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

Chapter 4 and 5 Estimating and Reducing Costs  Cost Structure  Reducing Labor Costs  Workload Balancing  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 資產報酬率  Return on Assets = Return/Total Assets  Return On Invested Capital = Return/Invested Capital 資本報酬率 3 1

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. 4 The Role of Labor Costs in Manufacturing 100% Other Overhead 90% Warranty 80% Quality 70% Labor costs 60% 50% Parts and Parts and material material 40% costs costs Logistics costs 30% 20% Material costs 10% 0% Final Including Including Rolled ‐ up Assembler’s Tier 1 Tier 2 Costs over cost Costs Costs ~ 5 Tiers 5 2

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. 6 Financial Structure of 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. 7 3

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 8 Building an ROIC Tree Return Return Revenue    ROIC Invested Capital Revenue Invested Capital 獲利率 資本週轉率 Throughput Revenue Price Return Revenue Direct Cost 獲利率 Total Cost Indirect Cost ROIC Throughput 資本週轉率 Revenue Revenue Price Invested Cap. Invested Cap. 9 4

The Drivers of Process Capacity Number of workers Available Hours Hours worked per year per worker Process  Capacity Actual production time ≈ Throughput activity time Wait time Hours per + piece + Time needed before production time Set ‐ up time 10 ROIC Tree for Direct Costs Number of workers Available Hours Hours worked per Direct year per worker Labor Kg per piece Hourly wage rate Direct + Wood per + Costs piece Material cost Scrap loss per piece Direct Price of wood Materials Throughput 11 5

Expanded ROIC Tree Number of workers Price Demand Available Revenue Hours worked per Hours year per worker Process Throughput Capacity Actual production time Hours per (activity time) piece Wait Return Marketing Time needed before time Revenue Management production time Set ‐ up Indirect Finishing / QA time Costs Depreciation Number of workers Rent Available Total Hours worked per Hours ROIC Cost Direct year per worker Labor Hourly Direct wage rate Price of wood Cost Material cost Kg per Direct per piece Revenue Wood per piece Material piece Revenue Throughput Invested Cap. Scrap loss Invested Cap. 12 ROIC Tree for Invested Capital 不動產與設備 PP&E Raw Materials Inventory + Invested + WIP Capital Throughput + Total $ spent on wood Working Pre ‐ Material costs Capital Payments Time of pre ‐ payment + Revenues Unearned % Down ‐ payment Revenue Time of down ‐ payment 13 6

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. 14 Analyzing an Scooter Assembly Process 15 7

Initial Process Flow Components Finished Xootrs Activity 1 Activity 3 Activity 2 13 minutes 11 minutes 8 minutes Process Capacity of System 1 = one unit every 13 min. = 4.6 scooters/hour = 161 scooters/week 16 Labor Content and Idle Time  Assume the current demand is 125 units per week.  The process operates 35 hours per week. 17 8

Estimating Labor Costs Labor content = sum of activity times with direct labor = 32 min / unit labor content Average labor utilization= = 63.4%  labor content direct idle time Total wages per time unit $1260/week  Cost of direct labor = Flow Rate per time unit 125 units/week = $10.08 / unit 18 Line Balancing Reduces Imbalances 19 9

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 20 What If the Demand Increases to 200/week?  System 1 becomes capacity ‐ constrained flow rate = 161 units/week $1260/week cost of direct labor = = $7.83 per unit 161 units/week  System 2 is also capacity ‐ constrained . flow rate = 164 units/week $1260/week cost of direct labor = = $7.68 per unit 164 units/week 21 10

1 30 1 30 1 30 1 30 2 25 2 25 2 25 2 25 3 100 3 100 3 100 3 100 4 66 4 66 4 66 4 66 5 114 5 114 5 114 5 114 674 623 674 6 49 6 49 6 49 6 49 792 7 66 7 66 7 66 7 66 8 100 8 100 8 100 8 100 9 30 9 30 9 30 9 30 10 43 10 43 10 43 10 43 11 51 11 51 11 51 11 51 12 118 12 118 12 118 12 118 13 110 13 110 13 110 13 110 14 59 14 59 14 59 14 59 15 33 15 33 15 33 15 33 635 602 766 16 96 16 96 16 96 16 96 648 17 135 17 135 17 135 17 135 18 84 18 84 18 84 18 84 19 56 19 56 19 56 19 56 20 75 20 75 20 75 20 75 21 95 21 95 21 95 21 95 22 20 22 20 22 20 22 20 23 43 23 43 23 43 23 43 665 450 450 581 24 114 24 114 24 114 24 114 25 94 25 94 25 94 25 94 26 84 26 84 26 84 26 84 22 Performance of the Balanced Process  Process Capacity = 189 units/week  Average labor utilization 1890  94.7% =   1890 42 63  cost of direct labor $1260/week  $6.65/unit = 189 units/week 23 11

Scale Up to Higher Volume  Demand reaches 700 units/week 24 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   12 35 $ 12  Cost of direct labor = $ 7 . 2 /unit 700 25 12

1 30 Job Specialization 2 25 3 100 4 66 5 114 3. one line, 12 workers 6 49 7 66 The last step is the bottleneck 8 100 9 30  Capacity=700 units/week 10 43 11 51 12 118 13 110 Why does capacity decrease? 14 59 15 33 16 96 17 135 18 84 Answer: Since moving a task to the next 19 56 worker becomes more significant, the 20 75 21 95 process is less balanced. 22 20 23 43 24 114 25 94 178 26 84 26 Reverse the Trend of Specialization  Having one worker perform all assembly tasks Capacity=66 units/week  Only need 11 workers  726 units/week   11 35 $ 12   Cost of direct labor= $ 6 . 6 /unit 700 27 13

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. 28 14