Business Growth & Development

Training Program
21 Feb 2023
 EGYPTIAN | GERMAN PRIVATE SECTOR INNOVATION (PSI)
WHITE CORP FOR CONSULTATION AND TRAINING

Business Growth & Development

Training Program

DAY 3

Product & Process Quality Management

Agenda
Day 3
09:00-09:45 12:15-12:30
Registration and coffee Break
break 12:30-14:30
9:45-11:10 Quality
Procurement and Management
Warehouses
14:30-15:30
11:00-11:15
Lunch Break
Break
15:30-17:00
11:15-12:15
Closing and Next Steps
Operational Costs
Procurement and Inventory
Purchasing in Supply Chain
 Purchasing Participants and Objectives

Types of Purchases
Capital expenditures
• Property, plant, and equipment; uses a request-for-quote (RFQ) process

Regular purchases
• Raw materials (includes subcomponents)
• Services
• Maintenance, repair, and operating (MRO) supplies
Directly used in product
• Direct materials
• Direct labor
Part of overhead (not directly used in product)
• Indirect materials
• Indirect labor
 Purchasing Participants and Objectives

Value-Added Role of Purchasing and Other Participants

▪ Which is more profitable, a 10% increase in sales or a
10% reduction in direct materials (or production) cost?
▪ Scenario: $10/unit price, 1,000 units/month, $5/unit
direct materials, $1/unit direct labor, $3,000 overhead
Purchasing Participants and Objectives
Purchasing Participants and Objectives

Purchasing Participants
▪ Marketing:
▪ Historically, purchasing – Reflects customer requirements
was sole responsibility of (order qualifiers and winners).
purchasing department.
▪ Engineers:
▪ Led to disconnects.
– Clearly specify requirements.
▪ Must work to ensure that
▪ Production planners/shop floor:
purchasing meets
– Right things received when
objectives for marketing,
needed.
engineers, production
planners. – Do rejects, scrap, rework, or
inventory holding outweigh cost
savings from cheaper supply or
ordering in bulk?
 Purchasing Participants and Objectives
Purchasing Objectives
Conventional
objectives
• Purchase correct goods and
services in specified quality
and quantity.
• Purchase at lowest total cost
(e.g., landed cost or total cost
of ownership).
• Minimize delivery lead times
and optimize other customer
service aspects (right time,
place).
Supply chain
management objectives
• Invest in partnerships with
key suppliers.
– Supplier relationship
management (SRM)
– Supplier certification
• Fulfill organizational
corporate social responsibility
and sustainability goals.
• Part of supplier selection
 Establishing External Supply
Purchasing Process
 Establishing External Supply

Establish Specifications: Functional Requirements

▪ Form, fit, function
▪ Purpose and how it integrates
▪ Quality
– Fitness for use and value for money (grade)
– Conformance to requirements (specification limits)
– Allowed number of nonconforming items (affects price)
– Inspections or trust?
▪ Description of all details (e.g., engineering drawings and process)
versus what it needs to do (e.g., physical or chemical characteristics or
performance requirements)
– Brand name
– Samples
 Establishing External Supply

Establish Specifications: Quantity and Price Requirements

▪ Quantity
– Units per order
– Order frequency
– Best cost: economies of scale, full truckload discounts
▪ Price
– What market will pay
– Material and service costs face this constraint
– Based on how much value it adds in eyes of consumer
 Establishing
Establishing External
External Supply Supply
Selecting Suppliers

Basic sourcing methods Selection criteria

Single- Assign weight; then rank

Sole-source source suppliers per factor:
supplier supplier • Technical/manufacturing
capabilities
• Location
Multisourcing • Price
• Reliability
• Supply chain maturity
• Service offerings
• Management attitude and
culture fit
 Establishing External Supply

Trusted Partners
Key suppliers Contracts for
(single-source, better Shared
long-term) relations destiny, vision

Communicate Supply chain Lean relies on

(e.g., bullwhip) cost, not shift quality

Shorter lead
times, better
quality
 Establishing External Supply

Managed Inventories
▪ Vendor-managed inventory (VMI)
– Can mitigate bullwhip effect
– Regularly scheduled inventory reviews and restocking
▪ Consignment
▪ Continuous replenishment
 Completing
Establishing the
External Purchasing
Supply Process
• Negotiate Contracts
▪ Purchase order (PO): one-time Negotiate on
• contract
▪ Contract buying (complex or
frequent need)
– Blanket POs: release materials• Price
• at predetermined delivery dates
• Terms and conditions
– Longer-term contracts: e.g., for • Delivery and quantity
trusted partners • Quality.
▪ Relative negotiating power (good
• alternatives?)
▪ Best alternative to negotiated
agreement (e.g., cost of doing it
in house, others on short list)
 Completing the Purchasing Process

Purchase Process Signals

Conventional Kanban
requisitions signals

MRP planned Buffer

order
releases replenishment
Purchase
Process
 Completing the Purchasing Process

Purchasing Cycle
 Responding to Supply Disruptions, Changes

Supply Disruptions and Changes

1. Mobilizing

5. Operation 2. Sensing

4. Configuration 3. Analyzing
 Measuring Supplier Performance

Supplier Performance
Monitor actual results and compare to goals:
• Policies and strategic priorities
• Total cost of ownership rather than just price
Give feedback:
• Improve process itself and control (e.g., prevent fraud).
• Help suppliers improve and meet goals.
– Initiate follow-up so they can self-correct.
– Scorecards track multiple goals and results per time period.

Metrics:
• Perfect orders
• Inventory buffer management
• Administration
• Speed of problem resolution
 Inventory and Inventory Management

Inventory: “Those stocks or items used to support

production (raw materials and work-in-process items),
supporting activities (maintenance, repair, and operating
supplies), and customer service (finished goods and spare
parts).”

Inventory management: “The branch of business

management concerned with planning and controlling
inventories.”
 Inventory Targets
Objectives of Aggregate Inventory Management

Minimize
inventory
investment.

Maximize
manufacturing
efficiency.
 Inventory Targets

Minimizing Inventory Investment

Total investment in inventory depends on perspective.
▪ Internal: Finance has incentive to push for low
inventory levels. (Purchasing may or may not.)
▪ Entire organization: May minimize inventories at
expense of others in supply chain.
– If suppliers hold more, more smaller lots increase total.
▪ Supply chain and lean perspective: Minimize total
inventory anywhere in supply chain; then sell more
due to lower price. (Share savings.)
 Inventory Targets

Maximizing Manufacturing Efficiency

▪ Smooth, uninterrupted flow; no over- or undercapacity.
▪ Decoupling supply from demand:
– Supplier from customer
– Work center from work center (diverse rates,
spontaneous bottlenecks)
– Capacity or materials available sooner than needed
▪ Other: Level strategy, long runs, few setups, large lots.
▪ Only good reason to hold inventory is when not
carrying it would be more costly overall.
 Types and Functions of Inventory

How Inventory Flows Through Supply Chain

 Types and Functions of Inventory

Functions of Inventory
▪ Safety stock
▪ Decoupling
▪ Buffers (per theory of constraints)
▪ Anticipation inventory (e.g., seasonal)
▪ Lot-size inventory (cycle stock)
▪ Transportation inventory
▪ Hedge inventory
 Inventory Valuation

FIFO, LIFO, and Average Cost

First In, First Out Last In, First Out Average Cost
To describe Pick from oldest Pick from newest Can’t pick
inventory items first items first average item;
movement (can may account for
mix methods) bulk storage
Accounting COGS Actual current Can’t get actual
method (just one), understated COGS cost from average
prices rising . . .
. . . prices falling COGS
overstated
Value of unsold Fairly current Given inflation, Halfway between
inventory can be grossly FIFO and LIFO
understated
 Safety Stock and Service Levels

Safety Stock
Basis for quantities at stockkeeping location
▪ Demand variability during lead time
▪ Targeted customer service level
▪ Order frequency
▪ Duration of lead time
 Safety Stock and Service Levels
Establishing Service Levels
▪ Level of service (customer service ratio or number of
allowed stockouts per period); for example, 95%
service level is 5% stockout percentage.

