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Process Selection: Volume Drives Process Selection: Volume Drives Costs and ProfitsCosts and Profits
COB 300CCOB 300C
BusingBusing
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Process Selection
• Process selection includes:
– Technical issues–basic technology used to produce a service or good
– Volume or scale decision–using the proper amount of mechanization to leverage the organization’s work force
MECHANIZATION
Work Force
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Product Design, Process Selection, and Capacity Decisions
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Volume Drives Costs (Slide 1 of 3)
Quick-as-a-Blink Printing Center needs to invest in equipment to bind books. Management could purchase manual or automatic binding equipment.
Annual Variable
Fixed Labor Production
Machine Cost Cost Rate
Manual $1,000 $18/hr 10 units/hr
Automatic $9,000 $2/hr 100units/hr
The total-cost equation is as follows:
TC = FC + (VC) (Xp)
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Volume Drives Costs (Slide 2 of 3)
Manual:
TC= $1,000+ (1,000 units)
= 2,800
Unit Cost=
= $2.80 per unit at volume 1,000
$18/hr
10 units/hr
$2,800
1,000
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Automatic:
TC = $9,000+ (1,000 units)
=$9,020
Unit cost =
= $9.02 per unit at volume of 1,000
$2/hr
100 units/hr
$9,0201,000
Volume Drives Costs (Slide 3 of 3)
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Power of Volume toReduce Costs
Volume Manual Automatic
$/unit $/unit
1,000 $2.80 $9.02
10,000 1.90 .92
100,000 1.81 .11
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Finding the Pointof Indifference
At what production volume are the costs of the manual and the automatic binding equipment equal?
Total cost manual = Total cost automatic
$1,000 + ? (X) = $9,000 + ? (X)
1,000 + 1.80(X)= 9,000 + .02(X)
Solve for X:
(1.8 - .02) (X) = 9,000 - 1,000
X = 8,000 / 1.78
X = 4,494 units
$18 $2
10 units 100 units
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Understanding the Scale Factor
• Economies of scale doctrine
– most efficient size for a facility
– most efficient size for a firm
– Put a large volume of the same product across the same equipment or fixed cost base.
• Economies of scope occurs when a large volume and high variety of products are produced by the same equipment for fixed cost base
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Scale Factor: Cost-VolumeProfit Model (Slide 1 of 3)
TR= (SP) (Xs)
TR = Total Revenue
SP = Selling price/unit
Xs = Number of units sold
TC = FC + (VC) (Xp)
TC = Total cost
FC = Fixed cost
VC = Variable cost/unit
Xp = Number of units produced
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Scale Factor: Cost-VolumeProfit Model (Slide 2 of 3)
The profit (P) equation is
P = TR -TC
P = SP(Xs) - {FC + VC(Xp)}
If X= Xs = Xp, then
P = SP(X) - {FC + VC(X)}
P = SP(X) - VC(X) - FC
P + FC = (SP - VC)(X)
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Scale Factor: Cost-VolumeProfit Model (Slide 3 of 3)
Solve for X as follows:
X =
If C is defined as contribution/unit, then C = (SP - VC).
Then the equation becomes
X=
(P + FC)
(SP - VC)
C
(P + FC)
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Cost-Volume-Profit Model
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Assumptions of theCost-Volume-Profit Model
• Sales volume is equal to production volume
• Total cost and total revenue are linear functions of volume
• Historical data on costs and selling price are representative of what will happen in the future
• The organization has only one product
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Hint: Fixed cost shared by all 3 products. Coffee Pot Mixer Blender
Product mix 45% 20% 35%
Selling price/unit 12 16 9
Variable cost/unit 6 7 4
Contribution unit 6 9 5
Profit target = $20,000/yr.
Fixed cost = $30,000/yr.
WC = .45($12/unit - $6/unit) + .2($16/unit - $7/unit) +.35($9/unit -$4/unit)
= $6.25 unit
Multiple-Product Case (Slide 1 of 3)
WC M SP VCi i ii
n
( )
1
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Multiple-Product Case (Slide 2 of 3)
In the multiple-product case, the weighted contribution per unit substitutes for the contribution per unit.
X=
= $20,000 + $30,000
$6.25/unit
= 8,000 units
P + FC
WC
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Multiple-Product Case (Slide 3 of 3)
Interpreting the results: The variable X is measured as a composite unit,
that is, a unit consisting of 45% coffee pot, 20% mixer and 35% blender. One composite unit
.45 .2 .35
Coffee Pot Mixer Blender
Product Mix No. Required
Coffee Pot .45 3,600 units
Mixer .20 1,600 units
Blender .35 2,800 units
8,000 units
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Cost Structure of Low-Volume Producer
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Cost Structure ofHigh-Volume Producer
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Operating Leverage
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Matching Process Alternatives with Product Characteristics
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Characteristics of theProcess Alternatives
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Process Flows Before and After Applying Group Technology (Slide 1 of 2)
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Process Flows Before and After Process Flows Before and After Applying Group Technology Applying Group Technology (Slide 2 of 2)(Slide 2 of 2)
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Automation Systems
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Problems with Managing Large, Unfocused Operations (Slide 1 of 2)
• Growing facilities add more levels of management and make coordination and control difficult
• New products are added to the facility as customers demand greater product variety
• Hidden overhead costs increase as managers add staff to deal with increased complexity
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Problems with Managing Large, Unfocused Operations (Slide 2 of 2)
• The result is higher operating costs
– Productive time is being taken to do setups
– More mistakes are made by attempting to manage increasing complexity with control systems designed for a single product facility
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Focused Factory
• Smaller facility (less than 500 employees) concentrates on one or few products
• Limits scope of operations to a few process technologies
• Strives only for highest level of quality
• Strives for simplicity in management and control