5.5. Production Planning (HL only)
Syllabus Content
- The supply chain process
- The difference between JIT and just-in-case (JIC)
- Stock control charts based on the following: lead time, buffer stock, re-order level & re-order quantity
- Capacity utilization rate
- Productivity rate
- Cost to buy (CTB)
- Cost to make (CTM)
Production Planning
Purchasing and Supply Chain Management
Supply Chain Management is concerned with the flow of goods and services through the organisation with the aim of making the firm more competitive.
A degree of control is sought over the supply process and businesses actively manage the number of suppliers they use, implement outsourcing arrangements as necessary and consider developing strategic partnerships where appropriate.
What caused the need for closer supply chain links?
Christopher (2005) identified a number of factors:
● Shorter product life cycles requiring more efficient supply pipelines
● Increasingly global supply chains requiring greater coordination
● A move towards more flexible organisations that partner with others (organisational integration)
● More demanding customer service standards
Effective Supply Chain Management
Porter recognized that management of the supply chain and supply network could be a source of competitive advantage. Supply chains today must be responsive and reliable. Integration between the organisation and other chain members, both upstream and downstream, should be facilitated by integrated information systems.
Supply Chain Networks
A supply chain network is an interconnecting group of organisations which relate to each other through linkages between the different processes and activities involved in producing products/services to the ultimate customer.
Historically, businesses in supply chains have operated relatively independently of one another to create value for the ultimate customer. Independence was maintained through holding buffer stocks and managing lead times.
Market and competitive demands are now, however, compressing lead times and businesses are reducing inventories and excess capacity. Linkages between businesses in the supply chain must therefore become much tighter. This condition is shown in the integrated supply chain
The aim is to co-ordinate the whole chain, from raw material suppliers to end customers. The chain should be considered as a network rather than a pipeline (a network of vendors support a network of customers, with third parties such as transport businesses helping to link the companies). The potential for using the internet to allow customers and suppliers to acquire up-to-date information about forecasting needs and delivery schedules is a recent development, but one which is being used by an increasing number of companies. Some supply chain relationships are strengthened and communication facilitated through the use of extranets (intranets accessible to authorised outsiders)
Implications for supply chain management
Supply chain management involves optimising the activities of companies working together to produce goods and services.
● Reduction in customers served – companies might concentrate resources on customers of high potential value
● Price and inventory co-ordination – businesses co-ordinate their price and inventory policies to avoid problems and bottlenecks caused by short-term surges in demand.
● Linked Computer systems – closer links may be facilitated through the use of Electronic Data Interchange (EDI) and through the use of a computer extranet
● Early supplier involvement in product development and component design
● Logistics design – certain product components can be added at the distribution warehouse rather than at the central factory (manuals in certain language)
● Joint problem solving
● Supplier representative on-site.
Task 1: Group work. Each group will be assigned an article and take notes on the how the supply chain is managed
Task 2: This video gives a good introduction to the practice of an 'integrated supply chain' - what are the pieces of advice the narrator communicates about the development of such a supply chain?
Task 3: Watch this video which demonstrates how an integrated supply chain works - pay particular attention to the conceptual reference
The video below gives an outline of how an organisation (DHL) operates an effective global supply chain.
Stock Control Methods
Holding stock incurs warehouse storage costs and ties up working capital. Funds must be found to pay for materials, components and unsold goods with interest.
Running out of one item of stock could bring the whole factory to a halt. Staff must still be paid even though they do not have the parts to carry on production.
Stock control aims to hold sufficient items on site to enable production while minimising stock holding costs. There are two methods of stock control - just in case and just in time.
Task 4: Define the term ‘stock’. Identify the three types of stock that a manufacturing organisation may hold in their warehouses.
Just in Time
Just in Time (JIT) is an approach to operations based on the idea that goods and services should produced only when they are needed – neither too early (so that inventories build up) nor too late (so that the customer has to wait). JIT is also known as ‘stockless production’ and may be used as part of a lean production process. In its extreme form, a JIT system seeks to hold zero inventories.
