bdmm chapter 5 toc

8/12/2019 Bdmm Chapter 5 Toc

1/36

Chapter

5Theory of Constraints

What You Will Find Out About in This Chapter

The importance of managing system throughput

The differences between cost-world orientation and throughput orientation

The importance, and often the difficulty, of identifying constraints

The five-step process of constraint management

The circumstances in which the theory of constraints is valuable in increasingthroughput

How throughput accounting and appropriate performance measures canencourage a throughput emphasis


2/36

Management Accounting for Change: Process Improvement and Innovation

84

5.1 INTRODUCTION ............................................................................. ................................................................ 855.2 MANAGING PROCESS THROUGHPUT ............................................................................................ .......... 85

5.2.1 Defining TOC .......................................................................................... ................................................... 865.3 NATURE OF THE GLOBAL GOAL VS LOCAL PERFORMANCE MEASUREMENT...... .................. 87

5.3.1 The Global Goal ........................................................................... .............................................................. 875.3.2 Local Performance Measurement................................................................................. .............................. 875.3.3 Conflicts Between Local Performance and the Global Goal..................................................................... 875.3.4 Traditional Accounting Measures - Incentives to Create Inventory ......................................................... 89

5.4 NATURE AND CONSEQUENCES OF CONSTRAINTS ............................................................................. 915.4.1 External Constraints............................................................................................... ..................................... 92

Market Constraints............................................................... ............................................................................ 92Supply Constraints..................... .................................................................................. .................................... 92

5.4.2 Internal Constraints.................................................. ................................................................................... 93Material Constraints................................................................. ........................................................................ 93Capacity Constraints............................................................................... ......................................................... 93Logistical Constraints ................................................................................................. ..................................... 93Managerial Constraints....... ......................................................................................... .................................... 93Behavioural Constraints............................................................................................ ....................................... 93

5.5 THE CONCEPT OF A BINDING CONSTRAINT ............................................................................... .......... 945.6 MANAGING THE BINDING CONSTRAINT ......................................................................................... ...... 955.6.1 Drum-Buffer-Rope Concept.............. ................................................................................. ........................ 955.6.2 Systematic Constraint Management......................................................... .................................................. 96

Step 1 Identify the Systems Binding Constraint..................... ....................................................................... 96Step 2 Exploit the Binding Constraint.......................................................................................................... ... 99Step 3 Subordinate All Other Activities Along the Production Line to the Binding Constraint............... .. 102Step 4 Elevate the Constraint ........................................................................ ................................................ 102Step 5 Repeat the Process.......... ......................................................................................... ........................... 102

5.7 THROUGHPUT ACCOUNTING ................................................................................................... ............... 1025.7.1 Maximising ROI ................................................................................ ....................................................... 1035.7.2 Measuring Management Effectiveness ...................................................................... .............................. 1045.7.3 Measuring Work Station Performance............... ......................................................................... ............. 1055.7.4 Other Performance Measures ....................................................................... ............................................ 106

5.8 IMPLICATIONS OF A THROUGHPUT FOCUS ........................................................................................ 1065.9 SUMMARY.............................................................................................. ....................................................... 107


3/36

Chapter 5 Theory of Constraints

85

5.1 INTRODUCTION

The ultimate objective of for-profit organisations is to make more money now and inthe future. Organisations face constraints in achieving this objective. For some, it will

be a lack of demand for their product. For others, demand will exceed the ability tosupply. In the first scenario, a firm may seek to break the demand constraint byseeking new markets or producing new products. In the second scenario, the firmwill seek to remove any constraint that limits production because lost production islost sales, and lost sales are profits that are lost forever. Like water flowing through ahose, the point of least capacity will determine the rate of production. Managing thiscapacity constraint is critical to the organisations ability to generate revenue.

The notion that constraints need to be identified and managed is not new. The formalmanagement of constraints can be traced back at least as far as 1979 when GeneralMotors began a system for optimising production timetables. This led to newdevelopments such as optimised production technology (OPT) and synchronousmanufacturing. Today constraint management is a tool that seeks to ensure a flowof products through the plant that matches market demand in a timely manner. But itis even more than that: the Theory of Constraints expounded by Eli Goldrattinvolves a fundamental shift in the way an organisation is managed. Of particularsignificance to management accountants are the criticisms that constraintmanagement raises about conventional cost accounting and the development of newmeasures that support the achievement of the global goal of profit maximization.

This chapter will explain how the identification and optimisation of a bindingconstraint can help the organisation make more money now and in the future. Tocontinue our analogy, we will see how to open up the tap that constrains what is

known as throughput, and therefore the revenue, of the organisation. Managementaccounting can play an important role in supporting and complementing operationalmanagement through the use of throughput accounting and the introduction ofperformance measures designed to encourage throughput thinking.

5.2 MANAGING PROCESS THROUGHPUT

There are various measures that can be used to evaluate process performanceincluding cost, quality, response time and innovation. This chapter focuses onmanaging the rate at which the organisation converts raw materials into salesrevenue. Rather than focusing on input or output in the traditional sense, the theoryof constraints (TOC) focuses on the rate at which a system generates money.


4/36


86

Managing What Matters

Some traditional measures can be misapplied so that theycontribute to even slower production rates and reduced profits.For instance, Debra Smith, a consultant with DSC Associatesin Enumclaw, Wash., saw the damage that occurred when acompany tried to reduce one measure - the hours of directlabor per unit of production - without looking at the entire

production process.

Management at the company, which supplied wire mesh to theautomotive industry, gave additional work to the employeeswho operated the looms under the rationale that they spent toomuch time just sitting around.

Management did not recognise that the looms, because theymalfunctioned unpredictably, were a constraining resource.The production process could move no faster than the loomsdid. Once management had mistakenly redeployed theworkers, it took longer to fix any malfunctions, further throwingoff production schedules. Even with increased workerovertime, on-time delivery to customers dropped from 85% to70%.

When TOC concepts were introduced in the plant,managements focus shifted to throughput and on the need tokeep the looms (and, thus, the rest of the production process)moving as fast as they could. On-time deliveries rose to 99% infour months without adding staff.Source: Kroll, K (1998) The Theory of Constraints Revisited,Industr week A ri l20.

An important message of TOCis that resources need to bemanaged according to theireffect on throughput. There willalways be a constraint thatlimits the throughput of the

organisation. That constraintmust be identified and carefullymanaged to ensure that itoperates at maximum capacity.On the other hand, non-bindingresources (i.e. those nowsuffering from constraint) willoften be operating at less thanmaximum capacity (i.e. with idletime).

5.2.1 Defining TOC

The TOC focuses on three variables and the relationships between them. Thesethree variables will already be familiar to you but their definitions are significantlydifferent when used in connection with TOC.

Throughput is the rate at which the system generates money through sales and ismeasured as sales less unit-level variable costs such as direct materials, powerused in operating equipment (but not for lighting), royalties paid on the basis of unitsproduced or sold, and sales commissions. For simplicity, we assume that directmaterials are the only unit-level variable costs, so that throughput becomes salesless direct material costs. Note that this definition is related to sales, not production i.e. if you produce something, but dont sell it, its not throughput.

Inventory is all the money that the system has invested in purchasing things that itintends to sell. It is measured as the depreciated value of plant, property andequipment (which can, of course, be sold) and inventories valued at direct materialcost only. Yes, thats right - property, plant and equipment are also included in the

definition of inventory!

Operating expense is all the money the system spends to turn inventory intothroughput. It is measured as all salaries (direct labour is not differentiated fromadministrative salaries), utilities, supplies, marketing expenses, insurance, taxes, etc.

Under TOC, the aim of the enterprise is to increase throughput (i.e. sales directmaterial cost), whilst reducing inventory and operating expense. There is, however,no simultaneous minimum of both. It is always possible to reduce operating expense


5/36


87

by increasing inventory, and it is likewise possible to reduce inventory at the cost ofincreased operating expenses. The trick is to minimise (or effectively manage) bothinventory and operating expenses.

