Another New Book Part 12

This post is, once again, taken from my newest book, Theory of Constraints, Lean, and Six Sigma Improvement Methodology – Making the Case for Integration. Specifically, the material for this series is taken from Chapter 5 entitled, A Better Way to Measure a System’s Success. As I explained in my last post, readers that are totally familiar with the Theory of Constraints might find this series a bit basic, but I’m writing this series for those who are not totally familiar with the Theory of Constraints.

TA is used to identify constraints, monitor performance, control production, and determine the impact of decisions.  The table below is a manufacturing situation consisting of just three parts with each part requiring the same three steps.  Each product requires a different number of minutes per step, but the total time required for each part is the same.  Labor costs per minute are the same across all steps.

Part A has the highest price and the lowest raw material cost per part while part C has the lowest price and highest raw material cost per part.  Because the same workers will be used to produce any product mix, the best mix would seem to be to produce as much of part A as demanded, then B, then C.  Following this priority, the factory will produce 100 units of A, 75 of B, and none of C.  Note that Step 2 limits enterprise production regardless of whether it’s actually recognized as the constraint.  Operating expense includes rent, energy and labor.  Let’s look at an example comparing CA to TA’s product mix decision as laid out in the table below.

When CA allocates operating expense to products based on their raw material costs, the resulting product costs confirm the expected priority:  Product A has a lower product cost than Product B. Unfortunately, with this product mix, this business generates a net loss of $250.  Because Part A appears to be profitable while Part B generates a loss, it’s tempting to conclude that producing none of B would stop the loss.  However, the Operating Expense covered by Product B would then have to be covered entirely by Product A, which would yield an even larger loss.  If additional work was started, in an effort to keep the workers at Steps 1 and 3 fully utilized (i.e. to maximize efficiency), work-in-process inventory would grow.  The inevitable conclusion, using Cost Accounting, this business is not profitable!

Bob Sproull