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SKILL SET
Advise managers on the use of management techniques
for quality, efficiency, and continuous improvement.

TOPIC
Management techniques for efficiency and quality

Course learning objective

After completing this course, you should be able to examine the impacts of i) total
quality management (TQM) (ii) just-in-time (JIT) production, iii) the theory of constraints on
efficiency, inventory and cost, and the implications for decision-making.

Introduction

Total quality management (TQM) is a structured approach to overall organisational management.

The focus of the process is to improve the quality of an organisation's outputs — its products or
services — through the continual improvement of internal practices.

There are four key principles of TQM.

The successful implementation of TQM is dependent on a number of factors including the ability
to involve and train staff and whether the production processes can be improved.

There are a number of techniques that promote the principles of TQM. These include just-in-time
(JIT) production and the theory of constraints.

JIT production involves reducing inventory levels to the bare minimum — ideally zero — with
manufacturing occurring only when an order is received from a customer. This system is reliant

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on strong relationships with suppliers and good management information systems.

The theory of constraints applies where bottlenecks or restrictions exist in the production
process. This analysis enables the maximisation of resources available and minimises the impact
of bottlenecks in production.

These techniques may require a significant investment of time and resources to implement.
However, the benefits are likely to outweigh these costs in the long term.

TQM principles and techniques

TQM involves an integrated and comprehensive system of planning and control within all
functions of an organisation so that the products or services provided meet or exceed customer
expectations.

TQM is applied throughout the entire organisation and to every activity within it. It aims to ensure
that errors are prevented before they occur with an emphasis on ‘total quality’ where products
and services are designed to minimise the need for future rectification costs. To achieve this, the
following principles should be applied:

TQM Principles

Click each folder to learn more.

1. ‘Get it right the first time’

The costs of correction are often much higher than the costs of prevention, so instilling a
culture that strives for zero defects is a fundamental to TQM.

2. Continuous improvement

An organisation should continuously review its processes and identify methods for
improvement. Because a zero-defect target is unlikely, TQM suggests there is always an
opportunity for improvement.

3. Customer focus

Most markets are customer-driven, with increased service levels and flexibility being
demanded and a significant level of market competition to fulfil them. Recognising this with

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the implementation of a ‘demand-pull’ production system can create a competitive advantage.

4. Ownership and resolution of problems

It is crucial for the workforce to feel empowered to make decisions and to be responsible for
them. There must be a culture of teamwork and responsibility, working towards a common
goal.

TQM focusses on the costs of quality — conformance and nonconformance. Conformance costs
arise from avoiding defects before they occur and can be split into prevention costs and appraisal
costs. Nonconformance costs arise from failures in the process and are split into internal and
external failure costs.

Examples include:

Conformance costs Nonconformance costs

Prevention costs Appraisal costs Internal failure costs External failure costs

Machine maintenance Quality inspection of Product correction Compensation to

goods received costs customers

Staff training Batch set-up Wastage of materials Repair costs

inspections used in production

TQM allocates responsibilities to the entire workforce for quality at every stage of production —
from the initial design stages to after-sales service. If a problem is detected during any stage of
the production process, it is resolved by that department before it affects subsequent production
stages. In that way, issues are eliminated before they affect the final customer.

TQM advantages
Greatly improved quality of the final product or service
Cost savings through a reduction in waste — Replacing faulty or damaged goods or
components can be expensive and may adversely affect the reputation of the organisation
Increased productivity because staff time is used more effectively
Increased market share as a result of improved products and services creating a
competitive advantage

TQM drawbacks

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Requires a significant time commitment

Not a 'quick fix' — It can take years to implement, and it is a constantly evolving process.
Costly to implement (includes capital costs and the costs of retraining staff)
Requires significant investment of management time to implement (a prerequisite for
transition)
Difficulty to have real involvement and empowerment for all staff. — Success greatly
depends on the roles of the staff members within the organisation and the characters of
the individuals concerned. (Some may be content with less involvement in the
organisation.)

Two techniques that can be implemented that share the principles of TQM are JIT production and
theory of constraints.

JIT production

JIT is ‘a system whose objective is to produce or procure products or components as they are
required by a customer or for use, rather than for inventory’. It represents an approach to
inventory management that focusses on continuous improvement, in line with TQM principles.

