Economic Manufacturing Quantities: The Right Amount and the Right Locations

by Foley & Lardner LLP

Does your manufacturing firm have enough facilities creating the optimum number of products in the right locations? As manufacturing abroad became viable, the siting options became innumerable. Now, already difficult decisions are becoming more complicated due to market trends. Oil prices are rising and automation is spreading. Also, although differences still exist, relative wages are converging and regulations are becoming more uniform. As a result, transportation costs increasingly influence strategic decisions. Add localization barriers to trade, which force production within a given country’s borders, and any strategic planner must ask, “Where should we locate production facilities? How many should we have around the world? How many units should we produce at each site?”

Performing an analysis I dubbed “economic manufacturing quantities” (“EMQ”) could provide manufacturers guidance to help answer these questions. (Note, to my knowledge, the EMQ concept is not a widely known or accepted idea. Rather, the term occurred to me while mulling over a combination of supply chain management principles, including economic order quantity.) In the past, retailers faced difficult questions regarding inventory stocking—how much, when, and where. Economic order quantity provided an answer through a calculation by which sellers determine at what point a given location should replenish its inventory and how much that location should order. Premised on assumptions about demand and shipping times, an economic order quantity calculation seeks to minimize ordering and carrying costs while avoiding shortages.

Likewise, in calculating EMQ, decision makers would make assumptions, including the number, price, and cost of a product that can be sold in a given market. EMQ would theoretically answer three questions:

  1. How many manufacturing plants a company should have,
  2. In what locations those plants should be located, and
  3. How many units each plant would produce. To do so, various scenarios, using systems of equations, would calculate optimum values to maximize the target value: profit.

Equations would be used to represent practical effects. For example, adding a production facility could mitigate shipping costs. But, as economies of scale are lost, overhead costs would likely jump with each additional production location. On the revenue side, a company’s ability to even sell products in a market could be contingent upon whether it maintains a production site in that market. In the calculations, revenues and costs would probably fluctuate interdependently. Through algebraic formulas, these and other financial considerations would be woven together to generate meaningful information.

Fortunately, commonplace software like Microsoft Excel, not to mention an enterprise resource management system, can perform these types of calculations. To calculate enterprise-wide profits, EMQ would go beyond the facility-level by feeding the optimum quantities for each location into a company-level equation. The quantity that maximizes profitability for a particular facility may not necessarily maximize profit for the whole company. Using scenario analysis, manufacturers can analyze how their bottom line might be affected by putting a production site in each of their major markets vs. using centralized facilities. Software could generate and decision makers could review company-level projections for a variety of options. Thus, EMQ could aid companies in analyzing more than how many units each facility should produce, but also how many facilities a manufacturer should utilize and where they should be located. Like other advanced analytics, developing EMQ analyses could help a manufacturer create a competitive advantage.

Beyond the numbers, qualitative considerations cannot be ignored. Ultimately, the traditional manufacturer with one or two plants may not be agile enough to adjust to significant changes in the global market. As recently as last year, the National Association of Manufacturers expressed significant concerns about the widespread use of protectionist policies. So how would your company be affected if Brazil, Russia, or India mandated a heavy tax on each product sold within its borders but manufactured in a different country, like China? Or could your company continue to ship goods if oil prices skyrocketed overnight? By keeping an eye on the horizon and implementing advanced analytics, like EMQ, Next Generation manufacturers can position themselves to thrive in the years to come.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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