5.3 NATURE OF THE GLOBAL GOAL VS LOCAL

PERFORMANCE MEASUREMENT

5.3.1 The Global Goal

It is a fundamental tenet of TOC that the global goal of an enterprise is to make moremoney now and in the future. Producing products, or purchasing in a cost-effectivemanner, or employing people, or increasing market share, or having up-to-the minutetechnology, or quality are all merely means of achieving the goal, not the goal itself.Logically, then, any action that moves the organisation toward making money isproductive; any action that takes away from making money is unproductive.

5.3.2 Local Performance Measurement

The throughput concepts just introduced can be compared and contrasted with thetraditional cost world orientations. In the cost world, the assumption is that, bycontrolling individual department costs per unit, management can maximise thedifference between company revenues and expenses and thus the overallperformance of the enterprise. Since it is believed that total unit costs are minimisedif each local area effectively controls costs, the managers of local areas areevaluated on the basis of cost incurrence reflecting the efficiency with which they usethe resources (primarily labour and equipment) available to them.

5.3.3 Conflicts Between Local Performance and the Global Goal

However, this emphasis on reducing operating expense has two major limitations.The first is that the benefits are limited - operating expenses can only be reduced somuch (i.e. to $0 if all expenses were eliminated). That is, once costs are reduced to$0, they cannot be reduced any further.

The second fundamental problem with focusing on decreasing operating expense isthat it often comes as a trade-off with revenue generation now and in the future. An

undue emphasis on cost reduction can encourage managers to cut too deep, withsevere consequences for the organisations capacity to generate revenue. By wayof simple example, salary and wages costs can be relatively easily reduced bygetting rid of all staff. However, of course, if you reduce staff too much, you will notbe able to produce or sell a product.

Although waste should never be tolerated, the TOC approach emphasises thegeneration of revenue rather than the minimisation of cost. Revenue is generatedthrough sales, and so TOC focuses on increasing the rate at which the system


6/36


88

generates money through sales. This focus overcomes the two major limitations ofthe cost orientation.

The case of Jack and Jills Bucket Factory illustrated below explains the potentialproblems associated with local performance measurements and the implications of aTOC approach.

Illustrative Example: Jack and Jills Bucket Factory

Jack and Jill make buckets. The resources required, rates of production, operationalsteps, and market demand are shown in the diagram. Jack and Jill each work 8hours a day (480 minutes) and they cannot substitute for each other. There is noother work except as detailed in the diagram. Study the diagram for a moment. Yourtask is to determine how Jack and Jills time will best be used.

Figure 5.1 Jack and Jills Bucket Factory

Jills time must be split between the two processes that she performs in the ratio of4:6. This will ensure that she produces the right number of component B. A quickcalculation (480/10 x 4) indicates that she will spend 192 minutes on process J2, andthe remaining 288 minutes on process J1.

We can calculate the production capacity for each process by dividing the availabletime by the time required for that activity. From this we find that Jack can produce 64units of component A per day. However, in the time available, Jill can only produce48 units of component B, and complete the production of 48 buckets (process J2).Jill is the binding constraint in this example because she determines the amount ofthroughput - it is limited to the 48 units of component B and the 48 buckets that shecan complete.

Market Potential100 buckets/ day

JillProcess J2

4 minutes / bucket

JillProcess J1

Component B6 minutes / unit

JackProcess K1

Component A7.5 Minutes/ unit


7/36


89

The above analysis has 2 major implications for Jack &Jills bucket Factory.

(1) In order to produce those 48 buckets (and therefore maximise production), itis important that Jill works productively for the entire 480 minutes and

The organisation will need to alter the approach to assessing Jacks performance.Why? According to traditional measures of performance evaluation, Jack will only

appear efficient if he works to his maximum capacity (i.e. if he produces 64component As per day). In this case, thats 16 more than Jill can use. After a weekof production there will be 80 (16/day x 5 days) units of component A piling up infront of process J2. In traditional cost world, the good news is that this will notproduce any unfavourable labour efficiency variance and there will be increasedassets on the balance sheet. The problem is that if Jack and Jills Bucket Factorycontinues to be profitable in this manner it will go out of business! Why? Letsconsider this in more detail.

5.3.4 Traditional Accounting Measures - Incentives to Create Inventory

In addition to utilising productivity measures that encourage all staff to produce asmuch as they can (even if the output cannot be used), a traditional accountingsystem rewards the build-up of inventory by classifying it as an asset. This meansthat labour costs and overhead are not treated as an expense in the current period,but instead are carried forward as WIP inventory. Profits increase and the balancesheet looks good. But does this contribute to achieving the global goal of makingmoney? No, only the sale of finished goods contributes to the global goal of makingmoney. In fact, accumulating inventories incurs additional costs (the cost of thewarehouse, insurance, the risk of obsolescence, etc.). If allowed to continue, thebuild-up of WIP inventory will choke the production flow (imagine all those units ofcomponent A sitting on the production floor). It will also tie up excessive amounts of

capital (the raw materials have to be purchased and the investment can not berecouped until the finished product is sold).

The alternative as advocated by the TOC is to synchronise Jacks production withJills. To limit his production to 48 units a day, Jack will be idle for the remaining 120minutes. If we assume that direct labour is a fixed cost (i.e. Jack is a full-time ratherthan a casual employee) idle time does not increase costs, but reducing inventorieswilldecrease costs, often in ways that are not immediately apparent or anticipated.(There are also important benefits that often accompany increases in the rate ofinventory turnover as illustrated in Figure 5.2 below.)


8/36


90

Consider this

From the Dell Computers example we can see some of the benefits of improving theresponsiveness of the organisation by reducing inventory levels and increasing therate of throughput. Unfortunately, the cost accounting system is unable to capturethe value of these intangible benefits, particularly when you are not getting them! Sowhen considering the costs of holding inventories we must recognise that there areopportunity costs, as well as the cost of physically holding the inventoriesthemselves.

Goldratt identifies six issues that he believes determine competitive advantage, all of

which benefit from lower inventory levels and a greater rate of throughput that aresummarised in the table below

Figure 5.2 A Role for Reduced InventoryRationale

Quality TOC emphasises the TQM principle of buildingquality into the process, rather than inspectingthe finished product.

ProductEngineering

The product can incorporate the latesttechnology

Higher margins Lower operating costs, e.g. overtime, andlower inventory-carrying costs.

Price Lower investment per unit Avoid investment in additional unnecessarycapacity to deal with bottlenecks caused bypoor scheduling.

Due-date performance

Responsiveness Shorter quoted lead time

As illustrated in the case of Dell computers,lower inventories help to increase the rate ofthroughput.

Adapted from Goldratt, E. and Fox, R. (1986), The Race, Great Barrington, MA: North RiverPress

Dellocity at Dell Computers

Dell computers has enjoyed meteoric growth over the past decade. Compared to an industry growth rateof 15-16%, Dells sales have increased by an average of 55% each year. Much of their success can beattributed to what they describe as Dellocity - the emphasis on the velocity of inventory through theproduction process. In the computer industry changes in technology make products virtually redundant inthree to nine months. Most firms carry 90-120 days of inventory, Dell carries only eight (and they areworking to reduce that even further). This means that their customers are always getting the latest

technology available. It also means that they can have their computer custom built.

How has this been implemented? Underpinning Dells apparently simple operating model is a highlycomplex production, logistics and distribution system, predicated on one of the most popular words inthe Dell lexicon: velocity. Speed is a critical part of the model. Inventory velocity is one of Dells keyinternal performance measures, with the company forcing itself to work constantly with suppliers toreduce inventory levels and increase the speed of every part of its operation. The faster Dell moves, thelower its costs. Low costs equal happy shareholders and customers. The building blocks of masscustomisation have emerged over the past decade, including more detailed sales data, improved supply-chain management systems, and computer-controlled, highly flexible factory equipment.

