Batch-Level Activities

Batch-level activities are tasks a business performs once for each batch, lot or production run of a product, regardless of how many units the batch contains. Common examples are setting up a machine, ordering and receiving materials for a run, moving a batch between departments, inspecting the first units of a run and scheduling production. The cost of these tasks rises with the number of batches, not with the number of units.

The idea comes from activity-based costing, which groups activities into a cost hierarchy: unit-level, batch-level, product-level and facility-level. Recognizing batch-level activities explains why small production runs are expensive and why traditional costing systems, which spread overhead in proportion to units or labor hours, often misstate the cost of low-volume products. The resulting cost is described under batch-level cost.

A print shop that receives an order for wedding invitations has to load the right paper, set up the plates and run a test print before the first good invitation comes out. That work is the same whether the couple orders 50 invitations or 500. Each job carries the same setup effort.

Those once-per-job tasks are batch-level activities. Because the effort does not shrink for small orders, a small order carries a much bigger share of setup work per invitation than a large one.

Activity-based costing sorts activities by what causes them:

• Unit-level activities. Performed for each unit, such as machining or assembling each item. Their cost varies with units produced.
• Batch-level activities. Performed for each batch, such as setups and first-article inspection. Their cost varies with the number of batches.
• Product-level activities. Performed to support a product line, such as engineering design changes or maintaining a bill of materials. Their cost varies with the number of products.
• Facility-level activities. Performed to sustain the plant as a whole, such as plant management and building security. They cannot be linked to particular products.

Batch-level activities sit in the middle: they are not fixed for the factory as a whole, but they are not unit-variable either. Treating them as either one leads to errors in costing and pricing.

• Machine setups and changeovers, including cleaning and calibration.
• Purchasing, receiving and inspecting materials ordered for a specific run, often triggered by a purchase order.
• Production scheduling and issuing work orders.
• First-article or sample inspection of each batch.
• Material handling, such as moving a completed batch to the next department or to the warehouse.
• Batch documentation and quality records required in regulated industries such as food and pharmaceuticals.

A plant makes two products. Product A is produced in 10 batches of 1,000 units a year; Product B in 40 batches of 50 units. Each setup costs $800, an indirect cost that no single unit causes. Batch-level setup cost totals $8,000 for A, or $0.80 per unit, and $32,000 for B, or $16.00 per unit. If the plant instead spread its $40,000 of setup cost on machine hours, and both products used similar hours per unit, Product A would carry far more setup cost than it causes and Product B far less. B would look profitable when it may not be, a classic cross-subsidy that activity-based costing exposes.

Once managers see these costs, they can act on them in two ways. They can reduce the number of batches, for example by encouraging larger orders, setting minimum order quantities or charging customers a setup fee for small runs. Or they can reduce the cost of each batch through faster changeovers, standardized setups and better scheduling, approaches central to lean manufacturing and just-in-time manufacturing. Activity-based management uses this information to decide where improvement efforts will save the most.

The appropriate choice depends on strategy. A business competing on customization may accept many small batches and price them accordingly, while a volume producer may prefer long runs. Either way, the batch size and number of batches should be visible in costing, budgeting and cost-volume-profit analysis, because batch-level costs will change if the production pattern changes even when total units do not. In a flexible budget, they should be budgeted by number of setups or runs, not by units or labor hours, so that spending can be judged fairly against the activity actually performed.