respectively, to cover their unique
costs of operation.
“You’d apply these varied costs
to a part simply by allocating the
amount of time used in each de-
partment to a given part or assem-
bly. So if it took, say, 0.2 hour to
cut a part on a laser, you’d multi-
ply 0.2 by the burden rate of $150,
and get $30. You’d then do this for
your other work centers. Here, let
me show you.”
Steve took a napkin and wrote
out the costing of a simple part
routed through laser cutting, ma-
chining, fabrication, and welding
(see Figure 1).
Bob sat quietly for a moment.
“Well, that was simple. So what do
I need to do to get this started?”
Phil quickly stepped in. “I can field
this question. Steve helped us get
started when we did this at our busi-
ness. It was a bit tedious but much
easier once you got going. Speaking
simply, we first determined which
departments should be broken out
into separate cost centers based on
the cost differences.
“Then we determined which
costs should be fully allocated in
a department or shared between
departments each time period.
We next determined the hours
each department would work that
time period. Finally, we took the
total costs and divided by the total
hours in that period to get our cost
per hour for each department.
“Some of the details on the
labor base used, such as indirect
labor and efficiency, took
some extra time to develop in
each department, but once we
understood, then the mechanics of
the process were straightforward.
“We then identified how the
hours were used on each part in
each department, just as Steve did
with the table he created. It can either be a manual route sheet for
each product or you can do it in an
ERP system. Then we created our
cost data by adding materials and
desired margins to determine our
selling prices. It was detailed work,
but we now have a lot more information on our production costs
and can therefore price out new
business with confidence.
“And not using our prior one-
overhead burden approach came
with additional benefits. When the
business is running at near full capacity, we are basi-
cally already covering all our fixed costs. Therefore, in
those instances we can consider using a contribution
margin approach for costing additional new business,
which leaves the fixed costs out of the equation. This
means we can add the margin to the sum of mate-
rial, labor, and variable overhead, selling it at a dis-
count equal to our fixed overhead, and still make the
full margin on this incremental business. On multiple
occasions this approach allowed us to take on proj-
ects using overtime to drive higher profits than we
Driving home from the meeting, Bob kept shaking
his head and smiling. It had been a great, productive
meeting, much better than he had expected. Before
they parted, Steve said he’d call to arrange for a visit.
Bob’s mind was off and running. He had just paid for
three breakfast plates, but he came away with so
Ken W. Mikesell is president of Lean Enterprise Solutions LLC, Arvada,
Colo., 720-318-9191, www.bottomlinefix.com, a business and operational
consulting and executive coaching firm. Mikesell brings almost three
decades of metal fabrication, welding, and machining experience to his
practice. A certified welder himself, he still spends his spare time creating unique metal products for a variety of markets.