|
|
|
Source: Small Business
Management
Determining
Quantity
The quantity of material you will need to buy
depends on:
a. how much material you will use in production
b. how much may be lost through damage or defects
c. what you have in inventory when you place the order, and
d. the average inventory you are willing to carry
To hold total costs of materials, including purchase price and inventory carrying
costs, as low as possible, it is desirable to separate purchased components into A, B, and
C categories.
These categories are determined by the characteristics of the materials, their use, and
their supply. The more erratically used, expensive, perishable and/or exceptionally bulky
class "A" components are generally kept under tight inventory control. Status of
these components is reviewed frequently and they are purchased in relatively small
quantities against a production schedule (see next heading - Determining Quantity Based on
Production Schedule).
Class "B" components are less expensive than the "A" components and
are either erratically used or perishable or bulky. They are best controlled using
perpetual inventory records which show an order point and the quantity to be bought. In
this way, purchasing is a fairly routine activity except during the seasonal or annual
review periods when all ordering decisions are evaluated.
Class "C" components are the least important components of the inventory.
These "C" components can be kept on a simple visual control system where an
order is placed whenever reserve stock has to be used. These materials are usually ordered
infrequently and in fairly large quantities.
For the class "B" and "C" materials, optimal order quantities exist
(economic order quantity) based on purchasing acquisition costs, set up costs, and
inventory carrying costs.
Determining Quantity Based on Production Schedule
Most manufacturers who use the same component for a number of different products, use a
material scheduling table, similar to the one that follows, to calculate production
requirements.
PRODUCT MATERIAL SCHEDULE - JANUARY
Product AC #3 #3 Plug 110V
Product Quantity Wire Wire Insulation Switch (AC) Socket
Desk lamp 40 1200' 50' 30' 40 40 40
Pole lamp 80 1500' 130' 50' 240 80 240
F1. tube lamp 400 1800' 100' 80' -- 400 --
Electric pencil
sharpener 300 1500' -- -- -- 300 --
______ _______ _______ _______ _______ _______
TOTALS 6000' 280' 160' 280 820 280
With such a product material schedule, the total amount of component parts used in one
period, or in several periods can be determined. Such a schedule is needed only for those
components, or materials, which deserve tight control. These are usually A items (B and C
items are controlled without specific comparison to schedules. In their case, an order is
placed when the minimum or reserve stock is reached.)
When detailed product material schedules are prepared several months in advance, they
provide the information which is needed for scheduling several different deliveries from a
large-quantity order which allows maximum volume discounts. Such a table is shown below:
MONTHLY COMPONENT USAGE
AC Wire #3 Wire #3 Insulation Switch plug(AC) 110V Socket
January 6000' 280' 160' 280 820 280
February 5300' 310' 200' 310 900 270
March 7110' 260' 180' 270 850 260
April 3760' 405' 170' 260 875 290
Note that the quantities for the month of January were obtained from the column totals
(the last row) of the January Product Material Schedule (shown before). If a quantity
discount for large volume purchases is available, it may be more profitable for this
manufacturer to buy several months' supply of materials at once, to obtain the greatest
discount - and then arrange to have portions of the order shipped once a month, to aid in
handling and storage.
Naturally, if quantity discounts are not available, it is usually more profitable to
place frequent orders for the minimum quantities you need, rather than place orders for
large volumes which tie up capital and create more handling, storage and obsolescence
problems.
Determining Quality - value Analysis
When quality requirements are not obvious, or when there is a need to review what
quality level is best, quality requirements can be determined through value analysis which
spells out the design specifications for a product. Quality specifications can be made in
many ways. They can be in the form of acceptable ranges for:
- weight
- shape
- size
- temperature resistance
- strength
- flexibility
- color, etc.
Quality specifications thus can include any physical aspect of the part to be made.
They can also be expressed in terms of number of pieces per hundred which do not operate
properly or do not meet the specifications.
Another aspect of quality that affects purchasing decisions concerns reliability or
appearance of a component. A less attractive switch or support that functions properly may
be fully adequate and therefore be preferable to a more expensive model.
