A ₹340 Offer, Idle Machines and a 30-Day Delivery
A small unit with 18 single-needle machines works 26 days a month on one 8-hour shift and currently runs at 85% line efficiency on a 22-minute SAM for a school shirt. Monthly fixed overhead (rent, staff salaries, the fixed component of power, and depreciation) is ₹1,20,000, already covered by existing orders that fill about 6,000 pieces a month. For a new inquiry of 2,000 shirts to be delivered in 30 days the figures are: fabric consumption 1.70 m per shirt at ₹150 per metre, trims ₹34 per shirt, and direct labour cost derived from the 22-minute SAM at ₹58 per hour. Normal process rejection is 3%. The buyer offers ₹340 per shirt ex-factory, payment 45 days after delivery, and asks for a 30-day delivery. The owner is keen because 'the machines are idle anyway'.
1. Calculate the variable cost per good shirt and the contribution of the order, and recommend whether to accept ₹340. State the assumption your recommendation depends on.
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Variable cost per shirt produced:
- Fabric: 1.70 m × ₹150 = ₹255.00
- Trims: ₹34.00
- Direct labour: (22 ÷ 60) × ₹58 = ₹21.27
- Total = ₹310.27
Correct for the 3% rejection: to ship 2,000 good shirts, production must be 2,000 ÷ 0.97 = 2,062 pieces, and the fabric, trims and labour in the 62 rejected pieces are still spent. So variable cost per good shirt = 310.27 ÷ 0.97 = ₹319.87.
Contribution: ₹340.00 − ₹319.87 = ₹20.13 per shirt, i.e. about ₹40,260 for the order (on 2,000 shipped pieces).
Recommendation: accept, but only marginally, and only because the fixed overhead is already recovered by existing orders. That is the key assumption: with idle capacity, the fixed overhead is a sunk cost for this decision, so any positive contribution improves profit. If the existing 6,000 pieces did not cover the ₹1,20,000 overhead, part of the overhead would have to be loaded onto this order and the ₹20 contribution would disappear. A ₹20 margin is thin - one adverse movement in fabric price, one extra rejection point, or overtime wipes it out. Quote, but build that risk into the terms.
2. Check whether the 30-day delivery can be met at 85% efficiency, and state what happens if the line actually runs at 75%.
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Daily capacity = (machines × minutes per shift × efficiency) ÷ SAM
- At 85%: (18 × 480 × 0.85) ÷ 22 = 7,344 ÷ 22 = 333.8 pieces/day, i.e. 8,679 pieces in 26 working days.
- Requirement: 2,062 pieces produced. Existing orders take 6,000 → spare capacity 2,679 pieces. 2,062 fits inside 2,679, with about 617 pieces of slack. The 30 days can be met at 85%.
At 75%: (18 × 480 × 0.75) ÷ 22 = 6,480 ÷ 22 = 294.5 pieces/day, i.e. 7,658 pieces in 26 days. Spare capacity is then only 1,658 pieces against a requirement of 2,062 - a shortfall of about 404 pieces, roughly 1.4 working days.
Implication: the offer is viable only if efficiency holds. A 10-point efficiency drop, which is entirely normal on a new style in the first weeks, converts a feasible order into a late delivery. Options: plan overtime or a Sunday shift in advance rather than as an emergency, put the style on the line early enough for the learning curve, and check the SAM of 22 minutes against actual time study - if the SAM is optimistic, both the labour cost and the capacity calculation are wrong. Whatever the buffer costs must come out of the ₹40,260 contribution, so confirm it still leaves a margin before signing.
3. Apart from the contribution figure, what factors should influence the owner's decision, and what two clauses would you insist on in the order confirmation?
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Non-cost factors:
- Payment terms: 45 days after delivery on a 30-day production cycle means the unit finances fabric, trims and wages for roughly 75 days. On this order that is a working-capital commitment of several lakh rupees; check whether the cash is available or whether an overdraft interest cost must be added, which would eat the whole ₹20 margin.
- Concentration risk: a buyer who is offered a thin price on idle capacity may become the unit's largest customer; dependence grows and the price becomes the reference for future orders.
- Buyer's quality regime: acceptance criteria, AQL levels, inspection cost and who bears it, and the penalty for late delivery - a single late shipment can cost more than the contribution.
- Reputation and reference value of the buyer, and whether the style builds a capability the unit can sell again.
- Capacity conflict: if a better-paying order arrives within the 30 days, the committed line cannot take it.
Two clauses to insist on:
- Price revision clause - if the fabric price moves beyond an agreed band (say ±5%) between confirmation and delivery, the price is adjusted, since fabric is more than 80% of the variable cost and the margin cannot absorb a movement.
- Payment and delivery clause - payment reduced to 30 days (or an advance/LC against documents, or a penalty-free extension for documented capacity or fabric delay), with a defined maximum late-delivery penalty rather than an open-ended claim.
Then sign only if the margin survives the interest cost and the worst realistic efficiency case.