What is the Theory of Constraints?

The theory of constraints, a variation of differential analysis, is an approach that enables companies to optimize the use of limited resources. 

Five steps are involved. 

• First, find the constrained resource (or bottleneck). 
• Second, optimize the use of the constrained resource. 
• Third, subordinate all non-bottleneck resources to the bottleneck. 
• Fourth, increase bottleneck efficiency and capacity. 
• Fifth, repeat the first four steps for the new bottleneck.

Constrained resources are often referred to as bottlenecks. 

A bottleneck is a process in which the work to be performed exceeds available capacity. 

The theory of constraints is a recently developed approach to managing bottlenecks

Using a Contribution Margin When Faced with Resource Constraints

Many companies have limited resources in such areas as labor hours, machine hours, facilities, and materials. 

These constraints will likely affect a company’s ability to produce goods or provide services. 

When a company that produces multiple products faces a constraint, managers often calculate the contribution margin per unit of constraint in addition to the contribution margin per unit. 

The contribution margin per unit of constraint is the contribution margin per unit divided by the units of constrained resource required to produce one unit of product. 

The result may lead a company to find additional resources to alleviate this resource constraint. Or perhaps the production process can be modified in a way that reduces the resource required (e.g., through increased automation). 

Whatever the outcome, companies with limited resources are wise to calculate the contribution margin per unit of constrained resource.

Related Topics

• Job Costing vs Process Costing
• Assign Direct Material and Direct Labor to Job
• Assign Manufacturing Overhead Costs to Job
• Assign Overhead Costs to Products
• Plantwide Cost Allocation
• Department Cost Allocation
• Activity-Based Costing
• Weighted-Average Cost of Products
• Production Cost Report
• Fixed, Variable, and Mixed Cost Estimations
• Contribution Margin Income Statement
• Cost-Volume-Profit Analysis
• Margin of Safety
• Contribution Margin per Unit of Constraint
• Absorption Costing vs Variable Costing
• Differential Analysis and Decisions
• Cost Decisions for Joint Products
• Capital Budgeting
• Life Cycle Costing
• The Master Budget
• Activity-Based Budgeting
• Standard Costs
• Imputed Value
• Variance Analysis for Product Costs
• Absorption Pricing
• Price Variance
• Absorption Variance 
• Responsibility Centers
• Comparing Segmented Income
• Using ROI to Evaluate Performance
• Using Residual Income to Evaluate Performance
• Use Economic Value Added to Evaluate Performance
• Transfer Pricing