Fundamentals of Industrial Plants Prof. Andrea Sianesi academical year 2011/2012

1. Fundamentals of Industrial Plants Prof. Andrea Sianesiacademical year 2011/2012 Costing: drill down to costing for production management

2. Management: decisional content • Define: • WHAT • WHEN • HOW • WHERE • HOW MUCH • PRODUCE / SHIP / BUY , to satisfy the problem CONSTRAINS, while trying to OPTIMIZE the pre-determined objectives

3. Criticalities • Uncertainty • External (clients, suppliers) • Internal (machines, manpower, materials) • Constrains to satisfy • Internal (manpower, machines, materials, …) • External (Clients, Suppliers, Subcontractor) • Optimization criteria • Volume and quality of the data to manage

4. Different objectives • Sales: • Availability of every product (customer satisfaction) • Production: • Machine usage regularity • Purchasing: • Long term visibility (to get discounts) • Human Resources: • Workforce employment regularity (overtime work and “cassa integrazione” minimization) • Administration and control: • Stock minimization (financial costs)

5. Optimization: specific costs • The main costs to be taken into account when evaluating a production programme are the following: • overtime work costs • subcontractors cost • stockout cost • stock holding cost • setup cost (order cost) • The last three costs are the ones that are fundamental for production decisions

6. Relevant costs • To be defined “relevant” for Production Management a cost should be: • future (past is already “sunk”) • avoidable (if we do not follow a certain plan we do not sustain that cost) • differential (with respect to other alternative plans)

7. Variables (they vary with production volume) They are differential only if different alternatives of production plans produce different quantities or if there are phenomena for which they vary in time (e.g. it is cheaper to produce in winter than in summer) Fixed (they do not vary with production volume) They are differential only if different alternatives of production plans hypothesise different investments (e.g. to buy new tooling machine, to build a new plant) Costs in Production Management Normally in Production Management we are not interested in the distinction between “direct” and “indirect” costs (that is fundamental for industrial costing) as this classification does not affect operative decisions

8. Stockout cost • Stockout cost incurs when current availability of finished product is unable to meet current orders • We should distinguish the two cases: • Stock-out can be RECOVERED (lateness penalties and logistic and administrative extracosts) • Stock-out can NOT be RECOVERED (lost margin) • In both cases there is a image loss that is difficult to quantify

9. Mass products: stockout cost Quantity of lost sales, it can be quantified by estimating lost “purposes to buy” [unit/year] CMV = MdC * Q [€ / year ] Margin lost per unit of lost sale [€/unit]

10. Client behaviour: ORDERDELETED Effect on supplier: Potential future loss (reduction in the purchases from that client, discounts,…) Immediate lost due to missed sale Durable goods Cost can be higher than Margin if materials have already been bought or some manufacturing activities have already been done

11. Client behaviour: POSTPONED ORDER Effect on supplier : Re-processing of the documents for missing articles Additional costs connected to delivery preparation and delivery of missing articles Production plans changes for preparing missing articles Reminders management (on both sides) Eventually discounts and/or penalties Durable goods

12. Stock holding cost • Stock holding cost incurs when an item has been produced before the moment in which it would have been requested (stock) • The stock holding cost has two components: • Expenses: actually spent to maintain the physical stock (stock insurance, obsolecence, warehouses, rents, etc…; they usually are written in the balance sheet) • Opportunity costs: to quantify them we should answer the question “how we could have used alternatively the money if we had not made stock?”, that is “which opportunity did we lose?”

13. Stock holding cost • Stock holding cost depend on: • Average stock in a period (Gmed) • Variable cost (costs actually anticipated to produce the material that is in the warehouse) C • Stock holding ownership rate i • Cmant = Gmed * C * i • i = (I +  ) /  • The stock holding ownership rate expresses the two components (expenses  and opportunity costs I),  allows to compare different measurement units (e.g.  = 12 if I want to compute the monthly stock holding costs starting from a yearly rate)

14. Stock holding ownership rate

15. Setup cost • It is the cost of the best alternative that is lost due to the setup. • It is obviously dependent (in part) to the time spent during the setup • It has two components: • Expenses (e.g. material, extrascaps, ecc.) • Opportunity costs