Safety stock is one way to

improve customer service.
 Safety Stock and Service Levels

Calculating Safety Stock for Service Level

▪ Can use standard deviation (SD), root mean squared
error (RSME), or mean absolute deviation (MAD)
▪ Assuming that forecast has minimized bias, error from
random variation will dictate safety stock level.
– This is demand variability during the lead time.
– Zero random variation = zero safety stock (always right).
▪ When no safety stock is held, there is only a 50%
chance of stockout (due to 50% chance of overstock).
 Safety Stock and Service Levels
Mean Absolute Deviation
 Safety Stock and Service Levels
Safety Factor Table (Abridged)
Customer Safety Factor
Service Level With SD With MAD
50.00 0.00 0.00
80.00 0.84 1.05
90.00 1.28 1.60
95.00 1.65 2.06
97.00 1.88 2.35
99.00 2.33 2.91
99.50 2.57 3.20
99.90 3.09 3.85

Safety Stock = SD or MAD in Units  Appropriate Service Factor for SAD or MAD

90% Service Level = 28 Units  1.60 = 45 units

 Safety Stock and Service Levels
Safety Stock Based on Acceptable Stockouts/Period
Period Demand Average 500 units
Orders per Period =
Order Quantity inventory
8,000
= = 20 Orders per Year
400

Units
250 units
Customer Service Level =
Orders per Period − Stockouts
Orders per Period
250 units
20 − 2
= = 0.9 = 90%
Units

20 125 units

Safety Stock at 90% =

28 Units × 1.60 = 45 Units Stockout opportunities

 Safety Stock and Service Levels
Adjusting Safety Stock Due to Lead Time Change
▪ More room for variability in longer lead times
▪ Approximation rather than recalculating MAD or SD for
multiple products (e.g., 45 units for 90% service,
6-week lead time currently):

√
New Safety Stock = Old Safety Stock × New Lead Time
Old Lead Time

5 Weeks = 45 ×
√ 5
6
7 Weeks = 45 ×
√ 7
6
= 45 × √ 0.83 = 45 × √ 1.17

= 45 × 0.91 = 41 Units = 45 × 1.08 = 49 Units

 Safety Stock and Service Levels
Stockouts: 5 per
Calculation of Safety Stock For Target Service Level
10-month period
10-month demand: 10,000 units Order quantity: 100 units MAD: 160 units

Step 1: Number of orders per 10-month period

Number of orders per 10 months = 10,000

= 100 orders
100

Step 2: Target service level

5 stockouts per 100 orders
Step 3: Safety stock level
= 95 orders with no stockouts
100 – 5
= = .95 or 95%
100

= 2.06 × 160 units = 330 units

 Safety Stock and Service Levels

Inventory Policies
▪ Stockkeeping unit (SKU)
– Unique part number (e.g., 6 colors, 5 sizes = 30 SKUs)
– Different SKUs based on location in distribution network
– Part numbers in plant don’t change based on location
▪ Wall-to-wall inventory
 Safety Stock and Service Levels

Safety Lead Time

▪ Protection from lead time fluctuations: order early
▪ MRP: firm planned order
▪ When used for independent demand ordering
systems:
– Temporary spike in inventory that resolves itself
– Preferred over safety stock for sporadic demand items
– If implemented incorrectly, supply partners see as
regular ordering time and order early too (like bullwhip
effect)
Inventory CostsInventory Costs

Item

Capacity-
related Carrying
Total Costs

Stockout Ordering
 Inventory Costs
Calculating Carrying Costs
Capital Storage Risk
costs costs costs

Financing cost Space Obsolescence

Opportunity cost Personnel Damage

Equipment Pilferage

Example: Insurance
• Capital costs 9% Storage costs 8%
Risk costs 7% = Total carrying cost rate 24% Deterioration
• Average inventory = $3 million per year
• Carrying costs = $720,000 per year

Carrying Cost = Carrying Cost Rate × Average Inventory Level in Dollars

 Inventory Costs
Calculating Ordering Costs
▪ Purchasing cycle costs (managing and expediting)
– Cost of each PO or each release against contract
▪ Factory costs
– Production control
– Setup (includes teardown)
– Lost capacity Fixed Cost
Average Ordering Cost per Order = + Variable Cost
Number of Orders
Example: $200,000 + $80,000
• $200k in annual wages = + $100
• $80k in operating expenses 4,000
• 4,000 orders per year = $170 per order
• $100 setup per order
 Inventory Costs

Tradeoff Calculation
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Sales forecast 2,000 3,000 4,000 3,000
Production 3,000 3,000 3,000 3,000
Ending inventory 1,000 1,000 0 0
Average inventory 500 1,000 500 0
Inventory cost $1,500 $3,000 $1,500 $0

Total cost of carrying anticipation inventory = $6,000

 Inventory Costs
Annual Cost Calculations

An importer operates a small warehouse that has the following annual

costs: wages for purchasing are $80,000, purchasing expenses are
$70,000, and customs brokerage is $45 per order. The estimated cost of
financing the inventory is 10 percent, storage costs are 7 percent, and
risk costs are 10 percent. The average inventory is $500,000, and
10,000 orders are placed in a year. What are the annual ordering costs
and carrying costs? What is the average ordering cost?

Annual ordering cost = $80,000 + $70,000 + ($45  10,000) = $600,000

Annual carrying cost = 27%  $500,000 = $135,000
Total annual cost = $600,000 + $135,000 = $735,000
Average ordering cost = $600,000  10,000 = $60 per order
 ABC Classification
ABC Inventory Control
Pareto’s law (80–20) basis for Value (factors may affect
ABC classification* individual ranking)
▪ A: critical few (10%–20% of items, 50%– ▪ Annual dollar usage
70% of value) (units × cost)
– High security, tightly controlled safety ▪ Bottleneck materials
stock, frequent counting
▪ Shelf life
▪ B: average (20% of items, 20% of value) ▪ Replenishment lead time
– Average controls and ordering ▪ Importance of stockout to
▪ C: trivial many (60%–70% of items, 10%– customers
30% of value)
▪ Turnover
– Order many few times a year, minimal
control or counting
*All percentages from APICS Dictionary, 16th edition, definition of ABC classification.
 ABC Classification
ABC Inventory Control Steps (Annual Dollar Usage)
1. Multiply annual unit usage by unit cost to find annual
dollar usage per product or product family.
2. Rank products by annual dollar usage (highest to
lowest).
3. Calculate cumulative percentage of total items.
4. Calculate cumulative percentage of annual dollar
usage.
5. Assign A, B, and C classifications based on step 4
(A: 50%–70% of value; B: 20%; C: 10%–30%*).
*All percentages from APICS Dictionary, 16th edition, definition of ABC classification.
 ABC Classification
ABC Inventory Ranked by Annual Dollar Usage
 ABC Classification

Cumulative Percent of Dollar Usage

 ABC Classification

ABC Classification Exercise

Item Annual
number dollar usage
1 $13,189
2 156,127
3 344
4 8,493
5 42,749
6 5,589
7 19,562
8 241,873
9 1,962
10 10,112
Total $500,000
 ABC Classification
ABC Classification Exercise
Annual Cumulative Cumulative
Cumulative
Item dollar percent percent of Class
dollar
number usage dollar usage items
usage
8 241,873 241,873 48.37 10 A
2 156,127 398,000 79.60 20 A
5 42,749 440,749 88.15 30 B
7 19,562 460,311 92.06 40 B
1 13,189 473,500 94.70 50 B
10 10,112 483,612 96.72 60 C
4 8,493 492,105 98.42 70 C
6 5,589 497,694 99.54 80 C
9 1,962 499,656 99.93 90 C
3 344 500,000 100.00 100 C
500,000
Design Supply Chain
Organization
Supply Chain Functions
Traditional Organization
Evolving Organization
Hybrid Organization
Operational
Costs
Intro Has nothing to do
with Costing
but with Business
 Stage 1 Stage 2 Stage 3 Stage 4 Stage 5
Existence Survival II Success III Taking off IV Maturity V
I
Operate
Success
Sell /
Retrenc
Make it Merge h

