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Improving manufacturing efficiency

Business Case

AUTHOR

Deana Claessen

Content Manager

Lack of supply chain visibility leads to inefficiencies as manufacturing operations are halted or slowed, awaiting material delivery.

We hope to show there are 2 major costs which are caused by a lack of material availability due to supply chain visibility

  1. The cost of inefficiency

  2. The cost of recover for the inefficiency

Summary

  • Cost of Inefficiency: Lack of inbound material visibility and supply chain disruptions cause an inefficiency ripple effect. When builds stops due to material shortages, workers shift to alternate tasks. Once the awaited materials arrive, transitioning back disrupts workflow further. Each pause, shift, and restart wastes time, erodes productivity, and incurs additional costs.

  • Cost of Recovery: These inefficiencies translate into overtime costs when personnel work extended hours to catch up on lost production time. It’s typical for companies to run on 10-20% overtime, therefore a small 5% reduction in overtime can lead to cost savings worth tens of thousands of dollars per year

  • P&L: Inefficiency on the P&L manifests as a deviation from planned standard hours, leading to unutilized labour costs. To recover, overtime hours at a premium rate are incurred, appearing as an additional labour expense. This dual impact showcases a tangible cost of inefficiency and its recovery, underscoring the financial imperative of efficient operations. It can be calculated as (Standard hours – inefficiency) + Overtime hours

  • On Time Deliveries: Visibility over inbound materials streamlines manufacturing schedules, ensuring timely production and ultimately better On-Time In-Full (OTIF) delivery to customers. A higher OTIF score not only satisfies customers but also boosts morale as employees often have bonuses tied to this critical KPI

Problem: The Cost Of Inefficiency Due to Material Unavailability

The absence of visibility over inbound material orders adversely impacts material availability, crucial for Just-In-Time operations, subsequently triggering a cascade of inefficiencies on the production shop floor.

Shift in Focus: Employees might be redirected to work on other tasks or projects, which can lead to a loss of focus undermining the operational rhythm and cost-effectiveness

Idle Resources: Resources such as labor and machinery stand idle during these halts, leading to under-utilization and increased operational costs per unit produced.

Production Halts: When essential materials are delayed, production lines may have to be halted. This pause disrupts the manufacturing schedule and can lead to missed deadlines.

Example:

Assumptions:

  1. The factory operates 8 hours a day, 5 days a week.

  2. The hourly rate for operating the factory is $500 (includes labor, overheads, utilities, etc.).

  3. The factory is scheduled to manufacture 100 units of a product every day.

  4. A key material for production is expected to be delivered first thing in the morning to ensure a smooth production run.

  5. Any delay in material delivery necessitates a switch in production to another product, and a subsequent switch back once the materials are available.

Scenario Impact:

On a particular order, there’s a delay in the delivery of materials by 3 days.

  1. Upon realizing the material is unavailable, the production switches to another product, taking 1 hour, and a subsequent switch back, taking another hour, once the materials are available.

  2. The total switch time is therefore 2 hours (1 hour switch to + 1 hour switch back).

  3. The cost of these switches is 2 hours × $500/hour = $1,000.

  4. Additionally, due to the disruption, the efficiency of production is reduced by 20% for the first day of resumption, costing an extra 20% × 8 hours × $500/hour = $800.

  5. The production inefficiency cost for this disruption is $1,000 (switch cost) + $800 (efficiency loss) = $1,800.

  6. The unit cost increase is $1,800 / 100 units = $18 per unit.

  7. If such disruptions occur frequently, say 20 times a year, the annual cost of inefficiency would be 20 × $1,800 = $36,000.

 

In reality the lack of visibility over inbound materials impacting material availability occurs much more than 20 times a year. Its a regular occurrence compounded by the complexity of having to manage thousands of inbound purchase orders

Problem: The Cost Of Recovery

The cost of recovery from inefficiency in manufacturing often manifests through the expense of overtime pay as teams work to get back on schedule post disruptions.

Typically, overtime pay is at a higher rate, often time and a half, making it a significant cost.

If a manufacturing business is currently running 15-20% of time on overtime to recover from disruptions and inefficiencies, reducing this overtime by enhancing visibility and efficiency in the supply chain can lead to substantial savings.

For instance, if overtime can be reduced to 10% from 15%, the savings can amount to tens of thousands of dollars annually.

Example:

The scenario outlined exemplifies a situation where a build process is halted at 80% completion due to the lack of necessary materials. The workforce then has to shift focus to other tasks, and when the awaited materials finally arrive, they need to re-orient back to the original task.

This back-and-forth not only leads to unproductive time but also necessitates overtime to catch up on the production schedule.

How inefficiency appears on the P&L

The total cost of inefficiency is a double hit (standard hours – inefficiency) + over time hours. This then impact gross margins and net income

P&L
Explanation
Example
Operating Expenses: Standard Hours
The cost of inefficiency against your planned standard hours.
The planned standard hours for operations maybe 100, but only 80 were utilized for productive work due to a lack of material availability.
Operating Expenses: Overtime Hours
The cost of recovery for the inefficiency paid at a higher rate than standard hours
The remaining 20 hours were made up through overtime to catch up on the production schedule
Gross Margins:
Higher operating expenses impacts gross margins
Net Income
Ultimately, the bottom line (net income) will be negatively impacted as a result of these increased costs and reduced efficiencies.

AUTHOR

Deana Claessen

Content Manager

Resources

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