Consider the following business scenario:
You are the owner of a collection company and have noticed an increase in the number of accounts your company collects on, but your recovery ratios are down. In addition, you have noticed that your collectors are unable to contact all the accounts in their WIPs, you have a higher employee turnover rate than normal, the collectors don’t seem to be as dedicated to working their WIPs, and your operating expenses are increasing but revenue is static. The collectors also complain about a lack of good contact information.

As a result of the above conditions, your collection manager is insisting that more collectors be hired to take on the increased number of accounts. In addition, the collection manager would like to purchase additional dialer seats so more accounts can be contacted. Your skip tracing department wants to start using a new data vendor to improve the department’s results. But you are not certain that any of these steps are necessary. You feel that if the collectors worked longer shifts they would be able to get caught up. Also, because expenses are increasing (but revenues are not), you’re thinking some cost cutting measures might be appropriate.

How do you determine the appropriate course of action? Should you do what your collection manager asks, or should you implement some cost cutting measures? Or should you try a little bit of all of the above?

This scenario and the decisions to be made, in one form or another, face each of us everyday. There is a business methodology, known as the Theory of Constraints, that can help in determining the appropriate course of action when confronted with multiple problems and choices. The Theory of Constraints (also known as TOC) was developed by Eliyahu M. Goldratt. At Columbia Ultimate, we regularly use the Theory of Constraints to identify which processes have constraints and are in need of improvement. I believe The Theory of Constraints is effective for a number of reasons.

I will briefly introduce you to a few of the major concepts of the Theory of Constraints, and you can determine if this type of methodology can work for your organization as well.
The Theory of Constraints is a management philosophy based upon the premise that the goal of every “for profit” business is to make money, now and in the future. To achieve this goal the Theory of Constraints is simply defined as: A business practice making the assumption that in order to increase the throughput of any business, you only need to identify the one constraint that is preventing an increase in throughput and remove it. (“Constraint” can be defined as a bottleneck, and “throughput” defined as revenue minus direct outside costs.)

The key point in this definition is that although, at any given time, there may be many bottlenecks in your business there is only ONE bottleneck (or constraint) that needs to be removed to increase your company’s throughput.

Implied in this definition, and this is an important concept, is if you attempt to remove multiple constraints simultaneously, you actually increase overall operating expenses and profitability will decrease. One other major premise of the Theory of Constraints is that the bottleneck restricting throughput must be identified for the company as a whole, not just within a single department. This requires a holistic company approach to problem solving. Without taking a holistic approach, the probability of identifying and resolving the wrong bottleneck increases.

The Theory of Constraints consists of a 5-step process:

1. Identify the major constraint
2. Exploit the constraint
3. Subordinate the constraint
4. Elevate the constraint
5. Find the next constraint and repeat steps 1 through 4.

(Steps 2 and 3 ensure that the constraint doesn’t become more restrictive than it already is, and step 4 is about removing the constraint and increasing the throughput).

Bottlenecks can be determined by analyzing company problems and separating the problems into two categories: root causes and undesirable effects. Undesirable effects are problems that will go away when a root cause is resolved. Identifying the root cause helps in identifying the process that needs to be improved.

When confronted with multiple bottlenecks, the natural tendency of most business people is to try and remove all of them simultaneously. The general business belief is if all bottlenecks are removed, or in other words, if the efficiency of all departments is improved, then the company’s overall throughput will increase. But in reality, this practice actually increases expenses and makes matters worse, not better. Why? Because not all bottlenecks restrict overall throughput. How can this be?

Let me give you a simple example. Suppose you have a company with two processes: P1 and P2. The input to P2 is dependent on the output from P1. If P1 can output 10 units and P2 can output 20 units, which one restricts the company’s overall throughput?

Obviously, P1 is the answer. Now, let’s say we wanted to increase the company’s overall throughput to 20 units. It should be obvious that it would be a waste of money and resources to increase the output of P2, since it is not the process restricting overall output. Now, here’s the key: Until P1 increases its output to match P2, any resources spent on P2 will reduce overall profitability and, therefore, is a waste.

Going back to our collection agency scenario at the beginning of this article, let’s apply the Theory of Constraints in determining what to do. First of all, we will reject the proposal to try a little bit of everything (such as hiring additional collectors, requiring overtime, adding dialer seats, etc.). Rather, we will concentrate on identifying the constraint that is restricting overall company throughput. This is accomplished by analyzing the reported problems, separating the undesirable effects from the root cause, and noting which process the root cause (or constraint) is in, then solving it. Here’s what we do:

1. First, identify the processes involved. The scenario indicates there are three processes used by this collection company: 1- collectors contact accounts manually; 2- collectors contact accounts via a dialer; 3- a skip tracing department that obtains good contact information.
2. Then we identify the problems that are being experienced: Decreased collection ratios, collectors not being able to contact accounts assigned to them, expenses going up but revenues staying static, higher than normal employee turnover, complaints regarding lack of contact information, collectors not dedicated to working their WIPs (Works In Progress).
3. After identifying the problems and searching for a root cause, we find that a lack of good contact information is the root.

The other problems appear to be undesirable effects stemming from the root cause. As a result, the root cause (bad contact information) prevents collectors from making contact with accounts in their WIPs, which prevents promises for payment from being made, which prevents payments from being received, which causes recovery ratios to decrease. Since collectors can’t meet their goals, the end result is dissatisfied collectors, hence the higher turnover rate and an increase in operating expenses resulting in lower profitability. In this example, identifying the root cause (bad contact information) and resolving it by concentrating on the skip tracing department will cause the other problems, or undesirable effects, to go away.

Although the above analysis of this collection agency example is overly simplified, it illustrates how the Theory of Constraints focuses attention on the real cause and prevents resources from being wasted on proposed solutions that really don’t solve any of the problems.

For a more thorough introduction to the Theory of Constraints, I encourage you to read The Goal by Eliyahu M. Goldratt. Organizations seeking to find better solutions to address internal issues and problems should strongly look at the application of Theory of Constraints.