Atkinson Management ing 6e Chapter 7 Solutions 1m5c5h

Chapter 7: Measuring and Managing Process Performance

Chapter 7 Measuring and Managing Process Performance

QUESTIONS 7-1

The throughput contribution is the difference between revenues and direct materials for the quantity of product sold. Investments equal the materials costs contained in raw materials, work-in-process, and finished goods inventories. Operating costs are all other costs, except for direct materials costs, that are needed to obtain throughput contribution.

7-2

In process layouts, all similar equipment and functions are grouped together. Process layouts typically occur in organizations in which production is done in small batches of unique products. In process layouts, products are moved and processed from one area to another until the product is completed. In contrast, in product layouts, equipment is organized to accommodate the production of a specific product. Product layouts are most effective for companies producing high-volume products. Typically, products move and are processed along an assembly line.

7-3

Group technology (also called cellular manufacturing) involves the organization of a plant into a number of cells. Cells are often U-shaped, which allows workers convenient access to required parts and good visual control of the workflow. Within each cell, machines that are needed to manufacture a group of similar products are arranged close to one another. This organization reduces production cycle time, which is the time from receipt of raw materials from the supplier to delivery of the finished good to distributors and customers.

7-4

Lean manufacturing, derived from the Toyota Production System, is a philosophy centered on producing the highest quality product with the lowest level of waste and inefficiency. This approach views any resource spending that does not create value for the end customer to be wasteful, and therefore must be eliminated. Value is defined as any action or process for which a customer would be willing to pay. – 233 –

Atkinson, Solutions Manual t/a Management ing, 6E

7-5

“Cost of nonconformance” refers to the cost an organization incurs when the quality of products or services does not conform to quality standards.

7-6

Waste, rework and net cost of scrap are examples of internal failure costs.

7-7

Quality engineering, quality training, statistical process control and supplier certification are examples of prevention costs.

7-8

Three examples of each of the following quality costs are: (a) (b) (c) (d)

7-9

prevention costs—quality training, supplier certification and statistical process control; appraisal costs—inspection and testing of incoming materials, process control monitoring and product quality audits; internal failure costs—waste, downtime due to defectives, rework costs and scrap; external failure costs—product liability lawsuits, product recalls, and warranty claims.

A JIT system is very different from a conventional manufacturing system. In a JIT system, a good or service is produced or delivered only when a customer requires it. JIT production requires a product layout with a continuous flow once production starts. Underlying the JIT system is a continuous improvement philosophy of eliminating or reducing delay, error, and waste, such as materials movement, storage, rework, and waiting time. In a typical JIT system, all types of inventories (raw materials, work-in-process, and finished goods) are minimized. The ultimate measure of success with JIT occurs when the processing cycle efficiency ratio equals 1. Under many conventional manufacturing systems, goods are produced to a production schedule that may not be directly tied to when customers require the goods. All types of inventories are kept on hand just in case unforeseen events occur. Little attention is given to studying efficient and inefficient activities, and materials movement, storage, rework, and waiting time are part of the conventional work environment.

7-10 Under many conventional manufacturing systems, goods are produced to a production schedule that may not be directly tied to when customers require the goods. Goods are produced in batches to reduce setting up, moving, and handling costs, but batch processing increases the inventory levels in the system. This is because at each processing station all items in the batch must wait while – 234 –


the designated employees process the entire batch before moving all parts in the batch to the next station. If the rate at which each processing area handles work is unbalanced—because one area is slower or has stopped working due to problems with equipment, materials, or people—work piles up at the slowest processing station, increasing the work-in-process inventory level at that station. Since supervisors evaluate many processing area managers on their ability to meet production quotas, processing station managers try to avoid the risk of having their facility idle. Many managers deliberately maintain large stocks of incoming work in process so that they can continue to work even if the processing area that feeds them is shut down. Similarly, to avoid idling the next processing station and suffering the resulting recriminations, managers may store finished work that they can forward to supply stations further down the line when their stations are shut down because of problems. Finally, inventories may be kept on hand just in case inputs to various stages of the manufacturing process are defective. Because group technology (cellular manufacturing) and just-in-time production reduce the production cycle time and focus on reducing waste by improving process and product quality, and quality improvement programs reduce the defect rate, work-in-process inventory is likely to decrease on the implementation of these programs. 7-11 Production cycle time and the level of work-in-process inventory are positively related because reduction in time spent waiting for the next stage of production reduces both production cycle time and work-in-process inventory levels. 7-12 The following three types of costs (only two are required for this question) are incurred when implementing a group technology (cellular manufacturing) layout: 1.

Costs of moving machines

2.

Costs of reinstallation of machines

3.

Costs of training the workers for group technology

7-13 Financial benefits resulting from a shift to group technology (cellular manufacturing), just-in-time production, or continuous quality improvements may include the following (only two are required): 1.

Increased sales because the short production cycle time enables a company to win customers by cutting the delivery time.

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2.

Reduction in the number of workers needed to move materials from one area to another, due to close proximity of manufacturing processes and reduction in work-in-process inventory levels.

3.

Reduced material waste because of reduced damage caused by materials handling. Lower work-in-process inventory levels also reduce the potential for products to become obsolete.

4.

Reduced cost of storage because less space is used to store the reduced work-in-process inventory.

5.

Reduced clerical costs for keeping inventory records.

6.

Reduced financing costs of inventories

7.

An improvement in quality because defective processes are detected much faster before many defective items are produced.

7-14 Kaizen costing is a method to reduce the cost of a product through small, continuous improvements during the manufacturing stage of the total life cycle of a product. 7-15 A cost variance investigation is undertaken under Kaizen costing in order to compare actual cost reduction amounts to target Kaizen cost reduction amounts. Variance investigation occurs whenever cost-reduction targets are not attained. 7-16 The Kaizen costing system operates outside of the standard costing system because the standard costing system is oriented to complying with Japanese financial ing standards and not internal operations, per se. 7-17 Benchmarking is a process in which organizations gather information concerning the best practices of others in order to meet or exceed the benchmark. Products, functions, processes, and strategies all can be benchmarked. Benchmarking is highly effective because organizations save time and money by avoiding mistakes that other organizations have made or by not reinventing a process or method that other companies have already developed and tested. 7-18 The five stages of benchmarking are: (1) internal study and preliminary competitive analyses, (2) developing long-term commitment to the benchmarking project and coalescing the benchmarking team, (3) identifying benchmarking partners, (4) choosing information gathering and sharing methods, and (5) taking action to meet or exceed the benchmark. 7-19 The three broad classes of information on which firms interested in benchmarking can focus are: (1) product—any type of product or service, (2) functions or process—all types of organizational activities from R&D, – 236 –


manufacturing to service, and (3) strategic—the variables on which the organization chooses to compete such as cost, quality, etc. Variables related to the design and functioning of the management ing system fall under the strategic category. 7-20 The stage of the benchmarking process that is the most important for benchmarking management ing methods is stage four, relating to information gathering and information sharing. 7-21 The two general methods of information gathering and sharing when undertaking a benchmarking exercise are unilateral and cooperative information. 7-22 The three types of information gathering and sharing under the cooperative form of benchmarking are database, indirect/third party, and group. 7-23 A “benchmarking (performance) gap” is the difference between an organization’s performance and the desired performance (best-practice performance) on a specific measure, such as on-time delivery, number of defectives, or employee satisfaction. 7-24 The additional cost of replacing a rejected unit that must be scrapped includes all the incremental material and conversion costs already incurred on such a unit that must be repeated. Furthermore, additional costs such as handling, storage, etc. corresponding to the material that is lost also are included. From a managerial perspective, opportunity cost may also be included if relevant. 7-25 Rework costs include direct rework labor, any additional direct materials used, and if relevant, incremental . From a managerial perspective, opportunity cost may also be included if relevant. 7-26 When evaluating the profit impact of an increase in the sales of a product, it is important to evaluate the contribution margins on the increase in sales for that product, and on the decrease in sales of other cannibalized products (other products that lose customers to the product being evaluated). In addition, if inventory and s receivable increase with sales, then the cost of carrying these additional current assets are also relevant.

