The assumption that bigger is better has been with us for many years and is built into many of our management systems and assumptions. When we ask for the price for a quantity of goods, we naturally expect that the unit price will fall as the quantity grows: $10 for one, $9 each if you buy 20, $8 if you buy 100.
That “volume price” scheme is based on the assumption that fixed costs for making, selling and shipping the product is spread over whatever quantity is purchased/shipped. That is a valid assumption, to a certain extent, but is not necessarily the whole story. Other factors might make that volume/price relationship misleading.
Because of the volume discount, many companies purchase supplies and materials in larger quantities than they really need — six months’ worth of a component, for example, to get a lower unit cost and to save on shipping. Then, they have to hold and manage (store, secure, insure, count) that inventory for the six months they own it, tying up cash and warehouse space. What if the product becomes obsolete, the design changes to eliminate that component, or the forecast turns out to be wrong?
Large-quantity orders are not always optimal for the supplier, either. A large production run could tie up plant equipment for an extended time, delaying the production of other products for other customers. The price break will lower revenue, perhaps more than the savings that volume production generates. There could also be issues with raw materials, storage space or shipping and receiving the large quantities.
Many companies have moved toward smaller quantities and more frequent deliveries as part of Lean operations programs. One of the things that Lean focuses on is the reduction of inventory and one of the easiest ways to reduce inventory is to work with smaller quantities and just-in-time production and delivery. This also greatly increases flexibility (agility). But companies don’t have to be on a Lean campaign to reduce lot sizes. It just makes sense on its own merits.
Smaller production quantities become economically attractive when fixed costs are reduced. More flexible production equipment, shorter change-over times, reduced administrative requirements and simplified processes all contribute to this goal.
For purchased components and materials, talk to the suppliers (I mean really talk to them, collaborate on a schedule and terms). You may be surprised to learn that quantity price breaks are not always the best thing for them either. Other savings like reduced inventory or increased flexibility might be enough to overcome increased shipping costs or a slightly higher unit cost so both buyer and supplier benefit.
Reprinted from Portsmouth Herald / Seacoastonline.com – August 20, 2012
