Part 1
Study Unit 4
Operational Efficiency and Business
Process Performance
Jim Clemons, CMA
Learning Objectives
• You need to be able to answer the following:
– Define Just-in-Time systems and describe its central
purpose.
– Identify and describe the operational benefits of
implementing a just-in-time system
– Defined the term Kanban and how Kanban is used in a justin-time system
– Demonstrate an understanding of how work cells and how
they relate to just-in-time processes
– Define material requirements planning (MRP)
– Identify and describe the benefits of an MRP system
– Calculate subunits needed to complete in order for a
finished product using MRP
Learning Objectives
• Calculate subunits needed to complete in order for a
finished product using MRP
• Explain the concept of outsourcing and identifying the
benefits and limitations of choosing this option
• Demonstrate a general understanding of the theory of
constraints
• Identify the five steps involved in a theory of constraints
analysis
• Define throughput costing (super variable costing) and
calculate inventory cost using throughput costing
• Define and calculate throughput contribution
• Discuss how the theory of constraints activity based costing
are complementary analytical tools
Learning Objectives
• Describe how capacity levels affect product
costing, capacity management, pricing
decisions, and financial statements.
• Explain how using practical capacity as a
denominator for fixed cost rate enhances
capacity management.
• Calculate the financial impact of implementing
the above mentioned methods
4.1 Just-In Time Inventory and Lean
Operation
• Many companies have traditionally built parts and components for
subsequent operation on a preset schedule. Such a schedule
provides a cushion of inventory so that the next operation will
always have parts to work with-they just in case method.
• Just-in-time Model (in contrast)
– Limits output to the demand of the subsequent operation.
– Reduction in inventory
•
•
•
•
Less money invested in idle assets
Less storage space
Less inventory taxes
Less pilferage
– Identify defects in parts due to limited supply
– QC is focuses on prevention of quality problems.
4.1 Just-In Time Inventory and Lean
Operation
• Just-in-time Model Objectives
– Higher productivity
– Reduced order costs / carrying costs
– Faster & cheaper setups
– Shorter manufacturing cycle times
– Improved quality
– Flexible processes
– Increased competitiveness and higher profits!
4.1 Just-In Time Inventory and Lean
Operation
• JIT originated from a Japanese philosophy that combines
purchasing, production, and inventory control. It is a reaction to the
trends of global competition and rapid technological progress that
have resulted in shorter product life-cycles in greater consumer
demand for product diversity.
• JIT strives to minimize inventory due to many of the inventoryrelated activities do not add value.
• Symptom of problems:
– Poor quality
– Long cycle times
– Lack of coordination
• JIT is a pull system
– Items are pulled through production by current demand, not pushed
by anticipated demand.
– Examples???
4.1 Just-In Time Inventory and Lean
Operation
• JIT allows for the elimination of certain
internal controls
– Frequent and smaller deliveries requires a less
sophisticated inventory control system.
– No need for a central warehouse. Delivery made
to production centers.
– Quality of parts is determined by the use of
statistics and not inspection of incoming parts.
– Storage, counting, and inspecting are eliminated.
Maximize value-added work.
4.1 Just-In Time Inventory and Lean
Operation
• High inventory levels can often create mass
production problems because the effective parts
can be overlooked when plenty of good parts are
available. If only enough parts are made for the
subsequent operation, however, any defects will
immediately halt production.
• The focus of quality control under JIT shifts from
the discovery of defective parts to the prevention
of quality problems, so zero machine breakdowns
and zero defects are ultimate goals.
• Lean operation is often used as a synonym for JIT.
4.1 Just-In Time Inventory and Lean
Operation
• Therefore JIT suppliers’dependability are crucial.
– Use of long-term and negotiated contracts.
– Continuous replenishment arrangements.
• Reliance on supplier’s forecasting
– Use of electronic data interchange (EDI)
• EDI allows for the supplier to access the buyer’s online
inventory management system.
• Frequent receipts of deliveries from suppliers often means
less need for sophisticated inventory control system and for
control personnel.
4.1 Just-In Time Inventory and Lean
Operation
• The quality of parts provided by suppliers is verified
by the use of statistical controls rather than
inspection of incoming goods. Storage, accounting,
and inspecting are eliminated an effort to perform
only value-adding work.