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EXERCISES 7-27 A grocery store is organized using a process layout—similar foods are grouped together to make it easier for customers to find what they want. A grocery store might be reorganized into a modified cell layout. For example, someone wanting to prepare a certain meal, like lasagna, might find all the required ingredients in one place. However, this approach is likely to be costly and impractical and make stock rotation difficult. 7-28 Prevention costs are incurred to ensure that companies produce products according to quality standards. Prevention costs include quality engineering, training of employees in methods designed to maintain quality, etc. Appraisal costs are related to inspecting products to make sure that they meet both internal and external customers’ requirements. Inspection of purchased parts and materials and process control monitoring are examples of appraisal costs. Internal failure cost occurs when the manufacturing process produces a defective component or product. The cost of downtime in production as a result of defects is an example of an internal failure cost. External failure costs are incurred when a customer in the field detects a problem with a product or the product fails. Examples of external failure costs include warranty costs, service calls, and product liability recalls. 7-29 Of the four quality costing categories, an external failure cost is the most damaging to the organization. Customer satisfaction and future sales may be jeopardized. Moreover, product liability lawsuits can be extremely costly to the organization not only in dollars, but also in of corporate reputation. One key example of this is the Ford Pinto. 7-30 As shown below, benefits from the switch to JIT operations are estimated to be $461,600:

Sales Costs: Direct material Direct labor Inventory carrying costs Profit

Before the Change $1,000,000

After the Change $1,500,000

Difference $500,000

(250,000) (200,000) (270,000) (26,400)

(300,000) (225,000) (255,000) (4,800)

(50,000) (25,000) 15,000 21,600

$253,600

$715,200

$461,600

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7-31

Inventory Costs Direct material Work in process

$300 × 60,000 units × 2/12 = ([$300 × 100%] + [$400 × 50%]) × 60,000 units × 2/12 =

Finished goods

($300 + $400) × 60,000 units × 1/12 =

Total Inventory carrying cost Annual inventory carrying cost

$3,000,000 5,000,000 3,500,000 $11,500,000 10% $1,150,000

PROBLEMS 7-32 Both the theory of constraints and activity-based costing aspects of process improvement and improved profitability, but differ in many other respects. The theory of constraints emphasizes the short-run optimization of throughput contribution, and downplays operating costs (except direct materials) because they are viewed as difficult to alter in the short-run. Consequently, analyses of activities and cost drivers are not conducted as they are in activitybased costing. Proponents of activity-based costing take a long-term perspective in which managers can alter capacity resources. Therefore, it is viewed as beneficial to produce accurate cost information by tying actual resources consumed to cost objects, such as products, services, channels, and customers. The theory of constraints and activity-based costing might conceivably be used together. 7-33

Incremental costs: Machine moving and reinstallation Incremental benefits: Increase in contribution margin $200,000  0.31 = Savings in inventory carrying costs $200,000  0.25  0.15 = Net benefit (loss) from a change in plant layout in year 1

($100,000)

62,000 7,500 $(30,500)

The proposed change in plant layout should not be implemented because its costs are greater than its benefits, if only one year’s benefits are considered. Net present value analysis, which is covered in other courses, should be used to evaluate the benefits over the entire useful life of the machine. – 239 –


7-34 (a)

PCE in minutes under the traditional system equals [120/(120 + 80 + 240 + 40)] = [120/480] = 0.25. PCE under the JIT system equals [75/(75 + 20 + 60 + 5)] = [75/160] = 0.47.

(b)

Based on the calculations above, Walker Brothers should implement the JIT system since the processing cycle efficiency is almost double that of the traditional system (0.47 vs. 0.25).

7-35 Group technology (cellular manufacturing) refers to the organization of the plant into a number of cells so that within each cell, all machines required to manufacture a group of similar products are arranged in close proximity to each other. The shape of a cell is often a U shape, which allows workers convenient accessibility to required parts. The machines in a cell manufacturing layout are usually flexible and can be adjusted easily, or even automatically, to make the different products. Often the number of employees needed to produce a product can be reduced due to the new work design. The U shape also provides better “visual control” because employees can observe more directly what their coworkers are doing. Group technology (cellular manufacturing) layouts reduce costs and quality problems associated with conventional manufacturing and facilities layouts. Usually production cycle time is improved with a group technology (cellular manufacturing) approach. A just-in-time manufacturing system requires making a good or service only when the customer, internal or external, requires it. It is most appropriately used in repetitive manufacturing for products such as automobiles or electronic components. Just-in-time production requires a product layout with a continuous flow (no delays) once production starts. This means that there must be a substantial reduction in setup costs in order to eliminate the need to produce in batches, therefore, processing systems must be reliable. A just-in-time production system is based on the elimination of all nonvalue-added activities such as materials movement, storage, rework, and waiting times in order to reduce cost and time. It is an approach to continuous improvement and requires employee empowerment and involvement to eliminate the need to perform nonvalue-added activities. Just-in-time production encomes all facets of making the good or service, including developing the design, acquiring the factors of production, making the good or service, delivering it to the customer, and following up after the delivery. Critical performance indicators in just-in-time systems include inventory levels, which should be as low as possible; the number of failures, whether these are material, people, or machine failures, with a goal of zero; moving with a goal of zero; and the amount of storing activities with a goal of zero. The ultimate measure of success with JIT occurs when the manufacturing – 240 –


cycle efficiency ratio equals 1 that is, when processing time equals total production time. The group technology (cellular manufacturing) approach is not inconsistent with the philosophy of JIT as group technology (cellular manufacturing) also focuses on continuous improvement. In fact, some JIT systems use manufacturing cells to make specific components as part of the finished product. 7-36 Estimated cost savings as a result of the quality improvement: Decrease in number of rejects: (0.064 – 0.051)  10,000 = 130 Rejected valves are returned to the initial production stage to be melted and recast. The company recovers the brass but not any finishing materials. Rework requires DL and TDABC in Casting; DM, DL, and TDABC in Finishing; and DM (= $0), DL, and TDABC in Inspection. There are no Packing cost savings on reworked values because all finished valves are inspected before packing and shipping. Assuming, as stated in the problem, that the TDABC costs can be reduced if not needed, the estimated total savings as a result of the quality improvement are $89,810. Rework costs Casting Finishing Inspection 7- DM $ 0 $ 12 $ 0 DL 84 121 24 TDABC 122 164 30 Total per valve $206 $297 $54 $ 557  130 Decrease in number of rejects Savings from decrease in reject rate $72,410 Savings from reduction in inventory carrying cost: ($386,000 – $270,000)  0.15 Total savings

