The Califomia-lllini Manufacturing Company's (CI) plant operates in the rural central valley of California. It is family-owned

Question:

The Califomia-lllini Manufacturing Company's (CI) plant operates in the rural central valley of California. It is family-owned and run. CI's plant manager, a grandson of the founder, went to school with many of the employees. Despite this family atmosphere, CI is the largest producer of plain and hard-faced replacement tillage tools in the United States. It averages annual sales of $13 million. Fanmers use tillage tools to cultivate the land. Haixl-facing, the application of brazed chromium carbide to leading edges, increases a tool's durability.

THE PRODUCTION PROCESS Historically, CI grew from the founders' original blacksmith shop, and today the production process is still relatively simple. The plant manager described the process as

'You simply take a piece of metal. And then you bang, heat, and shape it until it's a finished product. It really isn't a sophisticated process. We just do it better than anyone else." The production process is like a flow following a routing from one cost center to another in a sequence of move, wait, setup, and runtime for each process. Wori

THE COST SYSTEM: MEASURING PERFORMANCE CI uses standard unit costs to measure performance and profit potential. In this cost system, each materials and labor input is given a standard usage, and production managers are evaluated on their ability to meet or improve upon these standards.

Differences from the standard were called "Variances." For example, if a certain manufacturing operation required at standard 5 minutes, the operator would be expected to complete a lot of 100 parts in 500 minutes. If actually 550 minutes were required, there would be a 50 minute unfavorable variance. Also, using the operator's wage rate, the cost of the variance could be calculated.

CI'S IMPROVEMENT STRATEGY The depressed market in the mid-1980s caused a 1986 net loss of close to $1.8 million.

Inventory turns were down to one and a half, and cash flow was poor. Facing these conditions, management adopted a new strategy stressing improvements in accounting perfomnance and reduction of inventories. Their strategies for improvement included:

increasing productivity, cost cutting (overhead control), improving technology, and increasing prices.

1. Productivity. Productivity improvements centered on direct labor productivity measures. Output per direct labor hour was the crucial factor. Accordingly, improving efficiency, by definition, consisted of keeping direct labor busy producing as much product as possible during regular worthing hours. Actions supporting this strategy were 1) reducing idle manhours between jobs, 2) increasing batch sizes to maximize runtime, and 3) reducing setup times.

The operational control system measured the "earned labor hours" for each department daily. While the plant manager only received these reports weekly, he was still aware of the daily figures. Budget reports, including variances, while processed monthly, were often two to three weeks late! Thus, they had little direct /

impact on day-to-day decisions. However, the plant manager knew what the accounting reports should be like from his daily earned labor hours infomiation.

The short-term results of these efforts were impressive because plant effiaency measures rose about 15%. There were, however, some negative, unanticipated side effects in wori

First wori

Second the large batch sizes made scheduling difficult. They reduced plant flexibility by keeping machines on single jobs for long periods. Therefore, it was difficult to adjust for normal production problems and still maintain the production schedule Machines were not readily available for special situations and expediting.

Finally these large batches, while increasing productivity, created the need for overtime to maintain the schedule. Overtime in the finishing department, for example increased by 15-20%, thus raising operafing expenses. The larger lots reduced the variety of products produced each production period. This increased the lead fime for custom oixlers could get stuck behind jobs with long runtimes.

Overtime then, became necessary to expedite out-of-stock orders. These factors combined with low sales volumes to create losses and more cash flow problems.

2. Overhead. Overhead improvement focused on two strategies. The first was direct cost reduction. The second concentrated on reducing unit costs by increasing volume. The higher volumes allowed overhead to be absorbed over more units. However, because CI's cost structure had large fixed obligations (like union contracted pension fund contribution), potential overhead savings were minimal. The results of these strategies were unimpressive. The union didn't make many concessions, and few overhead savings occurred. Production volumes did increase, but the plant was producing to cover overhead rather than to satisfy immediate demand. Management hoped that increasing sales would eventually take care of the excess production. Unfortunately, this didn't happen. By 1989 inventories were 24% higher than in 1986. And, once again, there were cash flow and eamings problems.