Failure
(endpoint
Sell C ++ Operate 7)

Head for Successfull

y Regroup
growth Re- (endpoint 6)
for Growth
Failure trench
Sufficientl
Unsuccessfull
y Dis- Sell / C+ y (endpoint 5)
prospe Engagement Merg
r
Minimally e Adapt (endpoint 3)
(endpoint 2)
Continu Re-
Exist No-
e trench
adapt (endpoint
C- 4) Fold Fold
Fail
Fold
Fol
d
sell C A : Sell Assets
CA (endpoint 1) Adapt and continue as is permanently or temporarily
C - : Sell at a loss
Fail C + : Sell at a Profit
Change in
Fol strategy C ++ : Sell at a greater Profit
d
Owner
Fold : Bankruptcy

Vs.
Busines
s
 Stage 1
• Many such companies never
gain sufficient customer
acceptance or product
capability to become viable.
In these cases, the owners
close the business when the
start-up capital runs out and,
if they’re lucky, sell the
business for its asset value.
endpoint 1
• the main problems of the
business are obtaining
customers and delivering the
product or service contracted
for.
• the owner does everything
and directly supervises
subordinates, who should be
of at least average
competence.
• Systems and formal planning
are minimal to non-existent.
• The company’s strategy is
simply to remain alive.
• The owner is the business,
performs all the important
tasks
• the owners cannot accept the
demands the business places
on their time, finances, and
energy, and they quit. Those
companies that remain in
business become Stage II
enterprises.
Stage 2
• In the Survival Stage, the
enterprise may grow in size and
profitability and move on to Stage
III. Or it may, as many companies
do, remain at the Survival Stage
for some time, earning marginal
returns on invested time and
capital (endpoint 2 )and
eventually go out of business
when the owner gives up or
retires
• The organization is still simple.
The company may have a limited
number of employees
supervised by a sales manager
or a general foreman. Neither of
them makes major decisions
independently, but instead carries
out the rather well-defined orders
of the owner.
• Business has enough customers
and satisfies them sufficiently
with its products or services to
keep them. The key problem thus
shifts from mere existence to the
relationship between revenues
and expenses. The main issues
are as follows:
1. In the short run, can we generate
enough cash to break even and to
cover the repair or replacement
of our capital assets as they wear
out?
2. Can we, at a minimum, generate
enough cash flow to stay in
business and to finance growth to
a size that is sufficiently large,
given our industry and market
niche, to earn an economic return
on our assets and labour?
Stage 3
• The decision facing owners at this stage is
whether to:
1. exploit the company’s accomplishments and
expand
2. or keep the company stable and profitable,
providing a base for alternative owner activities.
• Thus, a key issue is whether to use the company
as a platform for growth—a substage III-G
company— or as a means of support for the
owners as they completely or partially disengage
from the company—making it a substage III-D
company.
• Substage III-D. In the Success-Disengagement
substage, the company has attained true
economic health, has sufficient size and
product-market penetration to ensure
economic success, and earns average or above
average profits.
• It require functional managers to take over
certain duties performed by the
owner(competent but
• need not be of the highest calibre)
• the first professional staff members come on
board, usually a controller in the office and
perhaps a production scheduler in the plant.
Basic financial, marketing, and production
systems are in place. Owners actually choose
this route; if the company can continue to adapt
to environmental changes, it can continue as is,
be sold or merged at a profit, or subsequently be
stimulated into growth(endpoint 3)
• Substage III-G. :In the Success-Growth
substage, the owner consolidates the company
and marshals resources for growth. The owner
takes the cash and the established borrowing
power of the company and risks it all in
financing growth
• Operational planning is, as in substage III-D, in
the form of budgets, but strategic planning is
extensive and deeply involves the owner. The
owner is thus far more active in all phases of the
company’s affairs than in the disengagement
aspect of this phase
• If the III-G company is unsuccessful, the causes
maybe detected in time for the company to shift
to III-D. If not, retrenchment to the Survival
Stage may be possible prior to bankruptcy or a
distress sale.
Stage 4
• In this stage the key problems are
how to grow rapidly and how to
finance that growth. The most
important questions, then, are in the
following areas:
Delegation.
Can the owner delegate responsibility
to others to improve the managerial
effectiveness of a fast growing and
increasingly complex enterprise? Further,
will the action be true delegation with
control son performance and a
willingness to see mistakes made, or will
it be abdication, as is so often the case?
Cash.
Will there be enough to satisfy the great
demands growth brings(often requiring a
willingness on the owner’s part to
tolerate a high debt-equity ratio) and a
cash flow that is not eroded by
inadequate expense controls or ill-
advised investments brought about by
owner impatience?
those who bring the business to the
Success Stage are unsuccessful in Stage
IV, either because they try to grow too
fast and run out of cash (the owner falls
victim to the omnipotence syndrome), or
are unable to delegate effectively enough
to make the company work (the
omniscience syndrome).
If the company fails to make the big time,
it may be able to retrench and continue
as a successful and substantial company
at a state of equilibrium (endpoint 7). Or
it may drop back to Stage III (endpoint 6)
or, if the problems are too extensive, it
may drop all the way back to the Survival
Stage (endpoint 5) or even fail. (High
interest rates and uneven economic
conditions have made the latter two
possibilities all too real in the early
1980s.)
Stage 5
• The greatest concerns of a
company entering this stage are,
first, to consolidate and control
the financial gains brought on by
rapid growth and, second, to
retain the advantages of small
size, including flexibility of
response and the entrepreneurial
spirit. The corporation must
expand the management force
fast enough to eliminate the
inefficiencies that growth can
produce and professionalize the
company by use of such tools as
budgets, strategic planning,
management by objectives, and
standard cost systems—and do
this without stifling its
entrepreneurial qualities.
• A company in Stage V has the staff
and financial resources to engage
in detailed operational and
strategic planning. The
management is decentralized,
adequately staffed, and
experienced. And systems are
extensive and well developed. The
owner and the business are quite
separate, both financially and
operationally.
• The company has now arrived. It
has the advantages of size,
financial resources, and
managerial talent. If it can
preserve its entrepreneurial spirit,
it will be a formidable force in the
market. If not, it may enter a sixth
stage of sorts: ossification.
 Small Business Stage of Development

Success Success Resources

Existence Survival Take Off
disengagement growth Maturity
Management Direct Supervised
Functional Functional Divisional Line and Staff
Style Supervision supervision

Organizational
Structure

Formal System Not exist Minimal Basic Developing Maturing Extensive

Maintaining
Get resources Return in
Major strategy Existence Survival Profitable Growth
for Growth Investment
status quo
Owner Vs.
Business
Cost Accounting
Facts

1 2 3
All people do Cost They also mix up with Tracing product Activities
their products But pricing strategies is Not an Easy Job

What we`re going to cover

1 2 3
Comparison between ABC Cost Volume profit Case Study
and traditional Costing Analysis
Which Come First
“Cost or Price”?
Relations among Sales Price, Cost, and
Profit

1.Costs + profits = sales price

2.Sales price − profits = costs

What do you notice when you look at these two equations?

If you get the impression that they say the same thing, you have a knack for math.
Mathematically, there is no difference between the two equations.
However, if you are a business manager or someone fluent in finance concepts, you would
recognize the equation’s algebraic similarity, but you would also insist that they are two
completely different ways of thinking.

How can we explain this?

Relations among Sales Price, Cost, and
Profit
in the first equation costs + profits = sales price
1. the method for determining the sales price is to add a profit margin onto costs.
2. Specifically, we first identify and add up all the costs involved in manufacturing a planned
commercial product.
3. Then we tack on a profit margin to reach a sales price. We can call this the “cost up”
method.

