Review of Part 4

In Part 4 of our Two Different Thinking Bridges series, we used the Least Cost and Global Thinking Bridge (TB) cost analysis techniques to evaluate a purchase proposal. The evaluation was similar to the scenario in Part 3 of the series, with a couple of modifications.

Once again, our Part 4 scenario results were completely different for each Thinking Bridge, similar to our results for the scenarios in Parts 2 and 3.

The purchase proposal shows a significant decrease in cost savings, using the Least Cost TB. This proposal costs the organization $36,500 in the first year and $31,500 in subsequent years, based on the unit cost increase. Based on the Least Cost TB analysis, this proposal should be rejected.

In using the Global TB, although the proposal increases the standard cost of the product, it increases the relative capacity of workstation 102. With 124,800 minutes per year/23 minutes per widget, this workstation now produces 5,426 widgets per year. With a new market potential of 6,000 widgets for this scenario, the additional widgets produced can all be sold. This fixture increases the annual capacity by 434. With a Throughput of $320 per widget, the annual Throughput increase is $138,880. Based on the Global TB analysis, this proposal should be accepted.

Today’s Scenario

In Part 5 of our Two Different Thinking Bridges series, we will look at a fourth and final scenario, applying much of the same data from our original scenario in Parts 1 and 2, with a couple modifications. We will apply both Thinking Bridges to analyze the same proposal made by the plant engineer. As in the previous posts, we will use material from the highly recommended book entitled Management Dynamics—Merging Constraints Accounting to Drive Improvement written by John and Pamela Caspari[1].

Cost Analysis: Initial Data

Again, we begin with the original scenario, assuming the firm’s market has grown to 6,000 widgets. The plant engineer makes a suggestion that lowers the total time to produce the product by three minutes.

As the table below shows, two minutes are added to workstation 103’s processing time, while processing for workstation 101 is reduced by five minutes. The net is a time reduction of three minutes.

Work Station	Original Processing Time	Proposed Processing Time
101	15 minutes	10 minutes
102	25 minutes	25 minutes
103	10 minutes	12 minutes
104	5 minutes	5 minutes
Total Time	55 minutes	52 minutes

Applying the Least Cost TB

In today’s scenario, the result using the Least Cost TB shows the same net decrease in processing time obtained in the original scenario in Parts 1 and 2. The standard cost of a widget decreases from $195.66 to $189.35. Based on these calculations, the engineer’s proposal appears to be desirable. But is it really? Let’s take a look at it from the perspective of the Global TB.

Applying the Global TB (i.e., Throughput Accounting)

As a reminder, the Global TB, otherwise known as Throughput Accounting, uses three cornerstones: 1) Throughput, 2) Investment/Inventory, and 3) Operating Expense. When using the Global TB, we always ask five questions about the proposal:

1. What prevents the firm from increasing Throughput?
2. Will the total amount of Throughput change?
3. Will the Operational Expenses of the firm change?
4. Will the amount of Inventory/Investment in the firm change?
5. What is the real economic effect of this proposal?

Q1: What prevents the firm from increasing Throughput? Just as in the scenarios in Parts 2 and 3, because workstation 102 takes the longest time to complete its work, it restricts this company’s ability to serve all of its potential customers.

Q2: Will the total amount of Throughput change? Unlike the scenarios in Parts 2 and 3, this scenario does not involve the limiting workstation, 102. Therefore, the firm neither gains, nor loses capacity because of the proposal. Sales remains at 4,992 widgets, so Throughput does not change.

Q3: Will the Operational Expenses of the firm change? No. As explained in the scenario in Parts 1 and 2, OE will not change.

Q4: Will the amount of Inventory/Investment in the firm change? Yes. As explained in the previous scenarios, Investment increases by $5,000, which is the cost of the new fixture.

Q5: What is the real economic effect of this proposal? The company loses $5,000 from its investment in the fixture. Therefore, the recommendation is to reject the proposal.

Summary of Results

All four scenario results are summarized in the table below. The Casparis have included a column for you to write in your opinion as to which is the preferable analysis for each scenario.

What we originally assumed would be a minor incremental enhancement, with a cost of $5,000 and an annual benefit of $20,000, actually resulted in a range of bottom-line profitability totaling more than a quarter of a million dollars!

Note: Numbers inside parenthesis represent a loss to the company.

	Least Product Cost (LPC)	Global Measurements (T,L,& OE)	Which analytical technique do you believe more correctly reflects reality?
Scenario 1	$17,085	($5,000)
Scenario 2	$26,500	($123,400)
Scenario 3	($36,500)	$133,880
Scenario 4	$26,500	($5,000)
Range of Estimates of Bottom-line Profit Effect	$63,000	$257,280

In closing, ask yourself what you can learn by applying the Least Cost and Global Thinking Bridges. Three conclusions are evident to me in our exploration of scenarios in this series:

1. We need to think carefully about what we mean by “improvement.”
2. In each of the four scenarios, the limitations on the ability to produce or sell the product created a leverage point for the company (i.e. the constraint).
3. The Least Cost Thinking Bridge appears to be flawed!

Coming up in the Next Post

In my next post, we will look at an entirely new improvement subject. As always, if you have any questions or comments about any of my posts, leave me a message and I will respond.

Until next time,

Bob Sproull

References:

[1] Management Dynamics – Merging Constraints Accounting to Drive Improvement, written by John and Pamela Caspari, published by John Wiley & Sons, Inc. 2004