Chapter 18 McGraw-Hill/Irwin Costing and the Value Chain © The McGraw-Hill Companies, Inc., 2002 The Value Chain—Focus on Core Operations The value chain is the set of activities and resources necessary to create and deliver products and services valued by customers. R&D and Design McGraw-Hill/Irwin Suppliers and Production Distribution and Marketing Customer Service © The McGraw-Hill Companies, Inc., 2002 Value and Non-value-Added Activities Value-added activities add to product or service desirability in customers’ eyes. Identify Non-valueadded activities Eliminate Non-value-added activities add cost without additional desirability, and can be eliminated without reducing quality or performance. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Value and Non-value-Added Activities Activities Analysis and Classification Non-valueAdded Activities ValueAdded Activities Reduce or Eliminate Continually Evaluate and Improve McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Non-value-Added Activities Examples of non-valueadded activities are: Storage of materials, work-in-process, or finished goods. Moving parts and materials in the factory. Waiting for work. Inspection. McGraw-Hill/Irwin Get rid of them! © The McGraw-Hill Companies, Inc., 2002 Activity-Based Management — Drive Out Costs What’s the difference between activity-based costing and activity-based management? McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Activity-Based Management — Drive Out Costs Activity-based costing establishes relationships between overhead costs and activities. McGraw-Hill/Irwin Activity-based management focuses on managing activities to reduce costs. © The McGraw-Hill Companies, Inc., 2002 ABC: a Subset of Activity-Based Management Identify activities McGraw-Hill/Irwin Create cost pools Identify activity measures Determine cost per unit of activity Collect benchmark information Analyze activities © The McGraw-Hill Companies, Inc., 2002 Activity-Based Management and the Value Chain Chart activities needed to meet customer expectations. Use ABC to determine cost of activities. Classify all activities as value-added or non-value-added. Improve value-added activities and eliminate non-value-added activities. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 The Target Costing Process — Creating Customer Satisfaction Let’s move along to a new topic. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 The Target Costing Process — Creating Customer Satisfaction Driven by the customer. Focused on design. Target costing is aimed at the earliest stages of new product and service development. Focused simultaneously on profit and cost planning. McGraw-Hill/Irwin Consideration given to the entire value chain. © The McGraw-Hill Companies, Inc., 2002 The Target Costing Process Attaining the Target Cost Establishing the Target Price Production design and value engineering Concept development Target price Planning and market analysis McGraw-Hill/Irwin Profit margin Target cost Production and continuous improvement © The McGraw-Hill Companies, Inc., 2002 Major Influences on Target Pricing Price McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Components of the Target Costing Process Developing target prices and target costs requires four steps: Develop products that satisfy customer needs. Target price – Profit margin = Target cost Set target price using Use value engineering competitors’ prices and customers’ perceived value for product. to find least costly combination of resources to meet customer needs. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Life-Cycle Product Costing and Pricing Product discontinued and customer support ends Marketing McGraw-Hill/Irwin Research, design, and development Lifecycle costing Production © The McGraw-Hill Companies, Inc., 2002 Life-Cycle Product Costing and Pricing Product discontinued and customer support ends Marketing McGraw-Hill/Irwin Research, Pricing must generate revenue to cover costs of all phases of product life cycle. design, and development Production © The McGraw-Hill Companies, Inc., 2002 Characteristics of Target Costing Processes Involve entire value An understanding of chain in reducing costs while satisfying customer needs. relationships between process components and costs is critical. A product’s functional characteristics to the customer are emphasized. A primary ABC is used to objective is reducing development time. determine changes that will reduce costs. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Just-in-time (JIT) Inventory Procedures Let’s move along to another topic. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Just-In-Time (JIT) Inventory Receive customer orders. Complete products just in time to ship to customers. Schedule production. Receive materials just in time for production. McGraw-Hill/Irwin Complete parts just in time for assembly into products. © The McGraw-Hill Companies, Inc., 2002 Relationship Between JIT and Total Quality Management (TQM) Less warehouse space needed Reduced inventory carrying costs Reduced risk of obsolete inventory McGraw-Hill/Irwin With reduced inventories, quality must be emphasized to avoid production delays and late deliveries. © The McGraw-Hill Companies, Inc., 2002 Relationship Between JIT and Total Quality Management (TQM) Less warehouse space needed More rapid response to customer orders Reduced inventory carrying costs Reduced risk of obsolete inventory McGraw-Hill/Irwin Higher quality products Greater customer satisfaction © The McGraw-Hill Companies, Inc., 2002 JIT, Supplier Relationships, and Product Quality Successful implementation of a JIT system requires: A limited number of suppliers who will make on-time deliveries of quality materials. Quality that is “designed-in” and “manufactured-in” rather than “inspected-out”. A well-trained flexible work force. An efficient plant layout. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Measures of Efficiency in a JIT System ProductionS tarted Goods Shipped Process Time + Inspection Time + Storage and Waiting Time + Move Time Manufacturing Cycle Time Only the process time is value-added time. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Measures of Efficiency in a JIT System ProductionS tarted Goods Shipped Process Time + Inspection Time + Storage and Waiting Time + Move Time Manufacturing Cycle Time Manufacturing Efficiency = Ratio McGraw-Hill/Irwin Value-added time Manufacturing cycle time © The McGraw-Hill Companies, Inc., 2002 Measures of Efficiency in a JIT System If cycle time goes up, McGraw-Hill/Irwin costs may go up, and service and quality may go down. © The McGraw-Hill Companies, Inc., 2002 Total Quality Management and the Value Chain Let’s move to the last topic in the chapter. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Why is Quality Important? Quality products and services Increased business volume Greater customer satisfaction McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality Prevention costs Inspection of materials upon delivery Inspection of production process Equipment inspection Employee training Appraisal costs Finished goods inspection Field testing of products McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality Internal failure costs – defects discovered before delivery to customers Scrap materials Rework Reinspection of rework Lost sales resulting from late deliveries McGraw-Hill/Irwin Cost Report © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality External failure costs – defects discovered after delivery to customers Warranty repairs Product liability Marketing costs to improve product image Lost sales due to poor product quality McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality Cost of prevention and appraisal McGraw-Hill/Irwin Internal and external failure costs © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality Ultimate Objective: Cost of prevention and appraisal McGraw-Hill/Irwin Zero defects while minimizing all four quality cost categories. Internal and external failure costs © The McGraw-Hill Companies, Inc., 2002 Components of the Cost of Quality Cost of Quality External and Internal Failure Total Cost of Quality Direction of recent trend in industry. Prevention and Appraisal Low Quality McGraw-Hill/Irwin High Quality © The McGraw-Hill Companies, Inc., 2002 Measuring and Reporting the Cost of Quality Prevention Costs: Training Maintenance Quality planning Appraisal Costs: Material inspections Equipment inspections Supplier relations Testing Internal Failure Costs: Rework Downtime Scrap External Failure Costs Warranty Lost sales Repairs Total McGraw-Hill/Irwin Amount Total $ 12,000 10,000 8,000 $ 30,000 3.2% 6,000 2,000 4,000 5,000 17,000 1.8% 5,000 7,000 8,000 20,000 2.1% 31,000 $ 98,000 3.3% 10.4% 4,500 20,000 6,500 % of Sales © The McGraw-Hill Companies, Inc., 2002 Productivity and Quality Traditional managerial accounting systems may emphasize production quotas and cost minimization. Managers often find that emphasis on quality also increases productivity. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002 End of Chapter 18 I’m managing some quality time in a value-added activity. McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002