the theory of constraints and implications for inventory ......the theory of constraints and...
TRANSCRIPT
The Theory of Constraints and
Implications for Inventory and
Operations Management
Hank “IT DEPENDS” Barr
CFPIM, CSCP, CLTD, CSCM, 6σBB, C.P.M., CLA/CLT
Vancouver, BC, Canada
October 30, 2019
Introduction
The Goal Is To Make Money
Managers Want To Manage Well
Most People Believe That Businesses Have A Multitude of Constraints To Deal With
The Theory of Constraints Proposes That You Only Have One Constraint At A Time
Agenda
To Consider What Your Constraint Is
And What It means To Your
Organization
To Discuss Some Common Measures
of Performance
To Examine Some Costs And Question
Some Benefits
Let Me Count The Ways To
Describe, Qualify Or Quantify
Costs Or Expenses
100+ and still counting!!!
Words to describe, categorize or Qualify Costs
or Expenses
Activity
Actual
Admin
Allocated
Allotted
Allowable
Amortized
Artificial
Assigned
Average
Benefits
Buildings
Capital
Carrying
Change
Changeover
Contract
Cost
Damage
Delay
Delivery
Direct
Education
Event
Expedite
Expense
Facilities
Finance
Fixed
Handling
Words to describe, categorize or Qualify Costs
or Expenses
Hard
Historical
Holding
Idleness
Imaginary
Implied
Imputed
Incremental
Indirect
Info Systems
Inspection
Insurance
Interest
Interruption
Investment
Irrelevant
Item
Job
Land
Landed
Lease
Legal
Long Term
Machine time
Marginal
Materials
Measurement
Medium Term
Obsolescence
Operating
Words to describe, categorize or Qualify Costs
or Expenses
Operation
Opportunity
Ordering
Out-of-pocket
Overhead
Paperwork
Period
Process
Procurement
Production
Quality
Real
Receiving
Relevant
Rent
Resource
Rework
Risk
Salaries
Selling
Set-up
Shipping
Short term
Shrinkage
Soft
Standard
Stock-out
Sunk
Tax
Theft
Words to describe, categorize or Qualify Costs
or Expenses
Time
Tools
Total
Tracking
Training
Transaction
Transfer
Transportation
Utility
Value-added
Variable
Virtual
Wages
Wrap rate
Associated
Overview
Every Business and Every Person Has To
Deal With Constraints
In Manufacturing, Significant Constraints
Are Addressed During Master Production
Scheduling In A Process Called Rough Cut
Capacity Planning
Dependency, Variation, And Change Are
Constants
Vocabulary
RCCP - process of converting the MPS into
requirements for major resources in time.
MRP - a process for calculating the timing
and quantity requirements for components.
Bottleneck - constrains throughput
Productivity - output compared to input
Throughput – (not to be confused with output)
revenue from sales minus totally variable
costs
More Vocabulary
Resources - together provide capacity
Fixed Costs - don’t change on a day to
day or decision by decision basis
Average Costs - usually fixed costs
divided by an estimated time or quantity
Incremental Costs - change with almost
every decision
Dependency
Vertical Dependency - requirements for components come from the “Planned Order Releases” of the next higher planning echelon
Horizontal Dependency - you can’t make the next higher assembly if all items at the same level are not available
Process Dependency
Traditional Bottleneck
Output=
50/hr
45-55
100/hr
90-110
75/hr
70-80
Process Dependency
50/hr
45-55
Variation & Change
Forecasts Change
Designs Change
Early or Late Shipments From Vendors
Machine Breakdown
New Technology
Sickness or Injury
Good days and Bad days
I want to be a great
manager, but
clouds are in my way?
Spider Web Conflict Cloud
Used with permission of Debra Smith author of the Measurement Nightmare.
5 Step Process for TOC & DBR
Identify System Constraint
Maximize Use of Constraint
Subordinate Everything Else
Elevate the Constraint
Keep Going!
What, When, How Many, Cost?
Land
Facilities
Machinery
Tools
Labor
Materials
Setups
Temporary Interruptions
Idle Capacity
Outside Purchases
$10,000,000/day
profit after tax/737
Customers
75/Month
Final Assembly
75/Month
Sales/Mkt, Finance, Mfg, HR,
IS, Purchasing, Engineering
WG 1
50/Month
WG 2-50
75/Month
Vendors
100/Month
What, When, How Many, Cost?
Vertical and horizontal dependency require a scheduled
output of approximately 50 per month.
What happens to traditional productivity metrics and variance
analyses?
And, how do you deal with variation (Murphy)?
Customers
50(75)/Month
Final Assembly
50(75)/Month
Sales/Mkt, Finance, Mfg, HR,
IS, Purchasing, Engineering
WG 1
50/Month
WG 2-50
50(not 75)/Month
Vendors
50(not 100)/Month
EOQ Graph & Formula
Quantity or Lot Size EOQ= 2 * U * S
I * C
U=annual usage, S=setup or order cost, I=hold %,
C=item $
Total $
Costs
Order/Set-UP Costs
$1,000
Weeks
Incremental View of Total Costs
Quantity or Lot Size EOQ= 2 * U * S=0
I * C
U=annual usage, S=setup or order cost, I=hold %,
C=item $
Costs
Comparison
•Using average costs in EOQ
results in larger lot sizes and
larger average inventory.
•Using incremental cost analysis
leads to ordering only what you
need and only when you need it.
Make vs. Buy
A sales opportunity comes your way.
