Question: Precision Systems, Inc. (PSI).1 Precision Systems,
Precision Systems, Inc. (PSI).1 Precision Systems, Inc. (PSI) has been in business for more than 40 years and has generally reported a positive net income. The company manufactures and sells high-technology instruments (systems). Each product line at PSI has only a handful of standard products, but configuration changes and add-ons can be accommodated as long as they are not radically different from the standard systems. Faced with rising competition and increasing customer demands for quality, PSI adopted a total quality improvement program in 1989. Many employees received training and several quality initiatives were launched. Like most businesses, PSI concentrated on improvements in the manufacturing function and achieved significant improvements. However, little was done in other departments. In early 1992, PSI decided to extend its total quality improvement program to its order entry department, which handles the critical functions of preparing quotes for potential customers and processing orders. Order processing is the first process in the chain of operations after the order is received from a customer. High-quality output from the order entry department improves quality later in the process, and allows PSI to deliver higher quality systems both faster and cheaper, thus meeting the goals of timely delivery and lower cost. As a first step, PSI commissioned a cost of quality (COQ) study in its order entry department. The study had two objectives: • To develop a system for identifying order entry errors • To determine how much an order entry error costs. PSI’s Order Entry Department PSI’s domestic order entry department is responsible for preparing quotations for potential customers and taking actual sales orders. PSI’s sales representatives forward requests for quotations to the order entry department, though actual orders for systems are received directly from customers. Orders for parts are also received directly from customers. Service-related orders (for parts or repairs), however, are generally placed by service representatives. When PSI undertook the COQ study, the order entry department consisted of nine employees and two supervisors who reported to the order entry manager. Three of the nine employees dealt exclusively with taking parts orders, while the other six were responsible for system orders. Before August 1992, the other six were split equally into two groups: One was responsible for preparing quotations, and the other was responsible for taking orders.
The final outputs of the order entry department are the quote and the order acknowledgment or “green sheet.†The manufacturing department and the stockroom use the green sheet for further processing of the order.
The order entry department’s major suppliers are
(1) Sales or service representatives;
(2) The final customers who provide them with the basic information to process further; and
(3) Technical information and marketing departments, which provide configuration guides, price masters, and similar documents (some in printed form and others online) as supplementary information. Sometimes the printed configuration guides contain information in the format the order entry requires, but other times it does not.
At times there are discrepancies in the information available to order entry staff and sales representatives with respect to price, part number, or configuration. These discrepancies often cause communication gaps between the order entry staff, sales representatives, and manufacturing.
An order entry staff provided the following example of lack of communication between a sales representative and manufacturing with respect to one order.
If the sales reps. have spoken to the customer and determined that our standard configuration is not what they require, they may leave a part off the order. [In one such instance] I got a call from manufacturing saying when this system is configured like this, it must have this part added. . . . It is basically a no charge part and so I added it (change order #1) and called the sales rep. and said to him, “Manufacturing told me to add it.†The sales rep. called back and said, “No [the customer] doesn’t need that part, they are going to be using another option . . . so they don’t need this.†Then I did another change order (#2) to take it off because the sales rep. said they don’t need it. Then manufacturing called me back and said, “We really need [to add that part] (change order #3). If the sales rep. does not want it then we will have to do an engineering special and it is going to be another 45 days lead time. . . .†So, the sales rep. and manufacturing not having direct communication required me to do three change orders on that order; two of them were probably unnecessary.
A typical sequence of events might begin with a sales representative meeting with a customer to discuss the type of system desired. PSI’s sales representatives have scientific knowledge that enables them to configure a specific system to meet a customer’s needs. After deciding on a configuration, the sales representative then fills out a paper form and faxes it or phones it in to an order entry employee, who might make several subsequent phone calls to the sales representative, the potential customer, or the manufacturing department to prepare the quote properly. These phone calls deal with such questions as exchangeability of parts, part numbers, current prices for parts, or allowable sales discounts. Order entry staff then keys in the configuration of the desired system, including part numbers, and informs the sales representative of the quoted price. Each quote is assigned a quotation number. To smooth production, manufacturing often produces systems with standard configurations in anticipation of obtaining orders from recent quotes for systems. The systems usually involve adding on special features to the standard configuration. Production in advance of orders sometimes results in duplication in manufacturing, however, because customers often fail to put their quotation numbers on their orders. When order entry receives an order, the information on the order is reentered into the computer to produce an order acknowledgment. When the order acknowledgment is sent to the invoicing department, the information is reviewed again to generate an invoice to send to the customer.
Many departments in PSI use information directly from the order entry department (these are the internal customers of order entry). The users include manufacturing, service (repair), stockroom, invoicing, and sales administration. The sales administration department prepares commission payments for each system sold and tracks sales performance. The shipping, customer support (technical support), and collections departments (also internal customers) indirectly use order entry information. After a system is shipped, related paperwork is sent to customer support to maintain a service-installed database in anticipation of technical support questions that may arise. Customer support is also responsible for installations of systems. A good order acknowledgment (i.e., one with no errors of any kind) can greatly reduce errors downstream within the process and prevent later non–value-added costs.
cost of quality
Quality costs arise because poor quality may—or does—exist. For PSI’s order entry department, poor quality or nonconforming “products†refer to poor information for further processing of an order or quotation (see Exhibit 7-18 for examples). Costs of poor quality here pertain to the time spent by the order entry staff and concerned employees in other departments (providers of information, such as sales or technical information) to rectify the errors.
