Management Research Review

Theory of constraints contributions to outbound logistics

Fernando Bernardi de Souza Slvio R.I. Pires

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Fernando Bernardi de Souza Slvio R.I. Pires, (2010),"Theory of constraints contributions to outbound
logistics", Management Research Review, Vol. 33 Iss 7 pp. 683 - 700
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Togar M. Simatupang, Alan C. Wright, Ramaswami Sridharan, (2004),"Applying the theory of constraints
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Mahesh C. Gupta, Lynn H. Boyd, (2008),"Theory of constraints: a theory for operations management",
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dx.doi.org/10.1108/01443570810903122
Shams-ur Rahman, (1998),"Theory of constraints: A review of the philosophy and its applications",
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Theory of constraints
contributions to outbound
logistics
Fernando Bernardi de Souza

TOC
contributions to
outbound logistics
683

Sao Paulo State University (UNESP), Bauru, Brazil, and

Slvio R.I. Pires

Methodist University of Piracicaba (UNIMEP), Piracicaba, Brazil
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Abstract
Purpose The purpose of this paper is to systematically describe the key practical contributions of
the theory of constraints (TOC) to outbound (distribution) logistics.
Design/methodology/approach Based on theoretical research, this paper presents the main
practical aspects of the approach suggested by TOC to outbound logistics and discusses the
assumptions upon which it is based.
Findings This paper corroborates the thesis defended by TOC, according to which the current
ways of managing outbound logistics, based mainly on sales forecasts lead to difficulties in handling
trade-offs between logistics (stock and transportation) costs and stock-out levels.
Research limitations/implications The reported research is of a theoretical nature.
Practical implications TOC offers a proposal that is complementary in many aspects and very
distinguishable in others about the way some key processes and elements of supply chain
management (SCM) are managed, especially outbound logistics.
Originality/value Considering the dearth of papers dealing with the conceptual articulation and
organization of this subject, the paper contributes to systematize the knowledge currently available
about the contributions of the TOC to outbound logistics, highlighting the practical implications of
applying TOC to outbound logistics.
Keywords Stock control, Costs, Distribution management, Order systems, Lead times
Paper type Conceptual paper

1. Introduction
Since its inception almost three decades ago, the theory of constraints (TOC) has
developed quickly and stood its ground as a management philosophy (Watson et al.,
2007), and a general theory in operations management (Gupta and Boyd, 2008). Many
management issues have been studied, structured and presented under the TOC
perspective. Some examples are the approaches for performance measures based on
throughput accounting (Goldratt, 1990a; Corbett, 1998), the study of drum-buffer-rope
and the buffer management method for production planning and control (Goldratt,
2004; Schragenheim and Dettmer, 2001), the proposal of the critical chain as an
alternative for project management practice (Goldratt, 1997; Cerveny and Galup, 2002),
and even use of the thinking processes for problem identification, solution and
implementation development (Goldratt, 1994; Kim et al., 2008).
Distribution logistics and supply chain management (SCM) are areas in which TOC
principles have been less explored. Thus, a review of the literature was made to
identify important references on the application of the TOC in SCM, particularly with
respect to distribution logistics. Although some publications have dealt jointly with the
themes of SCM (and outbound logistics) and TOC, most of them focus on aspects other
than those proposed here.
In a review of the literature on TOC published in 1998, Rahman (1998) does not
mention the potential contributions of TOC in the ambit of SCM, although Goldratt

Management Research Review

Vol. 33 No. 7, 2010
pp. 683-700
# Emerald Group Publishing Limited
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DOI 10.1108/01409171011055780

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(1994) had already addressed this issue for the first time a few years earlier. Works
such as those of Perez (1997) and Rahman (2002) directly addressed the application
of the TOC in SCM, but did so without detailing the proposal of TOC for distribution
logistics. Other publications, in addressing SCM-related issues, did so making only
indirect use of TOC techniques or concepts, as in Yeo and Ning (2002), Stratton and
Warburton (2003), Aslanertik (2005), Kampstra and Ashayeri (2006) and Lockamy
(2008). Kim et al. (2008) describe SCM as an area of application of the thinking
processes. Kaihara (2001) establishes a rapid relation between SCM and TOC, but the
importance of TOC in the development of his paper does not go much beyond that.
This papers main objective is to describe the TOC pull-distribution methodology,
systematically describing the knowledge found in the literature on the subject. The
discussion that follows is, for the most part, conducted from the standpoint of the
producer in the distribution system. The links upstream from the producer will not be
discussed here directly.
The paper is structured as follows: section 2 briefly presents some of the basic
principles of TOC. Section 3 introduces some traditional practices challenged by TOC.
Section 4 discusses the principal actions proposed by TOC with respect to distribution
logistics, while section 5 highlights some results of the application of the TOC pull
methodology. Section 6 presents the final comments concerning this article.
2. TOCs
According to Goldratt (1990a), TOC initially recognizes that every organization must
be understood as a system with a goal; hence, every action taken by any part of the
system must be judged by its impact on that goal. It is imperative to define measures
that allow for the evaluation of the impact of any subsystem, and of any local action in
this subsystem. A system constraint must be defined as anything that significantly
prevents a system from improving its performance towards that goal. Every system
must present at least one constraint. In addition, there will always be very few
constraints, since there is always a single weaker link in a chain (Goldratt, 1990b).
The constraint may be physical, such as a machine with limited capacity, a policy or
a behavior constraint. Policy constraints often arise when the company environment
changes while its policies remain unchanged. Most significantly, policy constraints are
usually under the control of the organizations management (Mabin and Balderstone,
2003).
Goldratt (2004) asserts that the goal of a capitalist enterprise is to make money in
both the present and the future, and that this must be evaluated in terms of its net
profits (NP) and return on investment (ROI). To judge the impact of a local action on NP
and ROI, TOC uses three performance measures (Corbett, 1998):
(1) Throughput (T): revenue minus total variable costs (TVC). TVC is the cost that
varies for every extra unit produced (such as raw material) and does not include
direct (unless they are paid by piece) or indirect labor costs. All other costs are
included in the operating expense (OE) category. The throughput will tell us
how much money the company generates with the sale of one unit of the
product.
(2) Investment (I): all the money captured by the system.
(3) OE: all the money that the system spends transforming investments into
throughput.