JIT is based on the principle that the cost of holding inventory rarely adds value to a product.
Therefore, little or no inventory should be held. Instead, there are frequent, smaller deliveries from
quality suppliers arriving just in time for inventory to be used in production or distributed to the
customer. Holding costs are the costs directly associated with storing inventory such as
insurances, security, power, and temperature control of the storage area.

The system promotes a ‘demand-pull’ production process through which products are
manufactured based on customer demand and pulled through the system. This is in contrast to a
‘cost-push’ production process which creates time delays through work-in-progress waiting for
the next stage of production as the product moves through the manufacturing process.

Characteristics required for the successful implementation of JIT include the following:
Reliable suppliers delivering quality goods at short notice, on a regular basis, and when they
are needed by the organisation — Strong relationships with suppliers are required along
with service level agreements (SLAs) to ensure goods arrive on time and are of high quality.
Strong management information systems for monitoring sales levels and making purchase
orders to suppliers promptly
Flexible workforce trained to operate all machines within their section to enable the
fulfilment of orders when required
Short production processes reducing the lead time to customers

However, the following are some potential disadvantages of JIT:

An increased risk of stockouts occurring which can lead to delays in the production process

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Overreliance on a supplier
Premium costs charged by suppliers to fulfil orders quickly and at short notice

Theory of constraints

This theory focusses on maximising the throughput of a production process. Throughput is

defined as ‘revenue less direct material cost’.

The theory of constraints works on the basis that there are always limiting factors that restrict
throughput, known as ‘bottlenecks’. These bottlenecks could be the lack of availability of supplies,
limited factory capacity, inadequately skilled labour, or even a lack of customer demand.

Once an organisation has identified its bottlenecks, management’s focus should be on actions to
eliminate these constraints. This could be achieved by sourcing alternative materials, changing
designs to use alternative materials, increasing factory capacity, training staff or recruiting skilled
labour, or optimising sales and marketing activities to increase demand.

The aim is to focus on pulling inventory through the production process as quickly and as
efficiently as possible without being limited by bottlenecks.

To minimise the difficulties arising from constraints or bottlenecks, the organisation should
1. identify where the bottlenecks are,
2. identify how to reduce or remove the bottlenecks in production, and
3. maximise throughput by alleviating the bottlenecks.

Scenario

You have recently joined Benji’s Chocolates as the finance manager. This is a new role in the
organisation. Previously, the financial affairs were managed by a local firm of accountants, but
Benji’s Chocolates recently decided it was time to bring the finance function in-house. The in-
house finance staff now consists of you, a part-time bookkeeper, and a payroll clerk.

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Benji’s Chocolates is an owner-managed entity that was established seven years ago by Benji
Bernstein. Benji’s Chocolates manufacture and sell luxury chocolate and fresh fudge, offering an
extensive range with more than 140 different varieties.

The organisation follows traditional methods using only the finest ingredients, and it opts for
organic suppliers for many ingredients. The chocolate and fudge are sold individually or in
‘selection boxes’ (preselected gift boxes with a mix of chocolates or fudge). A selection box is a
premium product, so the retail price is high at USD$55 for a 1kg box and USD$30 for a 500g box.
Each box is well-presented, finished off with a hand-tied ribbon.

The organisation experienced rapid initial growth but has seen a decline in revenue in the last
couple of years. The organisation includes five small stores (located in prime retail space) and a
factory that employs 10 staff. Each store has a manager and four to six sales assistants, some
full-time and some part-time.

The organisation also distributes through an online store. Benji manages this side of the
business, filling orders by taking inventory from the Park Avenue store (one of the five stores).

Today, you are meeting Benji. He is concerned about a steady decline in profits and has asked
you to review the business to see where the problems are arising. After a tour of the factory and
discussions with Benji, you identify the following issues:

Inefficiency in processes

Online orders are fulfilled from inventory delivered to the Park Avenue store. Some online
customers have complained about the lead time for delivery and requested refunds and
compensation for the delay.
The factory layout requires products to be moved around the building from the ground floor
to the first floor and back again on a regular basis. This results in wastage of 5% of finished
goods production.
There is overreliance on one employee, Randall, who is the only skilled staff member able to
produce certain varieties. Randall’s recent absence meant that other production employees
were required to work overtime to fulfil orders, and the organisation experienced an
increase in product wastage from 5% to 15% during this time.
The production employees are demotivated and feel that they are not valued in the
workplace.

