* This example has been adapted from the book "The Haystack Syndrome - Sifting Information out of the Data Ocean", by Eliyahu M. Goldratt.

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Suppose you have the following company which produces two products; product P and product Q.

Suppose, also, that the times in minutes per unit indicated in the following diagram represent your resource utilisation to manufacture each of those two products.

You have four workstations; A, B, C and D. You use three different raw materials, RM1, RM2 and RM3, with RM2 being common to both products P and Q. Also you purchase one outsourced part which is used to make product P at workstation D. The cost of raw materials and products from your vendors is indicated in dollars per unit.

Now, let's say the selling price of P is $90 per unit and the selling price for Q is a little bit more at $100 per unit.

On top of all this, we happen to know that the market demands 100 units per week of product P and 50 units per week of product Q. You can sell every product you manufacture up to these amounts but additional units made will just sit on the shelf in your finished goods store.  

Now, let's assume the plant runs 5 days a week, 8 hours a day, 60 minutes an hour with no downtime to simplify the case.This gives a total available production time of 2400 minutes per week.

As a final assumption we'll say that the plant has an operating expense of $6000 per week. Operating expense includes all worker and manager salaries, rents, utiltities and so on and pretty much everything with the exception of the truly variable costs which, in this case, are only our purchased raw materials and parts. Truly variable costs would increase if we made extra products - hence it is the raw material costs. These are purchased and allocated as Inventory. Our worker salaries don't increase as we are paying them anyway (in fact we pay the workers and managers anyway whether they are making our products or playing cards in the lunch room and hence they are just a part of our constant operating expense).

We have all the data. It is all accurate and we know everything precisely. And so the question is....

What is the maximum net profit this company is capable of earning per week?

If you answered $1500 you have probably found the problem to be very straightforward. You have been very systematic in your analysis. And you are very wrong.

Here's a hint: it is incorrect to assume the company has infinite capacity. It does not! This is the key to the correct solution. You can ignore the constraints in your own business (and wonder why you never achieve the performance you thought you should) but your constraints will never ignore you!

If you answered -$300 (i.e. a loss of $300) you are also wrong.

The correct answer is a profit of $300.

(P.S. If you don't know why $300 is the correct answer you will make less money from this business than you should and, in all probability, you are not making as much money as you could in your own business because the cost accounting principles you are using are the same as you used here).

Okay, what about this question...

Which product, P or Q, is the most profitable?

If you get this answer wrong you might have a real problem as you could be directing your marketing and sales teams to sell the least profitable products in your own business right now! 

Here's another hint: Product Q is NOT the right answer!

This is a simple example but it is NOT a "trick of the numbers". This demonstrates the fundamentally flawed assumptions intrinsic to cost accounting principles used all around the world for the past century or so. If you make the wrong assumptions you will come to the wrong decisions. That's just logic and reality. Pure and simple.

Understanding the logical solution to this problem is key to understanding the power of Theory of Constraints and how it will help you make more money, now and in the future.

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