$17,400 $89,810

37 Before the rearrangement, PCE in minutes for Whisper Voice Systems equals [70/(70 + 45 + 55 + 30)] = 70/200 = 0.35. After the rearrangement, PCE in minutes equals [30/(30 + 10 + 20 + 15)] = 30/75 = 0.40. The percentage improvement in PCE after the rearrangement is [(0.4 – 0.35)/0.35] = .143 or 14.3%. Thus, the change exceeds Ray Brown’s requirement of a 12% improvement in PCE. 7-38 (a)

The approach used at McDonalds in which customers wait in several lines is consistent with the push or conventional manufacturing approach. As one comes into McDonalds it is clear that they have been, and are building – 241 –


inventory in each of the specific bins that they use for, let’s say, Big Macs, fish sandwiches, regular hamburgers, etc. Having inventory at predefined levels keeps the production process going. The motivation to use the traditional production method is to sustain a certain level of inventory to reduce the time the customer has to wait for an order. Notice in McDonalds that hot lights are used to keep the sandwiches warm. One goal of this approach is that customers perceive that they can get their sandwich very quickly due to the inventory of sandwiches always on hand. On the other hand, Wendy’s uses more of a pull or JIT system. As you enter into Wendy’s, notice that you cannot really observe any sandwich inventory building up. The idea in forming one line is that each person has the perception (and often the reality) that each sandwich is made on the spot. This procedure is designed to show customers how fresh the sandwiches are. The motivation to use a justin-time approach is to improve the quality of the food and to reduce waste by eliminating the need to throw out food that has been sitting too long. As processing time and setup costs drop, the organization can move closer to just-in-time, reducing the waste and quality problems that arise with batch production. (b)

From a customer’s perspective, it does depend on what one favors. If a customer goes to a fast food restaurant, his or her goal is to get food quickly. On any particular day, the customer may be in a great hurry and wish to run in and run out of a fast food establishment. Having multiple lines at a place like McDonalds may be very appealing as far as the perception of the speed with which one can get a meal (compared to a single line at Wendy’s). On another day, perhaps having a meal made freshly on the spot, without any “warming” time under hot lights is more appealing than the speed of getting the food. Of course, one may simply like the taste of one company’s hamburgers over another’s. From management’s perspective, apart from taste, competing in selling hamburgers may depend on other variables such as the speed with which an order is filled versus tailoring the production process to individual taste. The traditional push production process can lead to a lot more waste than the JIT system, because if a batch of hamburgers is made and demand drops, the quality of the food deteriorates and often has to be thrown out. However, if the line at Wendy’s is very long and customers begin to get impatient, the freshness of the food may begin to lose its appeal.

7-39 (a)

The article reports that customer service representatives are commonly evaluated on time to complete a call or whether they sell a new product to the customer. The article further states that companies should evaluate – 242 –


service representatives on the basis of how well they resolve the customer’s problem. For example, a company can track improvement in the number of problems that are resolved on the customer’s first call. (b)

The cost of quality framework can be applied to customer service processes by considering the customer’s experience with the customer service representative as the “product” for which the company desires to satisfy customer expectations. The article mentions a number of activities that can be viewed as helping to prevent customer dissatisfaction with customer service. These activities include training customer service representatives in listening skills and knowledge of the company’s products, arranging for representatives to hear a customer talk about positive and negative interactions with the call center, and encouraging representatives to share their challenges and successes. Making sure that the company treats representatives well can also be included among prevention activities. Appraisal issues arise in choosing measures to evaluate whether representatives are likely providing high quality service to customers. As stated in part (a), measuring the time to complete a call from a customer or the number of times a new product is sold are less likely to provide insight into the customer’s perception of customer service quality, and may induce representatives to focus on achieving a good score on the measure instead of resolving the customer’s problem. Measuring improvement in the number of problems resolved on the customer’s first call is much more likely to provide the desired insight and better aligns the representative’s incentives with resolving the customer’s problem. The article further suggests evaluating customer-satisfaction ratings for each representative, not merely the average, because the average can mask important problems. Once a company identifies problems or needed areas of improvement, the company can arrange for appropriate training (a prevention activity). As in other contexts, attention should be given to prevention of poor quality, with the intent of reducing external failures, which in this context is a customer who is dissatisfied with the customer service experience. The low-quality experience may cause negative financial consequences for the company. For example, the customer may switch to a competitor company or may tell many other potential customers about the negative experience and thereby influence the customers to purchase the good or service from a competitor company.

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7-40 There really is no one “correct way” to allocate the $2 million of quality costs to the four categories. Clearly, managers hope that they can minimize quality costs as much as possible. But, in this hypothetical example, we are assuming that managers, a priori, have much more discretion than they probably do. Probably the most desirable quality cost trend is to load up costs at the prevention stage and to incur some costs during the appraisal stage. By increasing prevention costs, such as extensive training and quality engineering, and appraisal costs, such as maintenance of test equipment, process control monitoring and inspection of incoming materials, an organization can reduce other quality costs, especially those related to internal and external failure. Regarding the allocation of the $2,000,000, the “correct” trend is a high level of costs for prevention, followed next by lower costs for appraisal, internal failure and external failure.

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7-41

(a)

Quality Cost Report for Madrigal Company Quality Cost Annual Category Cost Prevention Costs: Quality training $ 150,000 Quality engineering 600,000 Statistical process control 300,000 Supplier certification 108,000 Research of customer needs 90,000 Total $1,248,000

Percent of Sales* 0.13% 0.50% 0.25% 0.09% 0.08% 1.04%

Appraisal Costs: Inspection of and testing of in-coming materials Maintenance of test equipment Process-control monitoring Product-quality audits Total

$ 480,000 420,000 1,200,000 570,000 $2,670,000

0.40% 0.35% 1.00% 0.48% 2.23%

Internal Failure Costs: Waste Net cost of scrap Rework costs Downtime due to defects Total

$ 840,000 762,000 1,440,000 150,000 $3,192,000

0.70% 0.64% 1.20% 0.13% 2.66%

External Failure Costs: Product-liability lawsuits Repair costs in the field Warranty claims Returned products Product recalls Total

$5,400,000 1,020,000 2,814,000 1,440,000 2,400,000 $13,074,000

4.50% 0.85% 2.35% 1.20% 2.00% 10.90%

Total Quality Costs:

$20,184,000

16.82%

*Total sales were $120,000,000

(b)