Neil ShoebridgeSource: Australias Business Review Weekly, November 16, 1998.


9/36


91

By way of summary, Figures 4.3 and 4.4 outline some of the fundamental differencesbetween TOC and conventional cost accounting.

Figure 4.3 Throughput Account ingFundamental concepts ofconventional cost accounting

New principles of throughputaccounting

There are direct and indirect costs: directcosts are variable and indirect costs arefixed

Distinguishing between indirect and direct costsis not useful

Summing component costs to derive aproduct cost and subtracting the result fromthe sales price is a good way to determinerelative product profitability

It is the rate at which the factory earns moneythat determines ultimate profitability, not thecontribution of each product

Inventory is an asset and working onmaterial increases its value

Inventory is not an asset. It is the outcome ofunsynchronised manufacturing and hinders theorganisation in achieving the global goal

Reducing component costs directlyincreases profit

Profit is a function of material cost, total factorycost and throughput

Adapted from Dugdale and Jones, 1996, p. 25

In a traditional cost world the emphasis is on increasing profit by cutting costs.Attention then turns to throughput and finally managing inventory. TOC turns theemphasis around to focusing on throughput first, then inventory and finally operatingexpense. Note that the primary emphasis on throughput (rather than inventory) alsodistinguishes TOC from the Just-in-Time (JIT)philosophy. Figure 4.4 illustrates theway these three approaches differ in their focus.

Figure 4.4A New Paradigm of Management

Adapted from Dugdale and Jones, 1996, p. 25

5.4 NATURE AND CONSEQUENCES OF CONSTRAINTS

An organisational constraint is any element that prevents the organisation fromachieving the goal of making more money.

Every organisation has constraints that limit the amount of money it is making. Thereis always one constraint, termed the binding constraint, which determines maximumperformance and profitability. It is the task of managers, then, to identify and focuson that constraint because it limits the achievement of the global goal.

Return on Inventory = Throughput - Operational Expense

Inventory

Cost WorldTOC World

JIT World


10/36


92

The binding constraint will be considered further later in the chapter. For themoment, we will consider various constraints, some of which are external to theorganisation and others that are internal.

5.4.1 External Constraints

Market Constraints

In todays competitive environment it is more common for production capacity toexceed customer demand than for demand to exceed capacity. In thesecircumstances the enterprise must find ways to retain existing customers whilstseeking additional markets. Managements first priority is to accurately determinedemand and produce accordingly. Overproduction will lead to obsolete inventory thatclogs the organisations warehouses and makes it even less responsive to changingcustomer requirements.

However, proactive management does not take customer demand as given. It maybe possible to break this constraint. Increasingly this can only be achieved bysimultaneously providing greater customer value at lower costs. Value engineeringisone of the methods that have proven to be successful in the challenge todifferentiate the product in cost-effective ways.

It also helps to consider the purchase from the customers perspective, recognisingthat the cost of the purchase includes more than just the purchase price. Forexample, providing the product on a reliable JIT basis will decrease the customersneed to hold inventories. This decreases the customers total costs and therebyincreases the acceptable price for the product. In some circumstances it is possible

to simultaneously reduce the costs for both the enterprise and its customers byrecognising and leveraging the linkages between them. A good example of this hasbeen the development of Electronic Data Interchange (EDI) that, particularly inbusiness-to-business trading, provides qualitative (less obsolescence) and financial(less inventory holding costs) benefits for both the supplier and the consumer.

Supply Constraints

Needless to say, without the necessary raw materials, production will cease. A lackof raw materials may be the result of poor planning on the part of the organisation(an internal constraint discussed below) or unreliable suppliers. Managing supplier

relationships is, therefore, extremely important.

Raw material constraints may also be the result of a material shortage in themarketplace. In this situation the availability of quality raw materials and theassociated lead-time must be managed very carefully. A good example of thisoccurred a few years ago in Australia when coffee production was severely affectedby the lack of good-quality beans.


11/36


93

5.4.2 Internal Constraints

As opposed to external constraints, where capacity exceeds demand, with internalconstraints, demand exceeds capacity. In this situation, the enterprise can increasethroughput by increasing the speed with which inputs are converted into final productand sold. Internal constraints can relate to material flow, capacity, logistics,

managerial strategies/policies, and employee behaviour.

Material Constraints

Material constraints will occur when production processes are starved of materials.There may be a number of causes: for example, poor production scheduling or thebreakdown of a preceding process. The importance of synchronisation and inventorybuffers will be discussed later in the chapter.

Capacity Constraints

The capacity of the resources, i.e. labour and machines, directly influences a plantsability to maintain the required production flow. Capacity constraints exist when totaldemand exceeds total capacity. Managing capacity constraints is also discussedlater in the chapter.

Logistical Constraints

Logistical constraints are caused by the planning and control system. Wanderingbottlenecks are an example of a logistical constraint. . Here we see resourcesalternate between insufficient capacity and excess capacity as waves of productionhit them. For example, a firm may have a batch order entry system in which sales

representatives hold order forms until the end of the week before submitting them.This causes demand to come in waves that adversely affect the synchronousoperation of the system.

Managerial Constraints

Management strategies and policies may also adversely affect synchronousoperations. Managerial constraints may lead to the suboptimisation of the system.For example, decisions about batch sizes and order quantities may be based onpolicies and procedures that have failed to keep up with changes in themanufacturing environment. Management may adopt policies that limit the firms

capacity, e.g. management may have policies such as no overtime working, only oneshift per day, or no new product development.

Behavioural Constraints

Managerial policies and procedures are often entrenched in the evaluation andreward systems and this will affect the habits, practices, and attitudes of employees.


12/36


94

An example is the Month- or Day-end Syndrome where budgets often createpressure to ship as much product as possible by the end of the month. This causesbottlenecks to appear, just like the bottleneck that occurs at a bank 15 minutesbefore closing time. Managing this constraint may require changing the wayemployees and customers behave. The bottleneck at the bank could be reduced bybalancing demand across the entire day, or by utilising alternative technologies (e.g.

ATMs and phone banking).

Another example of this is the emphasis on variances in performance evaluation. Apurchasing agent may be able to achieve a bonus by making purchases for less thanthe expected cost by purchasing in large volumes and achieving volume discounts.This results in large amounts of raw material inventory. Another commonmanifestation of a behavioural constraint is the keep-busy attitude. When there isexcess capacity a keep-busy approach will only lead to work being done that isneither scheduled nor required (refer to Jack in the Jack & Jill example earlier in thisChapter).Before finishing this discussion on constraints and moving to a discussion of bindingconstraints, there are a few final important points to note.

(i) The process of identifying and eliminating constraints is never-ending. As eachconstraint is identified and brought under control, another constraint will emerge and(2) The temptation to treat all constraints as capacity constraints should be avoided.Buying another machine, or employing another worker, is not always the answer.Getting to the root cause of the constraint will often involve identifying behavioural,managerial, and/or logistical factors.

5.5 THE CONCEPT OF A BINDING CONSTRAINT

The concept of a binding constraint is illustrated in the following example, adaptedfrom Reeve (1995), p. 308-309.

Imagine five people lined up in a row. Each person has two dice, except for theperson in the third position, who has one die. The object is to move poker chips fromthe beginning of the line (upstream) to the end of the line (downstream). Poker chipsare moved from upstream to downstream by the roll of the dice. There is a stack ofpoker chips, representing raw materials, in front of the first person. Each person rollsthe dice ten times.

How many chips do you think have been processed over the ten turns?

