More economic arguments for setup reduction

In addition to the cost of acquisition, there can be significant expenses in actually being in possession of inventory, including, but not limited to:

- Borrowing costs of capital
- Cost of storage space – racking, storage bins, building space rent, lighting, heat, etc.
- Insurance
- Spoilage of inventory (e.g. obsolescence or deterioration)
- Theft, pilferage and other losses
- Damage to inventory – physical damage from lift trucks or during other handling
- Cost of handling to move or rotate
- Cost of management, measurement and accounting for inventory
- Cost of inefficiency due to inventory issues – e.g. layouts may be less than optimal in a large factory with large amounts of inventory
- Loss of business due to inventory problems – e.g. inaccuracies in inventory records that lead a business to assume that there is sufficient inventory, when there in fact is not, leading to overdue deliveries

A reasonable rule of thumb is to estimate that inventory holding costs can equal 25% to 33% of the inventory value each year.

Also considered by some is the opportunity cost – the value of other uses of the money identified above. It should be noted that opportunity cost is not a category in a financial statement.

Some estimates put the total cost of inventory as high as 50% per annum.

We have seen some of the benefits of quick setup:
- flexibility, for better customer service
- lower costs, due to less inventory

Other benefits to be explored are:
- improvement in quality
- improvement in safety
- improvement in general operations, due to need for coordination
- ability to work to customer order instead of forecast
- smaller factories improve communication
- improvement in problem solving
- ability to level loading

Setup reduction and flexibility - the economics

The above image shows how quick setup provides flexibility to an operation. By reducing the time spent setting up, it is possible to retain the original productivity, but reduce run size.

There may be marginally higher costs to initiate each order. These could include more material handling, more supervisory time (on paperwork, and the like), more maintenance time (on last off inspection to determine tool condition), more time spent preparing and cleaning up after each setup, and perhaps other similar activities. In the above example, the WIP was reduced by a factor of 12 (i.e. greater than 90%).

Depending on circumstances, the cost of holding WIP and finished goods is 30% to 50% annually (including opportunity cost). There is also a value to the business of the increased flexibility that is harder to determine – but it pertains to how well the customer is served, and what benefits this provides. It is mainly the cost of servicing return business compared to the cost of obtaining new customers. Furthermore, to achieve this level of flexibility, quality and maintenance must be very good, further reducing the cost of production.