ABSTRACT:

The purpose of this paper is to develop and demonstrate an outsourcing model in which constraint resource prevents the throughput of the organization. The paper proposes an integrated model by combining the productivity criterion, the theory-of-constraints (TOC) and linear programming (LP) into a single evaluation model in a multi-product constraint resource environment. A case study is presented to demonstrate the effectiveness of this model. The decision model compares three alternatives: standard cost accounting, standard TOC and our own solution, which is an approach that combines TOC, LP, and the productivity criterion. The numerical results show that this model is superior and more realistically optimizes resource allocation and measures the performance of the model. This research is limited to the production processes that do not have multiple constraints. This is the first time that the integrated model comprising of Productivity -TOC-LP model has been used to maximize the product throughput. Instead of calculating $ return per constraint minute, this method decides the priority of product and resource centre that maximizes the product throughput in the constraint resource environment. It makes a significant contribution to the manufacturing organization where one can compare the financial performance of the organization by selecting the right decision model.

INTRODUCTION:
The decision to outsource production is the outcome of constraint resource analysis. Such situations are characterized by market demand in excess of a companys production capacity. This article analyzes a scenario in which market demand exceeds a companys capacity to manufacture. The decision maker needs to decide how much is to be manufactured and how much is to be bought from external contractors. This section presents a brief review of the modelling in the cost accounting literature. Since different models provide radically different answers to the outsourcing problem, we compare four alternatives: standard cost accounting, standard theory-of-constraints (TOC) (Goldratt, 1988; Fox, 1988; Ronen and Starr, 1990), linear programming and our Productivity-TOC-LP model. The present study outlines an integrated model combining the Productivity criterion, TOC, and the LP technique. The Productivity criterion is best suited for giving priorities to each product of the product-mix problem for manufacturing cost analysis. The degree of relative importance for technical requirements is computed with the Productivity criterion. Integrating Productivity criterion with TOC determines the optimum profit. Literature survey of the various methods reveals the following drawbacks: i) Standard cost accounting does not consider constraint resources. ii) Standard TOCs considers constraint resources but it does not provide optimal solution. This study analyzes the case in which demand exceeds a companys capacity to manufacture and applies the Productivity procedure to the analysis of constraint resources. This evaluation technique requires input parameters, like raw material cost, hourly rate, selling price, demand, working time, and so on. The following section presents, the proposed methodology, the model formulation and a case study that uses a combined Productivity -TOC-LP model. The last section compares between three alternatives: standard cost accounting, standard TOC (Goldratt, 1988; Fox, 1988 and our integrated Productivity -TOC-LP

model. The result obtained clearly shows that our integrated model gives the best result.

LITERATURE REVIEW:
Many researchers explained the difficulties of standard accounting procedure (Johnson, 1991; Mehra et al., 2005). One research stream stressed throughput accounting (Goldratt, 1988; Dugdale and Jones, 1996; Srikant and Robertson, 1995; Srikant and Umble, 1997). Another research stream worked on TOC with traditional cost accounting and activity-based cost management (Kee, 1995; Baxendale and Gupta, 1998). Another group of researchers (Spencer and Cox, 1995) focused on software optimized production technology. Luebbe and Finch (1992) conclude that a TOC-based approach is superior to the LP approach. On the other hand, Balkrishnan and Cheng (2000), using a small modification to the data of Luebbe and Finch (1992) explain that the LP approach is superior to a TOC-based approach when dealing with several binding constraints. Lee and Plenert (1993) analyze a slightly modified form of product mix decision, in which the launch of a product under one binding constraint is analyzed. Plenert (1992) found that when multiple constraint resources exist, LP is a better planning tool than TOC. Posnack (1994) criticized Lee and Plenert. He argued that without having integer solution, TOC heuristics solution would be optimal. Among the new management philosophies established in recent decades, the TOC, developed by Goldratt at the beginning of 1980s, plays a vital role. Its main purpose is to identify, analyze, and eliminate those constraints that restrict a firms value adding process (Goldratt and Fox, 1986). As a tool for product mix decision, the approach based on TOC (Lockmy and Cox, 1994) is often used alternatively (or parallel) to optimiza-tion tools, such as the contribution margin (CM) per constraint unit method or LP approaches. The present work explains how the authors were able to determine the product throughput of a manufacturing firm using a combined Productivity- TOC-LP model and discusses the justification of the proposed model. Much research has been done on outsourcing problems. But no researcher has studied the performance aspect of the Productivity -TOC-LP model. While analyzing constraint resources, researchers mostly considered three decision models: standard cost accounting, standard TOCs, and LP as base model. Ray et al. (2007a, b) compared these three models with LP enhancement of goal programming technique and AHP-TOC-LP model. They have described the latter as the optimum model for outsourcing. Soren et al. (2005) assessed quality of the TOC-based approach which generates good or even optimal solutions with different results particularly when compared with other product mix decision tools. Low (1992), Luebbe and Finch (1992), Patterson (1992), Boyd and Cox (2002), and Mabin and Davies (2003) show by means of numerical results from situations with one constraint that the TOC-based approach leads to an optimal solution. Umble et al. (2006) criticized the traditional cost accounting and stressed the throughput accounting. Sarkar et al. (1998, 2001) suggested combining LP with the TOC concept. A.Ray et al. (2008) compared Standard accounting, standard TOC, LP and there proposed Hurwicz-TOC-LP model. They have described the latter as the optimum model for outsourcing.

