BUS 644 Week 4 Discussion 1 & 2 plus Week 4 Assignment

7

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Facility Location and Process Selection

Learning Objec�ves A�er comple�ng this chapter, you should be able to:

Discuss loca�on as a strategic decision. Discuss the quan�ta�ve and qualita�ve factors influencing loca�on decisions. Integrate qualita�ve and quan�ta�ve factors to make effec�ve loca�on decisions. Describe how loca�on influences other opera�ng decisions. Describe the process selec�on decision and how it is influenced by the volume of product demanded. Define the different process types: line flow, batch flow, flexible manufacturing system, manufacturing cell, job shop, and project. Construct a cost-volume-profit model of a firm, and understand how to use the model to manage the firm. Calculate the break-even point for cases involving both single- and mul�ple-product breakeven.

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Fast-food restaurants, hotels, hospitals, and gas sta�ons are o�en located on heavily traveled roadways in order to provide customer convenience and accessibility.

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7.1 Facility Location

The previous chapters in this book have provided an understanding of what opera�ons are, why they are important, how they can be used to create compe��ve advantage, how they impact key business elements such as cost and quality, and how they relate to suppliers. This chapter provides some organiza�onal context for the study of opera�ons.

The purpose of an organiza�on is to manufacture a good or provide a service, and opera�ons play a key role. This begins with designing the produc�on system, which includes:

1. Designing a product, which was discussed in an earlier chapter 2. Determining where and how the product will be created (loca�on and process) 3. Se�ng the capacity of the organiza�on

There are other decisions involved in designing the system that produces these goods and services, such as how to lay out and organize the facility and design the individual jobs that employees must perform. However, these topics are beyond the scope of this text.

Facility loca�on is the placement of a facility with regard to a company's customers, suppliers, and other facili�es with which the company interacts. The loca�on decision usually commits substan�al resources and cannot be easily changed. Many of the principles and techniques used in loca�ng a facility are the same whether an organiza�on is selling fried chicken or groceries, provides fire protec�on or health services, stores electronic parts or food, or makes computer chips or paper. Managers making the decision should consider the costs of opera�ng at a par�cular loca�on, including costs to acquire the land and build the facility, as well as costs for labor, taxes, and u�li�es. They should consider the convenience of a par�cular loca�on for customers as well as the cost to transport materials to the facility and move finished product from the facility. Managers should also consider access to banking, educa�onal, and other ac�vi�es that are important to the success of their organiza�on. Thus, many factors, both quan�ta�ve and qualita�ve, influence the loca�on decision. Quan�ta�ve factors are easily measurable, while qualita�ve factors are more subjec�ve.

What o�en differs from one industry to another are the weights assigned to these various factors. The size of the weight assigned to a factor indicates its importance. For example, a primary factor in loca�ng a fire sta�on is its response �me to the buildings within that fire district. Thus, response �me should be assigned a large weight. When loca�ng a restaurant, easy customer accessibility may be more important than the cost to transport raw material (food and beverages) to the facility. An organiza�on producing solar cells may feel that it is very important to locate in an area close to a university or research park that specializes in key technology. Organiza�ons that produce plywood, dimensional lumber, or paper need a readily available supply of wood, so they usually locate near �mber resources. Managers of labor-intensive opera�ons may feel that low labor cost is the cri�cal factor that determines the loca�on of their facility.

Location as a Strategic Decision

The loca�on decision usually involves commitment of a large capital investment that cannot be moved. As a result, loca�on should be viewed as a long-term, strategic decision because it will have a major impact on the organiza�on's ability to compete. The loca�on decision should not be based solely on marke�ng issues, produc�on factors, or transporta�on costs. Successful managers integrate the relevant factors and weigh them appropriately in order to make the best long-term decision for the organiza�on.

This long-term commitment should fit with the organiza�on's overall strategy. In some cases, organiza�ons develop marke�ng and opera�ng strategies that have an impact on the loca�on decision. A regional facility strategy requires that each produc�on facility has a defined marke�ng area and each facility produces a complete line of products for that area. This is o�en done when customer convenience and access are important, or when outbound transporta�on costs are very high. Fast-food restaurants, instant oil change opera�ons, hospitals, and branch banks are examples of opera�ons located to provide maximum customer convenience and access. Many customer-oriented service opera�ons are located in this way. Bo�le making, corrugated box produc�on, and aluminum can making opera�ons are examples of facili�es that are located by region to keep outbound transporta�on costs low. These finished products have high shipping costs because they occupy a lot of space—shipping a can to the beverage company means shipping a lot of empty space. When these low-value finished products are shipped long distances, transporta�on costs increase the cost of the product, making the company less price compe��ve.

A product facility strategy means that one facility is responsible for producing one product or product line and shipping that product throughout the country and the world. This approach is appropriate when the produc�on process is complex and hard to control, such as making ceramic heat shields for spacecra�. It can be used when a firm does not want to duplicate expensive equipment, facili�es, and highly

trained personnel. This approach is also popular when there are advantages to specializa�on and economies of scale, and when transporta�on costs are not prohibi�ve. The produc�on of igniters for jet aircra� engines, for example, would benefit from a product facility strategy. This item is small, so shipping costs are low. An igniter is high in value, so shipping cost, as a percent of purchase price, is also small.

Manufacturing Location Factors

There are differences in the loca�on decision for manufacturers and service providers. Manufacturing firms consider a variety of factors.

Quan�ta�ve factors for manufacturers include:

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Material costs Transporta�on U�li�es, taxes, real estate costs, and construc�on costs Government incen�ves

Qualita�ve factors include:

Labor climate Quality of life Proximity to customers and markets Proximity to suppliers and resources

Service Location Factors

In service opera�ons, many of the factors iden�fied with manufacturing are s�ll relevant. In most service opera�ons, service providers would consider labor cost, taxes, real estate costs, construc�on costs, and government incen�ves as important elements in a loca�on decision. On the other hand, material cost and transporta�on costs would be relevant for only some service providers, such as restaurants and retail opera�ons that purchase, transport, and resell goods. U�lity costs are not a significant factor for most service opera�ons because consump�on is generally low compared to manufacturing. The qualita�ve factors listed for manufacturers are likely to be relevant for service providers, with the excep�on of proximity to suppliers and resources. This is because materials and component parts are not always shipped from suppliers.

If a business has customers that u�lize a service facility in person, being close to customers is very important. For example, retail opera�ons require this proximity to the customer, but a call center can be located anywhere in the world. Customers o�en place a high value on their �me, therefore, convenience is essen�al. Transporta�on costs are important for warehousing and distribu�on, but response �me—the �me elapsed between a request for service to the delivery of that service—may be even more important. If travel distance and �me are short, total inventory in the system can be kept very low. In some cases, the trip from producers to the distribu�on center to the retail store can be one day or less.

Loca�on of compe�tors may also be an important factor for service opera�ons. In some services, such as newspaper publishing, having compe�tors in the immediate area o�en has a significant nega�ve impact on sales. In others, service providers tend to cluster together. In many cases, they adver�se together. Nearly every medium-size town and large city has an "auto mile" or "auto strip" where one of every car dealer is located. The idea of such a loca�on is to create a cri�cal mass, so customers can quickly and easily compare products from different dealers. Fast-food restaurants will o�en locate in similar clusters. These clusters are caused to some extent by the need to deal with customer choice. For example, in a large group of poten�al customers, some will want pizza, some will want burgers, and others will want chicken. Fast-food chains locate their restaurants near high-volume ac�vi�es, such as large shopping malls, sport centers, and expressway exits in large urban areas.

The loca�on of emergency units, such as fire protec�on and ambulance service, is determined by minimizing response �me, providing minimum coverage, and opera�ng from a mobile loca�on. Response is important when �me is a cri�cal factor. The objec�ve is to locate a facility so that the maximum response �me to any point served by the emergency unit is minimized.

Minimum coverage implies that all customers have a minimum level of coverage. For example, no house in the city will be more than one mile from a fire sta�on or an ambulance service. The number and placement of facili�es required to provide minimum coverage can be determined by grouping customers into appropriate popula�on centers and examining candidate facility loca�ons to see if the minimum coverage is provided. This can be accomplished by lis�ng the popula�on centers in the columns of a table and lis�ng the poten�al facility loca�ons in the rows of the same table. Then, each poten�al facility can be judged to determine if the minimum coverage is achieved. In many cases, more than one candidate facility may be required to provide that coverage.

Government Incentives

Many states and local governments have been very aggressive in their efforts to a�ract new businesses. One incen�ve offered by state and local governments is a significant reduc�on in property taxes. They have also offered low-interest loans, provided free training to workers, and subsidized wages for a specified period of �me. In addi�on, many states and ci�es have established agencies that can help private industry slice through governmental red tape. In some cases, state and local governments have put together parcels of land by using their powers of eminent domain. Simply stated, eminent domain means that an owner can be forced to sell property to the government at fair market value if it will be used for the good of all. Once obtained, proper�es are sold to private industry for development. Governments can acquire property more quickly and less expensively than private industry can. As soon as word gets out that private industry is interested in developing an area, the land prices are sure to increase significantly. With the power of eminent domain, the government can avoid being delayed by owners of key parcels.

In some cases, businesses that have been in a state for years are grumbling about the preferred treatment given to newcomers, and some states are beginning to wonder if the jobs created are worth the costs of the incen�ves. Despite this, bidding wars among states for the jobs these new developments bring are likely to con�nue. The pressure on elected officials to create jobs in the short term seems to mask the long-term impact that this treatment may have on future revenues and expenses of the state.

Highlight: Changing Loca�ons for Automo�ve Assembly

For many years, automobile assembly plants were located in the Midwest, and new facili�es were built in this region in order to provide good, low-cost access to a large percentage of the North American popula�on. As the popula�on has increased in the South and Southwest, many automobile companies—especially foreign producers—have located new assembly facili�es in the South to take advantage of lower labor costs, lower construc�on costs, cheaper land, and government incen�ves. Alabama persuaded Mercedes-Benz to build an assembly facility for making sport u�lity vehicles. Honda opened a facility in Lincoln, Alabama, that employs more than 2,000 people to make its Odyssey minivan. Toyota has constructed an engine assembly facility in Huntsville, Alabama. Hyundai Motor Company of South Korea has built a final assembly facility in the South.

These efforts have cost Alabama nearly $700 million in incen�ves. Cri�cs argue that the state has not received sufficient return on its investment. Also, these investments have taken money away from schools and services, and made it difficult for the state to provide tax relief for its low-income residents. Proponents argue that these efforts are "Alabama's new day." Other companies are inves�ga�ng the poten�al that Alabama has to offer.Processing math: 0%

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State and local governments offer incen�ves such as tax breaks, low- interest loans, and help cu�ng through red tape to a�ract and retain businesses and jobs.

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7.2 Evaluating Locations

The factors that must be weighed when evalua�ng loca�ons are grouped into three subsec�ons: (1) managing the quan�ta�ve factors, including the impact of loca�on on cost and the increasing importance of government incen�ves; (2) describing the qualita�ve factors and illustra�ng how these can be analyzed as well as integrated with the quan�ta�ve factors; and (3) discussing the effects of the loca�on decision on other opera�ng factors.

