Co-Products and By-Products Configuration

In the world of manufacturing and supply chain management, production is rarely as simple as putting parts together to create a single finished item. While discrete manufacturing—like building a bicycle or a computer—usually follows a linear path where components result in one specific end product, process manufacturing is different. In industries like chemicals, food production, oil refining, and pharmaceuticals, a single production run often results in multiple outputs.

Understanding how to manage these outputs is the difference between having an accurate inventory system and one that is constantly out of sync with reality. When you refine crude oil, you don't just get gasoline; you get diesel, jet fuel, and various petrochemicals simultaneously. If you process dairy, you might be aiming for cheese, but you will inevitably produce whey. These secondary outputs are classified as either co-products or by-products.

Configuring these correctly in your Enterprise Resource Planning (ERP) system or product management software is vital for two main reasons: cost accounting and material planning. If you don't account for the value or the quantity of these additional items, your cost per unit for your primary product will be inflated, and your warehouse will be full of "ghost" inventory that the system doesn't know exists. This lesson will dive deep into the mechanics of configuring co-products and by-products, how to handle their unique costing requirements, and how to ensure your production planning accounts for them accurately.

Understanding the Core Concepts

Before we jump into the configuration steps, we need to establish a clear distinction between our three types of outputs: the primary product, the co-product, and the by-product.

The Primary Product

The primary product is the main reason you are running the production order. It is the item that usually drives the demand. If you are a flour mill, your primary product is the specific grade of flour you are currently milling. All planning and scheduling are typically centered around meeting the demand for this specific item.

Co-Products

Co-products are items of high value that are produced simultaneously with the primary product. They are not "accidents" or "waste." They are intended outputs that have a significant market value. In many cases, the distinction between a primary product and a co-product is simply a matter of which one you have more demand for at the moment.

For example, in a timber mill, when you cut a log to produce high-grade structural beams (primary product), you also produce standard 2x4 planks. These 2x4s are co-products. They have significant value, they are sold as standalone products, and they share the production costs of the original log and the labor used to cut it.

By-Products

By-products are secondary products that have low value compared to the primary product or co-products. They are often residuals or leftovers from the production process. While they might be sellable, they aren't the reason you started the batch.

Using the timber mill example again, the sawdust and wood chips generated during the cutting process are by-products. You might sell the sawdust to a particleboard manufacturer or use it for animal bedding, but the revenue it generates is minimal compared to the lumber. In some cases, by-products might even have a "negative value" if you have to pay someone to haul them away, which we refer to as disposal costs.

Callout: Co-Product vs. By-Product Distinction The most important factor in deciding whether an item is a co-product or a by-product is its economic significance. If the item significantly impacts the profitability of the production run and requires its own cost allocation, it is a co-product. If it is a minor incidental item where you just want to track the quantity and maybe offset a tiny bit of cost, it is a by-product.

The Formula-Based Approach

In most advanced product systems, co-products and by-products are managed through Formulas rather than Bills of Materials (BOMs). While a BOM is a list of ingredients for a single end-item, a Formula is a recipe that defines the inputs and all the resulting outputs.

When you configure a formula, you define the "Batch Size." This is a critical concept. Because process manufacturing involves mixing, heating, or chemical reactions, the output ratios are often fixed based on a specific volume of input. For instance, if you process 1,000 gallons of raw chemical, you might always get 600 gallons of Product A, 300 gallons of Co-Product B, and 100 gallons of By-Product C.

Configuration Structure

To set this up, your data model usually looks like this:

1. Formula Header: Defines the name, the site, and the standard batch size.
2. Formula Ingredients: The raw materials and components consumed.
3. Co-Products: A sub-table listing the secondary high-value outputs and their cost allocation percentages.
4. By-Products: A sub-table listing the low-value outputs and their "burden" or cost-offset values.

Step-by-Step Configuration Guide

Let's walk through the process of setting up a production formula for a fruit juice manufacturer. In this scenario, we are producing Premium Orange Juice (Primary), Orange Oil for flavoring (Co-Product), and Dried Orange Peel for cattle feed (By-Product).

