The selection process for an oil laboratory is "in process", a "completed process", or not even a thought in your mind, but have you considered how to pay for your oil analysis? There are two billing methods associated with oil analysis: prepaid and postpaid (oil sampling in which the cost is billed at the end of the month). Your selection of billing methods affects your overall expenditures based on your internal bottle shrinkage.
Bottle shrinkage is essentially the percentage of bottles that disappear before ever making it to the oil laboratory. Whether the sample bottle is used to store nuts and bolts, or the lube tech's supply of cough drops, the bottle is removed from the available supply of sample bottles and is not being utilized for its intended purpose. Industry figures estimate bottle shrinkage between 10 to 15 percent of the available inventory. This loss can be detrimental or insignificant, but it is dependent upon your particular practices for oil analysis.
Laboratories have different methods for billing their services. This article focuses on the general concepts of prepaid and postpaid billing practices where weighted average pricing is utilized.
Prepaid
The prepaid billing method is one in which the cost of performing a sample analysis is included in the cost of ordering the bottle. Essentially, a sample bottle that costs around $1 is ordered for $15. The $14 difference covers the cost associated with analysis of the sample. To put this in perspective, the $1 bottle that leaves the inventory for reasons other than oil sampling actually costs $15 - a bit expensive for a cough drop storage container.
Postpaid
Postpaid sampling allows for the purchase of sample bottles up front and billing for the number of samples burned on a monthly or weekly basis. If sample bottles are ordered for $1 per bottle, then the cost is $1 when they exit the inventory. At the end of the billing cycle, you are billed for the number of samples burned. If 1,000 bottles are ordered for the month with only 900 samples analyzed, billing would include only those 900 samples. If the cost is $15 per sample, the total would be $15,000 plus the cost of the bottles. Note that the cost of postpaid sampling is higher than prepaid due to the administrative costs associated with the secondary billing.
With both billing methods in mind, it is important to consider bottle shrinkage and take steps to determine the internal rate of shrinkage specific to your situation. As stated, industry estimates put the average rates of bottle shrinkage between 10 to 15 percent over time. By determining the specific rate of bottle shrinkage, a more exact cost associated with loss can be calculated.
Calculating rate of shrinkage can be done at a basic level by counting the sample inventory at both the beginning of the month and the end of the month. Sample bottles purchased during the month must be accounted for, as well as the number of samples that are analyzed for the month. Sample bottles that are not accounted for are used to calculate the shrinkage rate.
Rate of Shrinkage Calculation - An Example
Inventory Count
Beginning (ICB) 1,000
Ending (ICE) 900
Bottles Purchased (BP) 500
Samples Burned (SB) 500
Calculated Inventory (CI)
= (ICB - ICE) + BP
= (1,000 - 900) + 500
= 600
Bottles Unaccounted For (BU)
= (ICB - ICE) + BP - SB
= (1,000 - 900) + 500 - 500
= 100
Rate of Shrinkage
= BU / CI
=100 / 600
= 0.166667 or 16.7 percent
Because of fluctuations in the work loads, performing the calculations over several months will add to the accuracy of the rate of shrinkage. One month may have a lower number of samples analyzed and bottles purchased compared to the next month, which may have unusually higher numbers. These fluctuations will result in artificially low or high numbers for calculating rates of shrinkage.
Prepaid sampling normally has a less expensive up-front cost which makes it look more attractive when compared to postpaid. However, considering bottle shrinkage, it is necessary to look further at the pricing. This basic formula for comparing prepaid and postpaid pricing will aid in determining the break-even number of samples required on a monthly basis.
Prepaid Cost Formula:
Sample Cost = N * $ * (1 + S)
Where:
N = Number of Samples
$ = Cost per Sample
S = Rate of Shrinkage (in decimal form)
Postpaid Cost Formula:
Sample Cost = (N * B * (1 + S)) + (N * $)
Where:
N = Number of Samples
B = Cost per Bottle
$ = Cost per Sample
S = Rate of Shrinkage (in decimal form)
In Figure 1, the break-even point is essentially zero. This example highlights a high volume of monthly samples. In this instance, the prepaid billing would be economically beneficial based on the pricing and rate of shrinkage. Prepaid billing offers a cost savings of $2,400 per month.
The focus of Figure 2 is a low-volume industrial setting. A shrinkage rate of five percent was utilized in the calculation. Because of the low volume, a cost savings of approximately $60 would be realized per month if 100 samples are analyzed on a prepaid basis.
Figure 3 utilizes the same cost information as Figure 2; however, the shrinkage rate has increased to 15 percent. The increase in shrinkage has altered the recommendation from prepaid billing to postpaid billing. In addition, the projected cost savings has increased to $220 per month. This demonstrates that a change in a variable can have a dramatic effect on the recommendation and the bottom line. A change in shrinkage for a high volume of samples based on the data in Figure 1 can be equivalent to doubling the cost savings.
For an industrial setting, the number of samples processed may be fewer than the examples for Figure 1, but the cost per sample increases significantly. Figures 2 and 3 show the possible cost differences related to a lower volume of samples with a cost that is double that of the high-volume samples.
Conclusion
These examples may offer a negligible amount for a break-even point; however, changes in variables to reflect your business situation can have an impressive impact on these numbers. These examples demonstrate how changing the sample cost or shrinkage rate can affect your choice in prepaid vs. postpaid over a span of one month. Knowing your rate of bottle shrinkage can be a key point to address when it comes time to training lubricant technicians. The more they understand about the concept and how it affects the bottom line, the more ownership they take with their portion of the task.
