Show me the Money! - Part 4

Show me the Money! - Part 4

James O'Sullivan

Over the past 3 blogs we have gone progressively deeper into the changing relationship between fixed, (direct), and overhead, (indirect), costs and the implications these changes have for the solvency and expansion of a company.

In this article I want to take a closer look at the importance of “time” or “speed of production” in operations decision-making.

Time has only a partial effect on the fixed component of the overall cost calculation. On the one hand, direct labor costs per unit will increase the longer it takes to make a product. But on the other hand, that unit takes the same amount of material irrespective of how long it took to make.

However, time has a full-blown effect on the indirect component of the overall cost calculation. The indirect cost must be fully covered by whatever level of production is made, so the more units you can produce in the time available, the lower your unit overhead cost will be.

This introduces two factors, and the first is Capacity Level.

There are only so many hours in a day, but by increasing the number of assets brought to bear, you can overcome this limitation up to a given capacity level. Thus, if one machine makes 10 units per hour, 2 machines can make 20 units in the same hour, allowing you to double your absorption and halve your unit cost.

However, adding more assets is a complex and expensive decision process, and not something we are going to get into today. That’s because we still have a major weapon in our armoury. Which brings us to the second factor, the time consumed by “Developed Traffic” in the organization.

Developed Traffic refers to any unusual or unnecessary movement of people, communications, or materials along the company’s flow lines, creating a situation where a great many actions were necessary when only one correct action was needed.

Predictive systems tell you what is going to happen based on your current production setup and can therefore massively reduce Developed Traffic. By forecasting when and where production personnel will be required, they reduce waste in direct labor. Additionally, because managers are not trying to cover all the bases, they can target their assets very efficiently thereby increasing the number of units produced to absorb overhead and so reduce indirect unit cost.

The result of Predictive Systems then is a magical increase in run-time availability of both people and equipment.

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