Systems Thinking and the Theory of Constraints. The “JobShop” Simulation. 4 types of products. Product #1. Product #2. B. Start. B. Start. Finish. Finish. A. D. A. D. C. C. Product #3. Product #4. Finish. B. B. Start. Start. A. D. A. D. C. C. Finish.
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Product #1
Product #2
B
Start
B
Start
Finish
Finish
A
D
A
D
C
C
Product #3
Product #4
Finish
B
B
Start
Start
A
D
A
D
C
C
Finish
The “Cost World” Perspective
$60,000
$20,000
Do It!
8%
2%
$15,000
$20,000
Maybe?
2%
0.5%
Do NOT Do
$4,000
$20,000
0.5%
0.1%
next time!
No problem. Everything is OK!
Is 99.5% Quality Good Enough For You?If it is, then you won’t mind if:
Do It
Maybe?
Do NOT Do
* Assuming starting inventory of $15M and 25% carrying cost
Inventory Valuation and Cost Accounting
Raw Material cost per unit: $10
WIP value per unit: $20
Finished Goods value per unit: $35
Sale Price per unit: $50
Other Operating Expenses: $4 Million in 2006; $3.75 Million in 2007
2006 2007
Beginning WIP Inventory (1000 units) 50 50
Beginning FG Inventory (1000 units) 40 40
Raw Material (1000 units) 400 330
Sales (1000 units) 400 400
Ending WIP Inventory (1000 units) 50 10
Ending FG Inventory (1000 units) 40 10
2002 2007
Sales (1000 $)
Beginning WIP Inventory (1000 $)
Beginning FG Inventory (1000 $)
Raw Material Purchase (1000 $)
Other Expenses (1000 $)
Ending WIP Inventory (1000 $)
Ending FG Inventory (1000 $)
Cost of Goods Sold (1000 $)
Profit (1000 $)
20,000
20,000
1,000
1,000
1,400
1,400
4,000
3,300
4,000
3,750
1,000
200
1,400
350
8,000
8,900
12,000
11,100
Net Profit = Sp Revenuep  Sc Expensec.
But how do we use this information to, say, decide on launching a new product?
Net Profitp = Revenuep  Expensep, and so,
Net Profit = Sp Net Profitp
CSN, Inc. is a home maintenance services operation, started by three men, Cromby, Steele, and Nash.
Services offered: Plumbing, Window Cleaning, Gutter Guard Installation, and Landscaping.
There is ample demand for these services. However, there is also a shortage of qualified workers in the area.
CSN has had a motto: “Teach Your Children Well,” ever since their younger days. They have employed their children, 5 highschool graduates, to run operations.
Monthly wage per employee = $2,000 including benefits
Hours budgeted per employee per month = 200 hours
Monthly capacity with 5 employees = 1,000 hours
Total Direct Labor cost per month = $10,000
Direct labor rate = $10,000/1,000 = $10 per hour
Plumbing
Window Cleaning
Gutter Guards
Landscaping
Current Monthly Output
Labor Hours/job
2 hours
90 jobs
70 jobs
4 hours
3 hours
80 jobs
60 jobs
5 hours
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
CSN, Inc.: Revenue & Cost DataNote:
Total number of jobs per month = 90 + 70 + 80 + 60 = 300 jobs.
At current output level, capacity used = 90 x 2 + 70 x 4 + 80 x 3 + 60 x 5
= 1,000 hours per month
Monthly Administrative Overhead (Salaries) = $18,000.
Monthly NonAdministrative Overhead (Rent, Truck Fleet Maintenance, Marketing, Depreciation) = $9,000.
Overhead is currently allocated to products based on production volume. Current volume is 300 jobs per month.
Administrative Overhead per job $18,000/300 = $60.
NonAdministrative Overhead per job = $9,000/300 = $30.
