2.3. Cumulative Obsolescence Cost

So, downtime cost per hour equal to 3% of your equipment cost. Equipment cost is nothing but 900 rupees per hour.

Downtime cost per hour = × (900) = 27 rupees per hour

Yearly downtime costs for the first year is, Downtime cost per year = 27 × 2000 = 54,000 rupees.

Downtime costs represent the financial losses incurred when equipment is not operational. In the first year, the downtime cost is calculated as 3% of the equipment's hourly rate (900 rupees), resulting in 27 rupees per hour. When the machine operates for 2,000 hours in a year, the total downtime cost becomes 27 rupees/hour multiplied by 2,000 hours, equaling 54,000 rupees for that year.

Imagine you own a small bakery that makes 1,000 rupees per hour. If your oven breaks down, and you lose 3% of that income every hour it's down, you'd be losing 30 rupees per hour. If the oven takes 10 hours to fix, that’s a loss of 300 rupees, which is your downtime cost.

Similarly, calculate the downtime costs, let us calculate for the second year, in the second year the downtime percentage is 6%. So, downtime cost is 6% of your equipment cost, equipment cost is 900 rupees per hour.

Downtime cost per hour = × (900) = 54 rupees per hour

Downtime cost per year = 54 × 2000 = 1,08,000 rupees.

In the second year, the downtime cost increases to 6% of the equipment cost. Therefore, the hourly downtime cost is now 54 rupees. Operating for the same 2,000 hours, the total downtime cost for the second year amounts to 54 rupees/hour multiplied by 2,000 hours, which results in 1,08,000 rupees.

Continuing with the bakery example, if you now have a more complex machine that has a higher chance of breaking down (6% downtime), your hourly loss would increase to 54 rupees. After the same 10-hour situation, you would lose much more, totaling 540 rupees for that day if the machine fails.

Now, you find the cumulative downtime cost. Everything is done on cumulative basis. So, find the cumulative downtime cost by adding it.

So, 54,000 + 1,08,000 gives you 1,62,000.

To get the cumulative downtime cost over multiple years, you simply add the downtime costs from each year together. For instance, in the first year, the cost was 54,000 rupees and in the second year, it rose to 1,08,000 rupees. Thus, the cumulative cost after two years totals 1,62,000 rupees.

Think of it like saving for a new bakery machine. In the first year, you saved 54,000 rupees for repairs and in the second year, you saved an additional 1,08,000 rupees. If you add those together, you have a total of 1,62,000 rupees saved for your new machine.

Now the cumulative cost per hour you can calculate by dividing the cumulative costs by the total hours operated.

Cumulative cost, end of the first year = 54,000 / 2000 = 27 rupees per hour

Cumulative cost, end of the second year = 1,62,000 / 4000 = 40.5 rupees per hour.

To find the cumulative cost per hour, you divide the total cumulative downtime cost by the total hours the machine was operational. After the first year, with 2000 hours, the cost per hour is 27 rupees. After the second year, with 4000 total hours, the cost per hour rises to 40.5 rupees as costs accumulate.

Imagine if your energy bill increased as you baked more each week. In the first month, you spent 54,000 rupees on energy and baked for an average of 2000 hours. Your cost is 27 rupees/hour. By the second month, your total is 1,62,000 rupees over 4000 hours, meaning your average cost per hour is now 40.5 rupees.

Now, you have to account for the loss in productivity. So, as we discussed earlier the loss of productivity results in increase in production cost because the machine has spent the time in the repair yard.

Loss in productivity due to downtime directly affects the overall costs. When machines are out of service for repairs, production slows down, resulting in higher costs to either accelerate future production or get additional labor or machines to meet production demands.

If your bakery stops baking for a week due to machine repairs, you might need to hire extra bakers or rent additional machines to catch up on your orders. This extra cost reflects the productivity loss you experienced during the downtime.

So, to bring back the productivity to the original production rate. For that, we have to increase, we have to spend some more cost, some more money we have to spend. So, that results in some increase in cost due to downtime.

When productivity drops, organizations often need to make additional investments to restore normalcy. This may involve hiring extra helpers or extending work hours, leading to increased cumulative costs that adjust for productivity losses.

Returning to our bakery example, if producing the same amount of bread now takes more hours or extra workers because a machine is down, you incur additional costs that need to be calculated into your total expenses.

Every year your obsolescence factor is increasing as machine is becoming more obsolete. The obsolescence cost is calculated as a percentage of equipment cost, with equipment costs at 900 rupees per hour.

Obsolescence costs arise when older machines become less efficient compared to newer models. As time passes, these costs increase, reflecting the better productivity and cost-efficiency of newer technology compared to the aging equipment, calculated as a percentage of the equipment cost.

Consider how a smartphone's value drops once newer models are released. If your old phone performs worse than the latest model, you are essentially facing an obsolescence cost for sticking with outdated technology, similar to what happens with machinery.

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