Tag: capacity

Bottleneck Orientation

Bottleneck Orientation

Various reasons can lead to the fact that products and services manufactured or refined in-house cannot be delivered according to customer requirements, i.e. in line with incoming orders.

The possible causes are manifold:

    • Insufficient inventory of finished or semi-finished products
    • Lack of raw materials or late deliveries from suppliers
    • Energy or other operating material deficiencies
    • Failure of machines or tools
    • Insufficient personnel capacities in production cost centers
    • Delayed final quality inspections of manufactured items
    • Insufficient production capacities of certain facilities

In such situations, it is important to identify the respective bottlenecks and to master them in such a way that the available capacities are used optimally until the bottleneck is eliminated. This optimal utilization occurs when the maximum possible contribution margin I is generated, taking into account the dominant bottleneck in each case. Because, as has been shown several times in this blog, the contribution margins generated are used to cover fixed costs and profit.

Cost center planning

In the example company Ringbook Ltd. the sleeves and closing mechanisms are joined together to ring binders ready for sale in the assembly cost center. For this purpose 4 parallel assembly lines are available. Each of these lines is in operation for 8 hours per working day. With 230 annual working days, the capacity of each line is 230 * 8 * 60 minutes = 110,400 minutes. Together all four assembly lines have an annual capacity of 441,600 minutes.

Production management planned an annual activity of the assembly area of 422’400 minutes (see lines 1 – 3). The capacity of 441,600 minutes should therefore be sufficient for the planned production. For each piece of ring binder produced, an employee in the assembly department works 1 minute. 57,600 minutes are planned per year for organization, cleaning, maintenance and training (lines 6 and 7). In total, the presence time of the five employees (including cost center managers) amounts to 480,000 minutes. After taking into account the other direct costs, the costs directly caused by the products amount to 278,784 in line 11 in the “proportional” column and the proportional planned cost rate of 0.66 per minute in line 12.

Bottleneck orientation
Costcenter plan “Assembly”

Product costing and contribution margins

In lines 13 – 19, the product costing and contribution margin calculation can be traced. Product A requires 10 minutes per piece in the assembly line, product B 6 minutes. Together with the costs for the envelope and for the binder mechanism, the proportional costs per unit result in line 16. In line 18, the contribution margins per unit are calculated.

Calulation CMi
Contribution margin per unit

 

Machine breakdown in assembly

One of the four assembly lines suffers a machine breakdown. The supplier reports that four months !! will pass until the necessary spare parts will be delivered and the plant will be ready for operation again. As a result, one third of the capacity of one of the four lines is missing, namely 36,800 machine minutes (cf. line 4: 441,600 / 4 / 12 x 4). These are no longer available for assembly.

The production manager wants to reduce the production of product A because each unit of A requires 10 minutes of production time, whereas for product B it is only 6 minutes per unit (line 2). The sales manager replies in the management meeting that the contribution margins of the products must be considered before the production program is determined. Who is on the right track?

Line 19 gives the answer. Product A generates a CM I per piece of 15.10. Per minute of bottleneck usage (cost center assembly) this is 1.51. Product B uses the bottleneck less, but because of the lower sales price “only” generates a CM I of 1.12 per minute.

CMI bottleneck
CMI per bottleneck unit

If the remaining capacity of 73,600 minutes (line 20) were used exclusively for product A, a CM I of 111,136 could be generated, while concentrating on product B would generate 82,677 (line 22). This is, of course, a hypothetical calculation, since what has to be produced is what the customers buy. However, the difference of 28,459 CM I between the two products shows that concentrating on the products that are stronger in terms of the bottleneck leads to a higher total CM I and thus to a better company result.

This example intends to show that in operational management it is necessary to analyze in each case how a bottleneck affects the overall result, e.g. earnings before interest and taxes (EBIT). For this purpose, the CM I per bottleneck unit must be calculated. Bottlenecks can be raw materials that are difficult to procure, insufficient service availability from suppliers, own personnel capacities or the availability of own equipment.

If the activity level decreases, but the personnel cannot be used in other cost centers or cannot be committed to a lower degree of employment, the fixed costs, resp. the spending variances of the considered cost center increase. To avoid this is the task of the cost center manager concerned.

Piloting in Production

Tracking capacity utilization and measuring process improvements are essential elements of piloting in production.

Piloting in Production

Piloting in Production is neccessary because also the development in the areas of production or services requires a multi-year view. Strategic intentions often lead to the rebuilding or further development of existing processes and capacities, while operationally the focus is on improving one’s own cost position compared to the competition (produce cheaper than the competition can).

Foreseeable capacity limits

Usually it can be assumed that larger quantities will have to be produced in the next years and that the variety of the product range will become broader at the same time.

