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The last two decades have been a period of tremendous turmoil and change in the business environment. Competition in many industries has become worldwide in scope, and the pace of innovation in products and services has accelerated. This has been good news for consumers, since intensified competition has generally led to lower prices, higher quality, and more choices. However, the last two decades have been a period of wrenching change for many businesses and their employees. Many managers have learned that cherished ways of doing business don’t work anymore and that major changes must be made in how organizations are managed and in how work gets done. And to add even more dynamism, the Internet has been changing ways of doing business in more and more industries since the mid 1990s. These changes in the business environment have affected managerial accounting—as we will see throughout the rest of the text. First, however, it is necessary to have an appreciation of the ways in which organizations are transforming themselves to become more competitive. Since the early 1980s, many companies have gone through several waves of improvement programs, starting with Just-In-Time ( JIT ) and passing on to Total Quality Management (TQM), Process Reengineering, Lean Production, Six Sigma, and various other management programs—including in some companies the Theory of Constraints (TOC). When properly implemented, these improvement programs can enhance quality, reduce cost, increase output, eliminate delays in responding to customers, and ultimately increase profits. However, they have not always been wisely implemented, and considerable controversy remains concerning the ultimate value of each of these programs. Nevertheless, the current business environment cannot be properly understood without some appreciation of what these programs attempt to accomplish. Each is worthy of extended study, but we will discuss only those aspects of the programs that are essential for understanding managerial accounting. The details of improvement programs are best handled in operations management courses. This section on the changing business environment will close with a discussion of the role of international competition and the impact of the Internet on business. Just-In-Time (JIT)Traditionally, manufacturers have forecasted demand for their products into the future and then have attempted to smooth out production to meet that forecasted demand. At the same time, they have also attempted to keep everyone and everything as busy as possible producing output so as to maximize “efficiency” and (hopefully) reduce costs. Unfortunately, this approach has a number of major drawbacks including large inventories, long production times, high defect rates, product obsolescence, an inability to meet delivery schedules, and (ironically) high costs. None of this is obvious—if it were, companies would long ago have abandoned this approach. Managers at Toyota are credited with the insight that an entirely new approach, called Just-In-Time, was needed. When companies use the Just-In-Time (JIT)A production and inventory control system in which materials are purchased and units are produced only as needed to meet actual customer demand. production and inventory control system, they purchase materials and produce units only as needed to meet actual customer demand. In a JIT system, inventories are reduced to the minimum and in some cases are zero. For example, the Memory Products Division of Stolle Corporation in Sidney, Ohio, slashed its work in process inventory from 10,000 units to 250 units by using JIT techniques.3 The JIT approach can be used in both merchandising and manufacturing companies. It has the most profound effects, however, on the operations of manufacturing companies, which maintain three classes of inventories— raw materials, work in process, and finished goods. Raw materialsMaterials that are used to make a product. are the materials that are used to make a product. Work in processUnits of product that are only partially complete and will require further work before they are ready for sale to a customer. inventories consist of units of product that are only partially complete and will require further work before they are ready for sale to a customer. Finished goodsUnits of product that have been completed but have not yet been sold to customers. inventories consist of units of product that have been completed but have not yet been sold to customers. Traditionally, manufacturing companies have maintained large amounts of all three kinds of inventories to act as buffers so that operations can proceed smoothly even if there are unanticipated disruptions. Raw materials inventories provide insurance in case suppliers are late with deliveries. Work in process inventories are maintained in case a workstation is unable to operate due to a breakdown or other reason. Finished goods inventories are maintained to accommodate unanticipated fluctuations in customer demand. While these inventories provide buffers against unforeseen events, they have a cost. In addition to the money tied up in the inventory, experts argue that the presence of inventories encourages inefficient and sloppy work, results in too many defects, and dramatically increases the amount of time required to complete a product.
