Quality, Time, and the Theory of Constraints Chapter 19

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Introduction
To satisfy their customers and to be competitive, managers need to find costeffective ways to continuously improve the quality of their products and to shorten delivery time. s This chapter describes how managers streamline processes to improve quality and reduce delays.
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Two Aspects of Quality

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Quality of design measures how closely the characteristics of products or services meet the needs and wants of customers. Conformance quality refers to the performance of a product or service according to design and product specifications.

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Two Aspects of Quality

Actual Performance Design Specifications Customer Satisfaction

Conformance Quality Failure

Quality of Design Failure

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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. s These costs focus on conformance quality and are incurred in all business functions of the value chain.
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Costs of Quality
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Prevention costs--costs incurred in precluding the production of products that do not conform to specifications. Appraisal costs--costs incurred in detecting which of the individual units of products do not conform to specifications.

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Costs of Quality
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Internal failure costs--costs incurred by a nonconforming product detected before it is shipped to customers. External failure costs--costs incurred by a nonconforming product detected after it is shipped to customers.

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Costs of Quality
Peoria Photo Corporation made 10,000 photocopying machines in the year 2000. s Peoria Photo determines the costs of quality of its photocopying machines using a 7-step activity-based costing approach.
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Costs of Quality (Steps 1 and 2)

Step 1: Identify the chosen cost object(s). s The cost object is the 10,000 photocopying machines that Peoria Photo makes. s Step 2: Identify the direct costs of quality of the product. s The photocopying machines have no direct costs of quality.
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Costs of Quality (Step 3)

Step 3: Select the cost-allocation bases to use for allocating indirect costs of quality to the product. s Peoria Photo classifies activities that result in prevention, appraisal, internal failure, and external failure costs. s (Information on the total quantities of each of these cost-allocation bases used in all of Peorias operations is not provided.) 19 - 10
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Costs of Quality (Step 4)

Step 4: Identify the indirect costs of quality associated with each cost-allocation base. s These are the total costs (fixed and variable) incurred on each of the costs of quality activities. s (Information about these total costs is not provided.)
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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. s 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 costallocation base.
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Costs of Quality (Step 5)

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Peoria Photo chooses the number of inspection hours as the cost-allocation base for the inspection activity in all of Peorias operations.

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Costs of Quality (Step 5)

Cost of Quality and Value Chain Category (Assumed) Rate 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: 19 14 Rework (Manufacturing) $100 -per

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

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Costs of Quality (Step 6)

Step 6: Compute the indirect costs of quality allocated to the product. s Peoria Photo first determines the quantities of each of the cost-allocation bases used by the photocopying machines. s This amount is multiplied by the costallocation rate calculated in Step 5.
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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: 19 - 17 Rework (Manufacturing) 50,000 hours

Costs of Quality (Step 6)

Cost of Quality and Value Chain Category External failure costs: Customer support (Marketing) Transportation (Distribution) Warranty repair (Customer Service) Quantity 6,000 hours 1,500 loads 60,000 hours

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Costs of Quality (Step 6)

What is the total cost for design engineering? s 20,000 hours $80 = $1,600,000 s What is the total cost for inspection? s 120,000 hours $40 = $4,800,000
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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 19 - 20 $4,800,000

Costs of Quality (Step 6)

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

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Costs of Quality (Step 6)

Cost of Quality and Value Chain Category External failure costs: Customer support (Marketing) Transportation (Distribution) Warranty repair (Customer Service) Total Total Costs $ 300,000 360,000 6,600,000 $7,260,000
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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. s 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
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Techniques Used to Analyze Quality Problems

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Three methods that companies use to identify quality problems and to improve quality are: Control charts Pareto diagrams Cause-and-effect diagrams

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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. s 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.
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Control Charts
Each observation is plotted relative to specified ranges that represent the expected statistical distribution. s Only those observations outside the control limits are ordinarily regarded as nonrandom and worth investigating.
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Control Charts
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On the basis of experience, Peoria decides that any observation outside the arithmetic mean 2 standard deviations should be investigated.

