Quality, Time, and Theory of Constraints

National Chengchi University

2007.5.9

1 Quality as a Competitive Tool

A product is a quality product if it conforms with the design and customers’
expectation. Design quality refers to how closely the characteristics of a prod-
uct or service meet the needes and wants of customers. Conformance quality
refers to the performance of a product or service relative to its design and prod-
uct specifications.
Total quality management (TQM) is the unyielding and continuous effort
by everyone in the firm to understand, meet, and exceed the expectations of
customers. Certain characteristics of most TQM are:

• Focusing on satisfying the customer

• Striving for cotinuous improvement

• Fully involving the entire work force

• Actively supporting and involving top management

• Using unambiguous and objecitive measures

• Recognizing quality achievements in a timely manner

• Continuously providing trainning on total quality management

2 The Financial Perspective: Costs of Quality

Cost of quality are costs of activities associated with prevention, identifica-
tion, repair, and rectification of poor quality and opportunity costs from lost
production time and lost sales as a result of poor quality.

1. Prevention Costs — costs incurred to keep quality defects from occuring.

• quality trainning costs

• quality planning costs

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 • equipment maintenance costs
• supplier assurance costs
• information system costs1
• product redesign and process improvement
• quality circle2

2. Appraisal Costs — costs incurred to detect which of the individual units

of products do not conform to specifications.

• test and inspection costs

• acquisition cost of test equipment and instrument
• quality audits3
• laboratory acceptance testing
• field evaluation and testing
• information costs4

3. Internal Failure Costs — expenditures spent to find the cause of failure

and to correct the problem.

• costs of corrective action

• rework and scrap costs
• process costs
• expediting costs5
• reinspect and retest costs
• lost contribution due to increased demand on constrain resources

4. External Failure Costs — costs incurred on degective products after they

are shipped to customers.

• repair or replacement costs

• costs to handle customer complaints and returns
• product recall and product liability costs
1 Costs expended for developing data requirements and measuring, auditing, and reporting of

data on quality.
2 A quality circle is a group composed of workers who meet together to discuss workplace im-

provement, and make presentations to management with their ideas. Typical topics are improving
safety, improving product design, and improvement in manufacturing process.
3 Salaries and wages of all personnel involved in appraising the quality of products and services

and other expenditures incurred during quality appraising.

4 Costs to prepare and verify quality reports.
5 Costs incurred to expedite manufacturing operations due to time spent for repair rework.

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 • lost sales due to unsatisfactory products and customer ill will
• costs to restore reputation

Prevention and appraisal costs are costs of conformance becasue they are
incuured to ensure that products or services meet customers’ expectations. In-
ternal failure costs and external failure costs are costs of nonconformance.
They are costs incurred and opportunity costs because of rejection of products or
services. The costs of quality is the sum of conformance and nonconformance
costs.

CASE 1: Cost-of-Quality Reports (page 625∼627)

Answer: Exhibit 19-2. ♣

3 Types of Conformance
Goalpost conformance is conformance to a quality specificatoin expressed as
a specified range around the target. Absolute quality conformance (or the
robust quality approach) requires all products or services to meet the target
value exactly with no variation. The Taguchi quality loss function depicts the
relationship between the total loss to a firm due to quality defects.6

L ( x ) = k ( x − T )2 (1)

where:
x = an observed value of the quality characteristic
T = the target value of the quality characteristic
k = the cost coefficient, determined by the firm’s costs of failure

4 The Customer Perspective: Nonfinancial Measures

of Customer Satisfication
• Market research information on customer preferences for and customer
satisfication with specific product features (to masure design quality)

• Market share

• Percentage of customers that give high rating for customer satisfaction

6 Read my further supplements.

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 • Number of defective units shipped to customers as a percentage of total
units shipped

• Number of customer complains

• Percentage of products that fail soon after delivery

• Delivery delays (difference between the scheduled delivery date and the
date requested by the customer)

• On-time delivery rate (percentage of shipments made on or before the

scheduled delivery date)

5 The Internal-Business-Process Perspective: Ana-

lyzing Quality Problems and Improving Quality
• Control charts

• Pareto diagrams

• Cause-and-effect diagrams

CASE 2: Relevant costs and benefits of evaluating quality improvement (page

630∼631)
Answer: Exhibit 19-6. ♣

6 The Learning-and-Growth Pespective for Quality

Improvements
• Employee turnover (ratio of number of employee who leave the company
to the average total number of employees)

• Employee empowerment (ratio of the number of processess in which em-

ployees have the right to make decisions without consulting supervisors
to the total number of processes)

• Employee satisfication (ratio of employees indicating high satisfication

ratings to the total number of employees surveyed)

• Employee training (percentage of employees trained in different quality-

enhancing methods)

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7 Time as a Competitive Tool
Customer-response time is how long it takes from the time a customer places
an order for a product (or service) to the time the product (or service) is deliv-
ered to the customer

• Receipt time: from customer places order to order received by manufac-

turing

• Manufacturing lead time: from order received by manufacturing to or-

der manufactured (becomes finished good)

– Waiting time: from order received by manufacturing to machine

setup begins for order
– Manufacturing time: from machine setup begins for order to order
manufactured (becomes finished good)

• Delivery time: from order manufactured (becomes finished good) to or-

der delivered to customer

A time driver is any factor that causes a change in the speed of an activity
when the factor changes.