4.1 Just-In Time Inventory and Lean
Operation
• JIT and Kanban are often confused.
– JIT is a total system.
– Kanban is an element within the JIT system.
• Kanban = ticket
• Tickets control the flow of production or parts
so that they are produced or obtained in the
needed amounts at the needed times.
• Withdrawal kanban – Qty that a later process
should withdraw from its predecessor
4.1 Just-In Time Inventory and Lean
Operation
• Production kanban – States the output of the
preceding process
• Vendor kanban – Tells a vendor what, how
much, where and when to deliver.
• US companies have integrated their existing
computer systems with the JIT systems.
4.1 Just-In Time Inventory and Lean
Operation
• Factories are reorganized to permit lean production.
• JIT lean production plant layouts arranged by manufacturing
cells and not by department.
• Workers in each cell must be able to multitask, or may be
idle.
• Support departments are reduced thereby saving space and
allowing for smaller and leaner factories.
• Manufacturing cycle time and setup time are also reduced.
Flexible!
• Team based. Employees are empowered.
• Objectives of continuous improvement and zero defects.
Question 1
Companies that adopt just-in-time purchasing systems often experience
A
A reduction in the number of
suppliers.
B
Fewer deliveries from suppliers.
C
A greater need for inspection of
goods as the goods arrive.
D
Less need for linkage with a vendor’s
computerized order entry system.
Question 1 Answer
Correct Answer: A
The objective of JIT is to reduce carrying costs by
eliminating inventories and increasing the deliveries
made by suppliers. Ideally, shipments of raw materials are
received just in time to be incorporated into the
manufacturing process. The focus of quality control under
JIT is the prevention of quality problems. Quality control
is shifted to the supplier. JIT companies typically do not
inspect incoming goods; the assumption is that receipts
are of perfect quality. Suppliers are limited to those who
guarantee perfect quality and prompt delivery.
Question 2
In Belk Co.’s just-in-time production system, costs per setup were reduced from $28
to $2. In the process of reducing inventory levels, Belk found that there were fixed
facility and administrative costs that previously had not been included in the carrying
cost calculation. The result was an increase from $8 to $32 per unit per year. What
were the effects of these changes on Belk’s economic lot size and relevant costs?
Lot Size
Relevant Costs
Decrease
Increase
Increase
Decrease
Increase
Increase
Decrease
Decrease
A
B
C
D
Question 2 Answer
Correct Answer: D
The economic lot size for a production system is
similar to the EOQ. For example, the cost per set-up
is equivalent to the cost per order (a numerator
value in the EOQ model). Hence, a reduction in the
setup costs reduces the economic lot size as well as
the relevant costs. The fixed facility and
administrative costs, however, are not relevant. The
basic EOQ model includes variable costs only.
4.2 Material Requirements Planning and
Outsourcing
• Short-range plans must be converted into specific
production targets for finished goods.
• Raw material deliveries carefully planned.
• Master Production Schedule (MPS)
• Develops specific dates for completion and availability
based on the numbers of finished goods called for in
demand forecasts.
• Materials Requirements Planning (MRP)
• Coordinates both the manufacture of component parts for
finished goods and the arrival of raw materials.
• Combines production scheduling and inventory control.
• Right part, right quantity, right time.
4.2 Material Requirements Planning and
Outsourcing
• MRP is a Push System
• Demand for raw materials is driven by the
forecasted demand for the final product.
• Computer Program
• MRP system utilizes bill of materials (BOM), which
and how many subassemblies go into the finished
product.
4.2 Material Requirements Planning and
Outsourcing
• Example on Page 138
4.2 Material Requirements Planning and
Outsourcing
• MRP creates schedules identifying when
inventory items will be needed in the production
departments.
– Purchase orders are automatically generated based on
inventory levels.
– Timing of deliveries is vital.
• MRP benefits
–
–
–
–
Reduced idle time
Lower setup costs
Lower inventory carrying costs
Increased flexibility
4.2 Material Requirements Planning and
Outsourcing
• Manufacturing Resource Planning (MRP II)
• Closed-loop manufacturing system that integrates
all facets of production, sales, inventories,
schedules, and cash flows.