The second equation sales price − profits = costs

1. Set sthe sales price according to the market price.
2. To do this, we first find out how much the planned product will likely fetch on the market
and take that value as the sales price.
3. Then we need to decide how big a profit margin is required.
4. The total costs are what is left over when we subtract the profit from the sales (market)
price.
5. After that, we can go on to ask questions like, “What kind of materials can we use and
still keep the costs within the equation’s total cost figure?” We can also work out our
choices of production methods and labor resources in this way.
 As can be seen, anatomically speaking, these two factories are
almost complete opposites

In the latter case, the sales price is set according to the “going price” on the market.
The company’s sales division is busy carrying out energetic
marketing activities in sales promotion, distribution channels, and other areas.
Meanwhile, all of the employees in the production division are equally busy with broad-
reaching efforts to completely eliminate human errors, product defects, and waste.
As a result, the company is able to maintain sales, suppress costs, and turn a good
profit. When profits rise, so does employee morale. In addition, management is more
willing to underwrite such initiatives as R&D, sales promotions, plant investment, and
improvement activities. Here we have an example of a profitable factory, fueled by
innovation. And remember, innovation is the key to success.
Pricing strategies
• Cost-plus pricing: Calculate your costs and add
a mark-up.
• Competitive pricing: Set a price based on what the
competition charges.
• Price skimming: Set a high price and lower it as the
market evolves.
• Penetration pricing: Set a low price to enter a
competitive market and raise it later.
• Value-based pricing: Base your product or service’s
price on what the customer believes it’s worth.
The Backscene
Impact the Income statement Could
evaporated
And also the Whole
strategy
The Breakeven
Point & CVP
 Breakeven Point and Target Operating Income

The breakeven point (BEP)

is that quantity of output sold at which total revenues equal total costs—that is, the quantity of
output sold that results in $0 of operating income. We have already seen how to use the graph
method to calculate the breakeven point.
we can calculate the breakeven point directly for any product Success rather than trying out
different quantities and checking when operating income equals $0.
Cost-Volume-Profit Graph
 Current Scenario

Share Percentage Factory Revenues Monthly Expenses 464 K

60 % 1.82 M 2.29 M Losse
s

53 orders 1.15 Raw material

Expenses

Same work force

1.27 Over
Head
Sales & Marketing
 Breakeven Scenario 1

Share Percentage Factory Revenues Monthly Expenses

Zero
Losses
60 % 3.67 M 3.45 M Zero
Profit
Increase Increase
Same Share
2x Current Volume 1.5 x Current Volume

106 orders 2.3 Raw material

Expenses
Same work force
1.3 Over
Head
Sales & Marketing
Costing Structuring
Cost accounting

Cost accounting is a process of assigning costs to

cost objects that typically include a company's
products, services, and any other activities that
involve the company.

Cost accounting purpose:

measure costs to enable performance analysis,

decision-making and internal reporting
Cost accounting

Objectives:
• Determine selling prices and each product
profit margin
• Costs controls and identify inefficiencies
Cost accounting

Types of costs
• Direct Costs
• Indirect Costs
• Fixed Costs
• Variable Costs
Cost accounting

Fixed costs
• Fixed costs are those that remain constant regardless of
the level of production or sales.
• These costs do not vary with changes in output or sales
volume and must be paid even if no goods or services
are produced.
• Examples include rent, insurance, salaries, loan
payments, depreciation, and other overhead expenses.
Cost accounting

Variable costs
• Variable costs are those that change with the level of
production or sales.
• These costs increase as output increases and decrease
as output decreases.
• Examples include raw materials, labor, commissions,
shipping fees, and other direct expenses related to
producing a product.
Cost accounting
Direct costs

• Direct costs are those that can be easily traced to a

specific cost object such as products.

• Examples include raw materials used in production,

labor used to produce a product, spare parts used for
machines, shipping fees for delivering products to
customers, etc.
Indirect costs

• Indirect costs are those that cannot be easily traced to a specific

cost object but still contribute to overall business operations.
• Examples include rent for office space used by all departments in
an organization; insurance premiums; salaries for administrative
staff; loan payments; advertising expenses; utilities; etc.

• These types of expenses are necessary for running an organization

but cannot be directly attributed to any product produced by the
organization.
Direct costs Vs Indirect Costs
Direct costs Vs Indirect Costs

• Direct costs are typically variable costs, which

means the cost fluctuates based on the production
volume.
• Indirect costs, on the other hand, tend to be fixed
costs, so the expense amount is independent of the
production volume.
Direct costs Vs Indirect Costs
Traditional costing
 How Traditional Cost Systems Allocate

• Most companies use ‘traditional’ cost systems

•Several choices for ways to allocate costs
•Allocate by the percentage:

1. Of volume produced
2. Of labor hours used

Simple Example : A factory produced 5 products and incurs

$100,000 in indirect costs.

• How much of the overhead should be allocated to the different

products?
Traditional Cost System Performance

Can provide a ‘representative’ cost

•Presuming the allocation method makes sense (eg. using labor as a factor when there is
a high labour content)
•Presuming the operation is not highly complex where a standard allocation method
would not capture the cost adding requirements
•Presuming the operation has enough volume over which to distribute the overhead costs
Highly relative
•Is it representative or accurate enough? How much more effort would be required to
make it more accurate?

And how much more would it cost to get that incremental accuracy?
Traditional Cost System Performance

• The traditional costing system is an accounting method

used to determine the cost of making products based on
allocating overhead (or indirect costs).

• This system relies on calculating predetermined average

overhead value per each product produced.
Traditional Cost System Performance
Traditional Cost System Performance

Traditional costing– How it works

1.Identify overhead costs
2.Estimate the overhead costs for a specific time period
3.Choose a cost driver to use in your calculations
4.Estimate the figure for the cost driver
5.Calculate the predetermined overhead rate
6.Apply the overhead rate to your product
Challenges
& Risks
Overhead Allocation Challenge

• Because overhead (manufacturing OH in this case) is an indirect

cost
• Not so easy when there is no direct relationship between the
product and the indirect cost
• How can the firm decide to allocate the overhead costs to provide
management with an informed assessment of the cost to produce
a product or serve a customer?

This is the challenge for the cost system.

Activity based
costing
Activity-based costing (ABC)

• Activity-based costing (ABC) is a method of assigning

costs to products or services based on the activities
that are required to produce them.
• It is an accounting system that assigns costs to activities
based on the resources they consume.
• ABC is used to identify and measure the cost of activities that are necessary
for producing a product or service, and then assigns those costs to
the product or service.
Activity-based costing (ABC)

Objectives:
• ABC is used by companies to better understand their
costs and make more informed decisions about pricing,
production, and other business operations.
• It helps companies identify areas where they can reduce
costs and increase efficiency.
• ABC also helps companies allocate resources more
effectively by providing a better understanding of how
their activities are related to their costs.
Activity-based costing (ABC)

Activity based costing – How it works

Activity-based costing (ABC)
Activity-based costing (ABC)

Activity based costing – How it works

1. The ABC process begins with identifying all the activities
involved in producing a product or service. This includes
both direct and indirect activities such as research and
development, marketing, customer service, manufacturing,
distribution, etc.
2. Once all the activities have been identified, each activity is
assigned a cost based on its resource consumption.
3. The total cost of each activity is then allocated to the
products or services it supports.
Activity-based costing (ABC)

Traditional costing VS Activity based

costing
• ABC can be used in conjunction with traditional costing
methods such as job costing or process costing.
However, ABC provides more detailed information
about how resources are being used in production
processes than traditional methods do.