1. Uncertainty about when customers will order products or service

2. Bottlenecks due to limited capacity

Average waiting time (AWT) is the average amount of time that an order
will wait in line before the machine is set up and the order is processed.

EXAMPLE 1:

• Average number of order = 30 (Order = 30)

• Each order is for 1,000 units

• Each order will take 100 hours (TI ME = 100)

• Actual capacity of the machine is 4,000 hours (CAP = 4, 000)

Order × TI ME2 30 × 1002

AWT = = = 150 hours
2 × [CAP − (Order × TI ME)] 2 × [4, 000 − (30 × 100)]

EXAMPLE 2: Introduce a new product.

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 • Average number of the new order = 10 (Order2 = 10)

• Each order is for 800 units

• Each order will take 50 hours (TI ME2 = 50)

Order1 × TI ME12 + Order2 × TI ME22

AWT =
2 × [CAP − (Order1 × TI ME1 ) − (Order2 × TI ME2 )]

30 × 1002 + 10 × 502
AWT = = 325 hours
2 × [4, 000 − (30 × 100) − (10 × 50)]

Introducing the new new product causes average waiting time for an order
to more than double (from 150 ⇒ 325) hours. With the addition of this new
product, average manufacturing lead time for the “old” product now is 425
(325 + 100), and for the “new” product 375 (325 + 50). Note that the “old”
product spends 86.7% (325 ÷ 375) of its manufacturing lead time just waiting
for a manufacturing to start.

EXAMPLE 3: To introduce or not to introduce.

Price Price Direct Material Cost Invenotry carrying cost

Product Order AWT < 300 AWT > 300 per order per Order per Hour
Old 30 $22,000 $21,500 $16,000 $1.00
New 10 10,000 9,600 8,000 0.5

Alternatives:

1. Old + New

• Expected Revenue: $21, 500 × 30 + $9, 600 × 10 = $714, 000

• Expected Variable Cost: $160, 000 × 30 + $80, 000 × 10 = $560, 000
• Expected inventory carrying costs: (425 × $1.00 × 30) + (375 × $0.50 ×
10) = $14, 625
• Expected revenues minus expected costs: $166,375

2. Old Only

• Expected Revenue: $22, 000 × 30 = $660, 000

• Expected Variable Cost: $160, 000 × 30 = $480, 000
• Expected inventory carrying costs: (250 × $1.00 × 30) = $7, 500
• Expected revenues minus expected costs: $172,500

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8 Theory of Constraints and Throughput-Contribution
Analysis
The theory of constraints (TOC) describes methods to maximize operating in-
come when faced with some bottleneck and some nonbottleneck operations.
The TOC defines three measures:

1. Throughput contribution equals revenue minus the direct material costs

of the goods sold.

2. Investments equal the sum of materials costs in direct materials, work-in-

process, and finished goods inventories; R&D costs; and costs of equip-
ments and buildings

3. Operating costs equal all costs of operations (other than direct materi-
als) incurred to earn throughput controbution. Operating costs include
salaries and wages, rent, utilities, depreciation, and the like.

The steps in managing bottleneck operations are:

Step 1: Recognize that the bottleneck operation determines throughput

contribution of the entire system.

Step 2: Identify the bottleneck operation by identifying operations with

large quantities of inventory waiting to be worked on.

Step 3: Keep the bottleneck operation busy and subordinate all nonbot-
tleneck operations to the bottleneck operation. That is, the needs of the
bottleneck operation determine the production schedule of the nonbot-
tleneck operations.

Step 4: Take actions to increase the efficiency and capacity of the bot-
tleneck operation: The objective is to increase the difference between
throughput contribution and the incremental costs to increaseing effi-
ciency and capacity.

Several specific actions include:

• Eliminate idle time at the bottleneck operation.

• Process only those parts or products that increase throughput contribu-

tion, not parts or products that will remain in finished goods or spare
parts inventories.

• Shift products that do not have to made on the bottleneck machine to

nonbottleneck machines or to outside processing facilities.

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• Reduce setup time and processing time at bottleneck operations (e.g., by
simplifying the design or reducing the number of parts in the product)

• Improve the quality of parts or products manufactured at the bottleneck

operation.

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9 Exhibits

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