Step 1: Item Master Setup

Before you can add items to a formula, they must exist in the item master. You need to ensure that the co-product and by-product items are set up with the correct "Product Type." Most systems require these to be "Stocked Products" because you will be receiving them into inventory upon completion of the production order.

Note: Ensure that your Co-Product has a cost price defined, or at least a price calculation group assigned. Since co-products share the cost of the primary production, the system needs to know how to value them when they hit the warehouse shelves.

Step 2: Creating the Formula

Create a new Formula record. Set the "Site" or "Warehouse" where the production occurs and define the "Formula Size." Let's say our formula size is 1,000 Liters of Orange Juice.

Step 3: Adding Ingredients

Add your raw oranges, water, and enzymes to the formula lines. These are standard consumption lines.

Step 4: Configuring Co-Products

Navigate to the Co-products section of the formula. Here, you will add the Orange Oil.

• Quantity: Specify how much oil is produced per 1,000 Liters of juice (e.g., 5 Liters).
• Allocation Method: Choose how the cost is split. We will discuss this in detail in the Costing section below.
• Cost Allocation Percentage: If using a manual split, you might assign 10% of the total batch cost to the Orange Oil.

Step 5: Configuring By-Products

Navigate to the By-products section. Add the Dried Orange Peel.

• Quantity: Specify the weight (e.g., 50kg).
• Costing: Usually, by-products use a "Standard" or "Reciprocal" costing method where the value of the by-product is subtracted from the cost of the primary product.

Cost Allocation Methodologies

This is the most complex part of advanced product configuration. When you spend $5,000 on raw materials, labor, and electricity to run a batch, how much of that $5,000 belongs to the juice, and how much belongs to the oil?

There are three primary industry-standard methods for allocating these costs:

1. Total Cost Allocation (TCA)

TCA is a dynamic calculation. The system looks at all the co-products on the formula and distributes the total production costs based on a weighted average. You define a "Cost Allocation Term" for each item.

Callout: The TCA Formula The cost for a specific co-product is calculated as: (Total Batch Cost) * (Co-Product Cost Share / Total Cost Shares of all products) This ensures that 100% of the cost is always accounted for, regardless of whether the batch was more expensive than planned.

2. Physical Measure

This method allocates cost based on a physical characteristic like weight or volume. If you produce 800 lbs of Product A and 200 lbs of Co-Product B, Product A takes 80% of the cost, and Product B takes 20%. This is common in chemical and metal industries where the "value" of the product is closely tied to its mass.

3. Net Realizable Value (NRV)

NRV is used when products require further processing after the initial batch. If the Orange Oil needs to be refined in a second production step before it can be sold, the cost allocated to it at the "juice" stage is its final market price minus the cost of that second refining step. This is a more sophisticated accounting approach used to ensure that every product shows a similar profit margin.

Technical Configuration: A Pseudo-Code Example

While most of this configuration happens in a user interface, understanding the underlying data structure helps when troubleshooting or performing data migrations. Below is a representation of how a Formula and its Co/By-products might be structured in a JSON format for an API-based ERP system.

{
  "FormulaId": "FORM-ORANGE-001",
  "Description": "Orange Juice Extraction Process",
  "BatchSize": 1000,
  "UOM": "Liters",
  "Ingredients": [
    { "ItemId": "RAW-ORANGE", "Quantity": 2500, "UOM": "kg" },
    { "ItemId": "WATER-PURIFIED", "Quantity": 200, "UOM": "Liters" }
  ],
  "Outputs": {
    "PrimaryProduct": {
      "ItemId": "JUICE-PREMIUM",
      "Quantity": 1000,
      "CostAllocation": 0.85
    },
    "CoProducts": [
      {
        "ItemId": "ORANGE-OIL",
        "Quantity": 5,
        "UOM": "Liters",
        "AllocationMethod": "TotalCostAllocation",
        "CostShare": 15
      }
    ],
    "ByProducts": [
      {
        "ItemId": "ORANGE-PEEL-DRY",
        "Quantity": 50,
        "UOM": "kg",
        "ByProductType": "Fixed",
        "CostValue": 0.50
      }
    ]
  }
}

Explanation of the Code Structure:

• CostShare: In the Co-Products array, the CostShare of 15 represents the "weight" this item carries in the cost distribution. If the primary product has a share of 85, the total shares are 100.
• ByProductType "Fixed": This indicates that the orange peel has a fixed credit value. For every kg produced, $0.50 is deducted from the total production cost of the juice and oil.
• BatchSize: This is the anchor. All quantities for ingredients and outputs are relative to this 1000-liter batch size.