Class I Failures
Class I failure costs are incurred when nonconforming products (incorrect quotes or orders) are identified as nonconforming before they leave the order entry department. The incorrect quotes or orders may be identified by order entry staff or supervisors during inspection of the document. An important cause of Class I failures is lack of communication. Sample data collected from the order entry staff show that they encountered more than 10 different types of problems during order processing (see Exhibit 7-18 for examples). Analysis of the sample data suggests that, on average, it takes 2.3 hours (including waiting time) to rectify errors on quotes and 2.7 working days for corrections on orders. In determining costs, the COQ study accounted only for the time it actually takes to solve the problem (i.e., excluding waiting time). Waiting time was excluded because employees use this time to perform other activities or work on other orders. The total Class I failure costs, which include only salary and fringe benefits for the time it takes to correct errors, amount to more than 4% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Class II Failures
Class II failure costs are incurred when nonconforming materials are transferred out of the order entry department. For PSI’s order entry department, “nonconforming†refers to an incorrect order acknowledgment as specified by its users within PSI. The impact of order entry errors on final (external) customers is low because order acknowledgments are inspected in several departments, so most errors are corrected before the invoice (which contains some information available on the
![Precision Systems, Inc. (PSI).1 Precision Systems, Inc. (PSI) has been in business for more than 40 years and has generally reported a positive net income. The company manufactures and sells high-technology instruments (systems). Each product line at PSI has only a handful of standard products, but configuration changes and add-ons can be accommodated as long as they are not radically different from the standard systems. Faced with rising competition and increasing customer demands for quality, PSI adopted a total quality improvement program in 1989. Many employees received training and several quality initiatives were launched. Like most businesses, PSI concentrated on improvements in the manufacturing function and achieved significant improvements. However, little was done in other departments. In early 1992, PSI decided to extend its total quality improvement program to its order entry department, which handles the critical functions of preparing quotes for potential customers and processing orders. Order processing is the first process in the chain of operations after the order is received from a customer. High-quality output from the order entry department improves quality later in the process, and allows PSI to deliver higher quality systems both faster and cheaper, thus meeting the goals of timely delivery and lower cost. As a first step, PSI commissioned a cost of quality (COQ) study in its order entry department. The study had two objectives: • To develop a system for identifying order entry errors • To determine how much an order entry error costs. PSI’s Order Entry Department PSI’s domestic order entry department is responsible for preparing quotations for potential customers and taking actual sales orders. PSI’s sales representatives forward requests for quotations to the order entry department, though actual orders for systems are received directly from customers. Orders for parts are also received directly from customers. Service-related orders (for parts or repairs), however, are generally placed by service representatives. When PSI undertook the COQ study, the order entry department consisted of nine employees and two supervisors who reported to the order entry manager. Three of the nine employees dealt exclusively with taking parts orders, while the other six were responsible for system orders. Before August 1992, the other six were split equally into two groups: One was responsible for preparing quotations, and the other was responsible for taking orders.
The final outputs of the order entry department are the quote and the order acknowledgment or “green sheet.” The manufacturing department and the stockroom use the green sheet for further processing of the order.
The order entry department’s major suppliers are
(1) Sales or service representatives;
(2) The final customers who provide them with the basic information to process further; and
(3) Technical information and marketing departments, which provide configuration guides, price masters, and similar documents (some in printed form and others online) as supplementary information. Sometimes the printed configuration guides contain information in the format the order entry requires, but other times it does not.
At times there are discrepancies in the information available to order entry staff and sales representatives with respect to price, part number, or configuration. These discrepancies often cause communication gaps between the order entry staff, sales representatives, and manufacturing.
An order entry staff provided the following example of lack of communication between a sales representative and manufacturing with respect to one order.
If the sales reps. have spoken to the customer and determined that our standard configuration is not what they require, they may leave a part off the order. [In one such instance] I got a call from manufacturing saying when this system is configured like this, it must have this part added. . . . It is basically a no charge part and so I added it (change order #1) and called the sales rep. and said to him, “Manufacturing told me to add it.” The sales rep. called back and said, “No [the customer] doesn’t need that part, they are going to be using another option . . . so they don’t need this.” Then I did another change order (#2) to take it off because the sales rep. said they don’t need it. Then manufacturing called me back and said, “We really need [to add that part] (change order #3). If the sales rep. does not want it then we will have to do an engineering special and it is going to be another 45 days lead time. . . .” So, the sales rep. and manufacturing not having direct communication required me to do three change orders on that order; two of them were probably unnecessary.
A typical sequence of events might begin with a sales representative meeting with a customer to discuss the type of system desired. PSI’s sales representatives have scientific knowledge that enables them to configure a specific system to meet a customer’s needs. After deciding on a configuration, the sales representative then fills out a paper form and faxes it or phones it in to an order entry employee, who might make several subsequent phone calls to the sales representative, the potential customer, or the manufacturing department to prepare the quote properly. These phone calls deal with such questions as exchangeability of parts, part numbers, current prices for parts, or allowable sales discounts. Order entry staff then keys in the configuration of the desired system, including part numbers, and informs the sales representative of the quoted price. Each quote is assigned a quotation number. To smooth production, manufacturing often produces systems with standard configurations in anticipation of obtaining orders from recent quotes for systems. The systems usually involve adding on special features to the standard configuration. Production in advance of orders sometimes results in duplication in manufacturing, however, because customers often fail to put their quotation numbers on their orders. When order entry receives an order, the information on the order is reentered into the computer to produce an order acknowledgment. When the order acknowledgment is sent to the invoicing department, the information is reviewed again to generate an invoice to send to the customer.
Many departments in PSI use information directly from the order entry department (these are the internal customers of order entry). The users include manufacturing, service (repair), stockroom, invoicing, and sales administration. The sales administration department prepares commission payments for each system sold and tracks sales performance. The shipping, customer support (technical support), and collections departments (also internal customers) indirectly use order entry information. After a system is shipped, related paperwork is sent to customer support to maintain a service-installed database in anticipation of technical support questions that may arise. Customer support is also responsible for installations of systems. A good order acknowledgment (i.e., one with no errors of any kind) can greatly reduce errors downstream within the process and prevent later non–value-added costs.
cost of quality
Quality costs arise because poor quality may—or does—exist. For PSI’s order entry department, poor quality or nonconforming “products” refer to poor information for further processing of an order or quotation (see Exhibit 7-18 for examples). Costs of poor quality here pertain to the time spent by the order entry staff and concerned employees in other departments (providers of information, such as sales or technical information) to rectify the errors.
