Chapter 4 and 5 Estimating and Reducing Costs Cost Structure - - PDF document

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Chapter 4 and 5 Estimating and Reducing Costs

 Cost Structure  Reducing Labor Costs  Workload Balancing 3

 Operations Cost = Fixed Cost + Variable Cost

= Administrative Costs + Depreciation and Interest + Production Cost + Inventory and Transportation Cost + …

 Operations Cost = Direct Cost + Indirect Cost

= Direct Materials Cost + Direct Labor Cost + Overhead and Utilities Cost + …

 Return (Net Income) = Sales – Operations Cost – Taxes  Return on Assets = Return/Total Assets  Return On Invested Capital = Return/Invested Capital

資產報酬率 資本報酬率

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Reducing Waste to Improve Cost Performance

 Reducing cost is easier than increasing revenue.  Excess capacity is waste.  Reducing excess capacity at some process steps

can improve efficiency and reduce cost.

 Moving excess capacity to rescue the bottleneck

can increase the overall process capacity.

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The Role of Labor Costs in Manufacturing

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0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Final Assembler’s cost Including Tier 1 Costs Including Tier 2 Costs Rolled‐up Costs over ~ 5 Tiers

Parts and material costs Parts and material costs

Material costs Logistics costs

Labor costs

Quality Warranty Overhead Other

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Paul Downs started making furniture in 1986, in a small shop in Manayunk. Over the years we have outgrown 4 other shops and we now operate a 20,000 square feet shop in Bridgeport, PA. Much of our work is residential, but we also do a lot of office furniture, including desks and conference tables. We complete 125 commissions per year, consisting of about 500 separate pieces of furniture.

Financial Structure of

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Production facility Machines valued about $450k, depreciation $80k p.a. Overall facility is utilized at 100% right now Show rooms and factory: $150k for rent Indirect costs: $100k marketing, $180k management, $60k finish Inventory: $50,000 WIP and $20,000 raw material Suppliers need to be paid 1 month before receiving the wood.

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Work Force (fixed cost, direct cost) 12 cabinet makers, $20 per hour (220 days @8h/day) Labor utilization around 90% (idle time resulting from waiting) Spend 15% of time on set‐ups (build fixtures, program machines) Actual labor content is about 40 hours per unit of furniture End Product Average price is $3000 per unit Requires 30kg of wood (costs about $10 per kg) plus 25% scrap Customer pays 50% down and gets her furniture 3 months later

Building an ROIC Tree

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ROIC Return Revenue Revenue Invested Cap. Direct Cost Indirect Cost Price Throughput Invested Cap. Revenue Revenue Total Cost Price Throughput

獲利率 資本週轉率

Capital Invested Revenue Revenue Return Capital Invested Return ROIC   

獲利率 資本週轉率

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The Drivers of Process Capacity

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Process Capacity Available Hours Hours per piece Number of workers Hours worked per year per worker Actual production time activity time Time needed before production time Set‐up time Wait time +  +

≈ Throughput

ROIC Tree for Direct Costs

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Direct Costs Direct Labor Number of workers Hours worked per year per worker Available Hours Hourly wage rate Direct Materials + + Kg per piece Scrap loss Price of wood Wood per piece Throughput Material cost per piece

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Expanded ROIC Tree

12 Indirect Costs Direct Labor Number of workers Hours worked per year per worker Rent Depreciation Available Hours Hourly wage rate Management Finishing / QA Marketing

ROIC

Return Revenue Revenue Invested Cap. Price Direct Cost Revenue Invested Cap. Price of wood Wood per piece Kg per piece Scrap loss Throughput Process Capacity Available Hours Hours per piece Number of workers Hours worked per year per worker Actual production time (activity time) Time needed before production time Set‐up time Wait time Demand Direct Material Material cost per piece Throughput Revenue Total Cost

ROIC Tree for Invested Capital

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Invested Capital PP&E Working Capital Inventory Unearned Revenue % Down‐payment Revenues Raw Materials WIP Time of down‐payment Pre‐ Payments Total $ spent

• n wood

Time of pre‐payment Throughput Material costs + + + + 不動產與設備

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Valuing Operational Improvements

How to improve ROIC?

