68 CHAPTER 2 TRADITIONAL STAGE It COST SYSTEMS equipment and the type of tests to be performed at exch station. 1Cs, for example, could follow six different Hows through the facility. While some ICs only re- uiced clectrical testing at room temperature, solder abiliey, and leak detection, others also (equired thermal shock and burn-in, Fach type of component required separate software development, end custom tools and Axuures were often required. Software, tools, and fixtures were developed by the engineering group, which was made up of spe- cialists in software development, equipment. mainte ‘hance, calibration ené repais, tooling and Hixturing, and testing equipment operation. Software engineers devel- oped programs for specific applicstions. The programs were then retained in & software library for future use. ETO had 6,500 different software programs on file, of which 1 300 were programs developed in the past year ETO also had an inventory of 1,500 tools and fixtures, ‘of which 200 had been developed in the past year. The large number of tools and fntures allowed the testing of components with a wide variety of leads, pin combina dons, and mating configurations, ‘The testing facility was divided into two rooms. The ‘main testing room contained the equipment used for electrical wsting, The mechanical room contained the equipment used for mechanical testing, plus incoming receiving and the stockroom. A total of 20 people worked in the (Wo rooms oa each of fw mein Shifts, and 10 people worked on the night shift Cost Accounting System The cost accounting system measured two components of cost direct labor ané burden. Burden was gronped into a single cost pocl which included burden ascoci- ated with each of the testing coors, as weill as the engi- acering burden costs relating co software and tooling development and the acministraive costs of the divi- sion. Toral burden costs were divided by the sum of testing and engineeting labor doliars to ante at a bur- den rate per direct labor dollar. The division costed each lot of components. Burden was calculated for exch lot by muliplying the actual direct labor dollers associated: with the lot by the 145% of burden rate, The resulting burden was then added to the actual dizeet labor costs to determine the lot's total cost. In 1988, the facility-wide burden rate was 145% of each direct labor doilat, of Which more than 25% wes attributable to equipment de- preciation (see Exhibit 2), Signs of Obsolescence Several trends pointed to the ebsolescence of the labor based Durden allocation process. Since the foandine of the division im 1983, direct labor honrs per Tot tested had been declining steadily, This trend was aggravated by an increased dependence on vendor certification. Vendor certification wes a key component of ju delivery. With vendor certification, Sel grams suppliers did the primary testing of components, ETO then utilized statistical sampling to verify that the ‘supplier's production process was stil in control. Thus, while JIT fed to an increased number of sinallerfots be ing received by ETO, vendor certification reduced the namiber of tests performed. Barly indications were that JIT deliveries would account for 309%) of Seligram’s shipments within the nest ive yeu. In addition te declining direct labor content and fewer test lots, the obsolescence of the labor-based allo: cation system was intensified by a shift from simple in: spection services to broader based test technelogy. On complex puts requiring sereening, environmental con- ltioning, and testing, the division was consistently chesper than outside services. Where only elementary testing was reqnited, however, low-tech outside labora tories were often cheaper, especially on large loss. The advantage that the division brought customers over the Outside Tabs was that the later provided essentially no engineering support, whereas ETO with its resident en- gineering resources was able to support such service on 4 sapid and cost-effective hasis. The shift ro more tech. aieally sophisticated services prompted a shift in the k bor mix (rom dizect to indirect personnel. ‘Ike division expected to see a crossover etween engineering head sount and hourly head count early in the 1990s. Finally, the introduction of higher technology com- ponents created the need for more automatic testing longer test cycles, and more data per part. Digital com- Ponents, for example, were currenlly tested for up to 100 ceneitious (combinations of electrical input and output states) The new generation of digital compo- eats, on the other hand, would be much more complex and require verification of up to 10,000 condit ‘These would require very expensive highly automated equipmets. This increase in eutorsation would, in urn, lead 0 a smaller base of direct laber (0 absorb the de- preciation costs ofthis new equipment ‘These were fears thet the resulting increase in buuden sates would drive some customers away. BYO had inns omnes teenaein ee con piasmonoineseTT already noticed an increase in the number and fre quency of complaints ftom customers regarding the fates they were charged for testing. ‘The division’s accounting manager groposed a new cost aceounting system to alleviate the problem. Under this new system, burden would be directly traced 1 two cost pools. The first pool would contain burden re- lated to the administrative and technical functions (4i- vision management, engineering, planing, and admin- istrative personnel. This poo! would be charged on a rate per direct lebor dollar. Tae soeond pool would in- clude all other burden costs and would be charged based on machine hours. Exhibit 