Managing Quantitative Factors

Quan�ta�ve factors include the costs associated with facility construc�on, produc�on, overhead, and transporta�on to and from the facility. State and local governments offer incen�ves to a�ract and retain businesses and jobs. Such incen�ves include tax abatement, low-interest loans, help in cu�ng through red tape, low business taxes, and low rates for unemployment insurance and worker's compensa�on. Finally, the loca�on can affect sales volume and selling price. The announcement of a new facility may ini�ate price-cu�ng or other costly product promo�on ac�vi�es by exis�ng compe�tors in the area.

Loca�on decision plays an important role in shaping the cost func�on. The total-cost equa�on is:

TC = (VC)X + FC

where

TC = total cost

VC = variable cost per unit

X = the number of units produced

FC = fixed costs

Variable costs are affected by prevailing wage rates, material costs, u�lity rates, and transporta�on costs for incoming materials and outgoing finished products. Fixed costs are affected by construc�on and land costs and the cost of administra�on, all of which are likely to be lower in rural areas. There also may be tax incen�ves or other special considera�ons for a par�cular site.

To prepare cost es�mates for a site, data are collected and analyzed. To illustrate, Table 7.1 contains data for a site in Indianapolis, Indiana, for a facility to build computer control panels. These data can be used to prepare a pro forma opera�ng budget.

Table 7.1: Data for site in Indianapolis, Indiana

Produc�on Costs

Type Rate Projected Usage

Labor Welding Electrical General assembly

$10.00/hr. $12.00/hr. $9.00/hr.

0.5 hrs./unit 0.3 hrs./unit 1.1 hrs./unit

Material Sheet metal Threaded fasteners Electrical wire

$.40/lb. $2.00/100 $.06/lineal �.

100 lbs./unit 20/unit 70 lineal �./unit

U�li�es Natural gas Electricity

$4.00/1,000 cu. �. $.06/kilowa� hr.

500 cu. �./unit 200 kilowa� hrs./unit

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Transporta�on* In rail In motor carrier In motor carrier Out motor carrier

$.03/lb. (sheet metal) $.04/lb. (fasteners) $.04/lb. (wire) $20/unit (finished)

100 lbs./unit 5 lbs./unit 4 lbs./unit 1

Facility Overhead Ini�al Investment Land acquisi�on costs Building construc�on Plan start-up costs Ini�al employee training

$2,100,000 $175,000,000

Special Considera�ons Tax abatement Low-interest loans Supplementary training expenses

$25,000,000

*Rates are given from specific origin to a specific des�na�on, so distance has been accounted for.

Table 7.1 contains projected labor, material, and u�lity usage in addi�on to the rates. U�li�es may have both fixed and variable components. Some u�lity costs are variable and directly linked to producing a product, such as the power required to run a drill press. In other cases, u�lity costs cannot be linked to a product. An example is the energy needed to heat a building. The amount of heat required is not related to the number of units produced. Table 7.1 shows variable u�lity costs. The fixed component of u�li�es is included in overhead expenses. Transporta�on costs are a func�on of the quan�ty of materials shipped, the distance traveled, and the type of carrier used.

Table 7.1 also lists as a lump sum an es�mate of facility overhead expenses, such as supervisors, material handling, and plant management staff. The value of the investments in the facility and the value of any special considera�ons are also listed as lump sums. The special considera�ons figure is shown as a savings that should be deducted from the ini�al investment.

Table 7.2 shows a pro forma opera�ng budget based on producing 45,000 units per year at the site described in Table 7.1. An opera�ng budget usually does not include capital costs for facili�es. The costs of making products at this facility can now be es�mated. Considering only the variable costs, the unit variable cost is calculated as follows:

Unit variable cost = $100.46/unit

The cost including a share of the annual facility overhead is:

Cost with overhead = $147.13/unit

*Throughout this text, to enlarge the size of the math equa�ons, please right click on the equa�on and choose "se�ngs" then "scale all math" to increase the viewing percentage.

Table 7.2: Pro forma opera�ng budget for one year based on es�mated sales of 45,000 units

Labor Welding Electric Assembly Total Labor costs

($10.00/hr.)(0.5 hrs./unit)(45,000 units) ($12.00/hr.)(0.3 hrs./unit)(45,000 units) ($9.00/hr.)(1.1 hrs./unit)(45,000 units)

$ 225,000 162,000 445,500 $ 832,500

Material Sheet metal Fasteners Wire Total material costs

($.40/lb.)(100 lbs./unit)(45,000 units) ($2.00/100)(20/unit)(45,000 units) ($.06/lin. �.)(70 lin. �./unit)(45,000 units)

$ 1,800,000 18,000 189,000 $ 2,007,000

U�li�es Natural gas Electricity Total u�lity costs

($4.00/1,000 cu. �.)(500 cu. �./unit)(45,000 units) ($.06/kwh)(200 kwh/unit)(45,000 units)

$ 90,000 540,000 $ 630,000

Transporta�on Sheet metal Fasteners Wire Finished product Total transporta�on costs

($.03/lb.)(100 lb./unit)(45,000 units) ($.04/lb.)(5 lb./unit)(45,000 units) ($.04/lb.)(4 lb./unit)(45,000 units) ($20.00/unit)(45,000)

$ 135,000 9,000 7,200 900,000 $ 1,051,200

Variable costs Facility overhead* Grand total

$ 4,520,700 2,100,000 $ 6,620,700

*Some overhead costs can be variable, but to simplify the discussion in this case, we will assume all overhead costs are fixed.

Comparing Quantitative Factors

To make effec�ve loca�on decisions, management must organize the poten�al costs and revenues for each site in a way that allows them to be easily compared. Begin by examining the cost data for the Indianapolis site (detailed in Tables 7.1 and 7.2), and for an alterna�ve site in Lexington, Kentucky. The new facility is scheduled to produce 45,000 units per year. The costs for both sites are summarized here. (The incen�ves are to be subtracted from the ini�al investment.)

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Variable Costs $100.46/unit $95.77/unit

Annual Overhead Cost $2,100,000/year $1,900,000/year

Ini�al Investment $175,000,000 $168,000,000

Incen�ves $25,000,000 $10,500,000

Several assump�ons are made including: (1) revenue is not affected by either choice; (2) sales volume per year, selling price, unit variable costs, and fixed costs do not change over the period in ques�on; and (3) the �me value of money is ignored. The �me value of money is the no�on that one dollar received today is worth more than one dollar received at some future point. One dollar received today can be invested and earn a posi�ve return, thereby making its value greater than one dollar.

Problem

Compare the costs of the Indianapolis and Lexington sites over a five-year period, using the total-cost equa�on. (The subscript I stands for Indianapolis and the subscript L for Lexington.)

TC = (VC)X + FC

TCI = ($100.46/unit)(45,000 units/year)(5 years) + ($2,100,000/year)(5 years) + $175,000,000 – $25,000,000

= $22,603,500 + $10,500,000 + $150,000,000

= $183,103,500

TCL = ($95.77/unit)(45,000 units/year)(5 years) + ($1,900,000/year)(5 years) + $168,000,000 – $10,500,000

= $21,548,250 + $9,500,000 + $157,500,000

= $188,548,250

Over a 5-year period, Indianapolis has a lower total cost.

At what point in �me will the costs of these two sites be equal? In this case, X will represent the number of years un�l costs are equal. This informa�on may be very useful for managers when choosing between the alterna�ve sites.

TCI = TCL

(100.46)(45,000)X + 2,100,000X + 175,000,000 – 25,000,000 = (95.77)(45,000)X + 1,900,000X + 168,000,000 – 10,500,000

$4,520,700X + $2,100,000X + $150,000,000 = $4,309,650X + $1,900,000X + $157,500,000

$6,620,700X – $6,209,650X = $157,500,000 – $150,000,000

$411,050X = $7,500,000

X = 18.25 years

Check the answer by subs�tu�ng the �me X into the cost equa�ons for Indianapolis and Lexington and seeing if the costs are equal.

If the amount sold per year is allowed to vary, the point of equal costs could be viewed in a different way. In the model, the number of years could be a constant, and the number of units sold per year could become a variable. If the �me period is set at five years, how many units must be sold each year if costs are equal? Here, the variable X represents the number of units sold each year.

TCI = TCL

(100.46)(X)5 + (2,100,000)5 + 175,000,000 – 25,000,000 = (95.77)(X)5 + (1,900,000)5 + 168,000,000 – 10,500,000

X = 277,186 units/year

Including Qualitative Factors

Qualita�ve factors do not usually have measurable, direct effects, but they do need to be carefully considered and integrated into the decision by management. The chapter 7 appendix contains a sample list of some of the qualita�ve factors that could be considered such as labor climate, cultural ac�vi�es, and weather.

To integrate qualita�ve factors into the loca�on decision, managers should:

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2. Weigh each of the factors—some may be more important than others 3. Evaluate each site so that ra�onal comparisons can be made

Unless a manager makes a judgment about the importance of each factor, all the factors are assumed to have equal weight. These weights are usually selected prior to determining the rankings or raw scores so that the scores do not bias the weights. The weights are mul�plied by the scores to determine the weighted scores. Then, the weighted scores are added together to determine total scores.

Problem

A commi�ee has determined that the following factors are relevant to the decision. Indianapolis and Lexington are ranked on a scale of 1 to 10, with 10 being most desirable. The rankings are subjec�ve es�mates.

Factor Weight Indianapolis Raw Score Lexington Raw Score

Recrea�onal ac�vi�es 20 8 7

University research facili�es 40 8 8

Union ac�vity 40 4 7

Banking services 80 7 6

Available labor pool 60 7 5

The rankings can eventually be added; 10 is considered "good" in all cases, but a ten may not indicate more of that factor. For example, a 10 in university research ac�vi�es is desirable and indicates high levels of research; a 10 in union ac�vity is also desirable, but may indicate low levels of union ac�vity.

Mul�ply the weight by the raw score for both Indianapolis and Lexington.

          Indianapolis           Lexington

Weight Raw Score Weighted Score Raw Score Weighted Score

Recrea�onal ac�vi�es 20 8 160 7 140

University research facili�es 40 8 320 8 320

Union ac�vi�es 40 4 160 7 280

Banking services 80 7 560 6 480

Available labor pool 60 7 420 5 300

Total 1,620 1,520

As long as the same weights are applied to each loca�on, the weighted scores are comparable. The absolute value of each score does not have meaning, but comparing total scores is useful.

If Indianapolis is superior in profit and investment, then the choice between the two loca�ons is easy because Indianapolis also has a slight qualita�ve edge. If Indianapolis is not superior in profit and investment, then management should judge the impact of these qualita�ve factors on the long-term success of the organiza�on. Even though a mathema�cal model can be used to analyze the data, the results must s�ll be interpreted and a decision made.

On-Site Versus Off-Site Expansion

Loca�on can have a significant impact on an organiza�on's ability to compete. It can influence costs, selling price, demand, educa�onal opportuni�es for employees and their families, and access to financial services. How can the loca�on decision affect other factors in produc�on?

Assume that demand for an organiza�on's product exceeds present capacity. An organiza�on can consider two op�ons to increase capacity: build addi�ons to the exis�ng plant on- site, or design and build a new plant in another loca�on. On-site expansion is more popular because it usually involves less capital investment. Many services, such as shipping, receiving, and administra�on, may not need to be expanded. Only the cri�cal opera�ons— that is, the bo�lenecks—require capacity increases.

