Can You Maximise this Business’s Profit and ROI?

I wrote about this business a while ago and asked the above question. I got NO answers.

Recapitulation: All the letters are big businesses. Together they are part of a much bigger business. Each of the squares is a profit centre. The lower squares sell to the top. All sell to external markets. Transfer prices are negotiated and based on market prices.

Financial analysis shows businesses at the top have significantly lower margins compared to those at the bottom.

Prices at the top are higher than at the bottom of the diagram. The product “T” has the lowest margin of all (margins are often negative). The same product also has the highest prices.

The constraint is within the bottom pale green square. If you believe in the Theory of Constraints, you want to maximise the constraint’s financial Throughput.

The profit centres fight for enough products to satisfy their demand. They solve the problem of who should get how much for their sales by ranking businesses by the margins earned.

It is easy to imagine that products at the bottom get what they want while those at the top (particularly the “T” product) are starved. The lack of products to sell damages their margins further.

The business inside the red square did not make much money at all. Reported profits at the bottom were mostly wiped out by losses at the top.

What would happen if the corporation reversed its policy? They give the highest price products that the markets demand and starve the low-price products. What must happen?

Will the system’s profit increase or decrease?

Sales will increase

Materials cost will remain the same …

… whatever constraint can produce. Since more of the top products will be produced there will likely be some additional yield or scrap losses. (Are they so big they will negate the increase in sales?)

Operating expenses (cost) stay constant.

If sales increase and all expenses remain constant profit must increase!

A lowly and very shy but intelligent bookkeeper discovered this. He tried several times but was unable to convince the managers of this business. The business continued to be less than exciting. Eventually, it was sold. I don’t know how well the new management is doing.

How would you have managed such an agglomeration of businesses?

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