IB Design and Technology Product Development Economic Considerations

Cost Factors The final cost of producing a product is determined by a number of cost factors: Design & development costs Design & development costs Scale of production Scale of production Complexity of product Complexity of product Material requirements (including cost of procurement and availability) Material requirements (including cost of procurement and availability) Resources and skill requirements (including labour) Resources and skill requirements (including labour) Quality control Quality control Size and weight of product (for storage and distribution) Size and weight of product (for storage and distribution) Type of advertising and marketing Type of advertising and marketing Resources and Distribution (R&D) Resources and Distribution (R&D) Profits Profits Taxes Taxes Labour Labour Manufacturing costs Manufacturing costs capital costs capital costs overheads overheads distribution and sales distribution and sales

Costs Manufacturing Costs = Direct Production Costs + Fixed Charges + Overhead Charges Direct Production Costs are known as Variable Costs and are costs that vary with output, e.g. fuel or raw materials. Fixed Charges and Overheads are collectively knows as Fixed Costs and are the costs that must be paid out before production starts, e.g. machinery. These costs do not change with the level of production.

Cost Factors Identify which of the following cost factors are Fixed and which are Variable. Design & development costs Design & development costs Scale of production Scale of production Complexity of product Complexity of product Material requirements (including cost of procurement and availability) Material requirements (including cost of procurement and availability) Resources and skill requirements (including labour) Resources and skill requirements (including labour) Quality control Quality control Size and weight of product (for storage and distribution) Size and weight of product (for storage and distribution) Type of advertising and marketing Type of advertising and marketing Profits Profits Taxes Taxes

We will use the following example of a product which cost $500 in design, development and set-up/tooling costs and has a production cost of $1 per item. This is vary simplified data to illustrate the point. In reality, the variable cost does not increase at such a predictable rate as there are economies of scale to be considered.

Production Costs As production number increases, so variable costs increase. Fixed costs remain steady.

As production increases, the proportion of the fixed cost that must be returned from each sale falls

The total cost per product is found by adding together the variable cost and the fixed cost assigned to an individual product at each production level.

By adding on a profit margin (the amount of profit to be realised by an individual sale – in this case $10) the selling price per product can be determined. This type of exercise allows producers to determine most effective scale of production and economic selling price.

Breaking Even Once a “Break even” point is reached, profits can be made, because the fixed costs have been covered. Variable costs will continue to rise with increased production. Once a “Break even” point is reached, profits can be made, because the fixed costs have been covered. Variable costs will continue to rise with increased production.

The relative significance of fixed and variable costs to the selling price of a product can vary. Consider the following two examples: Hand crafted mahogany table – craft production Hand crafted mahogany table – craft production Injection moulded aerosol nozzle - automation Injection moulded aerosol nozzle - automation In which example would fixed costs (machinery & tooling) be significantly higher than variable costs (material, labour)? In which example would the reverse apply? Why?

Type of Production To add further to the confusion when determining level of production, manufacturing costs and, ultimately, selling price the producer also has to decide whether they are going to carry large amounts of stock and have it standing by ready for the orders OR have virtually no stock and simply make the required number each time. This is known as Just In Case (JIC) or Just In Time (JIT).

Advantages & Disadvantages of JIC Advantages Buffer of goods in stock in case of unforeseen circumstances and rapid changes in demand Buffer of goods in stock in case of unforeseen circumstances and rapid changes in demandDisadvantages Unsold stock Unsold stock Space needed for storage Space needed for storage Increased capital investment required Increased capital investment required

Advantages & Disadvantages of JIT Advantages Saving on storage space Saving on storage space Increased efficiency Increased efficiency Reduced capital investment Reduced capital investment Reduced work in progress Reduced work in progress Fewer unsold items Fewer unsold itemsDisadvantages Possible stoppages due to non-delivery of external components, communication breakdown or distribution and transportation breakdown Possible stoppages due to non-delivery of external components, communication breakdown or distribution and transportation breakdown