Value analysis studies parts, assemblies, and/or packaging, to determine whether there
are changes in components or functions which will provide the same "value" for
users at less cost, or greater "value" at the same cost. Value analysis consists
of the following steps:
- defining the function and purpose of the object in study; e.g., to conduct electricity,
to hold a metal body together, to propel an object, to turn an axle, etc.
- determining alternate solutions: e.g., can the metal be replaced with plastic; can the
weight of the object be reduced; can the housing be made with thinner material, etc.?
- determining and comparing feasibility and costs of the alternative solutions with the
present component: e.g., if plastic is used instead of metal, will it hold up as well;
will the performance of the product be affected; will production costs be lowered; can
present machinery be adapted to create the plastic part, etc.?
- implementing the best solution
- evaluating the subsequent performance
- following up and refining the component further, if necessary
Value analysis often results in changes in component design or part material,
substituting one part for another, or eliminating a part entirely. Here is a possible
checklist for conducting a value analysis:
SAMPLE CHECKLIST FOR CONDUCTING A VALUE ANALYSIS
Can the component be eliminated?
Can a standard item be used, if the present item is not standard?
Can the size of the item be reduced?
Can the weight of the item be reduced?
Can the quality of the item be reduced?
Are the ranges which are specified smaller than necessary?
Are unnecessarily fine finishes specified?
Can the item be made from a less expensive material or more efficient material?
Can the design of the product be simplified to simplify production?
Is it less expensive to make the component in your plant than to buy the component from
a supplier? (This point is discussed further, later in this section.)
Can the item be bought for less than it costs your plant to manufacture it?
Can the cost of packaging or shipping be reduced?
Have suppliers been asked for suggestions on how to reduce cost?
One example of determining whether a more or less expensive component should be used in
a product is given below.
A certain product which sells for $150 is guaranteed by the manufacturer to be free
from defects. This means that any products returned with defects during the first year
have to be repaired free of charge. Last year there were 60 repairs, 45 of them due to one
component, part P-38. Repairs related to this P-38 component cost $12 per unit.
There is one P-38 part in each unit and last year 500 units were sold.
In recent years, sales have been tapering off due to growing customer discontent with
the product defect.
The P-38 component costs $10 each. However, a higher quality component (B-52) is on the
market, at a cost of $12 a piece. This B-52 component is guaranteed by the supplier to
reduce the defect rate to less than 2%.
What would you do if you were the manufacturer? Would you replace the P-38 component
with the B-52 component, or not?
Factors to be considered when determining whether to replace the P-38 component with
the more expensive B-52 component are as follows:
The additional cost for the higher quality component is $12 for the B-52, less $10 for
the P-38, or $2 per unit.
The additional cost for the higher quality per year is 500 parts used each year x
$2/per part, or $1,000 per year.
The cost of repairing P-38 parts each year are: 45 repairs made per year x $12 per
repair, or $540 to repair P-38 parts each year.
The number of B-52 repairs which would be required each year are: 500 units used per
year x 2% repair rate, or approximately 10 repairs on B-52 components each year.
The annual cost of repairing the B-52 components is: 10 repairs made per year x $12 per
repair, or $120 to repair B-52 components each year.
The net costs saved on annual repairs is then: $540 to repair P-38 components, less
$120 to repair B-52 components, or $420 would be saved each year by using the higher
quality B-52 component.
The net cost each year of using the higher quality B-52 component is: $1000 per year of
the additional cost of using the B-52 component less $420 per year saved on repairs. It
would cost $580 per year to utilize the higher quality B-52 component in manufacturing.
The decision, thus, is a difficult one and would amount to a reduction in profit of
approximately $1.15 on 500 units sold. If it will stop the loss of sales, or even reverse
it, the new component may be worth the extra net cost.
A similar analysis, in a different situation, could show a much better picture and
result in a gain, either from the use of a higher quality or a lower quality component.
Frequently it is possible to obtain less costly components which require some redesign
or manufacturing process change with a significant initial investment. These decisions,
too, require detailed analysis to calculate the advantages they may bring.