Planning and MRP Considerations

Master Requirements Planning (MRP) behaves differently when co-products are involved. This is where many organizations run into trouble.

In a standard BOM, if you need 100 bicycles, MRP tells you to buy 200 tires. It's a simple parent-child relationship. However, with co-products, the relationship is "sideways."

The "Supply from Co-Product" Logic

Imagine you have a demand for 10 Liters of Orange Oil. You check your inventory and you have zero. In a correctly configured system, MRP will look at your formulas. It sees that Orange Oil is a co-product of Orange Juice.

The system then has a choice to make, based on your configuration:

1. Planned Order for Juice: It might suggest running a batch of Orange Juice to get the oil you need. This is risky because you might end up with 2,000 Liters of juice you don't need just to get the 10 Liters of oil.
2. Manual Planning: Many companies set co-products to "Manual" planning, meaning the system won't suggest a production order for them. Instead, it waits for a primary product order to be created, and then it simply "acknowledges" that oil will be produced as a result.

Planning Formulas

You can also set up "Planning Formulas." This is a specific type of formula where there is no single primary product. Instead, the formula represents a process that produces a "basket" of items. This is very common in oil refining. You don't "make gasoline"; you "run the cracker," and the cracker produces various outputs. MRP then balances the total demand for all outputs against the capacity of the refinery.

Tip: Use "Negative Quantities" in formulas cautiously. While some legacy systems used negative ingredient quantities to represent co-products, modern ERPs have dedicated co-product tables. Always use the dedicated tables to ensure cost accounting functions correctly.

Industry Examples

1. Chemical Manufacturing

In the production of caustic soda, chlorine gas is always produced as a co-product through electrolysis. You cannot make one without the other. Because chlorine gas is dangerous to store and difficult to transport, the production of the primary product (caustic soda) is often limited by the company's ability to sell or use the co-product (chlorine). Configuring this requires "Capacity Constrained" planning where the co-product's limitations dictate the primary product's schedule.

2. Meat Processing

A cow is the ultimate "Formula." When a carcass is processed, you get various cuts of meat (co-products) like ribeye, flank steak, and ground beef. You also get hides, bones, and fat (by-products). The cost allocation here is usually based on "Market Value." Since a ribeye sells for much more per pound than ground beef, it absorbs a much higher percentage of the cost of the cow.

3. Semiconductor Manufacturing

During the "wafer fab" process, a single wafer produces multiple chips. Due to variations in the manufacturing process, some chips perform at high speeds (Grade A) and others at lower speeds (Grade B). These are co-products. The manufacturer doesn't know exactly how many of each they will get until the batch is finished and tested. This requires the use of "Planning Percentages" in the formula configuration to estimate the yield of each grade.

Comparison Table: Co-Products vs. By-Products

Best Practices for Configuration

1. Regular Review of Cost Allocation

Market prices change. If you are using the "Market Value" or "Net Realizable Value" method for cost allocation, you must review these percentages at least quarterly. If the price of your co-product drops significantly but it is still absorbing 40% of the production cost, your primary product will appear artificially "cheap" and your co-product will appear to be losing money.

2. Use "Burden" for By-Product Disposal

If a by-product costs money to dispose of (like toxic waste or heavy sludge), configure it with a "Negative Cost" or "Burden." This ensures that the cost of disposal is added to the cost of the finished goods, providing a true picture of the product's margin.

3. Define Clear Yield Percentages

Process manufacturing is rarely 100% efficient. When configuring your formula, use "Step Consumption" or "Yield Percentages" for your co-products. If you expect a 5% loss during the separation of a co-product, build that into the formula so that MRP doesn't over-promise inventory to your sales team.

4. Manage "Variations" with Versions

If you have a process that produces different ratios of co-products based on the season (common in food/agriculture), don't create multiple formulas. Instead, use "Formula Versions" with different validity dates. This keeps your data clean and ensures that the system uses the correct ratio for the current time of year.

