day 2 basic tools pg 75-127

8/10/2019 Day 2 Basic Tools Pg 75-127

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GLIM Pag

BEP :A REFRESHER AS EVERYONE SEES IT

Given overleaf is a recap note on Break Even Point analysis, as relevant to Service

Operations Management.

As I am sure, you would have already dealt with this topic as part of other subjects.

Hence go through this recap to avoid duplication prior to class.

We will discuss only specific issues of relevance to us service operations professionals.


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GLIM Pag

Recap notes on break even point concept as relevant to Operations Management

Different ways of classifying cost:

Costs involved in the a manufacturing or service process can be classified invarious

ways: For example as:

o Fixed costs and variable costs

o Direct costs and indirect costs

o Average costs and marginal costs

o Standard costs

Fixed and Variable cost

Fixed costsdo not change when production is higher or lower.

Examples of fixed costs:

Lighting, heating and power of factory

Wages and salaries of workers

Rent of building

Insurance on vehicles or fire insurance

Variable costschange in direct relation to the level of production.

Examples of variable costs:

More raw materials will be used when production levels increase.

You might need to employ more workers, and hence more wages when

production level is increased.

Increased production can also lead to workers having to work overtime.

Direct & Indirect Cost

Direct costscan be directly linked with the product that is produced. Example :The raw

material used for a product is a direct cost.

Indirect costsare not directly linked to the product or the production process. Example :

rent of the factory, administration cost of the business, the wages and salaries of the

administration staff.

Average Cost & Marginal Cost


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GLIM Pag

Average cost of producing an articleis found by dividing the total number of units

manufactured by total cost. If production levels increase, the unit cost of an article will

decrease. This is because the fixed cost stays the same although the variable costs

increase in direct relation to the increased production.

Marginal costis the cost of making one product. It is calculated by looking at the

difference in total costs if one extra item is produced.

Example:

o To produce 50 chairs costs $2000.

o If 51 chairs are produced the total cost will increase to $2020.

o Average Cost:

The averagecost of one chair if 50chairs are produced: $2000 / 50 =

$40.

The averagecost of one chair if 51chairs are made: $2020 / 51 = $39.6.

o Note: Production costs can go down when more units are produced, because the

fixed costs stay the same only variable might be incurred.

Marginal Cost

The marginal cost to make an extra chair is $20.

The average cost of making 51 chairs is $39.6. The average cost per

chair decreases because the fixed costs stay the same.

o Another Example

o In a Photocopy shop

Output in

pages

photocopied

Fixed costs

in $ [ rental for

place and

machine]

Total Variable

costs $ ( of

manpower and

consumable)

Total cost

incurred $

0

1,000

2,000

1,500

1,500

1,500

0

500

1,000

1,500

2,000

2,500

When 1,000 units are produced the unit cost is $2 Total cost/number of units

When 2,000 units are produced the unit cost decreases to $1.25 2,500/2,000.From

the example you can see that when more units are produced the cost of producing one

unit decreases.

BEP AS WE KNOW


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GLIM Pag

A business reaches the break-even point in production when the total sales value equals the total

cost incurred to produce the item. At this point no profit or loss is made

Example of working out the break-even point

Consider a haircutting saloon. The fixed cost of a business is $10,000 and the variable

cost of each persons hair cut unit is $8. The firm charges $12 per p

Calculate the break-even point:

Number of

customers

Fixed

costs $

Variable

costs $

Total

costs $

Revenue @

$12 per unit

Profit/

(Loss) $

0

1,0002,000

2,500

3,000

10,000

10,00010,000

10,000

10,000

0

8,00016,000

20,000

24,000

10000

18,00026,000

30,000

34,000

.0

12,00024,000

30,000

36,000

(10,000)

(6,000)(2,000)

Break even

2,000

Any unit produced over 2,500 will result in a profit

One formula to calculate the break-even point

Fixed cost-------------------------------------------------------

selling price per unit less variable cost per unit

= 10,000 / (12 - 8) = 10,000 / 4 = 2,500 units

BEP CHART:


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GLIM Pag

When we put this on a graph we need to look at:

Sales Revenue -this is plotted against units sold. [The higher the price the steeper the

gradient line. The lower the price the less steep is the gradient line.] This is the line marked

sales revenue in the diagram below.

