PROBLEM SOLVING

AND COST BENEFIT

Presented by:
ANDRE PAOLO B. LIM
P.I.E., ASEAN Engineer

ANALYSIS
COURSE OBJECTIVES
1. To be able to identify key operating cost components
that influence the business
2. To be able to measure the impact of each cost
component with respect to the business into Benefits
and Detriments.
3. To be able to analyze and prioritize the impacts of each
cost component
4. To be able to make sound business decisions based on
the outcome of your Analysis
PROBLEM SOLVING SKILLS
Kepner-Tregoe Methods: AN APPROACH TO PROBLEM-SOLVING
ANALYSIS
In 1957, Charles H. Kepner and Benjamin B. Tregoe were working in
social science research for the RAND Corporation.
After a period of intense study, they developed a set of four basic
techniques in approaching problem solving.
The first technique is often used as part of Root Cause Analysis, while all
four are used in such areas as Total Quality Management in association
with the Deming Cycle of process improvement.
KEPNER-TREGOE PROBLEM SOLVING ANALYSIS
There are four basic steps when using the Kepner Tregoe decision matrix:
1. Systems Analysis- is used to clarify the situation, outline concerns and choose a
direction
2. Problem analysis - here the problem is defined and it's root cause determined
3. Decision analysis - alternatives are identified and a risk analysis done for each
4. Potential problem analysis - the best of the alternatives is further scrutinized
against potential problems and negative consequences and actions are proposed
to minimize the risk.
Following the step-by-step approach of Kepner Tregoe decision making allows for
the use of critical thinking skills in considering many possible factors that may be
vital in making the decision.
KEPNER-TREGOE PROBLEM SOLVING ANALYSIS
SYSTEMS ANALYSIS
If there is an unwanted situation which consumes resources and tends to
happen in a repeated fashion, then there is a possibility that it might be
beneficial to figure out what is really causing this situation to occur and
remove it so the situation does not occur again.
This is generally referred to as Root Cause Analysis.
Finding the real cause of the problem and dealing with it rather than
simply continuing to deal with the symptoms.
KEPNER-TREGOE PROBLEM SOLVING ANALYSIS
SYSTEMS ANALYSIS FOCUS AREAS:
a. METHOD
 PROCESSES
b. MAN
 PERSONNEL, COMPETENCY, TRAINING
c. MACHINE
 ACCURACY, TECHNOLOGY, MAINTENANCE
d. MATERIALS
 CONSISTENCY, QUALITY, QUANTITY, CONFORMANCE
e. MOTHER NATURE
 ENVIRONMENT
f. MANAGEMENT
 OBJECTIVES, ADMINISTRATION, POLICIES
PROBLEM ANALYSIS STEPS
1. DEFINING THE PROBLEM
A. 5 Whys analysis:
When developing a problem definition always use the "5 Whys
Technique" to arrive at the point where there is no explanation for the
problem.
Using 5 Whys with Kepner-Tregoe only accelerates the process.
PROBLEM ANALYSIS STEPS
1. DEFINING THE PROBLEM
A. Why-why analysis:
PROBLEM ANALYSIS STEPS
ESTABLISHING THE POSSIBLE CAUSES
ISHIKAWA (FISHBONE) DIAGRAM ANALYSIS
PROBLEM ANALYSIS STEPS
TEST THE MOST PROBABLE CAUSE
With a short list of possible causes, the next step is to think-through each possible problem.
Ask the question:
"If ____ is the root cause of this problem does it explain the problem IS and what the problem
COULD BE but IS NOT?"
 