TOC suggests five focus steps that must be followed to ensure effective ongoing
improvements (Goldratt, 2004):
(1) Identify the system constraint(s).

TOC
contributions to
outbound logistics

(2) Decide how to exploit the system constraint(s), i.e. increase the system
throughput, completely eliminating any kind of waste in the system constraint.
(3) Subordinate everything else to that decision. This implies ensuring that all the
other elements of the system work towards exploiting the constraint, which
should be evaluated according to how well they achieve that objective.

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(4) Elevate the system constraint(s), i.e. increase the system throughput by
increasing the investment volume towards the constraint, e.g. by investing in
new market segments to elevate a market constraint.
(5) If a constraint was broken in a previous step, return to the first step, but
prevent inertia from becoming the system constraint.
The TOC methodology for outbound logistics is a direct application of these steps, as
will be discussed in section 4. An important aspect of the TOC steps is their orientation
towards improvement efforts. TOC, unlike many continuous improvement initiatives
intended to reduce OE and which by its inherent nature would be limited (Larsson et al.,
2008), it makes more sense to focus improvement efforts on increasing Throughput as
means of improving the global financial performance. Throughput orientation
is a direct effect of the five steps described above and is supported by the use of
performance measurement systems that facilitate throughput maximization through
management of constraints (Boyd and Gupta, 2004). The TOC approach for outbound
logistics has a definite throughput orientation, which challenges some of the premises
often associated with practices aimed primarily at local optimizations and at the
reduction of logistics costs. These assumptions are discussed below.
3. Some assumptions challenged by TOC
TOC challenges some implicit or explicit premises about SCM and logistics practices
that users and academicians often take for granted. Because of their important
implications, each of these assumptions is presented and discussed according to the
TOC perspective.
3.1 Supply chain (SC) performance measures failed
According to Holmberg (2000) and Beamon (1999), SC performance measures are often
an extension of traditional company indicators. Neely et al. (1995) claimed that a
systemic approach and generic application of SC performance measures have not yet
been created for that purpose. Beamon (1999) and Holmberg (2000) agree that there is
no connection or compatibility between SC performance measures and SC strategies.
Traditional approaches for SC performance measures fail when they assume that if
each chain member is managed as a separate entity and its is performance maximized,
the benefits of the chain as a whole will also be maximized. A typical problem in
SCM is that the system of measures seeks to optimize the performance of individual
processes. In fact, many performance measurement systems evaluate the performance
of a link in the chain as a function of how well it met the needs of its immediate client,
instead of the SCs end consumer. Another problem lies in the fact that each link

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686

Figure 1.
Conflict between local and
global optimum in an SC

eventually has its own system of measures, leading to a dysfunctional behavior

(Watson and Polito, 2003).
According to Goldratt and Goldratt (2007), from a company perspective, when there
is a conflict between a local optimum (sector performance) and a global optimum
(company performance), the local optimum should be discarded. However, such is not
the case in a SC composed of several business units. When there is conflict between a
local optimum (business unit performance) and a global optimum (SC performance),
neither the local nor the global optimum should be discarded (Goldratt and Goldratt,
2007). Figure 1 illustrates this conflict from the standpoint of a business unit inserted
in an SC.
Conflicts between local and global optima in a company are strong evidence that
incorrect performance measures are being used to evaluate each area. Moreover,
conflicts between local and global optima in an SC are strong evidence that the
rules that govern the business relationships between the companies are erroneous.
Therefore, new rules are needed to enable companies to work together to eliminate
such conflicts (Goldratt and Goldratt, 2007).
To eliminate this conflict, a fundamental question that each link should ask itself
is (Goldratt and Goldratt, 2007): at what moment does a sale occurs? Usually, each SC
member focuses decisions on maximizing sales from immediate downstream partners
(myopic revenue), and minimizing (myopic) costs from the relationship with its immediate
upstream partners (Simatupang et al., 2004). The source of the so-called myopic revenue is
payment transfer from the exchange of stocks between trading partners, since a stock
transaction between SC members is considered a sale. The result is that each member
tends to reason within organizational boundaries, instead of considering the SC as a
whole. Each company improves its own revenue, ignoring the impact of its actions on the
other SC links. Therefore, maximization of individual performance often takes place at the
expense of the overall SC performance, and maximization of the SC performance as a
whole is usually not attained (Simatupang et al., 2004).
According to TOC, a sale should only be acknowledged when the final SC customer
has concluded the purchase (Goldratt and Goldratt, 2007). At that moment, the money
paid should be distributed among the links of the chain participating in the supply of the
sold item. While the links of an SC continue to believe that a sale took place only when
there was a transaction of goods between links, the synchronization and cooperative
efforts in the SC will be blocked. Besides the fact that they do not lead to real cooperation
among the members of the SC, a significantly undesirable effect of the use of measures
aimed at maximizing the performance of each link in the SC is that they encourage the

