1. The Theory of Scarcity Constraints
Enterprises often face resource shortages that prevent them from meeting full market demand. These shortages are called limiting factors or operational constraints (e.g., raw material shortages, direct labor hour deficits, or limited machine capacity).
2. Maximizing Profit per Unit of Scarcity
When a constraint exists, maximizing net profit does not mean focusing on the product with the highest selling price or the highest contribution margin per unit. Instead, management must maximize the contribution margin per unit of the limiting factor.
3. Optimization Step Protocol
- Calculate the standard contribution margin per unit for each product line.
- Identify the exact amount of the scarce resource required to build one unit of each product.
- Calculate the optimization index:
“𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐩𝐞𝐫 𝐔𝐧𝐢𝐭 𝐨𝐟 𝐋𝐢𝐦𝐢𝐭𝐢𝐧𝐠 𝐅𝐚𝐜𝐭𝐨𝐫” = “𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐦𝐚𝐫𝐠𝐢𝐧 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭”/”𝐒𝐜𝐚𝐫𝐜𝐞 𝐫𝐞𝐬𝐨𝐮𝐫𝐜𝐞 𝐫𝐞𝐪𝐮𝐢𝐫𝐞𝐦𝐞𝐧𝐭 𝐩𝐞𝐫 𝐮𝐧𝐢𝐭” - Rank the products based on this index (highest value is Priority 1).
- Allocate the scarce resource to satisfy full market demand for Priority 1 first, then use any remaining resource capacity for Priority 2, and so on, until the resource is fully consumed.