Fixed Cost line -Before commencing production a firm must buy what are known as its

FIXED ASSETS. As such they have to be paid for regardless of output. Let's say that in our

example the fixed costs are $10,000 whether we fully produce or make a complete zero

amount of whatever it is we are producing. We can see in the diagram below that the fixed

costs line is horizontal.

Variable Cost line:Next we need to look at our variable costs, which do vary with changes

in output. Therefore the line on the diagram is upward-sloping. At zero production we will not

incur any variable costs but as we expand production for each successive unit made we incur

additional cost of say 3$.

Total Cost line: When we add the fixed costs to the variable costs we get total costs line.

With fixed costs needing to be paid for regardless of sales, we can predict that in most

companies low levels of sales will not result in profits.

However, as sales increase so the fixed costs are being spread over a larger output and will

reduce per unit sold. To put this in more technical language the average fixed cost will start to

fall. So, if for example output is 100 units, fixed costs are $100 per unit produced, then if

output rises to 2000 units the average fixed cost will be $5 per unit produced.

The output required to break even is 2000 units (as marked break-even on the diagramabove), at which level the total sales revenue and costs equate at $16000.

It is always sensible to leave some room for change and so we introduce the concept of

margin of safety. This is the difference between the actual output and the break-even output.

So, if this company couldroduce 3000 items its margin of safety is 1000 units.

Mini caselet Dog Grooming & BEP: Linear


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GLIM Pag

After working for ten years as a dog groomer, youre thinking of starting your own dog grooming

business. You found a place you could rent thats right next to a popular shopping center, and two

of your friends (who are also dog groomers) have agreed to work for you. The problem is that you

need to borrow money to start the business and your banker has asked for a breakeven analysis.

You have prepared the following cost estimates for your first year of operations:

Fixed Costs

Salaries $105,000

Rent and utilities $36,000

Advertising $2,000

Equipment $3,000

Variable Cost per Dog

Shampoo $2.00

Coat conditioner $1.50

Pet cologne $0.75

Dog treats $1.25

Hair ribbons $0.50

You went online and researched grooming prices in your area. Based on your review, you

have decided to charge $32 for each grooming.

Q 1:o Whats the breakeven point in unitshow many dogs will you need to groom in

the first year to break even?

o If you and your two employees groomed dogs five days a week, seven hours a

day, fifty weeks a year, how many dogs would each of you need to groom

each day? Is this realistic given that it takes one hour to groom a dog?

Q 2:

o If you raised your grooming fee to $38, how many dogs would you need to

groom to break even?

o At this new price, how many dogs will each of you have to groom each day

(assuming working as in Q1.)? Q 3:

o Would you start this business? What price would you charge to groom a dog?

o How could you lower the breakeven point and make the business more

profitable?

BEP As an Operation manager see it


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GLIM Pag


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Example situation- Non Linear cost / price Jeanie In 2008

Brian plans to start a tailoring shop wherein he will stitch Denim Jeans to customers

measurement. The business model he plans to follow is:

-

The customers will bring their own cloth and Jeanie the Tailors will stitch custom fit

pants.

He understands that the demand for their product Designer Jeans is strongly influenced

by the price. To assess the price at which he can offer his stitching services and hence

establish price to demand relationship Brian decides to conduct a !ar"et #esearch . He

surveys among $%%% visitors to a shopping mall by showing a sample stitched &eans how

much they are willing to pay for the stitching alone.

The research shows the following estimate of sales at different prices.

'T(T)H(*+ ,#() 'T(!TD /T0

11.2-13.2 4%%

13.2-51.2 32%

51.2-23.2 6%%

Brian has already fi7ed up a shop in Bugis.

He now estimates the costs he is li"ely to incur to include the following for the first few

months of operation:

a8

a fi7ed monthly rental of 9 62%%

b8

a counter staff with a fi7ed salary of 9 $2%%

c8

!onthly electricity etc. will be appro7imately 9 2%%


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d8

,art time tailors will be employed who will be paid 9 $1 for every pant they

cut and stitch

e8

The consumables for the pant- vi. ip ; button thread etc. would cost

appro7imately 9 6 per pant.