Knowledge check

Group items by dragging them into their corresponding boxes.

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Question
Benji’s Chocolates has incurred a significant amount of nonconformance costs of quality
due to the inefficiencies in production processes.

Categorise each of the following costs as internal failure or external failure costs.

Solution

Cost of refunds to online customers Increased cost of wastage in Randall’s absence.

Cost of compensation to online customers

Internal failure costs External failure costs

Submit

Knowledge check feedback

Nonconformance costs include internal failure and external failure costs.

Internal failure costs arise as a result of the products not meeting the requirement quality
standard. The increased cost of wastage in Randall’s absence is an example of an internal failure
cost.

External failure costs arise when issues are not discovered until after the customer is involved.
Therefore, the cost of refunds and compensation to online customers caused by the delays in
delivery are known as external failure costs.

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Scenario (continued)

You meet with Benji to discuss the implementation of a TQM philosophy at Benji’s Chocolates.
You feel that its principles to ‘get it right first time’ would provide an opportunity to reduce costs
and inefficiency and maximise profits.

You: TQM seems a good fit for Benji’s Chocolates. It requires a strong customer focus and
continuous improvement to take place over time. Implementing TQM is likely to incur additional
costs initially. However, this investment leads to higher returns in the future. This enables the
organisation to return to increased profitability.
Benji: We would certainly benefit from a customer focus. The industry is competitive, and the
customer has so much choice. We pride ourselves in providing a premium product and want to
maintain that reputation, but the cost of using high quality ingredients and a labour-intensive
process is draining the profits.
You: At the moment our failure costs are having a significant impact on profits. These costs
cannot be passed on to the customer. If we focus on preventing the inefficiencies by incurring
conformance costs of quality, the financial impact is reduced and the customer experience is
improved. Similarly, TQM requires employees to be empowered to make decisions to increase
their motivation, which is lacking at present. I can email some details this afternoon.

Email to Benji

To: Benji Bernstein

From: Finance manager
Subject: Total quality management (TQM) at Benji’s Chocolates

Hi,

As we discussed in our meeting this morning, please find attached my summary of

suggestions for improvements to the production process using the principles of TQM. I have

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suggested an improvement to the process, as well as the additional expected costs of

conformance, alongside the expected savings in nonconformance costs currently being
incurred.

For each inefficiency, the conformance costs incurred in preventing the issues are likely to be
much less than the nonconformance costs. This increases profits and improves Benji’s
Chocolates’ reputation in the longer term, which helps secure our position in the market.

These are the first steps in implementing TQM. However, this is a long-term strategy of
continuous improvement. We can formulate a strategy that identifies where we want to be in a
year’s time then look at how we can progress to that point.

You must ensure the workforce feels engaged in the process (through team and individual
meetings) so they can make you aware of the issues they are facing and so you can
encourage them to suggest solutions to the problems they face. Acting on these suggestions
is likely to be viewed favourably by the staff because they will feel involved and valued —
leading to the empowerment of the workforce.

A full review of the production process could be conducted. A good place to start is evaluating
the component ingredients and establishing whether there are efficiencies to be gained by
reducing the range of ingredients or by using a different quality of ingredient. The ratio of
inputs to outputs needs to be clearly identified for each product.

Consideration should also be given to the need for 140 different varieties. We need to
understand whether this is something the customer values. A high number of products leads
to a higher number of machinery set-ups and each of these will incur batch set-up costs. The
production schedule needs to be carefully managed, responding quickly to the demand by
customers.

If you have any questions, please get in touch. I am confident that the organisation can benefit
from the TQM approach.

Kind regards,
Finance manager

Attachment

Inefficiency TQM solution Additional Nonconformance

conformance costs cost savings

Online customer Delivery of online None Customer refunds and

complaints regarding orders directly from compensation are
delays leading to the the factory eliminated, and the
organisation’s
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Inefficiency TQM solution Additional Nonconformance

conformance costs cost savings
payment of refunds reputation improves
and compensation as customer
satisfaction
increases. Reduction
in distribution costs
as products are
delivered directly to
the customer

Wastage of 5% of Amendment of the Costs of moving Reduced wastage

finished goods production line machinery into a levels
production due to a layout to avoid time more appropriate
poor factory layout delays and wastage production layout
transporting
products between
processes

Overreliance on one Upskill other Prevention costs — Overtime cost

skilled employee — production training costs of reduction when
Randall employees through production Randall is absent
training in all aspects employees Increased wastage
of the production eliminated when
process Randall is absent

Scenario (continued)
After Benji has had time to review the email you sent, he schedules a meeting with you.