This allows companies to make more informed decisions about pricing, production
processes, and other business operations.
 Activity-based costing (ABC)

Considerations in Implementing Activity-Based Costing Systems

Managers choose the level of detail to use in a costing system by evaluating the expected
costs of the system against the expected benefits that result from better decisions. There are
telltale signs of when an ABC system is likely to provide the most benefits. Here are some of
these signs:

• Significant amounts of indirect costs are allocated using only one or two cost pools. All or
most indirect costs are identified as output unit-level costs (few indirect costs are
described as batch-level costs, product-sustaining costs, or facility-sustaining costs).
• Products make diverse demands on resources because of differences in volume, process
steps, batch size, or complexity.
• Products that a company is well-suited to make and sell show small profits; whereas
products that a company is less suited to produce and sell show large profits.
• Operations staff has substantial disagreement with the reported costs of manufacturing
and marketing products and services.
Activity-based costing (ABC)
Traditional Costing VS (ABC) Costing
Traditional costing
• Short timeframe: When you
have a deadline approaching,
using traditional costing can
save time.
• Indirect costs are lower than
direct costs: This scenario can
occur when production requires
significantly more hands-on
labor than machine labor or
when a company produces only
one product.
Activity based costing
• Accuracy is key: When accuracy
is crucial, activity-based costing
is preferable because it looks at
more factors related to overall
costs, such as managerial,
facility and administrative costs.
• Indirect costs are higher than
direct costs: This situation
occurs in companies that rely
significantly on automated
production processes rather
than direct labor.
Activity based
costing
SOP
Activity based costing SOP

1. Measure Each product raw material cost based on its bill of

material.
2. Determine average monthly sales volume for each product.
3. Calculate production time study for each product through each
production process (activities).
4. Analyze factory expenses and calculate Indirect costs to direct
cost percentage.
5. Determine each workstation utilization and absorption factor.
6. Calculate direct cost for each machine (activity) per minute.
7. Calculate each product direct cost through activities and raw
material cost.
8. Allocate indirect cost (overhead costs) depends on activities and
their costs.
 Activity based costing SOP

Utilization Rate
Measures the efficiency at which a company can utilize its
employees to maximize productivity and output.
𝐴𝑐𝑢𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑣𝑜𝑙𝑢𝑚𝑒
1. Utilization Rate =
𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦

𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑒 ∗ 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠

2. Production maximum capacity (workstation) =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑚𝑎𝑐ℎ𝑖𝑛𝑒𝑠 𝑜𝑟 𝑜𝑝𝑒𝑟𝑎𝑡𝑜𝑟𝑠

𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
3. Production rate =
𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑡𝑖𝑚𝑒
 Activity based costing SOP

Absorption rate
There are risks associated with allocating overhead
without calculating work centers utilizations and know
actual production volume will be produced

What if the standard used is too low? Or too high?

The result is that the overhead will be overallocated to

some and under-allocated to other work centers
Activity based
costing
Case study
 Quality
Management
 What's Your
Quality
Perspectives?
 Quality

Degree to which a set of

inherent characteristics fulfils
requirement
 Quality
Definition 1: The ability of a product or service to
consistently meet or exceed customer expectations.

Definition 2: a: Peculiar and essential character.

b: an inherent feature. c: degree of excellence. d:
superiority in kind. e: a distinguishing attribute. f: an
acquired skill. g: the character in a logical proposition
of being affirmative or negative. h: vividness of hue.

Definition 3: The ability to meet standards.

Dimensions of Quality / products
• Performance - main characteristics of the
product
• Aesthetics - appearance, feel, smell, taste
• Special features - extra characteristics
• Conformance - how well product/service
conforms to customer’s expectations
• Safety - Risk of injury
• Reliability - consistency of performance
 Dimensions of Quality / products

• Durability - useful life of the product/service

• Perceived Quality - indirect evaluation of
quality (e.g. reputation)
• Service after sale - handling of customer
complaints or checking on customer satisfaction
 Examples of Quality Dimensions
Dimension (Product)
Automobile
1. Performance Everything works, fit & finish
Ride, handling, grade of materials
used

2. Aesthetics Interior design, soft touch

3. Special features Gauge/control placement

Convenience Cellular phone, CD player
High tech

4. Safety Antilock brakes, airbags

 Examples of Quality Dimensions

Dimension (Product)
Automobile
5. Reliability Infrequency of breakdowns

6. Durability Useful life in miles, resistance to rust &

corrosion

7. Perceived Top-rated car

quality

8. Service after Handling of complaints and/or requests for

sale information
Dimensions of Quality / Process

Performance

Reliability

Resilience
The Consequences of Poor
Quality

•Loss of business
•Liability
•Productivity
•Costs
The Consequences of Poor
Quality
• Loss of business: Customer quietly stops buying.
Customer complaints rarely reach to the upper
management.

• Liability: Due to damages or injuries resulting

from poor quality (design, conformance, ease of
use, service)

• Low productivity: Rework or scrap. More input

but does not increase the output.

• High costs
 Quality Perspectives
transcendent &
product-based user-based

needs
Marketing
Customer

value-based Design
products
and manufacturing-
based
services
Manufacturing
Distribution

Information flow
Product flow
 Quality Costs

There are four types of Quality Costs

1. Preventive cost
2. Appraisal cost
3. Internal failure cost
4. External failure cost
 Quality Costs / Preventive Cost
Preventive Cost: Any Efforts to Help People
“Do it right the first time and all the time.”
• Marketing, customer/user interaction
• Product/service/design development
• Purchasing and vendor partnership
• Operations (manufacturing/services)
• Quality engineering
• Quality administration
• Other prevention costs
 Quality Costs / Appraisal Cost

Appraisal Cost: Testing, inspection and related

equipment/supplies
• Purchasing appraisal cost: incoming goods or products
• Appraisal operations: testing and inspection
• External appraisal: field test outside company
• Data review
• Cost supporting appraisal efforts.
Quality Costs / Internal Failure Cost

Internal Failure Cost: Defects/problems prior to

shipping
• Product design failure
• Service failure
• Purchasing failure: incoming part failure
• Defectives/rejects/scraps/downgrading
• Repair or rework
• Materials review
• Corrective actions
Quality Costs / External Failure Cost

External Failure Cost: Problems after Shipping

• Complaint investigations
• Problem solving
• Failure analysis
• Returned goods
• Retrofit and recall
• Warranty claims
• Liability costs
• Penalties
• Others
 Quality Management

A philosophy that involves everyone in an

organization in a continual effort to
improve quality and achieve customer
satisfaction.
Quality Manual
 Quality manual

Quality manual is a document which

fully describes the quality
management system of an
organization
 Quality manual

• Clearly communicate information

• Serve as a framework for meeting
quality system requirements
• Convey managerial commitment
to the quality system.
 Quality manual
Example
..\..\Q\Manual\Quality.do
cx
Quality Metrics
 Cost of Quality
• Cost of quality is one of the most important, yet often
overlooked, metrics to monitor.
COQ = COPQ + COGQ
• Internal COPQ such as scrap, rework and re-inspection
• External COPQ when defects reach the customer, including
adverse event reporting, warranty, corrections and removals,
product liability and loss of brand reputation

COGQ is comprised of what you spend to create conforming

products, including:

• Appraisal costs such as inspection and testing, quality audits and

calibration
• Prevention costs such as statistical process control (SPC), quality
planning and training
Yield
• Yield is a classic measure of process or plant
effectiveness. Beyond total yield, consider monitoring
first-pass yield (FPY), the percentage of products
manufactured correctly the first time without rework.

REWORK
For example:
• 200 units enter A and 150 leave. The FPY for process A is 150/200 = .75
• 150 units go into B and 145 units leave. The FPY for process B is
145/150 = .97
• 145 units go into C and 130 leave. The FPY for C is 130/145 = .89
• 130 units got into D and 129 leave. The FPY for D is 129/130 = .99
 Defects

Defective parts per million (DPPM): Interchangeably called

parts per million (PPM) or defects per million (DPM), you can calculate
DPPM with the following formula:

Defects per million opportunities (DPMO): This metric is

more useful when looking at defects in subassemblies, which may have
multiple opportunities for failure.