However, on-site expansion can create many problems, especially if it is a repeated prac�ce. As more produc�on space is added, material handling and storage become more difficult because inventory space is o�en converted to produc�on. As new product varia�ons are added, the once simple product flow becomes complicated or stymied because plant addi�ons o�en occur over many years and no long-term planning for future addi�ons is made. When on-site expansion is used to increase capacity, intra-plant transporta�on and communica�on can become strained.

Staying at the same site o�en postpones the introduc�on of new product and process technologies. Old equipment and old produc�on methods are used longer than they should be. Future product innova�on, produc�vity increases, quality improvements, and cost reduc�ons can be nega�vely affected. On-site expansion can mean a growing number of workers, products, and processes that must be managed. Such layering of expanded responsibili�es creates complexi�es for managers at all levels.

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Leverage means making the workforce more produc�ve through the use of be�er tools and equipment. One worker with a few simple tools may be able to assemble an automobile, but not at a compe��ve cost.

©Monty Rakusen/Cultura/Ge�y Images

7.3 Foundations of Process Selection

Process selec�on is determining the most appropriate method of comple�ng a task. It is a series of decisions that include technical or engineering issues and volume or scale issues. The technical or engineering issues include the basic methods used to produce a service or good. For example, deciding to remove a gall bladder using laparoscopic surgery versus tradi�onal methods is a technical decision made by physicians. The decision depends on the pa�ent's condi�on and is o�en made at the �me of surgery. On the other hand, determining the number of surgery rooms and the number of surgeries to perform each day at the regional medical center is a volume or scale decision that is related to demand. In general, the technical aspects of process selec�on are beyond the scope of this course, so the focus will remain on volume or scale issues.

There is a strong rela�onship among process selec�on and three cri�cal elements in business: volume, cost, and profit. The volume or scale decision involves applying the appropriate mix of technology to leverage the organiza�on's workforce. Leverage means making a workforce more produc�ve through the use of be�er tools. For example, one person working alone with a few simple tools may be able to assemble an automobile, but he or she cannot build it at a cost that competes with organiza�ons providing their employees with sophis�cated tools and technology. The person working alone, or even with many others like him or her, cannot build enough cars to sa�sfy demand without significant automa�on and an organiza�on to leverage their �me and talent. More sophis�cated tools allow a workforce to produce more with the same commitment of �me and effort. This produc�vity improvement lowers the unit cost of the product and raises the capacity of the workforce. Similarly, a surgeon performing a surgery without the proper equipment and an effec�ve suppor�ng staff will not only be less produc�ve but could also be dangerous to the pa�ent.

This presents an interes�ng trade-off between efficiency and costs in the process selec�on decision. As more sophis�cated tools are applied to the produc�on process, produc�vity and capacity increase and labor cost per unit declines. As tools become more sophis�cated, the cost of acquiring them o�en increases, which translates into increased fixed costs.

Process Selection Relates to Product Design and Capacity

Product design, capacity, and process selec�on are decisions that should be considered simultaneously. The way the product is designed affects how many people will buy it, and that affects the producer's capacity planning decision. This, in turn, affects the process and the costs to produce the product, which affects how many people can afford to buy it. This logic can be represented as a circle with customers at the center, as illustrated in Figure 7.1.

Figure 7.1: Product design, process selec�on, and capacity decisions are closely related

Rela�ng Process Selec�on to Product Design

Decisions made when designing a product have an impact on the process for making it. For example, if a bed is made of brass, there is no need for woodworking equipment in the manufacturing process. Process selec�on and process technology, in turn, influence the product design. Electronic funds transfers, music downloads, and streaming video are examples of products that are now feasible because of improvements in informa�on and communica�on technology.

Rela�ng the design of the product to process selec�on goes beyond the examples listed in the preceding paragraph. The teamwork concept is changing how organiza�ons approach product design and process selec�on. In service organiza�ons, such as fire departments, teams of managers from various disciplines design the services, which may include fire

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preven�on programs for homes and businesses, fire safety for school-age children, and firefigh�ng. While developing a product design, the team examines various process selec�on decisions, including the types of equipment and facili�es needed, the techniques used in figh�ng fires, the methods used to develop educa�on programs, and the type and level of training needed by employees who deliver these services.

Manufacturing firms combine design engineers with process engineers (some�mes called manufacturing engineers) to create a design team. This team, like the team at the fire department, is responsible for providing what is best for the customer. Because the design engineers and the process engineers work together, the lead �me required to bring a new product from an idea to a reality is reduced. This effort, called concurrent engineering, enables the organiza�on to par�cipate in �me-based compe��on. By doing what is best for the customer, the organiza�on hopes to be rewarded with increased demand for its products and high profit margins. These teams also improve communica�on, which decreases the number of engineering change orders, avoids unnecessary delays, and gets the product to market more quickly, preven�ng mistakes that could increase costs.

Process Selec�on and Capacity

Process selec�on is also related to the volume demanded in the marketplace. If the market for the product is es�mated at only 1,000 units per year, it may be difficult to jus�fy expensive, specialized equipment that produces 100 units per hour. Such equipment would be required to operate only 10 hours each year. It is unlikely that the cost of this specialized equipment could be supported by the 1,000 units demanded unless a very high price is charged for each unit.

Problem

Quick-as-a-Blink Prin�ng Center is growing rapidly, and many of its customers are demanding that their documents be professionally bound. Management has made a decision to purchase a binding machine. The op�ons are to purchase a manual binding machine that requires con�nuous operator a�en�on or an automa�c machine that requires only periodic operator a�en�on. The following data are available for analysis. Note that the costs of materials can be ignored because we are assuming that the cost of the printed documents and the binding material are the same regardless of the machine used.

Machine Annual Fixed Costs Variable Labor Costs Produc�on Rate

Manual $1,000 $18/hour 10 units/hour

Automa�c $9,000 $2/hour 100 units/hour

The total-cost equa�on is as follows:

TC =FC + (VC)(Xp)

where

TC = total cost

FC = fixed costs

VC = variable cost per unit

Xp = number of units produced

Comparing Costs: What is the cost to produce 1,000 units per year on each machine? From the following calcula�ons, it is clear that the manual machine has lower costs. Dividing the total cost by the volume produced gives a unit cost that includes the variable cost and a share of the fixed costs.

Manual:

TC = = $2,800

Unit Cost = = $2.80 per unit at a volume of 1,000

Automa�c:

TC = = $9,020

Unit Cost = = $9.02 per unit at a volume of 1,000

What happens if 10,000 books need to be bound? The marginal labor cost of binding each addi�onal book on the automa�c machine is only $.02 because the labor cost is $2.00 per hour and the output is 100 units per hour. On the manual machine, the marginal cost of binding a book is $1.80.

Manual:

TC = = $19,000

Unit Cost = = $1.90 per unit at a volume of 10,000

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Automa�c:

TC = = $9,200

Unit Cost = = $0.92 per unit at a volume of 10,000

The unit cost for binding 10,000 books with the automa�c opera�on is significantly lower. As demand increases, the automa�c process becomes more and more appealing.

The Indifference Point: At what produc�on volume are the costs of the manual and automa�c machines equal? The variable X represents the volume produced. To check the accuracy of the following calcula�ons, subs�tute the computed value of X into the total-cost equa�on for each machine to determine if the two total costs are equal. Except for differences caused by rounding, they should be:

Total cost manual = Total cost automa�c

(1,000) + (1.80)(X) = (9,000) + (0.02)(X)

Solve for X:

(1.80 - 0.02)(X) = 9,000 - 1,000

X

X = 4,494 units

The Power of Volume to Reduce Costs: This problem illustrates how unit costs can be decreased by purchasing high-speed equipment and producing large numbers of parts. The following table lists the unit costs for various volumes. Verify the unit cost for binding 100,000 books.

Volume Manual Automa�c

1,000 $2.80 $9.02

10,000 1.90 0.92

100,000 1.81 0.11

This example makes many simplifying assump�ons, such as unlimited capacity, no increase in maintenance costs, and no increase in the failure rate of the machine as volume increases. These and other relevant factors could be es�mated and considered in the analysis. The impact of volume on unit cost is very clear based on this example.

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The economies of scale principle states that there is a most efficient size for a facility and a most efficient size for the firm.

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Shipping Goods by Container Ships: Economy of Scale; Addicted to Cheap Shopping? Why the Real

Cost of Goods Keeps Going Down

7.4 Understanding Effects of Scale

Business leaders have long recognized the advantages that can be gained by having high-volume opera�ons. The tremendous increase in prosperity in the United States and other developed countries was driven by making large quan��es of the same or similar products on the same equipment, that is, the same fixed-cost base. This approach, o�en called mass produc�on, is based on the concept of economies of scale. Recall from Chapter 3 that the economies of scale principle states that there is a most efficient size for a facility, and a most efficient size for a firm. In prac�ce, the principle has been used to jus�fy both building larger facili�es for the produc�on of goods and services and purchasing more automated equipment to speed produc�on and lower costs.

An organiza�on can use both or either of these approaches to leverage the �me and talents of the people who create the large volume of services and goods that customers demand. If organiza�ons and society are to progress, investments in equipment and facili�es (fixed costs) must be made to increase the produc�vity of labor and management.

The cri�cal challenge when achieving economies of scale is pu�ng a large volume of product across the same equipment or fixed-cost base. In the past, it was necessary that different products produced on a machine where very similar because equipment was not flexible enough to cope with design differences. With technological advances, it is possible to achieve economies of scale by making

different products on the same equipment, and this can be done without the extra costs that are incurred when equipment is stopped and changed over to make the new product. Economies of scope is the term that describes this situa�on. Economies of scope are economies of scale across products. For example, Allen-Bradley has a facility that can produce a wide variety (100 different designs) of computer motherboards in produc�on lot sizes as small as one unit. The facility can produce them at a rate and cost that rivals mass produc�on.

Cost-Volume-Profit Modeling

To understand scale, it is helpful to construct a simple model. A model is an abstrac�on of the key variables and rela�onships in a real problem, and is used to simplify the problem and increase understanding. The cost- volume-profit (C-V-P) model uses es�mates of costs, revenues, volume sold, and volume produced in order to es�mate profit.

C-V-P Model Formula�on

The C-V-P model is formulated by determining total revenue and costs, as shown in the following equa�ons:

TR = (SP)(Xs)

where

TR = total revenue

SP = selling price per unit

Xs = number of units sold

TC = FC + (VC)(Xp)

where

TC = total cost

FC = fixed cost

VC = variable cost per unit

Xp = number of units produced

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The profit (P) equa�on is total revenue minus total cost: P = TR – TC

By subs�tu�ng the TR and TC equa�ons into the equa�on for profit, the following mathema�cal model can be used to calculate profits, given sales and produc�on volumes. This is the cost-volume-profit model.

P = SP(Xs) – [FC + VC(Xp)]

This model can also be manipulated to determine the volume required to earn targeted value for profit. In order to do this, assume that the number of units sold is equal to the number of units produced.

