5.7 Production Planning Chapter 36

The cost of STOCKS 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%. This can be an area of great cost-savings to business.

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

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

Type of STOCK Manufacturing business 1. Raw materials & components Purchased from outside suppliers. They are held until ready to be used in the production 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. 3. Finished Goods Items that have completed the production process and are ready to sell.

Stock-holding Costs What costs are associated with holding stocks? 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 Warehouse costs (air conditioning, refrigeration, security, insurance) Risk of Waste and Obsolescence If stocks are not sold quickly, they may become out-dated, obsolete, damaged, or deteriorate.

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

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.

Controlling Stock Levels 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. Maximum Stock Level The most stock that can be held due to space limitations, financial costs, or deterioration

Controlling Stock Levels 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. Lead Time The time it takes between ordering and delivery

Controlling Stock Levels 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. Material Requirements Planning Systems 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

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. JIC Large Inventory Factory Production

Advantages/Disadvantages of JIC Easy to meet unexpected increase in demand by increasing production High opportunity costs of working capital tied up in stock costs Raw-material “hold-ups” will not lead to stopping production High storage costs Economies of scale are realized with bulk buying discounts Risks of damaged stocks or outdated stocks 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 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 Stockpiles of inventory can meet expected increases such as seasonal items

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. JIT Inventory Factory Production

Advantages/Disadvantages of JIT Opportunity cost is reduced because less is invested in stocks Any failure to receive stocks can lead to production delays Costs of storage are reduced Delivery costs increase as smaller quantities are delivered Storage space can be used for other productive purposes Administration costs rise because more attention is needed to multiple orders Less opportunity for stock to become outdated or damaged Reduction in bulk discounts pricing because of smaller orders 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 Multi-skilled workers may be more motivated

JIT not suitable to everyone 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. Raw material costs or delivery costs may actually rise making future production more expensive with newer raw materials.

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

Capacity Capacity utilization is the proportion of maximum output capacity currently being achieved when compared with the total capacity available. Current output level X 100 = rate of capacity utilization Maximum output level 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% HL

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 low…. Then average fixed costs are spread over fewer units causing an increase in average fixed costs HL

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

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

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

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 Maximum Capacity Current output capacity HL

Capacity Shortage 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. HL

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

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

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

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