Lecture 11 Chapter 16

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Lecture 11Chapter 16

• Managing suppliers, customers and quality

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Outline

• Describe how e-commerce technologies and
  enterprise resource planning (ERP) systems can be
  used to enhance supply chain management.
• Understand the value of creating close
  relationships with suppliers, and use
  activity-based techniques to analyse supplier
  costs.

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Outline continued

• Understand how supplier relationships can be
  evaluated from both the suppliers and the firms
  perspective.
• Use the EOQ formula to calculate the ordering
  cost and carrying costs, and to determine the
  optimum order quantity and reorder point for
  inventory items.

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Outline continued

• Understand the philosophy underlying JIT systems
  as well as their key features.
• Explain how customer relationship management can
  be used to create long-term relationships with
  customers.
• Use activity-based methods to undertake customer
  profitability analysis.

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Outline continued

• Measure customer performance and understand the
  relationship between various customer performance
  measures.
• Define quality and explain how it can be
  measured.
• Describe the four types of quality costs and
  prepare and interpret cost of quality reports.

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Outline continued

• Describe the key features of a total quality
  management system.
• Explain the concept of quality accreditation.
• Appendix not required for ACC2IMB.

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Supply-chain management

• Processes of streamlining the supply chain by
  managing costs, accelerating time-to-market of
  new products, and creating close relationships
  with supplier and customers
• May include the adoption of e-commerce
  technologies and cost management techniques

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Analysing supplier costs

• Activity-based costing can be used to estimate
  the costs of dealing with suppliers
• Costs associated with dealing with a particular
  supplier, other than the cost of purchased
  material and components
• Costs of purchasing - ordering, receiving and
  inspection
• Costs of holding inventory
• Costs of poor quality
• Costs of delivery failure

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Managing suppliers

• Evaluating supplier performance
• Supplier performance index the ratio of supplier
  costs to total purchase price
• Measures may include ability to supply at the
  contact price, material quality, supplier
  delivery performance, quality of relationships
  between employees, union and management
• Measure may also focus on the purchasing firms
  performance within the relationship

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The importance of inventory management

• Why hold inventory?
• Cope with uncertainties in customer demand and in
  production processes
• Qualify for quantity discounts
• Avoid future price increases in raw materials
• Avoid the costs of placing numerous small orders
  with suppliers

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Conventional approaches to inventory management

• Focused on balancing
• ordering costs
• the incremental costs of placing an order for
  inventory
• carrying costs
• the costs of carrying inventory in stock
• shortage costs (or out of stock costs)

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Economic order quantity (EOQ)

• The optimum order size for individual inventory
  items, to minimise the total ordering and
  carrying costs

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Exhibit 16.6 Economic Order Quantity
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Timing of orders under EOQ

• Inventory reorder point (ROP)
• the level of inventory on hand that triggers the
  placement of a new order (or setup)
• ROP
• inventory used per period of time x order lead
  time

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Timing of orders under EOQ

• Inventory reorder point (ROP) including safety
  stock
• safety stock
• the extra inventory kept on hand to cover any
  above-average usage or demand
• ROP (inventory used per period of time x order
  lead time) Safety Stock

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Exhibit 16.7 Ordering, lead time and usage of
inventory item
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Assumptions underlying EOQ

• Demand is known and constant
• Incremental ordering costs are known, constant
  per order
• Acquisition cost per unit is constant
• Entire order is delivered at one time
• Carrying costs are known, constant per unit
• On average, one-half of order is in stock at any
  time

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Just-in-time (JIT) inventory management

• JIT inventory and production system is
• a comprehensive system for controlling the flow
  of manufacturing in a multistage production
  environment
• An underlying philosophy of simplifying the
  production process by removing non-value-added
  activities

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Just-in-Time Inventory and Production Management

• No materials are purchased and no products are
  manufactured until they are needed.

