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  • This slide reviews the topics to be covered in this section In addition to discussing new management/operating considerations (JIT, TQM, Benchmarking, etc.) we will place most of our emphasis on the information needed (primarily management accounting information) necessary for these techniques to succeed! The major point is that accounting must become a “value-added” activity!!! Note that activity-based-analysis will be touched briefly and then covered in detail at the end this section as an illustration
  • Notice the EXTERNAL FOCUS of strategic management * This is in contrast to the traditional management approaches that were largely internally focused (standard costing, variance analysis, incremental budgeting, etc.) Emphasis on a PROACTIVE approach In summary, this approach deals with the critical resource allocation questions on which top management must concentrate
  • Porter says these are approaches to obtaining “sustainable competitive advantages”
  • These ideas represent the true, “VALUE-ADDED” aspects of management accounting We must help management achieve the objectives of the entity!!!
  • Participation in the decision-making process involving the organization’s strategy, value-chain, and strategic positioning Especially important to the allocation of limited resources
  • Specific performance measures identified (LIMITED) Comparative reports prepared Financial = Oper. Income; Sales growth; ROI Customer = Customer satisf.; # complaints; Mkt share; On-time delivery Internal processes = Efficiency meas.; mfg. Lead times; % of defective units Innovation & learning = New products; New patents; Time to market; # of employee suggestions adopted
  • Goal of any organization = maximize value while minimizing the cost of a product or service to final customer. Work backward from final product or service to basic raw materials Internal vs. External value chains Internal (value-added) within one entity External entire industry Uses of value chain perspective Look for linkages (view suppliers and customers as partners) – involve them in decisions Allows an entity to focus on core competencies (outsourcing where appropriate) Focus on processes NOT departments (avoid across board budget cuts) Continuous improvement Process reengineering = redesign of process Benchmarking = identifying “best practices” and utilize where possible
  • Product life cycle = the time a product exists, from conception to abandonment Life-cycle costs = all costs associated with the product for its entire life cycle Whole-life costs = life-cycle costs of a product + postpurchase costs incurred by the buyer (includes all items through disposal) Some argue this is an expanded defin. Of “life-cycle costs” but more from a customer’s perspective
  • Both ABC and ABM are part of this broader concept Analysis of activities is the key to both of these concepts ABC involves the more mechanical aspects, but it is more than just a multiplication of overhead rates ABC attempts to get closer to the “cause-and-effect relationships that exist within the organization BE SURE TO DISTINGUISH THE IDEA OF VALUE-ADDED USED IN THE ACTIVITY-BASED LITERATURE FROM THE CONCEPT OF SHAREHOLDER VALUE!! IN THIS SITUATION WE ARE FOCUSING ON THE OPERATIONAL AND STRATEGIC CONCEPTS OF VALUE-ADDED!!
  • Eliminate unnecessary activities - short term goal may be reduction Increase efficiency of necessary activities Improving operating functions Kaplan (Mgt. Acctg., Nov. 1992) ...”by determining the process drivers for critical activities, employees and operators are given SPECIFIC targets for day-to-day improvement activities.” Example: ABM goal = to reduce cost of material movements Approach: Identify and communicate the drivers of the materials handling process, e.g., handling distances, number of inventory stocking points, material stops between successive operations Appropriate combination of activities Sharing necessary activities = economies of scale ADDING NEW VALUE-ADDING ACTIVITIES IS EXTREMELY IMPORTANT, BUT OFTEN OVERLOOKED - REQUIRES CREATIVITY!!
