19 - 1 quality, time, and the theory of constraints chapter 19
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19 - 1
Quality, Time, and the
Theory of Constraints
Quality, Time, and the
Theory of ConstraintsChapter 19
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Learning Objective 1Learning Objective 1
Explain the four cost categories
in a cost-of-quality program.
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Two Aspects of QualityTwo Aspects of Quality
ActualPerformance
DesignSpecifications
CustomerSatisfaction
Quality ofDesignFailure
ConformanceQualityFailure
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Costs of QualityCosts of Quality
Prevention costs Appraisal costs
Internal failure costs External failure costs
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Costs of Quality ExampleCosts of Quality Example
Vegas Photo Corporation made 10,000photocopying machines last year.
Vegas Photo determines the costs of qualityof its photocopying machines using a 7-step
activity-based costing approach.
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Costs of Quality (Steps 1 and 2)Costs of Quality (Steps 1 and 2)
Identify cost objects.
10,000 photocopying machines
Identify the direct costsof quality of the products.
No direct costs of quality
Step 1 Step 2
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Costs of Quality (Step 3)Costs of Quality (Step 3)
Select the cost-allocation bases to use forallocating indirect costs of quality to the products.
• Prevention• Appraisal• Internal failure• External failure
Step 3
Information on the totalquantities of each of thesecost-allocation bases usedin all of Vegas operations
is not provided.
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Costs of Quality (Step 4)Costs of Quality (Step 4)
Identify the indirect costs of qualityassociated with each cost-allocation base.
Step 4
Information about total (fixed and variable)costs is not provided.
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Costs of Quality (Step 5)Costs of Quality (Step 5)
Compute therate per unit.
Step 5
Inspection hours is onecost-allocation base.
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Costs of Quality (Step 5)Costs of Quality (Step 5)
Prevention costs:Design engineering (R&D) $80 per hourProcess engineering (R&D) $60 per hour
Appraisal costs:Inspection (Manufacturing) $40 per hour
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Costs of Quality (Step 5)Costs of Quality (Step 5)
Internal failure costs:Rework (Manufacturing) $100 per hour
External failure costs:Customer support (Marketing) $ 50 per hourTransportation (Distribution) $240 per loadWarranty repair (Customer Service) $110 per hour
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Step 6
Compute the indirect costs of qualityallocated to the product.
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Prevention costs:Design engineering (R&D) 20,000 hoursProcess engineering (R&D) 22,500 hours
Appraisal costs:Inspection (Manufacturing) 120,000 hours
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Internal failure costs:Rework (Manufacturing) 50,000 hours
External failure costs:Customer support (Marketing) 6,000 hoursTransportation (Distribution) 1,500 loadsWarranty repair (Customer Service) 60,000 hours
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Costs of Quality (Step 6)Costs of Quality (Step 6)
What is the total cost for design engineering?
20,000 hours × $80 = $1,600,000
What is the total cost for inspection?
120,000 hours × $40 = $4,800,000
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Cost of Quality andValue Chain Category Total Costs
Prevention costs:Design engineering (R&D) $1,600,000Process engineering (R&D) 1,350,000Total $2,950,000
Appraisal costs:Inspection $4,800,000
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Cost of Quality andValue Chain Category Total Costs
Internal failure costs:Rework (Manufacturing) $5,000,000
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Costs of Quality (Step 6)Costs of Quality (Step 6)
Cost of Quality andValue Chain Category Total Costs
External failure costs:Customer support (Marketing) $ 300,000Transportation (Distribution) 360,000Warranty repair (Customer Service) 6,600,000Total $7,260,000
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Costs of Quality (Step 7)Costs of Quality (Step 7)
Step 7
Compute the total costs of quality of the product.
Prevention costs $ 2,950,000Appraisal costs 4,800,000Internal failure costs 5,000,000External failure costs 7,260,000Total $20,010,000
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Learning Objective 2Learning Objective 2
Use three methods to
identify quality problems.
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Techniques Used to AnalyzeQuality Problems
Techniques Used to AnalyzeQuality Problems
1. Control charts
2. Pareto diagrams
3. Cause-and-effectdiagrams
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Control ChartsControl Charts
On the basis of experience, Vegas decidesthat any observation outside the arithmetic
mean ± 2 standard deviationsshould be investigated.