Class I Failures
Class I failure costs are incurred when nonconforming products (incorrect quotes or orders) are identified as nonconforming before they leave the order entry department. The incorrect quotes or orders may be identified by order entry staff or supervisors during inspection of the document. An important cause of Class I failures is lack of communication. Sample data collected from the order entry staff show that they encountered more than 10 different types of problems during order processing (see Exhibit 7-18 for examples). Analysis of the sample data suggests that, on average, it takes 2.3 hours (including waiting time) to rectify errors on quotes and 2.7 working days for corrections on orders. In determining costs, the COQ study accounted only for the time it actually takes to solve the problem (i.e., excluding waiting time). Waiting time was excluded because employees use this time to perform other activities or work on other orders. The total Class I failure costs, which include only salary and fringe benefits for the time it takes to correct errors, amount to more than 4% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Class II Failures
Class II failure costs are incurred when nonconforming materials are transferred out of the order entry department. For PSI’s order entry department, “nonconforming” refers to an incorrect order acknowledgment as specified by its users within PSI. The impact of order entry errors on final (external) customers is low because order acknowledgments are inspected in several departments, so most errors are corrected before the invoice (which contains some information available on the
order acknowledgment) is sent to the final customer. Corrections of the order entry errors do not guarantee that the customer receives a good quality system, but order entry’s initial errors do not then affect the final customer. Mistakes that affect the final customer can be made by individuals in other departments (e.g., manufacturing or shipping).
Sample data collected from PSI’s users of order entry department information show that more than 20 types of errors can be found on the order acknowledgment (see Exhibit 7-18 for examples). The cost of correcting these errors (salary and fringe benefits of order entry person and a concerned person from another PSI department) accounts for approximately 7% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
In addition to the time spent on correcting the errors, the order entry staff must prepare a change order for several of the Class II errors. A change order may be required for several other reasons that cannot necessarily be controlled by order entry. Examples include (1) changes in ship-to or bill-to address by customers or sales representatives, (2) canceled orders, and (3) changes in invoicing instructions. Regardless of the reason for a change order, the order entry department incurs some cost. The sample data suggest that for every 100 new orders, order entry prepares 71 change orders; this activity accounts for 2.6% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Although order entry’s errors do not significantly affect final customers, customers who find errors on their invoices often use the errors as an excuse to delay payments. Correcting these errors involves the joint efforts of the order entry, collections, and invoicing departments; these costs account for about 0.12% of order entry’s annual budget (see Exhibit 7-19). The order entry staff also spends considerable time handling return authorizations when final customers send their shipments back to PSI. Interestingly, more than 17% of the goods returned are because of defective shipments, and more than 49% fall into the following two categories: (1) ordered in error and (2) 30-day return rights. An in-depth analysis of the latter categories suggests that a majority of these returns can be traced to sales or service errors.
The order entry department incurs costs to process these return authorizations, which account for more than 1.9% of the annual budget (see Exhibit 7-19). The total Class I and Class II failure costs account for 15.72% of the order entry department’s annual budget for salaries and fringe benefits. Although PSI users of order entry information were aware that problems in their departments were sometimes caused by errors in order entry, they provided little feedback to order entry about the existence or impact of the errors.
Changes in PSI’s Order Entry Department
In October 1992, preliminary results of the study were presented to three key persons who had initiated the study: the order entry manager, the vice president of manufacturing, and the vice president of service and quality. In March 1993, the final results were presented to PSI’s executive council, the top decision-making body. During this presentation, the CEO expressed alarm not only at the variety of quality problems reported, but also at the cost of correcting them. As a consequence, between October 1992 and March 1993, PSI began working toward obtaining the International Organization for Standardization’s ISO 9002 registration for order entry and manufacturing practices, which it received in June 1993.
The effort to obtain the ISO 9002 registration suggests that PSI gave considerable importance to order entry and invested significant effort toward improving the order entry process. Nevertheless, as stated by the order entry manager, the changes would not have been so vigorously pursued if cost information had not been presented. COQ information functioned as a catalyst to accelerate the improvement effort. In actually making changes to the process, however, information pertaining to the different types of errors was more useful than the cost information.
Required
(a) Describe the role that assigning costs to order entry errors played in quality improvement efforts at Precision Systems, Inc.
(b) Prepare a diagram illustrating the flow of activities between the order entry department and its suppliers, internal customers (those within PSI), and external customers (those external to PSI).
(c) Classify the failure items in Exhibit 7-18 as internal failures (identified as defective before delivery to internal or external customers, that is, Class I failures) or external failures (nonconforming “products” delivered to internal or external customers, that is, Class II failures) with respect to the order entry department. For each external failure item, identify which of order entry’s internal customers (that is, other departments within PSI who use information from the order acknowledgment) will be affected.
(d) For the order entry process, how would you identify internal failures and external failures, as defined in question (c)? Who would be involved in documenting these failures and their associated costs? Which individuals or departments should be involved in making improvements to the order entry process?
(e) What costs, in addition to salary and fringe benefits, would you include in computing the cost of correcting errors?
(f) Provide examples of incremental (fairly low-cost and easy to implement) and breakthrough (high-cost and relatively difficult or time consuming to implement) improvements that could be made in the order entry process. In particular, identify prevention activities that can be undertaken to reduce the number of errors. Describe how you would prioritize your suggestions for improvement.
(g) Discuss the issues that PSI should consider if it wishes to implement a web-based ordering system that permits customers to select configurations for systems.