Meeting with Benji

Benji: Your suggestions make sense, and I am keen to get these systems in place as soon as
possible. Did you mention that there were some other techniques that might complement TQM?
You: Yes, during my review, I identified some further inefficiencies in relation to inventory control
that are costly to the organisation. We would definitely benefit from the introduction of a JIT

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approach to inventory management. However, we must be sure that our processes are conducive
to its success. The issues are:
There is no formal inventory management or control system in place. Any factory employee
can place an order from a list of suppliers located in the stores office when the inventory
levels appear too low. Too much or too little inventory may be ordered. Both are costly to
the organisation — resulting in increased holding costs and subsequent obsolescence or
resulting in delays in production until the deliveries arrive.
Inventory is produced on the basis of historic demand leading to overstocking of certain
varieties. Twenty per cent of finished chocolates are written off as obsolete every year.
There have been a number of instances in which the inventory of ingredients has been over-
ordered by mistake, most recently with dried cranberries. Perishable goods have a limited
shelf life, require storage until they are used, and may need disposing of when the expiry
date passes. Furthermore, the dried cranberry varieties are not popular with customers.
The lack of inventory management increases the risk of theft which may be costly to Benji’s
Chocolates.

Benji: We certainly need to obtain better control of our inventory. We source from high quality
organic suppliers, so the ingredients are expensive; and, as you pointed out, they have a limited
shelf life.

Knowledge check

Select the choice(s) that best answers the question below.

Question
Which three of these are costs associated with holding inventory at Benji’s Chocolates?

Solution

A. Rental costs for the space taken up by the inventory.

B. Delivery costs of inventory.

C. Theft of ingredients.

D. Purchase order staff salaries.

E. Obsolescence of inventory that has a short shelf life.

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Submit

Feedback
A. Correct. This is a direct cost of holding inventory.

B. Incorrect. This relates to the purchase cost of the inventory.

C Correct. This cost arises due to holding inventory as the risk of theft increases when it
. is stored onsite.

D. Incorrect. This is an order cost relating to inventory.

E. Correct. This is a holding cost that would not apply if JIT was implemented.

Scenario (continued)
For JIT to be effective, strong relationships with reliable suppliers must be established. This
should reduce the number of suppliers used by Benji’s Chocolates to those that can meet criteria,
including the following:
Consistent quality of ingredients supplied (measured as a percentage of units failing
inspection versus inspected units)
No unexpected price variance (ordered price versus invoice price)
Reliable delivery with short lead time
Correct quantity of ingredients in each order
Correct type of ingredients in each order
Low return rate

It would be appropriate to limit inventory ordering to one individual who can build and maintain a
strong relationship with these selected suppliers. It would also be advisable to introduce SLAs
covering the quality, price, and delivery time. You would expect the supplier to have its own quality
management processes to ensure delivery to the terms of the SLAs.

Although holding costs are likely to decrease when JIT is implemented, order costs are likely to
increase. Orders are made frequently for smaller quantities which is likely to lead to a loss of bulk
buy discounts. However, these additional costs are unlikely to exceed the savings from reduced
inventory obsolescence, wastage, and write offs.

You send your notes describing JIT production to Benji. A few days later, he schedules a brief
follow-up meeting to discuss the technique further.

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Meeting with Benji

Benji: Thank you for the notes on JIT. You have definitely raised several problems that we need to
address and resolve.
You: For JIT to work effectively, Benji’s Chocolates needs to have a small number of reliable
suppliers that are happy to supply on this basis. The organisation would have to be confident
about the quality of the ingredients and the vendor’s ability to deliver the right quantity and the
right products at the right time. Otherwise, Benji’s Chocolates’ production process might suffer
without a surplus to buffer any issues that arise.
Benji: I am cautious about implementing this approach. What if there is a problem with one of the
suppliers? I’ve always preferred to hold inventories.
You: JIT does carry with it a risk of stockouts, and there have been examples of organisations
operating a JIT approach that have been adversely affected by problems in their supply chain. For
example, there could be contamination of a batch or a fire at the vendor’s depot.
A further criticism of this approach is that (with a high level of deliveries) there is likely to be an
increase in the carbon footprint for the business. Environmental concerns such as carbon
footprint are important, and a low carbon footprint may be valued by our customers. We can look
at alternative ways to reduce the overall carbon footprint (like using local suppliers).
There is no hard and fast formula to make JIT successful. The goal is to minimise inventory
levels with the aim to keep sufficient supply for one or two days of production. Some entities may
aim to have deliveries scheduled to arrive within hours of being used in production; others might
allow for a turnaround measured in days.

