Theory of Constraints Handbook - James Cox Iii [268]
The criterion for maximizing profits when one factor limits sales is to obtain the greatest possible contribution to profit for each unit of the limiting or scarce factor. The product that is most profitable when one particular factor limits sales may be the least profitable if a different factor restricts sales. When there are limitations, the conventional contribution or gross margin per sales dollar ratios provide an insufficient clue to profitability.
Figure 14-4a demonstrates the cost and revenue potential of a system through a simple break-even chart.4 Note that the “fixed costs” in the diagram include all OE as defined previously. The “total cost” line is all of the direct variable costs that are added on top of the fixed cost baseline that is associated to the sale of product. This company’s revenue potential is determined by the intersection of the relevant range and the total mix revenue. The company profit potential is the revenue potential minus the total cost at any given point above the break-even point.
FIGURE 14-4b TOC break-even chart of volume exploitation.
If top management’s attention is focused on investments directly impacting the bottom line as opposed to being distracted by endless requests in the name of localized improvement, then relatively rapid and significant organization improvement is close at hand.
The limitation of the constraint is the key factor that determines overall capacity and therefore the initial relevant range potential in Fig. 14-4a. By identifying and exploiting the constraint—the organization’s leverage point—and by applying all brain power and focus to squeezing more out provides a great opportunity to have an immediate and long-term impact to the bottom line for minimal or no investment.
Exploiting the constraint has two levels. The first level is first and foremost about increasing volume. This increase in volume can happen from two primary avenues, both of which require knowledge of the position and status of the constraint or drum. The first avenue is through volume that can be increased by squeezing more out of the constraint itself. This can be accomplished through a number of methods including improvements in its run rate, eliminating its starvation, or minimizing or reducing its setup time. The second avenue that volume can increase is through driving the sale of free products—a product that is free from passing through the constraint. Free product volume must be carefully managed so that it does not create an additional constraint. Careful management often means some sort of governing mechanism to adjust volume in relation to the total system’s effectiveness to support the constraint. If there is too much free product volume, it can often mean that the resources involved in making it will have less overall sprint or protective capacity5. This means that they are less responsive to the constraint or (once downstream from the constraint) the customer. The danger of this is obvious. It can cause disruptions to the constraint, late shipments, expedites or bigger buffers (time or stock) impacting lead times, DDP, or cash in inventory. Figure 14-4b shows the impact of volume-based exploitation techniques. Increasing the volume has expanded the relevant range of the system, which translates to higher total potential revenue and profit.
FIGURE 14-5 TOC break-even chart of rate-based exploitation of the resource constraint.
The second level of exploitation is about rate. Now that capacity/volume has been maximized, decisions must be made about which products create more profit relative to that available capacity/volume. The primary metric here is the rate at which products generate Throughput across the constraint. Using our clients as a benchmark over the past 15 years, we have seen the rates of Throughput generation per unit of constraint time by product differ by as little as $3 to $1 and as great as $20 to $1. Of course, free products do not cut across the defined constraint