If X = Xs = Xp, then

P = SP(X) – [FC + VC(X)]

P = SP(X) – FC – VC(X)

P + FC = (S – VC) (X)

Solve for X as follows:

If C is defined as contribu�on per unit, then C = (SP – VC). Thus, the equa�on becomes

The profit point is the number of units (X) that must be produced and sold at the contribu�on per unit (C) in order to cover the fixed costs (FC) and profit (P). Figure 7.2 represents this model graphically and illustrates the profit point. If the profit is set to zero, equa�on 7.1 is recognizable as the break-even formula. The break-even point (BEP) is the volume that must be produced and sold so that profit is zero.

Figure 7.2: Cost-volume-profit model

Problem

The mechanics of applying the C-V-P model are rela�vely simple. To calculate the profit point, you must know the selling price, variable costs, and fixed costs. Management can determine the projected level of profit to be used in the model. In this example, the fixed cost and profit are for a one-month period.

SP = $8.00/unit

VC = $4.50/unit

C = $3.50/unit

FC = $25,000/month

P = $8,000/month

In this case, the number of units that must be produced and sold to make $8,000 profit in one month is 9,429 units; that is the profit point.

X

 = 9,429 units/month

Managers can use this number in many ways. Here are two examples. First, if the organiza�on has a capacity of only 5,600 units per month, then achieving an $8,000 profit is not possible. Second, if the sales forecast is for 9,000 units, then that profit level will not be achieved because not enough units will be sold. Changes can be made to the

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model for the purpose of sensi�vity analysis and to answer what-if ques�ons. For example, what if the variable costs increased from $4.50 to $5.00 per unit? Under these circumstances, the profit point becomes 11,000 units per month.

C-V-P Assump�ons

The C-V-P model, like any model, makes several assump�ons. The assump�on that sales volume equals produc�on volume has already been men�oned. The model also assumes that total cost and total revenue are linear func�ons of volume. The model is based on historical data for costs and revenue. Any changes in these rela�onships caused by changes in technology, demand, or strategy may invalidate the use of this or any other model. Users of models should understand these assump�ons, or they may apply the model ineffec�vely and thus obtain misleading results.

The Mul�ple-Product Case of the C-V-P Mode

The discussion of the C-V-P model has considered only single-product firms. Many organiza�ons produce more than one product, using the same set of fixed costs. How can this firm be modeled? In this case, another set of variables, product mix, is added to the revenue and cost rela�onships. To solve the problem, a weighted contribu�on based on the mix of each product is calculated. Consider the following problem.

Problem

A company repairs small appliances. The table that follows provides the average selling price, variable cost, and contribu�on for each service. The product mix and profit target are also listed. The fixed costs are shared by all three products.

Coffeepot Mixer Blender

Product mix 45% 20% 35%

Selling price/unit $12 $16 $9

Variable cost/unit $6 $7 $4

Contribu�on/unit $6 $9 $5

Profit target = $20,000/yr.

Fixed costs = $30,000/yr.

The mix is the number of each product repaired divided by the total number repaired. The weighted contribu�on is calculated as:

where

WC = weighted contribu�on per unit

Mi = product mix as a percentage of total sales for product i, where i = 1,. . ., n for n different products or product lines

SPi = selling price for product i

VCi = variable cost for product i

Thus, the weighted contribu�on for the product mix shown above is:

WC = 0.45($12/unit – $6/unit) + 0.2($16/unit – $7/unit) + 0.35($9/unit – $4/unit)

= $6.25/unit

In the mul�ple-product case, the weighted contribu�on per unit subs�tutes for the contribu�on per unit in equa�on 7.1.

X = = = 8,000 units

Interpre�ng the Results: The variable X is measured as a composite unit—a unit consis�ng of 45% coffeepot, 20% mixer, and 35% blender.

One composite unit with a weighted contribu�on = $6.25

45% Coffeepot

20% Mixer

35% Blender

Product Mix No. Required

Coffeepot 0.45 3,600 units Processing math: 0%

Mixer 0.20 1,600

Blender 0.35 2,800

8,000 units

The number of units, 8,000, represents the total number of coffeepots, mixers, and blenders that must be repaired to make a $20,000 profit. The number of coffeepots required is (0.45)(8,000 units), or 3,600 units.

What Happens to the Profit Point if the Mix Changes?: In this model, the mix affects the profit point. If the es�mated mix is different from the actual mix, then the profit point will change. Assume the mix changes to 50% coffeepots, 10% mixers, and 40% blenders, and the total number of units repaired remains 8,000. How is profit affected?

Coffeepot Mixer Blender

Product Mix 50% 10% 40%

Selling price/unit $12 $16 $9

Variable cost/unit $6 $7 $4

Contribu�on/unit $6 $9 $5

Profit target (P) = unknown.

Fixed costs = $30,000/yr.

Equa�on 7.2 can be restated and used to calculate profit.

X

WC(X) = P + FC

P = WC(X) – FC

The fixed costs are $30,000, and the volume is given as 8,000 units. First, the weighted contribu�on is calculated based on the new mix.

WC = = 0.5($12/unit – $6/unit) + 0.1($16/unit – $7/unit) + 0.4($9/unit – $4/unit)

  = $5.90/unit

Now profit can be calculated.

P = $5.90(8,000 units) – $30,000 = $17,200

The profit is only $17,200 dollars because demand shi�ed away from mixers, which have a higher contribu�on per unit, to the lower-contribu�on coffeepots and blenders. Profit is not only a func�on of the volume produced and sold, but also a func�on of the product mix.

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An assembly line allows a company to make a fast-food pizza quickly and with low labor costs.

Newscast/ASSOCIATED PRESS/AP Images

7.5 Process Selection and Economies of Scale and Scope

From the perspec�ve of economies of scale or economies of scope, process selec�on focuses on the volume of product demanded in the market. Organiza�ons can influence that volume by increasing adver�sing, providing be�er service, and producing higher quality products. Regardless of how that volume is generated, an organiza�on needs to respond to higher demand with an appropriate process.

When does an organiza�on have sufficient volume to jus�fy specialized, high-speed equipment? Is a demand of 50,000 units per year sufficient? It is not possible to give specific answers to these ques�ons because the answers depend on what the organiza�on produces. For example, if it produces space shu�les, then an annual demand of 50,000 would certainly be large enough to support specialized facili�es, and even 5,000 would be considered a large volume. If, however, the organiza�on is processing checks for a bank, 50,000 a year is a very small number, and even 1 million per year is not large.

In process selec�on, Hayes and Wheelwright (1979, p.133) have suggested that product and process can be viewed through two sides of a matrix. Figure 7.3 displays a series of process alterna�ves that can be matched with iden�fiable product characteris�cs so that efficient opera�ons can be achieved. High-volume opera�ons are usually referred to as line flow processes. One type of line flow is the con�nuous flow process. A con�nuous flow does not usually iden�fy individual units; rather, the product is mixed and flows together in a con�nuous stream. Oil refining is a good example of a con�nuous flow process. Processing checks in a bank is another example. The term assembly line is used to describe the high-volume assembly of discrete products. A washing machine is a good example of an assembly-line product and making a fast-food pizza on a busy night is another. Con�nuous flow and assembly lines are usually dedicated facili�es that produce large volumes with li�le, if any, difference in the products. Because the items produced within such a facility are the same or very similar, the process involves economies of scale. To increase volume, cut costs, and achieve economies of scale, organiza�ons tradi�onally move up the shaded diagonal in Figure 7.3 (see next page).

Batch is a term used to describe a produc�on process that does not have sufficient volume from a single product to fully use a facility. In this case, the facility produces several products to build sufficient volume. When this resource sharing exists, a transi�on �me, or changeover �me, is usually required to change the facility from being able to make one product to being able to make the next. For example, Merck, which produces medica�ons, uses batch produc�on. Merck has equipment that is designed to mix ingredients and form pills or capsules. O�en this equipment can produce in a few weeks all the capsules of a par�cular medica�on needed for an en�re year. Because of shelf life considera�ons and inventory costs, making even a one-year supply in a single batch creates too much inventory. So, companies like Merck produce different medicines in smaller batches using the same equipment. In between batches, the equipment must be thoroughly cleaned so the next batch is not contaminated. These changes take �me and cost money, but are necessary to maintain enough volume to support the large investment in equipment.

As product volume declines, batching opera�ons may no longer be possible. Here, only a few units of a product are required, and there may be no assurance that the order will be repeated. The differences between products can be significant. In this situa�on, usually called job shop produc�on, the facility is general and flexible enough to meet a variety of needs. To achieve this flexibility, job shops generally have a much higher unit cost than line flow or batch processes for the same product. Fancy restaurants and hospital emergency rooms are examples of job shops. Both types of organiza�ons offer great product variety and cater to individual customer demands.

At the bo�om of the volume scale in Figure 7.3 are projects, which are usually one-of-a-kind opera�ons. Each job is different from the rest. Most large construc�on jobs are projects, and many service opera�ons can be categorized as projects. Installing new computer hardware, adding new computer so�ware, and implemen�ng a new management planning and control system could all qualify as projects. The rela�onship between product and process, illustrated in Figure 7.3, indicates that there is a one-to-one rela�onship between product volume and the type of process. For example, Figure 7.3 indicates that one-of-a-kind products cannot be produced on an assembly line or in a con�nuous flow shop. Figure 7.3, therefore, implies that an organiza�on's op�ons are limited to product and process matches on the diagonal. The diagram implies that if an organiza�on wants to achieve the low cost obtained in con�nuous flow or assembly-line opera�ons, it must significantly limit product variety. An organiza�on that wants to achieve the product variety obtained in a job shop or projects must incur high unit costs.

Figure 7.3: Matching process alterna�ves with product characteris�cs

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However, with the advances in informa�on and manufacturing technologies, organiza�ons have new process alterna�ves that are flexible, allowing changes from one product to another to be made quickly and with few costs. With these technologies, the products produced within a facility can be different, yet low in costs. This is economies of scope, and it implies moving off the shaded diagonal in Figure 7.3 toward the lower le� corner of the diagram. This segment of the diagram implies both low cost and high variety, which is called mass customiza�on and is discussed in a later sec�on.

The following sec�ons describe the tradi�onal process alterna�ves: con�nuous flow, assembly line, batch, job shop, and project, as well as manufacturing cells and flexible manufacturing systems.

Line Flow Processes

Con�nuous flow opera�ons and assembly lines have some differences; yet both are high-volume, mass-produc�on opera�ons characterized by a standardized product with interchangeable parts. Because of this, the process is the same for each unit, and the product has a dominant product flow through the facility. With li�le or no product varia�on, there is no reason to have more than one path through the facility. Furthermore, the equipment that processes the products should be arranged "around" the product so that material-handling and transporta�on costs are not excessive. This approach is called a product layout.

In terms of the cost structure, a con�nuous flow process or an assembly line has rela�vely high fixed costs and rela�vely low variable costs. The high fixed costs are, in part, a result of the substan�al investment in specialized equipment.

There are some differences between a con�nuous flow process and an assembly line. In a con�nuous flow process, the product is o�en a commodity in which one unit is not dis�nguishable from another. In this case, the producer makes no a�empt to track each unit separately. For example, in refining gasoline from crude oil, one gallon of unleaded regular gasoline is like another. Banks process checks one a�er another without changing methods. The produc�on of fiberglass insula�on is high-volume and fast-paced. It is not feasible to track and iden�fy each piece produced. The emphasis is on measuring inputs and comparing them to outputs.