Knowledge check

Group items by dragging them into their corresponding boxes.

Question
Drag each element to the appropriate category indicating whether it is likely to be either
‘Higher’ or ‘Lower’ once a JIT system has been implemented.

Solution

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Wastage Profit Risk of stockouts Unit costs for ingredients

Inventory holding costs

Higher Lower

Submit

Knowledge check feedback

Higher
Risk of stockouts — If we have unexpected demand, there may not be sufficient produce to
satisfy the customer.
Profit — The additional investment in planning and ordering is outweighed by cost savings
in holding inventory and by increased customer satisfaction.
Unit costs for ingredients — Bulk discounts may be lost as a result of ordering smaller
quantities more regularly.

Lower
Wastage — Handling inventory in smaller volumes and over shorter periods of time reduces
the risk of wastage.
Inventory holding costs — JIT aims to keep inventory levels to a minimum. Therefore,
holding costs such as insurance, power, and security costs are likely to reduce.

Scenario (continued)

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Your final suggestion for Benji’s Chocolates relates to the theory of constraints. This technique
focusses on maximising the throughput — the pace at which ingredients are converted into
sellable chocolates and fudge— by identifying bottlenecks in the production process.

You send Benji an email suggesting how this can be applied.

Email to Benji

To: Benji Bernstein

From: Finance manager
Subject: Theory of constraints

Good morning,

I have identified a bottleneck in the production process. There seems to be a problem with the
wrapping machines. There are only two workers able to use these machines, and machine
failure seems to be a common occurrence.

This means that the wrapping process is a frequent production bottleneck. One solution might
be to invest in a new, more reliable wrapping machine. There would be an initial cost. However,
the new machine increases efficiency and results in a shorter production cycle lowering the
operating costs. This would enable Benji’s Chocolates to convert ingredients to a sale in a
quicker period of time. Because the finished products are perishable goods, a shortened
production cycle would reduce the level of waste in our inventory of finished goods.

Secondly, we should train more production employees to use of the new wrapping machine to
prevent further bottlenecks if the two wrapping machine operators are absent from work at
the same time.

Although additional training costs are incurred initially, the benefit of a more versatile
workforce creates cost savings in the longer term and a more efficient production process.

To experience continuous improvement in the production processes, regular review and

monitoring must be carried out. I am preparing a regular schedule of evaluation for your
review.

Kind regards,
Finance manager

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Scenario summary

By implementing the principles of TQM, JIT, and the theory of constraints, Benji’s Chocolates is
able to do the following:
Increase customer satisfaction by reducing lead times to online customers
Reduce inventory holding costs and wastage by implementing JIT inventory management
Reduce inefficiencies in the production process by removing bottlenecks
Improve employee motivation by empowering the workforce and upskilling them for
versatility and flexibility

All of these improvements lead to reduced costs and increased profits for Benji’s Chocolates,
which was the original objective of Benji Bernstein. The TQM principles of continuous
improvement and ‘get it right first time’ should continue to be applied in the long term.

Conclusion
TQM involves the entire organisation and aims to improve the quality of an organisation’s outputs
through continual improvement of the quality of internal practices.

There are four key TQM principles.

‘Get it right first time’ — Correction costs are often higher than the costs of prevention.
Continuous improvement — An organisation should continuously review its processes and
identify methods for improvement.
Customer focus — Products should be made because a customer demands them. This is
known as a ‘demand-pull’ system.
Ownership and resolution of problems — Foster a culture of empowerment and
responsibility in the workforce working towards a common goal.

The following techniques promote the principles of TQM:

JIT production — Reduce inventory holding costs by holding minimal or no inventory and
placing orders with suppliers just in time to meet customer demand.
The theory of constraints — Maximise throughput by identifying and eliminating bottlenecks
in the production process caused by constraints.

