Production overrun refers to the production of much more products than required by the business.
When we look at the big picture, companies should always seek to product just enough for them to sell to consumers, with at most a little bit of buffer stock.
This is because oversupply would theoretically mean a reduction in selling price.
But this is a too simplistic view of overproduction.
Overruns can be the result of intentional or unintentional decisions made by management.
They can also occur out of necessity, or even done so strategically.
Excess raw materials
One of the most common reasons for production overrun is that the manufacturer has to order a minimum amount of raw materials from suppliers in the supply chain.
To avoid having the raw materials go to waste, producing more products is ordered by the operations manager.
For example, factory might have a minimum production capacity of 1,000 units of product per run which requires $800 worth of raw materials. But because it needs to produce 2,000 units due to an order from a customer, $1,600 of raw material is required. The supplies might require orders that come in $1,000 lots. So the manufacturer has no choice but to purchase $2,000 worth of raw materials to produce 2,000 units of product. Instead of letting the $400 raw materials go to waste, the production line is instructed to produce the 2,500 units that $2,000 worth of raw materials can be used for.
While it might seem like an easy decision to make for management as they get an additional 500 units of product, the logic behind it is not so straight forward.
This is because there might not be a demand for the excess.
The factory can also incur higher production costs that can be saved by not producing the excess. This is especially so for labour-intensive manufacturers.
If the products are perishables, then there’s also the prospect of the products expiring and condemned.
Excess orders
Another big reasons for production overruns is excessive ordering of products due to a lack of communication between procurement departments, or simply due to bad planning.
For example, if there are more than one person that places the orders, then a mistake in communications can lead to both of them placing the same order, resulting in overproduction.
Sometimes making errors in estimating demand for a product can also cause a company to order too much that necessary.
Strategic production
In highly competitive markets, it’s not unheard of for businesses flooding the market with their products to drown the competition.
This is especially when a new entrant is threatening the market share of an established player.
By producing more than necessary, products might sell at a discount due to oversupply, making it difficult for a startup to compete with the big players.
As established brands enjoy preferred treatment from big retailers and have a proven sell-through, a huge supply of branded products might induce retailers to give the brand more retail space… which was previously taken up by competitors.
This only makes it harder for new brands to compete in a mature market place.
The power big brands have in mature markets is one big reason why new entrants often find it hard to grab a significant market share.
