process management - managing quality, time by applyingthe theory of constraints - pareto...

MANAGING BOTH QUALITY AND

TIME, BY APPLYING

THE THEORY OF CONSTRAINTS

Introduction

To satisfy their customers and to be competitive, managers need to find cost-effective ways to continuously improve the quality of their products and to shorten delivery time.

This chapter describes how managers streamline processes to improve quality and reduce delays.

G e t u s e f u l a n d f u n d o w n l o a d s a t w w w . d i g i t a l d o w n l o a d s s h o p . c o m

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Two Aspects of Quality

1 Quality of design measures how closely the characteristics of products or services meet the needs and wants of customers.

2 Conformance quality refers to the performance of a product or service according to design and product specifications.



Two Aspects of Quality

Actual Performance

Design Specifications

Customer Satisfaction

Quality of Design

Failure

Conformance Quality

Failure

Costs of Quality

The costs of quality (COQ) refer to costs incurred to prevent, or costs arising as a result of, the production of a low-quality product.

These costs focus on conformance quality and are incurred in all business functions of the value chain.



Costs of Quality

1 Prevention costs--costs incurred in precluding the production of products that do not conform to specifications.

2 Appraisal costs--costs incurred in detecting which of the individual units of products do not conform to specifications.



Costs of Quality

3 Internal failure costs--costs incurred by a nonconforming product detected before it is shipped to customers.

4 External failure costs--costs incurred by a nonconforming product detected after it is shipped to customers.



Costs of Quality

Santa-Cruz Photo Corporation made 10,000 photocopying machines in the year 2000.

Santa-Cruz Photo determines the costs of quality of its photocopying machines using a 7-step activity-based costing approach.



Costs of Quality (Steps 1 and 2)

Step 1: Identify the chosen cost object(s).

The cost object is the 10,000 photocopying machines that Santa-Cruz Photo makes.

Step 2: Identify the direct costs of quality of the product.

The photocopying machines have no direct costs of quality.

Costs of Quality (Step 3)

Step 3: Select the cost-allocation bases to use for allocating indirect costs of quality to the product.

Santa-Cruz Photo classifies activities that result in prevention, appraisal, internal failure, and external failure costs.

(Information on the total quantities of each of these cost-allocation bases used in all of Santa-Cruz’s operations is not provided.)


Step 4: Identify the indirect costs of quality associated with each cost-allocation base.

These are the total costs (fixed and variable) incurred on each of the costs of quality activities.

(Information about these total costs is not provided.)




Step 5: Compute the rate per unit of each cost-allocation base used to allocate indirect costs of quality to products.

For each activity, the total costs calculated in Step 4 is divided by the total quantity of the cost-allocation base calculated in Step 3 to compute the rate per unit for each cost-allocation base.




Santa-Cruz Photo chooses the number of inspection hours as the cost-allocation base for the inspection activity in all of Santa-Cruz’s operations.


Cost of Quality and Value Chain Category Rate (Assumed) Prevention costs: Design engineering (R&D) $ 80 per hour Process engineering (R&D) $ 60 per hour Appraisal costs: Inspection (Manufacturing) $ 40 per hour Internal failure costs: Rework (Manufacturing) $100 per hour


Cost of Quality and Value Chain Category Rate (Assumed) External failure costs: Customer support (Marketing)

$ 50 per hour Transportation (Distribution) $240 per load Warranty repair (Customer Service) $110 per hour


Step 6: Compute the indirect costs of quality allocated to the product.

Santa-Cruz Photo first determines the quantities of each of the cost-allocation bases used by the photocopying machines.

This amount is multiplied by the cost-allocation rate calculated in Step 5.




Cost of Quality and Value Chain Category Quantity Prevention costs: Design engineering (R&D) 20,000 hours Process engineering (R&D) 22,500 hours Appraisal costs: Inspection (Manufacturing) 120,000 hours Internal failure costs: Rework (Manufacturing) 50,000 hours


Cost of Quality and Value Chain Category Quantity External failure costs: Customer support (Marketing)

6,000 hours Transportation (Distribution) 1,500 loads Warranty repair (Customer Service) 60,000 hours


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


Cost of Quality and Value Chain Category Total Costs Prevention costs: Design engineering (R&D) $1,600,000 Process engineering (R&D) 1,350,000 Total$2,950,000 Appraisal costs: Inspection

$4,800,000 Total$4,800,000


Cost of Quality and Value Chain Category Total Costs Internal failure costs: Rework (Manufacturing)

$5,000,000 Total$5,000,000


Cost of Quality and Value Chain Category Total Costs External failure costs: Customer support (Marketing) $ 300,000 Transportation (Distribution) 360,000 Warranty repair (Customer Service) 6,600,000 Total

$7,260,000



Costs of Quality (Step 7) Step 7: Compute the total costs of quality

of the product by adding all direct and indirect costs of quality assigned to it.

