Week 6 Cost Management

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Week 6 - Cost Management

• Chapter 19 - Cost Management Quality, Time, and
  the Theory of Constraints

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Learning Objectives

• 1. Explain four cost categories in a cost of
  quality program.
• 2. Describe three methods that companies use to
  identify quality problems.
• 3. Identify the relevant costs and benefits of
  quality improvements.
• 4. Provide examples of non-financial quality
  measures of customer satisfaction and internal
  performance.
• 5. Use both financial and non-financial measures
  of quality.

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Learning Objectives, continued

• 6. Describe customer response time, and explain
  the reasons for and the cost of lines and delays.
• 7. Define three main measurement in the theory of
  constraints
• 8. Describe and discuss theory of constraints.
• 9. Describe and discuss enterprise resource
  planning systems.
• 10. Back-of-chapter questions
• 11. Case 4, Clearwater Small Appliances, pages
  34 to 35 of the casebook

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Quality As A Competitive Weapon
Actual Performance
Design Specifications
Customer Satisfaction
Quality of Design
Conformance Quality

• Costs of quality (COQ) are costs incurred to
  rectify the production of of low-quality product

Pages 656 - 660
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Four categories of COQ

• - Prevention costs (design and process
  engineering)
• - Appraisal costs (inspection costs)
• - Internal failure costs (spoilage and rework)
• - External failure costs (warranty repair work)

6
Methods to Analyze Quality Problems

• Statistical quality control (SQC) or statistical
  process control (SPC) employ control charts to
  monitor successive observations at regular
  intervals of time
• Pareto diagrams indicates the frequency of
  failures (defects)
• Cause-and-Effect diagrams identifies potential
  causes of failures or defects such as human error
  or component failure

Pages 660 - 662
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Relevant Costs and Benefits of Quality
Improvements

• Relevant costs/revenues are those costs/revenues
  that differ across alternatives and therefore
  must be considered in deciding which alternative
  is the best.
• In considering quality improvements the relevant
  costs/revenues are those that differ between
  quality improvements made and quality
  improvements not made.
• Consider revenues, fixed costs, and variable
  costs, before and after the quality improvements.

8
Non-Financial Measures of Quality and Customer
Satisfaction

• Even if a product is defect free and meets
  conformance quality, it still must satisfy
  customer needs
• consider total customer satisfaction including
• features that provide fair value
• delivery when promised
• delivery a defect-free product
• ensure that product will not experience early
  failure
• ensure that product will not fail excessively in
  service

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Non-Financial Measures of Customer Satisfaction,
more examples

• the number of defective units shipped
• number of customer complaints
• customer response time ( differences between
  scheduled delivery date and date requested by the
  customer
• timeliness of delivery

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Financial Measures of Quality

• The cost of quality report
• - focus attention on costs of poor quality
• - useful for comparing different quality
  improvement programs and setting priorities
• - useful for evaluating tradeoffs among
  prevention and failure costs

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Non-financial Measures of Quality

• The advantages of non-financial measures of
  quality
• often easy to quantify and understand
• direct attention on physical processes and the
  exact problems
• immediate short-term feedback on quality
  improvement efforts
• useful indicators of long-term performance

Pages 666 - 667
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Time As A Competitive Weapon

• Time is a key variable in competition
• Doing things faster helps increase revenues and
  decrease costs
• Think of time in terms of
• - Customer response time time from order receipt
  to delivery of product
• - On-Time Performance delivered on scheduled
  date

Pages 667 - 672
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Time Driver

• A time driver is any factor where change in the
  factor causes a change in the speed of the
  activity
• - Uncertainty about when the customer will order
  is a time driver
• - Limited capacity and bottlenecks are also time
  drivers
• A bottleneck is an operation wherein the work
  required approaches or exceeds the available
  capacity

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Average Waiting Time

• The average waiting time is the average amount of
  time that an order will wait in line before it is
  set up and processed.

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Theory of Constraints (TOC), Three Measurements

• 1. Throughput contribution, i.e., sales revenue
  minus direct material costs
• 2. Investments equal to the sum of material costs
  of direct materials inventory, work-in-process
  inventory, and finished goods inventory, plus RD
  costs, plus costs of equipment and buildings.
• 3. Operating costs, equal to all operating costs
  (other than direct materials) incurred to earn
  throughput contribution including salaries and
  wages, rent, utilities, and amortization.

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TOC, the Objective

• Increase throughput contribution while decreasing
  investments and operating costs when faced with
  some bottlenecks and non-bottleneck operations..
  The theory of constraints considers short-run
  time horizons and assumes other current operating
  costs to be fixed.

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TOC, Steps in Managing Bottlenecks

• 1. Recognize that the bottleneck resource
  determines throughput contribution of the plant
  as a whole.
• 2. Search and find the bottleneck resource by
  identifying resources with large quantities of
  inventory waiting to be worked on.
• 3. Keep the bottleneck operation busy and
  subordinate all non-bottleneck resources to the
  bottleneck operation.
• 4. Take actions to increase bottleneck efficiency
  and capacity

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TOC, Focus

• Measuring throughput by the value of production,
  and not by physical units.