The most obvious problem at Madrigal is the extremely high externalfailure costs of almost 11%. Since as a norm many companies would like to keep their quality costs below 4% to 5% of sales, Madrigal Company’s quality costs are out of line. Note in particular that product-liability lawsuits, warranty claims, and product recalls are the biggest external– 245 –


failure costs. Madrigal must find out why its products seem to be failing in the field. Madrigal should first turn to an analysis of its other quality costs. Quality costs are incurred throughout the total life cycle of a product. If Madrigal does not control quality costs early in the research, development, and engineering stage by ensuring good product design, then design problems will lead to increased quality costs later on. At Madrigal both prevention and appraisal costs are a relatively small percent of total quality costs (1.04% and 2.23%, respectively). Madrigal should consider putting more effort into quality training, quality engineering, statistical process control, and supplier certification. The company should also determine whether to spend more money on appraisal. With regard to internal-failure costs, Madrigal also apparently incurs a great deal of rework costs. The product seems to require many additional costs that need not be incurred if the company could produce it correctly the first time. Perhaps the production process is at fault, or maybe Madrigal’s workers are not well trained. Note that Madrigal’s quality-related costs are very low at the prevention stage and increase for the appraisal and internal-failure cost categories. The external failure costs are extremely high. This pattern of quality costs is what most organizations hope to avoid because the highest category of quality costs corresponds to poor quality recognized only after products are in customers’ hands. The more desirable quality-cost trend is the reverse of Madrigal’s pattern. That is, organizations desire to have the greatest proportion of quality costs incurred in the prevention stage. By increasing quality training and quality engineering costs during this stage, a company can reduce other quality costs. With the company’s products failing less frequently in the customers’ hands, customer satisfaction should increase and the company’s reputation should improve. 7-42

(a)

Quality Cost Report for Ideal Company Quality Cost Annual Category Cost Prevention Costs: Quality training $ 150,000 Quality engineering 200,000 – 246 –

Percent of Sales* 0.20% 0.27%


Statistical process control Supplier certification Total

300,000 350,000 $1,000,000

0.40% 0.47% 1.33%

Appraisal Costs: Inspection of and testing of in-coming Materials Process-control monitoring Product-quality audits Total

$ 300,000 350,000 350,000 $1,000,000

0.40% 0.47% 0.47% 1.33%

Internal Failure Costs: Waste Net cost of scrap Rework costs Downtime due to defects Total

$ 900,000 1,500,000 2,000,000 600,000 $5,000,000

1.20% 2.00% 2.67% 0.80% 6.67%

External Failure Costs: Product-liability lawsuits Repair costs in the field Warranty claims Returned products Product recalls Total

$ 500,000 375,000 420,000 380,000 325,000 $2,000,000

0.67% 0.50% 0.56% 0.51% 0.43% 2.67%

Total Quality Costs:

$9,000,000

12.00%

*Total sales were $75,000,000

(b)

Since as a norm many companies would like to keep their quality costs below 4% to 5% of sales, Ideal Company’s total quality costs are relatively high. The highest level of quality costs occur for internal failure (6.67%) and external failure (2.67%) compared to lower levels for prevention and appraisal (1.33% each). Therefore, management should investigate why internal failure costs are so high, especially for scrap and rework costs. Regarding external failure costs, the two highest are for product liability lawsuits and warranty claims. Nevertheless, these costs are relatively low as a percentage of sales. The company should investigate whether placing more emphasis on prevention and appraisal would decrease internal failure and external failure costs.

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7-43 Exhibit 7-10 illustrates the comparison between Kaizen costing and standard costing. In contrast to traditional standard costing, Kaizen costing focuses on cost reduction and continuous improvement as overriding concepts in manufacturing, revises cost reduction targets monthly, uses cost variance analysis to compare target costs versus actual costs, and assumes that workers have the best knowledge to reduce costs. Standard costing uses a cost control system concept and assumes stability in current manufacturing processes. Standards are set annually or semiannually and cost variance analysis is used to compare actual to standard costs. The assumption is that managers and engineers have the best knowledge to develop standards as they have the technical expertise. 7-44 According to the Kaizen costing approach, workers have the best knowledge to reduce costs. The reason is that workers are much closer to the production process and have far more detailed knowledge and insight than engineers and managers. 7-45 Kaizen is the Japanese term for making improvements to a process through small, incremental amounts, rather than through large innovations. Kaizen costing is a method to reduce costs through small, continuous improvements. 7-46 If the cost of disruptions to production is greater than the savings due to Kaizen costing, then the cost savings due to Kaizen costing will not be applied. 7-47 (a)

The biggest problem with Kaizen costing is similar to the one that faces target costing, and that is the system places enormous pressure on employees to reduce every conceivable cost. The results of this pressure are internal conflicts among various parties and a great deal of employee burnout. Another concern has been that Kaizen costing leads to incremental rather than radical process improvements. This can cause myopia as management tends to focus on the details rather than the overall system.

(b)

To address the first problem, some Japanese automobile companies use a grace period in manufacturing just before a new model is introduced. This period, called a cost sustainment period, provides employees with the opportunity to learn any new procedures before the company imposes Kaizen and target costs on them. Another solution relates to the kinds of penalties that employees face as a result of not attaining cost targets. In Japan, for those employees with lifetime employment, there is virtually no chance of losing one’s job, however, there are “social penalties” such as – 248 –


loss of face, letting down the company, etc., associated with not achieving targets. In the United States the threat of job loss is much more salient. The last thing that U.S. managers would want to do is to threaten job loss to those who did not achieve targets. This would simply exacerbate the problem. In the final analysis, Kaizen costing has to be understood as a tool for change, but not as a hammer. With respect to the second problem above, management needs to focus on the overall production process as well as the details. 7-48 The key factors in identifying benchmarking partners are the size of partners, the number of partners, the relative position of partners within and across industries, and the degree of trust among partners. Choices on each of these variables will change from one benchmarking study to the next. Organizations will likely want to obtain information about a firm similar in size because of their comparable situations. It is useful to have a large number of participants in order to increase the amount of information obtained. Developing trust among partners is critical to obtaining truthful and timely information. Newcomers to an industry probably would like to see a wider variety of partners. 7-49 A manager asked to benchmark another organization’s target costing system would want information pertaining to the method by which target prices and target margins (and consequently, target costs) are set, supplier relations, how the organization uses value engineering to reduce costs, and the organizational structure and culture needed to manage the target costing process. While these are critical variables on which to gather information, target costing always has to be studied and understood in relation to the specific organization involved. 7-50 The Kaizen costing system differs from a traditional standard costing system. Under the traditional standard costing system, the typical goal is to meet the cost standard while avoiding unfavorable variances. With Kaizen costing, the goal is to achieve cost reduction targets. Further, variance analysis under a standard cost system usually compares actual to standard costs, while under Kaizen costing, variance analysis compares target Kaizen costs with actual cost reduction amounts. Kaizen costing, then, operates outside of the standard costing system, in part because standard costing systems in Japan are oriented towards complying with financial ing standards. Another key difference between standard and Kaizen costing has to do with the assumptions about who has the best knowledge to improve processes and reduce costs. Traditional standard costing assumes that engineers and managers know best since they have the technical expertise. Thus they determine procedures that workers are required to perform according to pre-set standards and procedures. – 249 –


Under Kaizen costing, workers are assumed to have superior knowledge about how to improve processes since they actually work with manufacturing processes to produce products. Thus, one of the central goals of Kaizen costing is to give workers the responsibility to improve processes and reduce costs. Thus, the standard costing system and the Kaizen costing system are used for very different purposes. The standard costing system is used for financial reporting purposes while the Kaizen costing system is used for cost management. The systems do coexist, although many believe that there is really no need for both systems, especially if the financial reporting system was modified to accommodate Kaizen costing. 7-51 (a)

The Kaizen costing system differs quite significantly from a traditional standard costing system and there are few similarities. Under the traditional standard costing system, the typical goal is to meet the cost standard while avoiding unfavorable variances. With Kaizen costing, the goal is to achieve cost reduction targets. Variance analysis under a standard cost system compares actual to standard costs, while under Kaizen costing, variance analysis is used to compare target Kaizen costs with actual cost reduction amounts. Kaizen costing is not really part of the standard costing system because, in Japan, standard costing systems are used primarily for compliance with financial ing standards and financial reporting purposes. Another difference between standard and Kaizen costing is that, under traditional standard costing, engineers and managers are assumed to have the best information about how to improve processes and reduce costs since they design and manage processes. However, under Kaizen costing, workers are assumed to have superior knowledge about how to improve processes since they actually work with manufacturing processes to produce products, and one of the central goals of Kaizen costing is to give workers the responsibility to improve processes and reduce costs.