The tradi�onal assembly-line process allows some varia�ons among units. Op�ons are usually selected from a list of possibili�es, and the minor adjustments needed to cope with this varia�on can be made by workers on the produc�on line. Adding green peppers to the standard pizza is easy to do. Adding custom floor mats to a car or a temperature probe to a microwave oven is also easy to do. As technology improves, assembly lines are becoming more flexible. The con�nuous flow and assembly-line characteris�cs are summarized in Table 7.3, along with the other process types.

Table 7.3: Characteris�cs of the process alterna�ves

Characteris�cs

Process Volume Product variety Product flow Facility layout Fixed costs Variable costs Equipment

Con�nuous flow High Standard Dominant Product High Low Special purpose

Assembly line High Standard with minor modifica�on Dominant Product High Low Special purpose

Batch High Some varia�on Dominant Product High Low Some flexibility

Flexible manufacturing system High Moderate variety Dominant Product High Low Flexible Processing math: 0%

A woodcarving business that makes carvings to order is one example of a job shop because it handles a large number of different products produced in small volumes, rather than producing large quan��es of the same product.

iStockphoto/Thinkstock

Manufacturing cell High Moderate variety Dominant Product Moderate Low to moderate Flexible

Job shop Low Major differences Random Process Low High Flexible

Project One One-of-a-kind Not applicable Fixed posi�on Low to moderate High Flexible

Batch Flow

When quan��es are not sufficient to support dedicated produc�on facili�es, several groups or batches are produced using the same facility. These products are usually similar in design and have similar processing requirements. For example, glass containers come in a variety of sizes but are designed and built similarly. A key to understanding whether or not differences among products are meaningful can be found when the equipment is shut down to change from one product to another. If the �me for these changes is not significant and the sequence of opera�ons is similar, then it is like a line flow process. However, if the changeover �me is significant, then these products are usually built in batches.

Because of the similar processing requirements in batch opera�ons, one or a few product flows dominate. For example, appliance manufacturers may produce several different models of refrigerators on the same assembly line. In cases where changeover �me is significant, manufacturers may produce a batch—for example, one week's produc�on of a par�cular model—and then switch to another model. Although the models show some differences from batch to batch, these differences are not significant enough to change the product-oriented layout of the facility. If a producer is able to design the product and the process so that different models can be produced one a�er the other with zero or near zero changeover �me, then the process is similar to an assembly line that is producing a standard product. The disadvantages of batch produc�on are that (1) changeover �me is nonproduc�ve, and (2) extra inventory must be maintained to sa�sfy demand for the products that are not being produced.

Job Shops

With limited product volume, batching opera�ons may not be possible. Here, only a few units of a product are required, and there may be no assurance that the order will be repeated. The differences between products can be significant. In this situa�on, usually called job shop produc�on, the facility is general and flexible enough to meet a variety of needs. To achieve this flexibility, job shops generally have a much higher unit cost than line flow or batch processes for the same product. Fancy restaurants and hospital emergency rooms are examples of job shops. Both types of organiza�ons offer great product variety, and cater to individual customer demands.

A job shop does not produce large quan��es of the same or even similar products, but is dominated by a large number of different products produced in small volumes. Because the products are different, they do not follow the same path through the facility. In fact, the movement of products between work centers is best characterized as random. As a result, it is not possible to organize machines by product flow as in the line flow processes or in batch opera�ons. It is necessary to group machines by process or type of opera�on because a job is as likely to require work at one work center as at any of the other centers. When similar equipment is grouped together it is called a process layout. The job shop is one of the process alterna�ves shown in Table 7.3.

Because the products are very different, specialized equipment cannot be jus�fied. Job shops use flexible equipment to meet the needs of the diverse product group.

A job shop produces different products on general-purpose machines using skilled labor. The cost structure has low fixed costs and high unit-variable costs.

Projects

In a project, cost structure is not the same as in other processes because there is only a single unit. In one sense, the cost for the project is all variable. Fixed costs in the form of overhead begin to make sense when a firm is engaged in more than one project and can spread certain major equipment costs and overhead costs across several different projects.

Product flow is not meaningful in projects because the end product of most construc�on projects is designed to remain sta�onary. The usual term that describes the layout is fixed posi�on. A project-oriented opera�on is very flexible, allowing extensive customizing of the finished products. Projects are common in service opera�ons, for example, Seibel Systems develops and installs so�ware systems that control banking opera�ons. These so�ware systems can monitor each transac�on, keep a history on it, and assist in reconciling the transac�on to the account. To design these systems, so�ware companies draw the needed talent from a pool of experts and form a project team. Because each system is different, different groups may be used to develop each system. These companies provide a service and use project management to successfully complete the work.

Manufacturing Cells and Flexible Manufacturing Systems

Manufacturing cells and flexible manufacturing systems (FMS) are process op�ons that offer the poten�al to produce low-cost products that meet varying customer requirements. Manufacturing cells rely on group technology to build a family of parts with similar design and processing characteris�cs. Group technology is a set of methods that enables firms to classify parts based on size, shape, use, type of material, and method of produc�on. A family of parts is a collec�on of parts with similari�es in these characteris�cs. In this way, a product-oriented layout (cell) can be designed that will reduce material-handling costs, increase machine u�liza�on, and shorten produc�on lead �mes. Because the processing is similar, less �me is required to change from one product within the family to another (see Table 7.3).

An FMS is similar to a manufacturing cell because it relies on group technology to build families of parts. Also, like a manufacturing cell, an FMS produces low-cost products with high variety. The major differences are that an FMS o�en has more automa�on, robots, and computer control than a manufacturing cell does, and it usually operates without people tending the machines.Processing math: 0%

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Flexible manufacturing systems grew from the need to cope with demand for increasing product varia�ons. With an FMS, an organiza�on can capture new markets by accumula�ng produc�on requirements from several low-volume products. Higher-volume opera�ons allow the arrangement of a set of machines in one layout to produce all the different products. The products, however, must be similar enough to have the same or a similar sequence of opera�ons, and the machines must be flexible enough to handle the differences. This system is feasible with computer technology and robo�cs that can quickly be adapted to new products. A manufacturing cell and an FMS enable organiza�ons to increase the volume of product moving across a group of machines and, thereby, reduce opera�ng costs.

Mass Customization

Mass customiza�on offers an alterna�ve to addressing product variety. Firms that seek mass customiza�on are able to design, produce, and quickly deliver products that meet specific customer needs at close to mass- produc�on prices. These firms develop close rela�onships with their customers, which depend on frequent informa�on exchange.

From an opera�ons perspec�ve, mass customiza�on is the low-cost, high-quality, large-volume delivery of individually customized goods and services. Put simply, mass customiza�on combines the pursuit of economies of scale and scope, quality improvement, and flexibility. Economies of scale and scope imply achieving high- volume opera�ons and low costs. When pursuing flexibility, there are three a�ributes to consider:

1. Range/variety—The number of viable states for the produc�on system and the degree of difference in those states. From the perspec�ve of range, the greatest variety is when a large number of very different products can be produced

2. Mobility/responsiveness—The ability to change quickly from producing one product to producing another. High mobility minimizes the need for long produc�on runs. How long does it take for the service center to shi� from doing brake work on a Ford to doing exhaust work on a Chrysler?

3. Uniformity—The ability to a�ain similar performance across the en�re range of outputs. Will the quality on the brake job for the Ford be at the same high level as the quality of the exhaust system for the Chrysler?

Flexibility is the greatest when all three elements of flexibility are at the highest level. That is, the firm can produce a large number of products that are very different, can change between them quickly, and can maintain a high level of performance.

Flexibility is an important factor for the service industry. Following are some examples of the product variety that services face.

1. Hospitals and medical clinics a�empt to treat pa�ents with a wide variety of needs. 2. With the deregula�on of financial markets, the differences between banks and brokerage houses have blurred. Banks are doing much more than taking deposits and making loans. 3. Universi�es are a�emp�ng to cope with an expanding number of majors, specialized degree programs, and individualized study programs. When this expansion occurs, universi�es

must have faculty who have the capabili�es to teach and conduct research across disciplines, else the capabili�es of the faculty may not match the changing needs of the organiza�ons that hire the graduates.

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Chapter Summary

Facility loca�on should not be based en�rely on produc�on factors and transporta�on. Loca�on is a long-term strategic decision that can have a major impact on the organiza�on's ability to compete. Loca�ng a facility can have strategic implica�ons. Some organiza�ons employ a regional facility approach where one facility is responsible for producing all the products for that area of the country. Others employ the product facility strategy where one plant produces one product or product line and ships it throughout the country. Both quan�ta�ve and qualita�ve factors influence the loca�on decision. These factors should be integrated if the decision-making process is to work effec�vely. Loca�on influences costs, selling price, demand, and access to financial services. Process defines the way that the products should be produced. Process selec�on is closely related to the product design and capacity decisions. A cost-volume-profit model is one way of reviewing processing op�ons. This model allows the organiza�on to examine the risks associated with selec�ng a processing op�on. Mass-produc�on alterna�ves involve greater risk, but have the poten�al for greater return. Process selec�on is a func�on of volume demanded. The different process types include line flow, which includes con�nuous flow and assembly line, batch, job shop, and project as well as manufacturing cells and flexible manufacturing systems. Each of these process types is summarized in Table 7.3. Mass customiza�on allows firms to achieve greater product variety while keeping costs low and produc�on volumes high.

Case Studies

Tilley Video Disc, Inc.

William ("Call Me Billy") Tilley, founder, president, and chairman of the board of Tilley Video Disc, Inc., has a very pleasant problem. The market for digital video discs (DVD) is expanding rapidly, and he has accepted an a�rac�ve offer for his controlling interest in Tilley Video Disc, Inc., while retaining his current management responsibili�es. The deal is con�ngent on Billy's development of a plan to expand produc�on from 10,000 to 50,000 units, and to lower produc�on costs. Evers, Inc., the company that has made the offer, feels the growth in sales will be drama�c if costs can be significantly reduced.

Presently, produc�on of the video discs takes place in one plant in Rimer, Oregon. The plant was formerly a slaughterhouse and meatpacking facility. Billy has quickly come to the conclusion that produc�on could be maintained at this facility, but that significant on-site expansion is not sound. The equipment in the facility was purchased from a bankrupt company and has been used for several years. It can best be characterized as slow, general-purpose equipment. The following data has been compiled from the exis�ng plant for the last 12 months:

Selling Price $6.50/unit Variable costs $3.25/unit Total Produc�on 9,824/year Rejects 644/year Sales 9,180/year Es�mated capacity 10,000/year Annual fixed costs $20,000

Evers' vice president of marke�ng thinks that the selling price should be reduced to about $5.00 in order to achieve the needed sales growth and to grab market share in the highly compe��ve consumer market. As a consultant to Billy Tilley, you are charged with developing a plan that will allow the company to increase capacity by 400% and reduce variable costs by 20%. You should use the cost-volume-profit model in building your plan. Use an annual profit of $80,000 as a target profit. Provide a wri�en report that addresses the following ques�ons:

1. Is it a good idea to keep the exis�ng facility? 2. What benefits may be derived from the new technology? 3. Should one facility be built, or should the plan have several small facili�es similar to the present facility? 4. Why and how will the cost structure of the new facility differ from that of the exis�ng one? Be specific. Use the C-V-P model to help describe the differences.