(h) What nonfinancial quality indicators might be useful for the order entry department? How frequently should data be collected or information be reported? Can you make statements about the usefulness of cost-of-quality information in comparison to nonfinancial indicators of quality?](../images/precision-systems-inc--psi-1-precision-systems-43561-1.jpg)
![Precision Systems, Inc. (PSI).1 Precision Systems, Inc. (PSI) has been in business for more than 40 years and has generally reported a positive net income. The company manufactures and sells high-technology instruments (systems). Each product line at PSI has only a handful of standard products, but configuration changes and add-ons can be accommodated as long as they are not radically different from the standard systems. Faced with rising competition and increasing customer demands for quality, PSI adopted a total quality improvement program in 1989. Many employees received training and several quality initiatives were launched. Like most businesses, PSI concentrated on improvements in the manufacturing function and achieved significant improvements. However, little was done in other departments. In early 1992, PSI decided to extend its total quality improvement program to its order entry department, which handles the critical functions of preparing quotes for potential customers and processing orders. Order processing is the first process in the chain of operations after the order is received from a customer. High-quality output from the order entry department improves quality later in the process, and allows PSI to deliver higher quality systems both faster and cheaper, thus meeting the goals of timely delivery and lower cost. As a first step, PSI commissioned a cost of quality (COQ) study in its order entry department. The study had two objectives: • To develop a system for identifying order entry errors • To determine how much an order entry error costs. PSI’s Order Entry Department PSI’s domestic order entry department is responsible for preparing quotations for potential customers and taking actual sales orders. PSI’s sales representatives forward requests for quotations to the order entry department, though actual orders for systems are received directly from customers. Orders for parts are also received directly from customers. Service-related orders (for parts or repairs), however, are generally placed by service representatives. When PSI undertook the COQ study, the order entry department consisted of nine employees and two supervisors who reported to the order entry manager. Three of the nine employees dealt exclusively with taking parts orders, while the other six were responsible for system orders. Before August 1992, the other six were split equally into two groups: One was responsible for preparing quotations, and the other was responsible for taking orders.
The final outputs of the order entry department are the quote and the order acknowledgment or “green sheet.” The manufacturing department and the stockroom use the green sheet for further processing of the order.
The order entry department’s major suppliers are
(1) Sales or service representatives;
(2) The final customers who provide them with the basic information to process further; and
(3) Technical information and marketing departments, which provide configuration guides, price masters, and similar documents (some in printed form and others online) as supplementary information. Sometimes the printed configuration guides contain information in the format the order entry requires, but other times it does not.
At times there are discrepancies in the information available to order entry staff and sales representatives with respect to price, part number, or configuration. These discrepancies often cause communication gaps between the order entry staff, sales representatives, and manufacturing.
An order entry staff provided the following example of lack of communication between a sales representative and manufacturing with respect to one order.
If the sales reps. have spoken to the customer and determined that our standard configuration is not what they require, they may leave a part off the order. [In one such instance] I got a call from manufacturing saying when this system is configured like this, it must have this part added. . . . It is basically a no charge part and so I added it (change order #1) and called the sales rep. and said to him, “Manufacturing told me to add it.” The sales rep. called back and said, “No [the customer] doesn’t need that part, they are going to be using another option . . . so they don’t need this.” Then I did another change order (#2) to take it off because the sales rep. said they don’t need it. Then manufacturing called me back and said, “We really need [to add that part] (change order #3). If the sales rep. does not want it then we will have to do an engineering special and it is going to be another 45 days lead time. . . .” So, the sales rep. and manufacturing not having direct communication required me to do three change orders on that order; two of them were probably unnecessary.
A typical sequence of events might begin with a sales representative meeting with a customer to discuss the type of system desired. PSI’s sales representatives have scientific knowledge that enables them to configure a specific system to meet a customer’s needs. After deciding on a configuration, the sales representative then fills out a paper form and faxes it or phones it in to an order entry employee, who might make several subsequent phone calls to the sales representative, the potential customer, or the manufacturing department to prepare the quote properly. These phone calls deal with such questions as exchangeability of parts, part numbers, current prices for parts, or allowable sales discounts. Order entry staff then keys in the configuration of the desired system, including part numbers, and informs the sales representative of the quoted price. Each quote is assigned a quotation number. To smooth production, manufacturing often produces systems with standard configurations in anticipation of obtaining orders from recent quotes for systems. The systems usually involve adding on special features to the standard configuration. Production in advance of orders sometimes results in duplication in manufacturing, however, because customers often fail to put their quotation numbers on their orders. When order entry receives an order, the information on the order is reentered into the computer to produce an order acknowledgment. When the order acknowledgment is sent to the invoicing department, the information is reviewed again to generate an invoice to send to the customer.
Many departments in PSI use information directly from the order entry department (these are the internal customers of order entry). The users include manufacturing, service (repair), stockroom, invoicing, and sales administration. The sales administration department prepares commission payments for each system sold and tracks sales performance. The shipping, customer support (technical support), and collections departments (also internal customers) indirectly use order entry information. After a system is shipped, related paperwork is sent to customer support to maintain a service-installed database in anticipation of technical support questions that may arise. Customer support is also responsible for installations of systems. A good order acknowledgment (i.e., one with no errors of any kind) can greatly reduce errors downstream within the process and prevent later non–value-added costs.
cost of quality
Quality costs arise because poor quality may—or does—exist. For PSI’s order entry department, poor quality or nonconforming “products” refer to poor information for further processing of an order or quotation (see Exhibit 7-18 for examples). Costs of poor quality here pertain to the time spent by the order entry staff and concerned employees in other departments (providers of information, such as sales or technical information) to rectify the errors.
Class I Failures
Class I failure costs are incurred when nonconforming products (incorrect quotes or orders) are identified as nonconforming before they leave the order entry department. The incorrect quotes or orders may be identified by order entry staff or supervisors during inspection of the document. An important cause of Class I failures is lack of communication. Sample data collected from the order entry staff show that they encountered more than 10 different types of problems during order processing (see Exhibit 7-18 for examples). Analysis of the sample data suggests that, on average, it takes 2.3 hours (including waiting time) to rectify errors on quotes and 2.7 working days for corrections on orders. In determining costs, the COQ study accounted only for the time it actually takes to solve the problem (i.e., excluding waiting time). Waiting time was excluded because employees use this time to perform other activities or work on other orders. The total Class I failure costs, which include only salary and fringe benefits for the time it takes to correct errors, amount to more than 4% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Class II Failures
Class II failure costs are incurred when nonconforming materials are transferred out of the order entry department. For PSI’s order entry department, “nonconforming” refers to an incorrect order acknowledgment as specified by its users within PSI. The impact of order entry errors on final (external) customers is low because order acknowledgments are inspected in several departments, so most errors are corrected before the invoice (which contains some information available on the
order acknowledgment) is sent to the final customer. Corrections of the order entry errors do not guarantee that the customer receives a good quality system, but order entry’s initial errors do not then affect the final customer. Mistakes that affect the final customer can be made by individuals in other departments (e.g., manufacturing or shipping).
