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Copyright  2001 McGraw-Hill Ryerson
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Student Centre Cost Management
Strategies for Business Decisions
First Canadian Edition, Hilton/Maher/Selto/Sainty

Student Centre

Chapter 11: Managing Quality and Time to Create Value

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    Chapter Outlines

    1. Cost Management Challenges. Chapter 11 presents three challenges.

      1. What can cost managers provide to better manage quality?

      2. Is there a conflict between meeting quality and time goals, or do these goals reinforce each other?

      3. How should cost managers choose among all the available quality and time management tools?

    2. Learning Objectives – This chapter has 4 learning objectives.

      1. It teaches how to evaluate similarities and differences of total quality management and return on quality approaches to managing quality.

      2. The chapter demonstrates how to measure and analyze dimensions of quality with commonly used diagrams, charts and reports.

      3. Chapter 11 aids in one's understanding of the importance of managing process time.

      4. It demonstrates how just-in-time methods create benefits by combining management of quality and time.

    3. Quality is an important quality for organizations to offer to its customers. Poor quality results in lost customers, and high quality attracts new customers and assures that existing customers will remain loyal. Improving quality translates into improved customer satisfaction. In a globally competitive market, improving quality is a high priority for organizations.

    4. Quality at any cost, or quality up to a cost-defining limit? There are two views on what the ideal level of quality is.

      1. Total Quality Management (TQM) promotes the view that perfect quality is never achieved, and that organizations must constantly seek improved quality. TQM advocates argue that customers will seek the highest quality, and are willing to pay a premium for the highest quality.

        1. TQM is a concept attributed to W. Edwards Deming.

        2. TQM advocates believe that improving quality pays for itself by creating higher profits.

      2. Return on quality (ROQ) is a more pragmatic view of quality. This view of quality assumes that there is a trade-off between the costs and benefits of improving quality. The optimum quality level of products and services maximizes profits rather than maximizing quality.

      3. TQM has a goal of "total delight" for customers. This means that the customer's expectations are exceeded. With total delight there are zero defects. ROQ seeks an optimum quality level. This level of quality is almost always lower than total delight. TQM assumes that the amount of profit is highest when quality is at its peak. ROQ assumes that the amount of profit is highest when quality is at some optimal level, usually lower than maximum quality. Beyond that optimal level, the cost of improving quality exceeds the amount of additional profit that can be earned from increasing prices.

      4. The ROQ view has been the traditional view of quality, but the TQM view emerged in the 1980s when quality became a competitive advantage of companies in global markets.

      5. The theoretical definitions of TQM and ROQ conflict with each other. In practice, organizations try to use ideas generated from both philosophies.

    5. There are two dimensions of quality that organizations need to be concerned about. They are product or service attributes and customer service before and after the sale.

      1. Product and service attributes are described as the tangible and intangible features. Tangible features include performance, adherence to specifications, and functionality. Intangible features include reputation, taste, appearance, style and appeal.

      2. Customer service before and after the sale influences whether purchasers of products will become new customers and remain as repeat customers. Customer service features include provision of pre-sale information, proper treatment of customers by salespeople, on-time delivery, follow up with customers, timeliness and accuracy of resolution of questions and complaints, and warranty and repair services.

      3. How do organizations measure quality? This question can be answered in many ways. To ensure that an organization is meeting expectations on the two dimensions of quality (product attributes and customer service), the organization should use measures that are lead indicators of customers' expectations for product quality. The organization should then measure customers' satisfaction with the products or services they have purchased.

        1. Lead indicators of quality can be used to evaluate tangible features of products, such as physical dimensions and functional performance before they reach customers. It is more difficult to measure tangible features of services because the service is not complete until the customer receives it. Service organizations must focus their attention on evaluating the capabilities of personnel and technology that will provide the service. Measurement of the intangible features of products and services are even harder to measure since the value of intangible features differs from customer to customer. Measures of intangible features may be obtained by customer surveys or other methods. Evaluating some features, like quality of service received from salespeople, customer service staff, or on-time delivery must be obtained after the customer has had contact with the organization.

          1. A primary source of poor quality is variation in process outcomes. Variability provides a greater chance for product and service attributes to disappoint customers. A bakery, for instance, does not want to undercook a pie (the crust will not be brown). It would also not want to overcook a pie (it will be burnt). Three tools to use for measuring lead indicators are histograms, run charts, and control charts.

