Process management - managing quality, time by applyingthe theory of constraints - pareto presentation

2. 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

3. 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.
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

4. Two Aspects of Quality
Actual
Performance
Design
Specifications
Customer
Satisfaction
Quality
of Design
Failure
Conformance
Quality
Failure

5. 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.
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

6. 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.
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

7. 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.
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

8. 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.
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

9. 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.

10. 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.)

11. Costs of Quality (Step 4)
 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.)
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

12. Costs of Quality (Step 5)
 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.
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

13. Costs of Quality (Step 5)
 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.

14. Costs of Quality (Step 5)
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

15. Costs of Quality (Step 5)
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

16. Costs of Quality (Step 6)
 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.
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

17. Costs of Quality (Step 6)
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

18. Costs of Quality (Step 6)
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

19. 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

20. Costs of Quality (Step 6)
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

21. Costs of Quality (Step 6)
Cost of Quality and
Value Chain Category Total
Costs Internal failure costs:
Rework (Manufacturing)
$5,000,000 Total
$5,000,000

22. Costs of Quality (Step 6)
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
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

23. 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

24. Techniques Used to Analyze
Quality Problems
 Three methods that companies use to
identify quality problems and to improve
quality are:
1 Control charts
2 Pareto diagrams
3 Cause-and-effect diagrams

25. 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.

26. 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.

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

28. Control Charts
1 2 3 4 5 6 7 8 9 10
Days
m
m + s
m + 2s
Production Line
m - s
m - 2s
DefectRate

29. Control Charts
 For the production line, the last two
observations signal that an out-of-
control occurrence is highly likely.
 Given the ± 2s from the mean rule, both
observations would lead to an
investigation.

30. Pareto Diagram
 Observations outside control limits serve
as inputs to Pareto diagrams.
 A Pareto diagram indicates how
frequently each type of failure (defect)
occurs.

31. Pareto Diagram
Copies are
fuzzy and
unclear
Copies are
too
light/dark
Paper gets
jammed
NumberofTimes
DefectObserved
700
500
200

32. 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.
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

33. Cause-and-effect Diagrams
 Santa-Cruz identifies four major
categories of potential causes of failure:
1 Human factors
2 Methods and design factors
3 Machine-related factors
4 Materials and components factors

34. Cause-and-effect Diagrams
Methods and
design factors
Human factors
Machine-related
factors
Materials and
components factors
Multiple suppliers
New operator Flawed part design
Poor maintenance

35. 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.

36. 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.
2 Redesign and strengthen the frames
and the containers used to transport
them to better withstand mishandling
during transportation.

37. 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.
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

38. Relevant Costs
Variable Allocated
Costs Fixed Costs
Total
Rework-hour $ 40 $60 $100
Customer-support-hr $ 20 $30 $ 50
Transportation/load $180 $60 $240
Warranty/repair hour $ 45 $65 $110
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

39. 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.

40. 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

41. 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

42. 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
$1,361,000
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

43. 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.

44. Nonfinancial Measures
 Nonfinancial measures can be categorized
into:
– Nonfinancial measures of customer-
satisfaction
– Nonfinancial measures of internal
performance

45. Nonfinancial Measures
 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

46. Nonfinancial Measures
 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)
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

47. 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.
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

48. Evaluating Quality Performance
 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.

49. Evaluating Quality Performance
– 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.

50. Evaluating Quality 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.

51. Evaluating Quality Performance
– 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.
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

52. 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 time
2 On-time performance

53. 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.

54. 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.

55. 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.

56. 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.

57. Time Drivers and Costs of Time
 Two important drivers of time are:
1 Uncertainty
2 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.

58. Time Drivers and Costs of Time
 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)]

59. Time Drivers and Costs of 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.

60. Theory of Constraints
 The three main measurements in the
theory of constraints are:
1 Throughput contribution equal to
revenues minus direct material costs.
2 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.

61. Theory 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
throughput contribution while decreasing
investments and operating costs.
 TOC considers a short-run time horizon
and assumes operating costs to be fixed
costs.

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

63. Managing Bottlenecks
 The four steps in managing bottlenecks
are:
1 Recognize that the bottleneck operation
determines throughput contribution of
the system as a whole.
2 Search and find the bottleneck operation
by identifying operations with large
quantities of inventory waiting to be
worked on.
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

64. 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.
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