The use of a level strategy means that a company will produce at a constant rate regardless of the demand level. In companies that produce to stock, this means that finished goods inventory levels will grow during low demand periods and decrease during high demand periods.
What is Level Production Strategy?
When a company produces items to meet the demands of consumers, it means that the company must insure that the right quantity of each item is available for sale at any time. The process that is used to determine the right quantity of each type of item is known as the Work-Availability Process for each product and is a major component of the concept known as Materials Requirements Planning (MRP). If a company produces to meet demand, this process will be followed automatically.
If the company employs a level production strategy, it means that the Work Availability process is followed, but only for each individual item (product). This means that if an item is in high demand, the company will manufacture a large quantity of it. In contrast, if an item is not in high demand, it will only produce a small quantity.
Factors That Are Considered in This Strategy
Many factors come into play when a manufacturing company is deciding whether it should produce to stock or a level production strategy. For example, the firm must consider the following:
- Capital Expenditures. A company may be hesitant to produce to stock, or use a level production strategy because the additional capital required for the production of goods in advance could be higher than if the company only produced when there was an actual order. As this is the case, the company must have the belief that the inventory carrying costs are less than the additional costs to produce items in advance.
- Inventory Holding Costs. In some cases, the inventory in the storage areas and the cost of replacing the items if damaged could be a major cost to the company. The cost of replacing finished goods inventory caused by factors such as theft or damage can be quite high and must also be considered.
- Production Management Skills. The firm must make sure that it can produce the items in a quality manner in a cost effective manner. If the company has poor management in the production warehouses, there is a good chance that they will not be able to produce in a timely fashion. If the management is poor, they could end up producing items that get damaged during storage and may not be able to reproduce the item for the store shelves. This will not only result in lost sales, but will cost the company money in the long run in replacement costs and in refunds to customers.
- The Pricing Strategy. The pricing policy that is adopted by the company will also play a role in their decision to produce to stock or on a level production basis. For example, a company that is selling on price will only want to sell a product when a customer requests it. In contrast, a company that is adopting a variable pricing strategy will have a much greater demand as they will reduce the price of their products in an attempt to increase demand.
- The Market Share Strategy Adopted. If the company is trying to maximize profits in the market place by using a low cost strategy of attacking all competitors on price, they may also consider using a level production strategy. This will insure that the customers orders are always filled at the price that the market will bear. While in contrast, a company that is going after market share using a differentiation strategy is likely to use a production to stock strategy.
Using a level production strategy enables a company to have lower production costs and higher inventory levels because capital spending is kept at a minimum and fixed cost are spread over larger Gross Margin dollars. This strategy also reduces the risk of carrying obsolete goods inventory throughout the year and is used in much the same way that a sales forecast is used. If a company has correctly estimated the demand for their products in the market and has built the inventory correctly, they can expect a increase in profits.
However, if the company has built an excess amount of inventory, they could find out that their forecasts were poor and that they need to reduce the production levels. This production level reduction must be considered as an additional cost.
Also, if the company uses higher valued products in their product portfolio and their inventory levels are too high, they could find themselves in a price war with their competitors. If this happens, the company will most likely suffer a cut in the prices that it receives and its gross margin and profit levels will suffer.
On the other hand, if the company sells mainly commodities, their costs are likely to be lower and they are likely to make a profit. Also, in situations where they use short production runs, a few excess products in inventory can essentially be canceled out by the reduced costs associated with a shorter production run.
The company must also be aware of the situation that the their suppliers are in. If for example the supplier is producing at 100% capacity and orders an additional 50%, of an item that the company has ordered. If the company does not do the same, the supplier is likely to cut them off from additional purchases. In an extreme case, the supplier may not accept any additional orders from the company.
Use of Level Production Strategy:
A good example of using a level production strategy can be seen in the fast food industry. A fast food company uses a level production schedule because the demand for there products is normally high and the gross margins are normally low when it comes to the products that they sell. With a high demand and low margin situation, the level production strategy works well.
A more common use of this strategy comes in the use of hospitals that supply medical supplies such as gloves, syringes, and stethoscopes. Hospitals have a constant demand for these products and they can be produced in a large quantity and stored in small spaces like underneath beds. This gives the company and high degree of flexibility in terms of forecasting their orders. One of the main reasons that this strategy is not used by many other kinds of companies is because of the high cost of storage.
The level production strategy is only cost effective under specific circumstances and is not cost effective under many others. In the long run the strategy may also hurt the company in that if the demand for products decreases and the company has too much product on hand, they could end up losing money.
The level production strategy is often adopted by companies in the following situation:
- If the company has a high fixed cost such as a storage facility or a product under development.