Answer: On average the complete line can only move as fast as the slowestoperation. Thus, even though all positions (except position three) have two dice andwill, on average, roll 7 on their two dice (i.e. 2+3+4+5+6+7+8+9+10+11+12 / 11)the average output is based on position 3. The average value of rolling the die forposition 3 is 3.5 (1+2+3+4+5+6 / 6 = 3.5) and, as result, the output of the productionline will be 35 chips (3.5 chips per roll * 10 rolls).

What happens between positions 2 and 3, and why?


13/36


95

Answer: Poker chips stack up in front of position 3. There is no place for these chipsto go. Positions 1 and 2 are paced at an average roll of 7 , but position 3 has only asingle die. Thus, position 3 cannot keep up. As a result, chips pile up in front ofposition 3.

Was the additional production from positions 1 and 2 productive?

Answer: Not really. These positions produced chips that cannot get through the line.If position 3 does not receive any more capacity, then these chips will never getthrough the line and inventory will continue to build. One of the concepts of TOC isthat throughput only counts if production results in sales. Production that merelybuilds up inventory is not value adding. Thus, the build up of chips in front of position3 by keeping positions 1 and 2 busy is getting us nowhere. The extra die of capacityin positions 1 and 2 are a waste. Building up inventory may also decrease theproductivity of the production process in general. Excess inventories can get in theway and make it difficult to find what is needed.

What is happening at positions 4 and 5?Answer: They are operating way below capacity. They are rolling averages of 7, but

can only move averages of 3.5. In other words, they are starved for work becauseposition 3 operates at a much slower pace than positions 4 and 5 can operate. Theextra capacity in positions 4 and 5 is wasted.

Clearly, the one die at position 3 is the binding constraint. This limits the flow ofpoker chips at the end of the line because (1) each event along the line is dependenton the events prior to it, and (2) statistical fluctuations, represented by the throw ofthe dice, are present. Position 3 is the economic leverage point for the whole systemand should be the focus point for continuous improvement endeavours.

The effect of performance evaluationConsider the effect of a traditional performance system where labour variances arecalculated for each production point. How would you rate the performance of eachindividual? Based on local performance measures position 1, 2 and 3 (the bindingconstraint) achieve acceptable levels of productivity (despite the fact that positions 1and 2 produce in excess of the requirements of position 3, so that WIP inventoriesbuild up.) Positions 4 and 5 would appear to be under performing, but as we haveseen, through no fault of their own.

5.6 MANAGING THE BINDING CONSTRAINT

This section discusses how a firm can avoid the limitations on throughput resultingfrom a binding constraint?

5.6.1 Drum-Buffer-Rope Concept

One option for managing the constraint is to remove the constraint by purchasing anadditional resource. For example, hiring an additional resource or purchasinganother machine. However, there are dangers in taking this step without dueconsideration as it constitutes taking a long-term decision for potentially a short-term,


14/36


96

and perhaps avoidable, reason. It may be difficult to subsequently reduce capacity ifthe demand at that resource declines because the root cause is addressed. Forexample, it is difficult to layoff employees after improvements in work design meanthey are no longer needed to meet demand.

In the absence of any immediate decision to invest in another resource, TOC

introduces the concept of drum-buffer-rope. According to this concept;

(1) the binding constraint should be the drumbeat for the rest of the line. Thuswhatever the bottleneck can produce dictates production along the rest of theproduction line. As in the illustration in the previous section, the alternative isthat the operation upstream (Positions 1 & 2) overproduce and build work-in-progress inventory that the constraint (Position 3) cannot handle. Meanwhile,there is little finished goods inventory. Indeed, lead times to supply themarket may be increased as WIP clogs up the process and diverts attentionand resources away from the binding constraint.

(2) A buffer inventory should be kept in front of the binding constraint to ensure itis operating at all times. Remember that, because it is the binding constraint,

its output determines the throughput of the system. Any lost production atthis constraint represents sales that are lost forever because the constraintcannot catch-up and

(3) Communication to production facilities upstream of what the bindingconstraint has produced becomes critical so that upstream operationsproduce an appropriate amount. This will keep inventory from continuallybuilding up in front of the binding constraint. This communication is called therope. It can be formal, such as a schedule or informal such as dailydiscussions.

5.6.2 Systematic Constraint Management

A more extensive analysis of binding constraint management (than that suggestedby the drum-buffer-rope concept) has been devised by Goldratt with a five-stepongoing improvement plan.

These five steps, which are explained in greater detail on the following pages, are:

1. Identify the systems binding constraint2. Exploit the constraint3. Subordinate all other activities along the production line to the constraint4. Elevate or eliminate the constraint

5. If steps 1,2,3, and 4 have broken the constraint, go back to Step 1 and repeatbecause it is likely that another resource has become a new binding constraint.

Step 1 Identify the Systems Binding Constraint

In practice this is one of the most difficult steps, and obviously the most important.Observation (e.g. looking for a resource or resources with large quantities ofinventory waiting to be worked on) or extracting the knowledge of staff by asking


15/36


97

Sources of Variation

No matter how well the production flow is planned, the actual flow of materials through the plantwill differ from the planned flow. This is the inevitable result of three key factors that affect allmanufacturing operations:1. Unpredictable disruptions, such as machine breakdowns. For example, even if it is known

that a particular work center will be out of action or off line for an average of 40 hours amonth, it is impossible to predict when it will be down.

2. Inaccurate/ indeterminate information, such as time standards. The precise time requiredto set up and/or process a batch generally varies, although the average over severalbatches may match the standard.

3. Large numbers of variables. The number of variables that can influence the performance

of a given work centre are so large that many of these variables are not considered in theplanning process.

Source: Umble, M. and Srikanth, M.L., (1990) Synchronous Manufacturing, pp. 86-87.

questions or conducting interviews can provide useful information. More formalmethods include analysing capacity usage and the use of Gantt charts (see Chapter6).

The identification of a systems binding constraint is particularly difficult when there isprocess variability, operations are synchronised, and inventory levels are minimal. In

this situation, it may appear that the bottleneck is constantly moving betweenresources (see the box Sources of Variation below).

In these circumstances, it is particularly important to distinguish between day-to-dayfirefighting where production can catch-up, and those constraints that have a long-term impact. For example, refer back to the illustration in which dice were used tocapture the notion of variable production capacity. Position 3 determined throughputbecause potential capacity was limited to a single die. Of course, it is possible thatthe preceding position (position 2) may, if both dice happened to roll a one, haveproduction as low as two. Such an event is exemplified in a real production situationby a production process that normally has unused capacity breaking down andthereby limiting production. A casual observer might see position 2 only moving 2chips and position 3 standing idle and incorrectly conclude that position 2 is abinding constraint. Of course, a more experienced observer would note that this isjust a temporary situation and that (i) the productive capacity of Position 2 is reallygreater than Position 3 and, on average it will easily catch up with position 3 and (11)the real binding constraint is position 3

For simplified examples, where production capacity is known and not variable, thebinding constraint can be identified by determining the capacity of each resource. Inthe Jack and Jill bucket factory this was calculated by dividing the time available by

the time required per unit (i.e. 480 minutes / 7.5 minutes per unit = 64 units ofproductive capacity for Jack).

