Comparing Seasonal Production with Level Production Model

To: Mr. David Dunton

From: Jack McClintock

Subject: Comparing seasonal production with level production model

I have compared Toy world’s current seasonal production model with the level production model. In an optimistic scenario we could save money under level production however considering the nature of the business and the risks associated with moving to level production, I strongly recommend continuing our current seasonal production model.

As you are aware, the business of manufacturing plastic toys is highly competitive, with low-barriers to entry. In our line of business, design and price competition is fierce, resulting in short product lives and relatively high rate of company failures. In recent years, competitive pressure has also intensified due to an influx of imported toys produced with low labor costs. In spite of all these factors, we continue to do well and grow at a healthy rate. One of the biggest reasons for it is our current production model i.e. just-in-time approach. This methodology enables us to be relevant with our products. We only produce those toys for which demand exits in the market. For example, we introduced a line of super hero action figures in 1991 which had a big impact on our profit. In 1992 however, competitors marketed similar products, and the factory price of those products plummeted. This however did not impact us in 1992 because we did not have these stocks in our inventory. Had we followed the level production method we would have had these toys in our inventory which we would have to sell by taking a hit on our margins.

Another issue with level production is high requirement of working capital. Considering the risk associated with level production, banks at the most would be willing to lend us 25% of inventory plus 40% of accounts receivables. This would not be sufficient to fund the level production operations during our peak months. Exhibit 3 highlights the working capital funding shortage for the company from August to December. At its peak the company would need additional funding of ~$2.3 mm.

Analysis:

Optimistic case – Level production: In this case I have assumed that the company would be able to sell the whatever it produces i.e. sales are assumed to be same as seasonal production. In this case, by switching to level production method, Toy World, Inc. could increase its annual profits by $174,000. Exhibit 1 shows the monthly savings under optimistic case level production and seasonal production. In total, the company will increase profits by about 50% over the previous year. Under this method, COGS will reduce from 70% to 65.1% of net sales. COGS are inclusive of costs of material to produce the product as well as labor costs. This savings is most apparent because of the elimination of overtime wage premiums which