Dailey Computer Service

Kathy Dailey, president of Dailey Computer Service, has called you into her office to help plan the company's future. Profits have been declining even though sales have increased. During this �me, selling price and costs have not changed. The company sells three services: a payroll package; data entry services; and computer forms. The following table shows the revenue and costs of these services:

Payroll Package

Data entry (per 1,000)

Computer forms (per 100)

Selling price $3,500 $25 $35 Variable cost $800 $16 $30

Fixed costs average $40,000 per month.

Sales data for the last two months are listed here.

Two Months Ago Last Month

Units Sales Units Sales Payroll (packages) 7 $24,500 5 $17,500 Data entry (1,000) 2,500 62,500 2,200 55,000 Forms (100) 1,400 49,000 2,000 70,000 Total sales $136,000 $142,500

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1. How did the firm manage to increase sales, hold the line on price and costs, and make less money? Be specific; Dailey wants numbers to back up your answer. 2. If Dailey Computer Service maintains the same sales mix as last month, how can it achieve a profit of $10,000 next month? Be specific. 3. From what you have discovered in this analysis, answer the following ques�ons:

a. How should Dailey Computer Service approach marke�ng? b. Should price changes be considered?

Discussion Ques�ons

Click on each ques�on to reveal the answer.

1. Why is facility loca�on important to an organiza�on? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Facility loca�on is the placement of a facility with respect to customers, suppliers, and other facili�es with which it interacts. The facility loca�on decision is cri�cal to an organiza�on's success because (1) the result of the decision is to commit a significant amount of an organiza�on's resources, (2) the costs of reloca�on are high, (3) the loca�on can greatly influence produc�on and transporta�on costs, (4) the loca�on affects an organiza�on's ability to serve its customers, and (5) the loca�on can be a key ingredient in an organiza�on's strategy. The facility loca�on decision is a long term, strategic decision, which can have a major impact on the organiza�on's ability to compete.

2. What factors are affected by the choice of loca�ons? Which of these factors can be measured in dollars, and which cannot? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Facility loca�on decisions depend on marke�ng issues, produc�on factors and environmental decisions. Many organiza�ons require easy access to customers. Some choose to locate near universi�es to take advantage of research facili�es. Some need easy access to raw materials. Some locate to take advantage of low labor rates, material and/or transporta�on costs. The quality of schools, cultural advantages and banking services, along with others, can also play an important role in the loca�on decision.

Many of these factors can be measured in dollars while others cannot. Quan�ta�ve factors include costs associated with building the facility, producing the product, overhead, and transporta�on to and from the facility. State and local governments offer incen�ves to a�ract and retain businesses and jobs, and these are quan�ta�ve, as well. Qualita�ve factors include recrea�onal and cultural ac�vi�es, availability of labor, educa�onal and research facili�es, and many others listed in the appendix to this chapter.

3. How can qualita�ve and quan�ta�ve factors be integrated to make a sound and logical loca�on decision? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Qualita�ve factors, whose direct impact on profits is not measurable, need to be carefully considered and integrated with quan�ta�ve factors. To integrate these factors, managers should decide which qualita�ve factors are relevant to the decision, weight each relevant factor, and evaluate each site so that ra�onal comparisons can be made. These scores can be summed for each site and compared with the results from the analysis of the quan�ta�ve factors. If one site is the best in both qualita�ve and quan�ta�ve factors, then it would seem to be the correct choice. If not, then trade-offs need to be made among the sites.

4. What hidden factors are influenced by on-site loca�on, and how are they influenced? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

On-site expansion can create many problems, especially if it is a repeated prac�ce. As more produc�on space is added, material handling and storage become more difficult because storage space is converted to produc�on. As new product varia�ons are added, the once simple product flow becomes complicated by twists, turns, and back-tracking. On-site expansion can strain intra-plant transporta�on and communica�on.

Staying at the same site o�en postpones the introduc�on of new products and process technologies. Old equipment and old produc�on methods are used longer than they should be. Future product innova�on, produc�vity increases, quality improvements, and cost reduc�ons can be nega�vely affected. On-site expansion can mean a growing number of workers, products, and processes that need to be managed. Such layering of expanded responsibili�es creates real complexi�es for management at all levels.

5. Why are spa�al rela�onships important in the loca�on decision? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

In addi�on to factors like local labor costs and u�lity costs, the loca�on decision should consider spa�al rela�onships. Spa�al rela�onships are important because convenient access by customers and/or the ability to transport large quan��es of material easily and quickly may be very important. In loca�ng a health care facility, the distance which customers travel should be considered because it is important to the customer. When outbound transporta�on costs are high, manufacturing and warehousing tend to locate close to customers. A good example of this is aluminum can producers. The cost to ship a can is very high because the organiza�on is shipping a lot of air and very li�le product. On the other hand, when inbound transporta�on costs are high, facili�es tend to be located close to suppliers.

6. What is process selec�on, and how can the organiza�on use it to gain compe��ve advantage? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Process describes the way in which the product is made. Process selec�on is a series of decisions that include technical or engineering issues and volume or scale issues. The technical issues include the basic technology used to produce the good or service such as con�nuous cas�ng to make slabs in the steel industry. It includes the sequence of steps, the equipment, and the facili�es needed to perform the services or produce the goods. Volume or scale decisions involve using the proper amount of mechaniza�on to leverage the organiza�on's workforce. Leverage means to make the workforce more produc�ve through the use of be�er tools. The purpose of leveraging is to achieve the desired level of produc�on at an acceptable level of cost. Process is strategically important because it helps to define the product's costs and quality.

7. How is process selec�on related to product design and capacity determina�on? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Product design, capacity, and process selec�on decisions should be considered simultaneously rather than independently. The market research that helps to shape the product design also provides an es�mate of the demand for the product at a price that customers are willing to pay. The demand for that product should be used to determine the capacity the organiza�on will select. The amount of demand will help to determine how the product will be produced. Large volume products (and low product variety) tend to be produced by line flow processes while low volume products (and high product variety) are produced in job shops.

The following example illustrates the rela�onships between product and process design. If a fast food sandwich is described as flame broiled, the process should not include grills for frying. In turn, process selec�on influences product design. A wrist watch powered by light is an example where improvements in technology ul�mately led to new product designs.

Process selec�on is constrained by the volume of the product required. For example, if the market for a product is es�mated at only 1,000 units per year, it would be very difficult to jus�fy spending a great deal of money on a machine that will produce 100 units per hour. The machine will only need to operate ten hours per year to meet demand.Processing math: 0%

8. Explain how the cost-volume-profit model of a firm is derived. How is it useful to opera�ons managers in making the process selec�on decision? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

The cost-volume-profit (C-V-P) model uses es�mates of costs, revenues, volume sold, and volume produced in order to es�mate profit. The C-V-P model is formulated by determining total revenue and costs. The difference between revenue and costs is profit. The model allows managers to calculate profit for any sales or produc�on volume. It also can be used to determine the volume required to be produced and sold to achieve a given level of profit. It is useful for opera�ons managers in making the process selec�on decision because the cost structure (the amount of fixed and variable costs) can be changed to represent the different processes. Line flow processes have high fixed and low unit variable costs while job shops have low fixed and high unit variable costs. By trying different alterna�ves, the impact of process selec�on on profit can be determined.

9. What are line flow processes, and what characteris�cs help to define them? Give examples. (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

High volume opera�ons are generally referred to as line flow processes. Line flow processes are characterized by standard products, a dominant product flow, high fixed costs, low unit variable costs, and special purpose equipment. One type of line flow is the con�nuous flow process. A good example of a con�nuous flow opera�on is an oil refinery. Another good example is a paper mill. Assembly lines refer to opera�ons that assemble a high volume of discrete products. Automobiles are made on assembly lines.

10. What is batch flow, and what characteris�cs help to define it? Provide examples. (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Batch flow describes a produc�on process that does not have sufficient volume from a single product to fully use the facility. Several products are made on the same equipment to provide sufficient volume. Changeover �me is generally required to change the facility from one product to the next. Thus, products are made in batches. Batch opera�ons are characterized by limited product variety, small differences between product flows, high fixed costs but not as high as a line flow process, moderate unit variable costs, and special purpose machines which have some flexibility in order to deal with product variety. The auto parts manufacturer referred to in the text is a good example of batch flow.

11. What is a job shop, and what characteris�cs help to define it? Provide examples. (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Job shops are characterized by the need to produce only a few units of a given product with no guarantees that the product will ever be made again. Differences between products can be significant. A job shop is characterized by product flows that vary significantly, low fixed costs, and high unit variable costs. The facility for such an opera�on must be general and flexible. Hospital emergency rooms and five-star restaurants are examples of job shops.

12. What is a project, and what characteris�cs help to define it? Provide examples. (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

Projects are generally one-of-a-kind opera�ons in which each job is different. Projects are characterized by low to moderate fixed costs, high variable costs, and tremendous flexibility. Construc�on work and installa�ons of large computer hardware and so�ware systems are good examples of projects.

13. How will flexibility help an organiza�on achieve a compe��ve advantage? (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644

In the future, flexibility in the produc�on process will play an increasingly important role. Changing customer demand and specialized design will give producers that have flexibility a compe��ve edge because they can provide a variety of products in a �mely fashion and at low costs.

Problems

1. Darwal Developers specializes in analyzing facility loca�on decisions. Presently, the company is looking at two loca�ons: Orlando, Florida, and Olympia, Washington, for which it has determined the following cost informa�on:

Orlando Olympia Variable costs $14.70/unit $16.45/unit Annual fixed costs $12,000,000 $11,000,000 Ini�al investment $166,000,000 $145,000,000

a. At a volume of 800,000 units per year for a 10-year period, which facility has the lower cost? b. At what annual volume do these facili�es have equal costs? Once again, assume a 10-year period. c. Graph the results of Part b.

2. Marvin Manufacturing is considering three loca�ons for its new plant: Tucson, Arizona; San Diego, California; and Newark, New Jersey.

Tucson San Diego Newark Variable costs $1.60/unit $1.45/unit $1.50/unit Annual fixed costs $1,800,000 $2,000,000 $1,900,000 Ini�al investment $14,000,000 $16,000,000 $15,000,000

a. At a volume of 2 million units per year for a 5-year period, which facility has the lowest cost? b. At what annual volume(s) do these facili�es have equal costs? Assume a 5-year period. (Hint: It is helpful to graph each of the cost equa�ons before solving for the point where

the costs are equal.)

3. Intensive Technologies consults for clients in the aerospace industry. Their corporate headquarters is located in Washington, D.C., but the organiza�on is planning to relocate to the West Coast. It is considering three sites: Sea�le, Washington; Portland, Oregon; and Oakland, California. The full costs of opera�ng at each site, which include ini�al investment, annual fixed costs, and variable costs, are approximately equal. A management team from Intensive Technologies has visited each city, and has evaluated each site using the following criteria. The evalua�on uses a 1-to-10 scale, with 1 being the best score. Top management selected the criteria and the weight assigned to each factor.