Operational requirements of JIT
● High quality – any errors in quality will reduce throughput and reduce the dependability of supply
● Speed – throughput in the operation must be fast, so that customer orders can be met through production rather than out of inventory
● Reliability – production must be reliable and not subject to hold-ups
● Flexibility – to respond immediately to customer orders, production must be flexible , and in small batches
● Lower costs – as a consequence of high quality production and with a faster throughput and the elimination of errors, costs will be reduced.
It is important that organisations which run a JIT system develop close relationships with their suppliers.
JIT may not be suitable for all firms at all times:
● There may be limits to the application of JIT if the costs resulting from production being halted when supplies do not arrive far exceed the costs of holding buffer stocks of key components.
● Small firms could argue that the expensive IT systems needed to operate JIT effectively cannot be justified by the potential cost savings.
● In addition, rising global inflation makes holding stocks of raw materials more beneficial as it may be cheaper to buy a large quantity now than smaller quantities in the future when prices have risen.
● Similarly, higher oil prices will make frequent and small deliveries of materials and components more expensive.
Just in Case is an inventory strategy in which companies keep large inventories on hand. This type of inventory management strategy aims to minimize the probability that a product will sell out of stock. A company practicing this strategy essentially incurs higher inventory holding costs in return for a reduction in the number of sales lost due to sold out inventory.
The JIC inventory strategy is much different than the newer 'just in time' (JIT) strategy where companies try to minimize inventory costs by producing the goods after the orders have come in.
The older 'just in case' strategy is used by companies that have trouble forecasting demand. With this strategy, the companies have enough production material on hand to meet unexpected spikes in demand. Higher storage costs are the main disadvantage of this strategy.
Task 5: List four criteria that could be used to assess supplier performance
Stock Control Charts
A stock control chart is a graphical illustration of a simple approach to stock management over time. This ‘saw tooth’ shaped diagram is normally shown as if sales were steady throughout each month. Whilst this oversimplifies the situation for many businesses, the principles can be adapted to most situations.
The key features and terms are:
● Maximum stock level – this is the maximum amount of stock a business would wish to hold. This could represent enough stock for a month or a week, it might be as much as the warehouse has space for, or it might depend on the order size needed to qualify for a quantity discount – known as the Economic Order Quantity (EOQ). On the diagram below, the maximum stock level is 600 units, and the usual order quantity is 500 units
● Re-order level – this acts as a trigger point, so that when stocks fall to this level, the next order should be placed. This helps take account of fluctuations in sales levels over time. When an order is placed, there is a lead time that the supplier needs to meet that order. Ideally this new order will arrive just before stocks fall below the minimum stock level. On the diagram below, 300 units
● Lead time – the amount of time between placing the order and receiving the stock On the diagram below, just under two weeks
● Minimum stock level – this is the minimum amount of product the business would want to hold in stock. Assuming the minimum stock level is more than zero, this is known as buffer stock – see below. On the diagram below, 100 units
● Buffer stock – an amount of stock held as a contingency in case of unexpected orders so that such orders can be met and in case of any delays from suppliers.
Just in case
The just in case method of stock control is best explained using a diagram called a bar gate stock graph. You need to understand the meaning of:
These levels will determine ‘when to order’ and ‘how many to order’
a. Reorder level: when inventories reach this level, an order should be placed to replenish stocks. The reorder level is determined by considering the rate of consumption and the lead time.
b. Minimum level: this is a warning level to signal to management that stocks are approaching a dangerously low level and that outages are possible.
c. Maximum level: this acts as a warning level to signal to management that stocks are reaching a potentially wasteful level
d. Reorder quantity: this is the quantity of inventory which is to be ordered when stock reaches the reorder level.
e. Average inventory – the formula for the average inventory level assumes that inventory levels fluctuate evenly between the minimum inventory level and the highest possible inventory level.
f. Lead time - the time it takes for ordered stock to arrive.
g. Buffer stock - level of stock held in case deliveries are held up or there is an unexpected large order.
Task 6: Identify from the graph above, in its appropriate measurement, the following:
a) The minimum stock level =
b) The maximum stock level =
c) The re-order quantity =
d) The lead time =
e) The buffer stock level =
Introduction to stocks and stock management
Stock control charts
Task 7: If using a JIC stock control method, explain the reasons as to why a certain minimum level of stock/inventories should be held by an organisation.