  • 6
  • JIT is NOT an inventory system!!! It is an OPERATING PHILOSOPHY tied to overall strategic objectives! * Improved firm profitability * Improved competitive position The real reason for implementing such a system should the strategic need to meet customer demands : * Improved delivery capability * Flexible production of diverse products * Speed new products to market (a key competitive factor) Suppose you are trying to become the first major distributor of a “recordable CD” * Total quality management may be a key competitive issue * Improved price position due to lower operating costs
  • Reduction in setup time: * Simplify operations * Eliminate non-value added activities * In concept, the target is to eliminate setup costs resulting in an optimum batch of ONE! * This approach is based on the idea of “continuous improvement” not IMMEDIATE ACHIEVEMENT! * Allows flexibility and diversity (ECONOMIES OF SCOPE) Direct cost identification results from focused operations Reduction in labor costs and transformation of many to fixed costs Impact on automation: * Improve quality * Simplify operations * Then consider automation - above steps may indicate where! Simplified accounting = “Backflush Costing”
  • JIT is not for everyone: * Tremendous uncertainty of demand makes JIT very difficult to use effectively * Seasonal production may be necessary (agricultural products) * One-product facilities may not achieve the same percentage of change, but some improvements may be possible!
  • The major point is that the same competitive advantages related to flexibility, diversity, quality, price, and overall customer satisfaction present for a product company also apply to service organizations.
  • SMAC

    1. 1. STRATEGIC MANAGEMENT AND ACCOUNTING <ul><li>Strategic Management </li></ul><ul><ul><li>Stakeholder analysis </li></ul></ul><ul><ul><li>Corporate objectives </li></ul></ul><ul><ul><li>Sustainable competitive advantages </li></ul></ul><ul><li>Strategic Management Accounting </li></ul><ul><ul><li>Appropriate analysis </li></ul></ul><ul><ul><li>Long-term considerations </li></ul></ul><ul><ul><li>Nonfinancial data </li></ul></ul>SMAC -
    2. 2. STRATEGIC MANAGEMENT AND ANALYSIS <ul><li>Strategic considerations </li></ul><ul><li>Strategic Marketing Analysis </li></ul><ul><li>Total Value-Chain Analysis </li></ul><ul><li>Target Costing </li></ul><ul><li>Life-Cycle Management and Costing </li></ul><ul><li>Operational considerations </li></ul><ul><li>Activity Based Analysis </li></ul><ul><li>JIT Operations: A Management Philosophy </li></ul><ul><li>Total-Quality Management and Costing </li></ul>SMAC -
    3. 3. STRATEGIC OBJECTIVES <ul><li>Primary Objectives </li></ul><ul><li>What the shareowners expect from their participation in the organization </li></ul><ul><li>“ Increase in shareowner value” </li></ul><ul><li>Secondary Objectives </li></ul><ul><li>What the organization expects to give to and receive from each stakeholder group other than its owners </li></ul><ul><li>“ Increase in social value” </li></ul>SMAC -
    4. 4. STRATEGIC MANAGEMENT <ul><li>“ The fundamental idea of strategic planning is quite simple: Continuously reassess what customers want, what competitors are doing, and other relevant environmental elements (such as emerging technology and trends in government legislation); size up these environmental changes; and use, or develop, available resources to turn these changes into advantages. </li></ul><ul><li>Obviously, carrying out strategic planning successfully is a lot more difficult than understanding what it is.” </li></ul>SMAC - Atkinson, Anthony A., Rajiv D. Banker, Robert S. Kaplan, and S. Mark Young, Management Accounting , Prentice Hall, Inc., 1995, p. 471.