Plumbing
Window Cleaning
Gutter Guards
Landscaping
Current Output
Labor Hours/job
2 hours
90 jobs
70 jobs
4 hours
3 hours
80 jobs
60 jobs
5 hours
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
Administrative Overhead Allocation
$60
$60
$60
$60
NonAdministrative Overhead Allocation
CSN, Inc.: Summary Cost Table$30
$30
$30
$30
CSN is using all its labor capacity, and is absorbing all overheads. So there is no labor variance or overhead absorption variance to worry about.
Therefore, the total profit is:
90 x ($10) + 70 x $30 + 80 x $10 + 60 x $35 =
$4,100 per month.
CSN, Inc. wants to use a better method to allocate the overheads (usingActivityBased Costing).
To accurately allocate Administrative Overhead, CSN gathers data on the time the administrators, Cromby, Steele and Nash, devote to the four products, each month. The data reveals the following breakdown on the time administration spends on the 4 products:
Plumbing: 30%; Window Cleaning: 35%
Gutter Guards: 20%; Landscaping: 15%
Plumbing
Window Cleaning
Gutter Guards
Landscaping
Percentage Effort
Admin O/H Allocated = %age effort x $18,000
$5,400
30%
$6,300
35%
20%
$3,600
15%
Number of Jobs
90 jobs
70 jobs
80 jobs
60 jobs
Administrative O/H Allocation per job
$60
$90
$45
CSN, Inc.: Administrative Overhead Allocation using ABCAdministrative Overhead to be allocated = $18,000
$2,700
$45
NonAdministrative Overhead to be allocated = $9,000.
The allocation is made based on labor hours.
Total labor hours = 1,000. So,
NonAdmin. O/H rate = $9,000/1,000 = $9.00 per labor hour.
Since Plumbing takes 2 hours, the NonAdmin. Overhead allocated to a Plumbing job is = $9 x 2 = $18.
Thus the NonAdministrative Overhead allocation per job is:
Plumbing (2 hours): $18; W. Cleaning (4 hours): $36
G. Guards (3 hours): $27; Landscaping (5 hours):
$45
Plumbing
Window Cleaning
Gutter Guards
Landscaping
Labor Hrs./job
Current Output
2 hours
90 jobs
70 jobs
4 hours
3 hours
80 jobs
60 jobs
5 hours
Revenue/job
$130
$170
$200
$250
Material Cost
$30
$10
$70
$75
Labor Cost
$20
$40
$30
$50
Administrative Overhead Allocation
$60
$90
$45
$45
NonAdministrative Overhead Allocation
CSN, Inc.: Improved Allocation with ABC$18
$36
$27
$45
Suppose the monthly demand for these services is:
Plumbing: 250 jobs
Window cleaning: 160 jobs
Gutter guard installs: 145 jobs
Landscaping: 120 jobs
Suppose, too, that CSN, Inc., can choose which products to go after.
What is the best product offering for CSN, Inc., that will maximize its profit?
Can CSN do better? Let’s use ABC cost figures.
Which is the most profitable product?
Compute profits if they first complete meeting the demand for the most profitable product, then focus on the next most profitable product, and so on. Use the following pages for your calculations.
Landscaping
First complete demand for 120 Landscaping jobs.
That uses up , leaving of capacity.
Next work on Gutter Guards. Each job takes 3 hours.
400 hours
600 hours
Can complete 400/3 =133 jobs.
(1 hour of labor unused.)
With this product mix, the apparent profit seems to be:
120 x $35 + 133 x $28 = $7,924.
Not the true profit. Why?
Answer: Unabsorbed overheads.
120 Landscaping and 133 Gutter Guard jobs will each recover $45 of Administrative Overhead, that is:
$45 x 120 + $45 x 133 = $11,385.
Admin. Overhead Variance =
$18,000  $11,385 = $6,615.
The 1 hour of unused labor gives a Labor Usage Variance of $10 and NonAdmin. Overhead Variance of $9.
So, the total of all the Variances is:
$6,634.
Actual profit with ABC is thus:
$7924  $6,634 = $1,290.
So, “optimal” profit is less than earlier profit! Why?