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Control ChartsControl Charts
0 1 2 3 4 5 6 7 8 9 10
Production Line A
Days
Def
ect R
ate + 2
+
- - 2
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Control ChartsControl Charts
0 1 2 3 4 5 6 7 8 9 10
+ 2+
- - 2
Production Line B
Days
Def
ect R
ate
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Pareto DiagramPareto Diagram
Copies arefuzzy andunclear
Copiesare too
light/darkPaper getsjammedN
umbe
r of
Tim
esD
efec
t Obs
erve
d
600
500
400
300
200
100
0
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Pareto DiagramPareto Diagram
As a first step, Vegas analyzes the causesof the most frequently occurring failure,
fuzzy and unclear copies.
Final Draft of aSales ContractFinal Draft of aSales Contract
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Cause-and-effect DiagramsMethods and
Design FactorsHuman Factors
Machine-related Factors
Materials andComponents Factors
Multiple suppliersIncorrect specification
Variation in purchasedcomponents
Flawed part designIncorrect
manufacturingsequence
Inadequate toolsIncorrect speed
Poormaintenance
Inadequatesupervision
Poor trainingNew operator
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Learning Objective 3Learning Objective 3
Identify the relevant costs and
benefits of quality improvements.
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Relevant CostsRelevant Costs
Careful analysis of Vegas cause-and-effectdiagram reveals that the frame of the copier
is often mishandled as it travels from thesuppliers’ warehouses to Vegas’ plant.
Mishandling causes the dimensions of theframe to vary from specifications, resulting
in fuzzy and unclear copies.
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Relevant CostsRelevant Costs
Alternative solutions:
Improve the inspection of the framesimmediately upon delivery.
Redesign and strengthen the framesand the containers used to transport
them to better withstand mishandlingduring transportation.
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Relevant CostsRelevant Costs
What must management do to evaluateeach alternative?
Additional AdditionalInspection Cost Redesign Cost Difference
$200,000 $230,000 $30,000
Vegas determines the fixed and variablecost component of each activity involved.
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Relevant CostsRelevant Costs
Further Redesigning Inspection Frames
Relevant savings:Rework costs $480,000 $ 640,000Customer-support costs 20,000 28,000Transportation costs 45,000 63,000Warranty repair costs 450,000 630,000Total $995,000 $1,361,000
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ComparisonComparison
Further Redesigning Inspection Frames
Relevant savings $995,000 $1,361,000Additional cost 200,000 230,000Difference $795,000 $1,131,000
What should Vegas do?
Redesigning the frames provides a $336,000incremental benefit over further inspection.
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Learning Objective 4Learning Objective 4
Provide examples of nonfinancial
quality measures of customer
satisfaction and internal
performance.
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Nonfinancial MeasuresNonfinancial Measures
Nonfinancial measures of customer satisfaction:
• Number of customer complaints
• Defective units as a percentage of total units shipped to customers
• Percentage of products that experience early or excessive failure
• On-time delivery rate
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Nonfinancial MeasuresNonfinancial Measures
Nonfinancial measures of internal performance:
• Number of defects for each product line
• Process yield (ratio of good output to total output)
• Employee turnover (ratio of the number of employees who left the company to the total number of employees)
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Learning Objective 5Learning Objective 5
Describe the benefits of
financial and nonfinancial
measures of quality.
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Evaluating Quality PerformanceEvaluating Quality Performance
Financial measures are helpful to evaluatetrade-offs among prevention costs,appraisal costs, and failure costs.
Nonfinancial measures help focus attentionon the precise problem areas that need
improvement and also serve as indicatorsof future long-run performance.
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Learning Objective 6Learning Objective 6
Describe customer-response
time and explain why delays
happen and their costs.
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Customer-Response TimeCustomer-Response Time
Order isplaced
Order isreceived
Order isset up
Order ismanufactured
Order isdelivered
WaitingTime
Mfg.Time
ReceiptTime
ManufacturingLead Time
DeliveryTime
Customer-Response Time
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On-Time PerformanceOn-Time Performance
On-time performance refers to situations in whichthe product or service is actually delivered at
the time it is scheduled to be delivered.
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Time Drivers and Costs of Time
Time drivers
1. Product or service order uncertainty
2. Bottlenecks due to limited capacity
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
Average waiting time equals:
Average number of orders × (Manufacturing time)2
÷
Annual machine Average no. Manufacturing capacity of orders time of product– ×[
[
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
Fredonia uses one machine to convertsteel bars into a special component (SC).