Sample data collected from PSI’s users of order entry department information show that more than 20 types of errors can be found on the order acknowledgment (see Exhibit 7-18 for examples). The cost of correcting these errors (salary and fringe benefits of order entry person and a concerned person from another PSI department) accounts for approximately 7% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
In addition to the time spent on correcting the errors, the order entry staff must prepare a change order for several of the Class II errors. A change order may be required for several other reasons that cannot necessarily be controlled by order entry. Examples include (1) changes in ship-to or bill-to address by customers or sales representatives, (2) canceled orders, and (3) changes in invoicing instructions. Regardless of the reason for a change order, the order entry department incurs some cost. The sample data suggest that for every 100 new orders, order entry prepares 71 change orders; this activity accounts for 2.6% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Although order entry’s errors do not significantly affect final customers, customers who find errors on their invoices often use the errors as an excuse to delay payments. Correcting these errors involves the joint efforts of the order entry, collections, and invoicing departments; these costs account for about 0.12% of order entry’s annual budget (see Exhibit 7-19). The order entry staff also spends considerable time handling return authorizations when final customers send their shipments back to PSI. Interestingly, more than 17% of the goods returned are because of defective shipments, and more than 49% fall into the following two categories: (1) ordered in error and (2) 30-day return rights. An in-depth analysis of the latter categories suggests that a majority of these returns can be traced to sales or service errors.
The order entry department incurs costs to process these return authorizations, which account for more than 1.9% of the annual budget (see Exhibit 7-19). The total Class I and Class II failure costs account for 15.72% of the order entry department’s annual budget for salaries and fringe benefits. Although PSI users of order entry information were aware that problems in their departments were sometimes caused by errors in order entry, they provided little feedback to order entry about the existence or impact of the errors.
Changes in PSI’s Order Entry Department
In October 1992, preliminary results of the study were presented to three key persons who had initiated the study: the order entry manager, the vice president of manufacturing, and the vice president of service and quality. In March 1993, the final results were presented to PSI’s executive council, the top decision-making body. During this presentation, the CEO expressed alarm not only at the variety of quality problems reported, but also at the cost of correcting them. As a consequence, between October 1992 and March 1993, PSI began working toward obtaining the International Organization for Standardization’s ISO 9002 registration for order entry and manufacturing practices, which it received in June 1993.
The effort to obtain the ISO 9002 registration suggests that PSI gave considerable importance to order entry and invested significant effort toward improving the order entry process. Nevertheless, as stated by the order entry manager, the changes would not have been so vigorously pursued if cost information had not been presented. COQ information functioned as a catalyst to accelerate the improvement effort. In actually making changes to the process, however, information pertaining to the different types of errors was more useful than the cost information.
Required
(a) Describe the role that assigning costs to order entry errors played in quality improvement efforts at Precision Systems, Inc.
(b) Prepare a diagram illustrating the flow of activities between the order entry department and its suppliers, internal customers (those within PSI), and external customers (those external to PSI).
(c) Classify the failure items in Exhibit 7-18 as internal failures (identified as defective before delivery to internal or external customers, that is, Class I failures) or external failures (nonconforming “products” delivered to internal or external customers, that is, Class II failures) with respect to the order entry department. For each external failure item, identify which of order entry’s internal customers (that is, other departments within PSI who use information from the order acknowledgment) will be affected.
(d) For the order entry process, how would you identify internal failures and external failures, as defined in question (c)? Who would be involved in documenting these failures and their associated costs? Which individuals or departments should be involved in making improvements to the order entry process?
(e) What costs, in addition to salary and fringe benefits, would you include in computing the cost of correcting errors?
(f) Provide examples of incremental (fairly low-cost and easy to implement) and breakthrough (high-cost and relatively difficult or time consuming to implement) improvements that could be made in the order entry process. In particular, identify prevention activities that can be undertaken to reduce the number of errors. Describe how you would prioritize your suggestions for improvement.
(g) Discuss the issues that PSI should consider if it wishes to implement a web-based ordering system that permits customers to select configurations for systems.
(h) What nonfinancial quality indicators might be useful for the order entry department? How frequently should data be collected or information be reported? Can you make statements about the usefulness of cost-of-quality information in comparison to nonfinancial indicators of quality?](../images/precision-systems-inc--psi-1-precision-systems-43561-2.jpg)
order acknowledgment) is sent to the final customer. Corrections of the order entry errors do not guarantee that the customer receives a good quality system, but order entry’s initial errors do not then affect the final customer. Mistakes that affect the final customer can be made by individuals in other departments (e.g., manufacturing or shipping).
Sample data collected from PSI’s users of order entry department information show that more than 20 types of errors can be found on the order acknowledgment (see Exhibit 7-18 for examples). The cost of correcting these errors (salary and fringe benefits of order entry person and a concerned person from another PSI department) accounts for approximately 7% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
In addition to the time spent on correcting the errors, the order entry staff must prepare a change order for several of the Class II errors. A change order may be required for several other reasons that cannot necessarily be controlled by order entry. Examples include (1) changes in ship-to or bill-to address by customers or sales representatives, (2) canceled orders, and (3) changes in invoicing instructions. Regardless of the reason for a change order, the order entry department incurs some cost. The sample data suggest that for every 100 new orders, order entry prepares 71 change orders; this activity accounts for 2.6% of order entry’s annual budget for salaries and fringe benefits (see Exhibit 7-19).
