Organizational Performance Part 55: Understanding Effective Use of Resources | Operational Excellence Quick Hits

Speaker 1: (00:06)
In today’s session we’re going to continue on the mindset change necessary to get breakthrough improvement. In today’s session we’re going to talk about the effect of using less effective resources. When I go into companies what they try to do is they try to rollout all products across the most effective resources. And if we have resources that are less effective, then they’re not typically used to help improve flow through the organization.

Speaker 1: (00:35)
What is a less efficient resource? It’s defined as a resource that has a slower cycle time, or maybe one that has a high changeover time. So, let’s go into an example to understand the effect of using less effective resources. If you’re familiar with the PQ exercise in theory constraints, there’s two products, product P and product Q that go through different resources with different cycle times. There’s three components, raw material one, raw material two that’s common to both products, and raw material three. Each one has a different demand and a different selling price.

Speaker 1: (01:13)
If you take these two products and you go through a cost accounting example by looking at material, labor and overhead, and you come up with a total cost and you look at the selling price and you calculate a margin, you see that Product Q have a margin of 40.4 and Product P has a margin of 9.1. when we take that data and we run it through a capacity analysis, so we determine what quantity we could produce of each unit, what we find is there’s enough capacity to product all of Product Q, which is the preferred product, and only 60 of Product P. And when you run that through a P&L statement, what you find is you end up with a $300 loss. So we have a huge direct labor variance of $583.33.

Speaker 1: (02:03)
What happens if we could train other resources that have extra capacity to help Resource B, which happens to be the constraint resource for Product Q? And if we cross-train those resources C and D, which have extra capacity, to do B’s work, and they produce that product at twice the cycle time, so instead of 30 minutes to produce Product Q it takes them 60 minutes. What happens if we do this? What’s the impact on Q’s margin? And what’s the impact on the company profitability?

Speaker 1: (02:39)
If I go through and I calculate the margin on Product Q by taking less effective resources that are twice as slow and cross-train them to do B’s work, what happens is my material stays the same, my direct labor goes up by an additional 24 minutes. So that’s 74 minutes. So the total direct labor cost at $10 an hour is $12.33. When we allocate the overhead, that goes to $33.91, total cost goes to $86.24. Then we calculate the margin at $15.9.

Speaker 1: (03:17)
So, what we see is that the margin goes down for Product Q. What that allows us to do is to produce all of P and all of Q at the resources we have, and the margin for Q goes down from $40.4 to $15.9. and when we run the P&L, we end up with a $1,500 profit. So, how is that possible? By reducing the margin by 24.5 points, yet we increased profit by 500%. So what we’re doing is we’re better utilizing our resources to use that excess capacity to make a product that will go out the door and not to build excess inventory or create over production.

Speaker 1: (04:02)
So when we look at using less effective resources in constraint areas, what will happen? One, for sure costs won’t increase. Two, we’ll increase throughput of the entire system. And three, that will improve profitability. But what happens if we use less efficient resource on a non-constraint? So we want to do that in a couple of cases. One, it’s also not going to increase costs because their direct labor is our direct labor. And we’re going to protect the system from starvation. So if we have a scenario where we’re going to starve the constraint, we want to use less efficient resources on non-constraints to make sure that we protect the constraint from starvation.

Speaker 1: (04:44)
That’s our session for today, understand the effect of less effective resources. If we use them wisely, even though their cycle time might be slower, or their setup time might be higher, we’re not going to increase costs of the system because we don’t allocate costs to the product. We’re looking at total cost to operate the system. We’re going to increase the throughput and improve profitability.

Speaker 1: (05:11)
Next week’s session we’re going to talk about the last three sessions, which is work changeover, smaller batches, less efficient resources, and how doing those, most people believe that’s going to increase the cost and reduce the profitability of the company. So we’re going to go through a scenario of looking at profitability when we look at doing more changeovers, smaller batches, using less efficient resources.