Successful implementation of TQM and the use of JIT and the theory of constraints leads to
better quality of products and services, lower inventory levels, and the best possible use of any
resource restrictions. However, organisations should be mindful of avoiding over-reliance on a
supplier and the investment of management time needed before implementing these approaches
to minimise the drawbacks associated with them.

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TOPIC
Business process improvement

Course learning objective

After completing this course, you should be able to discuss the benefits of process re-engineering
and the use of Kaizen costing, continuous improvement and cost of quality reporting.

Introduction

To sustain long-term success, an organisation needs to adapt its operations to achieve and
maintain a competitive advantage, increase profits and enhance its products or services to meet
or exceed customer expectations.

Process re-engineering can be used by an organisation when its current business processes need
to be reviewed and adapted. This may be instigated by feedback from customers who are
unhappy with an aspect of a product or service or by the employees who have identified
inefficiencies in processes.

Process re-engineering is a one-off change to revise not only production but any business
process to increase efficiency and to ensure that products or services satisfy customer needs.

Alternatively, an organisation can choose to adopt a Kaizen approach to process improvement.

Kaizen is a Japanese philosophy that supports the continual cost reduction of existing
components and products. It is one of continuous improvement rather than one-off change.

Continuous improvement requires that the workforce is sufficiently trained in this approach, that
new technology is properly integrated to increase performance, and that the organisation’s
philosophy is engaged with the concept of continuous improvement.

Kaizen places emphasis on the importance of managing the following costs of quality.

Costs of conformance
Costs incurred to avoid failure and to ensure the product or service is of the required standard
and quality.

Costs of nonconformance
Costs incurred as a result of the product or service failing to achieve the required standard and
quality.

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The focus on continuous improvement requires frequent planning, review, implementation, and
evaluation of its success.

Benefits of business process improvement

Adapting and improving business processes plays an important role in an organisation’s long-
term success. Efficient systems and processes can lead to an enhanced or lower-cost product
(depending on the organisation’s strategy), simultaneously increasing customer satisfaction and
profits. It can also provide a competitive advantage which is particularly valuable in a customer-
driven, global market.

There are two main approaches to business process improvement

Process re-engineering

The initial focus of process re-engineering is a consideration of the endpoint (that is, the
customer experience and how it can be improved). Once that has been established, management
works backwards through its systems to determine how activities and processes might be
adapted and improved to achieve that endpoint goal. Non-value adding activities (those that do
not enhance value for the customer) and bottlenecks in production are eliminated. Process re-
engineering is likely to result in significant changes in the production process which can lead to
substantial short-term disruption.

Click each folder to learn more.

Benefits of process re-engineering

Elimination of non-value added activities

Increased efficiency
Increased profits
Focus on demand-pull production

Disadvantages of process re-engineering

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Risk of staff demotivation from the perceived possibility of redundancy

Significant investment of management time
Short-term business disruption arising from significant changes

Kaizen

Kaizen is a Japanese philosophy of continuous improvement. Rather than reviewing business

processes to make significant changes on an infrequent basis, the workforce and management
are continually engaged in business processes and make small improvements and adaptations
as and when they are identified.

Kaizen costing, the continual cost reduction of existing components and products, is a culture
that is instilled throughout the organisation resulting in increased efficiency and an improved
customer experience. It can be applied to any aspect of the business cycle. For example,
organisations might improve products through the introduction of new varieties or experience a
positive impact on yield and quality through the use of different materials.

Employees operating within a Kaizen costing culture might set themselves internal targets to
reduce costs by a specific percentage each quarter. This is seen as a challenging and stimulating
environment that provides job satisfaction by some; however, others may be demotivated if it
appears that the success criteria are continually being changed.

Continuous improvement requires the workforce to be fully trained in the methodology of Kaizen,
that new technology is properly integrated to improve performance, and the business philosophy
is engaged with the concept of continuous improvement.

Costs of quality improvements

There are costs associated with quality improvements. Cost of quality reporting monitors the
different categories of cost incurred in relation to the quality of the product or service.

Conformance costs represent the costs of avoiding defects before they occur and can be split
further into prevention costs and appraisal costs. Nonconformance costs arise as a result of a
failure in the process and are split into internal and external failure costs.