It will take 2 hours to make an item
and $150 of raw materials which you
have to buy. When completed you
can sell it to Delta for $450. Or, you
can buy it for $250 and sell it for
$450.
Should you make it or buy it?
What does “it depend” on?
Make vs. Buy
Using full absorption costing I’d have 2 labor hours
@ $340/hr and the $150 of materials for $830 of
cost. Since I could only sell this thing for $450, It
looks like I would lose $380.
At the non-bottlenecks I have time on my hands and
if I make it there, I will contribute $300 in throughput
to additional profit.
If I make this at the bottleneck, I don’t lose $380. I
interfere with the $416,666.66/hr throughput stream
Comparison
At a non-bottleneck we only need to cover
variable expenses. Using full absorption
costing would keep us from making a
contribution to profit and overhead at non-
bottleneck resources.
At the bottleneck, purchasing outside
services would preserve the primary
revenue stream.
What, When, How Many, Cost?
Land F
Facilities F
Machinery F
Tools F
Labor F
Materials V
Setups 0 or $$$
Temporary Interruptions 0 or $$$
Idle Capacity 0 or $$$
Outside Purchases –Save $416K/hr
at bottleneck, Cause missed
contribution at non-bottleneck
Customers
50 not 75/Month
Final Assembly
50 not 75/Month
Sales/Mkt, Finance, Mfg, HR,
IS, Purchasing, Engineering
WG 1
50/Month Buffer Buffer
Buffer WG 2-50
50 not 75/Month
Vendors
50 not 100/Month
Measurement Thoughts Traditional Productivity Everywhere Leads
To Chaos and Large Inventories
Improvement For The Organization As A
Whole Depends On The Bottleneck
Use Selective Buffers To Protect
Throughput
Production or purchase is started to
maintain the buffers, so use simple visual
signals (Kanban)
RM 3
$14
RM 2
$4
RM 1
$12
A
6 min
C
1 min
A
5 min A
3 min
B
5 min B
2 min
B
3 min
D
7 min D
3 min
C
3 min
Product X
$100 price
180/wk demand
Product Y
$100 price
180/wk demand
Resource requirements if you try to make 180
(current market demand) of each product
Resource Minutes
necessary
for X
Minutes
necessary
for Y
Total
necessary
minutes
Necessary/
Available
A 1980 1440 3420 142.5%
B 900 1260 2160 90%
C 720 540 1440 60%
D 540 1260 1800 75%
Activity Cost
Production $4,800
Quality Testing $3,000
Shipping $3,200
Total $11,000
Total Cost of the Activities
Activity Activity
Cost
Cost
Driver
Cost
Driver
Capacity
Cost
Driver
Rate
Production $4,800 Minutes 9600 .50
Quality
Testing
$3,000 Minutes 2400 1.25
Shipping $3,200 Pounds 4,000 .80
Cost Driver Rates
X Y
A 11 8
B 5 7
C 4 3
D 3 7
Total 23 25
Use of the resources by the products
(minutes)
X Y
Total Minutes to
make one item
23 25
Cost Driver
Rate per
minute
.50 .50
Production
Cost/Unit
$11.50 $12.50
Tracing Production Costs to Products
Tracing Quality Testing to Products
X Y
Test time per
product (minutes)
12 12
Cost Driver Rate
(per minute)
$1.25 $1.25
Quality test cost
per unit
$15.00 $15.00
Tracing Shipping Costs to Products
X Y
Pounds per
unit
5 5
Shipping
driver rate
$.80 $.80
Shipping
cost per
unit
$4 $4
Total costs per unit using ABC
Sales Price
X
$100
Y
$100
Direct
Materials
16 18
Production 11.50 12.50
Quality
Testing
15.00 15.00
Shipping 4.00 4.00
Total cost 46.50 49.50
Margin $53.50 $50.50
Maximum profit using ABC:
180 X (best margin) and 52 Y (remaining capacity)
X Y Total
Revenues 18,000 5,200 23,200
Raw Material
Costs
2,880 936 3,816
Gross Margin 15,120 4,264 19,384
Operating
Expense
11,000
Maximum
Profit
8,384
What is the throughput or contribution
per unit of limited resource?
Product Price Totally
Variable
Cost
Throughput
per Unit
Time on
limited
resource
Throughput
per unit of
limited
resource
X 100 16 84 11 $7.64
Y 100 18 82 8 $10.25
Product Y actually contributes the most to profitability because
of its contribution per unit of scarce resource. This is very
different than ABC would have led us to believe.
To get the most profit , we should produce and sell all the Ys
the market wants and use remaining capacity to produce and
sell Xs.
Maximum profit using TA:
180 Y (best throughput) and 87 X (remaining capacity)
X Y Total
Revenues 8,700 18,000 23,200
Raw Material
Costs
1,392 3,240 3,816
Gross
Margin
7,308 14,760 22,068
Operating
Expense
11,000
Maximum
Profit
11,068
ABC v. TOC or LEAN
Traces costs
Generates many
transactions
Aggregates value to
WIP and FG
Did not properly guide
towards profit
Inconsistent between
accountants
Does not trace costs
No transactions
Few calculations
Guides towards profit
So simple it’s hard to be
inconsistent
Questions?
Where to get more information
Hank Barr 253 858-7680,
APICS, www.apics-ps.org, The Goal,
It’s Not Luck, Critical Chain, The
Measurement Nightmare, Throughput
Accounting, Necessary But Not
Sufficient, Lean Thinking, Who’s
Counting, Real Numbers, Learning To
See…