If this potential solution is the root cause then the potential solution has to "map to" or "fit
into" all the aspects of the Problem Analysis worksheet
KEPNER-TREGOE PROBLEM SOLVING ANALYSIS
Kepner Tregoe decision making is a structured methodology for
gathering information and prioritizing and evaluating it.
An important aspect of Kepner Tregoe decision making is the
assessment and prioritizing of risk.
So the idea is not to find a perfect solution but rather the best
possible choice, based on actually achieving the outcome with
minimal negative consequences.
COST-BENEFIT ANALYSIS
Deciding, Quantitatively, Whether to go Ahead
You can use Cost-Benefit Analysis to decide whether to go ahead with a
decision.
Cost-Benefit Analysis is a quick and simple technique that you can use for
non-critical financial decisions.
Where decisions are mission-critical, or large sums of money are involved,
other approaches – such as use of Net Present Values  and 
Internal Rates of Return   – are often more appropriate.
COST-BENEFIT ANALYSIS
As its name suggests, Cost-Benefit Analysis involves adding up the
benefits of a course of action, and then comparing these with the
costs associated with it.
The results of a cost-benefit analysis are often expressed as a
payback period – this is the time it takes for benefits to repay costs.
Many people who use Cost-Benefit Analysis look for payback in less
than a specific period – for example, three years.
COST-BENEFIT ANALYSIS
You can use Cost-Benefit Analysis in a wide variety of situations.
For example, when you are:
 Deciding whether to hire new team members.
 Evaluating a new project or change initiative.
 Determining the feasibility of a capital purchase.
However, bear in mind that Cost-Benefit Analysis is best for
making quick and simple financial decisions. More robust
approaches are commonly used for more complex, business-critical
or high cost decisions.
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
Step One: Brainstorm Costs and Benefits
First, take time to brainstorm all of the costs associated with the
project, and make a list of these. Then, do the same for all of the
benefits of the project. Can you think of any unexpected costs? And
are there benefits that you may not initially have anticipated?
When you come up with the costs and benefits, think about the
lifetime of the project. What are the costs and benefits likely to be
over time?
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
Step Two: Assign a Monetary Value to the Costs
Costs include the costs of physical resources needed, as well as the cost
of the human effort involved in all phases of a project. Costs are often
relatively easy to estimate (compared with revenues).
It's important that you think about as many related costs as you can.
For example, what will any training cost? Will there be a decrease in
productivity while people are learning a new system or technology,
and how much will this cost?
Remember to think about costs that will continue to be incurred once
the project is finished. For example, consider whether you will need
additional staff, if your team will need ongoing training, or if you'll
have increased overheads.
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
Step Three: Assign a Monetary Value to the Benefits
This step is less straightforward than step two! Firstly, it's often very
difficult to predict revenues accurately, especially for new products.
Secondly, along with the financial benefits that you anticipate, there are
often intangible, or soft, benefits that are important outcomes of the
project.
For instance, what is the impact on the environment, employee
satisfaction, or health and safety? What is the monetary value of that
impact?
As an example, is preserving an ancient monument worth PhP500,000, or
is it worth PhP5,000,000 because of its historical importance? Or, what is
the value of stress-free travel to work in the morning? Here, it's important
to consult with other stakeholders and decide how you'll value these
intangible items.
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
Step Four: Compare Costs and Benefits
Finally, compare the value of your costs to the value of your benefits,
and use this analysis to decide your course of action.
To do this, calculate your total costs and your total benefits, and
compare the two values to determine whether your benefits outweigh
your costs. At this stage it's important to consider the payback time,
to find out how long it will take for you to reach the break even point
– the point in time at which the benefits have just repaid the costs.
For simple examples, where the same benefits are received each
period, you can calculate the payback period by dividing the
projected total cost of the project by the projected total revenues:
Total cost / total revenue (or benefits) = length of time (payback
period).
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
EXAMPLE:
IF YOU WERE TO EMBARK IN A IMPROVEMENT PROJECT
TO INCREASE THE PRODUCTIVITY AND PROFITABILITY OF
MACHINE SHOP BUSINESS, HOW WOULD YOU USE COST-
BENEFIT ANALYSIS TO DETERMINE FEASIBILITY OF
IMPROVEMENTS?
STEPS IN EMBARKING IN A COST-BENEFIT
ANALYSIS
STEP 1: BRAINSTORM COSTS AND BENEFITS
COSTS BENEFITS
1. Improved documentation and procedures 1. Annual Sales – PhP 1,500.000
a. Personnel Administration 2. Markup: 20%
b. Quality system 3. Cost breakdown:
c. Materials and Inventory Management 4. Labor : 20%
d. Cost control 5. Material : 50%
e. Safety practices upgrade 6. Overhead : 30%
2. Personnel training 7. Sales increase from new product introductions
3. Layout and Process Flow improvement 8. Sales increase from capacity increase and capacity
4. Equipment upgrade balance
5. Research and development improvement 9. Better cost control
10. Cost avoidance from accidents
11. Savings in materials utilization
12. Increased Output
13. Decrease in Cost of Quality
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 2: ASSIGN MONETARY VALUE TO COSTS