Weight Oakland Score

Portland Score

Sea�le Score

University research specializing in aerospace 50 4 2 2 Processing math: 0%

Available pool of skilled engineers 50 4 3 2 Opportunity for advanced management educa�on 40 2 3 3 Cultural ac�vi�es 20 1 2 3 Recrea�onal ac�vi�es 20 2 4 3

a. What is the weighted score for each city? b. Which city has the advantage in terms of the qualita�ve factors? Is this advantage significant? c. What is your recommenda�on to top management?

4. Barrel City Health Care System is looking for a new loca�on for its corporate headquarters. It is considering Atlanta, Georgia, and Danville, Illinois. The ci�es are rated from 1 to 10 on each of the following factors, with 10 as the best score.

Weight Atlanta Score Danville Score Cultural ac�vi�es 40 8 6 University research facili�es 80 8 8 Union ac�vi�es 60 8 4 Banking services 60 6 8 Available labor 20 6 8

a. Determine the weighted scores for both ci�es. b. How can these scores be integrated with cost differences? c. Suppose the following costs apply:

Atlanta Danville Opera�ng costs $1,400,000/year $1,300,000/year Ini�al investment $22,000,000 $20,000,000

Over a 10-year period, Danville has a $3,000,000 advantage. To determine that, take the difference in opera�ng costs per year, and mul�ply it by 10 years. Then add the difference in ini�al investment. Under what circumstances might the company s�ll choose Atlanta? How much would Barrel need to value each point of Atlanta's qualita�ve advantage to make it the new headquarters?

5. Nelson, Neddel, and Nickersen (NNN) Stockbrokers are planning to invest in automated equipment that will process stock transac�ons. The equipment requires a $12 million annual investment. The opera�ng costs are $120 per hour. The equipment can generate 5,000 transac�ons per hour.

a. What is the unit cost of a transac�on if 1 million are required? b. What is the unit cost if 10 million are required? c. What is the unit cost if 100 million are required? d. Why would NNN want to keep the level of transac�ons high?

6. George's Mold Shop is planning to bid on a plas�c part for automakers. If George's gets the bid, the manager is planning to buy a new semi-automa�c machine to speed up the produc�on process. The annual fixed cost of the machine is $45,000. The machine requires only part-�me supervision, and the labor cost is es�mated at $1.50 per hour. This has been calculated as 0.08 hour of labor at $18.75 per hour. On average, the machine can produce 140 pieces per hour and is expected to operate for 2,000 hours per year.

a. What is the unit cost of a plas�c part if 10,000 are required? b. What is the unit cost if 100,000 are required? c. What is the unit cost if 200,000 are required? d. What is the unit cost if the machine operates at capacity for the en�re year?

7. Slimline Manufacturing makes briefcases. It is considering the purchase of new s�tching machines for its final assembly. Following are the data for analysis:

System Annualized Fixed Costs Variable Costs Spurance $3,500 $1.25/unit Yamamoto $8,000 $0.85/unit

a. If Slimline's demand is for 8,300 briefcases per year, which system should the company use? b. If Slimline needs to s�tch 19,800 cases per year, which system has the lower cost? c. At what volume do the two alterna�ves have equal costs?

8. Finn Bank and Trust is comparing a manual system for processing checks with a highly automated system. Presently, the bank processes about 10,000 checks each workday, and it operates 250 days per year. In the near future, it is planning to sell check-processing services to other small rural banks in the area. The bank's management has collected the following data:

System Annualized Fixed Costs Variable Costs Manual $50,000 $0.045/check Automa�c $350,000 $0.005/check

a. At its present volume of checks, which system should Finn use? b. If Finn can process checks for other banks and boost its volume to 100,000 checks per day, which system has the lower cost? c. At what volume do the two alterna�ves have equal costs?

9. The X-ray machine at Marchal Medical Center was purchased and installed nearly four decades ago. Medically, the machine func�ons very effec�vely, but requires excessive �me to adjust for each pa�ent. A new X-ray machine is available that will reduce the �me required to serve a pa�ent.

System Annualized Fixed Costs Variable Labor Costs Processing math: 0%

Old X-ray $40,000 $4.00/X-ray New X-ray $120,000 $1.00/X-ray

a. Which system would provide lower costs if the annual pa�ent demand is 15,000? b. If volume could be boosted to 20,000 pa�ents per year, which system would provide the lower costs? c. At what pa�ent volume do these alterna�ves have equal costs?

10. Quill Pen Company sells pens that are o�en purchased as gradua�on presents. The pens sell for $5.50 each and cost $1.50 per unit to produce. Fixed costs total $40,000 per year. a. How many pens must Quill sell to cover fixed costs? b. How many units must Quill sell to make $50,000 profit per year? c. If fixed costs increase by $10,000 per year, what are the answers to Parts a and b?

11. Brockman Visi�ng Nurse Service has determined that it will cost approximately $20 each �me one of its nurses visits a sick person at home. The charge is $30, part of which is paid by the pa�ent and part by insurance. Overhead expenses are $7,000 per month.

a. How many calls must the service make to cover overhead expenses? b. How many calls must it make to ensure a $3,000 profit per month?

12. A.J. Electronics produces monitors for microcomputers. It has a one-shi� opera�on with fixed costs of $25,000 per month. The cost of purchased parts is $20 per unit, and the standard labor cost is $15 per unit. The company sells the monitors for $55 each to customers who sell them under their own brand names.

a. How many monitors does A.J. have to produce and sell each month to cover costs? b. How many monitors must be produced and sold to meet a $5,000 target profit?

13. Presently A.J. has the capacity to produce 1,600 monitors each month if it maintains a one-shi� opera�on. The A.J. sales staff is nego�a�ng a deal with a major seller of microcomputers that will increase units sold per month from approximately 1,400 to 3,000. If the deal is successful the opera�ons manager plans to add a second shi�. Adding a second shi� will increase fixed costs by $10,000 per month and increase produc�on labor costs to $16 per unit for those units produced on the second shi�. This increase is due en�rely to paying a premium (shi� differen�al) for second-shi� labor. The unit price for purchased parts will drop by $0.50 for units produced on both shi�s because of discounts for buying larger quan��es. The addi�on of a second shi� will add 1,600 units per month to capacity.

a. Graph A. J.'s cost-volume-profit rela�onship for one shi� only. b. Graph A.J.'s cost-volume-profit rela�onship for two shi�s. c. How many units must A.J. produce and sell to cover its costs when the second shi� is in place? d. At what volume does A. J. make a $24,000 profit per month? e. What happens to the company's profit if the selling price of monitors drops by $5 per unit? Be specific, using calcula�ons to support your answers.

14. Carder Kitchen Utensil Produc�on makes steak knives and salad forks in the same facility.

Steak Knives Salad Forks Product mix 0.7 0.3 Selling price $0.80 $0.40 Variable cost/unit $0.50 $0.25

Annual fixed costs are es�mated at $250,000

a. At what volume will Carder cover its costs, given the present mix? b. At what volume will Carder report a $150,000 annual profit, given the present mix? c. If the mix changes to 0.6 for steak knives and 0.4 for salad forks, recalculate the answers to Parts a and b. d. If the price of a steak knife is raised by $.05, what is the impact of this new mix on the volume required to make a $150,000 profit?

15. Junge Hardware Products makes nuts, bolts, and washers in the same facility.

Nuts Bolts Washers Product mix 0.4 0.4 0.2 Selling price $0.07 $0.09 $0.03 Variable cost/unit $0.03 $0.06 $0.001

Annual fixed costs are es�mated at $2,500,000.

a. At what volume will Junge cover its costs, given the present mix? b. At what volume will it report a $1,500,000 annual profit, given the present mix? c. If the price of a bolt is raised by $.01, what happens to the volume required to make a $1,500,000 profit?

16. Winken, Blinken, and Knod, Inc., is considering three different machines to grind contact lenses. The annual costs and opera�ng costs are listed below.

Annualized Fixed Costs Variable Opera�ng Costs Manual grinder $9,000 $5.00/lens Automa�c grinder $30,000 $2.50/lens Computer controlled automa�c grinder $50,000 $0.75/lens

a. If 10,000 lenses are needed, which op�on has the lowest cost? b. If 20,000 lenses are needed, which op�on has the lowest cost? c. At what volume(s) of lens produc�on do the alterna�ves have equal costs? d. How would you explain these op�ons to management?Processing math: 0%

Click here to see solu�ons to the odd-numbered problems. (h�ps://media.thuze.com/MediaService/MediaService.svc/constella�on/book/AUBUS644.13.2/{pdf}bus644_ch07_odd_problem_solu�ons.pdf)

Key Terms

Click on each key term to see the defini�on.

assembly line (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A process through which discrete parts are put together to make a finished product. It is a high volume opera�on that produces products that are very similar in features and performance.

batch (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A term used to describe a produc�on process that does not have sufficient volume from a single product to fully use the facility. The facility must produce several products to have sufficient volume to achieve economies of scale. There is an equipment changeover prior to making each product.

break-even point (BEP) (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The volume of a good or service that must be produced and sold so that profit is zero. This is the zero profit point in the cost-volume profit model.

changeover �me (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The �me required to change the facility or equipment from making one product to making the next product.

concurrent engineering (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

Occurs when design and process engineers work together to make be�er decisions and reduce the �me it takes to bring products to market.

con�nuous flow process (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A process for mass producing products that does not iden�fy individual units. The products are mixed and flow together in a con�nuous stream. Oil refining is a good example of a con�nuous flow process.

contribu�on per unit (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The selling price of a unit minus the variable cost of producing the unit. It is the amount that each unit of sale contributes toward covering overhead costs and mee�ng profit objec�ves.

cost-volume-profit (C-V-P) model (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A simple model of an organiza�on that uses es�mates of costs, revenues, volume sold, and volume produced in order to es�mate profit.

economies of scope (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

Economies of scale across products. Implies building the volume necessary to cover fixed costs by producing a variety of products on the same equipment. This requires flexibility within the organiza�on.

family of parts (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A group of parts that require similar machining opera�ons.

group technology (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A set of methods that enables firms to classify parts based on size, shape, use, type of material, and method of produc�on.

job shop (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A facility capable of producing a wide variety of products in very small volumes. The produc�on facility is general purpose and flexible enough to meet a variety of needs.

leverage (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

When referring to opera�ons and produc�vity, leverage makes the work force more produc�ve through the use of be�er tools.

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line flow processes (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

High volume opera�ons. Two examples of line flow processes are con�nuous flow processes and assembly lines.

mass customiza�on (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The ability to quickly design, produce, and deliver products that meet specific customer needs at close to mass-produc�on prices. This is the low-cost, high-quality, large volume delivery of customized products.

process layout (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The grouping or arrangement of equipment by the type of process that the machine performs, such as all drilling equipment in one loca�on.

process selec�on (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A series of decisions that include technical or engineering factors and volume or scale factors. The result determines how the services or goods will be produced.

product facility strategy (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A strategy wherein one facility is responsible for both producing a product or product line and shipping that product all over the country and around the world.

product layout (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The physical arrangement of facili�es so that products move along one path. Resources are arranged around this path to minimize material movement, reduce material handling costs, and eliminate delays in produc�on.

profit point (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

The number of units that must be produced and sold at a given contribu�on per unit in order to cover fixed costs plus profit. The break-even point is a special case of the profit point where target profit is zero.

project (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A process for making one-of-a-kind products.

regional facility strategy (h�p://content.thuzelearning.com/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/books/AUBUS644.13.2/

A loca�on strategy in which each facility is assigned a market area and each facility produces a complete line of products for that area.