The primary goal of a JIT production system is to
reduce or eliminate inventories at every stage of
production.
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Key Features of the JIT Approach
Smooth, uniform production rate
Pull method of production
Purchase in small lot sizes
Quick, inexpensive setups
High quality of materials
Effective preventive maintenance
Teamwork
Multiskilled workers.
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JIT Purchasing
Long-term contracts with suppliers.
Only a few suppliers.
Grouped payments to vendor.
Parts delivered in small lots.
Minimal inspection of materials.
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Costs of JIT

• Substantial investment to change the production
  to minimise non-value-added activities
• An increase in the risk of inventory shortages
  and the associated loss of production, expediting
  materials costs and loss of sales

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Benefits of JIT

• Savings in inventory-carrying costs
• Lower insurance costs
• Fewer losses due to spoilage, obsolescence and
  theft
• No opportunity costs of high inventory
• Elimination of non-value-added activities
• Meets customers needs more effectively

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JIT and backflush costing(Appendix)

• Backflush costing
• a simplified method of product costing under JIT
• no raw material or WIP inventory account
• raw material charged to raw and in process
  inventory (RIP) account used
• conversion costs charged to finished goods
  inventory

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Costs and benefits of backflush costing (Appendix)

• Benefits of backflush costing
• simpler and less expensive than conventional
  costing
• Costs of backflush costing are
• provides much less detail than conventional
  costing
• Is the loss of detail overcome by cost savings?

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Role of the management accountant in managing
inventory

• MPR may maintain inventory master files and
  bills of material for all products
• JIT
• co-ordinate the flow of information to eliminate
  non-value activities
• provide reports to appropriate levels of
  management

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Managing customers

• Customer relationship management (CRM)
• Collecting and analysing data to understand
  individual customers behaviour patterns and
  needs
• To develop strong relationships with customers
• Can lead to improved customer service, customer
  retention, new customers, more effective and
  efficient marketing, increased sales and
  customer profitability

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Customer cost analysis

• Activity-based costing can be used to determine
  the profitability of customers
• Customer cost analysis assigning the costs of
  product and customer-driven activities to
  customers
• Customer profitability analysis
• Relative profitability of customers can be
  determined and used for a range of strategic
  decisions

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Customer Profitability Analysis
Requiredspecialpackaging.
Orderssmallquantities.
Demandfastservice.
Ordersfrequently.
Oftenchangesorders.
A costly customer
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How do customers differ?

• Customisation of products
• Marketing and selling activities
• Distribution channels
• Customer support activities

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Customer Profitability Analysis
Using ABC to determine the activities, costs, and
profit associated with serving specific customers.
For various reasons, some customers are less
profitable than others.
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Measuring Customer Profitability
Studies have shown that only 20 of a companys
customers contribute to profits. The remaining
80 generate losses.
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What calculate customer profitability?

• To address the following questions
• Which customers generate the most profits? and
  how do we retain them?
• Which customers generate the lowest profits? and
  how can we make them more profitable?
• What types of customers should we focus on to
  maximise profitability?

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Customer profitability analysis

• Four level of customer-driven activities and
  costs
• Order level activities
• Customer level activities
• Market level activities
• Facility level activities
• Customer performance measures

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Measuring Customer Profitability - Example
Assume Company X investigates 5 of its customers.
Bar graphs are common analytical tools.
Customer Profitability
Customer
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Measuring Customer Profitability - Example
Note that attention should be focused on
customers 102 and 114.
Question Why are these two customers not
profitable?
Customer Profitability
Customer
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Measuring Customer Profitability - Example
Comparing the customer-related costs for each
customer can reveal helpful insights.
We Investigate and find. . .
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Identify Effective Ineffective Customer-Related
Activities
Study closely all the customer-related activities
that drive cost.
Typical Customer-Related Activities Include

• Processing Orders
• Sales Contacts
• Sales Visits
• Processing Shipments

• Billing
• Engineering/Design Changes
• Special Packaging
• Special Handling

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Customer Profitability Analysis
HealthWave, Inc.
Which of these customer groups is the most
profitable for HealthWave?

• HealthWave, Inc. sells non-prescription
  pharmaceuticals to three major customer types
• Pharmacies
• Groceries
• Herbal Therapists

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Sales Pattern Analysis
HealthWave, Inc.
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Sales Pattern Analysis
Exh. 6.5
HealthWave, Inc.
At this point, it would appear that Pharmacies
provide the highest contribution margin
ratio. Lets examine further.
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Sales Admin Cost Analysis
HealthWave, Inc.
Ordering Costs
Selling Costs
Marketing Costs
Distribution Costs
General Administrative Costs
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Sales Admin Cost Analysis
HealthWave, Inc.

