Production Choice under a Capacity Constraint

Mack DasMesser, CEO of Lloydian Outpatient Surgical, is reviewing the financial results from the most recent fiscal year, trying to decide the profit-maximizing way to use the limited capacity of Lloydians surgical facilities. Lloydian currently performs three surgical procedures. DasMesser is wondering whether he should change the number of procedures performed, or even drop one procedure altogether. Results from 2009 were:

2009 PROFIT STATEMENT	Proc I	Proc II	Proc III	Total
Contribution margin	764	1,625	924	3,313
Less: procedure-specific fixed costs	131	483	311	925
Contribution toward corporate fixed costs	633	1,142	613	2,388
Less: allocation of corporate fixed costs	658	868	552	2,078
Pre-tax profit	(25)	274	61	310
Pre-tax profit per procedure	(0.78)	2.25	2.18

The accounting department had provided additional information:

2009 CAPACITY DATA	Proc I	Proc II	Proc III	Total
Number of procedures performed	32	122	28
Operating room hours per procedure	3	2	5
Total operating room hours used	96	244	140	480
Maximum demand for procedure	40	150	36

The procedures required different lengths of time in the operating rooms. Lloydians annual capacity of operating room hours is 480. This capacity was completely used in 2009.

Based on this information, Mack decided to:

Drop Proc I.

Increase the number of Proc IIs to 150.

Increase the number of Proc IIIs to 36.

His reasoning was as follows. Lloydian was losing 0.78 for every Proc I performed. It was not a difficult decision to discontinue performing this service. The only question was how to allocate Lloydians 480 operating room hours to the other two Procs. This, too, was an easy decision because servicing the maximum demand for Proc II and Proc III required exactly 480 operating room hours, Lloydians maximum capacity: 150 x 2 + 36 x 5 = 480.

Assuming no projected changes in fixed cost amounts, DasMesser estimated the impact on profits to be:

2009 pre-tax profit	310
+ elimination of loss from Proc I	25
+ profit from extra Proc IIs (150 122) x 2.25	63
+ profit from extra Proc IIIs (36 28) x 2.18	17
------------------------------------------------------- Projected 2010 pre-tax profit	415

Questions (Requirement):

a. What other considerations might factor into your decision regarding the allocation of the scarce resource of operating room hours?

b. In what sense is breakeven analysis relevant here?

c. What is surprising about your final recommendation?

d. What actions might you consider to further improve the financial success of Lloydian?

e. Summarize the sequence of logic that you would apply in a future similar situation.