The Modern Business Environment
P2 Chapter 2
Introduction to the modern business environment:
To compete successfully in today's highly competitive global environment
companies are making customer satisfaction an overriding priority, adopting
new management approaches, changing their manufacturing systems and
investing in new technologies. These changes are having a significant influence
on management accounting systems.'
Characteristics of the modern business environment:
1. Global environment:
The move away from standardised units of production towards
individual customised units means that mass production techniques are
redundant. Instead, it is of greatest importance to take an order from
placement to completion in the shortest time possible.
2. Flexibility
3. Employee empowerment:
To ensure this flexibility, managers need to empower their employees to
make decisions quickly, without reference to more senior managers.
4. Management accounting systems are moving from providing
information to managers to monitor employees to providing
information to employees to empower them to focus on continuous
improvement.
5. Companies operate in a world economy. Customers and competitors
come from all over the world.
6. Products are made from components from around the world.
7. Firms have to be world class to compete.
8. International regulations: In a global environment, customers have far
greater choice than ever before.
9. There has been a huge increase in demand for new, cutting-edge
innovative products.
10.Customers are demanding ever-improving levels of service in cost,
quality, reliability and delivery.
11.Customers demand flexibility. Companies need to respond to this in
order to survive.
World Class Manufacturing:
The World Class Manufacturing approach to quality is quite different from the
traditional approach because the primary emphasis is placed on the resolution
of the problems that cause poor quality, rather than merely detecting it. These
systems are more proactive and try to prevent problems from occurring in the
first place rather than waiting for them to occur and then fixing them.
The system might be developed formally under Total Quality Management.
Just-In-Time (JIT) production is defined as:
A production system which is driven by demand for finished products
whereby each component on a production line is produced only when
needed for the next stage.
JIT purchasing as:
A purchasing system in which material purchases are contracted so that the
receipt and usage of material, to the maximum extent possible, coincide.
A just-in-time system is a ‘pull’ system, which responds to demand, in
contrast to a ‘push’ system, in which inventory acts as a buffer between the
different elements of the system, such as purchasing, production and sales.
Toyota developed a different system known as JIT. This system is not a ‘push’
system but a ‘pull’ system. A product is not ‘made’ until the customer
requests it, and components are not made until they are required by the next
production stage.
In a full JIT system virtually no inventory is held, that is no raw material
inventory and no finished goods inventory is held, but there will be a small
amount of WIP, say one-tenth of a day’s production. The system works by
the customer triggering the final stage of production, the assembly. As the
product is assembled, components are used and this in turn triggers the
component stage of production and a small amount of WIP is made ready
for the next product.
So, the cycle goes on until the final trigger requests more raw material from
the supplier.
If a JIT system is to work satisfactorily, suppliers must deliver several times a
day and so when the raw material arrives it may go straight into the factory
and be used immediately.
This means that the production lead time (i.e. the time from raw materials
entering production to the finished goods emerging) should equal the
processing time.
An important consequence of the ‘pull’ system, is that problems in any
part of the system will immediately halt the production line, as earlier
workstations will not receive the ‘pull’ signal and later stations will not
have their own ‘pull’ signals answered.
This has the powerful effect of concentrating all minds on finding a long-term
solution to the problem. JIT exposes problems within a plant, and forces
management to address problems and rectify them, rather than simply burying
them by holding excess inventory.
The aims of JIT are to produce the required items, at the required quality and
in the required quantities, at the precise time they are required.
The labour force must be versatile so that they can perform any job within
reason to keep production flowing as required. Workers in a JIT cell are trained
to operate all the machines within it, and perform routine preventive
maintenance on them.
Production processes must be grouped by product line rather than by function
in order to eliminate inventory movements between workstations and to
speed flow.
A simple, infallible information system.
Originally the Japanese used a system based on cards which were called
kanbans.
There would be a small container of components (WIP) between each
workstation with a kanban resting on top. When the container was taken for
use by the following workstation the card would be taken off and left behind.
This would act as a trigger for the previous workstation to produce another
container of that component.
Nowadays computer systems are likely to be used instead of cards but the
basic simplicity of the system should not change.
A ‘get it right first time ‘approach and an aim of ‘zero defects’
TQM (Total Quality Management):
TQM is the general name given to programmes which seek to ensure that
goods are produced and services supplied of the highest quality. Its origins lie
primarily in Japanese organisations and it is argued that TQM has been a
significant factor in Japanese global business success.