(b)

Kaizen costing can be adapted in the United States in those companies that (1) see the benefits of the costing method, (2) have a willingness to change their existing thinking about the role of standard costing versus Kaizen costing, and (3) will rely more on the input of workers and managers to improve processes and reduce costs. As in the adoption of all management innovations, being open to significant cultural change is what will allow U.S. organizations to embrace and be successful with Kaizen costing. In addition, the cost of disruptions to production must be less than the savings due to Kaizen costing. – 250 –


7-52 The first thing that the student should do is determine what definition to follow regarding who the “best” student is. The definition could vary depending on whether “best” was defined as the one who consistently scores the highest on exams, or perhaps, the one who seemed to provide the most intelligent answers to questions in class, etc. The latter definition is the one that may be the most desirable in the long run (as a good test taker may not always be a successful decision maker), but also the hardest to try to emulate, as there may be a level of innate intelligence that cannot be “learned.” In order to do the exercise, let’s use the definition of best as the one who scores the highest on exams and assume that the student is trying to benchmark the study habits of the best student. The student should ask the best student questions like the following: 1.

What procedures do you go through when you study? a.

What methods do you use to take and review notes?

b.

What methods do you use to details?

c.

How many times do you read assigned materials?

d.

Do you do extra assignments that are not required?

e.

Do you study alone or with friends?

f.

Do you have any “secrets” to studying?

g.

How do you organize your notes?

2.

Where do you study? (At home, in the library, etc.)

3.

How do you decide what times of day are most effective for studying?

4.

What mix of leisure and work activities do you have?

5.

How many hours a day do you devote to each subject?

6.

Do you make good use of an instructor’s office hours?

7.

How do you review for an exam?

8.

What tips do you have for taking the actual exam?

Implementing some or all of these changes will take time especially if the other students’ habits are very different from what the student currently does. One suggestion is to start by implementing one or two suggestions at a time and to – 251 –


gradually implement more once the initial suggestions have been mastered. The implementation will probably fail if the student tries to simultaneously change on all dimensions. Obviously, this exercise is designed to illustrate to the student how difficult personal change is and this should be a nice lead in how complex organizational change is. 7-53 The instructor should: 1.

Make sure that students have done their homework on what the organization that they are going into produces and any other important background information.

2.

Make sure that students have read the material in the text on benchmarking and understand the five stages of benchmarking, which are: Stage 1:  Internal study and preliminary competitive analyses 

Preliminary internal and external competitive analyses



Determining key areas for study



Determining the scope and significance of the study

Stage 2:  Developing long-term commitment to the benchmarking project





Gaining senior management



Developing a clear set of objectives



Empowering employees to make change

Coalescing the benchmarking team 

Using an experienced coordinator



Training employees

Stage 3: 

Identifying benchmarking partners



Size of partners



Number of partners



Relative position within and across industries



Degree of trust among partners – 252 –


Stage 4:  Information gathering and sharing methods 

Type of benchmarking information: 

Product



Functional (process)

 

Strategic (includes management ing methods)

Method of information collection: 

Unilateral



Cooperative: 

Database



Indirect/third party



Group



Determining performance measures



Determining the benchmarking performance gap in relation to performance measures

Stage 5:  Taking action to meet or exceed the benchmark 

Making comparisons of performance measures

3.

In relation to the five stages listed above, ask students to determine a series of structured and unstructured interview questions for which they would like answers. Students should also be instructed to write down their observations of the facility and the people involved in the benchmarking project. Developing good questions and recording direct observations will help students write their report.

4.

The instructor might also ask students what criteria they will use to decide whether benchmarking was successful. For a short exercise like this, students will probably have to rely on what their interviewees tell them. It is unlikely that the organization will volunteer to show them actual company data to illustrate the effects of such a change. Discussing the need to rely on what interviewees say should lead naturally to discussing how one goes about determining the effects of management ing – 253 –


methods on organizations. Such a discussion could include the difficulty in getting proprietary company records, how to design good interviews, and the role of direct observation in trying to assess how well an organizational change has been implemented.

– 254 –


CASES 7-54 (a)

In the following diagram, “(v)” indicates activities that add value from the customer’s perspective, and “(n)” indicates activities that do not. Woodpoint Furniture Manufacturing Process Flow Chart Order raw materials (n)  Place raw materials into storage (n)  Remove wood from storage (n)  Move batch to saw area (n)  Saw wood (v)  Move batch to sanding and planing area (n)  Store batch in sanding and planing area (n)  Sand and plane required pieces (v)  (If a piece is damaged by planing or sanding, reorder piece from saw area and store remainder of batch) (n)  Move batch to assembly area when all planing and sanding is complete (n)  Store batch in assembly area (n)

(b)

Assemble batch (v)  (If a piece is defective , return it to appropriate area for rework) (n)  Move batch to painting or staining area (n)  Store batch in painting or staining area (n)  Paint or stain batch (v)  Move batch to assembly area (n)  Complete assembly (v)  Inspect batch (n)  (If a product is defective, return it to appropriate area for rework) (n)  Package product(v)  Move products into storage (n)  Ship product when ordered by a customer (v)

The response must specify what Woodpoint Furniture Manufacturing’s customers are likely to require. Presumably quality, cost, and service (in of product features and cycle time to fill order) will be important. The current production system should be evaluated based on its ability to allow the organization to meet whatever customer requirements are specified. If the specified items are quality, cost, and cycle time then each activity should be measured in of the time that it adds to the cycle time, the quality problems that it creates, and its cost. Possible specific measures include number of reworked pieces, number of defective pieces, number of missing pieces, and number of furniture items that fail inspection. – 255 –


7-55 (a)

Before, producing a Louis Vuitton “Reade” tote bag required 20 to 30 workers who specialized in one skill, working 8 days. Now, producing the bag requires just one day as 6 to 12 cross-trained employees work in Ushaped clusters with sewing machines on one side and assembly areas on the other. Each worker now handles multiple production tasks and the new system allows workers to detect and correct problems earlier than before. As a result, returns of faculty merchandise have decreased dramatically.

(b)

According to ariello (2006), Louis Vuitton is the world’s largest luxury-goods company; its value proposition centers on “product design, craftsmanship and image”. Customers were willing to pay high prices for Louis Vuitton bags in part because of the image resulting from the perception of skilled craftsmanship. Limited available quantities and long waits for products were part of the company’s plan to “bolster its cachet.” Thus, the company’s previous process was consistent with the value proposition.