Brian wonders what price he should charge how much orders he should get per month

to brea" even and how much for a profit which he can ta"e home of 9 1%%% at least


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11/37

Price sales qty sale Rev fixed cost var cost TC profit

1.0 1475 1475 6500 23600 30100 -28625

2.0 1450 2900 6500 23200 29700 -26800

3.0 1426 4278 6500 22816 29316 -25038

4.0 1401 5604 6500 22416 28916 -23312

5.0 1377 6885 6500 22032 28532 -216476.0 1352 8112 6500 21632 28132 -20020

7.0 1327 9289 6500 21232 27732 -18443

8.0 1303 10424 6500 20848 27348 -16924

9.0 1278 11502 6500 20448 26948 -15446

10.0 1254 12540 6500 20064 26564 -14024

11.0 1229 13519 6500 19664 26164 -12645

12.0 1204 14448 6500 19264 25764 -11316

13.0 1180 15340 6500 18880 25380 -10040

14.0 1155 16170 6500 18480 24980 -8810

15.0 1131 16965 6500 18096 24596 -7631

16.0 1106 17696 6500 17696 24196 -6500

17.0 1081 18377 6500 17296 23796 -541918.0 1057 19026 6500 16912 23412 -4386

19.0 1032 19608 6500 16512 23012 -3404

20.0 1008 20160 6500 16128 22628 -2468

21.0 983 20643 6500 15728 22228 -1585

22.0 958 21076 6500 15328 21828 -752

23.0 934 21482 6500 14944 21444 38

24.0 909 21816 6500 14544 21044 772

25.0 885 22125 6500 14160 20660 1465

26.0 860 22360 6500 13760 20260 2100

27.0 835 22545 6500 13360 19860 2685

28.0 811 22708 6500 12976 19476 3232

29.0 786 22794 6500 12576 19076 3718

30.0 762 22860 6500 12192 18692 4168

31.0 737 22847 6500 11792 18292 4555

32.0 712 22784 6500 11392 17892 4892

33.0 688 22704 6500 11008 17508 5196

34.0 663 22542 6500 10608 17108 5434

35.0 639 22365 6500 10224 16724 5641

36.0 614 22104 6500 9824 16324 5780

37.0 589 21793 6500 9424 15924 5869

38.0 565 21470 6500 9040 15540 5930

39.0 540 21060 6500 8640 15140 5920

40.0 516 20640 6500 8256 14756 5884

41.0 491 20131 6500 7856 14356 5775

42.0 466 19572 6500 7456 13956 561643.0 442 19006 6500 7072 13572 5434

44.0 417 18348 6500 6672 13172 5176

45.0 393 17685 6500 6288 12788 4897

46.0 368 16928 6500 5888 12388 4540

47.0 343 16121 6500 5488 11988 4133

48.0 319 15312 6500 5104 11604 3708

49.0 294 14406 6500 4704 11204 3202

50.0 270 13500 6500 4320 10820 2680


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-35000

-30000

-25000

-20000

-15000

-10000

-5000

0

5000

10000

0.0 10.0 20.0 30.0 40.0 50.0 60.0


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-40000

-30000

-20000

-10000

0

10000

20000

30000

40000

0 200 400 600 800 1000 1200 1400 1600

sale Rev

fixed cost

var cost

TC

profit


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The vertical axis of this logarithmic graph is the real unit cost of adding value, adjusted

for inflation. It includes the cost that the firm incurs to add value to the starting materials,

but excludes the cost of those materials themselves, which are subject the experience

curves of their suppliers.

Note that the experience curve differs from the learning curve. The learning curve

describes the observed reduction in the number of required direct labor hours as

workers learn their jobs. The experience curve by contrast applies not only to labor

intensive situations, but also to process oriented ones.

The experience curve, like the half-life, is also an empirical observation. It states that for

each doubling of cumulative experience (total units produced from the very beginning,

not just this year), real unit cost drops by a constant percent, for example 20%. If your

first million units cost $10 each, then your next million units should cost $8 each, the

next two million units, $6.40, the next four million units, $5.12, etc. Because cost is

driven by cumulative units produced (1+1+2+4 million in our example), the rate of

decline of cost drops over time unless unit volume grows at a sufficiently high

exponential rate.