Under ideal conditions, a company operating a Just-In-Time system would purchase only enough materials each day to meet that day’s needs. Moreover, the company would have no goods still in process at the end of the day, and all goods completed during the day would have been shipped immediately to customers. As this sequence suggests, “just-in-time” means that raw materials are received just in time to go into production, manufactured parts are completed just in time to be assembled into products, and products are completed just in time to be shipped to customers. Although few companies have been able to reach this ideal, many companies have been able to reduce inventories to only a fraction of their previous levels. The result has been a substantial reduction in ordering and warehousing costs, and much more efficient and effective operations. In JIT, the traditional emphasis on keeping everyone busy is abandoned in favor of producing only what customers actually want—even if that means some workers are idle. JIT ConsequencesManagers who attempted to implement the JIT approach found that it was necessary to make other major improvements in operations if inventories were to be significantly reduced. First, production would be held up and a deadline for shipping a product would be missed if a key part was missing or was found to be defective. So suppliers had to be able to deliver defect-free goods in just the right quantity and just when needed. This typically meant that the company would have to rely on a few, ultra-reliable suppliers that would be willing to make frequent deliveries in small lots just before the parts and materials would be needed in production. Second, the typical plant layout needed to be improved. Traditionally, similar machines were grouped together in a single location. All of the drill presses would be in one place, all of the lathes in another place, and so on. As a result, work in process had to be moved frequently over long distances—creating delays, difficulties in locating orders, and sometimes damage. In a JIT system, all of the machines required to make a single product or product line are typically brought together in one location—creating what is called a focused factory or a manufacturing cell. This improved plant layout allows workers to focus all of their efforts on one product from start to finish—creating a sense of ownership and pride in the product and minimizing handling and moving. One company was able to reduce the distance traveled by one product from three miles to just 300 feet. An improved plant layout can dramatically increase throughput, which is the total volume of production through a facility during a period, and it can dramatically reduce throughput timeThe time required to manufacture a unit of product. Throughput time is also known as cycle time. (also known as cycle timeSee Throughput time.), which is the time required to make a product.
Changing over production from one product to another, which involves setups, also creates problems for JIT. SetupsActivities that must be performed whenever production is switched over from making one type of item to another. require activities—such as moving materials, changing machine settings, setting up equipment, and running tests—that must be performed whenever production is switched over to making a different product. For example, a company that makes side panels for DaimlerChrysler’s PT Cruiser must prime and paint the steel panels with the color specified by DaimlerChrysler. Every time the color is changed, the spray paint reservoirs must be completely purged and cleaned. This may take hours and results in wasted paint. Because of the time and expense involved in such setups, many managers believe setups should be avoided and therefore items should be produced only in large batches. Think of this in terms of scheduling your classes. If you have to commute to school and pay for parking, would you rather have two classes back-to-back on the same day or on different days? By scheduling your classes back-to-back on the same day, you will only have to commute and pay for parking once. Managers follow the same reasoning when they schedule production. If the customer has ordered 400 units, most managers would rather produce all of them in one big batch and incur the setup costs once rather than in two batches of 200 units each, which incurs the setup costs twice. Indeed, because of setup costs, most companies have rules about the minimum batch size that can be run. If the customer orders just 25 units, managers will still run the order in a batch of 400 units and keep the other 375 units in inventory in case someone orders the item later. The problem with this line of reasoning is that big batches result in large amounts of inventory—the exact opposite of what JIT attempts to accomplish. In JIT, this problem is attacked directly by reducing setup time so that it becomes insignificant. Simple techniques, such as doing as much setup work as possible in advance off-line rather than waiting until production is shut down, are often very effective in reducing setup time and costs. Reduced setup times make smaller batches more economical, which in turn makes it easier to respond quickly to the market with exactly the items that customers want. Defective units create big problems in a JIT environment. If a completed order contains a defective unit, the company must ship the order with less than the promised quantity or it must restart the whole production process to make just one unit. At minimum, this creates a delay in shipping the order and may generate a ripple effect that delays other orders. For this and other reasons, defects cannot be tolerated in a JIT system. Companies that are deeply involved in JIT tend to become zealously committed to a goal of zero defects. Even though it may be next to impossible to attain the zero defect goal, companies have found that they can come very close. For example, Motorola, Allied Signal, and many other companies now measure defects in terms of the number of defects per million units of product. Benefits of a JIT System Many companies—large and small—have employed JIT with great success. Among the major companies using JIT are Bose, Goodyear, Westinghouse, General Motors, Hughes Aircraft, Ford Motor Company, Black and Decker, Chrysler, Borg-Warner, John Deere, Xerox, Tektronix, and Intel. The main benefits of JIT include:
As a result of benefits such as those cited above, more companies are embracing JIT each year. Most companies find, however, that simply reducing inventories is not enough. To remain competitive in an ever changing and increasingly competitive business environment, companies must strive for continuous improvement.