In a more complicated and realistic situation, where there are a number ofprocesses, it is useful to prepare a table as in the following example that relates toBens BBQs:


16/36


98

Figure 5.5 Constraint Example: Bens BBQs

In such a situation, determining the resource requirements for each product involvesfollowing the arrows backwards from the product to the start of the process. Toillustrate, we can identify the following requirements for each unit. Theserequirements can then be multiplied by the number of units demanded to determinethe total capacity requirements:

Product X

Selling Price = $150/ unitMarket Demand = 55 units

Product Y

Selling Price = $175/ unitMarket Demand = 60

Machine D4 Min/ Unit

Machine A25 Min/Unit

Machine D12 Min/Unit

Raw Material 1$20/unit



Machine C8 Min/unit

General Information: Plant operates 1 shift/day, 8 hours/shift, 5 days/week (2,400 minutes) There is 1 worker per resource (machine)

Machine C32 Min/unit

Machine B20 Min/Unit

Machine A17 Min/Unit

Machine D8 Min/ Unit


17/36


99

Table 5.1 Determining Product Requirements

Product X - per unit requirements Product Y- per unit requirementsMachine D - 4 minutes Machine D - 8 minutesMachine A - 25 minutes Machine B 20 minutesMachine D - 12 minutes Machine C - 8 minutes

Raw material 1 - $20 Raw material 2 - $25Machine B 20 minutes Machine A - 17 minutesMachine C - 8 minutes Machine C - 32 minutes

Raw material 2 - $25 Raw material 3 - $15

Table 5.2 Identify ing the Binding ConstraintNeeded Capacity (Min)Resource

X (D=55) Y (D=60)

TotalRequirements

(Minutes)

AvailableCapacity

(Mins)

Surplus/(Deficiency)

(Mins)Machine A 1,375

(25min x55)1,020

(17minx 60)2,395 2,400 5

Machine B 1,100(20 min x 55)

1,200(20minx60)

2,300 2,400 100

Machine C 440(8 min x 55)

2,400(40minx60)

2,840 2,400 (440)*

Machine D 880(16 min x 55)

480(8minx60)

1,360 2,400 1,040

* Machine C is the binding constraint because it has insufficient capacity to meetdemand, while all other machines have some excess capacity. But what if there hadbeen multiple constraints? For example, perhaps Machine A is scheduled for 200minutes of maintenance per week. This would mean that the available capacity wasonly 2,200 minutes and there would be two constraining resources. In this instanceour immediate attention would still be on Machine C, since it would have the greatestdeficiency. However, we would also have to consider the effect of the constraint atMachine A to be sure that the proposed product mix is feasible (as discussed

below_. It is even possible that the binding constraint will change as the product mixchanges in which case the optimal product mix will differ. Fortunately there arecomputer programs to perform these calculations.

Step 2 Exploit the Binding Constraint

Once the binding constraint has been identified, the second step in constraintmanagement is doing everything possible to ensure the production process (andparticularly the binding constraint) is operating as efficiently and effectively aspossible. In other words, doing everything possible to ensure that the bindingconstraint keeps working. In doing so, there are a number of considerations.

Quality

It is important to ensure quality prior to the binding constraint. If the bindingconstraint receives poor quality input into his / her work, it will slow him / her downeven more. Consider a fine restaurant where the binding constraint is a world-renowned chef. If poor quality ingredients are only discovered after the meal ispartially or fully prepared, the chefs time has been wasted. Furthermore, customersatisfaction will be significantly diminished if diners have to wait for the meal to be


18/36


100

prepared again. In many cases, customers will leave and a sale will be lost forever.It will be even worse if the sale is made, the customer is dissatisfied, and therestaurants reputation suffers. It is, therefore, essential to prevent poor qualitymaterials reaching the constraint. This will normally be part of supplier management,but may be achieved by inspections of incoming materials.

Inventory Buffers

Most processes are subject to a certain degree of variability. Unexpected problemswill arise that interrupt the flow of work in process. For those processes with excesscapacity it is possible to catch-up by increasing the rate of production. However, abinding constraint does not have excess capacity and if it is idle due to theinterrupted flow of work in process from proceeding steps, that throughput is lostforever. To avoid this, buffer stocks of inventory can be held in front of the bindingconstraint. The size of the buffer will be determined by the variability of the precedingprocesses and the rate at which the constraint consumes the work in process/ rawmaterial. In this way, even if the production breaks before the binding constraint, thebinding constraint can keep working.

Preventive Maintenance

The general principle is the importance of keeping the binding constraint operating atfull capacity. Unscheduled down time will result in lost throughput. Preventivemaintenance on the binding constraint (or the machine used by the bindingconstraint) should minimise the amount of down time.

Product Mix Decisions

Every firm faces the challenge of determining a product mix that maximisesprofitability. In the short-term traditional analysis model, the firm will rank its products

according to their respective contribution margin, so that emphasis is placed onproducing the product with the highest contribution margin first, until demand issatisfied, as so on. Contribution margin is the difference between selling price andunit variable costs. TOC disagrees with this approach in two ways. Firstly, some ofthe unit variable costs are treated as committed - their provision does not vary withthe amount of product produced and sold, although their utilisation might. Hence,only unit-level variable costs such as direct materials, some power, and salescommissions are subtracted from selling price to calculate throughput, but directlabour is not. Secondly, ranking of products should be based on throughput per unitof the binding constraint, not just throughput alone. Hence the binding constraintneeds to be identified in order for products to be ranked. Under this approach, thefirm will rank its products according to their respective throughput per unit of scarceresource (i.e. time on the binding constraint).

The approach, then, is to:

1. Calculate, for each product, the throughput per unit, i.e., sales price less directmaterial cost

2. Calculate the throughput relative to the demand placed on the binding constraint3. Use this throughput per unit of the binding constraint to prioritise the production

of each product (subject to market demand)


19/36


101

This concept is illustrated below using the Bens BBQs example introduced earlier.In this case, the throughput per unit for the two products at the binding constraint(Machine C) is

Table 5.3 Throughput Relative to Demand on Machine CProduct X Product Y

Selling Price $150 $175Raw Material 1 $20 -Raw material 2 $25 $25Raw material 3 - $15Total raw material cost $45 $40Throughput per unit $105 $135Machine C requirements 8 minutes/ unit 40 minutes/unitThroughput per minute of machine Cs time $13.125/min $3.375/min

On the basis of throughput per unit alone, product Y would appear to be the mostprofitable ($135 throughput per unit versus $105 throughput per unit for Product X).

Remember, however, that our focus is on the binding constraint and utilising it asprofitably as possible. We must determine how to maximise revenue given thelimited time available for machine C. To do this we determine the ratio of throughputto constraint time. Note that, for the same amount of time on machine C (40 mins), itis possible to produce 5 times as many units of product X than of product Y.Calculating the ratio confirms the fact that, given the limited capacity of machine C,throughput will be maximised by producing as much of product X as can be sold. Inother words, while Product Y gives a higher throughput per unit, Product X gives ahigher throughput per unit of Machine C time. Every minute spent on Machine Cproducing Product X will generate $13.125 of throughput, whereas that same minutespent on Product Y will only generate $3.375 of throughput.

Once the maximum Product X has been produced, the remaining capacity ofmachine C should be used to produce product Y. This can be calculated as follows;

Table 5.4 A TOC Approach to Prioritis ing Product Mix

Demand ThroughputTime

Required(Minutes)

TimeRemaining(Minutes)

Time available on the bindingconstraint

2,400

Prioritise the production of X @8 min/unit

55 units X $5,775 440 1,960

Utilise remaining time to produceY @ 40 min/unit

49 units Y 6,615 1,960 nil

Total $12,390 2,400

Compare this to the throughput that would be earned if Bens BBQs had prioritisedthe production of Y (as might be done if we only considered throughput per unit ofproduct and therefore ranked Product Y above Product X).

Table 5.5 Traditional Product Mix Priori tyNumber Throughput Time Req.

(Min)Time Remaining

(Min)


20/36


102

Time available on the bindingconstraint

2,400

Prioritise the production of Y @40 min/unit

60 units Y $8,100 2,400 nil

Table 5.5 shows that there is no time left to produce any units of product X, and thetotal throughput is less than that achieved in Table 5.4. Clearly, the product mixflowing from the TOC approach is better than that derived by prioritising onthroughput per unit of product only.

Step 3 Subordinate All Other Activities Along the Production Line to the

Binding Constraint

In Goldratts view, non-binding resources should produce at the rate dictated by thebinding constraint, even if this means that the non-binding resources are working atless than capacity. The alternative is a build up in work-in-process inventories thatcan be disruptive. This is similar to the drum in the concept discussed earlier.