16. Setup opportunity costs • We should distinguish between two situations: • Plant fully loaded (“do I have alternative to recover lost production?”): • Cost to do the setup in overtime hours • Subcontractors costs • Stockout costs (lost margin) • Plant not fully loaded(“I would not have sold that goods”): • ZERO if operators do not actively participate in the setup, or if they can work elsewhere • Line workforce cost if operators actively participate in the setup and: • It is a variable cost • It is a fixed cost but operators could have been used elsewhere

17. Euronylon EuronylonS.p.A was a medium size Italian company. It had several production plants based on a process production: the finished products produced in each plant had a similar production routing, composed by a phase of extrusion. Some specific products had also a phase of dyeing, this was performed out of the line. The case is about a production plant that was relatively modern. That plant, since the very first days it had been installed, produced continuosly one kind of product (the nylon thread type A), and had been stopped only for maintenance or strikes. The plant had been installed 3 years before and in the balance sheet it has been recorded with a value of 3,5 millions €, with an amortization time of 8 years. A recent report higlighted some data about the plant: the plant was supposed to work continuously for 3 shifts and therefore 5 complete teams of workers were assigned to the plant. Each team was composed by 2 people (1 chief and 1 not-specialized worker). When the machine was stopped, while the workers of the maintenance service performed specific interventions on the machines, the workers that should work on the plant performed other activities: extraordinary machines cleaning, checking and calibration of the machines. FIP-Industrial Performances Measurement

18. Euronylon The plant under analysis was part of a production unit made up of several production plants. Howevere, it had never happened (and it was considered not convenient for the high costs of training) that a team of workers assigned to a plant was asked to work on other plants. The average annual cost of a workers team was about 65000 €.  In October, the Production Planning Manager was preparing the plans for the following year to be presented for approval to the Director and was thinking about some data he/she was given by the Commercial Director. The Commercial Director stated that, due to the opening of a similar production plant by a competitor and due to the international crisis of the sector, he/she forecasted to sell in the following years (at maximum) 2500/ton nylon type A per year. The market was going to absorb the product steadily along the year as it has always happened. That means that there were no seasonal variation in the demand for the product (it was possible to absorb the little casual fluctuation by keeing an operative stock of finished product. It was kept in the finished product warehouse, where there was enough, or even excessive, available space).  The long term and maximum efficiency production rate was of 10 tons/day; taking into account the normal stoppages due to maintenance, filters substitution, firm recess, ecc…the plant availability was about 300 days/year. FIP-Industrial Performances Measurement

19. Since some years, the selling price of A was about 3 €/kg. Due to the oligopolistic structure of the market where the company acted, it was considered too risky to try to influence demand by changing the price. The analysis of industrial costs shows that variable cost (raw material, energy,…. ) per kg of A was 1,82 €, this value was calculated for plant working at maximum efficiency and taking into account the standard percentage of re-use of process waste; however productivities strongly vary when production rate varies. It was estimated that, within reasonable variations of production rate, the variable cost per kg changed of 2,5 cent €/kg when production rate reduces of 10% with respect to the rate of maximum efficiency. Given that production waste quantity was not negligible, a recovering plant for waste was built up one year before. It costet 400000 €. It could be used to treat both defective product and process waste, and it has a productivity of 60%.  In any case, when production plant is started again after a stoppage, on average the nylon produced during the first and half day could not be sold since it was not matching quality standards.  A part of the general expenses of the production unit (internal logistics, heating, supervision…) was assigned to the production plants on the basis of the nominal capacity value of each production plant. For the next year, this value was estimated to be equal to 250000 €. FIP-Industrial Performances Measurement

20. Among the others, one of the possibility to be analyzed was to produce another product when the production plant was not producing A. The product that could be produced was called B, and it had been asked by a client of the firm some time before. However, due to the high utilization rate at that moment, it was not possible to satisfy the client request. Due to the high competition in the market of B, the maximum selling price of B was estimated to be around 3,2 €/kg. Moreover, since the new product was not compatible with the technical characteristics of the production plant used to produce A, variable cost was estimated to be equal to 2,75 €/kg; production rate would have been the same: 10 tons/day. To perform each product change, in addition to the above stated time to re-start production, the Technical Direction estimated that setup activities (washing, calibration…) would have last 3 days. During these days, in addition to usual workforce, 2 technicians from Technological Direction would have worked on the plant and materials such as solvents and special cleaning products, for about 15000 €, would have been consumed. The entire quantity of B that could have been produced was to be bought by clients immediately, therefore it was not needed any additional warehousing space. FIP-Industrial Performances Measurement