    5. 5. WHAT IS STRATEGY? <ul><li>“ Competitive strategy is about being different. It means deliberately choosing a different set of activities to deliver a unique mix of value. </li></ul><ul><li>… the essence of strategy is in the activities -- choosing to perform activities differently or to perform different activities than rivals. “ </li></ul><ul><li>Porter, Michael E., “What is Strategy?,” Harvard Business Review , November-December, 1996. </li></ul>SMAC -
    6. 6. SMAC - <ul><li>Cost leadership </li></ul><ul><li>Product or service differentiation </li></ul><ul><li>Focus on market niche </li></ul>Porter’s Strategic Positions
    7. 7. DEVELOPING COMPETITIVE ADVANTAGE SMAC - Relative Cost Position Inferior Superior Relative Differentiation Position Inferior Superior Differentiation Advantage Stuck-in-the Middle Differentiation with Cost Advantage Low Cost Advantage Focus
    8. 8. STRATEGIC MANAGEMENT ACCOUNTING <ul><li>“ Accounting exists within an business primarily to facilitate the development and implementation of business strategy... </li></ul><ul><li>Three important generalizations emerge from this way of viewing management accounting: </li></ul><ul><li>Accounting is not an end in itself, but only a means to help achieve business success </li></ul><ul><li>Specific accounting techniques or systems must be considered in terms of the role they are intended to play </li></ul><ul><li>In evaluating the overall accounting system... the key question is whether the overall fit with strategy is appropriate.” </li></ul><ul><li>Shank, John K. and Vijay Govindarajan, Strategic Cost Management , The Free Press, Macmillan, Inc., 1993, pp. 6-7. </li></ul>SMAC -
    9. 9. SMAC - Strategic position analysis --an organization’s basic way of competing to sell products or services. Value chain analysis --the study of value-producing activities, stretching from basic raw materials to the final consumer of a product or service. Strategic Cost Management Cost driver analysis --the study of factors that cause or influence costs.
    10. 10. BALANCED SCORECARD <ul><li>A multi-dimensional measurement system that translates an organization’s mission and strategy into performance measures </li></ul>SMAC -
    11. 11. Balanced Business Scorecard Vision & Strategy Business Processes What business processes are the value drivers? Organization Learning Are we able to sustain innovation, change and improvement Customer Perspective How do we look to our customers? Financial Perspective How do we look to our shareholders?
    12. 12. LRP vs. STRATEGIC MANAGEMENT <ul><li>Long Range Planning </li></ul><ul><ul><li>Historical continuity </li></ul></ul><ul><ul><li>Periodic orientation </li></ul></ul><ul><ul><li>Internal focus </li></ul></ul><ul><ul><li>Optimistic </li></ul></ul><ul><ul><li>Detailed financial terms </li></ul></ul><ul><ul><li>“ Management by Exception” </li></ul></ul><ul><li>Strategic Management </li></ul><ul><ul><li>Recognition of change </li></ul></ul><ul><ul><li>Extended time horizons </li></ul></ul><ul><ul><li>External focus </li></ul></ul><ul><ul><li>Proactive but realistic </li></ul></ul><ul><ul><li>Multiple data sources </li></ul></ul><ul><ul><li>On-line analysis </li></ul></ul><ul><ul><li>Entrepreneurial </li></ul></ul><ul><ul><li>Global viewpoint </li></ul></ul>SMAC -
    13. 13. STRATEGIC MANAGEMENT Key Questions <ul><li>In what markets will we compete? </li></ul><ul><li>How will we position ourselves within these markets? </li></ul><ul><li>What will the basis of our competitive advantage? </li></ul><ul><li>What specific people, processes, other resources are necessary to successfully compete? </li></ul>SMAC -