• Ordering costs
• Selling costs
• Distribution costs
• Marketing costs
• General and administrative costs

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Selling Cost Analysis
Exh. 6.6
HealthWave, Inc.
HealthWave sells its products using sales
personnel in the field and telephone ordering. A
summary of those cost appear below. Note that
Herbal Therapists appear to have the lowest
selling costs.
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Marketing Cost Analysis
Exh. 6.7
HealthWave, Inc.
Marketing costs include personnel, databases,
equipment, and facilities. HealthWaves costs
can be broken down into Marketing Management
Costs, Promotion and Incentive Costs, Advertising
Costs, and Catalogue Development Costs. Again,
Herbal Therapists have the lowest marketing cost.
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Distribution Costs Analysis
Exh. 6.8
HealthWave, Inc.
Distribution costs include packing, shipping and
delivering products or services to customers.
HealthWave delivers goods using its own trucks
and a private delivery service,
PackageXpress. This time, Grocery customers have
the lowest distribution cost.
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G A Costs Analysis
Exh. 6.10
HealthWave, Inc.
Typically, general and administrative costs are
not directly customer-related. These costs can
often be difficult to trace to specific
customers. HealthWave breaks them into two broad
categories Customer Service and Manufacturing
Support Again, Herbal Therapists have the lowest
marketing cost.
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Customer Profitability Analysis
Exh. 6.11
HealthWave, Inc.
Finally, we put all the information together to
determine which customer-type is the most
profitable. The Groceries appear to be the most
profitable customer.
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Common-Sized Profit Statements
HealthWave, Inc.
To better compare different sets of data, the
dollar amounts can be recast as a percentage of
revenues.
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What To Do?
HealthWave, Inc.
The Pharmacy customers are not contributing to
HealthWaves profitability. What are the options?
Decrease operating costs
Do Nothing
Increase efficiency of serving pharmacy customers
Drop pharmacy customers
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Managing quality

• TQM is a management approach that focuses on
  meeting customer requirements by achieving
  continuous improvement in products or services
• TQM is a broad philosophy with a number of
  features which are not included in JIT

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Total Quality Management
Design
Grade
Conformance
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Total Quality Management (TQM)
Customers will seek out the highest quality
product.
Improved quality that exceeds customer
expectations will generate more revenues that
exceed the cost of quality.
Therefore, quality is free.
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Total Quality Management
Ranking between products or services having the
same functional use.
Degree to which actual product or service
meets its design specs. and is free of mfg.
defects.
Quality of Design
Quality of Conformance
Grade
Judged by . . .
Requires a certain . . .
Must be sup- ported by . . .
Product meets customer expectations for the grade
level chosen.
Customers
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Total Quality Management (TQM)
W. Edwards Deming proposed that improving quality
reduces cost and improves profitability.
Quality can be and should be improved
continuously.
Revenues
Max Profit
Cost
Max Quality
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Quality accreditation

• Organisations may achieve quality accreditation
  by meeting a series of quality standards set out
  in the ISO 9000 series.
• ISO 9000s are
• expensive to implement and maintain
• may have little relevance to many small
  businesses and service organisations

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Quality accreditation (QA) versus total quality
management (TQM)

• Organisations can have QA without TQM
• TQM is a philosophy - QA is a documentation
  process
• QA may encourage employees to think about quality

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Features of TQM

• TQM is holistic
• Customer-driven
• Involves empowerment
• Has a process perspective
• Is supported by a quality management system
• Involves continuous improvement

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Benefits and costs of TQM

• Benefits
• improved quality
• shorter lead times
• increased efficiency
• improved customer satisfaction
• TQM can be difficult and expensive to achieve
  because it may involve a change in organisational
  culture

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Cost of quality reports

• Quality of design
• degree to which a products design specifications
  meet customers expectations
• Quality of conformance
• degree to which a product meets formal design
  specifications

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Cost of quality reports

• Costs incurred in ensuring that the organisation
  maintains a high level of quality in its
  products, and the costs that arise from having
  poor-quality products
• Internal failure costs
• incurred when defective products or services are
  detected before they leave the firm

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Cost of quality reports

• External failure costs
• incurred as a result of defective products or
  services being delivered to customers
• Appraisal costs
• incurred to determine whether defects exist
• Prevention costs
• incurred to prevent internal or external failures
  and to minimise appraisal activities

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Quality Cost Reports

• Contains a breakdown of quality costs.