Conformance costs Nonconformance costs

Prevention costs Appraisal costs Internal failure costs External failure costs

Costs incurred to Costs of quality Costs arising from a Costs arising from a
prevent defects inspection and failure before the failure after the

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Conformance costs Nonconformance costs

Prevention costs Appraisal costs Internal failure costs External failure costs
occurring testing product reaches the product reaches the
customer customer

Investment in conformance costs of quality is considered more beneficial and less costly than
incurring nonconformance costs as a result of failures in business processes.

Costs of quality should be regularly reviewed as part of the Kaizen approach to minimise the cost
and impact of failures in products or services.

Scenario

You have recently joined Benji’s Chocolates as the finance manager. This is a new role in the
organisation. Previously, the financial affairs were managed by a local firm of accountants, but
Benji’s Chocolates recently decided it was time to bring the finance function in-house. The in-
house finance staff now consists of you, a part-time bookkeeper, and payroll clerk.

Benji’s Chocolates is an owner-managed entity that was established seven years ago by Benji
Bernstein. Benji’s Chocolates manufactures and sells (retail to consumer) luxury chocolate and
fresh fudge, offering an extensive range with more than 140 different varieties.

The organisation follows traditional methods using only the finest ingredients, and it opts for
organic suppliers for many ingredients. The chocolate and fudge are sold individually or in
‘selection boxes’ (preselected gift boxes with a mix of chocolates or fudge). A selection box is a
premium product, so the retail price is high at $55 for a 1kg box and $30 for a 500g box. Each box
is well-presented, finished off with a hand-tied ribbon.

The organisation experienced rapid initial growth but has seen a decline in revenue in the last
couple of years. The organisation comprises five small stores (located in prime retail space) and

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a factory that employs ten staff. Each store has a manager and four to six sales assistants, some
full-time and some part-time.

The organisation also distributes through an online store. Benji manages this side of the
business, filling orders by taking inventory from the Park Avenue store, one of the five stores.

Tour of the factory

Shortly after you joined Benji’s Chocolates, Benji gave you a tour of the factory, and you noted
numerous inefficiencies in personnel and inventory management, such as the following:
Inventory security — Doors are being left open due to poor air conditioning and ventilation,
creating a potential for theft of inventory and product defects due to lack of cooling.
Reliance on the skills of one employee — The main production area is overseen by one
employee, Randall. When Randall took time off for minor surgery, production was halted for
a week and wastage levels increased substantially.
Unreliable equipment — The wrapping machinery experienced regular break downs leading
to a backlog in the production process.

Scenario (continued)
In previous meetings with Benji, you have examined his production, distribution, and personnel
strategies, and the two of you have identified areas that can be improved. Although he has
expressed concerns about cost and logistics, he is generally receptive to making changes.

You meet with Benji to discuss the concept of process re-engineering.

Meeting with Benji

Total quality management (TQM) methodologies

Click to review the TQM definition.

TQM

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A management approach to long-term success that seeks to ensure that goods being produced
and services being provided are of the highest quality.

Benji: Now that we have implemented some positive changes to the production systems
following the introduction of total quality management (TQM) methodologies, I think it would be
beneficial to review the entire production process. Nothing has changed significantly since the
organisation commenced trading; but, if I had to start over, I would approach it very differently.
You: There is a method known as process re-engineering that we could adopt as a one-off, large-
scale exercise. The first step is to consider our products and whether they meet customer
requirements which allows us to work backwards reviewing our processes and eliminating any
non-value adding activities or bottlenecks. There are likely to be substantial changes as a result of
this exercise which can be disruptive in the short term and demotivating for the workforce.
Benji: I would like to explore this further. Could you send me some information relating to the first
step of examining our customer’s experience?
You: Of course, I can do that today.

Later that day you send Benji the following email:

Email to Benji

To: Benji Bernstein

From: Finance manager
Subject: Examining the customer experience

Hi,

I have summarised some considerations relating to our customer experience with a key focus
on customer needs and demand.

Reduce number of products

Currently, there are more than 140 different product choices for the customer. It is likely that
this is too broad a product range. Benji’s Chocolates should analyse the type of sales to
understand which products are most popular and focus on these varieties.

Special edition of flavours

If customers value the wide range, this could be accommodated by a series of ‘limited-edition’
production runs for ‘guest’ flavours. There would be opportunities for additional online sales if
this could be marketed effectively to customers.