What are the total costs of quality?Prevention costs $ 2,950,000

Appraisal costs 4,800,000 Internal failure costs 5,000,000

External failure costs 7,260,000 Total $20,010,000

Techniques Used to Analyze Quality Problems Three methods that companies use to

identify quality problems and to improve quality are:

1 Control charts1 Pareto diagrams1 Cause-and-effect diagrams

Control Charts

Statistical quality control (SQC), or statistical process control (SPC), is a formal means of distinguishing between random variation and nonrandom variation in an operating process.

A control chart is a graph of a series of successive observations of a particular step, procedure, or operation taken at regular intervals of time.

Control Charts

Each observation is plotted relative to specified ranges that represent the expected statistical distribution.

Only those observations outside the control limits are ordinarily regarded as nonrandom and worth investigating.

Control Charts

On the basis of experience, Santa-Cruz decides that any observation outside the arithmetic mean m ± 2s standard deviations should be investigated.

Control Charts

1 2 3 4 5 6 7 8 9 10

Days

m m +

s

m + 2s

Production Line

m - sm -

2s

Def

ect R

ate

Control Charts

For the production line, the last two observations signal that an out-of-control occurrence is highly likely.

Given the ± 2 s from the mean rule, both observations would lead to an investigation.

Pareto Diagram

Observations outside control limits serve as inputs to Pareto diagrams.

A Pareto diagram indicates how frequently each type of failure (defect) occurs.

Pareto Diagram

Copies are fuzzy and unclear

Copies are too

light/darkPaper gets

jammed

Num

ber

of T

imes

Def

ect O

bser

ved 700

500

200

Cause-and-effect Diagrams The most frequently recurring and costly

problems identified by the Pareto diagram are analyzed using cause-and-effect diagrams.

A cause-and-effect diagram identifies potential causes of failures or defects.

As a first step, Santa-Cruz analyzes the causes of the most frequently occurring failure, fuzzy and unclear copies.



Cause-and-effect Diagrams Santa-Cruz identifies four major

categories of potential causes of failure:1 Human factors1 Methods and design factors1 Machine-related factors1 Materials and components factors

Cause-and-effect Diagrams

Methods and

design factorsHuman factors

Machine-related

factors

Materials and

components factors

Multiple suppliers

New operator Flawed part design

Poor maintenance

Relevant Costs

Careful analysis of Santa-Cruz’s cause-and-effect diagram reveals that the frame of the copier is often mishandled as it travels from the suppliers’ warehouses to Santa-Cruz’s plant.

Mishandling causes the dimensions of the frame to vary from specifications, resulting in fuzzy and unclear copies.

Relevant Costs

The team of engineers working to solve this problem offers two alternative solutions:

1 Improve the inspection of the frames immediately upon delivery.

1 Redesign and strengthen the frames and the containers used to transport them to better withstand mishandling during transportation.

Relevant Costs What must management do to evaluate

each alternative? Measure the total relevant costs and total

relevant revenues. Additional Additional

Inspection Cost Redesign Cost Difference

$200,000 $230,000 $30,000

Santa-Cruz determines the fixed and variable cost component of each activity involved.



Relevant Costs

Variable Allocated Costs Fixed Costs

TotalRework-hour $ 40 $60 $100Customer-support-hr $ 20 $30 $

50Transportation/load $180 $60

$240Warranty/repair hour $ 45 $65

$110G e t u s e f u l a n d f u n d o w n l o a d s a t w w w . d i g i t a l d o w n l o a d s s h o p . c o m


Relevant Costs

Only variable costs are relevant because fixed costs are not affected.

Before making a decision, management must compare the incremental costs of each alternative against the corresponding incremental benefit.

Relevant Benefits Further Redesigning Inspection Frames

Savings in rework costs: $40 × 12,000 $480,000

$40 × 16,000 $640,000 Savings in customer- support costs: $20 × 1,000 $20,000 $20 × 1,400 $28,000

Relevant Benefits

Further Redesigning Inspection Frames

Savings in transportation costs for repair parts: $180 × 250 $45,000

$180 × 350 $63,000

Savings in warranty repair costs:

$45 × 10,000 $450,000 $45 × 14,000 $630,000

Relevant Benefits

Further Redesigning Inspection Frames Relevant savings: Rework costs

$480,000 $ 640,000 Customer-support costs 20,000 28,000 Transportation costs 45,000 63,000 Warranty repair costs 450,000 630,000 Total

$995,000 $1,361,000G e t u s e f u l a n d f u n d o w n l o a d s a t w w w . d i g i t a l d o w n l o a d s s h o p . c o m


Comparison

Further Redesigning Inspection Frames Relevant savings

$995,000 $1,361,000 Additional cost 200,000 230,000 Difference

$795,000 $1,131,000 What should Santa-Cruz do? Redesigning the frames provides a

$336,000 incremental benefit over further inspection.