The “Throughput World” Perspective
NET PROFIT
(Absolute)
RETURN ONINVESTMENT
(Relative)
CASH FLOW
(Survival)
Return on = Net Profit = T  OE Investment “Inventory” I
Turns “Inventory” I
Relating TOC Measures to Traditional MeasuresLeverage from
Decreasing OE
Leverage from
Increasing T
$
Revenue 100
RM 40
DL 10
OH 40
Cost 90
NP 10
100
114
40
48
0.95(100) = 95
1.20(95) = 114
8
10
40
40
88
98
12
16
Assume a) you have 20% excess capacity, and b) sales will increase by 20% if you can effect a 5% price reduction.
The Importance of Throughput
Lean Supply Chain Principle 12:
Decisions should promote a growth strategy. While enterprises should try to simultaneously increase throughput, decrease inventory, and decrease operating expenses, the focus must be on improving throughput.
Capacity at the constraint (total labor hours) = 1,000 hours.
Fixed costs are: Labor + Administrative O/H + NonAdmin. Overhead
= $10,000 + $18,000 + $9,000 = $37,000.
Do 250 plumbing jobs first (250 x 2 = 500 hours).
Next, do 145 gutter guards (145 x 3 = 435 hours).
With the remaining 65 hours, you can complete 65/4 = 16 window cleaning jobs (64 hours)
Net Marginal Profit = 250*$100 + 145*$130 + 16*$160 = $46,410.
Subtract fixed costs ($37,000) for net profit = $9,410.
This approach is known as Throughput Accounting
Summary:
Profit with arbitrary product mix: $4,100
“Optimal profit” with ABC: $1,290
Optimal profit with Throughput Accounting: $9,410
The Job Shop Simulation Revisited
Product #1
Product #2
Start
B
B
Finish
Start
A
D
A
D
C
C
Finish
Product #3
Product #4
B
Finish
B
Start
Start
A
D
A
D
C
C
Finish
Note: This is a different Job Shop
Job Shop Simulation: Product Costs
Product 1: $1,500 Product 2 : $2,500
Product 3 : $2,500 Product 4 : $2,000
Profit Contribution Calculations
for the 4 Products
Product
Matl. Cost (M)
Labor
(L)
Overhead (O)
Product Cost = M+L+O
Sales Markup (%)
Sales Price
Contribution
Which job(s) will make the company the most money? Rank them
1
3
1500
480
1680
3660
0.30
4758
1098
2
1236
2500
360
1260
4120
0.30
5356
2
3
1
2500
480
1680
0.30
6058
4660
1398
4
4
2000
360
3620
0.30
4706
1086
1260
The FiveStep Focusing Process
Conflicting goals (local and global).
“Tell me how you will measure me and I will tell you how I will behave.”
“If you measure me in an illogical way, … do not complain about illogical behavior.”
“If you measure me in an unreasonable way, no one knows how I will behave...”.
“Not even me.”
Ave. WIP Inventory
R1
R2
R3
R4
R5
R6
$90 / unit
$100 / unit
Q:
P:
100 units / week
50 units / week
D
D
Purchased Part
15 min.
5 min.
$5 / unit
C
B
C
10 min.
5 min.
15 min.
B
A
A
15 min.
15 min.
10 min.
RM1
RM2
RM3
$20 per
$20 per
$20 per
unit
unit
unit
Time available at each work center: 2,400 minutes per week
Operating expenses per week: $6,000
A Production System Manufacturing Two Products, P and Q
Processing Requirements (all times in minutes)
Can We Meet The Demand?Resource requirements for 100 P’s and 50 Q’s:
15
10
2000
3000
15
30
1750
15
5
1750
15
5
$45
$60
60 min.
50 min.
P
Q
30
1500
900
15
900/15 = 60
60
5700
60
(Whoops!)
LOSE $300!
60
30
60/30 = $2
45
15
45/15 = $3
P
Q
1500
900
30
900/30 = 30
30
6300
30
$300
P
“Yes, there are two paths you can go by, …
But in the long run,
There’s still time to change the road you’re on.”