(c)

Competitors such as Zara sell chic items that are less expensive than Louis Vuitton’s. Moreover, Zara excels at speed to market; the company can move from design to stocking the merchandise in stores in as little as two weeks (Capell 2008). Zara’s approach of manufacturing in small batches contributes to an aura of exclusivity and helps avoid the need for slashing prices to sell merchandise. Yet, Zara’s manufacturing flexibility allows the company to quickly increase the volume of items that are unexpectedly popular. Capell 2008). In the face of this competition, Louis Vuitton’s value proposition has changed. The company will remain a luxury-goods company, but now views having desired products available in its stores as part of its value proposition. The new production process will enable the company to produce items more quickly and with much lower defect rates, so that stores will have an ample supply of desired products.

(d)

Important performance indicators for evaluating Louis Vuitton’s manufacturing operations include defect rates, cycle time, and changes in these two measures over time.

7-56 (a)

According to Rockoff (2010), customers reported "foreign materials, black or dark specks" in some medicines, and Johnson and Johnson reported that some medicines “had higher concentrations of active ingredient than specified, and some products may contain tiny metallic particles left as a – 256 –


residue from the manufacturing process.” Further the U.S. Food and Drug istration (FDA) reported that “bacteria contaminated raw materials” that are ingredients for children’s Tylenol products. Problems were traced to the Fort Washington, Pennsylvania plant, and later also to the Las Piedras, Puerto Rico plant (Kimes 2010). Singer (2010b) and Rockoff and Kamp (2010) report that Johnson & Johnson (J&J) recalled their hip replacement implants because many of the implants failed, requiring patients to undergo another hip-replacement surgery. Rockoff and Kamp (2010) also report that J&J “withdrew about 100,000 boxes of lenses sold in Asia and Europe because a manufacturing problem prompted some customers to complain of pain, stinging or redness.” The problems with the lenses were traced to a plant in Ireland. (b)

The external failure costs include lost sales due to loss of reputation and concerns about quality, and the need to shut down the Fort Washington, Pennsylvania plant. Singer (2010c) reports that J&J’s, “sales of over-thecounter drugs and nutritional products in the United States plummeted to $438 million in the third quarter from $732 million in same time period last year, a decrease of about 40 percent.” In addition, she reports projections of a persistent decrease in market share in over-the-counter drugs. Other external failure costs include product liability lawsuits, the cost of returned products, the cost of developing materials for recall web pages and press releases, providing toll-free phone calls to consumers, and staff to respond to calls and messages.

(c)

According to Singer (2010c), while the Fort Washington plant is closed, J&J will upgrade it. J&J is also strengthening its manufacturing and quality controls (Singer 2010a), with a reemphasis on prevention costs and possibly appraisal costs. Prevention costs include quality engineering, quality training, statistical process control and supplier certification. Appraisal costs include costs relating to inspection/testing of incoming materials, maintenance of test equipment, process control monitoring and product quality audits. Kimes (2010) provides an in-depth description of how quality problems arose at J&J’s McNeil Division, which produces over-the-counter drugs.

– 257 –


References Kimes, M. “Why J&J’s Headache Won’t Go Away,” Fortune (September 6, 2010), pages 100-108. Rockoff, J. D. “FDA Widens Probe of J&J's McNeil Unit; Inquiry Follows Recent Recall of Over 40 Children's Medicines Because of Manufacturing Problems,” The Wall Street Journal (May 18, 2010), page B1. Rockoff, J. D. and J. Kamp. “J&J Latest Recall: Hip-Repair Implants,” Wall Street Journal (Online) (August 26, 2010). Singer, N. “Maker of Tylenol Explains Actions Taken to Alleviate Musty Smell of Pills,” The New York Times (March 17, 2010). Accessed online on January 11, 2011 at http://www.nytimes.com/2010/03/18/business/18drug.html? _r=1&s=1&sq=Las%20Piedras&st=cse. The online source has links to an FDA report on one of J&J’s plants and a letter with J&J’s response. Singer, N. “Johnson & Johnson Recalls Hip Implants,” The New York Times (August 26, 2010). Singer, N. “Tylenol Recalls Erode Johnson & Johnson Sales,” The New York Times (October 19, 2010). 7-57 (a)

Costs in the following items are relevant to Polley’s decision: 1, 2, 3, 4, 5, 7, 9, 10, and 13. Item 6 is not relevant because it is a sunk cost, and items 8, 11, and 12 are not relevant because the costs do not differ across the two options.

(b)

Polley is likely to consider the decreased health risks for workers with the new solvent, decreased risks of violating OSHA regulations and incurring penalties, and decreased risks of negative media coverage. Polley is also likely to consider the potential increase in demand for Kwik Clean’s services if the company markets its environmentally safer process. Polley may also try to assess whether individual customers are more sensitive to such marketing than are business customers.

(c)

For operations with potential environmental pollution, prevention can involve efforts to ensure pollution does not occur. Prevention efforts might include changing processes, as Polley is considering. Appraisal efforts might include inspections to ensure pollution levels are within acceptable limits or workers are following prescribed procedures for – 258 –


dealing with pollution or hazardous wastes. Internal failures are failures (accidental spillages or leakages of hazardous wastes, or illegal levels of pollutants) that are detected and cleaned up or corrected before reaching the public. Finally, external failures are failures that are not detected, cleaned up, or corrected before reaching the public. As in the cost of quality framework for manufacturing operations, environmental pollution external failures are often the most costly to the firm. If prevention efforts are feasible, attention should be focused on prevention. Given that some pollution or hazardous wastes are generated, efforts should also be focused on appraisal, with the intent of minimizing internal failures and external failures. 7-58 (a)

The company may be monitoring the amount of time spent talking to customers, and if it is monitoring the content of the calls, the company may be evaluating how polite the CS representatives are. There are many other measures that customers would like the company to monitor (see question (b)), but given the described CS behavior, it seems unlikely that the company emphasizes speedy problem remediation.

(b)

The customer is likely thinking about measures or issues such as the following:  Time from the first phone call to CS until the TV is repaired and returned  Number of phone calls required  Time per phone call  Total time spent on phone calls  Time between a phone call and the response from CS or WD authorizing repair  Time spent writing to the company to report on the unpleasant experience trying to get the TV repaired  Politeness of CS reps and supervisor  Ability to resolve the problem with one phone call  Wait time to talk to CS rep

(c)

Instead of faxing or mailing the receipt, the customer can be allowed to email the receipt by other electronic means, such as using a scanner to produce an electronic copy or taking a digital photo. The company could also think about ways to eliminate the need for CS to forward the warranty authorization to another department, in order to increase the likelihood that the customer’s request can be handled with one phone call and less delay. For example, if a customer knows that the request is for warranty – 259 –


repair, he or she could be allowed to deal with WD directly instead of relaying the information back and forth between the customer, CS, and WD. The company could also develop a better system for determining which approved repair shops are the closest to the customer’s address. Furthermore, the company could identify shops with high customer satisfaction and shops with fast turnaround time. The company could offer incentives to shops to encourage faster service and turnaround. (d)

RS3 can clearly learn from RS4’s approach of diagnosing the problem shortly after the TV arrives in the shop. This allows the shop to order parts shortly after the TV enters the shop, with the result that the total time that the TV spends in the shop is likely to much shorter than in RS3. RS3’s approach introduces unnecessary waiting time, a nonvalue-added activity from the customer’s perspective. In addition, RS3 needs space to store all the items waiting for diagnosis or parts. The customer faces additional waiting time because of RS3’s inability to pick up TVs on a timely basis.

