Setup cost is directly proportional to the setup time of machine and hence increases with increase in setup time. The setup time decides the flexibility of the organization. Shorter setup time gives higher flexibility and vice versa. Hence organizations generally prefer to reduce setup time which eventually reduces the setup cost.
Setup costs involve the costs of material and labour required to make the machine ready for new production lot. There are two kinds of setup costs: fixed and variable. Fixed costs include the capital expenditure like machine parts required to make the machine ready for new lot. Variable costs include wages of workers, consumables used in setup which vary with the skill-set of the people involved.
Setup costs play an important role in assembly line production. The cost is fixed and gets amortized over the batch size. Hence it is good to have larger batch sizes in order to reduce the proportion of setup cost in the unit cost of the product.