How to Fix Bottlenecks That Increase Production Costs - dummies

How to Fix Bottlenecks That Increase Production Costs

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

Accountants can use process costing to analyze the cost at each stage in a production process and the overall cost of manufacturing the product. If a bottleneck occurs at any stage in the production process, it increases manufacturing costs by increasing the amount of time required to manufacture the product. To reduce costs, you need to eliminate bottlenecks.

Recognizing a bottleneck and its fallout

A bottleneck occurs when production slows or stops completely. As the term implies, unfinished product builds up in a certain department and doesn’t move through the way it should. It’s similar to a traffic jam on a highway.

A bottleneck hurts a business in several ways:

  • Reduces productivity: A bottleneck slows the entire production process, resulting in less product produced during any given period of time.

  • Hinders timely delivery: Production delays may lead to late deliveries, disgruntled customers, and lost business.

  • Increases costs: Fixing the bottleneck costs time and money.

Fixing a bottleneck: Short- and long-term fixes

Solutions for fixing bottlenecks fall into two categories:

  • Short-term: Short-term solutions are usually stopgap measures to address an immediate need but aren’t cost effective. For example, if a business has an insufficient staff to handle the workload, it may hire temps or pay employees to work overtime.

  • Long-term: Long-term solutions are permanent solutions that must be cost-effective. For example, the business hires more full-time employees.

Exploring the Canada-to-U.S. oil bottleneck

Canada exports a lot of crude oil to the U.S. that’s refined and sold to gas stations and ultimately drivers. Once extracted, crude oil is sent by pipeline to U.S. refineries. Most of those refineries are on the gulf coast, because they also refine oil extracted from the Gulf of Mexico. So, Canadian crude oil has a long way to travel before it is refined.

New technology allows the U.S. to drill in new locations and extract previously inaccessible oil from old wells, increasing U.S. production. This poses several problems for Canadian crude producers:

  • U.S. crude producers are shipping oil by using the same pipelines, thus slowing the flow of crude oil from Canada.

  • Restricted delivery leads to lower sales and less revenue.

  • Increased supply leads to lower crude oil prices and reduced revenue.

Fixing the bottleneck: A short-term solution

Because pipeline availability is limited, Canadian oil producers turn to railroads. The railroad option is a reasonable short-term solution, but it has several drawbacks:

  • Railroads can’t deliver the same amount of oil as was pumped through the pipelines in the past, reducing sales; reduced sales mean reduced revenue.

  • Shipping oil in railroad tankers is significantly more expensive than pumping it through pipelines. And with crude oil prices dropping due to increased production in the U.S., Canadian crude oil producers can’t afford to continue delivering their oil via railroad.

  • Canadian crude oil producers may also need to ship their product in tanker trucks to the railroads, another expense.

Obviously, shipping crude oil via railroad isn’t a sustainable solution.

Fixing the bottleneck for good: A long-term solution

A long-term solution is to add pipeline capability. Of course, this long-term solution would require a substantial capital investment, and with crude oil prices on the decline, Canadian crude oil producers would have less capital to invest in exploration and drilling new wells. However, oil producers and government agencies in Canada and the U.S. could use tax dollars to help reduce the costs to producers.

In any event, any bottleneck requires a long-term solution in order for revenue to recover.