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5.7 Production Planning Chapter 36

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The cost of STOCKS Stocks are materials and goods required to allow the production and supply of products to the customers. Stocks are materials and goods required to allow the production and supply of products to the customers. The cost of storing and warehousing stocks is commonly calculated at 4%-10%. The cost of storing and warehousing stocks is commonly calculated at 4%-10%. This can be an area of great cost-savings to business.

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Types of STOCK Retail business: Retail business: Goods on display Goods on display Goods in the warehouse waiting to be shelved Goods in the warehouse waiting to be shelved Goods on the shelves waiting to be sold Goods on the shelves waiting to be sold

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Type of STOCK Service business (Banks, Insurance) Service business (Banks, Insurance) Office supplies Office supplies Stationery Stationery

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Type of STOCK Manufacturing business Manufacturing business 1. Raw materials & components 1. Raw materials & components Purchased from outside suppliers. They are held until ready to be used in the production process. Purchased from outside suppliers. They are held until ready to be used in the production process. 2. Work-in-Progress (Work-in-Process) 2. Work-in-Progress (Work-in-Process) The raw materials and components currently being finished into the final good. Batch production has high levels of WIP stock. The raw materials and components currently being finished into the final good. Batch production has high levels of WIP stock. 3. Finished Goods 3. Finished Goods Items that have completed the production process and are ready to sell. Items that have completed the production process and are ready to sell.

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Stock-holding Costs What costs are associated with holding stocks? What costs are associated with holding stocks? Opportunity Cost Opportunity Cost Working capital tied up in the cost of stocks that could be used elsewhere (pay off loans, pay vendors, left in bank earning interest) Storage Cost Storage Cost Warehouse costs (air conditioning, refrigeration, security, insurance) Risk of Waste and Obsolescence Risk of Waste and Obsolescence If stocks are not sold quickly, they may become out-dated, obsolete, damaged, or deteriorate.

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Costs of not holding ENOUGH Stock Lost sales Lost sales Including future potential orders Including future potential orders Payment penalties if you cannot meet delivery dates Payment penalties if you cannot meet delivery dates Idle production resources (if raw material or component stocks run out) Idle production resources (if raw material or component stocks run out) Expensive equipment not operating Expensive equipment not operating Paying labor that is not working Paying labor that is not working Special orders could be expensive Special orders could be expensive Unexpected special orders could be expensive or impractical to deliver Unexpected special orders could be expensive or impractical to deliver Small order quantities means: Small order quantities means: Expensive delivery Expensive delivery No economy of scale discounts on large orders No economy of scale discounts on large orders

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Economic Order Quantity (EOQ) Economic Order Quantity is the optimum quantity of stock to re-order taking into account delivery costs and stock-holding costs. Economic Order Quantity is the optimum quantity of stock to re-order taking into account delivery costs and stock-holding costs.

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Controlling Stock Levels Buffer Stocks Buffer Stocks The minimum amount of stock that should be on-hand to ensure production can take place in the event of delivery delays or unexpected production increases. The minimum amount of stock that should be on-hand to ensure production can take place in the event of delivery delays or unexpected production increases. Maximum Stock Level Maximum Stock Level The most stock that can be held due to space limitations, financial costs, or deterioration The most stock that can be held due to space limitations, financial costs, or deterioration

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Controlling Stock Levels Re-Order Quantity Re-Order Quantity The number of units to be ordered each time an order must be placed with a supplier. This will be influenced by the EOQ Economic Order Quantity. The number of units to be ordered each time an order must be placed with a supplier. This will be influenced by the EOQ Economic Order Quantity. Lead Time Lead Time The time it takes between ordering and delivery The time it takes between ordering and delivery

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Controlling Stock Levels Re-Order Stock Level Re-Order Stock Level The level at which reordering of more stock is triggered. It takes into consideration buffer stock and lead times of new stock arrival. The level at which reordering of more stock is triggered. It takes into consideration buffer stock and lead times of new stock arrival. Material Requirements Planning Systems Material Requirements Planning Systems Re-Order Stock levels can be set in computerized production planning systems (MRP) to trigger automatic ordering to suppliers. Re-Order Stock levels can be set in computerized production planning systems (MRP) to trigger automatic ordering to suppliers. EDI Electronic Data Interchange is a common computerized communication system between production factory and supplier EDI Electronic Data Interchange is a common computerized communication system between production factory and supplier

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Just-in-Case Stocking (JIC) Just-in-Case stocking holds high stocking levels in case there is a problem with receiving from suppliers or an unexpected increase in sales. Just-in-Case stocking holds high stocking levels in case there is a problem with receiving from suppliers or an unexpected increase in sales. JIC Large Inventory Factory Production

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Advantages/Disadvantages of JIC AdvantagesDisadvantages Easy to meet unexpected increase in demand by increasing production Easy to meet unexpected increase in demand by increasing production High opportunity costs of working capital tied up in stock costs High opportunity costs of working capital tied up in stock costs Raw-material hold-ups will not lead to stopping production Raw-material hold-ups will not lead to stopping production High storage costs High storage costs Economies of scale are realized with bulk buying discounts Economies of scale are realized with bulk buying discounts Risks of damaged stocks or outdated stocks Risks of damaged stocks or outdated stocks Stocks of finished products are plentiful so they can be displayed for potential customers Stocks of finished products are plentiful so they can be displayed for potential customers Getting it right is less important because of replacement stocks which increases costs Getting it right is less important because of replacement stocks which increases costs Stocks of finished good can meet sudden increased of consumer demand because they are finished and warehoused Stocks of finished good can meet sudden increased of consumer demand because they are finished and warehoused Space to store stock cannot be used for other purposes Space to store stock cannot be used for other purposes Stockpiles of inventory can meet expected increases such as seasonal items Stockpiles of inventory can meet expected increases such as seasonal items