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pushing of stock along the SC. This subject is the next topic of discussion. A different
system of measurement proposed by TOC is presented in section 4.
3.2 The pushing stock practice
If a sale is considered concluded when goods are transferred to the upstream link there
is a clear tendency for each link to push stock downstream in the SC. Manufacturers
under pressure to come up with ideal local solutions, usually aimed at reducing costs,
tend to push their products to the distribution channels as soon as they are
manufactured. The distributor, in turn, is then strongly motivated to push his stocks
along the SC downstream to improve his stock turnover performance. Thus, supplier,
manufacturer, distributor and each additional SC link strive to push stock until it
arrives at the store and/or the end consumer (Kendall, 2005).
There is also a marketing reason for such behavior. Many products have a shorter
customer tolerance time than replenishment time, requiring them to be available on
store shelves for immediate purchase. The general practice of chain members is
therefore to keep products as near as possible to final customers, usually at the retail
level. This is a typical downstream product push behavior aimed at increasing
consumption. However, the push behavior requires a good forecasting model to predict
where and when stocks will be needed (Goldratt and Goldratt, 2007; Schragenheim,
2007a). There is a narrow correlation between forecasting, batching and the practice
of pushing stock. Far-future forecasting encourages production planners to schedule
large batches. The supposed knowledge of requirements (from the forecast) in the
future, storage space for large stocks and pressure for efficiency and low costs lead
to larger than necessary batches (Schragenheim and Burkhard, 2007). Despite
sophisticated forecasting systems and high stock levels, shortages occur regularly.
Regardless of how good the forecasting mechanism is, it cannot really predict the
actual demand (Schragenheim, 2007a).
Goldratt and Goldratt (2007) defend that the batch practice, usually stimulated by
efficiency measurements, significantly inflates replenishing time, thereby inflating
the required stock level along the SC. They define replenishing time as the sum of
three types of lead times: order lead time (OLT), production lead time (PLT) and
transportation lead time (TLT) (further discussed in section 4). The effects of the batch
practice on these lead times are:
.

OLT: SC links usually get discounts when they order large quantities. Moreover,
since making decisions and placing orders requires time and effort, each chain
member chooses to work with batches.

PLT: to improve local efficiency measures (saving setups), production operations

use large production batches.

TLT: to improve transport costs, this is done in large batches. Some orders are
accumulated until their transport can be justified.

However, the practice of pushing stock, motivated by large batches (which are justified
by sales forecasts), leads to highly undesirable effects. Large batches extend product
replenishing times in factories, distribution centers or shops, increasing the quantity
of stock stored in these places. At the same time, large batches diminish due date
performance (DDP) and the capability to flexibly meet customers urgent needs,
missing better service opportunities that would lead to higher prices and/or larger sale
volumes (Yuan et al., 2003; Schragenheim and Burkhard, 2007).

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Shortages and surpluses are undesirable effects common to the practice of pushing
products along the SC, with negative consequences on sales due not only to the
unavailability of the product at the point of sale, but also to the need to deal with excess
inventories. The elimination of these undesirable effects must necessarily involve the
elimination of the practice of pushing products in the SC.

688

4. The TOC pull distribution methodology

There is a conflict in distribution environments that blocks the maximization of their
performance, driving managers and decision makers into a trade-off between ensuring
the availability of products to the end consumer while simultaneously reducing the
logistics costs of these distribution systems (Goldratt and Goldratt, 2007). Figure 2
illustrates this conflict.
The solution usually adopted to deal with the conflict is to find a compromise
between conflicting needs, often through mathematical modeling based on the costs
associated with each side of the conflict for later identification of the optimal point that
would minimize these costs. Calculations of economic order quantity (EOQ), with the
consequent use of larger lots than strictly necessary and their related effects, reflect
this way of thinking. Another typical consequence of living with this conflict is the
constant search for better ways to predict demand, so that optimal inventory levels are
maintained at each site and for each product.
Whenever a conflict leads to a bad compromise (such as undesirable levels of lost
sales resulting from shortages allied to low inventory turns), efforts should be made to
break the conflict, identifying one or more erroneous assumptions that help perpetuate
the conflict (Goldratt, 2008). The TOC approach presented in this section challenges the
assumption that the best way to manage distribution systems is by replacing stock as
a function of forecasted sales. As will be better demonstrated later in this section, the
TOC pull replenishment solution exploits the fact that the accuracy of the forecast
depends on the stage (retails, regional warehouse (RWH), central warehouse (CWH),
etc.) of the distribution system (Yuan et al., 2003).
The TOC proposal for distribution is a result of the application of the three firsts of the
five focus steps presented in section 2. The first step is to identify the system constraint. A
direct way to identify the constraint in an SC composed of distribution channels is to keep
in mind that the constraints govern the systems throughput. Thus, one could ask the
following question: what elements govern the distribution systems throughputs? The
answer seems obvious: consumers wishing to buy. This means that the more consumers

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Figure 2.
Generic conflict of
distribution systems

