Burden Costs 5

I need a good definition to explain burden cost as it pertains to manufacturing.

 

[BML]

Burden (aka overhead) is all the "little" stuff that makes manufacturing possible. Below is a list of some examples, but certainly not exhaustive:<br>
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Land purchase or lease cost<br>
Building lease cost<br>
Real estate taxes<br>
Environmental fees and taxes<br>
Utilities (electrical, water, phone, etc.)<br>
Staff salaries (management, indirect labor, etc.)<br>
Maintenance costs<br>
Real and capital depreciation<br>
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As you can see, pretty much anything that affects the product/process or the company can be included in burden. You can also think of burden as the cost of doing business after you take out material and direct labor costs. What bills do you have to pay to continue working?<br>
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There are two main schools of thought regarding the distribution of burden costs. The most popular is to assign each product a burden cost as a percentage of direct labor. It's very simple and is often accurate enough. A takeoff of this is to assign burden based on the amount of floor space a product takes up. However, there are some problems with this method. For example, I can show you a situation in which a plant makes four products. Dividing the burden up this way, one product seems to be losing money, so it is eliminated. But the whole burden still remains (remember, you may end a product line but you still have to pay for the whole building, etc.!). Then one of the "profitable" products looks "unprofitable", so it too is eliminated. This continues and pretty soon the entire plant is shut down, even though to begin with it was making millions of dollars of profit.<br>
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A new school of thought is called Activity Based Costing (ABC). This attempts to make a direct connection between burden costs and the product. Here, you examine how much of the building lease, taxes, indirect labor, etc. are used for each product. That amount of burden is then distributed among the items in that product family. This method will get you a more accurate cost, but is also much more involved. I would suggest that you try something in between the two, keeping in mind that the situation I described earlier can also happen with the ABC method.<br>
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I hope this helps!

 

[tcampbe1]

I have some concerns about the use of burdens when comparing costs among various manufacturing schemes, particularly the make vs. buy decision.<br>
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My concerns go back to my first Engineering job, at a company that applied full burden to its hourly shop rate. The burdened rate was quite high, and when compared to the cost of jobbing out work to outside subcontractors, going outside looked favorable, and work was sent outside. As this proceeded, there was less work in the shop, people were laid off, and morale suffered. At the same time, the total burden dollars, both variable and fixed, required to run the shop changed very little. All that was saved was generally the hourly wage and direct benefits of the people laid off. As a result, the fully burdened hourly shop rate went up, and it became favorable to send even more work to the outside subcontractors. The end result was that the company had a disgruntled hourly workforce, an expensive underutilized shop, and longer and more variable lead times due to the backlogs at subcontractors. To their customers, they could offer only higher prices, longer deliveries, and poor quality. It was not a recipe for success. They suffered a continuous decline that I would not like to see repeated anywhere.<br>
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What was their problem? A large part of it was that their costing did not reflect the true MARGINAL COST of manufacturing. Marginal costing is based on the incremental increase (or decrease) in cost with the addition of one more unit of labor or material. It recognizes that many burdens, even though categorized as variable, do not change with the addition or subtraction of incremental amounts of labor. Recognizing this leads to the full utilization of the fixed plant, which at he same time drives the burden rate down, leading to lower costs.<br>
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When pricing an article, it is useful to know all the burdens so that the selling price will cover our overall organizational costs with some profit. (However, pricing is mostly focused on the market, and the market price is generally driven by the marginal cost of the product!) When you use pricing programs to compare made versus bought components, it unfairly favors the buy decision by assuming that factory burden will decrease as a result of that decision. If that is not the case, or the reduction is less than calculated, you will be start gradually sending your manufacturing expertise outside, and experience the decline that many other companies have suffered.<br>

 

[OldChemie]

Using burden costs in 'make vs buy' decision is indeed tricky. In the example given (own shop vs contract out) <br>
Using 'marginal costs' alone will lead to undue preference for inhouse work and complaints of 'overload'..<br>
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I believe (and have experimented with) use of a context based choice:<br>
If it is a long run/ strategic decision, e.g. whether the shop should exist (or be sold), a fully burdened 'long run' economic cost is proper. Even here, I hesitate to include 'depreciation' without reflecting on the 'upside' potential. i.e. use of replacement cost vs historical cost based depreciation. <br>
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If it is tactical dcision, e.g. to route work to one or other shop, the incremental costs including variable labor work better (esp. if there is a proven flexibility in staffing, e.g. temp workers.)<br>
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In extreme short duration cases, e.g. where the labor is already committed and the issue is which machine to use.. true marginal costs: consumables only should count. <br>
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A good 'activity based management' program can 'codify' the decision analysis templates too simplify the task.