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By Root 2804 0

that three straightforward metrics—Throughput, sales revenue minus all variable costs (manufacturing and general, selling, and administrative), Inventory (or Investment), the funds an organization has expended to be in position to produce, and Operating Expenses, the repetitive expenditures a company must incur each period in order keep the company operating—are all the measures needed for day-to-day operating decisions (Goldratt and Cox, 1984). These three metrics have occupied space in every cost and management accounting textbook, under slightly different names, since at least the 1960s (Dopuch and Birnberg, 1969).

Different definitions of terms undoubtedly have caused much confusion. While it may be impossible, at this late date, to change TOC terminology, people trained in accounting call Throughput by the name contribution margin,24 with the same definition—revenue minus totally variable costs. Inventory is a highly controllable subset of Investment in total assets. Operating Expenses, in accounting terminology, would be fixed costs, including manufacturing fixed costs and general, selling, and administrative fixed costs.

Where to Focus Quality Improvements

The same example shown in Fig. 13-1, along with identification of the internal constraint (Resource 2) can be used to focus quality improvements. Assume the company experiences a scrap problem at Resource 4 resulting in 4 percent of units (3.6 units) of Product X being scrapped, 7 percent (0.7 units25) of Product Y, and 8 percent (6.4 units) of Product Z (see Fig. 13-2). The quality team can correct the problem on only one product at a time, the cost being approximately equal for each product. Which product should they work on first?

FIGURE 13-2 Scrap problem at Resource 4.

Provided the quality problem data shown in Fig. 13-2, most people immediately select Product Z for first attention because (1) it has the highest percentage of scrap, (2) it has the most units being scrapped, or (3) it is the company’s most profitable product. With traditional accounting, even if the cost of the time lost (45, 35, and 40 min, respectively, for Products X, Y, and Z), at $0.50 per minute26 is included in the analysis, along with the cost of materials ($60, $50, and $45 for Products X, Y, and Z, respectively) and variable manufacturing overhead ($8, $5, and $2 for Products X, Y, and Z, respectively), the priorities remain Product Z (with a total cost of $428.80), then Product X (total cost of $325.80), and then Product Y (total cost of $50.75).

Because there is sufficient time to replace the work lost on Resources 1, 3, and 4, however, the Throughput approach includes lost variable costs (materials and variable manufacturing overhead) plus the cost of lost time only on Resource 2. Units lost of Products Z and X will be replaced, resulting in fewer units of Product Y being produced and sold. First, we safely may ignore the option of fixing the quality problem on Product Y because only 1 unit is lost per week, leaving only Products X and Z for improvement consideration.

Since only whole units may be sold, if the quality problem on Product Z is corrected first, Product X’s remaining quality problem will result in 4 fewer units of Product Y being produced and sold. Product X production losses will be replaced, but 80 min (4 unit × 20 min) on the constraint (Resource 2) will have been lost. Thus, after Resource 2 has been used to produce 80 units of Product Z (still the best product, requiring 400 min) and 90 units of Product X (the next best product, requiring 1800 min), leaving only 120 min to produce and sell 6 units of Product Y, resulting in operating income of $12,126.

However, if the quality problem on Product X is eliminated first, Product Z’s remaining quality problem will result in 7 units having to be replaced, at 5 min per unit, meaning 35 min of Resource 2’s time will be lost, leaving 2,365 min available. Once again, 80 units of Product X, requiring 400 min on Resource 2, and 90 units of Product Z, requiring 1800 min on Resource 2, leave 165 Resource 2 minutes