NOTATIONS:

Let us introduce the following items:

i j aij bj Ri Di Pi Ci OE i

Product Index Resource Index number of minutes required by resource j to process product i resource js capacity (in min) raw material cost demand market price contractors price operating expenses productivity of product i

PROPOSED METHODOLOGY:
The following methodology has been developedStep1: The priority of each product is calculated using Productivity Analysis. Step1.1: Here first the input cost (in terms of $) and output (profit in $) received are evaluated for each product. Step1.2: Productivity of each product is calculated which is the ratio of output (profit) to input cost for each product. Step1.3: The product which gives the highest value for productivity is of top priority. Step1.4: The priorities of other products are according to the decreasing order of productivity. Step2: According to priority we allocate the resource centres to the raw materials. Step3: According to TOC we will check whether bottlenecks capacity is exhausted or there is insufficient capacity remaining to produce another unit of product.

Step4: If answer to the step 3 is Yes then satisfy the following LP functioni

(Pi-Ri ) + (Di-Xi)(Pi-Ci ) Xi bj , i= 1,....,N, j=1,.....,M

ij

Xi D i
And compare the results with other models.

MODEL FORMULATION:
Management aims to maximize its product throughput from manufactured quantity and from outsourced quantity. The product throughput from manufacturing one unit of product i is defined as the difference between market price and the cost of raw materials, or Pi Ri. Production of Xi units of product i generates a total product throughput of Xi(Pi Ri). To satisfy market demand the company orders a quantity of (Di Xi) from outside contractors, generating a product throughput of (Pi Ci) per contracted unit, accounting for a total product throughput of (Di Xi)(Pi Ci) for product i, units contracted outside. Thus total profit from product i is equal to Xi (Pi-Ri) + (Di-Xi) (Pi-Ci). Profits from all M products equal to
i

(Pi-Ri) +(Di-Xi)(Pi-Ci)]- O.E

Where OE denotes the companys operating expenses. The product mix problem should satisfy the following standard LP format: Max Subject to
ij i

(Pi-Ri)+(Di-Xi)(Pi-Ci)] - O.E

Xi Di, i {1,..., N} product demand constraint bj , j {1,....,M} manufacturing resource constraint.

A CASE STUDY:
A south-east Asia-based manufacturing firm produces three products P, Q, and R using three resources R1, R2, R3 (Table I). Due to its limited resources the company wants to outsource some production to a subcontractor. The available facility is five days a week for one shift consisting of eight hours per day. So the total working minutes available are 5 x 8 x 60 = 2400 min. The flow layout (Figure 1) of the product processing describes each of the three products

incorporating two of four raw materials 1, 2, 3, and 4. The cost of each raw material is $20. The market price of the products P, Q, and R are $130, $150, and $190, respectively. The customer demand is 100 units of each one of the three products. Contractors selling price to the company for P, Q, and R are $66, $68, and $98, respectively. These prices include the cost of raw materials.