There are two basic principles of TQM:
There are two approaches to Continuous Improvement: Kaizen Costing and
Target Costing.
Get it right, first time. TQM considers that the costs of prevention are less
than the costs of correction. One of the main aims of TQM is to achieve zero
rejects and 100% quality. One aspect of the Japanese management
philosophy is a zero-defect target.
Continuous improvement. The second basic principle of TQM is
dissatisfaction with the status quo. Realistically, a zero-defect goal may not
be obtainable.
The costs of quality: (IMP)
Quality costs are divided into compliance costs (or ‘conformance costs’) and
costs of failure to comply (‘non-conformance costs’).
Conformance costs are further divided into prevention costs (incurred in
preventing mistakes from happening) and appraisal costs (incurred in looking
for mistakes before a product is manufactured).
Prevention costs:
Are the costs of ensuring that defects do not occur in the first place. For
example: Routine preventive repairs and maintenance to equipment. Quality
training for operatives to improve skills and efficiency. Training employees
works, provided the employee also understand and accept the benefits of such
training.
Appraisal Costs:
a) Cost of incoming inspections (note that if suppliers adopt a total quality
approach, the cost of incoming inspections can be eliminated)
b) Cost of set-up inspections
c) Cost of acquiring and operating the process control and measuring
equipment.
Non-conformance costs are divided into ‘internal failure’ costs, that occur
when the units produced fail to reach the set standard; and ‘external failure’
costs.
External Failure Costs:
These arise when the faulty product is not detected until after it reaches the
customer.
a) Marketing costs associated with failed products and loss of customer
goodwill
b) Manufacturing or process engineering costs relating to failed products
Compensation/replacement for units returned by customers Repair
costs
c) Travel costs to visit sites with faulty products
d) Liability claims
Internal failure costs include:
These arise when the faulty product is not detected until after its made but
before it reaches the customer.
a) Costs of scrap
b) Reworking costs
c) Manufacturing and process engineering required to correct the failed
process
It is generally accepted that an increased investment in prevention and
appraisal is likely to result in a significant reduction in failure costs. As a
result of the trade-off, there may be an optimum operating level in which the
combined costs are at a minimum. In short, an investment in “prevention”
inevitably results in a saving on total quality cost
Recognising the importance of quality:
1. Accept that the only thing that matters is the customer. The only way to
stay in business is to relate everything to customer priorities.
2. Recognise the all-pervasive nature of the customer/supplier relationship.
This includes internal customers.
3. Move from relying on inspecting to a predefined level of quality, to
actually preventing the cause of the defect in the first place.
4. Each operative or team of operatives must be personally responsible for
defect-free production or service in their domain.
5. In production there should be a move away from acceptable quality
levels (AQL) to defect levels measured in parts per million.
6. Enforce zero defect programmes.
7. Quality certification programmes should be introduced.
8. The total cost of quality should be emphasised. Quality does generate
savings. For example, better trained operators do not waste material nor
do they abuse machines and equipment. Other savings can be achieved
by reviewing suppliers, preventive machine maintenance and reduction
of scrap and rework
Commitment to quality:
For TQM to bring about improved business efficiency and effectiveness it must
be applied throughout the whole organisation. It begins at the top with the
managing director, the most senior directors and managers who must
demonstrate that they are totally committed to achieving the highest quality
standards.
The role of middle management is also crucial. They have to understand the
importance of TQM and communicate this and their own commitment to
quality to the people for whom they are responsible.
It is essential that TQM is adopted by all parts of the organisation. Middle
management must ensure that the efforts and achievements of their
subordinates receive appropriate recognition, attention and reward. This helps
secure everyone’s full involvement –which is crucial to the successful
introduction of TQM.
Quality chains:
Throughout and beyond all organisations, whether they are manufacturing
concerns, retail stores, universities or hotels, there is a series of quality
chains. The ability to meet the customers’ requirements is vital, not only
between two separate organisations, but within the same organisation.
These quality chains may be broken at any point by one person or by one
piece of equipment not meeting the requirements of the customer, internal
or external.
To achieve quality throughout an organisation, each person in the quality
chain must be trained to ask themselves the following questions:
Customers:
Who are my internal customers?
