Chapter 15 - Production of Goods and Services
Lesson Objective: Costs of inventory; lean production methods
Businesses hold different types of inventory:
Raw Materials and Components - inventories of the needed inputs for the production process;
Work-in-Progress - partially finished goods that have not yet gone through the entire production process;
Finished Goods - goods that are ready to be sold and send out to customers.
Imagine having to hold all these different types of inventory! There are many costs associated with holding inventory:
Warehousing Costs: renting or purchasing a large storage space;
Handling Costs: cost of moving inventories in and out as needed;
Shrinkage Costs: the cost of damaged or lost inventories;
Insurance Costs: large businesses have insurance for their inventory;
Obsolescence: out-of-date and/or spoiled products;
Opportunity Cost: the working capital tied up to inventory could be used by the business in more profitable ways rather than holding inventories.
If holding inventories is so costly, why do businesses keep on having them?
There are many benefits of holding the different types of inventories for businesses:
Inventory of raw materials are essential for production - if they run out production stops (machines and workers become idle);
Finished goods inventory is needed for fulfilling customers' orders as they come in and ensure business profitability;
Economies of scale from bulk buying.
As we can see inventory can either be cost-generating or profit-making. It is all about holding the right amount and managing it well!
And speaking of cost-generating factors in production, here are the main sources of waste/costs in the production process:
Production defects;
High and badly-managed inventories;
Over production;
Idle resources
Transportation.
To try to eliminate waste and reduce costs businesses oftentimes seek to implementing lean-production - the management approach focused on wasting the minimum possible amount of resources - efficient manufacturing processes.
The main methods utilized in lean production are:
Just-In-Time Inventory Management (JIT)
Kaizen Method.
JIT is a common lean production technique for reducing inventory costs (such as waste) and therefore increase costs.
JIT eliminates the need for inventories of raw materials and finished goods:
For JIT to be possible a good relationship with suppliers is key: delivery time, quantity, and quality, should be exactly as requested for it to be successful.
One other key requirement for the successful implementation of JIT is flexibility of labor and capital:
In other words, workers and machinery/equipment should be able to cope with different demands at different times.
A second common lean production technique is the implementation of the ancient Japanese method of Kaizen:
The main idea behind this philosophy is giving workers freedom for suggestions on quality and productivity improvements. The premise is: workers are the ones doing it and therefore are the best ones to understand and suggest changes.
Lean production, therefore, bring many benefits to businesses:
The development of new products can be quicker;
Quality is improved;
Wastage of time and resources are reduced/eliminates;
Costs decrease which increases profits;
Businesses become more competitive in price.
To-Do List:
Activity 15.3 (p. 207)
Chapter 15 - Production of Goods and Services
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