Although order entry’s errors do not significantly affect final customers, customers who find errors on their invoices often use the errors as an excuse to delay payments. Correcting these errors involves the joint efforts of the order entry, collections, and invoicing departments; these costs account for about 0.12% of order entry’s annual budget (see Exhibit 7-19). The order entry staff also spends considerable time handling return authorizations when final customers send their shipments back to PSI. Interestingly, more than 17% of the goods returned are because of defective shipments, and more than 49% fall into the following two categories: (1) ordered in error and (2) 30-day return rights. An in-depth analysis of the latter categories suggests that a majority of these returns can be traced to sales or service errors.
The order entry department incurs costs to process these return authorizations, which account for more than 1.9% of the annual budget (see Exhibit 7-19). The total Class I and Class II failure costs account for 15.72% of the order entry department’s annual budget for salaries and fringe benefits. Although PSI users of order entry information were aware that problems in their departments were sometimes caused by errors in order entry, they provided little feedback to order entry about the existence or impact of the errors.
Changes in PSI’s Order Entry Department
In October 1992, preliminary results of the study were presented to three key persons who had initiated the study: the order entry manager, the vice president of manufacturing, and the vice president of service and quality. In March 1993, the final results were presented to PSI’s executive council, the top decision-making body. During this presentation, the CEO expressed alarm not only at the variety of quality problems reported, but also at the cost of correcting them. As a consequence, between October 1992 and March 1993, PSI began working toward obtaining the International Organization for Standardization’s ISO 9002 registration for order entry and manufacturing practices, which it received in June 1993.
The effort to obtain the ISO 9002 registration suggests that PSI gave considerable importance to order entry and invested significant effort toward improving the order entry process. Nevertheless, as stated by the order entry manager, the changes would not have been so vigorously pursued if cost information had not been presented. COQ information functioned as a catalyst to accelerate the improvement effort. In actually making changes to the process, however, information pertaining to the different types of errors was more useful than the cost information.
Required
(a) Describe the role that assigning costs to order entry errors played in quality improvement efforts at Precision Systems, Inc.
(b) Prepare a diagram illustrating the flow of activities between the order entry department and its suppliers, internal customers (those within PSI), and external customers (those external to PSI).
(c) Classify the failure items in Exhibit 7-18 as internal failures (identified as defective before delivery to internal or external customers, that is, Class I failures) or external failures (nonconforming “products†delivered to internal or external customers, that is, Class II failures) with respect to the order entry department. For each external failure item, identify which of order entry’s internal customers (that is, other departments within PSI who use information from the order acknowledgment) will be affected.
(d) For the order entry process, how would you identify internal failures and external failures, as defined in question (c)? Who would be involved in documenting these failures and their associated costs? Which individuals or departments should be involved in making improvements to the order entry process?
(e) What costs, in addition to salary and fringe benefits, would you include in computing the cost of correcting errors?
(f) Provide examples of incremental (fairly low-cost and easy to implement) and breakthrough (high-cost and relatively difficult or time consuming to implement) improvements that could be made in the order entry process. In particular, identify prevention activities that can be undertaken to reduce the number of errors. Describe how you would prioritize your suggestions for improvement.
(g) Discuss the issues that PSI should consider if it wishes to implement a web-based ordering system that permits customers to select configurations for systems.
(h) What nonfinancial quality indicators might be useful for the order entry department? How frequently should data be collected or information be reported? Can you make statements about the usefulness of cost-of-quality information in comparison to nonfinancial indicators of quality?
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1. Incomplete information on purchase order 2. Transposition of prices on purchase order 3. More than one part number on order acknowledgment when only one is required 4. Incorrect business unit code (used for tracking product line profitability) on the order acknowledgment 5. Freight terms missing on the purchase order 6. Incorrect part number on order acknowledgment 7. Incorrect shipping or billing address on the order acknowledgment 8. Credit approval missing (all new customers have a credit approval before an order is processed) 9. Missing part number on order acknowledgment 10. Customer number terminated on the computer's database (an order cannot be processed if customer number is missing) 11. Incorrect sales tax calculation on the order acknowledgment 12. Part number mismatch on purchase order ORDER ENTRY OTHER DEPARTMENTS TOTAL COSTS Class I failure costs Quotations 1.1% 0.4% 1.5% Orders 0.9% 1.7% 2.6% Total Class I failure costs 2.0% 2.1% 4.1% Class II failure costs Order acknowledgments Change orders 2.6% 4.4% 7.0% 2.6% 2.6% Final customers 0.02% 0.1% 0.12% Retum authorizations 1.9% 1.9% Total Class II failure costs 7.12% 4.5% 11.62% Total failure costs 9.12% 6.6% 15.72%
> What are two types of financial benefits resulting from a shift to group technology, just-in-time production, or continuous quality improvements?
> Why may financial information alone be insufficient for the ongoing informational needs of operators/workers, managers, and executives?
> What creates the need to maintain work-in process inventory? Why is work-in-process inventory likely to decrease on the implementation of group technology, just-in-time production, and quality improvement programs?
> How is a just-in-time manufacturing system different from a conventional manufacturing system?
> List three examples for each of the following quality costing categories: a. Prevention costs b. Appraisal costs c. Internal failure costs d. External failure costs.
> Quality engineering, quality training, statistical process control, and supplier certification are what kinds of quality costs?
> Describe the lean manufacturing approach.
> What is group technology?
> What is the difference between process and product layout systems?
> The theory of constraints relies on three measures: throughput contribution, investments, and operating costs. Define these three measures in the context of the theory of constraints.
> What costs and revenues are relevant in evaluating the profit impact of an increase in sales?
> What is the additional cost of replacing one unit of a product rejected at inspection and scrapped?
> What does the breakeven time (BET) metric for the product development process measure?
> What are the two general methods of information gathering and sharing when undertaking a benchmarking exercise?
> What are the three broad classes of information on which firms interested in benchmarking can focus? Describe each.
> According to the kaizen costing approach, who has the best knowledge to reduce costs? Why is this so?
