The Value of Identifying Bottlenecks

It's not news that when you have a bottleneck in your process you have a problem, backlogs build up, sales don't go out on time, customers get frustrated and cash flow starts to suffer. Identifying your bottlenecks and understanding the value of them then is important, so why don't more people pay attention to them? Moreover why isn't more time & money spent in fixing them? Could it be that your valuing them in the wrong way?  Let us apply a bit of Theory of Constraints thinking.

What is a Bottleneck?

A quick reminder on the basics of a bottleneck, a bottleneck is anything that limits the flow of product in the system. For example, in the flow below machine 3 is the bottleneck, it produces less than the other machines.

 If you think about the example above and run it forward for say 10 hours in your head here is what happens:

• Machine 1 produces 50 units which move to Machine 2
  
• Machine 2 produces 50 units which move to Machine 3
  
• Machine 3 eventually ships 40 units which you can sell
  

That leaves 10 units sitting in front of Machine 3 waiting to be produced. At a rate of 4 per hour Machine 3 will need another 2.5hrs of work to clear the backlog in the cue. Therefore Machine 3 is obviously the bottleneck in this system (note that we are assuming 100% quality to keep things simple). Obviously, none of the WIP in front of Machine 3 can be sold in it's current form. 

Perceived Value of a Bottleneck

Most companies look at Machine 3 and say well, it costs us $250 per hour to run that machine (this is machine rates/labour rates/overheads etc). So if the additional time to run it is 2.5hrs then the additional 'cost' of the bottleneck is 2.5 x $250 which is $625, that's what I have available to spend to improve it. But that's wrong!

You may also look and say OK well we have $150 of material in each unit that is now tied up in WIP so that's 10 x $150 so that's another $1500 to play with. Nope, still wrong, incidentally this is actually the value of your inventory you are talking about here as Work In Process is Inventory. 

The Value of Your WIP / Inventory

As we mentioned before your Work In Progress is actually Inventory, it just happens to be sitting in front of a machine & not on a stock shelf, it is still tying up cash from a sale so ultimately it is worth what a sale is. Let us assume that, for ease of the numbers a finished unit sells for $1000. The value of the excess inventory that is sitting in front of Machine 3 then is not $1500 it is $10,000. (10 units at $1000 per unit sales value)

The True Value of Your Bottleneck

Based on our previous assumption that each unit you fully manufacture has a sell price of $1000. Every unit that your bottleneck stops you progressing to a sale is clearly a lost sale, so you have lost $1000 for every unit in the system not sold.

The value of an hour of your machine then must be equal to the value of the sale that you can achieve, so a lost hour is equal to the value of the sales that you lost. So, in this case, an hour of the machine is actually equal to $4000 since it can produce 4 units per hour.

So the extra 2.5hrs is worth $10,000 to you not $625 since every additional unit that your bottleneck produces will give you $1000.

But what if the bottleneck was machine 2?

Well the value of the bottleneck each hour is still $10,000 so Machine 2's hrly value just went up, but guess what, the value of the next machine, Machine 3, is also $10,000 because although it could produce more it can only produce what it is given which is 4, so if you lose time here it is the same as losing it at the bottleneck.

So the question becomes, how much are you willing to invest to realise the increase in sales? It is after all your bottleneck that is constraining your sales, shouldn't you spend some money to realise those lost sales?