Each period, you must submit a production plan for each of your marketed brands, i.e. you must specify how many units you want to produce for the period. This decision must take into account the potential sales for the brand, the existing inventory at the beginning of the period and the flexibility of the Production department.
The Production department of your company is working for several divisions. It can thus be viewed as a highly flexible external supplier. As a consequence, you are not concerned about manufacturing investments, fixed costs or capacity utilization.
From one period to the next, you are completely free to increase or decrease the production plan of a given product, without any penalty. The Production department will always manufacture the required quantities in the best possible conditions.
Moreover, the actual production level for each product is automatically adjusted in response to actual demand for that product in the period, within 20% of your initial production plan. Hence, if you did not order enough units to cover the demand, the production will be automatically increased by up to 20%. On the contrary, if you ordered too many units and cannot sell them in the period, the production will be automatically reduced by up to 20%. In case your production plan was inaccurate by more than 20%, you will either lose sales or build inventory.
Figure 4 gives a few examples of varying situations of inventory, production plan and market demand (all numbers are in units).
|
|
|
Case A |
Case B |
Case C |
Case D |
|
Potential sales |
(a) |
154 000 |
154 000 |
154 000 |
154 000 |
|
Beginning inventory |
(b) |
20 000 |
20 000 |
20 000 |
None |
|
Production
plan |
(c) |
150 000 |
100 000 |
200 000 |
200 000 |
|
Actual production (automatic adjustment) |
(d) |
134 000 |
120 000 Increased to |
160 000 Reduced to |
160 000 Reduced to |
|
Actual sales |
(e) |
154 000 |
140 000 |
154 000 |
154 000 = (a) |
|
Lost sales Equal to (a) – (e) |
(f) |
None |
14 000 |
None |
None |
|
Ending
inventory |
(g) |
None |
None |
26 000 |
6 000 |
Figure 4 – Inventory and production plan versus market demand
The flexibility of the Production department goes beyond automatic adjustment of production plans. The units produced are charged to the Marketing department only when they are shipped to distributors to be sold to consumers. The price paid by Marketing to Production is called the transfer cost; it incorporates all costs associated with this high level of flexibility, including depreciation and fixed costs.
The transfer cost of a product is initially equal to the base cost of its base project, assuming that the first production batch is 100,000 units. The base cost is the unit cost that was decided when the project was developed by R&D. The transfer cost will then increase with inflation and decrease over time because of experience effects and economies of scale. As a rule of thumb, you can expect the transfer cost to be reduced by about 15% each time the cumulative production of a given product is doubled. If the first production batch is lower than 100,000 units, then the transfer cost will be higher than the project base cost. For instance, if the initial production is 50,000 units, the cost will be 15% higher.
Units produced in excess are kept in inventory, and inventory-holding costs are charged to the Marketing department until these units are sold. Inventory costs per unit are calculated as a percentage of the transfer cost. This information can be found in the Newsletter.
Production plans must be entered each period in the Marketing Mix decision form. These decisions should be based on your sales forecasts for the upcoming period and should take into account any units left in inventory. If you are holding a high level of inventory, you can set the production plan to 0 but in this case, no automatic adjustment is possible.