> Under what condition will the cost savings due to kaizen costing not be applied to production?
> What do the terms kaizen and kaizen costing mean?
> One aspect of facilities layout for McDonald’s is that when customers come into the building, they can line up in one of several lines and wait to be served. In contrast, customers at Wendy’s are asked to stand in one line that snakes around the front of
> Ray Brown’s company, Whisper Voice Systems, is trying to increase its processing cycle efficiency (PCE). Because Ray has a very limited budget, he has been searching for a way to increase his PCE by using group technology. One of Ray&ac
> Gurland Valves Company manufactures brass valves that meet precise specification standards. All finished valves are inspected before being packaged and shipped to customers. Rejected valves are returned to the initial production stage to be melted and re
> You are a manufacturing manager faced with the decision about how to improve manufacturing operations and efficiency. You have been studying both group technology and JIT manufacturing systems. Your boss expects you to prepare a report covering the costs
> Walker Brothers Company is considering the installation of a JIT manufacturing system in the hope that it will improve the company’s overall processing cycle efficiency. Data from the traditional system and estimates for the JIT system
> Consider an organization that has empowered its employees, asking them to improve the quality, productivity, and responsiveness of their processes that involve repetitive work. This work could arise in a manufacturing setting, such as assembling cars or
> To facilitate a move toward JIT production, AB Company is considering a change in its plant layout. The plant controller, Anita Bentley, has been asked to evaluate the costs and benefits of the change in plant layout. After meeting with production and ma
> Discuss the similarities and differences between activity based costing and the theory of constraints, as well as situations in which one approach might be preferable to the other.
> Assume that you are an average student who has a desire to be one of the best students in class. Your professor suggests that you benchmark the working habits of the best student in the class. You are somewhat skeptical but decide to take on the challeng
> Your organization, located in Worthington, Ohio, is contemplating introducing kaizen costing to help with cost reduction. As someone who has an understanding of management accounting, you have been asked for your opinion. Specifically, some of your colle
> Many companies are interested in adopting a kaizen costing approach to reducing costs. However, they are not sure how their current standard costing system will fit with the kaizen costing approach. Required How do the standard costing system and the ka
> As a manager asked to benchmark another organization’s mobile web experience provided to users, on what factors would you gather information? Why?
> What are the key factors in identifying benchmarking partners? Explain why these factors are important.
> Kaizen costing is a method that many Japanese companies have found effective in reducing costs. Required (a) What are the biggest problems in using kaizen costing? (b) How can managers overcome these problems?
> What factors differentiate kaizen costing from standard costing?
> The following data have just been gathered on last year’s quality-related costs at the Ideal Company: Total sales last year were $75,000,000. Required (a) Prepare a cost-of-quality report grouping costs into prevention, appraisal, int
> In which stage of the total life cycle of a product is target costing most applicable?
> What is an investment center?
> The following information shows last year’s quality-related costs for the Madrigal Company: Total sales for the year were $120,000,000. Required (a) Prepare a cost-of-quality report grouping costs into prevention, appraisal, internal
> Managers concerned with improving quality sometimes have a difficult balancing act, given the four types of quality costs they have to manage. As a new manager, you are trying to figure out a strategy for managing $2 million of quality costs; your total
> Read “Everyone Likes to Laud Serving the Customer; Doing It Is the Problem,” by Carol Hymowitz (Wall Street Journal, February 27, 2006, p. B1). Required (a) According to the article, what measures are commonly used to evaluate customer service represent
> Of the four quality costing categories, which quality cost is the most damaging to the organization? Explain.
> Regarding the quality costing categories, how do prevention costs differ from appraisal costs? How do internal failure costs differ from external failure costs?
> How would you classify the layout of a large grocery store? Why do you think it is laid out this way? Can you think of any way to improve the layout of a conventional grocery store? Explain your reasoning. (Hint: Think about JIT, cycle time, and so on.)
> SMY Corporation produces 60,000 videophones per year. The company estimates its direct material costs for the videophone to be $300 per unit and its conversion (direct labor plus support) costs to be $400 per unit. Annual inventory carrying costs, not in
> Boris Company introduced JIT manufacturing last year and has prepared the following data to assess the benefits from the change: Inventory financing costs are 12% per year. Support costs are based on a time-driven activity-based costing analysis. Estima
> Kwik Clean handles both commercial laundry and individual customer dry cleaning. Kwik Clean’s current dry cleaning process involves emitting a pollutant into the air. In addition, the commercial laundry and dry cleaning processes produce sediments and ot
> Johnson & Johnson (www.jnj.com), a major health care and pharmaceutical firm, voluntarily recalled a number of its products in 2010 because of quality problems. These products included hip-repair implants, contact lenses, and over-the-counter medications
> For each of the four steps of the plan–do–check–act cycle, describe examples of possible uses of management accounting information.
> Some firms in the fashion industry have adopted lean or just-in-time approaches to maintain or increase their competitive advantage. Read the following articles or other resources to address the questions below: “Brand-New Bag: Louis Vuitton Tries Modern
> Woodpoint Furniture Manufacturing produces various lines of pine furniture. The plant is organized so that all similar functions are performed in one area, as shown in Exhibit 7-17. Most pieces of furniture are made in batches of 10 units. Raw materials
> Rossman Instruments, Inc., is considering leasing new state-of-the-art machinery at an annual cost of $900,000. The new machinery has a fouryear expected life. It will replace existing machinery leased one year earlier at an annual lease cost of $490,000
> Daniel Morris purchased a 42-inch plasma television, manufactured by TVCO, from a local electronics store that permits customers to return defective products within 30 days of purchase. Approximately 45 days after Daniel’s purchase, the TV began to malfu
> Why might customer retention rate be a poor measure of customer loyalty?
> What does a pricing waterfall chart depict?
> “Companies should avoid high cost-to-serve customers because they are unprofitable.” Do you agree with this statement? Explain.
> Why are nonfinancial measures alone insufficient for managing relationships with customers?