𝑫𝒆𝒇𝒆𝒄𝒕𝒊𝒗𝒆 𝑷𝒂𝒓𝒕𝒔
𝑿𝟏, 𝟎𝟎𝟎, 𝟎𝟎𝟎
𝑻𝒐𝒕𝒂𝒍 𝑷𝒂𝒓𝒕𝒔 𝑿 # 𝑫𝒆𝒇𝒆𝒄𝒕𝒔 𝒐𝒑𝒑𝒆𝒓𝒕𝒖𝒏𝒊𝒕𝒊𝒆𝒔 𝒑𝒆𝒓 𝒑𝒂𝒓𝒕
Scrap
• Scrap rate is the percentage of materials sent to
production that never become part of finished products.
In addition, you’ll want to keep a close eye on total
scrap costs.

• Scrap to include in your calculations would be: vendor

scrap, internal scrap, and internal setup scrap.
Customer Complaints and Returns

Closely monitoring customer issues is the only

way to systematically prevent them. Figures to
help you track customer-related issues include:

• Complaints, rejects or returns over a specific period

• Number resolved during a specific period
• Average taken to resolve customer complaints
• Warranty costs
Supplier Quality Metrics
Supplier defect rate: Percentage of materials from
suppliers not meeting quality specifications

Supplier chargebacks: Total charged to suppliers for cost

of non-conforming materials (possibly including late delivery
and payroll costs)

Incoming supplier quality: Percentage of materials

received meeting quality requirements
Focusing on
Customers
 Who Are the Customers?

Defined as:

“Any person or organization that receives a product

or service (Output) from the work activities
(Process)” Whose needs must be met for this
process to be successful?
 Types of “customers”

External: Individuals or organizations outside of your

business who are usually associated with paying money for
your products and services

Internal: Colleagues who receive products, services,

support or information from your process – i.e. Engineering,
Manufacturing, Quality, Marketing, Regulatory: Any
government agency that has standards the process or
product must conform to

Which customer?
Customers can often be logically placed into groups or
segments (not all customers should be treated equally)
Customer-Driven Quality Cycle
Customer needs and expectations
(expected quality)

Identification of customer needs

Translation into product/service specifications

(design quality)

Output (actual quality)

Customer perceptions (perceived quality)

measurement and feedback

Generic Practices of Successful Companies

• They understand the voice of the customer

(VOC)
• They understand linkages between VOC
and design, production, and delivery
• They promote trust and confidence
• They have effective customer relationship
management processes
• They measure customer satisfaction
 The Voice of Customers

“Voice of the Customer” (VOC) is the expression of

customer needs and desires

Compare the VOC to what the process actually is

or what the process is actually delivering!
 4 Steps to Validating the VOC

1. Gather the Voice of the Customer (VOC)

2. Translate the VOC into Critical to quality
(CTQ)
3. Convert the CTQ into Key Process Output
Variables.
4. Create a tactical Process Map chart
 1. Gather the Voice of the Customer (VOC)

Sources of Customer Information

Internal and Listening Research

External Data Post Methods
➢ Existing Company ➢ Complaints ➢ Interviews
Information i.e.
➢ Customer Service ➢ Surveys
product returns,
Representatives
market share, etc. ➢ Focus Groups
➢ Sales
➢ Industry Experts ➢ Observations
Representatives
➢ Secondary Data
➢ Billing
➢ Competitors
➢ Accounts Receivable
➢ Collection
 2. Translate the VOC to (CTQ)

Critical to quality (CTQ) is the quality of a product or

service in the eyes of the voice of the customer (VOC).

Use: It is a good idea to identify the critical to quality

parameters as they relate to what is important to the
customer at large. It is this author’s opinion that two
things should be monitored.
 2. Translate the VOC to (CTQ)
Once the Voice of the Customer has been gathered, that
information must be translated into Critical Customer
Requirements (CTQ).

Voice of After Clarifying,

the Customer the Key Issue(s) Is... CTQ
“I hate dealing with Products are not 10 day lead time
this company!” delivered on time ±1 day

Good customer requirements:

– Are specific and measurable (and the method of measurement is specific)
– Are related directly to an attribute of the product or service
– Don’t have alternatives and don’t bias the design toward a particular
approach or technology
– Are complete and unambiguous
– Describe what, not how
 3. Convert the CTQ into Key Process Output
Variables (KPOVs)
Key Process Output Variables come from two sources:
The Critical to Customer Requirements (Voice of the Customer - VOC)
The Critical to Business Requirements (Voice of the Business – VOB)
These two sources come together to develop the Big “Y” outputs that the
process must meet

Customer
CTQ VOC
Issues
________ ________ ________

Y1 ________ ________ ________

________ ________ ________

Y2
Y3
Business
VOB CBR’s
________
Issues
________ ________
________

________ ________ ________ Yn

VOB - Voice of the Business VOC - Voice of the Customer

CBR - Critical Business Requirements CTQ - Critical To Quality
 4. Create a tactical Process Map

• Translate Customer Requirements into output specs and identify

related Key Process Output Variables.
• Go upstream to the process steps which most impact the Output
and determine the Key Process Input Variables.
• Try to use leading measures instead of lagging measures – if
lagging, then close/reduce amount of lag.
Quality Tools
 Lead Indicators of Quality
Variation indicates poor quality.
To measure variation, there are several
tools that can be used:

Histograms Control Charts Process

Capability
90
80
70

A graphical display of the 60

50
frequency distribution of 40
30
attributes. 20
10
0
Mon. Tues Wed. Thur. Fri.
 Diagnostic Information
While Lead indicators tell that there IS a
While lead indicators tell that there IS a
problem,
problem, diagnostic tools help determine
Diagnostic tools help to
WHAT the problem is.determine
WHAT the problem is.

Scatter
Cause-and-
Diagrams
Effect Diagrams FMEA

Process Flow Pareto Charts

Charts
 Histograms
▪ Histograms are powerful tools for elementary analysis
of data that contain variations.

▪ A histogram is a diagram which represents the class

interval and frequency in the form of a rectangle.

▪ There will be as many adjoining rectangles as there

are class intervals.
 Histograms

25

20
Frequency

15

10

Category
 Check sheets

• Special types of data collection forms in which the

results may be interpreted on the form directly without
additional processing.
Check Sheet
 Control Chart

▪ To identify common cause and special

cause variations

▪ The number of samples over a period

of time will help us to characterize the
nature of the process.

▪ Control charts are used to determine

whether a process will produce a product
or service with consistent measurable
properties.
Steps for Process Control Charts

▪ Identify critical operations in the process where

inspection might be needed.
▪ Identify critical product characteristics.
▪ Determine whether the critical product
characteristic is a variable or an attribute.
▪ Select the appropriate process control chart.
▪ Establish the control limits and use the chart to
monitor and improve.
▪ Update the limits.
 Types of measurements

▪ There are two types of measurement which you

can measure and plot on a Control Chart.

▪ Variables answer the question ‘how much?’ and are

measured in quantitative units, for example weight,
voltage or time.

▪ Attributes answer the question ‘how many?’ and are

measured as a count, for example the number of
defects in a batch of products.
Control Chart
Control Charts
 Case Study
Observation Coating LCL UCL Robot Manual
1 280 80 90 147 204
2 180 80 90 72.5 172
3 140 80 90 100 132
4 210 80 90 226 128
5 140 80 90 188 82
6 172 80 90 128 105
7 188 80 90 129 574
8 173 80 90 103 124
9 166 80 90 116 77
10 340 80 90 88 204
11 397 80 90 157 121
12 140 80 90 127 166
13 97 80 90 195 83.4
14 165 80 90 87.7 82.4
15 152 80 90 92 126
16 108 80 90 99 175
17 137 80 90 104 124
 Robot vs. Manual Painting
• The robot side paint averages • The Manual side averages
(123 um) lower than the manual (148um) higher than the Robot
part (148um). side (123um) and is out of
control.
• The variation is caused by
manual touch up for paint finish.