Warning: Avoid creating "Circular References" where a by-product of one formula is an ingredient in the same formula. While this happens in real life (recycling), most ERP systems will loop and crash during an MRP run. Use a separate "Recycling" production order to handle this flow.

Common Pitfalls and How to Avoid Them

Pitfall 1: Treating Everything as a Co-Product

A common mistake is to list every tiny scrap or floor sweeping as a co-product. This creates an administrative nightmare for the accounting department, as they now have to track the cost and value of literal trash.

• Solution: If the item's value is less than 1% of the total batch value, classify it as a by-product or don't track it in the formula at all. Handle it via a manual inventory adjustment at the end of the month if necessary.

Pitfall 2: Forgetting the "Batch Size" Logic

Users often enter co-product quantities as "per unit of primary product" rather than "per batch." If your batch size is 500 and you enter that you get 1 co-product, the system thinks you get 1 per 500, not 1 per 1.

• Solution: Always verify the "UOM" (Unit of Measure) and the "Per Series" field. Double-check the math: (Ingredient Qty / Batch Size) * Output Qty.

Pitfall 3: Ignoring the "Planning" Flag

If you don't configure the planning flags correctly, your co-products might start generating "Planned Orders." This can lead to a situation where the system tells you to start a massive production run of the primary product just because you are short on one small co-product.

• Solution: Set Co-products to "Planned by Primary" or "Manual" unless they are truly capable of driving the production schedule on their own.

Pitfall 4: Inconsistent Units of Measure

If your primary product is measured in Gallons but your co-product is measured in Pounds, the cost allocation can get messy if you use the "Physical Measure" method.

• Solution: Ensure you have accurate conversion factors set up in the system (e.g., how many pounds are in a gallon of this specific liquid). Without these conversions, the system cannot normalize the outputs to allocate cost fairly.

Advanced Feature: Variations and Potency

In some industries, the amount of co-product you get depends on the "Potency" of the raw material. For example, in wine making, the amount of "pomace" (by-product) depends on the sugar content and skin thickness of the grapes.

Modern systems allow for Attribute-Based Formulas. You can link the co-product output quantity to a batch attribute of the raw material.

• If Ingredient A has a Potency of 90%, Co-Product B quantity = 10.
• If Ingredient A has a Potency of 80%, Co-Product B quantity = 15.

This level of configuration is advanced but necessary for high-precision industries like pharmaceuticals or specialized chemical refining. It ensures that your inventory levels for co-products are adjusted in real-time as soon as the raw materials are tested in the lab.

Summary and Key Takeaways

Configuring co-products and by-products is a vital skill for any product information specialist or ERP consultant working in the process manufacturing space. It moves the system beyond simple assembly and into the realm of complex chemical and physical transformations.

By correctly identifying which outputs have significant economic value (co-products) and which are merely incidental (by-products), you can ensure that your company's financial statements are accurate and your warehouse managers aren't surprised by unexpected inventory.

Key Takeaways:

1. Economic Value is Key: The primary difference between a co-product and a by-product is its market value and its impact on the cost of the production run.
2. Use Formulas, Not BOMs: Process manufacturing requires a formula-based approach that allows for multiple outputs from a single set of inputs.
3. Cost Allocation is Critical: Choose an allocation method (TCA, Physical Measure, or NRV) that reflects the reality of your industry and keep it updated as market conditions change.
4. MRP Integration: Be careful with how co-products drive demand. In most cases, they should be "passive" outputs that don't trigger new production orders on their own.
5. By-Product Credits: Use by-products to "offset" the cost of your primary product. This lowers your Cost of Goods Sold (COGS) and provides a more accurate margin analysis.
6. Batch Size Accuracy: Always define your ingredient and output quantities relative to a standard batch size to avoid calculation errors during production posting.
7. Environmental and Disposal Costs: Don't forget that some by-products have "negative value." Use the burden configuration to account for the cost of getting rid of waste.

By mastering these configurations, you enable your organization to handle complex manufacturing scenarios with ease, providing better data for both the shop floor and the accounting office. Whether you are refining oil, baking bread, or processing chemicals, the ability to track every ounce of output ensures a leaner, more profitable operation.