Resources

Min/Weeks

R1 R2 R3

2 12 4 18

4 12 10 26

13 17 10 40

1900 4100 2400

Utilization Ratio, Demand/24 00 79.16% 170.83% 100%

Table 1: Resources per product in minute

Figure1: Resource time per product in minutes

STANDARD ACCOUNTING:
Standard accounting procedure decides those products that are more profitable per production time unit. To calculate the cost of each product the companys operating expenses $6,000 are divided by the number of resources and the maximum time limit per week. Thus the cost per minute of work for any resource is equal to $6,000/3/2,400=$0.83.The cost of each product is the sum of its raw material cost and total minutes of work for all three resources multiplied by the companys cost per minute ($0.83). The CM per product is the difference between the selling price and the cost. Product profit per minute is determined by dividing the product profit by total minutes of work as follows : $4.17 for P, $3.40 for Q and $2.92 for R. P is the most preferred product to manufacture since its contribution per work minute is the highest, followed by Q, making R the least preferred to manufacture. Hence the constraint resource B will manufacture 100 units of product P and 100 units of product Q, but due to unavailability of time, will not manufacture any units of product R. The throughput of each manufactured product is the difference between product selling price and raw material cost. The calculated throughput is multiplied by the number of units manufactured. The throughput of each contracted unit is calculated as its selling price less the price paid to the contractor. Finally, total product throughput (Table II) is the sum of manufactured throughput and contracted throughput. Product Total work min/product Product cost: time + raw material Product selling price Product profit Product profit/ min Demand Units to manufacture P 18 $54.94 $130 $75.06 $4.17 100 100 Q 26 $61.58 $150 $88.42 $3.4 100 100 R 40 $73.2 $190 $116.8 $2.92 100 0

Units to contractor Throughput/manufactured unit Throughput/ contracted unit Total product throughput Total facility throughput Operating expenses Net profit

0 $90 $64 $9000

0 $110 $82 $11000 $29200 $6000 $23200

100 $150 $92 $9200

Table II: Standard accounting analysis.

STANDARD TOC
TOC decides product throughput per unit of working time at the bottleneck. We divide the throughput by the bottleneck resource R2s time. Product Q has the highest throughput per constraint minutes, that is, $9.16 per constraint minute, and is therefore the first preference to manufacture. Hence, we manufacture 100 units. Product R with a throughput per constraint minute ratio of $8.82 per constraint minute is next (Table III). Due to R2s constrained capacity we only manufacture 70 units and outsource 30 units. Product Ps throughput per constraint minute ratio is the lowest, i.e. $7.50 per constraint minute, and since no more manufacturing capacity is available we outsource the full 100 units.

Components Selling price per units Raw material cost per unit Product Throughput Constraint resource R2 min Throughput/constraint R2 min Demands in units Units to Manufacture Units to Contractor

P $130 $40 $90 12 $90/12 = $7.5/min 100 0 100 $150 $40 $110 12

Q $190 $40 $150 17

$110/12 = $9.16/min 100 100 0

$150/17 = $8.82/min 100 70 30

Throughput / manufactured units Throughput / Contracted units Product throughput for manufactured units Throughput for contracted units Total product Throughput Total facility Throughput Operating Expenses Net Profit

$90 $64 0 $6400 $6400

$110 $82 $11000 0 $11000 $30660 $6000 $24660

$150 $92 $10500 $2760 $13260

Table III: Standard TOCs.

PROPOSED METHODOLOGY VALIDATION:

Step1: The priority of each product is calculated using Productivity Analysis. Step1.1: Here first the input cost and output received are evaluated for each product. Step 1.11: The input cost for each product will include cost of raw materials used and operating expenses (which will depend on the operating time of each product). To calculate the operating cost of each product the companys operating expenses $6,000 are divided by the number of resources and the maximum time limit per week. Thus the cost per minute of work for any resource is equal to $6,000/3/2,400=$0.83. The input cost of each product is the sum of its raw material cost and total minutes of work for all three resources multiplied by the companys cost per minute ($0.83). Step 1.12: The net output from each product is the difference of the selling price and the input cost (which will include the raw material cost and operational expenses as discussed in the earlier step). Step1.2: Productivity of each product is calculated which is the ratio of output value to input value for each product. Productivity of a product is given by the formula:

The productivity for P, Q and R after calculation is found to be1.36, 1.43 and 1.59 respectively.

Step1.3: As the productivity of R is largest so product R is of top priority followed by Q and P respectively. Step2: According to priority we allocate the resource centres to the raw materials based on bottleneck capacity of the resource centres. As in Table 1 we can see that resource R2 consumes maximum time out of the three resources, therefore considering R2 as the bottleneck resources we have allocated the products for manufacturing as shown in Table III.