Nonfinancial Measures

Nonfinancial measures can be categorized into:

– Nonfinancial measures of customer-satisfaction

– Nonfinancial measures of internal performance


Nonfinancial measures of customer satisfaction include:

– 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


Nonfinancial measures of internal performance include:

– 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)



Evaluating Quality Performance

Measuring the financial costs of quality and the nonfinancial aspects of quality have distinctly different advantages.

Financial measures are helpful to evaluate trade-offs among prevention costs, appraisal costs, and failure costs.

They focus attention on the costs of poor quality.




Advantages of COQ measures:– Consistent with the attention directing role

of management accounting, COQ focuses attention on how costly poor quality can be.

– Financial COQ measures assist in problem solving by comparing different quality-improvement programs and setting priorities for achieving maximum cost reduction.


– COQ provides a single, summary measure of quality performance.

Nonfinancial measures help focus attention on the precise problem areas that need improvement and also serve as indicators of future long-run performance.


Advantages of nonfinancial measures of quality:

– Nonfinancial measures of quality are often easy to quantify and understand.

– Nonfinancial measures direct attention to physical processes and hence focus attention on the precise problem areas that need improvement.


– Nonfinancial measures provide immediate short-run feedback on whether quality improvement efforts have, in fact, succeeded in improving quality.

– Nonfinancial measures are useful indicators of future long-run performance.



Time as a Competitive Weapon

Companies need to measure time in order to manage it properly.

Two common operational measures of time are:

1 Customer-response time1 On-time performance

Customer-Response Time Customer-response time is the amount of

time from when a customer places an order for a product or requests service to when the product or service is delivered to the customer.

The following are different components of customer-response time:

Receipt time is the time it takes a Marketing Department to specify a customer’s exact requirements to manufacturing.

Customer-Response Time Manufacturing lead time is the amount

of time from when an order is ready to start on the production line to when it becomes a finished good.

Delivery time is the time it takes to deliver a completed order to the customer.

On-Time Performance

On-time performance refers to situations in which the product or service is actually delivered at the time it is scheduled to be delivered.

On-time performance is an important element of customer satisfaction because customers want and expect on-time deliveries.

Time Drivers and Costs of Time

A time driver is any factor where change in the factor causes a change in the speed with which an activity is undertaken.

Managing customer-response time and on-time performance requires an understanding of the causes of delays and the resulting costs.


Two important drivers of time are:1 Uncertainty 1 Limited capacity and bottlenecks The following are different components

of customer-response time: Receipt time is the time it takes a

Marketing Department to specify a customer’s exact requirements to manufacturing.


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

Average waiting time = Average number of orders × (Manufacturing time)² Divided by 2 × [Annual machine capacity – (Average number of orders × Manufacturing time)]


The longer the manufacturing time, the greater the chance that the machine will be in use when an order arrives, and the longer the delays.

The denominator in this formula measures unused capacity, or cushion.

The smaller the unused capacity, the greater the delays.

Theory of Constraints

The three main measurements in the theory of constraints are:

1 Throughput contribution equal to revenues minus direct material costs.

1 Investments equal the sum of material costs in direct materials inventory, work-in-process inventory, finished goods inventory, R&D costs, and costs of equipment and buildings.


3 Operating costs equal to all operating costs (other than direct materials) incurred to earn throughput contribution.

The objective of TOC is to increase throughput contribution while decreasing investments and operating costs.

TOC considers a short-run time horizon and assumes operating costs to be fixed costs.


The theory of constraints emphasizes the management of bottlenecks as the key to improving the performance of the production system as a whole.

Managing Bottlenecks

The four steps in managing bottlenecks are:

1 Recognize that the bottleneck operation determines throughput contribution of the system as a whole.

1 Search and find the bottleneck operation by identifying operations with large quantities of inventory waiting to be worked on.



Managing Bottlenecks

3 Keep the bottleneck busy and subordinate all nonbottleneck operations to the bottleneck operations.

4 Take actions to increase bottleneck efficiency and capacity – the objective is to increase throughput contribution minus the incremental costs of taking such actions.



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