Step 4 Elevate the Constraint

Now that the binding constraint is being utilised as effectively as possible, the nextstep is to try to break the constraint. This might be done by purchasing a fastermachine, employing a more experienced employee, outsourcing, etc. The constraintwill not always be a machine or a person. Sometimes the constraint will be a policy,a rule, or even just a tradition. For example, a company may have a tradition offinishing work at 3pm on a Friday, thereby limiting the time available to generatethroughput.

Step 5 Repeat the Process

Continuous improvement is an essential element of TOC. There will always be someinternal or external factor that is limiting the organisations ongoing efforts to makemore money. Successful efforts to elevate the constraint will lead to anotherbottleneck appearing. Care must be taken at this point. Rules and policies may havebeen created to deal with the current binding constraint. Once this constraint isbroken, it is imperative to go back and review the applicable rules or policies or thesystem may end up wallowing in a sea of policy constraints, causing inertia.

5.7 THROUGHPUT ACCOUNTING

Goldratt describes traditional cost accounting as public enemy number one ofproductivity. Throughput accounting is both philosophically and technically distinctfrom traditional cost accounting. It is important to note the philosophical differencesbecause, at least on the surface, throughput accounting appears to be similar to acontribution margin approach. The role of the management accountant in thiscontext is as yet largely undefined. However, it is reasonable to assume that thetechniques described below, although not new, constitute one part of themanagement accountants contribution.


21/36


103

The calculation of net profit under TOC highlights the importance of throughput.

Net profit = Throughput - Operating Expense

Inventory turnover provides another useful measure:

Inventory turnover = ThroughputInventory

5.7.1 Maximising ROI

Recall that the TOC definition of inventory includes the depreciated value of plantand equipment. Therefore the calculation of Return on Inventory in TOC is similar tothe traditional concept of Return on Investment. The elements that affect thecalculation of Return on Inventory in the TOC definitions are sales less directmaterials (throughput), operating expense, and inventory.

Return on Inventory = Throughput - Operating ExpenseInventory

The maximisation of Return on Inventory can be accomplished by:

Raising sales price Increase throughputIncreasing sales Increase throughputImproving throughput byincreasing yields, reducingdowntime, and/or reducingproduct changeover time on the

binding constraint

Increase throughput, may alsodecrease operating expense

Incurring lower cost for directmaterials

Increase throughput

Reducing usage of directmaterials

Increase throughput

Improving the processing timeon the binding constraint

Increase throughput, may alsodecrease operating expense

Decreasing labour or machineusage costs by subordinatingnon-constraining resources

Decrease operating expense

Eliminate inventory, except forthe buffer in front of the

constraint

Reduce inventory holding costs.

These possibilities are not independent of each other. For example, raising the salesprice could reduce sales volume. Or cheaper direct materials may reduce materialquality, resulting in increased material usage. These tradeoffs need to be balancedin determining the practical policies that will increase Return on Inventory. Themanagement accountant has a role in providing information and statistical analysesfor making these decisions. While financial measures may be useful, the emphasis


22/36


104

will be on providing measures that support and encourage managers to maximisethe performance of the binding constraint and synchronise operations.

5.7.2 Measuring Management Effectiveness

Reports summarising operating data for organisational segments or the entire firmcan be used to evaluate weekly performance, as shown below.

Figure 5.6 Financial Statement Data

Dollar amounts in $000sSales $95Raw material cost $15Throughput (sales minus raw material cost) $80Operating expenses $50Net Profit $30

Cash at end of week $35Inventory $550Return on Inventory [(80-50)/550] 5.45% per weekInventory turnover [80/550] 14.54 times per week

Figure 5.7 Utilisation of Machines% of Time Spent in Activity

Machine Idle Time Breakdowns Production Set-upsWelder (The BindingConstraint)

5% 5% 87% 3%

Cutter 5% 25% 60% 10%Polisher 20% 5% 60% 15%Grinder 15% 25% 55% 5%Assembler 10% 15% 65% 10%

Products Demanded: 200Products Sold: 190

The preparation of a throughput profit statement and a balance sheet usingthroughput measurement may put a new perspective on periodic results. A typicalprofit statement that emphasises throughput (using data from Figure 5.6) is shownbelow:


23/36


105

Figure 5.8 TOC (Throughput) Profit Statement$000s

Sales 95Less Direct Materials (15)Throughput 80Direct labour (15)Production Overhead (15)

Administration Costs (10)Selling Expenses (Note that this issometimes identified as a direct cost) (10) (50)Operating Profit 30

One of the advantages of this type of report is that it is easy to understand. This willgenerally increase its acceptance and usefulness across the organisation.

Further analysis could segment throughput to show the contribution made byindividual products, as a guide to product mix and pricing decisions. The emphasison throughput may also have significant implications for pricing decisions. Sincemost costs are considered to be fixed, short-run marginal cost pricing would meanthat orders are accepted as long as they exceed the cost of raw materials. This maybe a means of breaking an external constraint if capacity is greater than demand.Care must be exercised, however, since the fixed costs must be recovered in thelong-run.

5.7.3 Measuring Work Station Performance

TOC relies heavily on synchronised operations and therefore, local areas should beevaluated on the basis of deviations from planned performance (NOT potentialperformance). In other words, because operations need to be synchronized (andplanned), it is important that each stage in the productive process works in

accordance with the plan, not what at the full potential. (refer back to the diceexample examined earlier in this chapter. In that case, although positions 1 & 2have the potential to move, on average, 7 chips, they would be assessed onproducing according to a plan which only requires them to move, on average, 3.5chips).

Deviations may be classified as either (1) actions that should have been taken butwere not taken, or (2) actions that should not have been taken but were. In the firstcategory, workstations can be viewed as suppliers for the next production centre,with predetermined delivery dates. Each day a workstation is overdue in completingan order, the missed throughput is charged to the late area. This action can be apowerful motivator.

In the second category, a workstation may produce a different item from the onescheduled. In this case, the firm suffers in two ways: not having the correct itemwhen it was needed and having an item in inventory before it was needed. Theoffending workstation is charged (1) the cost of the idle time in the receivingworkstation caused by the receipt of the incorrect item and (2) a penalty based ondollar days for producing an item before it was needed, resulting in unplannedinventory.


24/36


106

5.7.4 Other Performance Measures

The management accountant can promote maximum throughput at bottleneckscaused by a binding constraint in the following ways:

Continually measuring workforce productivity and direct material yields at thebinding constraint

Monitoring pre-binding constraint buffer stocks of work-in-progress Providing constraint capacity measures for different product lines in order to

prioritise work at constraints Reporting on lead times (the time taken form the start of a process to the end of

that process), setup times and wait times Measuring schedule adherence (that is, the ability of each work station to keep to

pre-set production schedules designed to maximise throughput) Being aware of, and providing a measurement system for all factors that affect

performance. For example, if the quality of direct material inputs is vital to theefficient operation at the binding constraint, develop and use a vendor qualityperformance measure. Similarly, if direct material delivery schedules areimportant, assess and report on vendors delivery performance

Lastly, the monitoring of stock by location, idle time and wait time throughout theproduction process can be valuable as indicators of the existence of constraints

5.8 IMPLICATIONS OF A THROUGHPUT FOCUS

By way of summary, this chapter has introduced a number of concepts andimplication for management, including

1. Product mix decisions should optimise throughput relative to the bindingconstraint.

2. Process improvement should focus on elevating and eliminating the constraint.Diverting resources to non-binding constraints will not increase throughput.

3. Any idle time on the constraint is lost throughput that cannot be made up.4. The cost of poor quality products identified after they have passed through the

binding constraint includes the opportunity cost of the lost throughput.5. Excess capacity/ idle time will exist on non-binding constraints.6. TOC and JIT share the view that inventory should be minimised to avoid the cost

and inefficiency associated with large inventories.7. Inventory will naturally build in front of the constraints. Contrary to theadmonitions of JIT manufacturing, these inventory buffers are necessary toensure that there is no idle time on the binding constraint.