7-59 Total net annual benefit from the new machine: Increase in contribution margin Decrease in inventory carrying costs Less increase in lease costs Net annual benefit from new machine a b

$648,000a 63,000b (410,000)c $301,000

[($56–$32)  48,000]–[(56–$42)  36,000] = $648,000 Inventory levels with the old machine:

Raw materials Work-in-process Finished goods

36,000  $144,000 36,000  $225,000 36,000  $276,000

$12



4/12

=

$25



3/12

=

$46



2/12

=

$645,000 Inventory levels with the new machine Raw materials 48,000  $11  1.5/12 = $ 66,000 Work-in-process 48,000  $20  1.5/12 = $120,000 Finished goods 48,000  $36  1/12 = $144,000 $330,000 Change in annual inventory carrying costs: ($330,000 – 645,000)  20% = $63,000 decrease c $900,000–$490,000 = $410,000 increase – 260 –


(b)

Rossman should replace its old machine with the new machine because the penalty of $280,000 for early termination of the lease is more than offset by the net annual benefit of $301,000 for each of four years with the new machine.

(c)

A manager evaluated on the basis of net income may decide not to replace the existing machinery if there is considerable uncertainty about the projections for increased sales or reduced costs, given the relatively small benefit in the first year based on the stated projections. This benefit is $301,000 – $280,000 = $21,000. Thus, a manager with a short-term focus may not lease the new machinery even though it would increase Rossman’s income over the long-run.

7-60 Precision Systems1 This case study illustrates that quality cost information can play an important role in alerting top management about the importance of quality improvement in a nonmanufacturing department of a manufacturing firm. The case is based on the following article by S. S. Kalagnanam and E. M. Matsumura: “Cost of Quality in an Order Entry Department,” Journal of Cost Management, Fall 1995, pp. 68— 74. Although the actual case takes place quite some time ago, the need for improvement in nonmanufacturing processes remains pervasive. We still encounter firms that take pride in their quality of manufacturing operations while continuing with poor quality nonmanufacturing processes. The required questions are designed to acquaint students with some of the terminology of “cost of quality” and some aspects of conducting a cost of quality study. Quality costs, defined as those that arise because poor quality may exist or does exist, have been classified into the following four categories: • • • •

Prevention (prevention of poor quality, or quality assurance); Appraisal (inspection and testing); Internal failure (costs such as rework or scrappage for nonconforming products identified before delivery to customers); External failure (costs such as warranty expenses or freight charges for nonconforming products delivered to customers).

This case focuses on prevention activities (see question (f)), as well as internal 1

Source: Institute of Management ants, Cases from Management ing Practice, Instructor’s Manual, Volume 12. Adapted with permission.

– 261 –


failure and external failure costs for the order entry department at Precision Systems, Inc., where internal and external failures are defined with respect to the order entry department. Suggested Solutions to Required Questions (a)

This question is designed to help students recognize how cost management systems can interface with quality improvement efforts. As the case states, in spite of PSI’s commitment to quality improvement, “the changes [in order entry] would not have been so vigorously pursued if cost information had not been presented. COQ information functioned as a catalyst to accelerate the improvement effort.” This is because the cost figures captured the attention of top management. Other responses might include the following: (1) It made order entry aware of the dollar impact of its errors; (2) It provided a means of prioritizing quality improvement efforts.

(b)

There are many possible flows. For example, a sales representative may order entry to request a quote for a system for a customer. Subsequently, the customer s order entry to place the order; and order entry then generates an order acknowledgement, which is sent to manufacturing, invoicing, and sales istration. Once the system has been shipped, an invoice is sent to the customer. Ultimately, collections will receive the invoice. Customer will the customer to arrange installation and will be available to answer questions over the phone. A request for parts from a service representative or directly from a customer would be received by order entry, which would generate an order acknowledgement that might then be routed to the stockroom, after which the part would be shipped and the customer would be billed. A request for service would result in an order acknowledgement being sent to the service department (see the following chart).

– 262 –


(c)

Items 1, 2, 5, 8, 10, and 12 are internal failures; the remainder are external failure items. Internal customers affected by external failure items are listed below. Item Number 3 4 6 7 9 11

Internal Customer(s) Affected Manufacturing, service, stockroom, invoicing Invoicing, sales istration (profitability analysis) Manufacturing, service, stockroom, invoicing, sales istration Shipping, invoicing, collections, customer Manufacturing, service, stockroom Invoicing, collections, sales istration

– 263 –


Other examples (not included in Exhibit 7-18): Error Type Incorrect serial # of system on order acknowledgement Duplicate order Incorrect sales rep. code

Internal Customer(s) Affected Service, customer Stockroom, shipping, manufacturing, sales istration Sales istration

(d)

An initial step would be to interview employees in order entry, as well as its suppliers and internal customers. Based on the interviews, data collection forms can be developed. For internal failures, order entry staff would keep track of the problems they encounter while preparing quotes and processing orders. For external failures, internal customers of order entry would keep track of the errors they encounter when using information from the quotes or order acknowledgements (examples of forms appear at the end of this teaching note: Form #1 pertains to internal failures and Form #2 pertains to external failures).Suppliers to order entry, internal customers of order entry, and order entry staff should be involved in making improvements to the order entry process.

(e)

Possible responses include the following: Office equipment and office space; Telephone (to clarify problems); Computer costs (making changes on the computer); Supplies (paper for printing new quotes or order acknowledgements); Lost interest and other costs associated from late payments by customers (due to invoicing mistakes resulting from order entry errors); Lost sales from new customers (due to delay in preparing quotes); Lost future sales from current dissatisfied customers (due to errors in order entry); Shipping costs on returns; Rework costs; Frustration and lower morale, possibly leading to poorer quality or high turnover; Costs related to duplication in manufacturing; Crisis management costs (express shipping); Lost revenues if underpricing; Scrappage of returns.

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(f)

Students can brainstorm about possible improvements during a class discussion. Possible responses follow. Incremental Improvements Empower employees. Allow sales representatives to correct errors without approval. Urge order entry to improve communication with manufacturing and other departments. Provide to order entry on types of errors, numbers of errors, and cost impact. Daily (suggestions for improvement) can be provided via computer. Educate sales representatives about effects of errors and about the process. Provide better training for sales representatives. Train sales representatives to develop accurate quotes and take on the order entry function. Have sales representatives take responsibility for the process. Track customer purchases to improve service to customers. Survey customers about problems; use the responses to prioritize problems. Stop the double entry of information. Get input from order entry on development of forms. Implement checking in order entry to help prevent order acknowledgement errors. Develop a reward system that motivates error-free performance of sales representatives and order entry. Benchmark. Breakthrough Improvements Develop a computer system to decrease the number of times data are entered. Develop a spreadsheet or computer program to check for inconsistencies between P.O. and quotes, check for duplication of orders, and check prices. Develop a computer system that allows sales representatives to prepare accurate quotes. Install a computer system linking order entry, manufacturing, invoicing, etc. Use cross-functional teams to manage “large” costs or different – 265 –


segments. Develop a system that allows parts customers to get their own quotes on-line. Note: Today, customers may add a request for a quote to their shopping cart but the web page does not provide a quote online. Incremental Improvements Made by PSI 1.