Coating with Robot (um) Manual Coating (um)

700 700
600 600
500 500
400 400
300 300
200 200
100 100
0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

LCL UCL Coating Thickness LCL UCL Coating Thickness

 Process capability

Process capability measures the ability of a

process to produce output within certain
specifications.

• Centering: Put the process on target

(accuracy)

• Spread: Reduce variation in the process

(precision)
 Process capability

• As the process capability improves, the error

rate (DPMO = defects per million opportunities)
will decrease and the Sigma level will increase:
 Specification Limits

• Specification Limits are defined by the

customer.
• They are one element of the “Voice of the
Customer "and may be modified over time.
• LSL= Lower Specification Limit
• USL= Upper Specification Limit
Specification Limits

Example
 Cause and Effect Diagram

▪ The cause and effect diagram is also called the

Ishikawa diagram or the fishbone diagram.

▪ It is a tool for discovering all the possible causes for

a particular effect.

▪ Show the relationships between a problem and its

possible causes.

▪ The major purpose of this diagram is to act as a first

step in problem solving by creating a list of possible
causes.
 Constructing a Cause and Effect Diagram

▪ First, clearly identify and define the problem or effect for

which the causes must be identified. Place the problem
or effect at the right or the head of the diagram.
▪ Identify all the broad areas of the problem.
▪ Write in all the detailed possible causes in each of the
broad areas.
▪ Each cause identified should be looked upon for further
more specific causes.
▪ View the diagram and evaluate the main causes.
▪ Set goals and take action on the main causes.
Cause and Effect Diagram
 Cause and Effect Diagram

Materials Procedures

Quality
Problem

People Equipment
 Cause and Effect Diagram

Measurement Human Machines

Faulty testing equipment Poor supervision Out of adjustment

Incorrect specifications Lack of concentration Tooling problems

Improper methods Inadequate training Old / worn

Quality
Inaccurate Problem
temperature Poor process
control Defective from vendor
design
Ineffective quality
Not to specifications management
Dust and
Dirt Material- Deficiencies
handling problems in product
design
Environment Materials Process
 Failure Modes Effect Analysis, FMEA

• A structured approach to:

• Identifying the ways in which a product or process
can fail
• Estimating risk associated with specific causes
• Prioritizing the actions that should be taken to
reduce risk
• Evaluating design validation plan (design FMEA) or
current control plan (process FMEA)

181
 What Is A Failure Mode?

• A Failure Mode is:

• The way in which the component, subassembly,
product, input, or process could fail to perform its
intended function

• Failure modes may be the result of upstream

operations or may cause downstream
operations to fail

• Things that could go wrong

182
 When to Conduct an FMEA

• Early in the process improvement investigation

• When new systems, products, and processes are being
designed
• When existing designs or processes are being changed
• When carry-over designs are used in new applications
• After system, product, or process functions are defined,
but before specific hardware is selected or released to
manufacturing

183
 FMEA Purpose
Preventive costs Cost of validation Warranty costs

Identify and eliminate Detection and correction Detection and correction

potential defects of defects EXTERNAL defects

Validation
tests
P-FMEA
D-FMEA

Product Project Pre-

development planning Production Lifetime
production

Manufacturer / supplier Customer

Preventive costs to identify potential defects by FMEA’s are relatively low compared to in-
house detection and correction of defects and even much lower than recovery costs in
case defects are found by our Customers.
The FMEA Worksheet
 The FMEA Worksheet
Resp. & p p p p
Product S O D R
Failure Failure Actions Target S O D R
or E Causes C Controls E P
Mode Effects / Plans Complete E C E P
Process V C T N
Date V C T N

1 2 3 4 5 6 7

Develop
Determine Determine Determine and
Product or “Effects” of “Controls” Drive
Process The Failure Detection Action Plan
Functions Mode Rating
Severity Determine
Rating “Causes” of
Determine The Failure Calculate
Failure Mode &
Modes Occurrence Assess
of Function Rating Risk

If an PFMEA was created during the Design Phase of the Program, USE IT!
Create an Action Plan for YOUR ROOT CAUSE
and Re-Evaluate the RPN Accordingly
 Contents of a FMEA

Process Function PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e
1. Record the process Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
COMPLETION
DATE
t
number and its 10 0
Component
name Wash Station

2. Give a brief Load parts

into wash
Surface
damage.
Unacceptable
weld quality
8 [SC] Handling
induced
3 None. 100%
downline leak
3 72 None.

description of the tray-basket. resulting in

premature
nicks and
dings.
testing,
visual
weld failure inspection at
steps within each or leak path. weld station,
weld sample
process testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Process Function PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e
1. Potential Failure Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
COMPLETION
DATE
t
Mode 10 0
Component
2. Identify the potential Wash Station

product Load parts

into wash
Surface
damage.
Unacceptable
weld quality
8 [SC] Handling
induced
3 None. 100%
downline leak
3 72 None.

& Process-related tray-basket. resulting in

premature
nicks and
dings.
testing,
visual
weld failure inspection at
failure modes or leak path. weld station,
weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Potential Effect(s) of PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
Failure Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

Assess the effect of the 10

Component
0

Wash Station
particular failure on the
Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
customer(s) into wash
tray-basket.
damage. weld quality
resulting in
induced
nicks and
downline leak
testing,
premature dings. visual
weld failure inspection at

This may include an or leak path. weld station,

weld sample
testing and
internal customer through planning.

to the ultimate end user Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1
0
24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Severity (S) PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e
Rank the impact of the Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
COMPLETION
DATE
t
failure mode on the 10 0
Component
customer Wash Station

Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.

into wash damage. weld quality induced downline leak

Rating from 1 to 10 with tray-basket. resulting in

premature
nicks and
dings.
testing,
visual
weld failure inspection at
10 being the most severe or leak path. weld station,
weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Severity (S) PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e
Rank the impact of the Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
COMPLETION
DATE
t
failure mode on the 10 0
Component
customer Wash Station

Load parts
into wash
Surface
damage.
Unacceptable
weld quality Require special assessment
8 [SC] Handling
induced
3 None. 100%
downline leak
3 72 None.

Rating from 1 to 10 with tray-basket. resulting in

premature
nicks and

•Capability
dings.
testing,
visual
weld failure inspection at
10 being the most severe or leak path. weld station,
•100% Inspection weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA
Suggested P-FMEA Severity Evaluation Criteria
Ranking Effect Customer Effect Manufacturing / Assembly Effect
Very high severity ranking when potential failure
mode affects safe vehicle operation and / or Or may endanger operator (machine or
10 - Hazardous without Warning
involves noncompliance with government assembly) without warning
regulation without warning
Very high severity ranking when potential failure
mode affects safe vehicle operation and / or Or may endanger operator (machine or
9 - Hazardous with Warning
involves noncompliance with government assembly) with warning
regulation with warning
Or 100% of product may have to be scrapped, or
Vehicle / item inoperable (loss of primary
8 - Very High
function)
vehicle / item repaired in repair department with
a repair time greater than one hour.
Or product may have to be sorted and a portion
Vehicle / item operable but at reduced level of (less than 100%) scrapped, or vehicle / item
SEVERITY

7 - High
performance. Customer very dissatisfied repaired in repair department with a repair time
between half an hour and one hour.
Or a portion (less than 100%) of the product may
Vehicle / item operable but Comfort /
have to be scrapped with no sorting, or vehicle /
6 - Moderate Cobvenience item(s) inoperable. Customer
item repaired in repair department with a repair
dissatisfied
time of less than half an hour.
Vehicle / item operable but Comfort / Or 100% of the product may have to be reworked,
5 - Low Cobvenience item(s) operable at reduced level of or vehicle / item repaired offline but does not go
performance. Customer somewhat dissatisfied to repair department.
Fit & Finish / Squeak & Rattle item does not
Or the product may have to be sorted, with no
4 - Very Low conform. Defect noticed by most customers
scrap, and a portion (less than 100%) reworked.
(greater than 75%)
Or a portion (less than 100%) of the product may
Fit & Finish / Squeak & Rattle item does not
3 - Minor
conform. Defect noticed by 50 % of customers.
have to be reworked with no scrap, on line but in
station.
Fit & Finish / Squeak & Rattle item does not
Or slight inconvenience to operation or operator,
2 - Very Minor conform. Defect noticed by discriminating
or no effect.
customers (less than 25%)
1 - None No discernible effect.
 Contents of a FMEA

Potential Cause PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
of Failure Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

List any possible causes 10

Component
0

Wash Station
for the failure mode (how
Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
the failure could occur) into wash
tray-basket.
damage. weld quality
resulting in
induced
nicks and
downline leak
testing,
premature dings. visual
weld failure inspection at
or leak path. weld station,
weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Occurrence (O) PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e
A numerical rating of the Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
COMPLETION
DATE
t
likelihood that a specific 10 0
Component
cause of failure will occur Wash Station

Rating from 1 to 10 with Load parts

into wash
Surface
damage.
Unacceptable
weld quality
8 [SC] Handling
induced
3 None. 100%
downline leak
3 72 None.