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interested in buying, the greater the systems throughput. Therefore, the constraint in a
distribution system is the market, which is understood as each final customer wishing to
purchase a product offered by this distribution system (Goldratt and Goldratt, 2007).
After the constraint is identified, the second step is to decide how to exploit the systems
constraint. Inability to exploit the constraint in a distribution system implies inability to
serve the customer wishing to buy. Therefore, exploiting the systems constraint means
having the right stock in the right place at the right time. That is the only way to take
advantage of this market constraint instead of wasting it (Goldratt and Goldratt, 2007).
The third step is to subordinate the entire distribution system to exploit the
constraint to keep the right stock in the right place at the right time. To this end, five
major actions are inherent and essential elements of TOC methodology (Goldratt and
Goldratt, 2007). Each of these major actions is presented in detail below.
4.1 Aggregating stock in the factory or warehouse
It is well known that demand variability at the supply point is much lower than at
the consumption point (Taylor, 2004; Chopra and Meindl, 2003). Forecasts about the
number of items of the same SKU (stock keeping unit) that will be sold on a national
basis are much more accurate than the same information on a regional basis. At the
opposite extreme, at the sale point level where many SCs actually sell something, the
accuracy of this information provided by forecast models is very poor (Yuan et al., 2003).
For the product to be available at different locations, the TOC approach recommends
aggregating stocks at the source and maintaining a plant warehouse (PWH) or CWH. If
the organization is a manufacturer, the entity is called a PWH, i.e. the warehouse for the
finished products in the factory. If the organization is a distributor, the entity is called
a CWH. The bulk of the stock is stored in this warehouse. According to statistical
principles, this aggregation ensures a more stable system than keeping stock at different
consumption points (Yuan et al., 2003; Schragenheim, 2007a).
Once a consumption point has sold a unit, that unit will be replaced from the PWH/
CWH. If the TLT from the PWH/CWH to the consumption point is very long, a RWH
may be needed between the PWH/CWH and the consumption points. An RWH will
act as a consumption point for the PWH/CWH and as a CWH for the consumption
point served. The idea is to pull the distribution from the PWH/CWH based solely on
consumption from the RWH (Schragenheim, 2007a; Umble and Umble, 2002).
The greater stability afforded by the aggregation of stocks in the PWH/CWH reduces
the consequences of the bullwhip effect on production and increases the reliability of
replenishment to RWH, by making the replenishment time equal to the transportation
time only (no longer depending on PLT). Shorter and more reliable replenishment times
significantly reduce the amount of stock that RWH need to keep. In this way, the
introduction of a PWH or a CWH does not increase the total stock levels in a system, but
actually reduces them. In fact, the investment required for the inventory of a PWH is
amply compensated by the reduction in the levels of inventory in RWH (Umble and
Umble, 2002; Yuan et al., 2003; Goldratt and Goldratt, 2007). The main objective of TOC,
however, is not to reduce stock levels and associated costs, but to provide a fast and
flexible system that maximizes the availability of each SKU in each storage place. This is
the main reason for aggregating stock, a clear throughput orientation.
4.2 Establishing the target stock for each place and for each product
The next step in TOC is to determine the initial stock level for each SKU at each stock
point in the SC. The aim is to set the right stock levels to ensure that every potential

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customer will find the desired products available for purchase. These initial levels
should be set according to the following factors:
.

average replenishment time;

average demand within replenishment time;

fluctuations of demand within replenishment time;

fluctuations in replenishment time;

loss caused by shortage;

customer tolerance time; and

cost of holding stock (Goldratt and Goldratt, 2007).

The target replenishment stock for each place and SKU is determined as the
maximum sales predicted within the average replenishing time, factoring in the level
of non-reliability of replenishing time (Goldratt and Goldratt, 2007). TOC requires that
target or buffer stocks include replenishment orders. Since it is impossible to determine
the level of stock on hand at any moment in the future because of continuous
fluctuations in both demand and replenishment time, TOC suggests that the total stock
in the system, the stock on hand and the stock in the pipeline are kept at a constant preestablished target level (Schragenheim, 2007a).
An extremely important complement of TOC is dynamic buffer management
(DBM), which indicates if and when the target replenishment level should be changed
(further discussed in section 4.4).
4.3 Obtaining daily orders and replenishing frequently
The replenishment lead time (RLT) is defined as the period between the moment an
item is sold and the moment it is replenished from the previous link in the SC. The RLT
is divided into three separate moments:
(1) OLT: The period between the moment an item is sold and the moment a
replenishing order is issued, i.e. the order frequency of the same SKU. If
possible, cut it down to zero, which usually means trying to replenish daily at
each consumption point what was sold that day. This means completely
superseding the assumptions that underpin batch policies, as pointed out before.
(2) PLT: The period between the moment the manufacturer decides to issue the
order and the moment the order is produced. Simplified drum-buffer-rope and
buffer management, a simplified TOC way for production planning and control
(see Schragenheim and Dettmer, 2001; Schragenheim, 2002), should be
implemented to significantly reduce PLT. The priority of manufactured parts
should be tied to their stock level at the PWH, using the buffer management
technique in a make-to-availability way (see Schragenheim, 2007b).
(3) TLT: The time it actually takes to ship the finished product from the supply
point to the stock location. Seek transportation alternatives. Finding
geographically closer raw materials or parts suppliers is also a possibility in
many cases. Because this is usually the part of RLT that is the least changeable,
every possibility should be considered.
TOC suggests challenging these three elements in order to cut the RLT to a bare
minimum (Umble and Umble, 2002; Simatupang et al., 2004; Goldratt and Goldratt,

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2007; Schragenheim, 2007a). Cutting the RLT reduces the dominance of the supply
factor, producing the following effects (Goldratt and Goldratt, 2007; Schragenheim,
2007a):
.

