process selection: volume drives costs and profits cob 300c busing

Process Selection: Volume Drives Process Selection: Volume Drives Costs and ProfitsCosts and Profits

COB 300CCOB 300C

BusingBusing

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

Product Design, Process Selection, and Capacity Decisions

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) (Xp)

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

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

$9,0201,000

Volume Drives Costs (Slide 3 of 3)

Power of Volume toReduce Costs

Volume Manual Automatic

$/unit $/unit

1,000 $2.80 $9.02

10,000 1.90 .92

100,000 1.81 .11

Finding the Pointof 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

$18 $2

10 units 100 units

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

Scale Factor: Cost-VolumeProfit Model (Slide 1 of 3)

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

Scale Factor: Cost-VolumeProfit Model (Slide 2 of 3)

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)

Scale Factor: Cost-VolumeProfit 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)

Cost-Volume-Profit Model

Assumptions of theCost-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

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

Multiple-Product Case (Slide 1 of 3)

WC M SP VCi i ii

n

( )

1

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

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

.45 .2 .35

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

Cost Structure of Low-Volume Producer

Cost Structure ofHigh-Volume Producer

Operating Leverage

Matching Process Alternatives with Product Characteristics

Characteristics of theProcess Alternatives

Process Flows Before and After Applying Group Technology (Slide 1 of 2)

Process Flows Before and After Process Flows Before and After Applying Group Technology Applying Group Technology (Slide 2 of 2)(Slide 2 of 2)

Automation Systems

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

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

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