What are their true requirements?
How do I find out what the requirements are?
How can I meet those requirements?
Suppliers:
Who are my internal suppliers?
What are my true requirements?
How do I communicate my requirements?
Do my suppliers have the capability to meet my requirements
Quality circles:
A quality circle is a team of four to twelve people usually coming from the
same area who voluntarily meet on a regular basis to identify, investigate,
analyse and solve work-related problems. The team presents its solutions to
management and is then involved in implementing and monitoring the
effectiveness of the solutions. The voluntary approach and the process by
which the team selects and solves its own problems are key features which
give the quality circle a special character: a character which is very different
to other problem- solving teams.
The problems that circles tackle may not be restricted to quality of product or
service topics, but may include anything associated with work or its
environment. Items such as pay and conditions and other negotiated items
are, however, normally excluded.
Successful implementation of TQM:
An organisation should undertake to achieve each of the following to ensure
TQM is successful:
1. Total commitment throughout the organisation.
2. Get close to their customers to fully understand their needs and
expectations.
3. Plan to do all jobs right first time.
4. Agree expected performance standards with each employee and
customer.
5. Implement a company-wide improvement process.
6. Continually measure performance levels achieved.
7. Measure the cost of quality mismanagement and the level of
firefighting.
8. Demand continuous improvement in everything you and your
employees do.
9. Recognise achievements.
10.Make quality a way of life
Non-financial measures include:
1. The strive to reduce the material price variance often led to the use of
inferior quality material
2. the costs of normal losses were absorbed by good output.
3. Number of defects at inspection expressed as a percentage of the
number of units completed.
4. Number of reworked units expressed as a percentage of total sales
value.
5. Number of defective units delivered to customers as a percentage of
total units delivered.
6. Number of customer complaints.
7. Number of defective units supplied by suppliers.
8. Time taken to respond to customer requests.
Throughput accounting and the Theory of Constraints:
The term throughput is defined by the following equation:
Throughput = Sales revenues less Direct material cost
The aim of throughput accounting is to maximise this measure of throughput.
The aim is to identify the bottlenecks and remove them or, if this is not
possible, ensure that they are fully utilised at all times. Non-bottleneck
resources should be scheduled and operated based on the constraints within
the system, and should not be used to produce more than the bottlenecks
can absorb.
The process of identifying and taking steps to remove the constraints that
restrict output as the theory of constraints (TOC).
The only cost that is deemed to relate to volume of output is the direct
material cost. All other costs (including labour costs) are deemed to be fixed.
These fixed costs may be called total factory costs (TFC)
Performance measures to measure throughput:
Return per factory hour:
Throughput per unit/Product time on bottleneck resource.
Cost per factory hour:
Total Factory costs/ Total time on the bottleneck resource
Throughput accounting ratio:
Return per factory hour/cost per factory hour.
Kaizen costing:
Continuous improvement, or ‘Kaizen’, is an integral part of the just-in time
management philosophy.
‘Kaizen’ is a Japanese term meaning to improve processes via small,
incremental amounts rather than through large innovations. Kaizen costing is
a planning method used during the manufacturing cycle that emphasises
reducing variable costs of a period below the cost level in the base period.
The organisation should always seek perfection. Perfection is never achieved,
so there must always be some scope for improving on current methods and
procedures. Improvements should be sought all the time.
Improvements will be small and numerous rather than occasional and far-
reaching.
Cost reduction targets are set and applied on a more frequent basis than
standard costs. Typically, these targets are set on a monthly basis whereas
standards within a traditional standard costing system are set annually or
perhaps semi-annually.
KAIZEN PROCESS:
Standardise an operation or activity
Measure the operation
Compare measurements against
requirements
Innovate to meet requirements and
increase productivity
Standardise the new, improved operation
Repeat on a continuous basis.
Standard costing concepts Kaizen costing concepts
Cost Control system Cost Reduction system
Assume current manufacturing Assume “Continuous improvement” in
conditions manufacturing
Meet cost performance Achieve cost reduction targets
Standard costing techniques Kaizen costing techniques
Standard are set manually or semi- Cost reduction targets are set and
manually applied monthly.
Cost variance analysis involving Kaizen is implemented during the year
standard costs and actual costs to attain target profits or to reduce the
gap between target profit and
estimated profit
Investigate and respond when Cost variance analysis involving target
standard are not met. kaizen costs and actual costs reduction
amount.