Task 8: Identify reasons as to why a JIT philosophy may not be beneficial to some firms (particularly small-scale firms).
Capacity Utilization rate
A metric used to measure the rate at which potential output levels are being met or used. Displayed as a percentage, capacity utilization levels give insight into the overall slack that is in the economy or a firm at a given point in time. If a company is running at a 70% capacity utilization rate, it has room to increase production up to a 100% utilization rate without incurring the expensive costs of building a new plant or facility.
This is also known as "operating rate".
Graphically:
Capacity utilization rates can also be used to determine the level at which unit costs will rise. For instance, let's say that Company XYZ currently produces 10,000 widgets at a cost of $0.50 per unit. If it is determined that it can produce up to 15,000 widgets without costs rising above $0.50 per unit, the company is said to be running at a capacity utilization rate of 66% (10,000/15,000).
Source- https://www.quora.com/What-is-capacity-utilization
This is best applied to companies that produce physical goods rather than services, as the capacity measurements are much easier to quantify.
There are potential drawbacks to operating at full capacity for a long period of time:
● Staff may feel under pressure due to the workload and this could raise stress levels. Operations managers cannot afford to make any production scheduling mistakes, as there is no slack time to make up for lost output.
● Regular customers who wish to increase their orders will have to be turned away or kept waiting for long periods. This could encourage them to use other suppliers with the danger that they might be lost as long-term clients.
● Machinery will be working flat out and there may be insufficient time for maintenance and preventative repairs and this could lead to increased unreliability in the future.
So many firms attempt to maintain a very high level of capacity utilisation, but to keep some spare capacity for unforeseen eventualities.
● Excess capacity: exists when the current levels of demand are less than the full capacity output of a business – also known as spare capacity.
● Full capacity: when a business produces at maximum output.
● Capacity shortage: when the demand for a business’s products exceeds production capacity.
Task 6: (a) If a firm is producing 10000 widgets but its total productive capacity is 15000 widgets, what is this firm’s capacity utilization rate?
(b) Are there any drawbacks to a firm of producing at 100% capacity?
Capacity Management overview
Business Maths - Calculating Capacity Utilisation
Productivity rate
Productivity is the rate at which goods are produced. Production is defined as the act of manufacturing goods for their use or sale.
Productivity is the ratio of output to input in production. It is a measure of the efficiency of production. It is related to the utilization or the use of resources to produce goods. It increases the output. It is the increase of output from each unit in the production process. If inputs remain the same and the production of output increases, then there is a rise in the level of productivity. If the output rises in a greater proportion than the increase in the input, there is still a proportionate rise in the level of productivity. However, if the output rises at a lower rate than the input, then there will be a fall in the productivity, even though there is an increase in production on the whole. Higher productivity results in a lower cost per unit of output resulting in higher levels of profit for a company. Thus, it refers to efficient utilization of resources. High productivity increase the economic well-being. It increases the income and the standard of living of the people. It brings in money for the company.
Employee Labor Productivity
If you manufacture a product to sell, you can measure the productivity of the entire plant dividing number of products manufactured by the total number of hours worked for a specific period. For example, in January you have 10 employees who work one eight-hour shift per day, five days a week, for 40 hours a week each. That is a total of 400 hours a week and 1,600 hours for the month. Your plant produced 24,000 items in January. 24,000/1,600=15. This means your employees collectively produced 15 products per hour in January.
Productivity has the following advantages:
- It emphasizes the efficient utilization of all the factors of production which are scarce universally.
- It attempts to eliminate wastage.
- It facilitates the comparison of the performance of a company to its competitors or related firms, in terms of aggregate results and of major components of performance.
- It enables the management to control the performance of the company by identifying the comparative benefits rising out of the use of different inputs.
Source - http://www.differencebetween.info/difference-between-productivity-and-production
Make or Buy Decisions
Businesses may be faced with the decision about whether to make components or products themselves (in house) or to obtain these from outside suppliers.
