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The importance of Batch Size Economics

The topic of batch-size economics can be a complex and intricate one. The principles associated with this concept revolve around an organization’s Transaction and Holding costs, but the Total cost is what what we are after. Don Reinertsen, who represents the scientific view of Lean, has explained this concept in detail, and any change agent should understand how it works.

In this article you will find guidance about Batch size economics with the analogy of a real world example.

Understanding Batch Size Economics

To better understand Batch Size Economics and how transaction and holding costs are related, we can consider the task of bringing firewood into the house on a beautiful, chilly winter day. The house is heated with a wood stove that requires a continuous supply of firewood. In this analogy, we can think of transaction cost as the cost of sending a batch and holding cost as the cost of not sending it.

For instance, in the case of bringing firewood into the house, the transaction costs are the effort and time it takes to collect and transport the firewood. On the other hand, the holding cost is the need for a warm and comfortable temperature inside the house. The longer we delay putting fuel in the stove, the colder the house will become.

The Transaction costs is the effort bring in firewood and the Holding cost is the need for a warm and comfortable temperature.

Shifting the optimum batch size to the right

Don Reinertsen has developed a diagram that shows the cost on the Y-axis and the number of items per batch on the X-axis. The diagram illustrates that the holding cost increases for larger batches since they take longer to deliver. On the other hand, the transaction cost decreases when more items are in the batches due to coordination gains. However, we must examine the total cost to determine the economic outcomes and the optimal batch size.

It’s important to note that the holding cost varies depending on the situation. For example, the holding cost is much lower in the summer since heating is unnecessary. Similarly, in a business environment, the holding cost may vary depending on the nature of the business.

The diagram shows that the optimal batch size shifts to the right when the holding cost is low. However, the holding cost is never low in a fast-changing business environment.

Lower Holding cost will shift optimum batch size right

Increasing the batch size

Suppose it’s winter, and the holding cost increases relatively fast with larger batch sizes. In that case, the optimal number of logs to bring in each time we go outside to the shed in the housewarming example would depend on the urgency and need for warmth. For instance, if we need to warm the house quickly, we may bring only one log at a time. This is an expensive option, but the holding cost is low. On the other hand, if we have more time, we may use a basket to bring ten logs, which could be close to the optimal batch size if one basket of wood would last for a good night’s sleep.

Optimum batch size

Shifting the optimum batch size to the left

It’s worth noting that investments can be made to lower the transaction cost. For example, a conveyor belt could be installed in the housewarming case to transport the firewood from the shed to the house with almost no work effort. Although the installation may be costly, the reduction in transaction cost can significantly influence the total cost, ultimately shifting the optimal batch size to the left.

Lower Transaction cost shift optimum batch size left

Investing in Enablers

In product development, Enablers, such as knowledge, tools, and automation, can similarly lower transaction costs. By reducing transaction costs, an organization can meet the customer’s needs more quickly, increasing the transaction volume and justifying the investment in reducing transaction costs.

To optimize a workflow, it’s crucial to reduce both batch size and transaction costs. By improving an organization with batch-size economics, more savings can be achieved than one might initially imagine. Whether you rely on metrics or not, understanding Batch Size Economics is helpful to use as a mental thinking model.

We recommend reading the book “Principles of Product Development Flow” by Don Reinertsen for a more in-depth understanding of batch-size economics.

Reinvest in Enablers to reduce transaction cost

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The intention of the Articles published on this website is to provide exciting knowledge about organizational development in any business. BDD hopes this knowledge will help take your organization to the next level. The information is based on our experience supporting many transformations and cutting-edge sources published in books, articles, and frameworks.

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