Sell or Process Further Decisions

Sell-Or-Process Further Decisions

 

  • ·        Firms can consider decisions to sell a product “as-is” or continue to refine the product so that it can be sold for a higher price.  We compare the incremental costs and benefits of this decision.  If the increase in revenue is enough to offset the increment cost, the company should process further; otherwise it is better off selling the product as is.  In looking at sell-or-process further decisions, one needs to look at the increased sales price one could get in processing further.  One must take into account the increased costs in direct materials, labor, and variable overhead; fixed overhead should stay the same.  If the increase in the sales price is more that the increase in incremental costs, then one should process further.  One should also incorporate opportunity costs whenever possible in the analysis.

 

  • ·        Prioritization of Products with Constrained Resources – As previously discussed, opportunity costs occur anytime that resources are limited or constrained.  The constrained resource could be anything that is needed to operate the business such as cash, employees, machines, or facilities.  When any of these resources is unable to meet demand, the company cannot produce enough products to fill customers and managers must decide on which products to produce or which customers to serve.  In supply chain management, lean thinking fosters process improvement to manage constrained resources by eliminating nonvalue-added activities such as rework and waiting, or by increasing the capacity of the constrained resource by hiring more workers, buying bigger or faster machines, or leasing additional space.  All of these alternatives take time and may result in higher costs.  In the short run managers can maximize profit by prioritizing  products or customers based on the amount of contribution margin generated by the most constrained resource, called the bottleneck.  The bottleneck limits the system’s overall output and therefore determines how much contribution margin is lost due to limited resources.  Firms focus on contribution margin because fixed costs do not change in the short run and are therefore irrelevant.  Whatever the constrained resource is, management should focus on maximizing the contribution margin in that constrained area.  If labor is the most constrained resource, managers should focus on maximizing the amount of contribution margin per labor hour.  If a machine is the most constrained resource, the focus should be on the amount of contribution margin per machine hour.  Prioritizing in this way results in the highest short term profit. If the bottleneck shifts to another resource, managers would then need to repeat the analysis with the new bottle neck process.

 

  • ·        Summary of Incremental Analysis – The week’s study showed short term decision approached one may encounter in supply chain management.  The work studied applied incremental analysis or relevant cost analysis to a number of short-term decisions.  Although the decision problems were different, the same basic approach was used to analyze each decision.  In all cases, the focus was only on relevant or incremental cost and benefits of the decision problem.  The quantitative analysis provides a starting point for making decisions but must be balanced against other qualitative factors such as quality, customer loyalty, employee morale, and other important factors.  Some common rules for analyzing relevant costs and benefits include:

 

  • o       Relevant costs and benefits occur in the future and differ between the decision alternatives
  • o       Relevant costs are also sometimes called avoidable or differential costs-costs that will change based on the decision made.
  • o       Variable costs are usually relevant to the decision because they vary with the number of units produced or sold.
  • o       Fixed costs may not be relevant they do not change with the number of units produced or sold.
  • o       Fixed costs that are directly attributable to the decision maybe avoidable and thus are relevant.
  • o       Common or allocated fixed costs are shared by multiple products or services and are generally not relevant.
  • o       Opportunity costs are the lost benefit of choosing one alternative over another.  These costs are relevant and occur when capacity is reached or resources are constrained.  Opportunity costs can be treated either as a benefit of one option, or as a cost of the other, but not both.