accounting is a “legacy system” firmly lodged in the cost world (34).  It appears that we must eventually replace it with something more systemic – constraints accounting.

Does this mean that the preceding discussion on throughput accounting is invalid?  No, not at all.  In fact I will argue we needed throughput accounting to transition from absorption accounting to constraints accounting.  This doesn’t mean that constraints accounting is derived from throughput accounting, it is not, but we needed to go there first before we completely understood what was missing.

Let’s view this by analogy.  In organic evolution, when a new need or opportunity arises, organisms must “make do” with whatever is on hand – because there is nothing else.  A pre-existing part is co-opted to a new function; thus we have the panda’s “thumb” – which isn’t a thumb at all – and a multitude of similar examples (35).  In business revolution then, when a new need or opportunity arises, firms also must “make do” with whatever is on hand – because, at first, there is nothing else.  When drum-buffer-rope first appeared there was a need for a consistent accounting approach.  Variable costing was at hand and pressed into service.  Of course, organic evolution is an entirely passive process whereas business revolution is decidedly active.  In business we can invent totally new solutions, but first, we need to understand the problem.  Throughput accounting limitations allowed us to better understand the problem that we wanted to solve.

Let’s try and capture this in a diagram.

Here we can see some of the broad developmental relationships between the different accounting approaches.  Cost accounting and activity based costing are reductionist/local optima approaches.  Their more recent extension, the balanced scorecard, is simply more of the same – looking for local drivers everywhere, including non-financial measures (36).  The balanced scorecard, as currently being implemented ignores the implications of a scare resource.  “The reason the balanced scorecard will not solve our dilemmas is because organizations do not have a model of the environment that can predict the effect on the entire organization (37).”

Variable costing also developed from cost accounting, but out of the recognition that some costs are incurred irrespective of the fixed cost component and thus better management decisions about product cost could be made by identifying these variable or differential costs (38).  Throughput accounting develops this concept further to the point where direct labor is no longer considered variable.  Although product cost is avoided by instead considering throughput, the concept isn’t very far away.  Constraints accounting is the only methodology that is truly a systemic/global optimum approach.

We saw some of the limitations of throughput accounting in our travels through this site.  For instance we lose sight of the constraints as soon as we get above a product level in our accounts.  In throughput accounting we make investment on the basis of a significant increase in output or throughput then have to depreciate the investment at some glacial rate over many years as operating expense.  When the constraint moves out into the market we don’t really know what contribution to expect from any new product, we know that anything above material cost is a positive contribution, but that knowledge alone isn’t sufficient.  To these examples we must add Smith’s concerns above about alignment.

Constraints accounting is a global throughput accounting paradigm with which we can evaluate our global-throughput decisions/operations in an internally consistent manner.  It brings the effect of identified constraints to the profit and loss statement and therefore effectively subordinates the management accounting function of the firm to the goal of the organization in a true process of on-going improvement.  It provides a bridge for building new product contribution expectations.  It allows us to recover investment in breaking constraints as operating expense at rates commensurate with the new rate of throughput.  And it provides a means of goal congruence via financial incentives to bust constraints, thus generating alignment for both short-term and long-term results.  In broad principle the incentive system is not dissimilar to those suggested for kaizen in Japan (39).

Let’s hope that constraints accounting will eventually be published.  In the meantime much of the basic material is available on-line (see links and resources).


We ended the preceding section on the note that if there is one department that can block all others then that department is finance.  We have seen, however, that there is no need for this to occur.  Indeed financial accountants – people who deal with and understand flows of money – will wonder what all the fuss is about.  After all it’s just common sense.

Let’s turn our attention then to some of the broader aspects of leadership.


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(39) Kawase, T., (2001) Human-centered problem-solving: the management of improvements.  Asian Productivity Organization, pg 111-119.

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