8. Reducing inventories will decrease short-term profits under traditional costaccounting because overheads are not being absorbed into the assets Work inProcess and Finished Goods Inventories, but this will benefit the organisation inthe long run.


25/36


107

5.9 SUMMARY

In the face of increased competition and more stringent customer requirements,organisations have over recent years sought to simultaneously reduce cost, improvequality, respond faster, and be innovative. TOC is a management philosophy thatfocuses on the time element, concentrating on reducing the time taken to generate

profits and the rate at which direct materials are turned into sales. It identifies sellingprice, sales volume, and material cost as the three key variables determiningprofitability and focuses on product flow by treating overhead and labour costs asfixed in the short term (Smith, 1995). Whilst intimately involved with processes, thetheory takes a somewhat simplistic, linear view of the production chain. Recent workwhich links activity-based and TOC concepts may develop into a much richercontribution to resource management.


26/36


108

5.1Throughput is equal to:

(a) sales less direct labour(b) sales less direct material cost(c) sales less direct materials, direct labour and variable overhead(d) sales divided by inventory(e) sales less operating expense

5.2Which of the following shows the priorities (from most important to least important) ofa traditional cost-world orientation?

(a) Operating expense, inventory, throughput(b) Operating expense, throughput, inventory(c) Inventory, sales, operating expense(d) Throughput, inventory, operating expense(e) Operating expense, sales, inventory, throughput

5.3Which of the following shows the priorities (from most important to least important) ofa TOC orientation?

(a) Operating expense, inventory, throughput(b) Operating expense throughput, inventory(c) Inventory, sales, operating expense(d) Throughput, inventory, operating expense(e) Operating expense, sales, inventory, throughput

5.4A constraint can be:

(a) a worker(b) a machine(c) a policy(d) all of the above(e) none of the above


27/36


109

5.5How might a capacity constraint be exploited?

(a) purchase additional capacity(b) reduce demand(c) optimise the product mix

(d) all of the above(e) none of the above

5.6According to the Theory of Constraints, inventory is defined as All the money thesystem invests in purchasing things the system intends to sell. Which of thefollowing will NOT be included as inventory?

(a) The depreciated value of property and plant(b) The depreciated value of equipment(c) Work in process valued at direct material and direct labour cost(d) Raw material at cost

(e) None of the above, i.e., all are included in the definition of inventory

5.7What is the global goal of a for profit organisation?

(a) to improve cash flow(b) to build quality into the product(c) to increase sales revenue(d) to make more money now and in the future(e) to increase market share

5.8The theory of constraints can be applied to:

(a) manufacturing firms(b) service organisations(c) government organisations(d) not for profit organisations(e) all of the above

5.9Which of the following would elevate a capacity constraint?

(a) purchase additional capacity(b) synchronise production(c) reduce demand for the product(d) optimise the product mix(e) all of the above


28/36


110

5.10Which of the following may indicate that a particular resource is a capacityconstraint?

(a) excessive idle time for the resource(b) persistent unfavourable labour efficiency variances for the resource

(c) a build-up of work in process inventory before the resource(d) a lack of inventory before the resource(e) none of the above

5.11What are some of the costs associated with holding inventory?

5.12What are the problems associated with the emphasis on reducing costs as themeans of improving profitability?

5.13

What is a constraint, and how does it affect throughput?

5.15Distinguish between throughput-based performance measures and conventionalmeasures of performance.

5.16Which of the above (4.15) two sets of performance measures better support a globalapproach to optimising resource management? Explain your answer.

5.17In addition to optimising the product mix, in what other ways can binding constraints

be managed?

5.18Explain how the notion of drum-buffer-rope would apply to the manufacture of motorvehicles on an assembly line.

5.19James Industries produces and sells products A, B, and C. The following figurespertain to these products:

A B CWeekly demand (units) 25 45 50

Selling price $9.00 $9.50 $4.40Materials $3.00 $2.20 $1.00Direct labour $1.50 $2.10 $0.90Variable overhead $2.10 $2.90 $1.50Constraint time per unit (hours) 0.40 0.45 0.20

Required:1. Rank the three products using contribution margin per unit (selling price minus

variable costs).


29/36


111

2. Rank the three products using the TOC approach.3. Assume James Industries has 34.25 hours of constraint time available each

week. In order to maximise total weekly throughput, how much of A, B, and Cshould James Industries produce?

5.20

The five steps of focusing can be applied to your daily life. Lets assume you findyourself constantly running out of time. There are simply not enough hours in a dayfor university, work, and family life.

Required:Apply the five focusing steps to your own personal throughput chain. If, for example,commuting to and from university and work is limiting the time you have for otheractivities, you might identify your long commuting time as a constraint. One possibleway to elevate this constraint is to move closer to your workplace or school. Identifyat least three other constraints and elevate them.

5.21

Goldenwater Pty Ltd manufactures two types of aspirin: plain and buffered. The firmsells everything it produces. Recently Goldenwater implemented a TOC approachfor its Fort Smith plant. The binding constraint was identified, and the optimalproduct mix was determined. The following diagram reflects the TOC outcome.

Materials for 2,000 bottles per day

Plain aspirin: 1,500

Buffered aspirin: 500

Mixing process

Inventory of 250

units of

buffered aspirin

Inventory of 750

units of

plain aspirin B

Tableting process C

Bottling process

Finished goods

1,500 bottles of plain

aspirin and 500 bottles of

buffered aspirin per day

A


30/36


112

Required:1. Explain what the letters A, B, and C represent. Discuss each of their roles in the

TOC system.2. What is the daily production rate? Which process sets this rate?3. How many days of buffer inventory is Goldenwater Pty. Ltd. carrying? How is this

time buffer determined?

5.22Your new employer has asked you to predict the profit for the coming four-weekperiod (20 working days) from his production process, and to assess the likelihood ofachieving that profit. The firm produces a single product, for which the four-weeklydemand is 70 units. The product passes through a number of workstations. Preparea list of questions that you would ask to allow you to do this.

5.23Price Industries Inc produces two different metal components used in medicalequipment (Component X and Component Y). The company has three processes:moulding, grinding, and finishing. In moulding, moulds are created, and molten metal

is poured into the shell. Grinding removes the gates that allowed the molten metal toflow into the moulds cavities. In finishing, rough edges caused by the grinders areremoved by small, hand-held pneumatic tools. In moulding, the setup time is onehour. The other two processes require no setup time. The demand for Component Xis 300 units per day and the demand for Component Y is 500 units per day. Theminutes required per unit for each component are given below:

Minutes required per unit of componentProduct Moulding Grinding FinishingComponent X 5 10 15Component Y 10 15 20

Price Industries operates one eight-hour shift. The moulding process employs 12workers (who each work eight hours). Each component requires one setup,irrespective of how many units are produced. Each setup requires one hour of eachemployees time. Prices policy is to use two setups per day: an initial setup toproduce all that is scheduled for Component X and a second setup (changeover) toproduce all that is scheduled for Component Y. The amount scheduled does notnecessarily correspond to each products daily demand.The grinding process has sufficient equipment and workers to provide 12,000grinding minutes per shift.The finishing department is labour-intensive and employs 35 workers, who eachwork eight hours per day.Selling prices for Component X and Component Y are $90 and $110, respectively.

The only significant unit-level variable costs are materials and power. ForComponent X, the unit-level variable cost per unit is $40, and for Component Y, it is$50.

Required:1. Calculate the time (in minutes) needed each day to meet the daily market

demand for Component X and Component Y. What is the major internalconstraint facing Price Industries Inc?


31/36


113

2. Describe how Price Industries should exploit its binding constraint. Specifically,identify the product mix that will maximize daily throughput.