– The same system is used for both the financial
reporting managing operations (both use the same
transactions and numbers).
– Because manufacturing resource planning
encompasses materials requirements planning, MRP is
a component of an MRP II system.
4.2 Material Requirements Planning and
Outsourcing
• Outsourcing
– Management / execution of day-to-day operations by a 3rd
party.
– Allows focus on core competency and have less concern on
marginal activities.
• Business Process Outsourcing
– Back office and front office functions.
• Insourcing
– Transfer of an outsourced function to an internal
department.
• Cosourcing
– Internal and external resources.
4.2 Material Requirements Planning and
Outsourcing
• Outsourcing Advantages
– Reliable service
– Reduced costs
– Technological access
– Leverage experts
• Outsourcing Disadvantages
– Dependence on outsiders
– Loss of control
– Costs
4.2 Material Requirements Planning and
Outsourcing
• Outsourcing Advantages
– Reliable service
– Reduced costs
– Technological access
– Leverage experts
• Outsourcing Disadvantages
– Dependence on outsiders
– Loss of control
– Costs
Question 1
In contrast to just-in-time manufacturing, materials requirements planning is
a
A
Push system.
B
Pull system.
C
Automated system.
D
Manual system.
Question 1 Answer
Correct Answer: A
MRP is a push system, that is, the demand for raw
materials is driven by the forecasted demand for
the final product, which can be programmed into
the computer. This is in contrast with just-in-time
manufacturing, which is a pull system, meaning
items are pulled through production by current
demand, not pushed through by anticipated
demand.
Question 2
aterials requirements planning (MRP) sometimes results in
A
Longer idle periods.
B
Less flexibility in responding to
customers.
C
Increased inventory carrying costs.
D
Decreased setup costs.
Question 2 Answer
Correct Answer: D
Among the benefits of MRP are reduced idle time, lower setup costs, lower
inventory carrying costs, and increased flexibility in responding to market
changes.
4.3 Theory of Constraints and Throughput
Costing
The theory of constraints developed in 1948, as a system to improve human thinking
about problems. It has been greatly extended to include manufacturing operations.
The basic premise of TOC as applied to the business is that improving any process is
best done not by trying to maximize efficiency in every part of the process, but by
focusing on the slowest part of the process, call the constraint.
1.
2.
3.
4.
Identify the Constraint. Bottleneck operation is where the work-in-process backs
up the most. Determine which phase has slack time – phase w/o enough
resources to keep up with input.
Determine most Profitable Product mix given the constraint. Max contribution
margin through the constraint – Throughput margin. Throughput costing (aka
Supervariable costing) uses only direct materials costs. Throughput margin =
Sales – Direct Materials
Maximize the flow through the constraint.
Increase capacity at the constraint. Redesign the manufacturing process for
greater flexibility and speed.
4.3 Theory of Constraints and Throughput
Costing
• See Example on p. 140 – 141
• Most profitable use of bottleneck operation –
calculate throughput margin per unit of time
spent in the constraint.
– Profit maximized when bottleneck is busy with the
product that has the highest throughput margin
per unit of time.
4.3 Theory of Constraints and
Throughput Costing
Increase Capacity at the Constraint
• While making the best use of the bottleneck is
encouraged in the short-run, the next best step
would be to increase the bottleneck’s capacity.
Redesign the Process
• Gain greater flexibility and speed.
• Long-term solution is to redesign the process
• Value engineering – balances product cost and the
needs of potential customers
4.3 Theory of Constraints and
Throughput Costing
Extended Example p. 142
• TOC Analysis complements activity-based
costing – focus on different aspects of
improvement process
– TOC is short-term
– ABC is long-term
Questions?
Question 1
Below are data concerning the hours spent by a
manufacturer’s two products in its two processes.
Assembly
Painting
Product A
21
14
Product B
32
8
The constraint is
A
Product A.
B
Product B in Assembly.
C
The assembly activity.
D
Cannot be determined
from the information
given.