          2. A histogram is a chart that displays the frequency distribution of an attribute's measures, showing its range and the degree of concentration around an average attribute value. The wider the range, the greater the variation, and the higher the chances that a customer will receive poor quality products or services.

          3. A run chart shows trends in variation in product or service attributes over time. It reflects measures of quality features taken at defined points in time. Run charts are especially useful after some process change has been made, because it shows whether the change has improved product or service quality.

          A control chart shows variation in product or service attributes over time, just as a run chart does. However, it goes further by including maximum and minimum desired levels. In this way, variations outside the acceptable range can be quickly and easily identified.

        2. Although lead indicator information identifies potential quality problems, it usually does not diagnose the cause of the problem. The next step, then, is to diagnose the problem. This can be accomplished by using cause-and-effect diagrams, scatter diagrams, flow charts, and Pareto diagrams.

          1. Cause-and-effect diagrams take the information related to potential causes of product or service defects, and then identifies the causes that may contribute to the problem. The cause-and-effect diagram splits probable causes into five distinct sources.

            1. Human resources (human error)
            2. Physical resources (insufficient capacity)
            3. Procedures (inadequate, improper procedures)
            4. Information technology (information not available, incorrect)
            5. Communication (failure to communicate)
            Using the simple example of baking times for pies, if a large bakery finds that too many pies are overcooked, it should ask "why" questions that can be answered in the context of these five different potential causes of the effect (the effect being poor quality).

          2. Scatter diagrams consist of a plot of two measures that may be related. These diagrams are used to diagnose cause and effect between outcomes and activities that may drive them. Scatter diagrams are useful for determining whether a suspected cause of a quality problem is really the true cause. The frequency of the suspected cause of the problem is paired with the quality attribute being evaluated. If the suspected cause is truly the reason for a quality problem, the scatter diagram will show a pattern that looks like an upward or downward line. If the suspected cause is not the true reason for a quality problem, the scatter diagram will not reflect any discernible pattern.
            ___One problem with using a scatter diagram is that it requires that the organization have reliable data on both the quality measures and the suspected causes.

          3. A flowchart can sometimes be used to show the cause-and-effect linkages among process activities. This can help to pinpoint where quality problems arise. Flowcharting the ideal process, and then flowcharting the actual process may also pinpoint where the quality problems emerge in the process.

          4. A Pareto chart (named after an Italian economist) prioritizes the causes of problems or defects as bars of varying heights, in order of frequency or size. Pareto charts help analysis teams to focus on the causes that may offer the greatest potential for improvement.

        3. Customer satisfaction is the degree to which expectations of attributes, customer service, and price have been or are expected to be met. In addition to measuring lead indicators of tangible and intangible product and service features, as described above, organizations should also try to measure customer satisfaction. Measures of customer satisfaction may be used as both lead indicators of future sales and as diagnostic tools to discover causes of unexpectedly low or high sales. The most common method of measuring customer satisfaction is customer surveys. Focus groups may also be used. Some organizations use phantom shoppers, who are actually employees sent out as customers, to see how regular customers are treated.

      4. Customers seeking high quality products understand that they must pay a higher price for higher quality. Customers may be willing to pay a higher price for a product or service if it clearly has higher quality than comparable products offered at the same price. Managers of organizations also understand the need to offer high quality products, but realize that increased quality comes at a cost. Managers must, therefore, balance the desire for high quality against the cost of that quality. This results in a quality/price trade-off. An important part of keeping the balance at the correct level is based on the ability to identify the costs of quality.

        1. Cost of quality (COQ) is the cost of activities to control quality. It is also the cost of activities to correct failure to control quality. Costs of controlling quality are associated with lead indicators of imminent quality problems. Costs of correcting failures may be lead indicators of future decreased sales. Organizations usually prefer to devote most of their costs of quality on activities intended to control quality rather than correcting quality failures.