3. Assume that the process engineering department has found a way to reduce themoulding setup time per employee for each product from one hour to 10 minutes.Explain how this affects the product mix and daily throughput.

5.24Insearch Productions Pty Ltd produces two types of bike frames (Frame X andFrame Y). Frame X passes through four processes: Cutting, Welding, Polishing, andPainting. Frame Y uses three of the same processes: Cutting, Welding, andPainting. Each of the four processes employs ten workers who work eight hourseach day. Frame X sells for $40 per unit, and Frame Y sells for $55 per unit. Rawmaterials are the only unit-level variable expense. The materials cost for Frame X is$20 per unit, and the materials cost for Frame Y is $25 per unit. Insearchsaccounting system has provided the following additional information about itsoperations and products:

Frame X Frame Y

Resource name Resource available Usage: per unit Usage: per unitCutting labour 4800 minutes 15 minutes 10 minutesWelding labour 4800 15 30Polishing labour 4800 15 NAPainting labour 4800 10 15

Market demand for X: 200 per dayMarket demand for Y: 100 per day

Insearchs management has determined that any production interruptions can becorrected within two days.

Required:1. Assuming that Insearch can meet daily market demand, compute the potential

daily profit. Now compute the minutes needed for each process to meet the dailymarket demand. Can Insearch meet daily market demand? If not, where is thebottleneck? Can you derive an optimal mix without using a graphical solution? Ifso, explain how.

2. Graph the constraints facing Insearch. Determine the optimal product mix andthe maximum daily contribution margin.

3. Explain how a drum-buffer-rope system would work for Insearch.4. Suppose that the engineering department has proposed a process design

change that will increase the polishing time for Frame X from 15 to 23 minutesper unit and decrease the welding time from 15 minutes to 10 minutes per unit(for Frame X). The cost of process redesign would be $10,000. What step in theTOC process does this proposal represent?

5.25Miller Company sells three products (products 611, 613, and 615), which itmanufactures in a factory consisting of four departments (Departments 1 through 4).Both labour and machine time in the four departments are consumed in producingthe products. The machine processing and labour skills required in each departmentare such that neither machines nor labour can be switched from one department toanother.


32/36


114

Millers management is planning its production schedule for the next severalmonths. There are labour shortages in the community. Some of the machines will beout of service for extensive overhauling. Available machine and labour time bydepartment for each of the next six months are as follows:

Monthly Capacity Available (Hours)(by department)

Dept1

Dept2

Dept3

Dept4

Normal machine capacity inmachine hours

Capacity of machines beingrepaired in machine hours

Available machine capacity in

machine hours

Labour capacity in direct labourHours

Available labour in direct labour hours

3,500

(500)

3,000

4,000

3,700

3,500

(400)

3,100

4,500

4,500

3,000

(300)

2,700

3,500

2,750

3,500

(200)

3,300

3,000

2,600

Labour and Machine Specifications(hours per unit of product)

Product Labour & machine time Dept 1 Dept 2 Dept 3 Dept 4611 Direct labour hours 2 3 3 1

Machine hours 2 1 2 2613 Direct labour hours 1 2 - 2

Machine hours 1 1 - 2615 Direct labour hours 2 2 1 1

Machine hours 2 2 1 1

The Sales Departments forecast of product demand for the each of the next sixmonths is as follows:

Product Monthly Sales Volume

611 500 units613 400 units615 1000 units

Millers finished goods inventory levels will not be increased or decreased during thenext six months.

Planned operating expenses per month comprise total direct labour cost of$100,000, total variable overhead cost of $50,000, and total fixed overhead cost of$45,000 (for the labour and machine hour capacities given).


33/36


115

Relevant unit price and cost data valid for the next six months follow:

Product

611 613 615

Unit costs:

Direct materials

Variable selling

Unit selling prices:

$7

3

$196

$13

2

$123

$17

4

$167

Required:1. Determine if the monthly sales demand for the three products can be met by

Miller Companys factory. Use the monthly requirement by department formachine hours and direct labour hours for the production of products 611, 613,and 615 in your calculations.

2. What monthly production schedule should Miller Company select in order tomaximise its monthly throughput? Support the schedule with appropriatecalculations, and present a schedule of the total throughput that would begenerated by the production schedule selected.

3. Prepare a TOC (throughput) profit statement.

5.26The Cleanvu Window Company (CWC) manufactures custom-insulated windowsand screens for use in residential and commercial premises. Each window ismanufactured to tight specifications for each application. CWC employs a JIT

approach to production, and schedules each production batch so that it can beshipped to the customer as soon as the batch is completed. Meeting shipping datesis very important to CWC, as most sales contracts contain a monetary penalty forlate delivery.

All windows pass through a finishing workstation. At this workstation screens areattached, and an inspection is performed to ensure that the windows meetspecifications. CWC has only one finishing workstation in its manufacturing plant.CWCs managers have been talking about adding a second finishing workstation forsome time. However, some managers believe that a second finishing workstation isnot warranted because the amount of processing time per window is so small.Production statistics gathered by CWC show that, on average, a window is in the

finishing workstation for 15 minutes. This is the least amount of time that a windowspends in any single workstation.Recently, a large shipment of windows was not delivered on time. As a result, CWCincurred a significant penalty due to the late delivery. A review of the productionrecords for this shipment revealed that the shipment was late because all 48windows were delivered to the finishing workstation on the afternoon that thewindows were due to be shipped to the customer. In addition, several of thewindows had to be returned to other workstations for minor rework and adjustments.The finishing workstation had been idle earlier during that day.


34/36


116

Required:1. How does the finishing workstation limit production?2. Management is concerned about whether inspection should be placed other than

in the finishing workstation. How would fishbone diagrams and Pareto analysishelp you establish where inspection should be placed?

3. Suggest how workflow may be better managed to alleviate the current impact ofthe finishing workstation.

4. What steps would you take in order to evaluate the decision not to add a secondfinishing workstation?

5.27 (refer to the Appendix)

Kensos Calculators produces two types of calculators, scientific and financial.Scientific calculators require 2 memory chips and 2 minutes on a special assemblymachine. Financial calculators require only one memory chip but 5 minutes on thespecial assembly machine. Other relevant details are as follows:

Scientific FinancialDemand per week 450 600Selling Price $35.00 $45.00Raw Material Cost $15.00 $30.00Throughput $20.00 $15.00

Required (answer each part independently of the other parts):1. Assume that only 1,000 memory chips can be obtained from the supplier.

Calculate the optimal product mix.2. Assume that the time on the special assembly machine is limited to 1,800

minutes per week. Calculate the optimal product mix.3. Use a graph to illustrate the constraints described in part 1 and 2. Determinethe optimal product mix given both of these constraints. On your graph clearlyidentify the set of feasible product mixes.


35/36


117

5.28Get-a-life Photos Pty. makes customized photo prints by through computerizedenhancement of a customers photo. For example, a customer may bring in a pictureof themselves, have it scanned into the computer, and then have their favoritecelebritys image also incorporated into the photo. There are two general products

offered a standard photo layout and a customized layout. The customized layoutdiffers in that a consultant spends time with the customer determining what the photoimage will look like. There is 900 minutes of consultants and computer timeavailable. The demand, price, and resource requirements for both services are asfollows:

Standard CustomisedDemand per week 60 50Price $16.10 $25.10Raw Materials $1.10 $1.10Throughput $15.00 $24.00Consultants Time Required 10 min 20 minComputer time required 15 min 10 minRequired:

1. Assume that only standard photos are produced separately calculate thelimits imposed by the limited consultants time and the limited computer time.

2. Assume that only customized photos are produced separately calculate thelimits imposed by the limited consultants time and the limited computer time.

3. Draw a graph and clearly identify the set of feasible product mixes.4. Identify the corner points of the set of feasible product mixes.5. Determine the optimal product mix.


36/36


bdmm chapter 5 toc

Documents