ON-THE-JOB ACTIVITY
Use the summary checklist shown earlier to conduct a value analysis of several items
which you use or manufacture within your business and where you believe that savings may
be possible. If you cannot easily identify such items, select components or products which
are widely used so that even small economies you achieve are likely to bring large dollar
savings.
If possible, discuss your thoughts with a person whose opinion you respect and see what
additional ideas come from such a discussion.
Make-Versus-Buy
An important aspect of value analysis is to determine whether it would be more
economical for your firm to manufacture a component part or to buy the part from a
supplier.
Even if you have a supplier who gives you a good price on materials you purchase in
fairly large quantities, it may be worthwhile to determine how much it would cost your
firm to make such materials. Sometimes such an analysis provides valuable insights for
negotiating price with a supplier. In this way, you have a better knowledge of what the
breakdown of costs are to manufacture the component, and will be in a better position to
realistically evaluate the price and discount schedule which the supplier offers.
Obviously, if your firm can make the same part less expensively than it could buy it from
a supplier, you should seriously consider manufacturing it yourself.
Many small businesses will make parts where they feel they have the know how and
equipment and will buy where the technology is beyond their expertise, or where the part
cannot be handled with existing equipment. However, since capabilities improve and
technology changes from year to year, it is important to consider the make-versus-buy
decision on a regular basis.
Companies in highly competitive industries often have to find ways to make as many of
their own parts as possible to reduce costs. Firms in growth industries, on the other
hand, usually can make better use of their capital to expand product lines, rather than
investing it in equipment, materials and additional space for making components.
One very important thing to remember when making the decision whether to make or buy
components, is to base the decision on all the facts. Often, the facts are incomplete and
misleading at first glance. Quick decisions are therefore best avoided where possible.
Here are two summary checklists which you might want to consider before you make a
"Make-versus-Buy" decision.
SUMMARY/CHECKLIST: FACTS TO CONSIDER BEFORE
DECIDING TO MANUFACTURE A COMPONENT
If, at first glance, a make - buy decision seems obvious, look again: Can better
suppliers than current ones be found?
Can a lower price, without loss of quality, be obtained?
Consider all costs involved in production:
- Labor
- Material
- Overhead - make sure the normal overhead is applicable and that the 'real' overhead is
not exceptionally high or low; for instance, waste or space requirements should not be
significantly higher than normal
- General administrative costs
Will you depreciate the required capital as quickly as you would if you invested it
elsewhere?
Consider that production efficiency may be low at first, since you will need time to
iron out any bugs in the operation.
Consider whether the required quantities will be large enough to justify the set-up
costs and manpower training needed to produce the component, but not so large so as to
disrupt production schedules.
Determine whether the demand for the part is stable, seasonal or temporary.
Be sure your company can produce the desired quality with the contemplated production
process.
Check for patent considerations which would require you to obtain a license in order to
make the part.
Determine whether present knowledge and personnel are adequate for producing the part,
or a special skill is involved.
Determine whether you can use present equipment, or whether new equipment must be
leased or bought.
Determine whether special considerations will affect scheduling manpower and
production.
SUMMARY CHECKLIST: FACTS TO CONSIDER
BEFORE CHOOSING TO BUY A COMPONENT
If, at first glance, it looks better to buy a component rather than make it, look
again!
Consider all costs involved in buying the component:
- Packaging costs
- Freight and shipping expenses
- Receiving costs
- Any extra handling costs
Determine whether the supplier is reliable.
Determine whether the supplier can meet the quality standards for producing the
component.
Check to see if the supplier guarantees the quality of the component.
Check the supplier's defect rate for producing this component, and how much would it
cost you to make repairs on returned items due to the defective component.
Determine whether you will normally receive deliveries on time.
Determine the probability that the supplier might be unable or unwilling to supply you
due to a strike, fire, or the needs of more important customers. |
Copyright © by
Bizmove.com - Small Business
Management. All rights
reserved |
|