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TOC Compared to ABC

• Some observers have claimed, incorrectly, that
  ABC costing assumes that almost all
  organizational costs are variable. This is
  incorrect.
• In most organizations the only variable costs are
  the material costs (and perhaps energy)
  associated with the incremental order
• TOC claims that material expenses are the primary
  short-term variable costs.
• ABC was never intended to measure short-term cost
  behaviour.

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TOC, Operating Expense Validity

• 1. How did operating expenses reach their current
  level?
• 2. All organizations in the same industry and the
  same line of business have the same level of
  operating expenses?

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TOC, Assessment

• The assumptions of TOC are excellent
  approximations of the reality for the problem.
  TOC has been designed to solve short term product
  mix and scheduling of bottleneck resources.
• This is a problem for which ABC provides little
  insights since during such a short period, all
  organizational expenses, other than materials and
  energy, are pre-committed.

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Enterprise Resource Planning Systems

• An ERP can provide a firm with an integrated set
  of operating, financial, and management systems.
• An ERP has a a common data structure and a
  centralized, accessible data warehouse that
  permits access from any of numerous systems or
  modules.
• An ERP allows all systems and modules to be
  brought into a single integrated system.
• Integrates financial accounting, ABC, operational
  feedback, inventory, budgeting, etc.

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ERP, Different Vendors

• SAP
• Oracle
• PeopleSoft
• Baan
• J.D. Edwards

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Traditional Architecture
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ERP Architecture
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ERP Architecture, Details

• Distributed client-server architecture
• Desk-top computing
• Internet, web pages
• Data warehouse
• Multi-functional
• Integrated
• Modular

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ERP, Business Case

• 1. Complete a detailed strategic assessment
• 2. Develop an IT strategic plan
• 3. Determine that an ERP solution is appropriate
• 4. Analyze costs and benefits, determining the
  payback period and/or IRR or NPV

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SAP, Functionality

• 1. Finance
• 2. Logistics
• 3. Human resources
• 4. Industry specific

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SAP, Finance Modules

• 1. Financial accounting
• 2. Controlling
• 3. Project systems
• 4. Asset management
• 5. Investment management
• 6. Treasury

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Financial Accounting, Sub-modules

• General ledger
• Specific ledgers
• Accounts receivable
• Accounts payable
• Legal consolidation
• Financial asset management

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Controlling, Sub-modules

• Cost centre accounting
• ABC
• Order and project accounting
• Product costing
• Profitability analysis
• Profit centre accounting

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SAP, Logistics Modules

• 1. Materials management
• 2. Production planning
• 3. Plant maintenance
• 4. Sales and distribution
• 5. Quality management
• 6. Project system
• 7. Service management

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SAP, Human Resources Modules

• 1. Time management
• 2. Personnel development
• 3. Payroll accounting
• 4. Organizational management
• 5. Personnel management

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SAP, Reasons for Installing

• Part of business process re-engineering
• Part of an IT strategy
• Competitive advantage through back office
  efficiencies

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SAP, Industry Solutions

• 1. Aerospace and defense
• 2. Automotive
• 3. Chemicals
• 4. Consumer products
• 5. Engineering and construction
• 6. Health care
• 7. High technology and electronics
• 8. Oil and gas
• 9. Pharmaceuticals
• 10. Public sector
• 11. Retail, etc.

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SAP, Architecture

• 1. Administration
• 2. Development workbench
• 3. Communications
• 4. Business engineering
• 5. Work flow

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SAP, Process Redesign

• SAP almost always forces a firm to redesign its
  business processes
• Process redesign is changing strategic
  value-added business processes and the systems,
  policies, and organizational structures that
  support them, in order to optimize productivity
  and the flow of work.
• The goal of process redesign is to eliminate
  non-value adding work, not necessarily to
  eliminate jobs.
• Process redesign with SAP allows the automation
  of low-value adding work

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Process Redesign, Themes

• 1. Gets products to customers
• 2. Uses sophisticated IT

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Process Redesign, Foci

• 1. Reduction in process costs and time
• 2. Improvement in quality and customer service
• Quality x Service
• Value --------------------------
• Cost x Time

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Process Design, Improvements

• 1. Eliminate redundancies
• 2. Automate and eliminate human error
• 3. Change the sequence of functions
• 4. Eliminates intermediate paperwork
• 5. Allows for operating over a wider geographical
  area by consolidating coding

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Back-of-Chapter Questions

• Exercises 19-20. 19-22, and Problem 19-28.

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Case 4, Clearwater Small Appliances, pages 34
to 35, casebook.

• The case will be read in class
• After each paragraph or exhibit a student will
  identify issues
• Then the root issue will be determined through
  analysis

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Root issues
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Analysis
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Recommendations
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The End