COSTS VALUE/ASSUMPTIONS
1. Improved documentation and procedures
a. Personnel Administration 1,000.00
b. Quality system 2,000.00
c. Materials and Inventory Management 1,000.00
d. Cost control 1,000.00
e. Safety practices upgrade 10,000.00
2. Personnel training 10,000.00
3. Layout and Process Flow improvement 500,000.00 (AMMORTIZED IN 10 YEARS)
4. Equipment upgrade 345,000.00
5. Research and development improvement 15,000.00 TESDA training
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
BENEFITS VALUE ASSUMPTIONS
1. Annual Sales – PhP 1,500.000
2. Markup: 20%
3. Cost breakdown:
4. Labor : 20%
5. Material : 50%
6. Overhead : 30%
7. Sales increase from new product introductions Increase of 1% of annual sales
8. Sales increase from capacity increase and capacity
balance Increase of 2% of annual sales
9. Better cost control
10. Cost avoidance from accidents Increase of 2% of annual sales
11. Savings in materials utilization Assumed PhP 200,000.00/yr medical costs
12. Increased Output Accounts to 10% of 90% material wastage
13. Decrease in Cost of Quality Increase of 2% of annual sales
14. Increase in labor productivity 2% of materials wastage
Increase of 20% of labor hours available per year
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Lets review the steps:
1. Do your Problem solving analysis and identify your root causes
2. Identify the appropriate interventions to address the root causes of your
problem. If the root cause is not addressed, the problem will still recur
3. Establish the cost breakdown of your subject’s product/service profile
(labor, material and overhead)
4. Establish the profit margin of your subject’s product/service profile
5. Assign the appropriate costs involved per identified intervention
6. Calculate the resulting savings and improvements of each identified
intervention (note that savings can be in the form of Intangible and
Tangible figures.
7. Segregate your savings calculations according to cost category (labor,
material and overhead) for easier presentation later
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
1.Establish the cost impact of your savings
a.Impact to labor cost
b.Impact to material cost
c.Impact to overhead cost
d.Impact to production/operating cost
e.Impact to total sales
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
1.Sample savings derivations to Labor
a.Reduction in labor lead time – impact to labor cost (reduction)
b.Conversion from manual to automated process - impact to labor cost
(reduction)
c.Increase in worker efficiency
a.Better attendance – expressed in the increase in number of hours at work
b.Decreased tardiness - expressed in the increase in number of hours at work
c.Decreased rework due to better Quality Control - expressed in the
decrease in number of hours at reworking versus total working hours
d.Decrease in worker downtime situations - expressed in the equivalent
downtime recovered from previous downtime occurrence
e.Increased Productivity due to personnel trainings – reduction in labor cost
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
2. Sample savings derivations to Materials
a.Decreased material replacements due to better Quality Control - expressed in the
value of materials previously replaced
b.Increased material utilization due to better materials issuance/usage controls -
expressed in the decrease in the value of materials over issued due to lack of
usage standards
c. Decrease in material requirements / inventory levels due to better Inventory
control - expressed in the decrease in materials requirements due to better
planning for ordering and arrivals
d.Implementation of proper receiving methods that promotes correct inventory
levels - expressed in the decrease in material requirements due to the
maintenance of proper inventory levels
e.Cost avoidance from materials spoilage – value of materials previously spoiled
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
3. Sample savings derivations to Overhead
a.Savings in electrical consumption from lighting - expressed in the
cost of electricity saved
b.Savings in electrical consumption from correct motor sizes -
expressed in the cost of electricity saved
c.Savings in electrical consumption from proper equipment
maintenance - expressed in the cost of electricity
d.Savings in water consumption – expressed in cost of water saved
(make sure water used is commercially supplied)
e.Savings in transportation cost – based on the budgeted number of
trips versus actual trips made
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
1.Sample savings derivations to Production/Operating cost
a.Reductions in production lead time - expressed in % decrease in production time resulting to more
output given same number of hours per day
b.Increase in productivity from increase labor efficiency - expressed in % decrease on production
time…
c.Increase in productivity from production input-output monitoring - expressed in the % decrease in
production time…
d.Increase in productivity from implementation of good housekeeping practices (5S) - expressed in
the % decrease in production time…
e.Reduction in production downtime from the implementation of Total Preventive Maintenance
practices - expressed in the % increase in production time
f.Reduction in Production downtime from the implementation of proper production planning and
control practices - expressed in the % decrease in production time…
g.Cost avoidance from Safety-related costs – cost of accidents per year avoided
h.Cost avoidance from materials spoilage charges – increase in capacity from materials utilization
STEPS IN EMBARKING IN A COST-
BENEFIT ANALYSIS
STEP 3: BRAINSTORM COSTS AND BENEFITS
Then we continue step 3:
1. Sample sales increase derivations (mostly intangible savings)
a. Increase in capacity without equivalent market demand
b. Increase in market share without firm orders
STEPS IN EMBARKING IN A COST-BENEFIT ANALYSIS
STEP 4: COMPARE COSTS AND BENEFITS

