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Process Selection: Volume Drives Costs and Profits

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Title: Process Selection: Volume Drives Costs and Profits


1
CHAPTER 8

Process Selection Volume Drives Costs and
Profits
2
Learning Objectives
  • Describe how Process Selection relates to Product
    Design and Capacity.
  • Understand the Scale Factor.
  • Explain The Focused Factory.
  • Define Mass Customization.
  • Explain the role of Computers in the Production
    Process.

3
How Process Selection relates to Product Design
and Capacity
  • Process Selection
  • Relating Process Selection to Product Design
  • Process Selection and Capacity
  • Building Volume through Global Expansion

4
Process Selection
  • Process selection includes
  • Technical issuesbasic technology used to produce
    a service or good
  • Volume or scale decisionusing the proper amount
    of mechanization to leverage the organizations
    work force

5
Product Design, Process Selection, and Capacity
Decisions
6
Relating Process Selection to Product Design
  • Teamwork Concept
  • Service Organizations
  • Manufacturing Firms

7
Process Selection and Capacity
  • 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
    18.00/hr 10 units/hr
  • Automatic 9,000
    2/hr 100units/hr
  • The total-cost equation is as follows
  • TC FC (VC) (Xp)

8
Process Selection and Capacity
  • Comparing Costs
  • 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
9
Process Selection and Capacity
Comparing Costs Automatic TC 9,000
(1,000 units) 9,020 Unit
Cost 9.02
per unit at volume 1,000
2/hr
10 units/hr
9,020
1,000
10
Process Selection and Capacity
What happens if 10,000 books need to be
bound? Manual TC 1,000
(10,000) 19,000 Unit cost
1.90 per unit at volume of
1,000
11
Process Selection and Capacity
  • What happens if 10,000 books need to be bound?
  • Automatic
  • TC 9,000 (10,000)
  • 9,200
  • Unit cost
  • 0.92 per unit at volume of 1,000

2
100
9,200
10,000
12
Process Selection and Capacity
  • 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)
  • 1,000 1.80(X) 9,000
    .02(X)
  • Solve for X
  • (1.8 - .02) (X) 9,000 - 1,000

  • X 8,000 / 1.78

  • X 4,494 units

2
18
100 units
10 units
13
Process Selection and Capacity
  • The Power of Volume to Reduce Costs
  • Volume Manual
    Automatic
  • /unit
    /unit
  • 1,000 2.80
    9.02
  • 10,000 1.90
    0.92
  • 100,000 1.81
    0.11

14
Building Volume Through Global Expansion
  • If volume is an important factor in lowering the
    costs of goods and services, having a business
    expand globally can enhance its ability to
    compete.
  • With a lower price, it may be possible to capture
    more of the market.
  • The volume gained by a company in one country is
    lost by a company in another country.

15
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.

16
Understanding the Scale Factor
  • Modeling the Scale Factor
  • Process Selection and Economics of Scale and
    Scope
  • Ethical Issues in Process Selection

17
Modeling the Scale FactorCost-Volume-Profit
Model
  • C-V-P Model Formulation
  • C-V-P Model Assumptions
  • Multiple-Product Case
  • C-V-P Model and Operating Leverage

18
C-V-P Model Formulation
  • TR (SP) (Xs)
  • TR Total Revenue
  • SP Selling price/unit
  • Xs Number of units sold
  • TC FC (VC) (Xp)
  • TC Total cost
  • FC Fixed cost
  • VC Variable cost/unit
  • Xp Number of units produced

19
C-V-P Model Formulation
The profit (P) equation is
P TR -TC P
SP(Xs) - FC VC(Xp) If X Xs Xp, then
P SP(X) - FC VC(X)
P SP(X) - VC(X) - FC
P FC (SP - VC)(X)
20
C-V-P Model Formulation

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)
(P FC)
C
21
Example of C-V-P Model
  • SP8.00/unit
  • VC4.50/unit
  • C3.50/unit
  • FC25,000/month
  • P8,000/month
  • X
  • 9,429 units/month

22
Example of C-V-P (Cost-Volume-Profit) Model
23
Example of C-V-P model
  • Managers can use this number in many ways, such
    as
  • Sensitivity Analysis
  • Answering What-if Questions
  • For example, What if the variable costs increased
    from 4.5 to 5.00 per unit?
  • X
    11,000 units/month

25,000/month8,000/ month
3.00/unit
24
C-V-P Model Assumptions
  • 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.

