Company X has a number of goals for the upcoming year. These goals include expansion into other regions, increased profit margins, and new distribution centers. Prior to today’s status meeting, it was determined that profit margins are, in part, related to the costs associated with product manufacturing. Therefore, I have been tasked with making recommendations on how Company X can improve the efficiency and effectiveness of it’s various manufacturing sub-processes including design, material acquisition, assembly, and testing.
The key to making these recommendations is understanding what is meant by efficiency and effectiveness. Efficiency is “the ability to control costs at a given level of sales activity” (Atkinson, Kaplan, Matsumura, & Young, 2007). In other words, to maximize efficiency, an organization must keep the costs of production low for any given sales volume. The key ingredient of efficiency is costs. It is the job of management accounting to recognize what costs are associated with production, and properly assign those costs to clearly define how expensive a particular production volume. It is important to understand the different kinds of activities involved in the manufacturing process and how costs are assigned to these activities. For example, some costs are directly related to the number of units produced. These costs are assigned per-unit. Other costs are only assigned to groups of units produced. These are batch-related costs and increase in steps. For example, if five chairs can be heat-treated simultaneously, the cost of heat-treating chairs is a batch-related cost and assigned per group of 5 chairs treated (Atkinson et al., 2007).
Effectiveness, on the other, is associated with measuring the outcome of manufacturing processes. These measurements highlight process completion, product quality, and budget adherence. In a way, efficiency is concerned with minimizing input into the manufacturing process, while effectiveness strives to increase output from the process. Together both efficiency and effectiveness seek to increase the profit margin of the product by working at the same goal from opposite ends.
At Company X, the design process works to create an authentic-looking replica product that maintains modern levels of quality and durability. Product design, and it’s associated costs, is a product-sustaining activity. Product-sustaining activities and costs provide the infrastructure necessary for production without being directly involved in production itself. Therefore, the costs of these activities are independent of the number of units manufactured (Atkinson et al., 2007). In the case of Company X, the cost of the design process is related to the number of products manufactured.
Assuming that all members of the design team are cross-trained across all product lines, the main costs associated with design are personnel and equipment in the form of computers and software. These costs are fixed costs since they don’t rely on the volume of product produced (Atkinson et al., 2007). The only way to reduce these costs is to either reduce the number of product lines offered by Company X, or change the manner in which design talent is employed. In other words, if all products are profitable, and design costs still need to be reduced, Company X will need to seek alternative design sources such as using outside contractors rather than employee designers. By shifting the cost of personnel and equipment to an external, specialist organization, Company X may have access to similar output with reduced fix costs. Unfortunately, fixed costs are not related to the amount of units sold, so the overall impact on profit margin might be low (Atkinson et al., 2007).
Materials acquisition purchases the raw materials necessary to assemble Company X product lines. Specifically, this refers to the wood, glass, mirrors, clock mechanisms, and nails that comprise the Company X product lines. The cost of these materials is assigned per-unit since their volume as the numbers units produce increase (Atkinson et al., 2007). Two things are required to improve the efficiency of the materials acquisition process: planning and research. Planning will reveal the anticipated production rates for each product line for a longer term. Since the materials used in the production of furniture do not deteriorate quickly, a longer production forecast means more raw materials can be purchased at once. A larger order of materials often results in larger discounts which leads directly to a lower per-unit cost. Research, on the other hand, is necessary to ensure that the raw material is acquired at the lowest price. The larger orders produced by better planning result in better prices since more providers will respond to pricing requests.
The effectiveness of the materials acquisition process relies completely on the quality of the planning and research which goes into it. Since our definition of effectiveness highlights completion, product quality, and budget adherence, it is important that Company X acquires the defined amount of materials without over-acquiring. Although acquiring too much raw materials will not result in a direct loss since they do not suffer from spoilage or short-term deterioration, changes in the business model could result in a loss if product lines are abandoned or re-designed. Therefore, when measuring the effectiveness of the materials acquisition process, any outcome that does not result in zero remaining materials can be considered a negative outcome.
In terms of measuring efficiency and effectiveness, the assembly process is the most complicated. Some costs, such as the amount of raw materials consumed, are variable per-unit. Other costs, such as factories, equipment, and personnel, are fixed costs that provide a capacity for use. Since the per-unit cost of materials is handled by the material acquisition process, the efficiency of the assembly process is concerned with maximizing production utilizing a minimum number of fixed cost generating assets. In other words, Company X needs to produce the largest number of profit generating products using the smallest number of factories, people, and machines (Atkinson et al., 2007). Once again, planning is the key to process efficiency. Understanding how much of each product the company intends to sell will give the assembly group an idea of how many machines and people they need to employ.
The effectiveness of the assembly process measures the number of units generated against the number of anticipated units. The testing process mentioned below will measure the quality of the units produced. Finally, the assembly process is concerned with two major budget items: the fixed costs of people and machines, and the per-unit cost associated with raw materials. In order to maximize effectiveness, the assembly process must not waste any of the materials acquired by the materials acquisition process. Specifically, this means that the assembly process must maximize resource usage and limit production defects. Together these measurements will illuminate any deficiencies in the assembly process.
The goal of the testing process is ensure all previous processes have produced a product that meets the quality standards set forth by the company. The testing group achieves this process by putting a sample of each production run through a battery of quality control tests. As illustrated by Nachshon Margaliot (1999), the determination of appropriate sample size is a science unto itself. Since it can be presumed that the product is consumed in testing, it is important to keep the sample size as low as possible to avoid unit waste. Therefore, the efficiency of the testing process is related to the number of units required to generate a representative sample. In order to maximize efficiency, a study should be conducted to determine the proper number of units required for testing based on the number of units produced for resale.
The effectiveness of the testing process is not measured in the number of defects discovered, but rather in the number of defects missed and reported by customers. This process relies on customer feedback through the sales organization to determine if its procedures are adequate. The goal of this group is to decrease the number of complaints by constantly refining its quality control procedures.
Every sub-process in the overall manufacturing process is affected by the amount of planning done before the process takes place. The most important thing Company X can do is a cost-volume-profit (CVP) analysis. A CVP analysis will give the company an idea of how profitable each product line is based on the anticipated sales volume. The CVP analysis can be used to discover break-even points for products, as well as highlight which products have the greatest profit margin. Properly assigning costs in the CVP analysis can show that products previously thought to be highly profitable, are actually only profitable when their costs are shifted to other products. For example, when looking at the entire volume of wood purchased by Company X, it easy to miss a subtle detail like the amount of wood wasted in the product of a bedroom suite. Although it is assumed that the bedroom suite has the highest profit margin, properly assigning costs may reveal the bedroom suite to be a loss leader. If that were the case, the CVP analysis would encourage Company X to move away from bedroom suites. This result would change ever aspect of the manufacturing process.
Atkinson, A. A., Kaplan, R. S., Matsumura, E. M., & Young, S. M. (2007). Management accounting (5th ed.). Upper Saddle River, NJ: Pearson.
Margaliot, N. (1999). Selecting a quality control attribute sample: An information-economics method. Annals of Operations Research, 91, 83. Retrieved November 24, 2008, from ABI/INFORM Global database. (Document ID: 404194081).