        2. Controlling quality requires that two activities take place. One is prevention. The other is appraisal, or detection.

          1. Prevention activities seek to prevent defects in products or services being produced. Prevention activities may include certifying suppliers, designing products to be manufactured defect-free, quality training, quality evaluations, and process improvement. TQM advocates argue that prevention activities are the most efficient use of resource use in the area of quality. ROQ advocates argue that preventing defects is effective, but suggest that preventing all defects may be prohibitively expensive. The ROQ philosophy does not prevent all quality problems before they occur. It attempts to detect them in ways that TQM advocates view as non-value-added activities. ROQ advocates also recognize that costs of quality beyond prevention costs are non-value-added costs. However, their view is that prevention costs may be too high to justify, and they opt instead to incur non-value-added costs.

          2. Appraisal activities, also called detection or inspection activities, require that inputs be inspected or that outputs (units of product) be inspected in order to detect whether they conform to specifications or customer expectations. Appraisal activities include inspecting materials, inspecting machines, inspecting processes, automated inspection, statistical process control, testing at the end of a process, and field testing (at a customer site).

        3. Failing to control quality leads to two types of failure. One type is internal failure, while the other type is external failure.

          1. Internal failure activities are required to correct defective processes or products and services, which are detected before being delivered to customers. Internal failure activities include disposing of scrap caused by defective products, rework to correct defects, re-inspecting or re-testing, and delays in processes. Internal failure can be very expensive. It is obviously a non-value-added activity, particularly when bottlenecks are affected (worsened) by defects.

          2. External failure activities are required when defective products or services are detected after customers have received them. These activities include warranty repairs, settling product liability claims, resolving customer complaints, restoring reputations, and lost sales. External failure activities are the most costly of all failure costs because they may permanently damage the reputation of an organization. This type of failure affects future sales, but this effect is difficult to quantify.

        4. Organizations must effectively measure costs of quality in order to manage them. Organizations using ABC and ABM have the activity-based information needed to compile cost of quality information. With ABC information, cost managers can take the additional step of classifying activities based on cost of quality category. Those organizations without ABC in place may find it expensive or time-consuming to develop the kinds of cost information to properly identify costs of quality.

        5. Reporting costs of quality may occur in a variety of forms. A cost of quality report always, however, will split the costs into the four categories – prevention, appraisal, internal failure, and external failure. Typically, the reports then provide more detail on the actual type of activity (inspection of materials, rework of defective product), the cost of the activity, and the cost as a percentage of sales. Reporting costs of quality as a percentage of sales places emphasis on the fact that profits are consumed by costs of quality just like any other type of cost consumes profits. Organizations may set benchmarks for costs of quality, for instance setting a ceiling on COQ of 5% of sales revenue.

      5. Quality has become so important to success that there are now international awards given to companies for the quality of their product, services, or processes. The Quality Award, created in 1983, recognizes Canadian firms that have outstanding achievements in quality. The Deming Prize is a Japanese award for companies around the world that excel in quality improvement. The International Organization for Standardization is a European organization best known for its development of international standards for quality management called ISO 9000. ISO 9000 is a set of global guidelines for the design, development, production, final inspection and testing, installation, and servicing of products, processes and services. To be certified, a company must document its quality systems and pass a rigorous third-party audit of its manufacturing and customer service processes.

      6. In addition to having to address the need to manage quality and control costs of quality, cost managers must be conscious of the need to manage time. There are three specific areas of concern with respect to time. They are new product and service development time, customer response time, and cycle time.

        1. New product and service development time is the period between the first consideration of a product and its initial sale to the customer. Businesses that respond quickly to demand for new products and services may develop a competitive advantage over competitors. The shorter the product development time is, the more likely it is that an organization will be the first to offer the new product.

        2. Customer response time is another important time dimension that organizations need to properly manage. Customer response time is the amount of time between a customer's placing an order or requesting service and the delivery of the product or service to the customer. The shorter the response time, the more competitive the company is on this dimension. Organizations work to reduce customer response time by automating ordering activities, scheduling bottleneck resources carefully, and by keeping reserve capacity for unexpected but valuable orders. When necessary, companies may use expedited services. If orders are placed before products are produced, the customer response time may be reduced by eliminating non-value-added activities in production processes. This reduces the cycle time.

        3. Since timeliness is so important in a competitive environment, organizations have come to recognize that longer process times mean more than higher production costs. They may also cause lost sales or opportunities. To motivate efficiency in cycle times, some organizations reward employees based on their ability to meet or exceed targeted cycle times.