The level of stock required at consumption points (and at warehouses) is lower,

since fewer days of demand need to be covered.

Fluctuations in supply time diminish as supply time decreases.

The required sales forecast for new products is much more accurate, since
forecasting errors increase when the forecasts extend further into the future (the
trajectory is longer).

The ability to respond much faster to real demand is evident.

In this way, TOC principles seek to encourage initiatives that trim different elements
of the RLT (Schragenheim, 2007a). To significantly reduce RLT, especially in terms of
OLT, TOC is based on a policy whereby the supplier manages the clients stocks. The
client therefore no longer replenishes his orders but simply informs the supplier, on a
daily basis, about the amount of each SKU sold. Based on this information, the supplier
replaces the sold products as quickly as possible, aiming to ensure total product
availability to the client. However, this mechanism does not suggest the need to
consign stock. What is really important is that the sales point daily inform the supplier
about the days sales, and that the supplier replenish those items as frequently as
possible (Umble and Umble, 2002; Simatupang et al., 2004; Goldratt et al., 2000).
Another aspect worth mentioning is the importance of a PWH in terms of feasibility
of the practice of daily ordering by the client (retailer, wholesaler or distributor).
Without the PWH, the factory itself would not encourage clients to place daily orders to
replenish everything sold that day, since that would probably force the factory to plan
many small batches, spending excessive time on setups. With the introduction of the
PWH, the factory receives replenishing orders directly from its stock at the PWH,
without having to produce one type of item to serve one client even when that item is
available in other clients stock. This alleviates production at the factory, since each
batch is naturally dimensioned as a function of overall market needs rather than of
only one client (Umble and Umble, 2002; Goldratt et al., 2000).
Also it is important to emphasize that the PWH allows the frequency of deliveries
per SKU to be increased while maintaining the truck shipment frequency. Increasing
the delivery frequency of each SKU improves the items availability in the RWHs
and at the sales points without increasing transportation costs. Moreover, the greater
availability in the RWHs reduces cross shipments among RWHs and sales points,
reducing overall transportation costs (Umble and Umble, 2002).
4.4 Dynamically managing buffers
In the TOC pull distribution methodology it is essential that the supplier control its
clients stocks. Basically, this means the supplier must replenish the clients stock of
each SKU and each place he controls as soon as the product is sold (equivalent to a minmax policy of stock control, but here the minimum level equals the maximum level),
or else daily replenish what has been sold each day. However, since the objective is to
ensure product availability, adjustments in stock levels will be needed whenever there
is a change in one of the factors considered in the target dimensions.
Thus, the supplier uses buffer management to control buffer size adjustments.
Corrective action is taken to decrease or increase the buffer whenever required.

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Because the buffer size reflects the consumption pattern, the supplier should monitor
the consumption of the buffer to determine appropriate actions (Simatupang et al.,
2004).
Such adjustments are made using the dynamic buffer management (DBM) technique.
According to DBM, stock buffers should be divided into three initially equal areas called
green, yellow and red areas. Depending on the dynamic behavior of on-hand stock, DBM
establishes some criteria to adjust the replenishment level (Umble and Umble, 2002;
Simatupang et al., 2004; Goldratt and Goldratt, 2007). Yuan et al. (2003) offer some
interesting contributions to the DBM technique. Most of the time, on-hand stock would
be significantly lower than the replenishment level. At the same time, it would be
expected to be above a certain level, below which it would be considered as almost
losing sales. Thus, the three zones of replenishment level can be defined as follows
(Goldratt and Goldratt, 2007):
(1) green: where the on-hand stock is close to the theoretical maximum;
(2) yellow: the intermediate level, where the normal on-hand stock should be; and
(3) red: where there is a risk of the impossibility of delivering the entire demand.
If the on-hand stock level has penetrated the red area too deeply during a period equal to
the replenishing time, the target should be increased. Conversely, if the on-hand stock
level is always within the green area during a period equal to the replenishing time, the
target level should be reduced. Except in special cases, such a reduction or increase
should be done by subtracting or adding to the replenishment level an amount equivalent
to an entire area, i.e. one- third (33 percent) of the target level (Goldratt and Goldratt, 2007).
Since TOC based on reacting to the real market demand and adjusting the buffers
accordingly, these buffers will be increased if the market demand picks up, creating
a mechanism that allows stock-outs only for very limited time periods. Therefore, sales
lost due to stock-outs of high-sale items are minimal with the TOC methodology. Because
lower stocks of all items are kept and the quantities are further decreased when
consumption is low, low-sale items are much less of a problem since their quantities
are minimal. Therefore, using pull distribution is very effective in eliminating lost sales
(Schragenheim, 2007a).
According to DBM, shortages are avoided not only by adjusting buffers levels,
but also by taking accelerated actions whenever an almost losing sales situation is
identified. When the red level is reached, actions should be taken not to endanger product
availability. The idea behind DBM can be summarized as the identification of situations
where the planned protection is almost exhausted. Once such a local case is identified
a warning is issued, causing high priority to be given to the problematic orders and
then using the rest of the protection to remedy the disruption. Almost exhausting the
protective buffer means very low on-hand stock (penetration into the red zone) to the
point that it could be totally depleted before the arrival of replenishments. Once the red
zone has been penetrated, the supplier should take action to speed up the replenishment
until the buffer has returned to the top of the green zone (Schragenheim, 2002). The
justification for such hastening actions is that any increase in costs would be more than
offset by the increase in throughput of the SC.
The objective of DBM, however, is not to increase sales solely by reducing
shortages, but also by reducing excess stock kept in the system. The throughput
orientation is visible here, as well. The main effect resulting from the elimination of
excess stock, from the TOC standpoint, is the increase in sales and not the welcome

