Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

11.4.1 Production or Procurement Costs: Batch-Size-Dependent Unit Costs, and Setup and Ordering Costs

Intended learning outcomes: Differentiate between batch-size-dependent production or procurement costs and batch-size-independent production or procurement costs.

Lot-size inventory is inventory that results whenever quantity price discounts, shipping costs, setup costs, or similar considerations make it more economical to purchase or produce in larger lots than are needed for immediate purposes ([ASCM22]).

Batch sizes that are not specified by the user lead to longer lead times and procurement deadlines and should therefore be avoided, as discussed in the Lean/JIT concept. Even there, batch sizes have to be accepted because of setup costs. In this section, we will examine the arguments that tend to favor either smaller or larger batch sizes.

There are batch-size-dependent production or procurement costs for every produced or procured unit of measure of the order, that is, the batch-size-dependent unit costs.

Batch-size-dependent production or procurement costs are

  • In the case of external procurement, acquisition cost per procured unit quantity plus eventual additional costs that are proportional to quantity (for example, customs, shipping, and so on).
  • In the case of in-house production, the sum of the costs of the components and operations needed to produce a unit quantity. The unit cost for an operation are calculated as “run load per unit  cost rate for internal labor costs,” whereby the cost rate generally includes full costs (fixed and variable costs).

Batch-size-independent production or procurement costs are incurred with the order, even with lot size one (batch size one).

Batch-size-independent procurement costs are mainly:

  • Ordering costs for procurement, which are the administrative costs of purchasing divided by the number of purcha­ses. Administrative costs of purchasing also include the costs of receiving stock and stock control. Batch-size-independent procurement costs also include all costs per order that are independent of quantity, such as shipping and handling costs. In the extreme case, these are dependent on the suppliers and the delivered items. To avoid large volumes of data, however, these costs are often added to purchasing costs.
    • Procurement costs can also be tapped by item class, such as according to the ABC classification. This results in varying batch- size-independent procurement costs for each ABC category (for example, higher costs for A parts than for C parts). For a more precise determination, see Section 16.4 (activity-based costing).

Batch-size-independent production costs are mainly:

  • Ordering costs for production, that is, the administrative costs of planning & control and other office functions.
  • Possible overhead costs of production that are independent of quantity (transportation, control, putting into and issuing from stock). Usually, they also count as part of the ordering costs.
  • Setup costs (= setup load ∙ the cost unit rate for internal labor costs) for the various operations (machine adjustments, tool assembly, start-up process, loss of materials at start-up, and so on). For this, management must decide whether to include full costs or only variable costs (essentially wages) in the calculations; this may influence the batch sizes.

Continuation in next subsection (11.4.1b).

Course section 11.4: Subsections and their intended learning outcomes