Product #1
Product #2
Start
B
B
Finish
Start
A
D
A
D
C
C
Finish
Product #3
Product #4
B
Finish
B
Start
Start
A
D
A
D
C
C
Finish
Profit Contribution Calculations
for the 4 Products
Product
Material Cost
Marginal Contribution
Marginal Contribution / Bottleneck Days
Revised Ranking (Old Rank)
Sales Price
# Bottle Neck Days Needed
1
1
1 (3)
1500
4758
3258
3258
2
1
2 (2)
2500
2856
5356
2856
3
2
4 (1)
2500
6058
3558
1779
4
1
3 (4)
2000
2706
4706
2706
2
Perhaps not.
B
$6,400
Profit
$/const
minute
Prod
Type
Plan B
Plan A
$4,500
(100)
P
$45
3.00
D
6.00
$1,800
(30)
Q
$60
2.00
D
P
$27

1.80
J
4.00
1.33
Q
$40

J
OE
$6,000
$300
Profit
Recovering Our Investment$4,185
(93)
$3,000
(50)

$2,000
(50)
$6,400
$2,785
IF:
Clients never change their mind,
Vendors always supply what we ask for, on time,
Our workers are excellently trained,
Our processes are extremely reliable,
Our quality is superb,
We do not have any absenteeism,
Data is readily available and accurate, and
You can decide on whatever policies you want.
THEN:
Managing production will be a piece of cake, …
right?
The Simulator provided you with a
paradise plant because all external causes
were eliminated.
Nevertheless,
Was it easy to manage production?
The Critical Chain
Typically involves completing a set of tasks
Tasks typically have long durations that are also highly variable
Project Management: CharacteristicsTask 2
5
25
Managing Projects Under UncertaintyAssume task durations are uniformly distributed (5,25)
If each task takes 15 days on average, what is average project completion time?
30 days
Task 3
Task 2
5
25
Managing Projects Under UncertaintyAssume task durations are uniformly distributed (5,25)
As before, each task takes 15 days on average.
What is the average project completion time?
33 days
Probability of completing project in 30 days?
36%
Task 3
Task 5
Task 2
Task 4
5
25
Managing ProjectsIf each task takes 15 days on average, what is the
probability that the project finishes in 45 days?
Srini; Here we get about 35% slide 86
< 25%
25
Determining Task and Project Durations – the Traditional WayTask 1
Task 3
Task 5
Task 2
Task 4
So, the average task times are “padded” to accommodate any possible delays. Instead of specifying a 50% time estimate (which fails half the time), a 98% confidence estimate is developed for the tasks and project duration.
The project is now estimated to take 70 days, not 45.
What is the chance the project will complete in 70 days?
98% of [5,25] = 5+.98*20 = 5+19.6 = 24.6
The Genesis of the Critical Chain
The Critical Chain implementation begins with 3 questions:
100%
75%
Percent of Project Completed
50%
Completion Date
25%
Time Elapsed
Project Due Date
Uncertainties multiply
Delays
Intrinsic
Uncertainties
Start Early
(CT )
Lines
High no. of
jobs in progress
Delays/
Shortages
Lead time
Resource contention
(Queues )
Backshops
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A2
B2
C2
A2
B2
C2
A2
B2
C2
Lead Time for Task A?
A6
B6
C6
Lead Time for Task A?
The Rules of the Critical Chain:
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Traditional Approach:
Critical ChainApproach:
Rationale: Project Buffers are more efficient than safeties within each task
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Most heavily loaded resource
2. Pipelining: Release Projects Based on Constraints Instead of Starting ASAPPipelining is more efficient than starting projects ASAP
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Chain 1
Buffer
20% buffer consumed
33% work completed
Chain 2
Buffer
60% buffer consumed
50% work completed
Burn Rate: % of buffer consumed vs. % of work completed. Automatically calculated on an ongoing basis to assess how much buffer is still available for future uncertainties.
Task Priorities: Tasks that lie on chains with less safety remaining are given top priority. This ensures that buffers are not wasted, and also reduces pressure to multitask.
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