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## Decision-making

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**Decision-making**Making routine decisions without the “help” of standard costs**Value Stream Costing is**simple, understandable, and economical But …… How do I make business decisions without having standard costs for every part?Pricing, margins, make/buy, product mix, ……. ?? Lean decision-making**What do we use standard costs for?**• Pricing & quoting • Make/buy and sourcing • Capital equipment decisions • Impact of improvements • Variance analysis and performance measurements • Inventory valuation • Transfer pricing • Profitability analysis and “rationalization” • External financial reporting**Product Costing**A. 12 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit What is the cost Product A? Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes A. 4 minutes**A Second Product in the Value Stream**B. 12 minutes A. 12 minutes B. 10 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit Product B is a lot more difficult to make and has a lot more labor & machine time. What is the cost of Product B? Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes A. 4 minutes B. 10 minutes**What About the Volume of Production?**B. 12 minutes A. 12 minutes B. 10 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit This week the customers require 400 units of A’s or B’s. Takt time is 12 minutes. The cost of A or B is $175 /unit. Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes A. 4 minutes B. 10 minutes**What About the Volume of Production?**B. 12 minutes A. 12 minutes B. 10 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit But next week, the customers only require 360 A’s & B’s. What is the cost of an A or a B ? Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes A. 4 minutes B. 10 minutes There is no such thing as THE cost of a product. It varies by production volume and mix.**A Third Product in the Value Stream**C. Zero minutes B. 12 minutes A. 12 minutes C. 6 minutes B. 10 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit Product C does not use the Drilling Machine, but does go thru the lathe, the grinding machine, and inspect/pack. What is the cost of Product C (assuming there is capacity to make it)? Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes C. 6 minutes A. 4 minutes B. 10 minutes C. 4 minutes Everything else remaining the same, product cost is determined by the flow rate through the bottleneck work center.**Now We Do Some More Lean Improvement**20% More Capacity B. 12 minutes A. 12 minutes B. 10 minutes A. 6 minutes Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit The value stream improvement team conducts a kaizen and eliminates waste from the Drilling operation. They open up 20% more capacity. The customer demand is still 400 per week. What is the cost of A or B? Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes A. 4 minutes B. 10 minutes**A Sales Opportunity ????**Total Value Stream Cost per Hour = $500 Material Cost = $75 per unit Price = $350 per unit The sales department can not find any more demand for A’s & B’s – at least in the short term. It will stay at 400 per week for the foreseeable future. But, they have found a customer wanting a D. The D product is very similar to A. Same production routing and same material cost. The customer needs 40 per week. The market price for D’s is $160. Should they accept this order? 20% More Capacity B. 12 minutes A. 12 minutes B. 10 minutes A. 6 minutes Machine on Lathe Drill on Drilling Machine 5 per hour Grind Inspect & Pack A. 8 minutes B. 12 minutes A. 4 minutes B. 10 minutes**Example**Given this annual cost information, calculate the Labor Rate ($ per labor hour) and Overhead Rate (as a percentage of Labor Rate) required for Standard Costing.**Example: standard cost**Calculate the Standard Cost for product Pro-Valve 602 given the following information.**Exercise: standard margin**The company receives a request-for-quote from a customer for 3000 Pro-Valve 602’s per month. The customer’s target price is $45 per unit. Your company requires a minimum of 15% margin. Work out the profitability using Standard Costing.**Example: low cost outsourcing**The company has found a Far East supplier quoting a landed cost of $33.00 for the XJ2’s. The customer’s target price is $45 per unit. Your company requires a minimum of 15% margin. Work out the profitability from outsourcing this product.**Example: value stream costing**Work out the profitability using Value Stream Costing. You need to get 2 new machines and 2 operators to support this volume increase to 3000 units/month**How do I set the price of a product?**• Pricing is set by the market. • The price is determined by the value created for the customer. • Product, services, intangibles • Pricing requires close understanding of the market, the customer’s requirements, and the competitors. • How much value are we creating for the customer?**Using value stream costing for measuring profit margins**• We use value stream profit and the overall return on the value stream; not individual product profit. • Contribution is the revenue of the value stream less the direct external costs. • Direct external costs include: • Purchased materials and components • Outside processes • Other direct costs paid to third party organizations • Labor cost or machine cost is not considered a direct cost.**What about make/buy decisions?**• Assuming the company has the capability to make the item & achieve quality levels, the make/buy decision is always based upon the capacity of the value stream. • If the value stream has capacity – particularly in the bottleneck work-center – the cost of making the product is effectively zero. • If there is no available capacity in the value stream, then the make/buy decision is based upon the contribution (revenue minus material cost) of the entire value stream.**Employee efficiency & asset utilization**• We use the cell and value stream performance measurements to monitor & control the value stream activity. • We are concerned not with efficiency but with value stream profitability and return. • We are also concerned about the value we create for the customer.**How should we approach new product introduction decisions?**• The same story…. How does this new product impact the total value stream profitability and return. • Products and processes should be designed to minimize the load on any bottlenecks. This will increase the value stream contribution because more products can be processed in the same amount of time.**How do we value inventory?**Inventory Valuation becomes less important. As Lean Manufacturing takes hold within the company inventory levels fall substantially. Lower inventories make the value of inventory less significant; less financially material. When raw material is pulled in frequently from the supplier and used immediately in production, the purchase cost of the materials is the materials cost of sales. Work-in-Process inventory is low and consistent because of effective value stream flow, cell design, and kanban pull.**Why there is no need to have a product cost.**Why marketing need a product cost. Why operations need a product cost. Orrey Fiume, CFO Wiremold Corporation