Research has shown that as the cumulative number of units of a product rises

(cumulative means the total number of units produced since the business was formed,)

the cost of producing a unit drops at a predictable rate. For example, as shown in Figure

1, every time production doubles (from 1X to 2X and from 2X to 4X), the cost of making

a unit drops by 40 percent (C1 to C2 and from C2 to C4).


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Figure 1: 40 Percent Experience Curve

To provide a numeric example, with a 40 percent experience curve the cost per unit

declines from $20.00 per unit at 10,000 units of cumulative production to $12.00 ($20 x

40% = $8, $20 - $8 = $12) at a cumulative production of 20,000 units (2 x 10,000 units.)

As can be observed, the experience curve concept is more applicable to some productsthan to others, and the rate of reduction varies greatly depending on the product and the

business.

The experience curve concept is not the same as Economies of Size. Economies of

size involve spreading a fixed amount of cost (e.g. facility cost, administration cost, etc.)

over an increasing number of units of production. Conversely, the experience curve

involves improving skills expertise, and finding new ways of doing things. Also, the

experience curve analysis is based on the number of units produced since the business

was started. Economies of size is based on the number of units produced during a

production period such as a calendar year.


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The experience curve relationship holds over a wide range industries. In fact, its

absence would be considered by some to be a sign of possible mismanagement. Cases

in which the experience curve is not observed sometimes involve the withholding of

capital investment, for example, to increase short-term ROI. The experience curve can

be explained by a combination of learning (the learning curve), specialization, scale, and

investment.

Implications for Strategy

The experience curve has important strategic implications. If a firm is able to gain market

share over its competitors, it can develop a cost advantage. Penetration pricing

strategies and a significant investment in advertising, sales personnel, production

capacity, etc. can be justified to increase market share and gain a competitive

advantage.

When evaluating strategies based on the experience curve, a firm must consider the

reaction of competitors who also understand the concept. Some potential pitfalls include:

The fallacy of composition holds: if all other firms equally pursue the strategy,

then none will increase market share and will suffer losses from over-capacity

and low prices. The more competitors that pursue the strategy, the higher the

cost of gaining a given market share and the lower the return on investment. Competing firms may be able to discover the leading firm's proprietary methods

and replicate the cost reductions without having made the large investment to

gain experience.

New technologies may create a new experience curve. Entrants building new

plants may be able to take advantage of the latest technologies that offer a cost

advantage over the older plants of the leadingfirm.


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Based on the principle:More we do a job quicker we do it

Noticed in 1930-40s during World War

Shortage of manufacturing capacity

Record of manufacturing time showed interestingtrend

Same concept honed later on y !"# in

19$0s as %&perience "ur'e(


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)t the start of production runs* Wor+ers are unfamiliar with their tas+s

,ime it ta+es to produce the first few units is high)s the wor+ers learn their tas+s* ,heir output per day increases up to a point

,hen their output le'els off to a rather constantrate

As the quantity doubled the

time required for the piece wasimpacted by the learning rate

factor


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Most aircraft manufacturing tasks experience an!" learning rate#

$f the production quantity doubles % labor&hoursrequired to assemble an aircraft is !# times originaltime#

$f 'st aircraft assembled requires '!!!! labor&hours

(nd aircraft would require !!! labor&hours

)th

aircraft would require *)!! labor&hours th aircraft would require +'(! labor&hours, and so on

10 20 30 40 50 60 70 80 90 100 110 120 130

20

80

40

100

60

Unit Number (n)

120

Labor-Hours for nth

UnitAircraft Assembly

80% Learning

Curve


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!y analying wor+ers learning situations. weare ale to estimate*

,he exact labor&hours re/uired to produce thenth unit of a production run

,he total labor&hours re/uired to produce Nunits in a production run

,he a-erage labor&hours re/uired per unit for N

units in a production run

.earning /ur-e 0 1stimating learning rate% achine Shop has a contract to manufacture 100 turines(

,he first 20 turines ha'e een completed( ,he laor-hoursre/uired for a portion of the completed turines are listed elow(se this data to estimate the shops learning rate in manufacturingthe turines(

2nit 3o# .abor&4ours 2nit 3o# .abor&4ours1 140 9

2 115 10 51

3 109 1 6

4 102 20 $5


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7earning "ur'e - )rithmetic )nalysis

