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By Root 3130 0

has found a new supplier who is willing to provide Raw Material #7, for $2.50, saving the company $200 a week. Figure 13-3 illustrates this opportunity. If Purchasing primarily were evaluated based on cost savings, they would like to make the deal. After trying a sample of the new material, however, the production manager states that Resource 4, Task 3 will incur approximately 10 percent scrap. Since Resource 4 has plenty of idle time, Purchasing assures the production manager, they can easily make up the 80 min lost due to scrap. Further attempting to seal the deal, the purchasing person tells the production manager that since Resource 4’s utilization will increase, efficiencies may increase, offsetting any scrap.

The production manager, having been trained in TOC concepts, states (not too patiently) that since the scrap occurs following processing on the constraint (Resource 2), each lost minute on Task 4 means that fewer units of other products can be produced and sold. Additional materials will be processed to make sure all demand for Product Z will be filled, so the lowest priority product, Product Y, will take the hit. Because Resource 2, Task 4 requires 5 min of processing time per unit, 40 min of Resource 2 time (8 units × 5 min) will be lost. Because Product Y requires 20 min per unit on Resource 2, two units of Product Y will be eliminated (at $183 Throughput per unit). Therefore, this material cost “savings” of $200 will cost the company $36628 in lost Throughput every week! (See the original “best” operating income versus the operating income if the proposed change were accepted in the Throughput_ Examples spreadsheet, cells BU1: CF40.)

FIGURE 13-3 Proposed acquisition of a cheaper material.

FIGURE 13-4 Product X, Resource 1, Task 1—make versus buy decision.

This “opportunity,” if accepted, would result in a decrease in operating profit of $166 ($366 – $200) each week. Fortunately, the production manager rejected this “cost-saving” proposal.

Outsourcing Proposal #1 Suppose another person in purchasing has received an offer from a new supplier to provide a component that will include Raw Material #1 and processing through Resource 1 for a cost of $21.75. No variable overhead is incurred for this operation. Should the offer, shown in Fig. 13-4, parts a (make) and b (buy), be accepted? Traditional accounting would say, “Absolutely.” The unit cost through that point in production is $22.67 ($20.00 for the material and $2.67 for 5 min of processing at a cost of $0.5333 per min); resulting in a savings of $82.80 each week ($0.92 a unit times 90 units) or over $4100 each year.29

However, TA would respond, “No way!” Resource 1 is not a constraint and already has 50 min of unused time each week.30 Accepting this outsourcing offer would result in incurring an additional cost of $1.75 a unit ($21.75 – $20) for the 90 units needed—$157.50 each week31; almost $8000 a year. Meanwhile, Resource 1 would incur additional idle time of 450 min each week. In addition, the company would lose direct quality control and incur the risk of unavailability of the component when needed.

FIGURE 13-5 Products X and Y, Resource 1, Task 2 and Resource 2, Task 3—make versus buy

Of course, traditional accounting would respond that Resource 1 should be put on a 4-day workweek since they now have over 8 hours of idle time. Sometimes this makes sense, but not normally. Cutting the pay, effectively, of one worker does not inspire high worker morale and job commitment. In addition, Resource 1 is the most likely constraint candidate should Resource 2 capacity’s be elevated.

Outsourcing materials and Resource 1 work, in the situation described, would not be a good decision.

Outsourcing Proposal #2 Purchasing also has an offer from a supplier to provide a component that would include Raw Material #3 and processing by Resource 1 and Resource 2 for a cost of $40. Variable manufacturing overhead for the operations involved is $2.50 a unit. Figure 13-5a shows the current arrangement, and Fig. 13-5b shows the “buy” proposal. Should the