> Consider the descriptions of management accounting provided in the chapter. Discuss why the associated responsibilities are viewed as “accounting” and how people handling those responsibilities interface with other functional areas in fulfilling the stat
> What is the net promoter score and why is it recommended for use by companies?
> List and describe the five stages of a hierarchy for categorizing customer satisfaction and loyalty. Which companies that you know or deal with as a consumer create the highest form of loyalty for you?
> Provide three reasons why customer loyalty provides benefits to companies.
> “The only nonfinancial measure for customer relationships that our company should focus on is customer satisfaction.” Do you agree with this statement? Explain.
> What insights can life-cycle profitability analysis provide about customer profitability and the desirability of various customer groups?
> How might the structure of salespersons’ incentives or compensation plans contribute to unprofitable customer relationships?
> What are four broad groups of actions that managers might use to transform unprofitable customers into profitable ones?
> Provide an example of how customers may use a specific company’s resources or services very differently.
> Why must service companies, even more so than manufacturing companies, focus on customer costs and profitability?
> What is the typical shape of a graph of cumulative profits versus percentage of customers ranked from most profitable to least profitable?
> What are the two essential financial elements needed to arrive at a target cost?
> Kronecker Company, a growing mail-order clothing and accessory company, is concerned about its growing MSDA expenses. It therefore examined its customer ordering patterns for the past year and identified four different types of customers, as illustrated
> In which industries would you expect the net promoter score to have the greatest predictive power for repeat purchases and growth? The least predictive power for repeat purchases and growth?
> KEM Company has begun studying customer lifetime value for its customers and has prepared the information below for selected customers. For simplicity, management has assumed that for a given customer, the retention rate is the same every year until the
> Randolph Company’s product mix has become more diverse over the past few years. Consequently the company undertook an activity-based costing initiative to develop accurate costs for production, as well as marketing, selling, distributio
> Write an essay to explain how the 80–20 graph for sales revenues would be prepared and describe typical findings with respect to proportions of products and customers generating percentages of sales. Also, describe how a whale curve is prepared and typic
> Hampstead Company’s order entry department has 20 order entry operators. The cost associated with these 20 operators (salaries, fringe benefits, and supervision, as well as occupancy and equipment costs) is $873,600 per year. After taking into ac
> Saunders Company has recently become aware of the large total discounts on its orders and would like to know the impact on profit. The company computed its operating profit as follows: Required (a) Suppose Saunders could reduce its sales discounts to p
> Refer to the pricing waterfall chart in Exhibit 6-4. Required (a) What circumstances result in firms often failing to be aware of all of the discounts and allowances granted on a customer order? (b) Once a firm becomes aware of pricing waterfalls leadin
> For each of the categories below, provide a specific example of how a company might transform its breakeven or loss customers into profitable ones: a. Process improvements b. Activity-based (menu-based) pricing c. Managed customer relationships d. Discip
> Wright Company, a new systems consulting company, is concerned about the profitability of its customers during the past year. The company has prepared the following data: Required (a) Prepare a whale curve, as described in this chapter. (b) What percen
> Consider the operation of a fast-food company with hundreds of retail outlets scattered about the country. Consider the descriptions of management accounting provided in the chapter to identify management accounting information needs for the following: a
> Tetra Company’s cost system assigns MSDA expenses to customers using a rate of 33% of sales revenue. The new controller has discovered that Tetra’s customers differ greatly in their ordering patterns and interaction w
> Stan’s, a department store chain, has conducted a survey to collect data on customer satisfaction and perception of its merchandise and service. Data for responses to the question “How likely is it that you would recom
> Compute the customer lifetime value for Customer 421 based on the data below for the first six years of the customer relationship. Costs (ct) were incurred to promote customer retention to a rate of 0.8 in years 1 through 6.
> In response to how the sales incentives might be contributing to falling profits despite growing sales, Chan Company’s controller has produced the following information on last year’s sales to two customers that purcha
> Read the Wall Street Journal article “Survival Strategies: After Cost Cutting, Companies Turn toward Price Increases” by Timothy Aeppel (September 18, 2002, p. A1). The article reports “an all-out search for new ways to charge more money without raising
> Why might an organization not experience financial improvement even after using activity-based costing to identify and take action on promising opportunities for process improvements and cost reductions?
> Why do companies producing a varied and complex mix of products have higher costs than companies producing only a narrow range of products?
> “When a company produces both high volume products and low-volume products, traditional product costing systems are likely to over cost high-volume products.” Do you agree with this statement? Explain.
> Under what two conditions are volume based traditional product costing systems most likely to distort product costs? How do activity-based costing systems provide more accurate costs when these two conditions hold?
> Why are traditional volume-based cost allocation systems likely to systematically distort product costs?
> The decline in our profits has become intolerable. The severe price cutting in pumps has dropped our pre-tax margin to less than 2%, far below our historical 15% margins. Fortunately, our competitors are overlooking the opportunities for profit in flow c
> What advantages does time-driven ABC have over original activity-based costing?
> Why might individuals resist implementation of activity-based costing?
> What are some special considerations in the design of cost accounting systems for service organizations?
> Why are service organizations often ideally suited for activity-based costing?
> Why is practical capacity recommended in calculating capacity cost rates?
> How the information from an activity can based costing system guide improvements in operations and decisions about products and customers?
> What two sets of parameters must be estimated in time-driven ABC?
> How is a time-driven ABC system updated as resource costs increase or changes in operations occur?
> Riverdale Bone and Joint Surgery specializes in treating injuries related to bones and joints, as well as surgeries such as knee replacements and hip replacements. In addition to performing surgeries, Riverdale offers post-operation treatment. Riverdale
> Garber Company uses a traditional activity-based costing system to assign $600,000 of committed resource costs for customer service on the basis of the following information gathered from interviews with customer service personnel: Required (a) Compute
> For each of the following products, suggest three measures of quality: a. Television set b. University course c. Meal in an exclusive restaurant d. Carryout meal from a restaurant e. Container of milk f. Visit to the doctor g. Trip on an airplane h. Pair