If the items are bought in from external suppliers, their purchase cost is wholly marginal (direct). However, if it is decided to manufacture the items internally, the comparative costs of doing so will be the variable production cost (direct materials, direct labour costs plus the variable factory overhead). Allocated fixed costs will not be relevant to the decision as they will not change, but any specific or avoidable fixed costs incurred in the production of the item under consideration would be included as part of the internal manufacturing cost.
If the total internally manufactured cost is greater than the cost of obtaining similar items elsewhere, it is obviously uneconomic to produce these items internally and they would be purchased externally. An item should be made in house only if the relevant cost of making the product in house or less than the cost of buying the product externally.
If spare capacity exists: the relevant cost of making the product in house = the variable cost of internal manufacture plus any fixed costs directly related to that product.
If no spare capacity exists: the relevant cost of making the product in house = the variable cost of internal manufacture plus any fixed costs related to that product plus the opportunity cost of internal manufacture (lost contribution from another product)
Illustration
Make or Buy Decision
Albax Ltd manufactures three components (A, B and C). All the components are manufactured using the same general purpose machinery. The following production cost data are available together with the purchase prices from an outside supplier
When comparing internal production costs and external buy-in costs, the relevant cost to use for the internal production cost is the variable cost of production.
In this case, Albax should purchase component C externally. Components A and B should be manufactured internally.
Reasoning behind making or buying
Reasons for Making:
There are number of reasons a company would consider when it comes to making in-house. Following are a few:
● Cost concerns
● Desire to expand the manufacturing focus
● Need of direct control over the product
● Intellectual property concerns
● Quality control concerns
● Supplier unreliability
● Lack of competent suppliers
● Volume too small to get a supplier attracted
● Reduction of logistic costs (shipping etc.)
● To maintain a backup source
● Political and environment reasons
● Organizational pride
Reasons for Buying:
Following are some of the reasons companies may consider when it comes to buying from a supplier:
● Lack of technical experience
● Supplier's expertise on the technical areas and the domain
● Cost considerations
● Need of small volume
● Insufficient capacity to produce in-house
● Brand preferences
● Strategic partnerships
See Xiaomi launches its own smartphone processor to cut reliance on suppliers
Make or Buy Decision - worked example
Make or Buy Decision - worked example
Task 7: An enterprise is considering whether it should buy-in a component for its sole product, or manufacture the component itself. The bought-in cost of the component is $21 per unit
The management of the enterprise estimate that they could manufacture the component at a relevant cost per unit of $20 made up of $6 direct material, $10 direct labour and $4 variable overheads.
Comment upon the sensitivity of these costs. Calculate the effect of a 15% increase in each cost separately (i.e. A, B and C).
Task 8: Unit production details of the three products manufactured by ZX Company are as follows:
The direct labour rate is $8 per hour, and variable production overheads are 150% of direct labour.
An external company has offered to provide the three products for:
X $115
Y $110
Z $130
Which products should be purchased externally?
Task 9: PQ Ltd manufactures three products, production cost details per unit are given:
The direct material cost per kg is $2.50 and variable production overheads are 150% of direct labour. An external company have offered to provide the three products for:
R: $75
S: $75
T: $50
Which products should be purchased externally?
Task 10: A firm called Speedy Bicycles manufactures bicycles. As part of its strategic evolution, It has to make a decision about whether to produce the bicycle seat (saddle) in-house or outsource production (purchase the seat from an outside supplier).
The Speedy Bicycles firm produces 5000 bicycles annually. A supplier called Saddle Up is willing to supply bicycle seat (saddles) at a price of $10 per unit.
The production manager received the accounts from her accountant which outlined the production costs of bicycle seats. The figures are presented below:
Cost of making bicycle seats internally
Direct Materials = $4.20 per unit
Direct Labour = $3 per unit
Variable overhead = $2 per unit
Depreciation of saddle machine = $14000
Allocation of general overheads = $20000
The decision
Should Speedy Bicycles produce bicycle seats in-house or purchase from Saddle Up?
Files to download
5.5.Production Planning 2017-18.docxSupply Chain management.pdf