reduction of costs. Goldratt and Goldratt (2007) emphasize that although keeping large
stocks may be a way to avoid shortages, large stocks may also risk sales, because:

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Large stocks are a consequence of long replenishment times, i.e. there is a

relatively long period between production and consumption moments. Therefore,
in environments where products have a short shelf-life, many units are offered to
customers close to their expiration date. This practice may lead to two outcomes:
the customer buys a product that is deteriorated or whose quality does not meet
his expectations, affecting future sales negatively or the customer decides not to
buy the product, affecting current sales negatively.

In marketplaces involving products with short life cycles, keeping large stocks
of products may typically give rise to three situations: high obsolescence rates
due to the launch of more modern products; high revenue losses due to price
reductions of older products, which, in turn, reduces the market share of new
products; and loss of market share due to postponement of new versions.

Keeping large stocks implies high investments. In environments where cash flow
is relatively limited, keeping large stocks of a range of products means cutting
down on other products. Product variety offered at the sales point is thus limited,
reducing sales.

To sustain a pull mode of distribution, it is crucial that performance measures that lead
to the practices of pushing stocks along the SC are replaced by other more appropriate
ones. The next topic addresses this issue.
4.5 Measuring performance from an SCM perspective
As a fundamental principle, to improve the whole SC implies not only improving
each company inside the chain, but also the cooperation between those companies. A
decisive point to make an SC work as a business unit, ensuring that a sale is only a real
sale when the final customer buys a product in the SC, is the existence of a performance
measure that indicates when it is safe to rely on a certain client or supplier.
SC collaboration assumes that there is a good degree of reliability between chain
members. For example, the retailer relies on the supplier to manage the stock and
ensure its availability and the supplier relies on the retailer to send timely and accurate
information about sales and to deliver good customer service. Successful SC
cooperation, therefore, depends largely on how each member keeps to the cooperation
scheme. Cooperation performance measures consist of a group of measures specifying
how the cooperation process is evaluated by individual members and by the SC as a
whole (Simatupang et al., 2004).
Simatupang et al. (2004) believe that the solution is to ensure that local decisions
regarding throughput, investments and OE measures are made as proposed by TOC.
However, the use of such measures implies two challenges. First, the chain members
must formulate a new replenishment policy that encourages chain members to align
their operating decisions to maximize the total revenue of the SC. If the SC consists of
a retailer and a producer, the retailer should focus on offering excellent customer
service and on supplying the markets needs, while the producer should respond
rapidly to those needs. Thus, the producer manages the retailers stocks, ensuring their
availability. The second challenge consists of new performance measures by the chain
members, aligned with SC global performance measures. Local performance measures

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should guide local decisions to maximize global throughput, maximizing individual

throughputs at the same time (Simatupang et al., 2004).
Performance measures should be able to induce chain members to follow a global
SC plan, creating throughput by delivering the right products at the right time in the
right place, using no more than a certain level of stock and a certain operation level of
expenses (Simatupang et al., 2004). Since global operation measures are measured by
throughput, investment and OEs, and since each member should control the execution
of the global plan in their particular area, chain members should measure their
performance in terms of the impact on the measures of throughput, investment and
OEs of the SC. It is necessary to use measures that indicate if the clients or suppliers
are operating according to the plan suggested by the chain. There are two ways of not
follow a production plan: producing in advance (forming excess stock) or producing
with delay (risking or reducing throughput) (Simatupang et al., 2004; Goldratt and
Goldratt, 2007). Two indicators to identify and monitor these two types of plan
dysfunction would be throughput-dollar-days (TDD) and inventory-dollar-days (IDD).
A third measure is local OE (LOE) (Goldratt and Goldratt, 2007).
TDD is a reliability measure that evaluates the faults in terms of commitment to
clients. TDD is the final result of things that should have been done but were not.
Therefore, TDD measures the importance of the commitment that was not adhered to in
the customers opinion (Goldratt and Goldratt, 2007). TDD is the indicator proposed by
TOC to control the execution of the program in terms of delivery deadlines. Based on
buffer management at the control points, it is possible to identify production orders that
are late, i.e. that have failed to arrive. The objective is to reach a TDD equal to zero
(Goldratt and Goldratt, 2007). It should be noted that the TDD measure leads to a different
behavior when it is compared with indicators such as the DDP. For instance, assume two
orders should be delivered today but the company in charge informs the client that only
one order can be delivered. Based on DDP criteria, the company will probably focus on
the easier order, minimizing the risks of a negative effect on the DDP. The monetary value
of each order is not considered by DDP. However, if the TDD measure is used, the
monetary value of the order is explicitly considered and the focus falls upon the order
with the higher value, which is usually the one requiring greater effort to be concluded.
IDD, on the other hand, is a system effectiveness measure. It measures the stock
value and the time it remains in a given location. The final result of things that should
not have been done but were done nevertheless is excess stock. Two things are
important when measuring IDD: the period when the stock is necessary and the value
of the stock. The aim is to have the fewest IDD necessary to ensure reliability (Goldratt
and Goldratt, 2007). IDD is calculated by multiplying the value of stock by the number
of days it is kept. IDD allows for item-by-item control, always according to the item
plan, unlike conventional stock control indicators based on stock turnover or on
average coverage time. IDD is especially efficient in eliminating the tendency to process
material in advance to avoid inactivity. With this measure, the employee realizes that it
is pointless to advance the plan and that he is measured negatively by that action. The
same reasoning applies when a company that generates stock simply to improve local
efficiency measures is penalized. The company should follow the SC production plan
instead of immediate local needs (Goldratt and Goldratt, 2007).
Finally, LOE is an efficiency measure. It includes only expenses under control of the
measured links, such as wages and refusals, but no type of allocation should be done
(Goldratt and Goldratt, 2007). LOE measures variations in real and planned expenses
(Simatupang et al., 2004).