Question 1 Answer
Correct Answer: C
In theory of constraints (TOC) analysis, the
constraint (bottleneck) operation is the slowest
part of the process. It can usually be identified
as the one where work-in-process backs up the
most. Of this manufacturer’s two operations,
the one that requires the most total time is
assembly.
Question 2
In a theory of constraints (TOC) analysis, the bottleneck operation (the constraint)
corresponds to which part of the drum-buffer-rope model?
A
Drum.
B
Buffer.
C
Rope.
D
No part of TOC analysis corresponds to
the drum-buffer-rope model.
Question 2 Answer
Correct Answer: A
Production flow through a constraint is managed using the drum-buffer-rope
(DBR) system. The drum (i.e., the beat to which a production process
marches) is the bottleneck operation. The constraint sets the pace for the
entire process. The buffer is a minimal amount of work-in-process input to
the drum that is maintained to ensure that it is always in operation. The rope
is the sequence of activities preceding and including the bottleneck operation
that must be coordinated to avoid inventory buildup.
4.4 Capacity Planning
• Strategic planning that is closely related to
capital budgeting.
• IMA Statement on Management Account
Measuring the Cost of Capacity state that:
• Maximizing the value created within an
organization starts with understanding the
nature of capabilities of all the company’s
resources.
4.4 Capacity Planning
• Strategic planning that is closely related to
capital budgeting.
• IMA Statement on Management Account
Measuring the Cost of Capacity state that:
• Maximizing the value created within an
organization starts with understanding the
nature of capabilities of all the company’s
resources.
Effective capacity cost management
requirements:
• Short run – optimize capital investments
– ROIC, IRR and NPV analysis
• Maximize the value delivered to customers
– Value chain analysis
• Minimize requirements for future investments
• Match firm’s resources with current and
future market opportunities.
– Utilization rates – redeploy assets
• Eliminate waste –
• Must provide useful costing information on
current process costs (current state) versus the
proposed future costs (future state) of an
investment.
• Capacity usage measurements – Key performance
indicators.
• Identify capacity requirements to meet strategic
and operational objectives.
• Detail opportunity cost.
• Provide pre-decision information and analysis on
the project and the cost of the project.
• Create a common language and understanding of
capacity cost management.
• This is the heart of Lean/Six Sigma.
Capacity planning and capital
budgeting
• Planning capacity levels allows for informed
decisions on expansion or disposal.
• Capacity costs drive product cost and price.
• According to Michael E. Porter:
– The decision to expand capacity is a major strategic
decision.
– Key forecasting problems are long-term demand and
the behavior of competitors.
• Capacity expansion is also referred to as market
penetration.
• If your product is profitable, under-capacity is
a short term problem. Investors will provide
funds or competition enter the market.
• Overcapacity is a problem. Price wars drive
down margins. Capacity is hard to reverse.
• Porter’s model for expansion:
– 1) Identify your options, 2) Forecast demand, 3)
Analyze the competition, 4) Predict total industry
capacity and company share (Share of Wallet) and
5) Test for inconsistencies.
Question 1
What is the key strategic issue when a firm is considering capacity expansion?
A
Forecasting long-term demand.
B
Analyzing the behavior of
competitors.
C
Identifying options.
D
Avoiding industry overcapacity.
Question 1 Answer
Correct Answer: D
Whether to expand capacity is a major strategic decision
because of the capital required, the difficulty of forming
accurate expectations, and the long time frame of the
lead times and the commitment. The key forecasting
problems are long-term demand and behavior of
competitors. The key strategic issue is avoidance of
industry overcapacity. Undercapacity in a profitable
industry tends to be a short-term issue. Profits ordinarily
lure additional investors. Overcapacity tends to be a longterm problem because firms are more likely to compete
intensely rather than reverse their expansion.
Question 2
Capacity expansion is also referred to as
A
Market penetration.
B
Market development.
C
Product development.
D
Diversification.
Question 2 Answer
Correct Answer: A
Market penetration is growth of existing
products or development of existing markets. It
occurs in mature firms within an industry.
Value Chain Analysis
To remain on the market, a product must provide value
to the customer and a profit to the seller.
Customers assign value to a product.
