What is Setup Cost?

Setup cost is those costs incurred to configure a machine for a production run. This cost is considered a fixed cost of the associated batch, so its cost is spread over the number of units produced. Setup costs include the following:

The labor to position tools and materials next to a machine
The labor required to configure a machine
The labor required to train employees on how to process the new production run
The scrap cost of test units run on a machine
The cost of the quality assurance staff who test the initial output of the new production run

The real cost of a setup is the time wasted while a machine is not operational, since this can represent lost income (if there is a backlog of work). In addition, when setup times have been minimized, this creates more productive capacity, which can generate more throughput for a business when the setup happens to be associated with a bottleneck operation. Consequently, there is usually an emphasis on shortening equipment setup times in order to reduce setup costs and increase throughput.

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Example of Setup Costs

A small business produces custom-printed T-shirts. They have received an order to print 500 T-shirts with a unique design. The breakdown of setup costs is as follows:

Design preparation. Cost of $150, which is the time spent by a graphic designer to finalize and format the customer’s artwork for printing.
Screen setup. Cost of $300, which involves the creation of a custom screen for the design.
Ink mixing and preparation. Cost of $50, which involves mixing custom colors to match the customer's design.
Equipment calibration. Cost of $100, which involves adjusting the screen printing press and testing initial prints to ensure proper alignment and quality.
Machine cleaning. Cost of $75, which involves cleaning the press and removing any residual ink from previous jobs to prevent contamination.

The total setup cost is therefore $675. These costs are incurred regardless of the number of T-shirts produced in this order. If the order size increases, the setup cost remains constant, but the cost per unit decreases as the fixed setup cost is spread across more units.