Who Wins in a Dynamic World: Theory of Constraints vs. Activity-Based Costing?
Cooper, Bray and Parzen (2007)
Introduction
-Value chain analysis serves as a powerful tool for economic planning
oCategorizing the value-adding activities of an organizational system
oIlluminating areas most likely to increase profitable outcomes
-Value chain identifies the value and cost drivers for each activity performed by an organization
oStrives to maximize aggregate value creation and minimize costs internal to an
organization
oTwo views: TOC & ABC
-According to TOC approach, identifying and addressing these constraints facilitates successful
management choices regarding optimization of an organizational system
-According to ABC, identifying the causal relationships behind the costs of a profit-making
organization facilitates cost assessment more optimally
oIlluminates areas of high overhead costs for management to consider and adjust
Hypothesis: ABC more optimal in a dynamic world where volume and costs vary
Hypothesis: ABC (bottom-up) more agile and less limiting than the “top-down” constraint-
identifying tact associated with the TOC approach.
oWith regards to organizational systems, “Bottom-up” approaches are more resilient to
volatility
Experiment 1: TOC vs ABC
ABC always generated more profit than the TOC approach did in a dynamic world
However, TOC produced a larger amount of revenue
oTOC approach identifies and addresses system constraints, maximizing revenue received
-TOC maximises revenue at the expense of increasing costs, such that profit is no longer larger
than the orders the ABC approach would have accepted if faced with the same choices
oABC generates lower revenue, but smaller costs and consequently larger profit
TOC treats operating expenses as fixed while ABC treats operating expenses as variable
oIn a dynamic world, operating expense vary by a greater amount than revenue
Implications
A hybrid TOC+ABC approach is the most optimal strategy to adopt for long-term value chains
oOptimal feature of TOC approach aid by selecting the first cut of orders that will generate
the highest revenues
oOptimal feature of ABC approach aid by selecting the orders that have the lowest costs
and thus highest profit
Firms need to be more agile at either adopting or ceasing activities dependent upon their profit
vs. associated costs
oFirms becoming less vertically structured and more market based