Total Quality Management (TQM)Perhaps the most popular approach to continuous improvement is known as Total Quality Management. There are two major characteristics of Total Quality Management (TQM):An approach to continuous improvement that focuses on customers and using teams of front-line workers to systematically identify and solve problems. (1) a focus on serving customers and (2) systematic problem solving using teams made up of front-line workers. A variety of specific tools are available to aid teams in their problem solving. One of these tools, benchmarkingA study of organizations that are among the best in the world at performing a particular task., involves studying organizations that are among the best in the world at performing a particular task. For example, General Mills studied NASCAR pit crews in action to figure out how to cut the time to change a production line from one product to another from 4.5 hours to just 12 minutes.4 Perhaps the most important feature of TQM is that “it improves productivity by encouraging the use of science in decision-making and discouraging counter-productive defensive behavior.”5
In sum, TQM provides tools and techniques for continuous improvement based on facts and analysis; and if properly implemented, it avoids counterproductive organizational infighting.
Process Reengineering focuses on simplification and elimination of wasted effort. A central idea of Process Reengineering is that all activities that do not add value to a product or service should be eliminated. Activities that do not add value to a product or service that customers are not willing to pay for are known as non-value-added activities.An activity that consumes resources or takes time but that does not add value for which customers are willing to pay. For example, moving large batches of work in process from one workstation to another is a non-value-added activity. To some degree, JIT involves Process Reengineering as does TQM. These management approaches often overlap.7 Managers must be very careful when trying to convert business process improvements into more profits. There are only two ways to increase profits—decrease costs or increase sales. Cutting costs may seem easy—lay off workers who are no longer needed because of the elimination of non-value-added activities. However, employees quickly get the message that process improvements lead to job losses and they will understandably resist further improvement efforts. If improvement is to be ongoing, employees must be convinced that the end result of improvement will be more secure rather than less secure jobs. This can only happen if management uses business process improvements to generate more business rather than to cut the workforce. The Theory of Constraints (TOC)
The Theory of Constraints (TOC)A management approach that emphasizes the importance of managing constraints. is based on the insight that effectively managing the constraint is a key to success. As an example, long waiting periods for surgery are a chronic problem in the National Health Service (NHS), the government-funded provider of health care in the United Kingdom. The diagram in Exhibit 1–4 illustrates a simplified version of the steps followed by a patient who is identified for surgery and eventually treated. The number of patients who can be processed through each step in a day is indicated in the exhibit. For example, appointments for outpatient visits can be made for up to 100 referrals from general practitioners in a day. The constraint, or bottleneck, in the system is determined by the step that has the smallest capacity—in this case surgery. The total number of patients processed through the entire system cannot exceed 15 per day—the maximum number of patients who can be treated in surgery. No matter how hard managers, doctors, and nurses try to improve the processing rate elsewhere in the system, they will never succeed in driving down wait lists until the capacity of surgery is increased. In fact, improvements elsewhere in the system—particularly before the constraint—are likely to result in even longer waiting times and more frustrated patients and health care providers. Thus, improvement efforts must be focused on the constraint to be effective. A business process, such as the process for serving surgery patients, is like a chain. If you want to increase the strength of a chain, what is the most effective way to do this? Should you concentrate your efforts on strengthening the strongest link, all the links, or the weakest link? Clearly, focusing your effort on the weakest link will bring the biggest benefit.