"ompute the learning rate for each of the 8doules(

nits 1 and 2 115:140 ; (5429nits 2 and 4 102:115 ; (5$44nits and 10 51:9 ; (52$nits 10 and 20 $5:51 ; (539

:4 ; (5499

,he appro&imate learning rate is 5?(

,hree approaches to learning-cur'e prolems

are*

)rithmetic analysis

7ogarithmic analysis

7earning cur'e tales

%&cel calculations


23/37

Arithmetic Analysis ,he simplest approach to learning-cur'e

prolems @f we wish to find the laor-hours re/uired to

produce nth unit. and nAust happens to e anumer that is one of the douled 'alues.then this approach wor+s(

Bor e&ample if 20th

unit ta+es $5 hours . 40th

unit will ta+e (5 & $5 hours(

) tale of learning cur'e coefficients allows usto compute*

,he laor-hours for the nth unit in a

production run ,he total laor-hours for the entire

production run. where the nth unit is the lastunit in the run


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,he manager of % achine Shop wants a goodestimate of the total laor-hours re/uired tomanufacture the entire 100 turines(

)lso. he is curious aout how many laor-hourswill e needed for the last unit(

se the oser'ed 5? learning rate and 140laor-hours re/uired for the first turine tocompute your estimates(

,otal time for 100 units*

,otal 7aor-Cours Re/uired for 100 nits;

@n ,ale locate the line for the 100th unit and read across tothe ,otal ,ime column under the 5? learning rate( ,he

'alue is 43(6(

,otal 7aor-Cours Re/uired for 100 nits; 140 ; $.12 laor-hours


25/37


26/37

7ogarithmic )nalysis"ompute. using logarithmic analysis. the laor-hours

re/uired for the 0th turine (

; log :log ; - 0(2344$23

,0 ; 140

; (399$23 or (400E140; $

Selecting a learning rate

@ndustry Aournals

Cistorical e&perience

ses and limitations

Froducts and ser'ices tend to e custom designed

!atches tend to e small Froduct:ser'ices tend to e comple&(((( learning

occurs /uic+ly


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Learning curve: 80%

0.000

10.000

20.000

30.000

40.000

50.000

60.000

0 100 200 300 400 500 600

Batch Number

CAT


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Learning curve: 90%

0.000

10.000

20.000

30.000

40.000

50.000

60.000

0 100 200 300 400 500 600

Batch Number

CAT

Learning curve: 60%

0.000

10.000

20.000

30.000

40.000

50.000

60.000

0 100 200 300 400 500 600

Batch Number

CAT


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80% Learning Rate

Batches Total Time CAT

1 50.00 50.00

2 80.00 40.00

4 128.00 32.00

8 204.80 25.60

128 1,342.18 10.49


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No Learning

Batches Total Time CAT

1 50.00 50.00

2 100.00 50.00

4 200.00 50.00

8 400.00 50.00

128 6,400.00 50.00

Implications of leanin! ta"in! place as oppose#to no leanin! ta"in! place if the cost is $ 1 peho% an# each &atch has 5 pieces.


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Average Cost/unit

'nits 80( )eanin! *o )eanin!

5 10.00 10.00

10 16.00 20.00

20 25.60 40.00

40 40.96 80.00

+ +640 268.44 1,280.00

80% Learning Rate

Batches Total Time Aea!etime

1 50.00 50.00

2 80.00 40.00

4 128.00 32.008 204.80 25.60

128 1,342.18 10.49


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No Learning

Batches Total Time Aea!etime

1 50.00 50.00

2 100.00 50.00

4 200.00 50.00

8 400.00 50.00

128 6,400.00 50.00

in#%st- aea!es

Aeospace 85(

/hip&%il#in! 80 85(

a mateials 93 96(

%chase# pats 85 88(


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Problems & caselets on Learning curve

1. An assembly line for making trays of cup cakes has a 90% learning curve. The line has

begun to work on the first tray and it takes 2 minutes for the first piece. !stimate"

The time needed for the first # trays The time taken for the 20

thto 2#thtray

2.

$illing up of a form is supposed to have a learning rate of 2%. Time for the first units

are &0.#' 2.' 2(.2 and 2(.0 )oes the assumption look realistic*

&.