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TDD should clearly be the primary or main SC measure, and it should be kept in
mind that its target value is zero. IDD and LOE are secondary measures. The target is
to reduce them without risking the primary measure. This means that companies or
chains using the measures proposed by the TOC should take actions that prioritize
maximization of the SC throughput, even if they lead to occasional increases of IDD or
LOE (Goldratt and Goldratt, 2007).
In addition to using the three local measures to control SC operations, chain
members can also use them to judge how the other partners contribute to the global
measures. The supplier can use IDD to evaluate the performance of the retailers stock.
The supplier can also provide the same measures to his own suppliers, enabling them
to evaluate his stock performance. On the other hand, the retailer can evaluate the
suppliers delivery performance by using TDD. Accordingly, the supplier can use
TDD to evaluate is own suppliers delivery performance. Thus, TDD and IDD are
performance measures that help SC members become uniformly accountable. This
chain of accountability encourages SC members to improve their mutual responses to
satisfy the final customer (Simatupang et al., 2004).
5. Results of the application of the TOC pull methodology
The TOC pull methodology focuses mainly on increasing the throughput, although
investment levels along the SC and cross shipment expenses may be significantly
reduced with the proposal. Therefore, the TOC distribution methodology does not
focus on finding a mechanism to reduce total costs in the system, or even on finding an
optimum point of tradeoff cost vs service level. The final objective to protect sales
by reducing replenishing time and increasing replenishment reliability should be
achieved at the lowest possible cost.
Kendall (2005), Goldratt and Goldratt (2007), Schragenheim (2007a) and Goldratt
(2008) describe some ways to increase throughput:
.

The items which are most subject to shortage are the ones most frequently sold,
possibly representing a significant slice of sales at the sales point. This means
that reducing the shortage and replenishing time of these products will result
in much greater sales increases than the proportional reduction of shortage
frequency.

With lower stocks per item, the sales point does not need to maintain large stocks
of low sale products. This eliminates a behavior that is highly deleterious to
sales, i.e. the retailer invests a great deal of effort to sell these slow-moving items,
blocking his display space at the expense of other items in the store. Major
efforts by the shopkeeper to sell these slow-moving items could have yielded
much higher revenues from fast-moving items.

With lower stocks and therefore higher available cash flow and less shelf space
taken up by each article, the distributor and the sales point are able to offer a
wider variety of items, thus increasing throughput in the same physical space.
This may be facilitated when the producer offers the shop the possibility of
returning slow-moving items and having them replaced with fast-moving items
identified in other stores in the same region.

Price reductions to get rid of excessively large stocks are less frequent. This
means not only that profit margins are increased, but also that price reductions
of obsolete products will not spoil the market for new products.

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With faster and more frequent replenishment, the time between production and
availability for the final client will be shorter. Products on the shelf will thus
be newer and hence more attractive. This can exert a significant effect on
throughput from articles with due-by dates.

The TOC methodology sharply reduces replenishment times. For many of the
less popular products, reduced replenishment time is shorter than consumer
tolerance time. These products can now be offered even without having them in
stock. Freeing the distribution system from the need to keep stocks of less
popular products will lead to a considerable increase in the offered product mix.

