April 1999 Issue


An Application Of The Theory Of Constraints

By J. Gregory Bushong and
John C. Talbott

The theory of constraints (TOC) is a management philosophy developed by Eliyahu M. Goldratt in a series of books and articles. TOC is a systems approach based on the assumption that every organization has at least one factor that inhibits the organization's ability to meet its objectives. The normal objective for a business is to maximize profit. TOC emphasizes the maximization of profit by assuring that the factor that limits production is used most

The Theory of Constraints

Throughput is the rate at which a system generates money through sales after reduction for material costs, commissions, and distribution cost. Under TOC, the objective is to maximize throughput while minimizing operating expenses for labor, sales, and administration and simultaneously minimizing investment outlays for inventory, plant, and equipment. The first step in applying TOC is to identify the constraining factor. For manufacturing concerns, the constraining factor is often but not always the time available on a certain machine or process. For companies that employ skilled workers, and for many service organizations, the constraint is often the time of one or a few key employees.

Once the constraining factor has been identified, the next step is to determine the throughput per unit of the constraining factor. This is done by dividing the throughput per unit of product by units of the constraining factor required to produce each unit of product. The key to maximizing profit is to concentrate on selling and producing products that provide the highest throughput per unit of constraining factor.

Implementation of TOC is often difficult because it may require a complete change in the way the company operates. For example, selling and producing the product in the product line with the lowest sales price per unit may maximize throughput. If the company compensates the sales force based on commissions as a percent of sales, there is an incentive to sell products with the highest sales price. This scenario would require a new method for compensating the sales force.

Use of TOC as a management philosophy is a dynamic process. Once the constraining factor has been identified, management should examine whether the constraining factor can be increased. If this is possible, some other factor may become the constraint, and the analysis should be revised based upon the new circumstances. In addition to examining ways to increase the constraining factor, management must continue to monitor operating expenses for labor and administration while at the same time minimizing investments in inventory and productive assets.

In an article in the January 1997 issue of The CPA Journal, Jack Ruhl provided a more detailed explanation of the theory of constraints and provided a simple example of how profit can be maximized in a manufacturing environment by following the theory of constraints. The following example uses an actual small business to illustrate how applying the theory of constraints can lead to decisions that improve company profitability.

Daufel Enterprises

Daufel Enterprises is a small business that produces hand-tied fishing flies. A fishing fly consists of feathers, furs, and synthetics placed on a hook and seamed with thread. The fly tier constructs these flies to represent aquatic organisms upon which fish feed.

Quality and speed are two issues that conflict in the fly-tying industry. The faster a tier can construct a fly, the more profitable. However, if speed is the only focus, quality will suffer. In the book, Patterns, Hatches, Tactics, and Trout (Vivid Publishing, 1995), popular fly fishing writer Charles Meck wrote the following about Daufel Enterprises:

Doug and Dan Daufel have tied flies commercially for the past five years. The young age of these identical twins from Dayton, Ohio, belies their tremendous fly-tying ability. They tie some of the best patterns I have seen in my forty-plus years of fly fishing and tying flies. They have tied flies for more than ten years and now tie commercially some of the finest flies I've ever seen.

In essence, the Daufel brothers must personally tie the flies or quality will suffer. In their business, therefore, the brothers' time is the constraint factor.


Exhibit 1 illustrates the contribution margin (throughput per dozen) for the five most popular flies constructed by the Daufel brothers. In addition, the brothers have quantified the labor constraint for each fly to determine the throughput per labor hour. As indicated by Exhibit 1, all flies have the same sales price and shipping cost, but differ in the material cost per unit and the time required to tie the flies. Exhibit 2 compares the apparent profitability of the various flies based on traditional contribution margin analysis with the profitability of the various flies based on constraint analysis.


To perform the constraint analysis, the brothers had to monitor their own time spent working on each type of fly. They intuitively knew the Thorax Dun required more time than the others to tie. They also knew it had the lower contribution margin, so they were not surprised when the results indicated it had the lowest throughput per labor hour. However, they were surprised by other results of the throughput analysis. The Compara Dun, which has the highest contribution margin, ranked next to last based on throughput per labor hour because it required the second highest amount of the brothers' time. The Woolly Bugger, which had the next to lowest contribution margin, had the second highest throughput per hour.

Because of the high quality of their work, the Daufel brothers are able to sell essentially all of their production of any model of fishing fly. Prior to performing the constraint analysis, the brothers had concentrated on Compara Duns and Pheasant Tails. The constraint analysis indicated that the brothers should switch their productive efforts from the Compara Dun to the Woolly Bugger.

To meet the needs of their best customers and continue with their own creativity, the brothers desired to continue producing all of the current models, while increasing their profitability. With this objective in mind, it was suggested that the brothers explore the possibility of increasing the price of the less profitable flies.

Constraint analysis can be used to determine the sales price required so that each model of fly would have the same $29.39 throughput per labor hour. This analysis reveals that the required prices for the Thorax Dun ($20.72 per dozen) and Compara Dun ($16.64 per dozen) were higher than customers would probably be willing to pay. The required prices for the Hare's Ear ($14.11 per dozen) and Woolly Bugger ($12.53 per dozen) would probably not substantially decrease demand. This additional analysis suggests that the Daufel brothers should consider raising the price of the Thorax Dun, Compara Dun, and Hare's Ear to $14.00 per dozen and the price of the Woolly Bugger to $12.50 per dozen. Exhibit 3 shows the throughput per dozen based on the new sales prices.


Sales and production records for Daufel Enterprises prior to performing the constraint analysis were not detailed enough to allow them to accurately determine the expected profit increase as a result of the proposed changes. However, simply switching 500 productive hours per year from the Compara Dun to the Pheasant Tail would result in increased profitability of over $4,600 per year. The other proposed changes in production and price would also likely have positive effects on Daufel Enterprises' profitability.

Use of Constraint Analysis

Daufel Enterprises' constraining factor is, like many small businesses, the time of one or a few key individuals. This is certainly true in most service businesses. Like the Daufel brothers, owners or managers of small businesses normally have an intuitive feel for which products are more profitable. Often a simple constraint analysis will allow them to quantify their intuitive feel and make precise adjustments. CPAs that service small businesses can help their clients become more profitable by assisting them with the analysis.

CPAs can also use constraint analysis to improve their own firm's profitability. The constraining factor for CPA firms is often partner-level time required to review work before it is submitted to the client. Some services that are priced higher often require more partner time to complete the review and ultimately may not be as profitable as lower-priced services. Since accounting firms normally keep track of time spent on individual jobs, the data is readily available for the analysis. *

J. Gregory Bushong, PhD, CPA, CMA, is an associate professor of accountancy, and John C. Talbott, PhD, CMA, a professor of accountancy, both at Wright State University, Dayton, Ohio.

The Daufel Brothers are graduates of the accounting program at Wright State University, and the authors gratefully acknowledge their assistance in preparing this article.

John F. Burke, CPA
The CPA Journal

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