The company wants to identify which of the following trainees will reach the set target

of reaching + hours or less by the time they manufacture the +thpiece.

Arun took 10 hours and 9 hours for the first and second piece.

,askar took 10 hours and hours for the first and second piece.

-harles took 12 hours and 9 hours for the first and second piece.

hich trainee / trainees will make the standard* !plain your reasoning.

. A has received a pilot order for setting 20 AT3 3achines ,ased on their eperience

of setting up the first two AT34s they will be 5uoting for additional 1 such AT34s. The

contract envisages that they will be paid separately for 6abour and material costs at the

rate of cost 7 10%. They are negotiating a learning rate with the material supplier as well

The first AT3 took 0 hours to complete and cost 8 &00 in materials and e5uipment

usage. The second took &2 hours and 8 210 in material. 6abour cost is charged at 8 1

per hour.

a

!stimate the total manhours re5uired for total of 20 AT34s.

b

hat will be the average total cost for the 20 AT34s in the contract.

c

ork out the financial advantage to the customer by not estimating based on 1st

AT3 alone and basing cost based on eperience curve principle.


34/37

#.

A customer has offered you the contract for cutting and packing vegetables for salad and

supply to :TA:. The raw material will be supplied by the customer. As per the customer

each packet of cut vegetable should be ready in an average time of 1.# minutes and

they are willing to reimburse your cost at the rate of 80.#0 per minute for the labour.

The contract is for 1000 sets. ;our first test took minutes and the second &.+ minutes.

ould you take the contract*


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3ini -aselets

6.

What should Bus Chair do?

,us -hair has developed a new chair.


36/37

Supply of Coffee Vending Consumables

Messrs Cofco , is in the business of supplying coffee vending machine consumables. On

1stSeptember 200, as the ne! C"O !ho has ta#en charge, Mr. Symonds has as#ed for a

briefing on the company$s operations as !ell as an opportunity to ta#e stoc# of their

operations. %he company$s business is to supply #its comprising of all the relevant

consumables & li#e mil# po!der, coffee po!der and sugar as re'uired to be put in thecoffee ma#ing machines. %hey procure these ra! materials in bul#, re pac# and deliver

as #it set for the coffee vending machine.

Mar#eting (rief)

*n the meeting, Mr. Mar# the Mar#eting chief has informed the C"O that)

%heir analysis sho!s they cater to 2 distinctly clear mar#ets )

a+ estaurants

b+ Corporate offices

%heir last year sales !ere -00,000 #its, 0/ being sold to restaurants.

%he company mar#ets the #it at a differential pricing to the t!o mar#ets i.e. at

- for the restaurants at - for the offices.

Obviously the office #it is pac#aged nicer and delivered in smaller lots for easy

usage by individuals. %he delivery to offices is aimed at ensuring delivery !ithin

one hour of receiving the call in at least 0/ cases.

%he restaurants have a regular delivery schedule. %hey are supplied !ee#ly and

on designated days. the van from the company visits the outlets and delivers the

goods. %hey stoc# typically 2 !ee#s re'uirement

%he Mar#eting manager also e3presses his concern about the estaurant business

!herein he is e3periencing stiff competition from a ne! entrant. 4s a result he feels


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they should reduce their sales price to restaurants by at least 1 per #it. 5e feels

other!ise he might lose his mar#et share to the competitively priced ne! entrant.

%he 4ccounts head Ms. Maria brief)

%he basic cost of material in each #it is 10 per pac#.

%he labour content involved in pac#ing is 6 per pac#.

%he company$s annual costs comprise of)

o Sales commission paid at - per #it.

o 7elivery related cost 2.8 million

o Mar#eting and advertising costs 1.6 million

o 9roduct management teams cost 0. million

o

4dministration 0.6 million

%he company the overheads : not directly allotted costs given above based on the

#its sold to each mar#et segment.

7ata 4nalysis)

Mr Symond the C"O carries out basic cost calculations in the meeting to determine)

a+

Margin for both mar#et segmentsb+ the net profit for each product segment.

c+ ;hat is the assessment of the business< ;hat should he dopac#ing

and organi?ing all deliveries intervene. 5o! can the operations professional

interfere in this situation

day 2 basic tools pg 75-127

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