3. Technology. Cl considered the technology focus to be particularly troublesome. Concentrating on reducing unit costs through technology improvement often blocked out other aspects of the decision. Management's assumptions were that the savings from each decision flowed directly to the bottom line. However for Cl this myopic view of unit costs encouraged mistakes. Management's use of robots provided a vivid example of the problems. Robots were investigated as a means of decreasing the unit costs for the application knife. The anhydrous ammonia applicator knife was popular worldwide, to revitalize the soil with ammonia fertilizer after each harvest. Although Cl led the industry in product quality, it was a high-cost producer. The primary reason was determined to be hand welding, using expensive piece rates, with manual electric arc welders. After a unit-cost analysis, the savings in labor and applied overhead seemed to justify the introduction of welding robots (T1-2-3). Subsequent price reductions increased sales from 20,000 to more than 60,000 units in the first. At the new, lower, price the company seemed to still realize savings of $1.25 per unit. Unfortunately, these savings were illusory. During the second year, other manufacturers became price competitive and sales volume dropped to 40,000 units; however, management still believed the robots saved the company money. At a 10% discount rate the three-year net present value was $63,730. A major problem was that labor savings disappeared as manual welders found work in other areas of the plant. In fact, the robots required additional new hires and caused increases in utilities and maintenance costs. New operating expenses were greater than tlie increased througliput. Thus, management was misled by its focus on standard unit costs.
4. Selling Prices. Unfortunately, the market for the fimri's products was very competitive. Due to such macroeconomic factors as govemment programs and foreign grain production, the domestic market was shrinking. Intemationally, CI's high unit costs made foreign markets difficult to enter. Consequently, management perceived the marketplace to be mostly out of their control. Their main focus was on improving plant performance. Nonetheless, CI still tried to increase the sales volume in domestic markets and to find new foreign markets. As for the foreign markets they experienced some success and some failures.
In an attempt to find new international markets, the company successfully set up a working relationship with a John Deere distributor in Mexico and, unsuccessfully pursued a contract in Saudi Arabia. This failure was very revealing because Saudi Arabian soils were made to order for CI's product. The Saudi's cultivation process was particulariy abrasive for tillage tools. Because of frequent breakdowns, crews with replacement parts had to constantly follow the field woricers. But with CI's parts this practice wasn't necessary. Consequently, the Saudis were very enthusiastic about the company's products. Unfortunately, CI did not believe the 10% profit margins to be large enough. CI rejected the Saudi Arabia offer. This happened while at the same time the plant was having difficulty with operating expenses, overhead, and inventories. Thus, the accounting cost standards influenced mariDuring this time, marketing and production meetings were frequent. Mari^eting pointed out that while quality was good, prices were too high and lead times were too inaccurate. On the other hand, production complained that mari^eting was constantly messing up their production schedules.
Using this combination of efficiency improvement, overhead reduction, unit-cost reductions and sales margins, management proceeded, over an 18-month period, to reduce domestic volume by 1 1 .5% and to tum away significant foreign opportunities.
Overall, decisions to improve the peri'onnance of the company using standard cost measurement failed. By February 1989, operating expenses were 20% greater than the disastrous 1986 figures. During the same period, inventories increased by 24%, and net profits continued to deteriorate.
At year-end CI hired a new Production Control/Inventory Control (PCIC)
manager. However, the plant manager was suspicious when the PCIC manager came to him with revised schedules. The PCIC manager suggested processing job lots of 100 to 150 parts rather than the current 6,000. The plant manager questioned the PCIC manager's ability. "Cleariy he isnt very knowledgeable. How can we make any money running only small lots? The setup costs will kill us!
Finally the PCIC manager gave the plant manager a copy of The Goal by E.
Goldratt and J. Cox. After reading the first few pages, the plant manager recognized many similarities between his plant and the one described in this book.
REQUIRED:
1 What is the firm's competitive strategy? Does the strategy seem appropriate?
2. What motivated the cost reduction strategy? Did the cost reduction strategy work?
Why?
3. How did CI's standard cost system affect the cost reduction strategy?
4. What is the role of work-in-process in the cost reduction strategy?
5. Is the new Production control/Inventory Control pciC) manager on the right track with the smaller lot sizes?

6. What steps is the PCIC likely to take now?
7. What type of cost system should be used at CI? image text in transcribed