- If the company can sell unwanted inventory at a lower price compared to the cost of production.
- If the company has a stable demand for a product with a low demand elasticity.
- If the company has the ability to convert inventory to cash quickly.
Types of Inventory Strategies:
- Just in Time Strategy – This is a strategy in which the inventory is produced before it is sold. This eliminates most of the costs associated with inventory. However, the costs associated with fixed capacity and investment in equipment is extremely high. This strategy improves the overall efficiency of the company, but it is also very risky. This strategy is the most common with production related industries.
- Inventory Strategies – In this type of strategy, the company produces items in a fixed production schedule. For example, a company might produced 500 units of a particular item per week for three weeks on a continuous basis.
- Level Production Strategy – This is the type of strategy that is advocated in this paper. It is similar to the Inventory strategy except that the company produces more items in order to take advantage of the economies of scale. It is also similar to the Just in Time Strategy, except that it produces inventory on a regular basis.
While these three strategies are the most common in mainstream manufacturing companies, the Second Hand or Used Strategy is also common. Freecycle.org is an example of an agent that uses this strategy in that the businesses they deal with receive a cost savings in the form of a reduction of the taxes that they pay.
The companies in Second Hand or Used Strategy use a strategy that reduces the cost of production. The benefits of this strategy is that the company will eliminate the cost of the actual product and the cost of storing and maintaining the product. However, they will also have to endure the risk of accepting bad debts from their customers. In other words, they have to figure out how to get the product back without having to pay for it.
This strategy can be dangerous for a company because they can find that they have large amounts of product that has been sold to customers that are unwilling or unable to pay for them. One of the best examples of this strategy can be seen in the copy machine industry. It is also done in the paper industry where the business sells the paper at a discount or for a low price to attract customers and then make a profit from the add on services, such as binding and finishing of the advanced copy.
Decision Making Techniques:
The first decision that companies must make is on the method in which they collect, display, analyze, and distribute the data regarding their inventory levels. The data about the inventory levels, sales levels, and production levels must be constantly looked at, analyzed, and reviewed by the managers, and the executives of the company. This way, in times of supply and demand fluctuations, they can make adjustments in the production or sales levels to help alleviate the problem.
Cost of carrying inventory:
The companies must decide on the degree of certainty that they need to keep so that they can forecast the demand levels and the concomitant supply levels. Too much certainty can be bad for the companies because it results in a waste by the company of funds that are needed to purchase the excessive inventory. To reduce the costs of inventory, companies can use standardizing, modularization, Just In Time and LEAN. While these methods of inventory elimination can be used individually or in combination, they will collaterally reduce the time and cost associated with inventory as the core benefit of producing under existing Lean principles.
This process involves the total elimination of some of the components to the manufacture of the product. This is mainly done when the actual player in the market is unknown and the competitor’s share is high. However, the standardization of production of the final product is mainly done because it has been found to be most suitable in the transfer of top line revenue in a simultaneous time frame as well as in cost reduction per unit. The key in using this strategy is in the efficiency of the receiving department to eliminate all the inventory at a faster rate and to deliver the products to the customers who have ordered and paid for it. Customers are willing to pay more for the product that is produced under Standardization because it is predictable in it quality, costs less in production and in distribution, and is shipped faster and appears to be better organized as seen from the customers point of view.
In this method, the materials are available on demand and the process involves a modulable production concept that involves the creation and installation of equipment and facilities for the production of different sized modules. The modules are created at cost that is close to that of a unit of production and it is subsequently assembled with the complete assembly line at a reduced cost. In this method, there are two different milestones in the process that are of concern; the new product launch and the change in the demand. The application of this method in the business is an easy one and thus the training program is simply a matter of explanation to the new individuals. A well trained person can be very effective at the time of transfer of the task to another trained person. This pattern is one of a continuous process of learning to include continuous training of the employees as they perform the task.
Just in Time Production:
The process by which any part should be made available at the place of its use, the manufacturer holds limited inventory and the customer, in making the order, offers a money option instead of holding the merchandise. A small order is placed in a large market and production takes place only when the demand is raised by the customer. This method produces much better response from the customers, it reduces the working capital requirements, it reduces the concentration of the inventory in the single plant, and it helps the company in reducing the cost of inventory by 50 percent.
LEAN production is basically a set of strategies that have been adopted to reduce the waste in the process of production. One of the reasons why this method of production has become so popular in the market is that it is known to bring more business and financial objectives at the same time. It is the convergence of the production process that has helped in bringing about a drastic change in the production circumstances.