Business Process Re-engineering:
The continuous improvement philosophy contrasts sharply with the concept
underlying business process re-engineering (BPR). BPR is concerned with
making far-reaching one-off changes to improve operations or processes.
BPR is defined as 'the fundamental rethinking and radical redesign of
business processes to achieve dramatic improvements in critical
contemporary measures of performance such as cost, quality, service and
speed.' In other words, BPR focuses on amending existing processes,
streamlining processes that are already in place
Five stages are normally recognised in any BPR project:
1. Develop the business vision and process objectives. State which
improvements are expected from processes based on some overall
business vision of Total Quality Management.
2. Identify the processes to be redesigned. Most firms tend to focus on
the more important processes, although significant improvements may
still be obtained by redesigning inefficient processes in any part of the
organisation.
3. Understand and measure the existing processes so that a baseline
against which to measure improvement is set.
4. Identify 'IT levers’ that can be used to apply change.
5. Design and build a prototype to show which changes are possible, and
involve customers before implementing any revised system
Value added analysis:
This BPR re-engineering pattern looks at the process (or sub-process) from a
customer’s perspective. A process or activity is said to add value if it increases
the worth of a product or service to the customer (for example, adding a sun-
roof to a car).
To be classified as ‘value-adding’, an activity must meet three criteria:
a) the customer is willing to pay for the output
b) the activity physically changes the output in some way
c) the activity is performed correctly at the first attempt.
Value adding activities:
Value-adding activities are distinct from ‘non-value-adding activities’,
such as:
• preparation and set-up
• control and inspections
• simply moving a product from one place to another without
physically changing it
• activities that result from delays or failures of any kind.
Non value-adding activities are those that do not increase the worth of the
product to the customer. Common examples are ‘inspection time’ and ‘idle
time’ in manufacturing. It is usually not possible to eliminate these activities
but it is often possible to minimise them.
Supply chain management:
Supply chain management is often explained with reference to Porter’s value
chain and value systems. A supply chain is the network of customers and
suppliers that a business deal with.
Recent decades have seen an increasing rate of globalisation of the economy
and thereby also of supply chains. The days when products were produced and
consumed in the same geographical area are long past. In fact it is often the
case that the different components of a product come from all over the globe.
Such a trend causes longer and more complex supply chains and thus changes
the requirements within supply chain management.
This, in turn, affects the effectiveness of the IT systems employed within the
supply chain. A longer supply chain often results in a lengthening of order-to-
delivery lead times.
Supply chain management considers logistics but also relationships between
members of the supply chain, identification of end-customer benefit and the
organisational consequences of greater inter-firm integration to form ‘network
organisations’
Supply chain management may be broken down into several areas:
Purchasing:
It is important for a company to work closely with its suppliers. A true
partnership will enable a better, faster and more reliable service. Purchasing
costs can be reduced by more than 10% when information systems are linked.
Day-to-day purchasing, progress chasing and stock control can all be
eliminated.
Inventories:
Efficient inventory control relies upon accurate customer records, well-
managed customer information and effective inventory-control information
systems. A close collaboration with suppliers and customers will enable
inventory levels to be kept to a minimum. Working more closely with the
supply chain partners will require mutual trust and investment in technology,
but it will bring benefits to all concerned.
Customer ordering:
From the customer’s perspective the ordering process should be fast, flexible
(meet individual customer needs) and efficient. A satisfied customer is more
likely to return for repeat orders. Factors such as price, quality, availability
from inventory etc. are important, but a fully automated fulfilment procedure
also plays a key part in overall customer satisfaction. On-line ordering is
becoming a prerequisite for many customers today. Orders should be
processed smoothly within the firm. Purchasing, inventory control, marketing
and accounts should all be linked to the customer-
ordering process.
Delivery and logistics:
Delivering to the customer is often the culmination of all the business
processes. Customers will expect fast, reliable, accurate and predictable
delivery schedules. Tracking systems such as radio frequency identification
(RFID) enable companies to trace the physical progress of the customer order.
Outsourcing:
Traditionally the insourcing/outsourcing decision was focused on a make-or-
buy decision for manufacturing functions. However, companies are now
beginning to apply the decision analysis to nearly all functions and activities.