    15. 15. PROCESS PERSPECTIVE Service the Customer Post- Sale Service Process Operations Process Deliver the Products/ Services Build the Products/Services Innovation Process Customer Need Satisfied Create Product/ Service Offering Identify the Market Customer Need Identified
    16. 16. VALUE CHAIN ANALYSIS <ul><li>Focus of the analysis </li></ul><ul><ul><li>External vs. Internal (traditional) </li></ul></ul><ul><ul><li>Highlights profit improvement areas </li></ul></ul><ul><ul><ul><li>Linkages with suppliers </li></ul></ul></ul><ul><ul><ul><li>Linkages with customers </li></ul></ul></ul><ul><ul><ul><li>Process linkages within a business unit </li></ul></ul></ul><ul><ul><ul><li>Linkages across business units </li></ul></ul></ul><ul><li>Steps in the analysis </li></ul><ul><ul><li>Identify an industry’s value chain </li></ul></ul><ul><ul><li>Assign costs, revenues, and assets to value activities </li></ul></ul><ul><ul><li>Diagnose cost drivers </li></ul></ul><ul><ul><li>Develop sustainable competitive advantages </li></ul></ul>SMAC -
    17. 17. VALUE CHAIN ANALYSIS PAPER PRODUCTS INDUSTRY SMAC - End-Use Customer Distribution Converting Operations Paper Manufacturing Pulp Manufacturing Logging and Chipping Timber Farming Competitor A Competitor B Competitor C Competitor D Competitor E Competitor F Competitor G
    18. 18. VALUE-CHAIN & STRATEGIC MANAGEMENT <ul><li>Integration with sustainable competitive advantages </li></ul><ul><ul><li>Low cost </li></ul></ul><ul><ul><li>Differentiation </li></ul></ul><ul><li>Management relative to competitors </li></ul><ul><ul><li>Better value for equivalent cost </li></ul></ul><ul><ul><li>Equivalent value for lower cost </li></ul></ul><ul><li>Placement in the value chain </li></ul><ul><ul><li>Each firm is only a part of the total chain </li></ul></ul><ul><ul><li>Overall value chain for each firm is unique </li></ul></ul>SMAC -
    19. 19. SMAC - Market Research Competitor Analysis Define Product/ Customer Niche Understand Customer Requirements Define Product Features Estimated Market Price Required Profit Target Cost ESTABLISHMENT OF TARGET COSTS
    20. 20. ATTAINMENT OF TARGET COSTS SMAC - Compute Cost Gap Design Costs Out Produce Initial Cost Estimates Compare to Target Cost Perform Value Engineering Design Products/ Processes Estimate Achievable Cost Perform Cost Analysis Release Design to Production Undertake Continuous Improvement Actual Cost
    21. 21. LIFE-CYCLE MANAGEMENT AND ACCOUNTING <ul><li>Cost commitment vs. incurrance </li></ul><ul><ul><li>Product life cycle </li></ul></ul><ul><ul><li>Life-cycle costs </li></ul></ul><ul><ul><li>Whole-life costs </li></ul></ul><ul><li>Management of life-cycle costs </li></ul><ul><li>Strategic implications </li></ul>SMAC -
    22. 22. LIFE-CYCLE COST COMMITMENT SMAC - Product Planning Preliminary Design Detailed Design & Testing Production Logistics Support 66 85 90
    23. 23. LIFE-CYCLE COST COMMITMENT SMAC - Product Planning Preliminary Design Detailed Design & Testing Production Logistics Support 66 85 90 Life-cycle cost ($) Cash Flow Matched Cost Life-cycle Cost
    24. 24. LIFE-CYCLE COST MANAGEMENT <ul><li>Management of activities throughout a product’s entire life-cycle so that a long-term competitive advantage is created </li></ul><ul><li>Consideration of the total value-chain of the product is essential to life-cycle management </li></ul><ul><li>Specific considerations </li></ul><ul><ul><li>Relation to target costing </li></ul></ul><ul><ul><li>Identification of development stage costs </li></ul></ul><ul><ul><li>Cost reduction and control </li></ul></ul>SMAC -
