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Measuring and Assessing the Cost of Manufacturing Cells and Lines

He then noted that the chronological time required to produce the part would be cut from three days to one. The manufacturing time for each individual process would remain the same, but since they would take place in a continuous flow, only one day would be required to manufacture an entire part. The “start-to-finish” time of manufacturing the product would be reduced from 13 days (three days manufacturing and ten days storage) to just one day. The ramifications of this reduction in manufacturing cycle time were clear to an operations pro like Dynamo. The added agility cellular manufacturing provides would allow him to react to customer demand much more quickly which, in turn, would reduce the need to keep so much finished goods inventory on hand. In his estimation, his 30-day finished inventory requirement could be reduced to ten days. Instead of beginning the production of a part 43 days before its expected sale, it could begin 11 days ahead of that sale, making the 20-day reduction in his finished goods inventory possible. This reduction would free up additional floor space for more productive use as well as reduce the cost of financing the business.

Why don’t any of these savings appear in Myopia’s analysis? Could there be something amiss with the way his company costs its products and processes?

This added agility also has a ripple effect upstream in the company’s raw material inventory requirements. A forecast of customer demand 11 days in advance will be more accurate than one made 43 days before the potential sale. This means that the safety stock of raw materials required to support manufacturing can be reduced substantially. Instead of the 30-day supply deemed necessary under current conditions, Dynamo estimates that the 11-day cycle time and reduction in “demand risk” would enable the company to limit its raw material inventory investment to a ten-day supply—20 days fewer than it is today. This would free up even more floor space for more productive use and further reduce the cost of financing the business.

Why don’t any of these savings appear in Myopia’s analysis? Could there be something amiss with the way his company costs its products and processes?

The answer to Dynamo’s questions should be clear; there is something wrong with the company’s direct labor-based costing system. Direct labor-based costing fails to reflect the fundamental economics involved in manufacturing. The company’s costing methods omit certain critical costs altogether and bury the cost of important processes in an overhead rate that gets “spread like peanut butter” using direct labor as a convenient, but inappropriate, knife to do the spreading.

Costing Cells & Lines1
Investment is a critical part of manufacturing, yet traditional costing practices, like direct labor-based costing, fail to measure the cost of this investment or assign it to the processes that make the investment necessary. The omission of a “weightedaverage cost of capital” (WACC) from cost calculations totally ignores the impact that tying up both fixed capital and working capital has on the cost of a process or a product.

As can be seen in Exhibit 3, the investment related to the production of a product spans from raw material to cell operations (where fixed capital is part of the investment as well as in-process inventory) and finally to finished goods inventory. I discussed the problem of material price vs. cost in my BONEZONE August article, so I will limit the discussion here to say that understanding the cost of a product produced in a cell or line requires an accurate measure of the “cost,” not just the “price,” of the raw materials, purchased components and outside manufacturing services used in its manufacture. The savings involved in creating cells and lines cannot be accurately measured if the cell’s or line’s impact on the “cost” of materials cannot be measured. For DMMD, creation of the cell reduces raw material inventory requirements and the “cost” of those materials.

Hicks Exhibit_3

The same is true for post-manufacturing costs—the cost of finished goods. Post-manufacturing costs will be the subject of a future article and will not be expanded upon here, but understanding the cost of cells and lines also requires the ability to accurately measure the impact cells have on the cost of activities (including the cost of capital) required to support the customer after the product has been produced. For DMMD, creation of the cell reduced the level of finished goods needed to support customer demand.

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