 Cut wages  Simplify the design to reduce the production time  Reduce scrap loss  Reduce setup times  New payment terms with the supplier or the landlord

Assume there are plenty of demands. A good approach is to produce more with a fixed workforce.

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Analyzing an Scooter Assembly Process

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Initial Process Flow

16 Activity 1 Activity 2 Activity 3

Components Finished Xootrs

13 minutes 11 minutes 8 minutes

Process Capacity of System 1 = one unit every 13 min. = 4.6 scooters/hour = 161 scooters/week

Labor Content and Idle Time

 Assume the current demand is 125 units per week.  The process operates 35 hours per week. 17

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Estimating Labor Costs

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time idle direct content labor content labor  Average labor utilization= = 63.4% units/week 125 $1260/week unit time per Rate Flow unit time per wages Total  Cost of direct labor = = $10.08 / unit Labor content = sum of activity times with direct labor = 32 min / unit

Line Balancing Reduces Imbalances

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Recalculating Capacity and Labor Costs

System 2 worker 1 792‐118=674 sec. worker 2 648+118=766 sec. worker 3 450 sec.

 Capacity = 164 units/week  Flow rate = min{ demand, process capacity }=125/week  Labor costs will not change if the process is demand

constrained

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What If the Demand Increases to 200/week?

 System 1 becomes capacity‐constrained

flow rate = 161 units/week cost of direct labor = = $7.83 per unit units/week 161 $1260/week

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units/week 164 $1260/week

 System 2 is also capacity‐constrained.

flow rate = 164 units/week cost of direct labor = = $7.68 per unit

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1 30 2 25 3 100 4 66 5 114 6 49 7 66 8 100 9 30 10 43 11 51 12 118 13 110 14 59 15 33 16 96 17 135 18 84 19 56 20 75 21 95 22 20 23 43 24 114 25 94 26 84

792 450 648

1 30 2 25 3 100 4 66 5 114 6 49 7 66 8 100 9 30 10 43 11 51 12 118 13 110 14 59 15 33 16 96 17 135 18 84 19 56 20 75 21 95 22 20 23 43 24 114 25 94 26 84

674 450 766

1 30 2 25 3 100 4 66 5 114 6 49 7 66 8 100 9 30 10 43 11 51 12 118 13 110 14 59 15 33 16 96 17 135 18 84 19 56 20 75 21 95 22 20 23 43 24 114 25 94 26 84

674 581 635

1 30 2 25 3 100 4 66 5 114 6 49 7 66 8 100 9 30 10 43 11 51 12 118 13 110 14 59 15 33 16 96 17 135 18 84 19 56 20 75 21 95 22 20 23 43 24 114 25 94 26 84

623 665 602

Performance of the Balanced Process

 Process Capacity

= 189 units/week

 Average labor utilization

=

 cost of direct labor

=

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94.7% 63 42 1890 1890    $6.65/unit units/week 189 $1260/week 

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Scale Up to Higher Volume

 Demand reaches 700 units/week

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Replicating the Line or Adding Workers

• 1. Four identical lines.

Total capacity = 1894=756 units/week

• 2. One line with 4 workers at each step.

Total capacity is also 756 units/week Cost of direct labor =

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/unit 2 . 7 $ 700 12 $ 35 12   

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Job Specialization

• 3. one line, 12 workers

The last step is the bottleneck  Capacity=700 units/week Why does capacity decrease?

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1 30 2 25 3 100 4 66 5 114 6 49 7 66 8 100 9 30 10 43 11 51 12 118 13 110 14 59 15 33 16 96 17 135 18 84 19 56 20 75 21 95 22 20 23 43 24 114 25 94 26 84

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Answer: Since moving a task to the next worker becomes more significant, the process is less balanced.

Reverse the Trend of Specialization

 Having one worker perform all assembly tasks

Capacity=66 units/week

 Only need 11 workers  726 units/week  Cost of direct labor=

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/unit 6 . 6 $ 700 12 $ 35 11   

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Summary

 Labor costs may be very significant for high contact services.  Labor costs are under the managerial control, while other

costs are either fixed or dictated by the market.

 Job Design and work balancing eliminates idle time and

increase capacity and/or labor utilization.

 Proper job motivation is as important as reducing labor

costs.

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