    25. 25. ACTIVITY BASED ANALYSIS <ul><li>Activity Based Costing </li></ul><ul><ul><li>A costing system focused on ESSENTIAL ACTIVITIES comprising a firm’s operations. </li></ul></ul><ul><ul><li>Costs are first traced to these activities and then to products/services. </li></ul></ul><ul><li>Activity Based Management </li></ul><ul><ul><li>A system-wide, integrated approach which focuses attention on activities performed by the firm and assessing their value, </li></ul></ul><ul><ul><li>The objective is to identify and continue only those activities that add value. </li></ul></ul>SMAC -
    26. 26. VALUE-ADDED ACTIVITIES <ul><li>Those necessary to remain in business </li></ul><ul><ul><li>Required - comply with legal requirements </li></ul></ul><ul><ul><li>Discretionary </li></ul></ul><ul><ul><ul><li>Produces a desired state of change in product or service </li></ul></ul></ul><ul><ul><ul><li>Not achievable by other activities </li></ul></ul></ul><ul><ul><ul><li>Enables other activities to be performed </li></ul></ul></ul><ul><li>VALUE-ADDED COSTS </li></ul><ul><ul><li>Costs to perform value-added activities with perfect efficiency </li></ul></ul>SMAC -
    27. 27. NONVALUE-ADDED ACTIVITIES <ul><li>Activities that are either unnecessary or are necessary but inefficiently performed and can be improved </li></ul><ul><li>Nonvalue-added activities = Nonvalue-added costs </li></ul><ul><li>From THE CUSTOMER’S PERSPECTIVE (within strategic constraints) </li></ul><ul><li>Examples of nonvalue-added activities </li></ul><ul><ul><li>Scheduling </li></ul></ul><ul><ul><li>Moving </li></ul></ul><ul><ul><li>Waiting </li></ul></ul><ul><ul><li>Inspecting </li></ul></ul><ul><ul><li>Useless accounting reports </li></ul></ul>SMAC -
    28. 28. OBJECTIVES OF ACTIVITY BASED MANAGEMENT <ul><li>Elimination of all unnecessary activities </li></ul><ul><li>Increase efficiency of necessary activities </li></ul><ul><ul><li>Improving operating functions </li></ul></ul><ul><ul><li>Improving combination of activities </li></ul></ul><ul><ul><li>Sharing necessary activities </li></ul></ul><ul><li>ADD, NEW , VALUE-ADDED ACTIVITIES </li></ul>SMAC -
    29. 29. The Two-Dimensional ABM Model SMAC - Resources Process Dimension Driver Analysis Analysis Performance Measures Product and Customers Cost Dimension Why? What? How Well?
    30. 30. PERFORMANCE MEASURES New Competitive Environment <ul><li>Performance standards </li></ul><ul><li>Ideal standards </li></ul><ul><ul><ul><li>Goals for operating level personnel </li></ul></ul></ul><ul><ul><ul><li>Continuous improvement philosophy </li></ul></ul></ul><ul><ul><ul><li>Basis for trend evaluation </li></ul></ul></ul><ul><li>Currently attainable standards </li></ul><ul><ul><ul><li>Reported to top management </li></ul></ul></ul><ul><ul><ul><li>Relates to current resource management </li></ul></ul></ul><ul><li>Directly correlates to ABM </li></ul>SMAC -
    31. 31. JIT OPERATIONS A Management Philosophy <ul><li>JIT Operations </li></ul><ul><li>Demand-Pull System </li></ul><ul><li>Focused Operations </li></ul><ul><li>Reduce Setup Time: Enables production of small batches (generates “economies of scope”) </li></ul><ul><li>Insignificant Inventories </li></ul><ul><li>Total Quality Management </li></ul><ul><li>Interdisciplinary Labor </li></ul><ul><li>Decentralized Support Services </li></ul><ul><li>Traditional Operations </li></ul><ul><li>Production-Push System </li></ul><ul><li>Functional Departments </li></ul><ul><li>Produce Large Batches: Reduces total setup time (generates “economies of scale”) </li></ul><ul><li>Significant Inventories </li></ul><ul><li>Acceptable Quality Levels </li></ul><ul><li>Specialized Labor </li></ul><ul><li>Centralized Support Services </li></ul>SMAC -