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Just-in-Time Stocking (JIT) Just-in-Time stocking aims to avoid holding extra stocks and requires suppliers to send stock when needed on the production on the line. Just-in-Time stocking aims to avoid holding extra stocks and requires suppliers to send stock when needed on the production on the line. JIT Inventory Factory Production

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Advantages/Disadvantages of JIT AdvantagesDisadvantages Opportunity cost is reduced because less is invested in stocks Opportunity cost is reduced because less is invested in stocks Any failure to receive stocks can lead to production delays Any failure to receive stocks can lead to production delays Costs of storage are reduced Costs of storage are reduced Delivery costs increase as smaller quantities are delivered Delivery costs increase as smaller quantities are delivered Storage space can be used for other productive purposes Storage space can be used for other productive purposes Administration costs rise because more attention is needed to multiple orders Administration costs rise because more attention is needed to multiple orders Less opportunity for stock to become outdated or damaged Less opportunity for stock to become outdated or damaged Reduction in bulk discounts pricing because of smaller orders Reduction in bulk discounts pricing because of smaller orders More flexibility in production is required which leads to adapting to changing customer needs More flexibility in production is required which leads to adapting to changing customer needs Significant dependence on outside factors the quality and dependability of outside suppliers Significant dependence on outside factors the quality and dependability of outside suppliers Multi-skilled workers may be more motivated Multi-skilled workers may be more motivated

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JIT not suitable to everyone What if costs of halting production because of no stocks is TOO expensive or risky? What if costs of halting production because of no stocks is TOO expensive or risky? Expensive computer systems are needed and small firms may not be able to justify the cost for potential cost savings. Expensive computer systems are needed and small firms may not be able to justify the cost for potential cost savings. Raw material costs or delivery costs may actually rise making future production more expensive with newer raw materials. Raw material costs or delivery costs may actually rise making future production more expensive with newer raw materials.

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Stock Control Chart 300 125 50 0 Max stock level Re-Order Level Buffer Stocks Time

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Capacity Capacity utilization is the proportion of maximum output capacity currently being achieved when compared with the total capacity available. Capacity utilization is the proportion of maximum output capacity currently being achieved when compared with the total capacity available. HL Current output level Maximum output level X 100 = rate of capacity utilization Plant A can produce a maximum of 5000 widgets. They are currently producing 3000 widgets. There current rate of capacity is (3000/5000) X 100 = 60%

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Impact on Average Fixed Costs When capacity utilization is high. Then average fixed costs are spread over more units causing a decrease in average fixed costs When capacity utilization is high. Then average fixed costs are spread over more units causing a decrease in average fixed costs When capacity utilization is low. Then average fixed costs are spread over fewer units causing an increase in average fixed costs When capacity utilization is low. Then average fixed costs are spread over fewer units causing an increase in average fixed costs HL

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Maximum Capacity Are there any downsides to operating at maximum or full capacity? Are there any downsides to operating at maximum or full capacity? What do you think? What do you think? HL Full capacity when a business is producing at the maximum output level

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Drawbacks to operating at full capacity Staff may feel pressure of workload and added stress Staff may feel pressure of workload and added stress Operations managers cannot make any scheduling errors Operations managers cannot make any scheduling errors Regular customers cannot increase their orders and may turn to other suppliers Regular customers cannot increase their orders and may turn to other suppliers Machinery cannot be shut down for maintenance or repairs Machinery cannot be shut down for maintenance or repairs HL

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What are choices? Should more production resources be purchased? Should more production resources be purchased? Should it keep existing capacity but subcontract work to other firms? Should it keep existing capacity but subcontract work to other firms? Can work subcontracted be assured of quality? Can work subcontracted be assured of quality? Will demand fall in the near future making expansion unnecessary? Will demand fall in the near future making expansion unnecessary? HL

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Excess Capacity Excess capacity exists when current levels of demand or less than full capacity output of the business. Also known as spare capacity. Excess capacity exists when current levels of demand or less than full capacity output of the business. Also known as spare capacity. Excess Capacity Maximum Capacity Current output capacity HL

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Capacity Shortage Capacity shortage when demand for products exceed production capacity Capacity shortage when demand for products exceed production capacity When capacity shortage is determined not to be short-term, capacity expansion options need to be considered. When capacity shortage is determined not to be short-term, capacity expansion options need to be considered. HL

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Ways to expand Capacity Outsourcing (or subcontracting) Outsourcing (or subcontracting) Using another business to undertake part of the production process (It is called offshoring when this activity occurs in another country.) Using another business to undertake part of the production process (It is called offshoring when this activity occurs in another country.) Business Process Outsourcing Business Process Outsourcing A form of outsourcing but for a business function not a production function (human resources or finance) A form of outsourcing but for a business function not a production function (human resources or finance) HL

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Reasons to Outsource Reduction in costs Reduction in costs Increased flexibility Increased flexibility Only buy the amount of capacity needed when needed Only buy the amount of capacity needed when needed Improved company focus Improved company focus Management can focus on core business rather than administrative activities Management can focus on core business rather than administrative activities Quality resources Quality resources Experts can be used that may not be available internally in your company Experts can be used that may not be available internally in your company Free up resources for other business activities Free up resources for other business activities Eliminate the payroll department, now space and employee resources can be used for customer service Eliminate the payroll department, now space and employee resources can be used for customer service HL

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Drawbacks to Outsourcing Loss of jobs within your business Loss of jobs within your business Quality issues Quality issues Customer resistance Customer resistance Ethical concerns Ethical concerns Security Security HL

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Make-Or-Buy Can you buy the component or service cheaper than you can produce it yourself? Can you buy the component or service cheaper than you can produce it yourself? HL