The principles and techniques of the TOC distribution methodology have been used
for over a decade by several companies in various sectors. Watson and Polito (2003)
mention some implementations of the TOC methodology at Brinney and Smith
(manufacturer of Crayola crayons), Procter & Gamble, Warren Featherbone
(manufacturer of childrens clothing) and at General Motors Cadillac Division, which
they call evidence in the literature that TOC-based methods can be used to improve
distribution outcomes. Kendall (2005), Schragenheim (2007a), Goldratt and Goldratt
(2007) and Goldratt (2008) present some results based on their own experience and
information from a variety of sources.
These results highlight the increase in sales and in stock turnover, and the reduction
in system-held stock, internal transfers between regional warehouses and levels of
obsolescence, while OEs remain practically unaltered. Positive results have also been
identified in simulation environments (Umble and Umble, 2002), including interesting
comparisons with the distribution requirements planning methodology (Watson and
Polito, 2003). A reference bank with TOC implementation results, including applications
in distribution environments, is also available at: www.goldrattconsulting.com/
6. Final comments
This paper focused on the TOC pull distribution methodology, presenting and discussing
its main characteristics. Although many of its specificities are not unique or exclusive to
it, such as how to manage a suppliers stock, replenishment based on actual consumption
and the ability to respond rapidly to market needs, many of these characteristics are
clearly specific to the TOC methodology. Some specifics include the focus on improving
SC throughput as a whole, the emphasis on the need to have stockpiles at the plant or
close to it, the DBM technique and the use of dollar-day-based measures.
The main objective of the TOC pull distribution methodology is to ensure
availability of the items at every sales point. Therefore, one of its premises is that extra
effort should focus on ensuring product availability (in terms of reducing RLTs,
responding quickly to demand, managing buffers dynamically and reacting rapidly to
the almost losing sales indicator), allowing for short- and long-term sales increases
and thus making up for occasional cost increases. Part of this extra effort involves the
maintenance of adequate levels of excess capacity (or protective capacity) in all the
links of the SC, which is the key to enabling it to absorb variations and tendencies for
sales increases without destabilizing its component links (Umble and Umble, 2002).
Another premise outlined here is that conventional outbound logistics systems
cause high shortage rates by pushing stocks along the SC in response to forecasts.
Shortages and surpluses are the results using forecasts as the basis for the
management of operations in a distribution system (Goldratt, 2008). The difficulty
managers face in substituting this mode of operation for a different one lies in the fact

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that behind every problematical policy there is a conflict between changing it or living
with it. The root conflict order more to avoid shortages vs order less to avoid
surplus is based on the assumption that the only way to order the correct quantity
is . . . to forecast the demand. TOC challenges this assumption by designing a system
of distribution that allows for the replenishment and maintenance of adequate levels of
stock based on real consumption data. TOC does not eliminate the need for forecasting,
but reduces its importance and changes the way in which it is applied. Management of
the three zones is a simple but effective method to forecast the appropriate stock level
and protect deliveries, since it assesses the robustness of the current protection.
Like any forecast, it assumes no sudden change in reality. When coupled with very
flexible and rapid logistical responses, it can quickly identify trends, so it sidesteps the
need for regular forecasting to underpin short-term decisions (Schragenheim, 2007a).
This is one of the major differences between TOC and any methodology based on
demand forecasting, such as the collaborative planning, forecasting and replenishment
approach.
If the proposed solution is aimed at improving the performance of the SC as a whole,
it must also be seen as beneficial for each of its links, leading to an environment of
cooperation and motivation among the links in the SC. Hence, the new form of
managing the SC should result in a win-win situation for all those directly affected by
it. Goldratt (2008) also argues that, besides being fundamental, it is always possible
find ways for win-win cooperation or for maintaining harmony among members of SC,
even when the power between the links is highly imbalanced.
To this end, the use of appropriate performance measures is essential to induce an
attitude of cooperation and a single focus, and to ensure a real perception that everyone
stands to gain from these relationships. Accordingly, performance measures that lead to
actions aimed at cost reductions should be used very cautiously, since the expected
counter effect is the reduction of prices of the products and services exchanged between
the links, whose inevitable consequences are the perception of a win-lose relationship
among the parties and the rapid deterioration of the relationship. The new base of
operations should allow the best expectations of each link to be met, and sharing
increases in throughput offers distinct advantages over the focus on cost reduction.
Performance measures that strengthen cooperation through effectively win-win
relationships could, for example, consider paying higher prices if, and only if, a change
in the producers mode of operation enables the client (another manufacturer, a
distributor, a wholesaler and/or a retailer) to enjoy considerably higher inventory
turns (or considerably smaller TDD), which are attained not only by reducing average
inventories but primarily through increased sales.
The TOC offers a proposal that is complementary in many aspects and very notable
in others about the way some key SCM processes and elements are managed, especially
outbound logistics. However, more implementations should be investigated, further
research is needed to improve these techniques, and precautions are advisable before the
methodology is adopted. Intensive practical and theoretical training in the methodology
should be considered obligatory in all the stages of the implementation process.
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About the authors
Fernando Bernardi de Souza is a Associate Professor of Operations Management at the Sao
Paulo State University, with focus on production planning and control and supply chain
management. An expert in Theory of Constraints (TOC), with a certification for practitioners in
the TOC Fundamentals exam and in the TOC Supply Chain Logistics by the TOC International
Certification Organization (TOCICO), he uses the TOC intensively in his undergraduate and
postgraduate courses. He has also headed consulting projects for large Brazilian companies and
for major multinationals operating in Brazil, such as Deloitte Consulting, the Santillana group
and Gerdau.

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Slvio R.I. Pires is a Full Professor of Operations and Supply Chain Management at the
Methodist University of Piracicaba (UNIMEP) and at the FGV-Management in Brazil. A former
manager of production planning and control at Villares-General Electric heavy equipment in
Brazil, visiting research professor at IMD in Switzerland, and visiting professor at the Instituto
de Empresa Business School in Spain, he has headed several consulting projects for large
companies operating in Brazil, among them SAP, Volkswagen, Vallourec-Mannesmann, Deloitte
Consulting, International Paper, Gerdau and the Santillana group. He has 25 years of practical
experience in operations and supply chain management. Slvio R.I. Pires is the corresponding
author and can be contacted at: sripires@unimep.br

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