Bottleneck and Non-Bottleneck Marginal Value Example

Review

In my last post we presented the foundation for an example of how to calculate the marginal values for both bottleneck and non-bottleneck resources. 

In today’s post we will complete the example of how to calculate the marginal values of both bottleneck and non-bottleneck resources. As with the other posts in this series, much of what we will discuss in this post references the book, Synchronous Management – Profit-Based Manufacturing for the 21st Century, written by L. Srikanth and Michael Umble. If you haven’t read this book, I highly recommend that you get a copy and do so!

The figure and table below are added for reference:

Assume that the financial data for the product are as follows:

·      Selling price per unit         =       $100

·      Material cost per unit        =       $ 20

·      Direct labor cost per hour  =       $ 10

Bottleneck and Non-Bottleneck Marginal Values

Consider the effect of gaining or losing an hour at any of the non-bottleneck resources (R1, R2, R4, R5, and R5). Gaining an hour of productive time at any of these resources only adds to the extra capacity of these resources and will not result in a gain in throughput since resource R3 can still only produce 200 units per week. Losing an hour at any one of these resources only means that they will have less extra capacity which will have no effect on their ability to produce 200 units per week. The bottom line is that the marginal value of the non-bottleneck resources is zero, no matter whether the capacity is increased or decreased. Let’s now consider the impact of losing or gaining an hour of bottleneck time.

If, somehow, an extra hour of bottleneck time can be achieved, then an additional five units can be produced (i.e. 60 minutes ÷ 12 minutes per unit per hour = 5 units) so that the total throughput is now 205 units for the week. As a result of these additional 5 units, then sales revenue will increase by $500 (5 units x $ = $500). The only additional costs would be the material costs for the 5 units which is $20 per unit or $100. Therefore, the total additional throughput for the week would be $400 (i.e. $500 - $100 = $400). On the other hand, if an hour of productive capacity on the bottleneck operation is lost at the bottleneck (resource R3), then production will decrease by 5 units per week and the net profit will decrease by $400. The conclusion is, the marginal value of one hour at the bottleneck (resource R3) is $400.

Our conclusion from this example is that improvements which result in more output at non-bottlenecks have little value or impact on the bottom line. In fact, when a bottleneck is present, the non-bottleneck resources contribute no value to the bottom line except as it relates to reduce inventory or operating expenses. On the other hand, if bottlenecks exist, then the gain for the company when these resources are improved can be very significant. The implication here is that all priority improvement efforts should be focused on the bottleneck resources.

Next Time

In my next post, we will begin a new series of posts on the types of different constraints that can exist within many different companies. As always, if you have any questions or comments about any of my posts, leave me a message and I will respond.

Until next time.

Bob Sproull

References:

[1] L. Srikanth and Michael Umble, Synchronous Management – Profit-Based Manufacturing for the 21st Century, Volume One – 1997, The Spectrum Publishing Company, Wallingford, CT