COST - BENEFIT ANALYSIS SHEET

ABC MACHINE SHOP

ANNUAL SALES (in Pesos) 1,500,000.00

Mark-up 20%

Cost of Production P 1,250,000.00

Materials 50% P 625,000.00
Labor 20% P 250,000.00
OH 30% P 375,000.00
100%
STEPS IN EMBARKING IN A COST-BENEFIT ANALYSIS
STEP 4: COMPARE COSTS AND BENEFITS
BENEFITS % impacted % Improvement BENEFIT IMPACT (in Peso)
Impact to Sales
Expected increase due to increase in capacity through new
equipment, balanced process, better marketing efforts and new
7% P 105,000.00
product developments, more competitive prices to be offered
caused by proper costing.
Cost avoidance due to better safety practices P 200,000.00
Impact to Direct Materials (90% of Total Materials for DM and 10% for IM)
Improved material utilization by closely monitoring receipts
issuances and deliveries through proper documentation and 90% 10% P 56,250.00
better inventory management and control

savings through reduction of errors due installation of Quality

2% P 12,500.00
control measures

Impact to Labor (100% of Total Labor is DL)

Improved labor effi ciency through implementation of better
people handling methods, established rules and regulations and 20% P 50,000.00
higher effi ciency from improved work flow.

TOTAL REAL SAVINGS (from Improvements) P118,751.22

TOTAL BENEFITS FROM RECOMMENDATIONS 423,751.2200

STEPS IN EMBARKING IN A COST-BENEFIT ANALYSIS
STEP 4: COMPARE COSTS AND BENEFITS
COST TO IMPLEMENT SHORT-TERM LONG-TERM TOTAL
Forms/Documents
Administrative and Prodn Monitoring Forms 5,000.00 5,000.00
Training
OSH / 5S/TPM 10,000.00 10,000.00 20,000.00
Layout
renovation of existing facility and building of new
500,000.00 50,000.00
facility(amortized over a period of 10yrs)
Safety
PPE 5,000.00 5,000.00
Wiring/lighting 20,000.00 20,000.00
Equipment
sheet bender 1 15,000.00 15,000.00
arc welders 3 25,000.00 75,000.00
handcart 1 5,000.00 5,000.00
15 kva transformer 1 300,000.00 300,000.00
R&D
TESDA 1 15,000.00 15,000.00
0.00
TOTAL COST TO IMPLEMENT P85,000.00 P325,000.00 P510,000.00

Over-all
Payback Period (real savings)
4.29 yrs

Payback Period (with increase in sales)

1.20 yrs
SAMPLE PROBLEM
Subcon Cooperative manufactures and sells three types of products.
The products vary according to the customer’s quality and design
specifications. The three can be classified as High Quality, Extra High
and Super High quality. Manufacturing and machining time is limited.
More time is required to produce Extra High and Super High.
Additional info are provided as follows: Answer the following
Product__________________ questions:
1. Calculate the weighted
High Quality Extra High Super High
average unit contribution
Selling Price P 600 P 1,000 P 1,600 margin?
Variable costs 400 650 1,100 2. Calculate the breakeven
Contribution Margin P 200 P 350 P 500 point using the current
==== ===== ===== sales mix?
Machine hours required 0.02 0.04 0.08 3. If we ignore machining
Units Sold 100,000 40,000 10,000 constraint, what is the
optimal sales strategy?
Sales Mix 10 4 1
4. Calculate the contribution
margin per unit if it has
Total Fixed Costs P 23,400,000 limited machine resource?
5. If there was additional
machine capacity, how
SAMPLE PROBLEM SOLUTIONS
1. The weighted average unit contribution margin is determined
by dividing the total contribution margin for this sales mix by
the number of units:

Total Contribution Margin = (10 x P200) + (4 x P350) + (1 x P500)

= P3,900
Weighted average unit contribution margin is computed as:
Total Contribution Margin P 3,900
Number of Units = 10+4+1 = P260
SAMPLE PROBLEM SOLUTIONS
2. Given this sales mix, the breakeven point is computed as:

Fixed Costs P 23,400,000

Weighted average unit = P 260 = 90,000 units
Contribution Margin
SAMPLE PROBLEM SOLUTIONS
3. The Super High quality products have the highest contribution
margin per unit.

Thus, if we ignore any manufacturing constraints, it would

appear that Subcon Cooperative should shift toward production
of more Super High Quality products.
SAMPLE PROBLEM SOLUTIONS
4. The contribution margin per unit of limited machine resource is
calculated as follows:
Product____________
High Quality Extra High Super High
Contribution Margin per unit_______ P 200 = P 10,000 P 350 = P 8,750 P 500 = P 6,250
Limited machine resource consumed per unit .02 .04 .08
SAMPLE PROBLEM SOLUTIONS
5. The High Quality products have the highest contribution margin
per limited machine resource, even though they seem to have the
lowest contribution margin per unit.

Given the machine resource constraint , any additional

capacity should be used to make High Quality product.