    32. 32. SMAC - Traditional Manufacturing Layout Product A Product B Lathes Grinding Welding A B A B Finished A Finished B JIT Manufacturing Layout Lathe Grinder Welding Product A Finished A Lathe Welding Product B Finished B Cell A Cell B Dept 1 Dept 2 Dept 3
    33. 33. JIT OPERATIONS Other Considerations <ul><li>Reduction in Setup Time </li></ul><ul><ul><li>Key to competitive advantages </li></ul></ul><ul><ul><li>Optimum batch of “ONE” </li></ul></ul><ul><ul><li>Flexibility and diversity </li></ul></ul><ul><li>Direct cost identification </li></ul><ul><li>Reduction in labor costs </li></ul><ul><li>Guide for automation </li></ul><ul><li>Proactive approach </li></ul><ul><li>Need for operational measures </li></ul><ul><li>Simplified accounting </li></ul>SMAC -
    34. 34. JIT OPERATIONS Costs and Limitations <ul><li>Commitment from employers and employees </li></ul><ul><ul><li>Continuous improvement </li></ul></ul><ul><ul><li>Empowerment of employees </li></ul></ul><ul><li>Changed relations with suppliers </li></ul><ul><ul><li>Long-term agreements </li></ul></ul><ul><ul><li>Stipulated prices </li></ul></ul><ul><ul><li>Guaranteed quality </li></ul></ul><ul><ul><li>Delivery assured </li></ul></ul><ul><li>Same for many customers </li></ul><ul><li>Reorientation of operations </li></ul><ul><li>JIT is not for everyone </li></ul>SMAC -
    35. 35. JIT OPERATIONS Service Organizations <ul><li>Essential Concepts Similar </li></ul><ul><ul><li>Demand-Pull </li></ul></ul><ul><ul><li>Focused Operations </li></ul></ul><ul><ul><li>Reduced Cycle Time </li></ul></ul><ul><ul><ul><li>Simplification of Activities </li></ul></ul></ul><ul><ul><ul><li>Continuous Improvement </li></ul></ul></ul><ul><ul><li>Total Quality Operations </li></ul></ul><ul><ul><li>Multidisciplined labor force </li></ul></ul><ul><ul><li>Decentralized support services </li></ul></ul><ul><li>Examples </li></ul><ul><ul><li>Loan application process at banks </li></ul></ul><ul><ul><li>Processing of claims by insurance companies </li></ul></ul><ul><ul><li>Registration process at universities </li></ul></ul>SMAC -
    36. 36. INVENTORY MANAGEMENT Essential Questions <ul><li>How much inventory must be ordered or produced? </li></ul><ul><li>How should the purchase order or internal production be managed? </li></ul>SMAC -
    37. 37. WHY IS INVENTORY NEEDED? Traditional View <ul><li>Balance ordering (or setup) costs and carrying costs </li></ul><ul><li>Satisfy customer demand and avoid stock-out costs </li></ul><ul><li>Avoid operating shut-downs </li></ul><ul><li>Buffer against unreliable production processes </li></ul><ul><li>Take advantage of purchase discounts </li></ul><ul><li>Hedge against future price increases </li></ul>SMAC -
    38. 38. INVENTORY COSTS <ul><li>Ordering - costs of placing and receiving an order </li></ul><ul><ul><li>Clerical costs, documents, insurance, unloading </li></ul></ul><ul><li>Carrying - costs of keeping inventory </li></ul><ul><ul><li>Insurance, taxes, obsolescence, opportunity cost, storage </li></ul></ul><ul><li>Stockout - costs of not having enough inventory </li></ul><ul><ul><li>Lost sales, cost of expediting, cost of interrupted production </li></ul></ul><ul><li>Setup - costs of preparing operating facilities to produce a particular product or service </li></ul><ul><ul><li>Setup labor, lost revenue (during setup) test runs, etc. </li></ul></ul>SMAC -
    39. 39. JIT & INVENTORY MANAGEMENT <ul><li>Setup & Carrying Costs </li></ul><ul><ul><li>Costs of acquiring inventory reduced </li></ul></ul><ul><ul><ul><li>Significant reductions in setup time </li></ul></ul></ul><ul><ul><ul><li>Using long-term purchase contracts </li></ul></ul></ul><ul><ul><li>Carrying costs reduced because of lower inventories </li></ul></ul><ul><li>Due-Date Performance </li></ul><ul><ul><li>Lead times reduced for quick response </li></ul></ul><ul><ul><li>Focused manufacturing </li></ul></ul><ul><ul><li>Reduction in setup time </li></ul></ul><ul><ul><li>Improved quality </li></ul></ul>SMAC -
