# Quality, Time, and the Theory of Constraints

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Quality, Time, and the Theory of Constraints
Chapter 19

Explain the four cost categories in a cost-of-quality program.
Learning Objective 1 Explain the four cost categories in a cost-of-quality program.

Two Aspects of Quality Actual Performance Design Specifications
Customer Satisfaction Conformance Quality Failure Quality of Design Failure

Costs of Quality Prevention costs Appraisal costs
Internal failure costs External failure costs

Costs of Quality Example
Vegas Photo Corporation made 10,000 photocopying machines last year. Vegas Photo determines the costs of quality of its photocopying machines using a 7-step activity-based costing approach.

Costs of Quality (Steps 1 and 2)
Identify cost objects. Identify the direct costs of quality of the products. 10,000 photocopying machines No direct costs of quality

Costs of Quality (Step 3)
Select the cost-allocation bases to use for allocating indirect costs of quality to the products. Prevention Appraisal Internal failure External failure Information on the total quantities of each of these cost-allocation bases used in all of Vegas operations is not provided.

Costs of Quality (Step 4)
Identify the indirect costs of quality associated with each cost-allocation base. Information about total (fixed and variable) costs is not provided.

Costs of Quality (Step 5)
Compute the rate per unit. Inspection hours is one cost-allocation base.

Costs of Quality (Step 5)
Prevention costs: Design engineering (R&D) \$80 per hour Process engineering (R&D) \$60 per hour Appraisal costs: Inspection (Manufacturing) \$40 per hour

Costs of Quality (Step 5)
Internal failure costs: Rework (Manufacturing) \$100 per hour External failure costs: Customer support (Marketing) \$ 50 per hour Transportation (Distribution) \$240 per load Warranty repair (Customer Service) \$110 per hour

Costs of Quality (Step 6)
Compute the indirect costs of quality allocated to the product.

Costs of Quality (Step 6)
Prevention costs: Design engineering (R&D) 20,000 hours Process engineering (R&D) 22,500 hours Appraisal costs: Inspection (Manufacturing) 120,000 hours

Costs of Quality (Step 6)
Internal failure costs: Rework (Manufacturing) ,000 hours External failure costs: Customer support (Marketing) ,000 hours Transportation (Distribution) ,500 loads Warranty repair (Customer Service) 60,000 hours

Costs of Quality (Step 6)
What is the total cost for design engineering? 20,000 hours × \$80 = \$1,600,000 What is the total cost for inspection? 120,000 hours × \$40 = \$4,800,000

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

Costs of Quality (Step 6)
Cost of Quality and Value Chain Category Total Costs Internal failure costs: Rework (Manufacturing) \$5,000,000

Costs of Quality (Step 6)
Cost of Quality and Value Chain Category Total Costs External failure costs: Customer support (Marketing) \$ 300,000 Transportation (Distribution) ,000 Warranty repair (Customer Service) 6,600,000 Total \$7,260,000

Costs of Quality (Step 7)
Compute the total costs of quality of the product. Prevention costs \$ 2,950,000 Appraisal costs ,800,000 Internal failure costs ,000,000 External failure costs ,260,000 Total \$20,010,000

identify quality problems.
Learning Objective 2 Use three methods to identify quality problems.

Techniques Used to Analyze Quality Problems
1. Control charts 2. Pareto diagrams 3. Cause-and-effect diagrams

Control Charts On the basis of experience, Vegas decides
that any observation outside the arithmetic mean  ± 2 standard deviations should be investigated.

Control Charts Production Line A  + 2 +  Defect Rate  - 
 - 2 Defect Rate Days

Control Charts Production Line B  + 2 +  Defect Rate  - 
 - 2 Defect Rate Days

Pareto Diagram 600 500 400 300 Number of Times Defect Observed 200
100 Copies are fuzzy and unclear Number of Times Defect Observed Copies are too light/dark Paper gets jammed

Pareto Diagram As a first step, Vegas analyzes the causes
of the most frequently occurring failure, fuzzy and unclear copies. Final Draft of a Sales Contract Final Draft of a Sales Contract

Cause-and-effect Diagrams
Human Factors Methods and Design Factors Inadequate supervision Poor training New operator Flawed part design Incorrect manufacturing sequence Inadequate tools Incorrect speed Poor maintenance Multiple suppliers Incorrect specification Variation in purchased components Machine-related Factors Materials and Components Factors

Identify the relevant costs and benefits of quality improvements.
Learning Objective 3 Identify the relevant costs and benefits of quality improvements.

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

Relevant Costs 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.

Relevant Costs What must management do to evaluate each alternative?
Additional Additional Inspection Cost Redesign Cost Difference \$200, \$230, \$30,000 Vegas determines the fixed and variable cost component of each activity involved.

Relevant Costs Further Redesigning Inspection Frames Relevant savings:
Rework costs \$480,000 \$ 640,000 Customer-support costs , ,000 Transportation costs , ,000 Warranty repair costs , ,000 Total \$995,000 \$1,361,000

Comparison Further Redesigning Inspection Frames
Relevant savings \$995,000 \$1,361,000 Additional cost , ,000 Difference \$795,000 \$1,131,000 What should Vegas do? Redesigning the frames provides a \$336,000 incremental benefit over further inspection.

Provide examples of nonfinancial quality measures of customer
Learning Objective 4 Provide examples of nonfinancial quality measures of customer satisfaction and internal performance.