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Control Charts
Production Line + 2 + - - 2 1 2 3 4 5 6 7 8 9 10 Days Defect Rate

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Control Charts
For the production line, the last two observations signal that an out-of-control occurrence is highly likely. s Given the 2 from the mean rule, both observations would lead to an investigation.
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Pareto Diagram
Observations outside control limits serve as inputs to Pareto diagrams. s A Pareto diagram indicates how frequently each type of failure (defect) occurs.
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Pareto Diagram
Number of Times Defect Observed 700 500 200 Copies are Copies are Paper gets fuzzy and too jammed unclear light/dark
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Cause-and-effect Diagrams
The most frequently recurring and costly problems identified by the Pareto diagram are analyzed using cause-and-effect diagrams. s A cause-and-effect diagram identifies potential causes of failures or defects. s As a first step, Peoria analyzes the causes of the most frequently occurring failure, fuzzy and unclear copies.
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Cause-and-effect Diagrams
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Peoria identifies four major categories of potential causes of failure: Human factors Methods and design factors Machine-related factors Materials and components factors

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Cause-and-effect Diagrams
Human factors
New operator Poor maintenance

Methods and design factors

Flawed part design Multiple suppliers

Machine-related factors

Materials and components factors

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Relevant Costs
Careful analysis of Peorias cause-and-effect diagram reveals that the frame of the copier is often mishandled as it travels from the suppliers warehouses to Peorias plant. s Mishandling causes the dimensions of the frame to vary from specifications, resulting in fuzzy and unclear copies.
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Relevant Costs
s 1 2

The team of engineers working to solve this problem offers two alternative solutions: Improve the inspection of the frames immediately upon delivery. Redesign and strengthen the frames and the containers used to transport them to better withstand mishandling during transportation.
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Relevant Costs
What must management do to evaluate each alternative? s Measure the total relevant costs and total relevant revenues. s Additional Additional Inspection Cost Redesign Cost Difference s $200,000 $230,000 $30,000 s Peoria determines the fixed and variable cost component of each activity involved.
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Relevant Costs
Variable Allocated Costs Fixed Costs Rework-hour $ 40 $60 Customer-support-hr $ 20 $30 Transportation/load $180 $60 Warranty/repair hour $ 45 $65 Total $100 $ 50 $240 $110

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Relevant Costs
Only variable costs are relevant because fixed costs are not affected. s Before making a decision, management must compare the incremental costs of each alternative against the corresponding incremental benefit.
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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
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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
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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
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Comparison
Further Redesigning Inspection Frames Relevant savings $995,000 $1,361,000 Additional cost 200,000 230,000 Difference $795,000 $1,131,000 s What should Peoria do? s Redesigning the frames provides a $336,000 incremental benefit over further inspection.
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Nonfinancial Measures
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Nonfinancial measures can be categorized into: Nonfinancial measures of customer-satisfaction Nonfinancial measures of internal performance

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Nonfinancial Measures
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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
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Nonfinancial Measures
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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)
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Evaluating Quality Performance

Measuring the financial costs of quality and the nonfinancial aspects of quality have distinctly different advantages. s Financial measures are helpful to evaluate trade-offs among prevention costs, appraisal costs, and failure costs. s They focus attention on the costs of poor quality.
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Evaluating Quality Performance

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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 qualityimprovement programs and setting priorities for achieving maximum cost reduction.
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Evaluating Quality Performance

COQ provides a single, summary measure of quality performance. s Nonfinancial measures help focus attention on the precise problem areas that need improvement and also serve as indicators of future long-run performance.

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Evaluating Quality Performance

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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.
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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.

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Time as a Competitive Weapon

Companies need to measure time in order to manage it properly. s Two common operational measures of time are: 1 Customer-response time 2 On-time performance
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Customer-Response Time
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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 customerresponse time: Receipt time is the time it takes a Marketing Department to specify a customers exact requirements to manufacturing.
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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. s Delivery time is the time it takes to deliver a completed order to the customer.
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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. s On-time performance is an important element of customer satisfaction because customers want and expect on-time deliveries.
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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. s Managing customer-response time and on-time performance requires an understanding of the causes of delays and the resulting costs.
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Time Drivers and Costs of Time

Two important drivers of time are: 1 Uncertainty 2 Limited capacity and bottlenecks s The following are different components of customer-response time: s Receipt time is the time it takes a Marketing Department to specify a customers exact requirements to manufacturing.
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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. s Average waiting time = Average number of orders (Manufacturing time) Divided by 2 [Annual machine capacity (Average number of orders Manufacturing time)]
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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. s The denominator in this formula measures unused capacity, or cushion. s The smaller the unused capacity, the greater the delays.
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Theory of Constraints
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The three main measurements in the theory of constraints are: Throughput contribution equal to revenues minus direct material costs. 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.
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Theory of Constraints
Operating costs equal to all operating costs (other than direct materials) incurred to earn throughput contribution. s The objective of TOC is to increase throughput contribution while decreasing investments and operating costs. s TOC considers a short-run time horizon and assumes operating costs to be fixed costs.
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Theory of Constraints
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The theory of constraints emphasizes the management of bottlenecks as the key to improving the performance of the production system as a whole.

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