Constraints Case Study

Problem Statement

In 1991, recessions marked the lowering of the market price near to or lower than product cost and it was increasingly difficult for Lehigh for selling at premium prices. Cost of production remaining the same with decline in the price and volume lead to lowering of profits. This meant that Lehigh was flush with inventories and cost. In an initial attempt to reduce the inventory cost the management decided to use the pull based marketing concept which proved to be a failure as it was difficult to eliminate the steps in production and changeover.

Later in 1992, the market recovered resulting in increased demand. But even with the increase in demand the company was not able to realize the profits. To overcome this situation

ABC does not take into consideration how smoothly material flowed through the plant and product profitability should reflect this kind of difference in resource consumption.

Therefore, ABC method is not recommended.

Refer Appendix 1 for calculation of Activity Based Costing calculations based on Exhibit 4, 5 and 6.

3.Theory of Constraints:

TOC proposed a simple operational measure to carry out the decision-making process - Throughput. Generally it is calculated as sales less direct variable cost and more commonly as sales less material cost which is comparable to contribution margin. According to this method profits can be increased by maximizing throughput per unit of the constrained resource. As already mentioned, the rolling process (CRM) is the bottleneck of the plant. This approach considers that the efficient management of the constrained resource is the most important factor to increase profitability. According to this approach, high speeds and alloys were the products that showed higher “contribution margins”: $25.00 and $17.70 per minute of rolling machine (constrained resource)