25
Multiple-Product Case
  • Hint Fixed cost shared by all 3 products.
  • Coffee Pot
    Mixer Blender
  • Product mix 45
    20 35
  • Selling price/unit 12
    16 9
  • Variable cost/unit 6
    7 4
  • Contribution unit 6
    9 5
  • 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

26
Multiple-Product Case
  • 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
27
Multiple-Product Case
  • Interpreting the results The variable X is
    measured as a composite unit, that is, a unit
    consisting of 45 printer, 20 typewriter and 35
    keyboard.
  • One composite unit
  • .45
    .2 .35
  • Coffee Pot
    Mixer Blender
  • Product Mix
    No. Required
  • Coffee Pot .45
    3,600 units
  • Mixer .20
    1,600
  • Blender .35
    2,800

  • 8,000 units

28
Multiple-Product Case
  • What Happens to the Profit Point if the Mix
    Changes?
  • Mix change to 50 coffee pots, 10 mixers,40
    blenders, how is profit affected?
  • Coffee Pot
    Mixer Blender
  • Product mix 50
    10 40
  • Selling price/unit 12
    16 9
  • Variable cost/unit 6
    7 4
  • Contribution unit 6
    9 5
  • Profit target unknown.
  • Fixed cost 30,000/yr.

29
Multiple-Product Case
  • X
  • WC(X)PFC PWX(X)-FC
  • WC.5(12/unit).1(16/unit-7/unit).4(9/unit-4
    /unit)5.90unit
  • P5.90(8000units)-30,00017,200

30
C-V-P Model and Operating Leverage
  • Low-Volume Option
  • High-Volume Option
  • Moving from Low-Volume Option to High-Volume
    Option

31
Low-Volume Option
Cost Structure of Low-Volume Producer
32
High-Volume Option
Cost Structure of High-Volume Producer
33
Moving from Low-Volume Option to High-Volume
Option
Operating Leverage
34
Process Selection and Economics of Scale and Scope
  • Line Flow Processes
  • Mass Production and Quality
  • Batch Flow
  • Manufacturing Cells and Flexible Manufacturing
    Systems
  • Applying Manufacturing Cells to Service
    Operations
  • Job shop
  • Project

35
Matching Process Alternatives with Product
Characteristics
36
Line Flow Processes
  • Continuous flow operations
  • Assembly lines

37
Characteristics of theProcess Alternatives
38
Mass Production and Quality
  • Mass production of goods and services does not
    necessarily imply inferior quality.
  • It is the pressure on price that forces cost to
    be reduced.

39
Batch Flow
  • When quantities are not sufficient to support
    dedicated production facilities, several groups
    or batches are produced using the same facility.
  • One or a few product flows dominate because of
    the similar processing requirements in batch
    operations.
  • When production becomes less of a line flow
    process and more of a batch process, management
    problems become more difficult.

40
Manufacturing Cells and Flexible Manufacturing
Systems
  • The process options that offer potential to
    produce low-cost product that meet varying
    customer requirement include
  • Manufacturing Cells
  • FMS Flexible Manufacturing System

41
Process Flows Before and After Applying Group
Technology
42
Process Flows Before and After Applying Group
Technology
43
Applying Manufacturing Cells to Service
Operations
  • The basic ideas of Manufacturing Cells and FMS
    can be applied to any service operation.
  • The ideas include
  • To group products into one or more families that
    have similar processing requirement.
  • Arrange equipment in close proximity that can
    meet those processing requirements.

44
Job Shop
Automation Systems
45
Project
  • Projects usually involve a one-of-a-kind product.
  • Product flow is not meaningful in projects.
  • Projects are common in service operations.

46
Ethical Issues in Process Selection
  • Many people believed that reduce automation can
    reduce unemployment.
  • But, the most effective way to increase the
    standard of living is to select the process that
    best fits the volume, cost and quality
    characteristics of the product.

47
Problems with Managing Large, Unfocused Operations
  • 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.

48
Problems with Managing Large, Unfocused Operations
  • 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.

49
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

50
Mass Customization
  • Types of Customization
  • Containing the Cost-Side of Mass Customization
  • A learning Organization the foundation of mass
    customization

51
Types of Customization
  • Customer-contact Customization
  • Adaptive Customization
  • Presentation Customization

52
Containing the Cost-Side of Mass Customization
  • Each level of process has different factors to
    consider in achieving customization.
  • Presentation customization is the simplest.
    Product design and process design are standard so
    flexibility is not required in these activities.
  • Adaptive customization takes the cost issues
    one-step further because the production of the
    finished product can be customized.
  • Customer-contact customization requires the
    customer and the company to interact to produce
    precisely what customers want.

53
Keys to Cost Containment
  • Adaptive customization and presentation
    customization allow the base product to be
    undifferentiated.
  • Modular product design facilitates economies of
    scale in design.
  • Modular process design allows firms to put
    processes together in different ways to make
    different products.
  • Postponement permits firms to delay product
    differentiation until the latest possible moment.
  • Flexibility in product design and production
    systems allows the firm to meet changing customer
    needs.
  • Information system planning and technology
    enables data, information, ideas, and decisions
    to be shared instantly among participant that
    need that information.

54
A Learning Organization The Foundation of Mass
Customization
  • Prior Relevant Knowledge
  • Communication Network
  • Communication Climate
  • Knowledge scanning

55
The Role of Computers In The Production Process
  • Robots
  • CAD
  • CAM
  • Computer-Integrated-Manufacturing
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