Chapter 7 Appendix

EXAMPLE OF THE FACTORS IN LOCATION ANALYSIS

Many factors that cannot be measured in dollars should be considered in the loca�on decision. The factors in the following list are o�en important.

UTILITIES

Water

Water supplied by: ________________________________Municipal __________Private ______

Name of supplier: ________________________________________________________________

Address: ________________________________________________________________________

For rate informa�on, contact: _______________________________________________________

Source of city water: River(s) _________ Wells ________ Lake(s) or reservoir(s) ____________

Supply of river water available: ____________________ cu. �./sec.

Supply of lake or reservoir water: __________________ gals.

Water supply approved by State Board of Health: Yes _________ No ____________

Capacity of water plant: __________________________ gals./min.

Average consump�on: ___________________________ gals./day Processing math: 0%

Peak consump�on: ______________________________ gals./day

Sanita�on

Type of sewage treatment plant: ________________________________________________

Treatment plant cer�fied by the State Board of Water Pollu�on: Yes _______ No _________

Characteris�cs of waste treatment plant:

Measurement          Capacity             Present Load

Gallons per day       _________________ _________________

Popula�on equivalent _________________ ________________

Natural gas

Natural gas service available:                  Yes __________ No _______

Name: ____________________________________________________________________

Address: __________________________________________________________________

For rate informa�on, contact: _________________________________________________

Electricity

Suppliers:         Municipal _______ Private _______ Co-op ______

Name(s): ________________________________________________________

Address(es): _____________________________________________________

For rate informa�on, contact: _______________________________________

LOCAL MANUFACTURING CHARACTERISTICS

Number of manufacturing plants in community: _________________________________________

Number of manufacturing plants with unions: ___________________________________________

Number of manufacturing employees in community: _____________________________________

Strikes within last 5 years affec�ng 5% or more of the labor force: __________________________

Major manufacturers or other large employers in community: _____________________________

Name of firm: _______________________________________________________________________

Employment: ______________________________________________________________________

Product(s) manufactured: ____________________________________________________________

LABOR MARKET ANALYSIS

Date of last labor market survey: ___________________________________________________

Results of survey: _______________________________________________________________

Es�mated labor force available: ___________________________________________________

This es�mate can be documented:           Yes ____________ No _____________

County labor data:

Civilian work force (annual average): ______

Unemployed: ______________________________________

Unemployed as a percentage of workforce: ______________

Total employment: __________________________________

Agricultural employment: _________________________

Nonagricultural employment: ______________________

Manufacturing employment: _____________________ Processing math: 0%

Nonmanufacturing employment: ___________________

HEALTH FACILITIES

Number of hospitals in community: __________

Number of beds: ____________

If no hospitals, distance to nearest facility: ___________________________________________

Clinic in community:       Yes ____________ No _____________

Medical personnel:        MD(s) _________ DO(s) ___________

Nurses:                  Registered ______ Prac�cal

RECREATIONAL FACILITIES

Type of recrea�onal facili�es available in city or within 10 miles:

Public golf course(s) ________________ Public park(s) __________________

Public tennis court(s) _______________ Public swimming pool(s) __________

Country clubs available:                     Yes ___________ No _____________

Nearest public access to lake or river:           _____________________miles

Ac�vi�es allowed:

Swimming ________________________ Fishing ________________________

Water skiing ______________________ Motor boa�ng _________________

LOCAL INDUSTRIAL DEVELOPMENT ORGANIZATION

Name of group: _________________________________________________________________

Person to contact: _______________________________________________________________

Address: _______________________________________________________________________

Phone number: _________________________________________________________________

Home: ________________________________________

Business: ______________________________________

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12.4 Dispatching in MRP

The rules men�oned above are limited because they only consider the condi�ons that exist for a given point in �me and a given work center. By and large, they ignore that a given part may be part of a subassembly that must be complete before the final product can be assembled.

MRP takes into account lead �mes. As long as the planning lead �mes used in MRP are valid, then the priority of each item should be based on the MRP lead �mes. Therefore, in an MRP system, priori�es are determined by referring to the planned order releases and lead �mes. Thus, the dispatching rules are irrelevant to MRP systems. Instead, MRP works from the order due dates, scheduling order releases far enough ahead of �me that the due dates should be met. Unfortunately, there s�ll may be conflicts at machines and work centers that need to be addressed.

Machine Loading

The dispatching rules previously described a�empt to determine a schedule based on the a�ributes, such as due date or processing �me, of each job. However, the �me it takes for a job to be processed consists of the following five components:

1. Wait �me 2. Move �me 3. Queue �me 4. Set-up �me 5. Run �me

Wait �me is the �me a job spends wai�ng before it is moved to the next work center. Move �me is the material-handling �me between work centers. Queue �me is the �me a job spends wai�ng to be processed at a work center. Set-up �me is the �me to prepare a machine to process that job, and run �me is actual processing �me.

In general, all of these components—except queue �me—will be nearly fixed. Queue �me really depends to a large extent on the workload that has been scheduled for each work center. If a machine's capacity is being used extensively, then it is more likely that many jobs will be wai�ng for processing at that machine. When the capacity of a work center is exceeded, lines of work (queues) will build up in front of that work center.

Loading is an approach to scheduling that a�empts to take capacity u�liza�on into account. There are several different approaches to loading, but loading begins with scheduling.

Forward Scheduling

Suppose scheduling begins immediately so that each job starts at the earliest possible moment. This is called forward scheduling. As jobs progress through a produc�on facility, each work center will have a certain workload placed on it from the jobs assigned to that work center. Figure 12.6 illustrates the schedule that could be generated by forward scheduling four jobs (A, B, C, and D) through three work centers (lathe, mill, and drill). This schedule assumes six hours for wait and move �me between machines. Note that the jobs use the same three work centers, but use them in different orders, so Opera�on l for Job A uses the lathe, but Opera�on l for Job D uses is the drill. Also note that Job B and Job D do not use the lathe and the mill, respec�vely.

Figure 12.6: Forward schedule for four jobs with finite loading

Work Center Sequence and Processing Time

(Number Is Sum of Set-up and Run Times in Hours)

Job Opera�on I Opera�on II Opera�on III

A Lathe 3 Drill 2 Mill 4

B Mill 4 Drill 3

C Lathe 2 Mill 3 Drill 4

D Drill 5 Lathe 4

In a forward schedule shown in Figure 12.6, each job begins as close to �me zero as possible, and each job is scheduled similarly through the successive opera�on, allowing six hours for wait and move �me between machines. Some jobs have been delayed (queue �me) at certain work centers because another job had already started at that work center.Processing math: 0%

For example, Job C had to wait three hours before it could start on the lathe because Job A was s�ll being processed on that machine. This approach of making one job wait if another has been scheduled on the same machine is called finite loading because it takes into considera�on the limited capacity on each machine. Another approach uses infinite loading, which does not take capacity considera�ons into account. Infinite loading assumes that there is unlimited or infinite capacity.

Backward Scheduling

Backward scheduling starts from a desired due date and works backward. The informa�on for the four jobs and three work centers previously presented is used again, but the following due dates are added:

Job Due Date

A Hour 24

B Hour 16

C Hour 24

D Hour 16

In this case, infinite loading will be used, elimina�ng the problem of more than one job at the same work center at the same �me. The resul�ng schedule is shown in Figure 12.7. Backward scheduling begins by scheduling the last opera�on for each job so that it would end at the �me due, and then works backward through each opera�on. As a result of infinite loading, some work centers have been scheduled to do more than one job at one �me. This may not be a problem if more than one machine is available. Actually, either finite or infinite loading can be used with either forward or backward scheduling.

Figure 12.7: Backward schedule for four jobs with infinite loading

Either of the preceding schedules can also be used to generate a load profile for each work center. A load profile indicates the workload being placed on that work center. Figure 12.8 shows the load profiles for the backward schedule of Figure 12.7 at an hourly rate. These load profiles were obtained by adding up the number of jobs scheduled during each hour for each machine. No�ce that any hour in which more than one hour of machine �me is scheduled could present a problem if only one of each machine is available.

Figure 12.8: Load profiles for backward schedule

Forward and backward scheduling are both widely used—and many companies use both. Forward scheduling is useful for jobs that need to start immediately. Backward scheduling works well when a desired due date is specified. Both finite and infinite loading can be used with forward and backward scheduling. Finite loading requires much more effort for companies to keep track of which jobs are scheduled for which machines and at what �me. Unforeseen problems, varia�ons in processing �me, and other factors can combine to make this a wasted effort. Therefore, most companies use infinite loading and then address over-loaded work centers a�er examining the load profile.

This approach to scheduling helps to point out the importance of capacity requirements planning and its �e-in with both the medium-range produc�on plan and the master schedule. While capacity requirements planning is only a rough es�ma�on, it s�ll helps to ensure that sufficient capacity will be available. If the master schedule indicates a realis�c capacity, then infinite loading does not o�en produce too many problems.

Sequencing

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When using a forward schedule with finite loading, two jobs are not allowed to be in the same work center at the same �me. Thus, if Job 1 had been started at work center A, Job 3 had to wait. But, would it have been be�er to start Job 3 on work center A first and make Job 1 wait? To answer that ques�on, it is possible to use a tool to schedule each work center— the Gan� load chart.

Each work center can be indicated by one bar on the Gan� load chart. The job being processed at each work center and its processing �me can also be indicated. Figure 12.9 shows the Gan� load chart that corresponds to the forward finite load schedule of Figure 12.6. The primary difference between the forward schedule shown in Figure 12.6 and the Gan� load chart in Figure 12.9 is that the former is organized by job and �me, and the la�er is organized by opera�on and �me. The Gan� load chart is very useful for finite scheduling because it allows only one job to be run on each machine or work center at one �me. Any conflicts will immediately become apparent.

Figure 12.9: Gan� load chart for forward schedule

Input/Output Control

Input/output control is a simple method for managing work flow and queue lengths. If work is put into a work center faster than it comes out, a queue will build up. If work is put in at a slower rate than it comes out, the work center may run out of work.

Figure 12.10 shows the input/output report for a work center. The cumula�ve devia�on of actual input from planned input, and cumula�ve devia�on of actual output from planned output are recorded each week. Further, the cumula�ve change in backlog is determined each week by comparing actual input to actual output. For example, in week 43, actual output exceeds actual input by 30 hours. Therefore, the cumula�ve backlog decreases by that amount. In week 45, actual input exceeds actual output by 20 hours, therefore, backlog increases by 20 hours.

Figure 12.10: Input/output report in standard hours

Simulation in Developing Schedules

Scheduling and sequencing can be rather difficult in some situa�ons. This is especially true in job shops where many different end products require different opera�ons. Unfortunately, manually developing schedules in such situa�ons can be extremely �me consuming and difficult because there are too many combina�ons to consider.

Computers help to address this difficulty. Using simula�on techniques, it is possible to develop a trial schedule on the computer and then test that schedule without actually processing the jobs. Through this simula�on, poten�al problems can be iden�fied and an improved schedule can be developed. Today, more companies are developing computer simula�on programs to help solve their scheduling problems.

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