Produc t accordi ng to priorit y

Market Deman d

R Q P

Time Produc Used Left time require ed time in in d per Quanti bottlene bottlenec unit ty ck k product resourc Resource for e centre centre,R resourc R2(in 2 (in e centre minutes minutes) R2 ) 100 17 100 1700 700 100 12 58 696 4 100 12 0 0 4 Table III: Used and Left time for bottleneck resource R2

Step3: According to TOC we will check whether bottlenecks capacity is exhausted or there is insufficient capacity remaining to produce another unit of product. There are 2400 minutes available for resource R2. Producing 100 R will leave 700 minutes for rest of the units as shown in Table III. Producing 58 units of Q will consume 696 minutes leaving 4 minutes. Now 4 minutes is not enough for producing any units of Q or P, so the remaining units will be outsourced. This method calculates the net profit to be of $25224, which is better than standard accounting and traditional TOCs. Net profit is calculated by subtracting operating expenses from the sum of the facility throughput, which is shown in Table IV.

Products Selling price per unit Raw material cost per product Operating expenses per unit product Total input cost per unit product Total profit(output) per unit product Productivity, P

P $130 $40 $0.83X18 =14.94 $54.94 $75.06 1.36

Q $150 $40 $0.83X26 =21.58 $61.58 $88.42 1.43

R $190 $40 $0.83X40 = 33.2 $73.2 $116.8 1.59

Demand, Di Units to manufacture Units to contractor Throughput/Manufactured units Throughput/ Contracted units Total facility throughput Operating expenses Net profit

100 0 0 $90 $64 $6400

100 0 58 $110 $82 $9824 $6000 $25224

100 100 100 $150 $92 $15000

Table IV: Productivity TOC LP analysis. Step 4: The solution satisfies the following LP function: max z = 90 X 0 + 64 X 100 + 110 X 58 + 82 X 42 + 150x100 + 92 X 0 - 6000 s.t. 4 X 0 + 2 X 58 + 13 X 100 2400 12 X 0 + 12 X 58 + 17 X 100 2400 4 X 0 + 10 X 58 + 10 X 100 2400 0 + 100 100 58 + 42 100 100 + 0 100 0, 58, 100, 100, 42, 0 0 The net profit is obtained by subtracting the plants operating expenses from the total throughput. In house throughput for product R= 100 X $150 = $15,000. The throughput for product Q (in house)= 58 X$110=$6,380 and P=0, respectively. Contracted throughput for product Q=42X$82=$3,444, R=0, and P=100X$64 = $6,400. The plants operating expenses = $6,000. Therefore, the total net profit=$25,224.

CONCLUSION AND DISCUSION:

Various methods have been proposed to deal with outsourcing problems. An efficient assessment system is essential for selecting the appropriate model. This paper started by describing the cause of the outsourcing problem, formulated it as a LP problem, developed a satisfying function, and offered a simplified criterion for the ordering products in terms of preference to manufacturing and preference to outsourcing. A real life production outsourcing problem is solved by combined Productivity-TOC-LP analysis. The result is compared (Table VI) with standard accounting, TOC, and LP model. Out of these four models, standard accounting is inferior as it does not consider constraint resource separately; rather it considers all resources as equal. TOC considers constraints resource, but, this model does not provide the optimal solution. On the other hand, the proposed model, Components P- manufactured Standard Accounting 100 TOC 0 Our Model 0

Q-manufactured R- Manufactured P-outsourced quantity Q-outsourced quantity R-outsourced quantity Net profit

100 0 0 0 100 $23200

100 70 100 0 30 $24660

58 100 100 42 0 $25224

Table VI: Summary of three methodologies. Considers priority of each product in terms of throughput to input cost ratio. Therefore, priority of product and resource centre is important as it justifies the product throughput of the organization and measures the performance of the system by optimizing in-house quantity with maximum throughput. The Productivity criterion is used to assess the performance of each product, and the result shows that constraint resource centre R2 has the maximum processing time (as shown in Table I). In spite of its similarity to the outcome of the LP solution, the proposed model is better than the LP model. The proposed methodology described here has been analyzed and indicates several advantages: (1) The Productivity criterion decides the priority of each product based on Output to input ratio. (2) This integrated model is well suited to deal with the throughput analysis that involves quantitative factors. (3) The degree of importance for each of the products determines the profit obtained from the product mix. (4) Rigorous and mathematical expressions of LP problems can be eliminated to a large extent. Some weakness of our proposed method might be: (1) It is difficult to change the traditional cost accounting system. (2) It would take time to implement the approach. It is very clear that the integrated model can be widely applied in industry and will be of immense practical value. In comparison with standard cost accounting and standard TOCs this integrated model is applicable and more effective.