Fredonia expects it will receive 30 orders,but it could actually receive 10, 30, or 40
orders for the special component.
Each order is for 1,000 units and will take100 hours of manufacturing time.
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
The annual capacity of the machineis 4,000 hours.
What is the expected manufacturingtime required on the machine?
(100 × 30) = 3,000 hours
What is the average waiting time?
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
30 × 1002 = 30 × 10,000 = 300,000
300,000 ÷ 2 × [4,000 – (30 × 100)]
300,000 ÷ 2 × (4,000 – 3,000)
300,000 ÷ 2,000
150 hours average waiting time
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
What is the average manufacturinglead time for an order?
150 hours of average waiting time+ 100 hours of manufacturing time
= 250 hours
Suppose that Fredonia is consideringintroducing a regular component (RC).
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
Fredonia expects to receive 10 ordersfor RCs (each order for 800 units).
Each order will take 50 hours ofmanufacturing time.
The expected demand for specialcomponents will be unaffected.
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Time Drivers and Costs of TimeTime Drivers and Costs of Time
Assume that introducing RCs would causeaverage waiting time to more than double,
from 150 hours to 325 hours.
The average manufacturing lead time fora special component order becomes
425 hours (325 + 100).
Average manufacturing lead time for a regularcomponent order is 375 hours (325 + 50).
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
The average selling price per order is: Average
manufacturing Product lead time SC RC
Less than 300 hours $22,000 $10,000More than 300 hours $21,500 $ 9,600
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
Product SC RCAverage number of orders 30 10Direct material costs per order $16,000 $8,000Inventory carrying costs/order/hour 1.00 0.50
Should Fredonia introduce RCs?
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
Introduce RCs
Expected revenues:($21,500 × 30) + ($9,600 × 10) = $741,000
Expected variable costs:($16,000 × 30) + ($8,000 × 10) = $560,000
Expected other costs: $ 14,625
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
How was the $14,625 other costs computed?
(Average manufacturing lead time for SCs× Unit carrying costs per order for SCs× Expected number of orders for SCs)
+ (Average manufacturing lead time for RCs× Unit carrying costs per order for RCs× Expected number of orders for RCs)
(425 × $1.00 × 30) + (375 × $0.50 × 10) = $14,625
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
Do Not Introduce RCs
Expected revenues:$22,000 × 30 = $660,000
Expected variable costs:$16,000 × 30 = $480,000
Expected other costs: $ 7,500
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
How was the $7,500 other costs computed?
Average manufacturing lead timefor SCs without RCs
× Unit carrying costs per order for SCs× Expected number of orders for SCs
250 × $1.00 × 30 = $7,500
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Relevant Revenues andRelevant Costs of TimeRelevant Revenues andRelevant Costs of Time
Relevant Introduce Do NotItems RC Introduce RC
Expected revenues $741,000 $660,000Expected total costs 574,625 487,500Difference $166,375 $172,500
Falcon Works should not introducethe regular component.
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Learning Objective 7Learning Objective 7
Apply the three measures
in the theory of constraints.
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Theory of ConstraintsTheory of Constraints
The three main measurements in the theoryof constraints are:
1. Throughput contribution equal to revenuesminus direct material costs.
2. Investments equal the sum of material costsin direct materials inventory, work in process
inventory, finished goods inventory, R&Dcosts, and costs of equipment and buildings.
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Theory of ConstraintsTheory of Constraints
3. Operating costs equal to all operating costs(other than direct materials) incurred to earn
throughput contribution.
The objective of TOC is to increase throughputcontribution while decreasing investments
and operating costs.
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Learning Objective 8Learning Objective 8
Manage bottlenecks.
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Managing BottlenecksManaging Bottlenecks
The four steps in managing bottlenecks are:
1. Recognize that the bottleneck operationdetermines throughput contribution
of the system as a whole.
2. Search and find the bottleneck operation byidentifying operations with large quantities
of inventory waiting to be worked on.
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Managing BottlenecksManaging Bottlenecks
3. Keep the bottleneck busy and subordinateall nonbottleneck operations to the
bottleneck operations.
4. Take actions to increase bottleneck efficiencyand capacity – the objective is to increase
throughput contribution minus the incrementalcosts of taking such actions.
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End of Chapter 19End of Chapter 19