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Categories: Theory of Constraints
Two Different Thinking Bridges

Two Different Thinking Bridges

By Bob Sproull

Review

In my last post, we completed our discussion of the four tools used to identify your system constraint by discussing the Cost-Utilization Diagram (i.e. CUT Diagram). The four tools we discussed were:

  • Process flow diagram
  • Time analysis
  • Load analysis
  • Cost-utilization diagram

In today’s post, we will begin a discussion on two distinctly different “Thinking Bridges” as it applies to making money for your company. In this series of posts, we will be presenting material published in a wonderful book entitled Management Dynamics—Merging Constraints Accounting to Drive Improvement written by John and Pamela Caspari[1]. I highly recommend this book for anyone trying to drive profitability to new levels.

Thinking Bridges

Numerous times in many of my past posts, I have written about two forms of accounting. I’ve discussed how, using each one in isolation from the other, the levels of profitability can be dramatically different. John and Pamela Caspari refer to these two approaches as “Thinking Bridges.” In their book, the Caspari’s use a simple example to describe the impact of these two bridges as a form of decision-making as it applies to profitability.

In this post, we will first present some initial data and then offer the first of four independent, but similar, proposed changes to the operation as four different scenarios. Each scenario will first be analyzed using what the Caspari’s refer to as the “Least Cost Thinking Bridge.” Next, we’ll analyze the same scenarios using what the Caspari’s refer to as the “Global Measurements Thinking Bridge.” Although each of the four proposed changes is similar to the others, you will see how the bottom line impact is different depending on which bridge is used.

Initial Data

The company we are studying is currently selling 3,500 widgets per year at a price of $400 each. The widget manufacturing process uses four workstations as follows:

Work Station

Processing Time

101

15 minutes

102

25 minutes

103

10 minutes

104

5 minutes

Total Time

55 minutes

The widgets process sequentially through all four workstations. When completed, the widgets either transfer to a finished-goods storage area or shipped directly to the customer.

Each widget requires raw materials costing $80. Individual employees at each workstation earn $18 per hour. Each employee works 2,080 hours per year (40 hours per week for 52 weeks per year), and the employees are not cross-trained. The company has other expenses of $900,000 with direct labor and overhead calculated in the following table.

Cost Element

Calculation

Rate per Direct Labor Minute

Direct Labor

$18/hour/60 minutes/hour =

$0.3000

Overhead

(4 direct labor employees) * (2,080 hours/year)

= 8,320 direct labor hours per year

(8,320 direct labor hours per year * 60 minutes/hour)

= 499,200 direct labor minutes per year

$900,000/(499,200 direct labor minutes)

$ 1.8029

Combined

$2.1029

The costs of materials, labor and overhead are combined, as shown in the table below, to form the $195.66 standard cost of a single widget.

Cost Element

Cost

Raw Materials

$ 80.00

Direct Labor (55 minutes @ $0.3000)

$ 16.50

Overhead (55 minutes @ $1.8029)

$ 99.16

Standard Unit Cost

$195.66

The plant engineer has been hard at work and has determined that, with the addition of a fixture that costs only $5,000, the processing times at each workstation can modify. We will now present the first of four scenarios.

Scenario 1

The company’s plant engineer proposes acquiring the fixture that will reduce the total processing time by three minutes per widget. The new fixture would permit station 101’s time to be reduced by 5 minutes; station 102 would be increased by 2 minutes and stations 103 and 104 would remain the same as depicted in the following table. According to the plant engineer, the total time reduces by 3 minutes per widget (55 minutes – 3 minutes = 52 minutes). We will now look at how the two “Thinking Bridges” analyze this proposal. You will see they are dramatically different in their recommendations.

Work Station

Original Processing Time

Proposed Processing Time

101

15 minutes

10 minutes

102

25 minutes

27 minutes

103

10 minutes

10 minutes

104

5 minutes

5 minutes

Total Time

55 minutes

52 minutes

Least Product Cost Analysis

Intuitively, the plant engineer knows that reducing the amount of time required to produce the widgets would be beneficial to his company. The new cost of the widget, reflecting the 3-minutes processing time reduction, is $189.35 is shown in the following table, for a net savings of $ 6.31:

New Cost Element

Original Cost

Cost

Raw Materials

$ 80.00

$ 80.00

Direct Labor (52 minutes @ $0.3000

$ 16.50

$ 15.60

Overhead (52 minutes @ $1.8029)

$ 99.16

$ 93.75

Standard Unit Cost

$ 195.66

$189.35

Difference in Cost (Original – New)

$ 6.31

The expected annual cost savings resulting from this proposal is $17,085, which includes deducting the cost of the new fixture:

Cost savings per widget

$ 6.31

Annual Volume of widgets

x 3,500

Total annual cost savings

$ 22,085

Less: Cost of fixture

$ 5,000

First year cost savings

$ 17,085

The internal rate of return of this proposal is over 400%, calculated as follows:

Cost savings (the presumed net cash inflow resulting from the investment) = $22,085 per year

Initial investment required = $ 5,000

Approximate value of, and upper limit on, the internal rate of return

** (cost savings/investment) (The payback* reciprocal) = 4,417 = 442%

*The payback period of this investment is about 3 months ($5,000/22085 – 0.226 years)

**The reciprocal of the payback period approximates the interest rate of return when both returns are high (greater than 50%) and economic life is long (greater than twice the payback period)

The Casparis ask some very good questions:

  • Since the payback period is less than 3 months, this appears to be an excellent proposal. But what do you think?
  • Is this proposal an improvement?
  • Is the example typical of how decisions are made in your organization?
  • Does your organization pursue production efficiencies with the purpose of increasing the bottom line?

Next Time

In my next post, we will answer the Caspari’s questions and then take a look at how the second “Thinking Bridge” would analyze this proposal. As always, if you have any questions or comments about any of the posts, leave 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

Bob Sproull

About the author

Bob Sproull has helped businesses across the manufacturing spectrum improve their operations for more than 40 years.

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