Managing Bottlenecks in Business to increase profitability

A Simple Example

Consider the example of a clinic providing screening and diagnostics for detection of breast cancer. In this simplified healthcare model, the following assumptions were identified:

• The clinic operates for 184 hours per month.
• The clinic has an unlimited number of patients.
• Mammography costs $220 per hour for labor and film, $0.80 per visit for supplies, and has $130 per month in fixed costs.
• The clinic offers two products:
  • Screening at 9 patients per hour ($80 per visit)
  • Diagnostics at 6 patients per hour ($110 per visit)
• The clinic has constraints on total sales of screenings and diagnostics.

Activity-based contribution

An analysis of the activity-based contribution yields the following results:

Activity Based Contribution

Using activity-based accounting rules, the average margin per visit for screenings and diagnostics is $54.68 and $72.42, respectively (noted in blue type). This leads management to the conclusion that to maximize profitability, the clinic should try to provide more diagnostic services and fewer screenings.

Opportunity-based contribution

However, analysis of the same data from an opportunity-based contribution yields a different result:

By taking into account the patient's per hour constraint, the clinic can improve profitability by $6.40 for each additional screening. If the clinic had increased the number of diagnostics in the manner implied by the activity-based cost analysis, it would have decreased profitability as a result of the ripple effect of constraints.

Closing Remarks

This example, while simplistic, demonstrates the impact of bottlenecks and contrasts the difference between activity-based costs and opportunity- or economic-based decision-making. By relieving the bottleneck on the minimum number of diagnostics, profits improved. The analysis of bottlenecks consistently provides opportunities with the greatest potential for increasing profitability. This example does not mean that your ABC information should be discarded, but rather that properly managing a business requires both opportunity value analysis and activity-based costing.

River Logic's Enterprise Optimizer® offers both opportunity value analysis and activity-based costing. It's “opportunity values” help to decide what to do in order to maximize profits. EO’s activity-based costing helps with pricing products and services to ensure each product is profitable. Click here to learn more about EO.