It’s not uncommon for roll formers to have an average 20% OEE. Some may even say that 20% OEE is a great number. As established in Part I of our OEE discussion, a 20% OEE says that you’re only experiencing 20% of what your roll former can produce, and you’re walking away from the remaining 80%. What is the opportunity cost of being satisfied with a 20% OEE?
What is Opportunity Cost?
Opportunity cost is defined as a benefit that could have been received but was given up in order to take another course of action. To put this in manufacturing parlance, we can say that opportunity cost is the benefit that could have been realized by running a production line as efficiently as the line was designed, but decisions were made to run the line at a less efficient rate. So how do we calculate this cost? Let’s consider Tim of ACME Manufacturing.
ACME Manufacturing is a typical custom fabricator in the U.S., running 2 shifts to produce roll formed siding and custom trim. Business is booming and ACME Manufacturing operations manager Tim has dreams of growing his operations to keep pace with the growing demand in the marketplace. Tim has answered “yes” to the question “if you could produce more, could you sell it.”
Adding Manpower and Shifts are Not Good Options
As a family-owned custom fabricator that has been in business for over 50 years, ACME Manufacturing knows only too well the difficulty in finding skilled workers. A past attempt at establishing a third shift ended disastrously, adding to their labor cost without increasing throughput enough to justify the added overhead.
An analysis of ACME Manufacturing’s production reveals the 20% OEE and this starts Tim thinking. Demand for ACME Manufacturing’s product is at an all-time high. Orders are getting backed up. Since adding an additional shift isn’t an option, Tim decides to calculate the opportunity cost of increasing production within their existing setup.
Understanding Fixed and Variable Costs
Fixed costs do not change and are not affected by volume. For example, overhead and building costs are fixed. These costs do not change to reflect how many jobs are processed at a given time. Regardless of how many or how few jobs are run, fixed costs remain constant and do not change.
Variable costs on other hand change depending on how many jobs are in production. These costs include material and freight, along with other costs of doing business such as commissions, discounts and rebates.
Variable costs per 3000 feet
|Average selling price||$1,300.00|
|Commissions, discounts, rebates||$3.00|
|Margin per foot||$0.13|
Opportunity cost calculation:
30 minute increase at 300 FPM
|Daily opportunity cost
(0.13 x 30 x 300)
|Weekly opportunity cost
(Daily x 5)
|Annual opportunity cost||$304,200|
Calculating Margin on Incremental Improvements in Production
Tim decides to use the premise that since he is calculating jobs beyond his normal production, he will start his opportunity cost calculation with some baseline assumptions: current business for ACME Manufacturing will remain unchanged and pay for all fixed costs. For this exercise, the incremental growth will be produced by the existing manpower, with no additional overtime. Using these baseline assumptions, fixed costs and labor costs will not be part of the incremental opportunity cost calculation.
By applying these assumptions, the table to the right illustrates what Tim uncovers:
Tim is confident he can increase production by reducing his high downtime rates and improving efficiency. Tim has a plan to start small: eliminate manual order entry at the controller. Tim estimates a conservative daily incremental increase of 30 minutes at 300 FPM. Based on the calculations above, Tim conservatively estimates an opportunity cost of $1,170 a day. Looking forward, this additional $1,170 a day equates to $5,850 a week, or $304,200 annually.
Opportunity Cost Calculations Help Justify Expenses
By completing the opportunity cost calculation exercise, Tim clearly sees how a small improvement can make a big impact on ACME Manufacturing’s capacity and profitability. As a bonus, Tim now has the justification to pursue a solution to eliminate manual order entry at the controller.
Tim plans on analyzing processes at ACME Manufacturing in greater detail to find more opportunities to improve capacity. His goal of meeting customer demand and increasing production capacity within his current framework is within his reach.
The Versatility of Opportunity Cost
The exercise of calculating opportunity cost is a valuable tool for manufacturers. By creating a monetary metric for any operational activity, opportunity cost can help quantify decisions and continuous improvement initiatives. From ways to reduce scrap, improve downtime or even calculating the ROI for a large equipment purchase, opportunity cost can inform these activities and help manufacturers make quality decisions.
Since opportunity cost puts a dollar figure on operational procedures, accurate calculations are very important. Be sure to remove the appropriate fixed costs from any incremental calculations for a true representation of opportunity cost.
Ultimately, opportunity cost shines a light on the financial impact of running a plant at a higher level of efficiency and capacity. In short, opportunity cost is one of the key tools in the journey for higher OEE.
About AMS Controls
AMS Controls has a complete production management system to optimize the manufacturing of panels, purlins, trim, studs, and more. Since 1977, AMS Controls has sold 13,000+ controllers worldwide.
Industry leaders have chosen AMS Controls’ complete production management system to optimize the manufacturing of roll forming cut-to-length panels, purlins, trim, studs and structural products. Our solutions can be used with any brand of roll former or folder to effortlessly eliminate mistakes, manage coil inventory and track production.