Process Selection: Volume Drives Costs and Profits COB 300C Busing

Process Selection Process selection includes: –Technical issues–basic technology used to produce a service or good –Volume or scale decision–using the proper amount of mechanization to leverage the organization’s work force MECHANIZATION Work Force Transparency 8.1

Product Design, Process Selection, and Capacity Decisions Transparency 8.2(Exhibit 8.1)

Volume Drives Costs (Slide 1 of 3) Quick-as-a-Blink Printing Center needs to invest in equipment to bind books. Management could purchase manual or automatic binding equipment. Annual Variable Fixed Labor Production Machine Cost Cost Rate Manual $1,000 $18/hr 10 units/hr Automatic $9,000 $2/hr 100units/hr The total-cost equation is as follows: TC = FC + (VC) (X p ) Transparency 8.3a

Volume Drives Costs (Slide 2 of 3) Manual: TC= $1,000+ (1,000 units) = 2,800 Unit Cost= = $2.80 per unit at volume 1,000 $18/hr 10 units/hr $2,800 1,000 Transparency 8.3b

Automatic: TC = $9,000+ (1,000 units) =$9,020 Unit cost = = $9.02 per unit at volume of 1,000 $2/hr 100 units/hr $9,020 1,000 Volume Drives Costs (Slide 3 of 3) Transparency 8.3c

Power of Volume to Reduce Costs Volume Manual Automatic $/unit $/unit 1,000 $2.80 $ , , Transparency 8.3d

Finding the Point of Indifference At what production volume are the costs of the manual and the automatic binding equipment equal? Total cost manual = Total cost automatic $1,000 + ? (X) = $9,000 + ? (X) 1, (X)= 9, (X) Solve for X: ( ) (X) = 9, ,000 X = 8,000 / 1.78 X = 4,494 units $18$2 10 units100 units Transparency 8.4

Understanding the Scale Factor Economies of scale doctrine –most efficient size for a facility –most efficient size for a firm –Put a large volume of the same product across the same equipment or fixed cost base. Economies of scope occurs when a large volume and high variety of products are produced by the same equipment for fixed cost base Transparency 8.5

Scale Factor: Cost-Volume Profit Model (Slide 1 of 3) TR= (SP) (X s ) TR = Total Revenue SP = Selling price/unit X s = Number of units sold TC = FC + (VC) (X p ) TC = Total cost FC = Fixed cost VC = Variable cost/unit X p = Number of units produced Transparency 8.6a

Scale Factor: Cost-Volume Profit Model (Slide 2 of 3) The profit (P) equation is P = TR -TC P = SP(X s ) - {FC + VC(X p )} If X= X s = X p, then P = SP(X) - {FC + VC(X)} P = SP(X)- VC(X) - FC P + FC = (SP - VC)(X) Transparency 8.6b

Scale Factor: Cost-Volume Profit Model (Slide 3 of 3) Solve for X as follows: X = If C is defined as contribution/unit, then C = (SP - VC). Then the equation becomes X= (P + FC) (SP - VC) C (P + FC) Transparency 8.6c

Cost-Volume-Profit Model Transparency 8.7(Exhibit 8.2)

Assumptions of the Cost-Volume-Profit Model Sales volume is equal to production volume Total cost and total revenue are linear functions of volume Historical data on costs and selling price are representative of what will happen in the future The organization has only one product Transparency 8.8

Hint: Fixed cost shared by all 3 products. Coffee Pot Mixer Blender Product mix 45% 20% 35% Selling price/unit Variable cost/unit Contribution unit Profit target = $20,000/yr. Fixed cost = $30,000/yr. WC =.45($12/unit - $6/unit) +.2($16/unit - $7/unit) +.35($9/unit -$4/unit) = $6.25 unit Multiple-Product Case (Slide 1 of 3) Transparency 8.9a

Multiple-Product Case (Slide 2 of 3) In the multiple-product case, the weighted contribution per unit substitutes for the contribution per unit. X= = $20,000 + $30,000 $6.25/unit = 8,000 units P + FC WC Transparency 8.9b

Multiple-Product Case (Slide 3 of 3) Interpreting the results: The variable X is measured as a composite unit, that is, a unit consisting of 45% coffee pot, 20% mixer and 35% blender. One composite unit Coffee Pot Mixer Blender Product Mix No. Required Coffee Pot.45 3,600 units Mixer.20 1,600 units Blender.35 2,800 units 8,000 units Transparency 8.9c

Cost Structure of Low-Volume Producer Transparency 8.10(Exhibit 8.3)

Cost Structure of High-Volume Producer Transparency 8.11(Exhibit 8.4)

Operating Leverage Transparency 8.12(Exhibit 8.5)

Matching Process Alternatives with Product Characteristics Transparency 8.13(Exhibit 8.6)

Characteristics of the Process Alternatives Transparency 8.14(Exhibit 8.7)

Process Flows Before and After Applying Group Technology (Slide 1 of 2) Transparency 8.15a(Exhibit 8.8)

Process Flows Before and After Applying Group Technology (Slide 2 of 2) Transparency 8.15b(Exhibit 8.8)

Automation Systems Transparency 8.16(Exhibit 8.9)

Problems with Managing Large, Unfocused Operations (Slide 1 of 2) Growing facilities add more levels of management and make coordination and control difficult New products are added to the facility as customers demand greater product variety Hidden overhead costs increase as managers add staff to deal with increased complexity Transparency 8.17a

Problems with Managing Large, Unfocused Operations (Slide 2 of 2) The result is higher operating costs –Productive time is being taken to do setups –More mistakes are made by attempting to manage increasing complexity with control systems designed for a single product facility Transparency 8.17b

Focused Factory Smaller facility (less than 500 employees) concentrates on one or few products Limits scope of operations to a few process technologies Strives only for highest level of quality Strives for simplicity in management and control Transparency 8.18