Nonfinancial Measures
Nonfinancial measures of customer satisfaction: 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

Nonfinancial Measures
Nonfinancial measures of internal performance: 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)

Describe the benefits of financial and nonfinancial
Learning Objective 5 Describe the benefits of financial and nonfinancial measures of quality.

Evaluating Quality Performance
Financial measures are helpful to evaluate trade-offs among prevention costs, appraisal costs, and failure costs. Nonfinancial measures help focus attention on the precise problem areas that need improvement and also serve as indicators of future long-run performance.

Describe customer-response time and explain why delays
Learning Objective 6 Describe customer-response time and explain why delays happen and their costs.

Customer-Response Time
Order is placed Order is received Order is set up Order is manufactured Order is delivered Waiting Time Mfg. Time Receipt Time Manufacturing Lead Time Delivery Time Customer-Response Time

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.

Time Drivers and Costs of Time
1. Product or service order uncertainty 2. Bottlenecks due to limited capacity

Time Drivers and Costs of Time
Average waiting time equals: Average number of orders × (Manufacturing time)2 ÷ [ [ Annual machine Average no. Manufacturing capacity of orders time of product ×

Time Drivers and Costs of Time
Fredonia uses one machine to convert steel bars into a special component (SC). Fredonia expects it will receive 30 orders, but it could actually receive 10, 30, or 40 orders for the special component. Each order is for 1,000 units and will take 100 hours of manufacturing time.

Time Drivers and Costs of Time
The annual capacity of the machine is 4,000 hours. What is the expected manufacturing time required on the machine? (100 × 30) = 3,000 hours What is the average waiting time?

Time Drivers and Costs of Time
30 × 1002 = 30 × 10,000 = 300,000 300,000 ÷ 2 × [4,000 – (30 × 100)] 300,000 ÷ 2 × (4,000 – 3,000) 300,000 ÷ 2,000 150 hours average waiting time

Time Drivers and Costs of Time
What is the average manufacturing lead time for an order? 150 hours of average waiting time + 100 hours of manufacturing time = 250 hours Suppose that Fredonia is considering introducing a regular component (RC).

Time Drivers and Costs of Time
Fredonia expects to receive 10 orders for RCs (each order for 800 units). Each order will take 50 hours of manufacturing time. The expected demand for special components will be unaffected.

Time Drivers and Costs of Time
Assume that introducing RCs would cause average waiting time to more than double, from 150 hours to 325 hours. The average manufacturing lead time for a special component order becomes 425 hours ( ). Average manufacturing lead time for a regular component order is 375 hours ( ).

Relevant Revenues and Relevant Costs of Time
The average selling price per order is: Average manufacturing Product lead time SC RC Less than 300 hours \$22,000 \$10,000 More than 300 hours \$21,500 \$ 9,600

Relevant Revenues and Relevant Costs of Time
Product SC RC Average number of orders Direct material costs per order \$16,000 \$8,000 Inventory carrying costs/order/hour Should Fredonia introduce RCs?

Relevant Revenues and Relevant Costs of Time
Introduce RCs Expected revenues: (\$21,500 × 30) + (\$9,600 × 10) = \$741,000 Expected variable costs: (\$16,000 × 30) + (\$8,000 × 10) = \$560,000 Expected other costs: \$ 14,625

Relevant Revenues and Relevant Costs of Time
How was the \$14,625 other costs computed? (Average manufacturing lead time for SCs × Unit carrying costs per order for SCs × Expected number of orders for SCs) + (Average manufacturing lead time for RCs × Unit carrying costs per order for RCs × Expected number of orders for RCs) (425 × \$1.00 × 30) + (375 × \$0.50 × 10) = \$14,625

Relevant Revenues and Relevant Costs of Time
Do Not Introduce RCs Expected revenues: \$22,000 × 30 = \$660,000 Expected variable costs: \$16,000 × 30 = \$480,000 Expected other costs: \$ 7,500

Relevant Revenues and Relevant Costs of Time
How was the \$7,500 other costs computed? Average manufacturing lead time for SCs without RCs × Unit carrying costs per order for SCs × Expected number of orders for SCs 250 × \$1.00 × 30 = \$7,500

Relevant Revenues and Relevant Costs of Time
Relevant Introduce Do Not Items RC Introduce RC Expected revenues \$741,000 \$660,000 Expected total costs 574, ,500 Difference \$166,375 \$172,500 Falcon Works should not introduce the regular component.

Apply the three measures in the theory of constraints.
Learning Objective 7 Apply the three measures in the theory of constraints.

Theory of Constraints The three main measurements in the theory
of constraints are: 1. Throughput contribution equal to revenues minus direct material costs. 2. 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.

Theory of Constraints 3. Operating costs equal to all operating costs
(other than direct materials) incurred to earn throughput contribution. The objective of TOC is to increase throughput contribution while decreasing investments and operating costs.

Learning Objective 8 Manage bottlenecks.

Managing Bottlenecks The four steps in managing bottlenecks are:
1. Recognize that the bottleneck operation determines throughput contribution of the system as a whole. 2. Search and find the bottleneck operation by identifying operations with large quantities of inventory waiting to be worked on.

Managing Bottlenecks 3. Keep the bottleneck busy and subordinate
all nonbottleneck operations to the bottleneck operations. 4. Take actions to increase bottleneck efficiency and capacity – the objective is to increase throughput contribution minus the incremental costs of taking such actions.

End of Chapter 19