International CompetitionOver the last several decades, competition has become worldwide in many industries. This has been caused by reductions in tariffs, quotas, and other barriers to free trade; improvements in global transportation systems; and increasing sophistication in international markets. These factors work together to reduce the costs of conducting international trade and make it possible for foreign companies to compete on a more equal footing with local companies. Reductions in trade barriers have made it easier for agile and aggressive companies to expand outside of their home markets. As a result, very few companies can afford to be complacent. A company may be very successful today in its local market relative to its local competitors, but tomorrow the competition may come from halfway around the globe. As a matter of survival, even companies that are presently doing very well in their home markets must become world-class competitors. On the bright side, the freer international movement of goods and services presents tremendous export opportunities for those companies that can transform themselves into world-class competitors. And, from the standpoint of consumers, heightened competition promises an even greater variety of goods, at higher quality and lower prices. What does increased global competition imply for managerial accounting? It would be very difficult for a company to become world-class if it plans, directs, and controls its operations and makes decisions using a second-class management accounting system. An excellent management accounting system will not by itself guarantee success, but a poor management accounting system can stymie the best efforts of people in an organization to make the company truly competitive. Throughout this text we will highlight the differences between obsolete management accounting systems that get in the way of success and well-designed management accounting systems that can enhance a company’s performance. It is noteworthy that elements of well-designed management accounting systems have originated in many countries. More and more, managerial accounting has become a worldwide discipline.
E-CommerceWidespread use of the Internet is a fairly new phenomenon, and the impact it will eventually have on business is far from settled. For a few brief months, it looked like dot.com startups would take over the business world—their stock market valuations reached astonishing heights. But, of course, the bubble burst and few of the startups are now in business. With the benefit of hindsight, it is now clear that the managers of the dot.com startups would have benefited from the use of many of the tools covered in this book, including cost concepts (Chapter 2), cost estimation (Chapter 5), cost-volume-profit analysis (Chapter 6), activity-based costing (Chapter 8), budgeting (Chapter 9), decision making (Chapter 13), and capital budgeting (Chapter 14). While applying these tools to a new company with little operational history would be difficult, it needs to be done. And the investors who plowed billions into dot.com startups only to see their money vanish would have been wise to pay attention to the tools covered in the chapters on the statement of cash flows (Chapter 16) and financial statement analysis (Chapter 17).
Established brick-and-mortar companies like General Electric, Wells Fargo, American Airlines, and Wal-Mart will undoubtedly continue to expand into cyberspace—both for business-to-business transactions and for retailing. The Internet has important advantages over more conventional marketplaces for some kinds of transactions such as mortgage banking. The financial institution does not have to tie up staff filling out forms—that can be done directly by the consumer over the Internet. And data and funds can be sent back and forth electronically—no UPS delivery truck needs to drop by the consumer’s home to deliver a check. However, it is unlikely that a successful blockbuster business will ever be built around the concept of selling low-value, low-margin, and bulky items like groceries over the Internet. 3 Nabil Hassan, Herbert E. Brown, Paula M. Sanders, and Nick Koumoutzis, “Stolle Puts World Class into Memory,” Management Accounting, January 1993, pp. 22–25. 4 Pallavi Gogoi, “Thinking Outside the Cereal Box,” Business Week, July 28, 2003, pp. 74–75. 5 Karen Hopper Wruck and Michael C. Jensen, “Science, Specific Knowledge, and Total Quality Management,” Journal of Accounting and Economics 18 (1994), pp. 247–287. 6 Ron Wilson, “Excising Waste: Health-Care Providers Try Industrial Tactics in U.S. to Cut Costs,” The Wall Street Journal Europe, November 10, 1993, pp. 1 & 8. 7 Activity-based costing and activity-based management, both of which are discussed in Chapter 8, can be helpful in identifying areas in the company that could benefit from process reengineering. | ||||||||||||||||||||||||||||