2.

3.

4.

5.

Key information for quotes is now obtained up-front by the sales representative; earlier, the sales representative faxed partial information to order entry and requested a quote. Order entry staff then spent a great deal of time obtaining missing information. With this change, the sales representative cannot request a quote until he or she has supplied key information to order entry staff. This could be considered a prevention activity. Customers are asked to include quotation numbers on their purchase orders. This allows PSI to match orders with quotes and avoid duplication in manufacturing. PSI prepares its manufacturing plan based on the quotes received because they have a reasonably good idea of which ones are likely to become firm orders. Proper tools are provided to the order entry staff: Procedure manuals. Guidelines for sales discounting. Previously, the order entry staff had to call sales to seek clarifications regarding discounts. Printed configuration guides that contain information in the format order entry requires. Previously, the formats did not always match. Order entry staff are now responsible for both quotes and orders. Previously, some staff were responsible only for quotes, and other staff were responsible only for orders. This change had an immediate impact, as the person who prepared a quote now had responsibility for processing the subsequent order. A regular system is now in place. Each internal customer department provides to order entry once every quarter. Benefits: Cycle time for preparing quotes was reduced by 60%, and cycle time for processing orders was reduced by 50%. Also, order entry staff experienced greater pride in their work.

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Breakthrough Improvement Efforts by PSI as of 1993 1. 2.

3.

Many of these improvements are prevention activities. PSI began working with a vendor to develop an on-line configuring program that would configure their standard systems (order entry staff would avoid keying-in part numbers). PSI planned to acquire a new, more integrated order entry system that can communicate with the configuring program and turn a quote into an order acknowledgement when the order comes in. The system will also be able to generate an invoice, thereby avoiding rekeying the information. PSI began working toward providing sales representatives with a laptop computer equipped with a built-in configuring program. It will allow them to prepare quotes in the field. The anticipated benefits include a reduction in errors caused by incorrect or duplicate part numbers and a reduction in cycle time for preparing quotes or processing orders and preparing invoices.

Prioritizing Improvement Activities Three considerations in prioritizing improvement activities are the perceived seriousness of the problems, the benefits of improvements, and the costs of the improvements. In this case study, the breakthrough improvement projects involve higher costs than the incremental improvement efforts. To identify the most serious problems, a Pareto analysis can be performed. In PSI’s case, correcting order acknowledgement errors became the highest priority because of its associated cost of 7% of the salary and fringe benefits budget (see Exhibit 7-19). Update: Improvement Efforts by PSI as of 1996 The first incremental improvement, a stringent policy of sales representatives filling out quote forms correctly, was abandoned because the forms quickly became obsolete and the policy was unpopular with sales representatives. In addition, the policy slowed the quotation process. The initial vendor’s quote for the desired configuring program was judged unaffordable. After an 18-month search, however, PSI was able to purchase a new integrated information system (including materials resource planning and ing) that included a configuring program. In the meantime, PSI developed an in-house configuring program that runs on the sales representatives’ laptop computers. As a consequence, problems with missing, incorrect, or changed part numbers have been greatly reduced. – 267 –


Information on part numbers originates in manufacturing and is maintained and kept current by the marketing department. A change from line-item pricing (listing each component part with its associated price) to bundling (listing the component parts but providing only a bottom-line price) reduced processing time because customers previously would call for verification if any one of the component prices on the invoice differed from what appeared on the quote. The current cycle typically runs as follows: • Sales representative prepares a quote using laptop computer configuring program and e-mails it to order entry. • Order entry reviews the quote and sends a quote packet to send to the customer (pricing on quote is reviewed by order entry supervisor). • When the customer’s order is received by order entry, the order is entered into PSI’s system configuring program; the order entry supervisor approves the order. • The controller approves the order. • The order acknowledgement is transmitted electronically to manufacturing. • Manufacturing builds the product. • The product is shipped. • The invoice is generated the same day the product is shipped, with no further review. (g)

PSI’s sales representatives have specialized scientific training in order to provide knowledgeable assistance to customers who wish to purchase high-technology instrumentation. The sales representatives guide the customers in choosing the appropriate instrumentation for the customers’ needs. The requirement for specialized knowledge creates difficulty in allowing customers to simply order systems online. Even if the technical issues related to customers determining what to order can be overcome, PSI must still ensure that its ing internal processes are of high quality. A web-based ordering capability in and of itself will not necessarily resolve PSI’s quality problems related to accuracy of orders and appropriate system configurations. For example, the information technology within PSI must ensure that configuration possibilities and pricing are always accurate.

– 268 –


(h)

Nonfinancial indicators that might be useful in improving quality in the order entry department include: • The frequency of the different types of errors. • Time spent on correcting problems. Frequency of reporting is an important issue when implementing a COQ system. Options for frequency of tracking data and reporting include: • Keep track of the information on a daily basis but report monthly. Continue doing this until improvements are made and the information is no longer needed. The assumption is that continuous improvement projects will be undertaken to rectify the situation. • Collect sample data for a specified period once every quarter or sixmonth period, for example, and assess the changes in the magnitude of problems. The assumption is that results from the sample data will be used to make process improvements. COQ information is useful for the following reasons: • COQ quantifies the financial impact of the errors/problems, thereby providing a universally understood method of assessing the seriousness of the situation. As emphasized in question (a), COQ figures can play an important role in alerting top management to the seriousness of quality problems overall or in a particular area. • Quality cost systems cut across departmental boundaries, thereby providing a holistic measure of the benefits derived from improvement efforts. COQ information should be used in conjunction with nonfinancial indicators, as the latter provide the information actually required for making changes to the system.

– 269 –


Form #1 - Class I (Internal) Failure Completed by Order Entry Staff Date Started _______________

Time Started ___________

Order serial # Is this a new order? Yes I No (If not, please specify —) Is this an engineering special? Yes / No Is all information available and clear? Yes I No Is the quotation # available on the Purchase Order? Yes I No If not, how did you track down the quotation? By dollar amount ____ By customer name ____ Called sales rep. ____ Other Is all relevant information available and clear on the customer’s P.O.? Yes I No Please provide below details of all the clarifications required. Serial No. Explanation of problem / clarification

How clarification obtained Time spent

How long did it take you to prepare the first draft of the order (including time spent obtaining clarifications? How much time did you spend inspecting the quote before finally giving it to your supervisor for inspection? Were there any changes as a result of your inspection(s)? Yes / No Time taken to make changes _____ minutes/hours. How many drafts of the order were printed including the one you gave to your supervisor for inspection? Complete after your supervisor has inspected the order Were there any changes as a result of your supervisor’s inspection? Yes / No Time taken to make changes _____ minutes/hours. After your supervisor’s inspection, how many drafts of the order were printed in addition to the final version mailed to the customer? Date and time order sent out to your internal customer? Other comments:

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Form #2- Class II (External) Failure Completed by Manufacturing Department (Immediate Internal Customer) Order/ Quotation serial #

Nature of error/clarification required/problem

How clarification obtained

Total number of errors Number of orders/quotations received Errors as a % of orders/quotations

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Time spent in obtaining clarification (including waiting time)

Atkinson Management ing 6e Chapter 7 Solutions 1m5c5h

Overview 4q3b3c

More details 26j3b

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