3 provides the pro- posed burden rates. Shorly after the sevounting manager submitted his propesal, a consultant hired by Seligram’s corporate management prepared an assessment of ETO"s cost sys- tem. He recommended the implementation of a three~ turden poo! system utilizing separate bardea centers for each test room and a common technical and administra- tive pool, Burden would be disceily taced each of the three burdon pools, Like the accounting manager's stem, burden casts in the test rooms would then be al- located on a machine hour basis. Technical and admin- isicative eosis would continue to be charged on a rate per ditect labor dolla To examine the impact of the wo altcenative sys- ems, ETO management asked that @ study be con- dacied on a representative sample of pers. Exhibit $ provides a breakdown of actual direct labor aad ma chine hour requirements per lot for the five components seleoted for the study. Technological Future In 1988, the division faced major changes in the tech nology of testing that required importa equipment ac- quisition decisions. The existing testing equipment was Belting ofd and would not be able to keep pace with developments in component tecknology. Existing coin: onenis, for example, had berween 16 and 40 input) ‘output terminations (¢-g. pins or other mating config CHAPTER 2 TRADITIONAL STAGE M1 COST S¥SiEMS 69 rations), andl ETO's equipment could handle up 10 120 ferminations. Although the 120-termination limit had only been reached 2 couple of times in the past few years, @ new generation of components with up to 256 ‘erminstions was already being developed. Similarly the upper limit of frequency on existing components ‘was 20 MHz, (million eycles per second), whereas the frequency on the next generation of components wes expected to be 5D MHz, The equipment cequited to test the neat gencration of comportents would be expensive. Each machine cost ap- proximately $2 million. Testing on this equipment would be more sutomated than existing equipment, with longer test cycles and the generation of more test ata per part. It was also likely that lot sizes would be Target. The new equipment would not replace the exist- ing equipment but would merely add capapilities ETO) dic not currently possess. Additionally. the new equip- ment would only be needed to service the requirements ‘of one or two customens in the foreseeable future. Ex- bit 5 provides a summary of the new equipment’s eco- nomics and operating charactevisties ‘The impect of this new equipment would be an ac- cceleration in the deetine in direct labor hours per lot of omponents. At the same time, borden would increase with the additional depreciation and engineering costs associated with the new equipment, This would resalt in a laege increase in the burden rate per direct Ishor dol Jer. As Paul Carte, Mansger of ETO, saw it, the acguisi sion of the new equipment could have a disastrous etfect fon the division's pricing structure if the labor:hased al Tocation system remained in use: We plan on investing $2 millon on a large electmoic tes ing machine to tt the chips of ore or iso customers. Tis smacine will be very fast ang will require tle ret a bor. Its acquistion will nave « significant effect an aus per direct labor dollar burden sate, which will result n a in crease in charges to our other customers, [ts clear ht ¢ number of customers wil walk away if we ty’ to pass this increase on. Tarn afraid that we will lowe 25% of our cus tomer hase if we don’t change our cost system70 caster 2 TRADITIONAL STAGE 8 COST sistens HBT SELIGRAM, INC. ELECTRONIC TESTING CENTER 1988 Budgeted Expenses Direct labor $9,260,015 Indirect labor 359,242 Salary expense 394211 Supplies & expenses 335.079 Sennces 245.226 Personnel allocations! 229140 Service allocations! 2438134 Total budgeted expences $2,973,097 ‘idades tod reper compat pense, eintenenr Sere and VCE ct telefon thes dso ncades incr nduslard vrploesfngs toni, ponomel depart ‘meet seniy, Rree/warchonsing and hobs aca ine Shadee badng seupansy loaphones depron, sor EXHIBIT 2 SELIGRAM, INC. ELECTRONIC TESTING OPERATIONS Caleulation of Burden Rate Based on 1988 Plan Indirect labor 059 282 Salary expense g94211 Supplies & expenses 536,029 ce 249,226 Personnel allocations 229) Service allocations 2408131 “Total burden $4713.982 TOTAL DURDEN $ arden 1 ‘TOTAL DURDEN ¢ a te DIRECT LABOR $ 3,260,015 i 144.69, Etective rate 143% aprecition 2ssa00 Other Bawa ey “atl bandos fcc dee ecientRATT prcnrassemmannssnat CHAPTER 2 exHueir 2 SELIGRAM, INC, ELECTRONIC TESTING OPERATIONS Proposed Burden Rates Based on 1988 Flan MACHINE HOUR RATES (MACHINE HS BURDEN § Main test room, 33,201 32,103,116 Mechanical test room 17.403 11926263 Total 30304 84029379 Burden $_ _ $4,029,379 Machine Hout Rate'= Si caine His 50,304 TEifective machine hour rate = $80.00 Rate per Direct Labor Hour Total engineering & aciministrative burden § = $684,605? Total direct laber dollars = $3,260,019" wurden rote ~ Engr & admin $ _ _$6846(3. _ , Burden rate = Tyrac Ibe 8 33,260,018 7 2% Eifective burden rate per direct Inbor $ = 20% Burdon Fed Visite Bypechaion Gir Taal Mantes mon $8737 fF 48770" SL ineOss 2.0016 Mechanica! ert oom 4c 882 Taal burden Harp yample $4505 Depreaaton 341118 otter 195,390 Tita ssa505 Mistude ll ze bor ets, cud det Adee nace inbowh test oom newb engine, EXHIBCT 4 SELIGRAM, INC. ELECTRONIC TESTING OPERATIONS Direct Lator and Machine Hour Reculrements ‘Actual for One Lot Mace 0uRS DIRECT MAK saci —___titons__noomt noose _torat KA $917 85 100g cB 2051 026.0400 Capacitor 1094 30 45 25 Amplifier 525 40 10 30 Diode 519 70 50120 TRADITIONAL STAGE H COST SYSTEMS TH