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Quality Cost Reports
Total Quality Costs
Costs
Prevention and Appraisal Costs
Failure Costs
Percentage of Defective Products
0
100
Minimum
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Quality Cost Reports

• A graphic Quality Cost Report might look like
  this

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Usefulness of cost of quality reports

• Places a dollar figure on the costs of poor
  quality
• Helps prioritise quality improvement programs
• Helps managers monitor the effects of the
  quality effort
• Can help identify the optimal level of quality
  for the firm

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Reasons for lack of use of cost of quality
reports

• Managers may believe costs outweigh the benefits
• Information is difficult to extract from
  conventional costing systems
• Many of the quality costs are spread across the
  organisation

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Return on Quality (ROQ)
Profit is maximized at the optimum quality level.
The optimum quality level is always achieved
before maximum attainable profit is reached.
Cost
Revenues
Optimum Quality
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Lead Indicators of Quality
Variation indicates poor quality. To measure
variation, there are several tools that can be
used
Run Charts
Control Charts
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Lead Indicators of Quality
Variation indicates poor quality. To measure
variation, there are several tools that can be
used
Histograms
Run Charts
Control Charts
A graph showing trends in variation over time.
Defects
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Lead Indicators of Quality
Variation indicates poor quality. To measure
variation, there are several tools that can be
used
Histograms
Run Charts
Control Charts
A run chart with upper and lower control limits.
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Diagnostic Information
While lead indicators tell that there IS a
problem, diagnostic tools help determine WHAT the
problem is.
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Cause-and-Effect Diagrams
Sometimes called fishbone or Ishikawa diagrams
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Scatter Diagrams
A plot of two variables that might be related. A
Patterns often indicates a causal relationship.
This pattern indicates a causal relationship.
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Flowcharts
A graphical illustration of sequential linkages
among process activities. Standardized symbols
are used to represent decisions, actions,
documents, and storage devices.
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Pareto Charts
A histogram of causes of errors or errors
arranged in order of frequency or size. Helps in
prioritizing actions to address problems.
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Cost of Quality (COQ)
Out-of-pocket costs associated with quality
generally fall into two categories
Costs associated with activities to correct
failure to control quality.
Costs associated with controlling quality.
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Control Quality Costs

• Prevention
• Activities that seek to prevent defects in the
  products or services being produced.
• Certifying Suppliers
• Designing for Manufacturability
• Quality Training
• Quality Evaluations
• Process Improvements

• Appraisal
• Activities for inspecting inputs and attributes
  of individual units of product and service.
• Inspecting Materials
• Inspecting Machines
• Inspecting Processes
• Statistical Process Control
• Sampling and Testing

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Costs of Failing to Control Quality

• Internal Failure
• Costs associated with defects in processes and
  products that are found prior to delivery to
  customers.
• Disposing of Scrap
• Rework
• Reinspecting/Retesting
• Delaying Processes

• External Failure
• Costs associated with defects in processes and
  products that are detected after delivery to
  customers.
• Warranty Repairs
• Field Replacements
• Product Liability
• Restoring reputation
• Lost Sales

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Managing Quality Time Productivity Capacity
JIT
The goal is to manage costs so that the savings
associated with JIT exceed the cost of
implementing JIT
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Traditional Push Manufacturing - Example
Computer Manufacturer
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JIT Pull Manufacturing - Example
Computer Manufacturer
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JIT Success Factors
2. Flexible Capacity.
1. Commitment to quality.
3. Reliable Supplier Relations.
4. Smooth Production Flow.
5. Well-trained workforce.
6. Reduced cycle and response times.