    40. 40. JIT & INVENTORY MANAGEMENT <ul><li>Avoidance of Shutdown </li></ul><ul><ul><li>Preventive maintenance </li></ul></ul><ul><ul><li>Quality control to reduce defects </li></ul></ul><ul><ul><li>Good supplier relationships for availability of materials </li></ul></ul><ul><li>Discounts and Price Increases </li></ul><ul><ul><li>Careful vendor selection </li></ul></ul><ul><ul><li>Long-term agreements </li></ul></ul><ul><ul><ul><li>Prices </li></ul></ul></ul><ul><ul><ul><li>Quality </li></ul></ul></ul><ul><ul><ul><li>Reduction in order costs </li></ul></ul></ul>SMAC -
    41. 41. TOTAL QUALITY MANAGEMENT <ul><li>Total Quality Management </li></ul><ul><ul><li>Management philosophy that attempts to eliminate all defects, waste, and activities that do not add value to customers </li></ul></ul><ul><li>Nature of Quality </li></ul><ul><ul><li>The degree of excellence </li></ul></ul><ul><ul><li>Quality product/service is one that conforms to customer expectations </li></ul></ul><ul><li>Types of Quality </li></ul><ul><ul><li>Quality of design </li></ul></ul><ul><ul><li>Quality of conformance </li></ul></ul><ul><li>Costs of Quality </li></ul>SMAC -
    42. 42. QUALITY OF DESIGN & CONFORMANCE SMAC - Quality of Conformance Low High Quality of Design Low High Do right things wrong (failure) Do wrong things wrong (failure) Do right things right (Winner!) Do wrong things right (failure)
    43. 43. COSTS OF QUALITY <ul><li>Prevention costs </li></ul><ul><li>Incurred to prevent defects in products or services being produced </li></ul><ul><li>Quality engineering, quality training programs, quality planning and reporting, supplier evaluations, quality audits, quality circles, design reviews, etc. </li></ul><ul><li>Appraisal costs </li></ul><ul><li>Incurred to determine whether products or services are conforming to specifications </li></ul><ul><li>Inspection and testing of raw materials, packaging inspection, supervising appraisal activities, product and process acceptance, supplier verification, and field testing </li></ul><ul><ul><li>“ The objective is to prevent nonconforming goods from being shipped to customers” </li></ul></ul>SMAC -
    44. 44. COSTS OF QUALITY Continued <ul><li>Internal failure costs </li></ul><ul><li>Incurred because nonconforming products and services are detected prior to being shipped to outside parties (detected by appraisal activities) </li></ul><ul><li>Scrap, rework, downtime due to defects, reinspection, retesting, and design changes </li></ul><ul><li>External failure costs </li></ul><ul><li>Incurred because products/services fail to conform to requirements after being delivered to customers </li></ul><ul><li>Returns, Warranties, Repairs, Product liability, Compliant adjustments, and LOST SALES ! </li></ul>SMAC -
    45. 45. MANAGEMENT OF QUALITY <ul><li>Traditional View </li></ul><ul><ul><li>Balance between prevention/appraisal costs and internal/external failure costs </li></ul></ul><ul><ul><li>Identification of an optimal level of defects </li></ul></ul><ul><li>World Class View </li></ul><ul><ul><li>Zero defects approach </li></ul></ul>SMAC -
    46. 46. SMAC - DISTRIBUTION OF QUALITY COSTS Traditional View Percent Defects Cost Optimal (AQL) 100% Total Failure Costs Total Control Costs Total Quality Costs
    47. 47. SMAC - QUALITY COSTS Contemporary View Cost Percent Defects 100% Total Failure Costs Total Control Costs Total Quality Costs