      7. Just-in-Time (JIT) is a process that requires that products be made and delivered just when they are needed. Organizations that use JIT expect to reduce or eliminate inventory carrying costs, which are costs of receiving, handling, storing, and insuring inventory. Obsolescence of inventory is another cost of having inventory on hand. Since JIT precludes stocking inventory in anticipation of sales, and materials are not ordered and stockpiled, a JIT operation requires high-quality processes. Defective products are incompatible with JIT since there is no product on hand in reserve just in case defective products are made, and have to be replaced for pending customer orders. Defects in a JIT organization trigger an investigation of processes to eliminate their causes.

        1. JIT manufacturing makes it necessary to minimize inventory, shorten cycle times, and eliminate defects. To a customer, inventory on hand represents a non-value-added cost. Costs of rework, or other cost-causing, non-value-added activities are also undesirable in the eyes of the customer. JIT manufacturing is a radical departure from traditional manufacturing. Both approaches are described below.

          1. Traditional manufacturing is referred to as "push" manufacturing because production is "pushed" through the production and sales processes based on forecasted sales orders. The sequence of events for a traditional manufacturing shop would be to forecast sales in advance of production; order all parts and other necessary inputs; prepare a production schedule in anticipation of production needs, and finally, when a customer order is received, sell it from finished goods inventory, or place the order on backorder to be filled as soon as the production schedule allows it.

            1. This traditional manufacturing approach has some drawbacks. First, it is driven by sales forecasts, which may be inaccurate. If the forecast is too optimistic, the company will overproduce, which results in unsold inventories and could result in obsolete product. If sales are higher than anticipated, there will not be enough product, resulting in the need to backorder sales, which increases the customer response time. Sales could be lost if customers can buy products from competitors. An alternative to backordering is to expedite production, which usually leads to overtime costs for employees and increases the costs of obtaining resources because their delivery must be rushed (at higher cost). A second drawback to traditional manufacturing is that it does not allow the organization to arrange production activities around the bottleneck production activities. This can result in a wasteful and costly build-up of incomplete inventories.

          2. JIT manufacturing is referred to as "pull" manufacturing. JIT production is pulled through the production and sales process by actual customer orders instead of forecasted orders. The sequence of events for a JIT manufacturer is as follows. First, a customer places an order. The sales order triggers a production order. Then, the production order triggers the acquisition of materials and other resources needed to fill the order. Finally, the customer receives the product on the promised delivery date.

            1. JIT has some drawbacks too. The main drawback is that any defect or obstacle in the production process may cause the entire production process to shut down, and there is no inventory in reserve to replace the item being manufactured "just in case" something goes wrong. JIT manufacturers try to avoid this problem by being certain that the production process does not have any flaws in it. Some companies that are JIT maintain minimal levels of inventory on hand just in case something goes wrong.

          3. Cost managers can play a key role by measuring the costs of excess inventories and costs of quality that are encouraged by traditional push production methods. Revealing the cost inefficiencies caused by traditional manufacturing may induce companies to consider adopting a JIT approach.

        2. There are several advantages offered by the use of JIT manufacturing. Six success factors are linked in such a way that failure to include any one threatens the likelihood of the success of JIT at an organization.

          1. JIT mandates that the organization maintain a strong commitment to quality. Defects cause delays, and require buffer inventories. If defects occur, the sooner an employee can detect and correct the problem, the less time is lost.

          2. Capacity must be flexible, and set-up times must be short. As much as possible, JIT manufacturers of mass-produced products should seek long-term purchase agreements.

          3. Suppliers must be reliable. In order for JIT manufacturers to complete production on time, they must be sure that suppliers can provide needed inputs on time. JIT manufacturers typically require that suppliers meet a stringent set of tests, and the number of suppliers may be reduced so that the quality and scheduling of inputs can be better managed.

          4. Production flow must be smooth. Unbalanced production leads to delays at bottlenecks, and makes it necessary to have buffer inventories.

          5. A well-trained, motivated, flexible workforce is critical. Workers need to be cross-trained so that they can work on production areas as needed.

          6. Cycle and customer response times must be minimized.

        3. Even if JIT is not adopted, organizations can benefit from adopting some of these success factors because they make any production environment more efficient.


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