The Lean system of production can be used even by the largest of the production systems in the world. LEAN production has been around for more than 30 years and during this time, it has helped many different companies in production of about 25 different product lines. The LEAN production system has therefore been proven in its concept of bringing about change in production process and in the management of Resources.
Over the last 10 years, LEAN has been used globally in about 1,200 different companies and it has helped save a whooping 1.7 million workers from repetitive tasks. The LEAN Production system is therefore very beneficial to the companies’ processes and helps in production of quality products at a reduced time and cost.
Purchasing is one of the other decisions that companies must make. This decision involves the purchase or disposal of finished goods, which are then used for the production of other goods in the company. This decision is based on how the company can manage its cash flow, its inventory level, its production time, and its production costs. A company must also have the ability to have an effective and efficient supply chain because if there is a hold up in getting the materials that are needed to make the product, the whole operation can be negatively affected.
The Purchasing department needs to do the following:
There are several ways to make a purchase and they range from cash purchasing to the deliberate over-capitalization of production capacity to provide a buffer against swings in demand level.
The company can also choose to go with the following methods of purchasing:
The company can also decide to produce the product itself. This is usually done whenever the company is certain about the demand in the market and is capable of producing the product itself as it takes the risk of making the product as the market fluctuates.The cost, however, of such a venture can be very high due to the need for production facilities to be purchased and maintained.
In this strategy, the company forces itself to produce the product itself at a higher level than it is required. In these cases, the company avoids sending out for a bid to the suppliers for the production of the product.
Breaking the Company into Production Tiers:
The strategy of breaking the company into tiers helps the company to be more flexible especially when the market is volatile and the demand for the product is high or low. This strategy can be adopted especially in the case of a seasonable product where the demand is high or low based on the season. It is basically a decision-making process that is made on the basis of the following factors:
The company again needs to consider the following:
The use of the segmentation strategy is often found to be unreliable as the market is large enough to sustain more than one company in the business. A study of this variation in production strategy has been traced back to the year 1980, and since then, the segmentation decision strategy has developed. The companies that are based on the segmented production strategy have also modified the manpower pattern in the business, and the use of strategic alliances, and technology as well as bulk and custom characteristics.
Companies in the business can either go the way of debt financing or the way of equity financing. Each of these financial methods are appropriate in the given context.
The method of debt financing involves the use of borrowed money to finance the assets in the business and this is usually required in the business in the case of Seasonal Business. The debt is repaid by the company at the end of the period of time of use of the asset. This is basically a variation in the Fund structure and it has several objectives. Some of these objectives are:
In this method of financial system, ownership is the motivation of the company, and the company is therefore keen to increase the worth of the business by implementing a new project and then selling the project to the shareholders. The company is therefore open to any investment in the business that the owner may require. It basically operates on the four principles of as follows:
Production is the process of extracting raw materials from the earth and from the sea and then transforming them into a set of goods or a service that is then offered to the consumer. It is the process of transforming the raw materials into a higher-quality product that can be offered to the consumer for a price that is higher than the production cost of the product. The production system often considers the product mix, the production technologies, and the production organization that are considered to be viable for the given firm.
The process of production can be carried out by combining different methods to produce the final goods that are thus offered to the consumer. These processes of production are often very expensive because they require the acquisition of capital-intensive assets that include plant, machine tools, and other technological means. Several of these products, however, are produced in the same process of production using the same inputs and resources which, therefore, makes the production process more flexible.
The production process of a product involves the following
The company is concerned about the overall production process and it therefore tries to decide on the kind of production process that is suited to its production plans. The company can either opt for the following methods:
Mix Method of Production:
To implement the mix method, the company first considers the target market and it then tries to make the correct product mix so that it can offer its product to the specific market. This mix method is decided on the basis of several factors*:
The company can also go with a simple product mix where the process of production is of a single product line. The simplicity of the product mix can help in deciding the level of production efficiency as well as the production efficiency.
Product Mix Individually:
The company can also decide its product mix individually. This means that the company decides the mix of the products based on the individual determination of the product mix. The company can make a product run test and decide on the mix of the products that it plans to market. This can often be risky but it can also help the company in determining the true mix of the product. It is also an excellent research method on the part of the company. The company can go with a full product run test the first time and then can make minor adjustments to the product mix on the second batch of product production.
Product Mix as a Function of Materials Mix:
The company has an important role to perform during the actual production process as it has to decide on the kind of product mix that it will work with. This is often done when the company has a plan or a scheduled run as well as a schedule for a product mix. The company makes a decision on product mix by considering the materials mix that it will use in the production of the product. It modifies the mix of the product based on the materials in the production process as well as the environmental concerns. A product mix is mostly done to provide the company with the ability to fulfill the needs of the consumers better through an effective mix of the product.