This means it is necessary to build up and maintain personnel and machine capacities and to find ways to reduce the cost per unit. In terms of capacity, several questions arise:

    • When will plants or cost centers reach their capacity limit and require an expansion step? By comparing the monthly actual activity of a cost center to its available capacity, it becomes apparent which are the bottleneck cost centers. These could prevent the achievement of revenue and contribution margin targets.
    • When will the headcount of a unit have to be increased?
    • Can batch sizes be increased to reduce setup and setup-times per piece?
    • How can waste be reduced, i.e. down-times shortened, yields increased and scrap reduced?
    • Can transport and waiting times between processing steps be reduced?

The last two points are central elements of “Lean Production“. In order to be able to assess the intended effects also in terms of value, these effects should be mapped in management accounting. If waste is to be reduced, this must be reflected in lower proportional unit costs (material and labor) as well as in lower fixed costs of the cost centers. Lean production targets are therefore incorporated into bills of materials and workplans as standards to be achieved, and thus also into planned product costing. Reduced waste in production management leads to lower fixed cost targets in the respective cost centers.

Development of staff and its qualifications

Assuming that personnel requirements needed for production will increase in the medium term, further piloting information becomes significant for each cost center:

    • How many employees will retire and in which years?
    • How many trainees will have completed their education by then and could fill the vacancies?
    • What are the personnel requirements to be recruited on the labor market for the next years?
    • What training or knowledge deficits need to be addressed so that production can run as smoothly as possible?

Both in manufacturing companies and in the retail sector, scrape can be a significant waste factor. Scrapping is the result of too large purchase orders or too high production orders. It leads to additional fixed costs because:

    • material spoils after a certain time or suffers quality losses,
    • more than the dispatched quantity is produced in order to completely process the obtained material and thus not have to deliver leftovers back to the warehouse,
    • the sales department hopes to be able to sell the remaining stock later and therefore asks the production department to produce more than ordered.

It is therefore advisable for production and purchasing managers to monitor the development of scrapping costs on an item-by-item basis at least annually and, if necessary, to adjust planned production.

Despite the increasing use of information technology, the workload tends to increase in the area of production planning and control and in management. Keywords are e.g.: Master data quality, more detailed planning, batch tracking, complaints processing, documentation, production data acquisition and employee support. These internal tasks should also be recorded in the production data acquisition,so that it becomes analyzable for which jobs how much working time is used for each job and how hourly requirements change over time.

Measure continuous process improvement

The increase in the range of products offered led to more but smaller production orders in the Stamping shop. In addition, the quantity produced increased by almost 20% over 5 years (from 6,000 to 7,100 pieces). This increase could be managed by 4 people (including the boss) without additional personnel. Although the total production costs of the cost center have increased by about 5% in these five years (wage increases), the stamping shop nevertheless produces today at a lower cost per piece.

The following factors have contributed to this:

    • Starting in year 2 the relief of the cost center manager through the introduction of electronic production data acquisition. The time freed up allowed him to work more directly on the products.
    • Shorter setup times per production order.
    • Process-oriented training of the employees led to fewer errors and shorter processing times per piece.

Overall, waste was reduced to a gratifying degree (Lean) over the years. But at the end of year 5 the stamping shop is the bottleneck for production output. If sales and thus production volumes continue to rise, additional staff needs to be engaged on time.

Piloting in production
Continuous process improvement and proportional costs per unit

From the graphical representation, the effects of these improvement measures can be seen when the analysis is approached in more detail:

    • Stamping shop full unit costs increased from 500,000 to 522,586 in year 5 (+4.5%). This is due to wage increases and price increases in supplies and operating materials.
    • Due to the process improvements mentioned above, the output produced increased from 6,000 units to 7,100 units, while the processing hours consumed for this purpose only increased from 6,000 to 6,450 hours. This explains why, in the graph on the right, proportional unit costs fell from 60.00 to 57.28 despite wage increases.
    • Fixed costs have decreased to 115,907 due to the introduction of operational data collection and due to the efforts of the cost center manager to perform internal tasks with less workload (left graph). As a result (in purely arithmetical terms), the fixed production costs per unit fell from 23.33 to 13.60 (right graph).

By reducing fixed costs and increasing productivity in manufacturing, this cost center has made an important contribution to improving the company’s cost position. As long as market prices remain the same, the company generates higher profits. If the competition lowers selling prices, e.g. to gain market share, the company can follow and still remain in the profit zone.

Observing the piloting variables of production and their development over time reveals where internal process and structural adjustments offer opportunities to strengthen competitiveness. Therefore, piloting is an essential part of integrated operational planning and control.