Producers can affect the customer’s perception of value
Differentiation & lowering price
Value
Price
Costs
Consumer surplus
Profit margin
All costs
The Value Chain
• It is a model for depicting the way in which every
function in a company adds value to a final product.
• IMA’s statement on the value chain
– “The value chain approach for assessing
competitive advantage is an integral part of the
strategic planning process.”
• The value chain is the firms overall valuecreating process.
• Primary activities deal with the product.
– R&D, manufacturing, shipping….
• Support activities aid primary activities.
– HR, IT, inventory management, accounting
Value Chain Analysis
The Supply Chain
Supply Chain
• Is the flow of materials and services from their
original sources to final customers.
• Involves more than one firm.
• To improve performance and reduce cost you
must analyze every step of the supply chain.
– insourcing versus outsourcing
– Vendors must be business partners
• Sharing information reduces inventory at
every step of the supply chain.
Value Engineering
• A systematic approach to assessing all aspects of
the value chain costs for a product in order to
target a specific cost for the product.
• Emphasizes controlling costs in design phase
• Cost incurrence is the use of resources
• Locked-in costs (designed in costs)
• Life-cycle costing – highlight upstream and
downstream costs that are often overlooked.
• Minimize costs without sacrificing customer
satisfaction.
Process Analysis
• Links internal processes to overall strategy
• Many types of processes
• Continuous, batch, Hybrid, Make-to-stock, Maketo –order.
• Degree of interdependence – “tightness”
• Tight process – JIT Loose process – Large WIP
• The process bottleneck is the slowest part of
the process. Only an issue when plant is at
full capacity.
Process Value Analysis
• Is the comprehensive understanding of how an
organization creates its product.
• Looks at the value adding and non-value adding
steps and looks for ways to reduce or eliminate
the non-value adding activities.
• ABM links product cost and continuous process
improvement to increase stockholder’ value.
• Kaizen is a Japanese word for continuous pursuit
of improvement in every aspect of operations.
• Activity analysis - Eliminate waste add value.
Business Process Reengineering (BPR)
• Is a complete rethinking of how business
functions are performed to provide value to
customers.
– Radical innovations not continuous
improvements.
– Current process and people are disregarded.
– Employees must be fully engaged in new process.
– Emphasis on monitoring internal controls.
– Monitoring may be separate, periodic or ongoing.
Benchmarking
• Is a means of helping companies with
productivity management and business
process reengineering.
• Best-in-class comparison
• The key is to build quantitative and qualitative
measurements and compare them to other
companies that are considered to be the best.
• The differences are compared at the root
cause and key action level and changes are
made.
Steps of Benchmarking
• Select and prioritize projects
– Identify key processes and drivers
– How does it relate to the company’s mission,
values and strategy.
– End goal – Customer satisfaction
• Select team
– C suite champion – Must have executive buy in.
– Cross functional team
– Team members must have knowledge of processes
Steps of Benchmarking
• Investigate and document internal process.
– Walk the process
– Understand process taxonomy (Arrangement method)
• Research and identify best-in-class performance
– Set up a database
– Choosing information sources
– Selecting partners
• Data analysis – understand the gaps
• Implementation – Leadership is key.
Balanced Scorecard
• A goal congruence tool to review performance
and ensure all objectives are being met.
• Typical Measurements
–
–
–
–
Financial
Customer
Learning, growth, and innovation
Internal business process
•
May be financial / non financial, internal / external and
short term / long term
• Best practice tie in
Cost of Quality
• Conformance costs
– Prevention
• Attempts to avoid defective output.
• PM, employee training, review of equipment design,
supplier evaluations
– Appraisal
• Statistical quality control programs
• Inspection
• Testing
• Nonconformance costs
– Internal failure
• Costs are detected before shipment
• Scrap, rework, tooling changes, downtime, redesign, lost
output, re-inspection, retesting, expediting of operations
after delays, lost learning opportunities, and searching for
and correcting problems.
– External failure
• Costs are detected after shipment
• Customer service complaints, rejection, return, repair or
recalls, warranty obligations, products liability claims, loss of
customers.
– Environmental costs – fines from regulators, lawyer fees, loss of
customer goodwill
– ISO 14000 Environmental auditing and performance evaluations.