10 being the most tray-basket. resulting in

premature
nicks and
dings.
testing,
visual
weld failure inspection at
frequent occurrence or leak path. weld station,
weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 PFMEA Occurance Evaluation Criteria (based on QS 9000 FMEA Ed 3)

Ranking Probability PPM Sigma Cpk Possible Failure Rate

10 -
Very High: Persistent failures
100.000 < 0,33 > 100 / 1000 pieces

9
OCCURANCE

- 50.000 > 0,33 50 / 1000 pieces

8 -
High: Frequent failures
20.000 > 0,51 20 / 1000 pieces

7 - 10.000 > 0,67 10 / 1000 pieces

6 - 5.000 > 0,83 5 / 1000 pieces

5 - Moderate: Occasional failures 2.000 ±3 > 1,00 2 / 1000 pieces

4 - 1.000 > 1,17 1 / 1000 pieces

3 -
Low: Relatively few failures
500 ±4 > 1,33 0,5 / 1000 pieces

2 - 100 > 1,50 0,1 / 1000 pieces

1 - Remote: Failure is unlikely 10 ±5 > 1,67 < 0,01 / 1000 pieces

195
 Contents of a FMEA

Current Process PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
Controls Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

Prevention: Controls 10
Component
Wash Station
0

that prevent the cause Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
into wash damage. weld quality induced downline leak
of failure from occurring tray-basket. resulting in
premature
nicks and
dings.
testing,
visual
Detection: Controls that weld failure
or leak path.
inspection at
weld station,

detect the cause of a weld sample

testing and

failure which leads to planning.

0
corrective actions Wash parts. Not
completely
Unacceptable
weld quality
8 [SC] Low wash
temperature,
3 Operator
monitoring
100%
downline leak
1 24 None.

clean. resulting in defective temperature at testing, weld

premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Detection (D) PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
A numerical rating of the Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
N ACTION(S)
DATE
t
probability that a set of 10 0
Component
controls will detect a Wash Station

specific cause of failure Load parts

into wash
Surface
damage.
Unacceptable
weld quality
8 [SC] Handling
induced
3 None. 100%
downline leak
3 72 None.

tray-basket. resulting in nicks and testing,

Rating from 1 to 10 with premature dings. visual
weld failure inspection at
10 being the least likely or leak path. weld station,
weld sample
to detect testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 D/PFMEA Detection Evaluation Criteria (based on QS 9000 FMEA Ed 3)

Ranking Effect Process detection (P) Type

Absolute Abs olutely certain of non-detection (Cannot detect or is not

10 -
Uncertainty checked)
C
Very Controls will probably not detect (Control is achieved with
9 -
Remote indirect or random checks only)
C
Controls have a poor chance of detection (Control is achieved
8 - Remote
with vis ual ins pection only)
C
Controls have a poor chance of detection (Control is achieved
7 - Very Low
with double vis ual ins pection only)
DETECTION

C
Controls m ay detect (Control is achieved with charting m ethods ,
6 - Low
s uch as SPC))
B C
Controls m ay detect (Control is bas ed on variable gauging after
5 - Moderate parts have left the s tation, or GO / NO GO gauging perform ed on
100% of the parts after have left the s tation) B
Controls have a good chance of detection (Error detection in
Moderately
4 -
High
s ubs equent operations , or gauging perform ed on s etup and
first piece check [for s etup caus es only]) A B
Controls have a good chance of detection (Error detection in-
s tation, or error detection in s ubs equent operations by m ultiple
3 - High
layers of acceptance: s upply, s elect, ins tall, verify. Cannot accept
dis crepant part) A B
Controls will alm os t certainly detect (Error detection in
2 - Very High s tation[autom atic gauging with autom atic s top feature]. Cannot
pas s dis crepant part) A B
Almost Controls certain to detect (Dis crepant cannot be m ade becaus e
1 -
Certain item has been error-proofed by proces s /product des ign)
A
"A" = Error-proofed, "B" = Gauging, "C" = Manual Inspection

198
 Contents of a FMEA

Risk Priority PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
Number (RPN) Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

The numerical product 10

Component
0

Wash Station
of the Severity (S), Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
Occurrence (O) and into wash
tray-basket.
damage. weld quality
resulting in
induced
nicks and
downline leak
testing,

Detection (D) ratings: premature

weld failure
dings. visual
inspection at
or leak path. weld station,
S x O x D = RPN weld sample
testing and
planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Recommended PROCESS
FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
Actions Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

List all actions required 10

Component
0

Wash Station
to reduce the overall Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
RPN score, mandatory into wash
tray-basket.
damage. weld quality
resulting in
induced
nicks and
downline leak
testing,

actions required if RPN premature

weld failure
dings. visual
inspection at
or leak path. weld station,
score exceeds allowable weld sample
testing and
limit (priority rules) planning.

0
Wash parts. Not Unacceptable 8 [SC] Low wash 3 Operator 100% 1 24 None.
completely weld quality temperature, monitoring downline leak
clean. resulting in defective temperature at testing, weld
premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

Responsibility & PROCESS

FUNCTION
POTENTIAL
FAILURE
POTENTIAL
EFFECT(S)
S
e
C
l
a
POTENTIAL
CAUSE(S)
O
c
c
CURRENT
PROCESS
CONTROLS
CURRENT
PROCESS
CONTROLS
e
t
R
P
RECOMMEN
DED
RESPONSIBILITY
& TARGET
e COMPLETION
Target Completion Requirements MODE(S) OF FAILURE v s
s
OF FAILURE u
r
PREVENTION DETECTION
c
t
N ACTION(S)
DATE

Date 10
Component
Wash Station
0

Identify who is Load parts Surface Unacceptable 8 [SC] Handling 3 None. 100% 3 72 None.
into wash damage. weld quality induced downline leak
responsible for tray-basket. resulting in
premature
nicks and
dings.
testing,
visual
completing the weld failure
or leak path.
inspection at
weld station,

recommended actions weld sample

testing and

by the specified target planning.

0
dates Wash parts. Not
completely
Unacceptable
weld quality
8 [SC] Low wash
temperature,
3 Operator
monitoring
100%
downline leak
1 24 None.

clean. resulting in defective temperature at testing, weld

premature heating machine, samples
weld failure elements. complete daily
or leak path. temp
verification via
DIS.
 Contents of a FMEA

ACTION RESULTS
S O D R C

Action Results RESPONSIBILITY &

TARGET
COMPLETION DATE
ACTION(S)
e
v
c
c
e
t
P
N
l
a
s
TAKEN
Identifies what was s

actually done and the

impact on the categories
described earlier
(severity, occurrence,
detection, risk priority
What are the failure modes?
number, and
• Paper not stapled
classification)
• Staple position
• Improper crimp
• Finger stapled to paper
FMEA Example