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Organic versus non-organic

Next, we should consider the nonfinancial values. Benji’s Chocolates uses high quality, organic
ingredients. These would typically have higher purchase costs than non-organic, lower-quality
ingredients. If customers value the use of organic products, then this should be continued. If
consumers are unaware of this feature, then it may be financially beneficial to switch to
cheaper ingredients.

Quality versus cost

The quality versus cost decision needs to be considered carefully. If the quality of the final
product is unlikely to be affected, then Benji’s Chocolates should consider using different
ingredients to reduce costs. However, the organisation has a reputation as a premium product
brand. Therefore, this would need to be evaluated carefully before progressing with cheaper
ingredients.

Packaging
Currently, the packaging is superior, with hand-tied ribbons conveying a sense of luxury that
matches the product within. Although consumers might value this if purchased as a gift, there
is potential to offer alternative cheaper packaging for non-gift products for a lower cost, to
generate more sales.

There is a lot to consider in process re-engineering, leading to a significant overhaul in our

processes. Although this is feasible, I am not sure it is the right approach for Benji’s
Chocolates.

Kind regards,
Finance Manager

Knowledge check

Select the choice(s) that best answers the question below.

Question
Which three suggestions are sensible for process re-engineering within Benji’s?

Solution

A. An improved product cooling system.

B. The introduction of just-in-time production.

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C. Retention of manual packing and finishing processes.

D. Investment in a new wrapping machine.

E. Online orders being distributed from all local stores.

Submit

Feedback

ACorrect. Currently, the cooling process takes longer than it should. Investment in a more
. efficient cooling process reduces the length of the production process and reduces the
risk of health and safety and food preparation legislation being breached.

BCorrect. To do so, Benji’s needs to establish a relationship with several key suppliers.
. Benji could enhance the order process with his suppliers by using data-sharing
technology. Benji should have management information systems capable of determining
inventory orders driven by production, which is driven by sales.

CIncorrect. Benji’s should investigate automating this process because it is likely to be

. more efficient. This search for efficiency needs to be balanced against the requirements
of the traditional style of the product, which may demand a more labour-intensive
approach.

DCorrect. Understanding the flow of product through the process is important in

. determining whether the balance is correct. Training staff to be able to work across all
areas would help eliminate bottlenecks and cover for staff absences.

E Incorrect. There is already extra time and costs involved in sending products to one of
. the stores, so distributing to all the stores would make the process even less efficient.

Scenario (continued)

After Benji receives your document, he stops by your workspace.

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Benji: Thank you for your email. I have reviewed your suggestions, and I too am concerned about
the impact of such a large scale, one-off re-engineering process. I think the workforce would be
more responsive to regular, incremental changes. We need to be flexible to a changing market
environment.
You: Yes, an alternative approach would be a philosophy known as Kaizen, which involves making
continuous improvements over time with a focus on minimising the costs of quality.
Benji: I believe I have come across this approach before. It provides a good fit with TQM
principles.
You: That is correct. The costs of quality are monitored with an emphasis on avoiding failures in
quality by incurring conformance costs. Conformance costs can be categorised as prevention
(costs incurred to prevent quality failure) or appraisal costs (inspection costs to avoid quality
failure).
Benji: It would be useful to understand the types of conformance cost that we might incur.

Knowledge check

Group items by dragging them into their corresponding boxes.

Question
To aid Benji’s understanding of conformance costs of quality, categorise the following
costs as either ‘Prevention’ or ‘Appraisal’ costs.

Solution

Cost of training the workforce in all aspects of production.

Cost of conducting research into reliable, high quality suppliers.

Cost of inspecting incoming deliveries of ingredients

Cost of employing of a highly skilled workforce.

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Cost of an annual equipment maintenance contract. Cost of quality control inspections

Cost of testing products against the product specification

Prevention Appraisal

Submit

Knowledge check feedback

Prevention costs
Include any cost incurred in avoiding defects in the quality of a product or service. Examples
include the following:
Cost of training the workforce in all aspects of production
Cost of conducting research into reliable, high quality suppliers
Cost of an annual equipment maintenance contract
Cost of employing of a highly skilled workforce

Appraisal costs
Comprise any cost incurred in quality inspections and testing. Examples include the following:
Cost of inspecting incoming deliveries of ingredients
Cost of testing products against the product specification
Cost of quality control inspections

Scenario (continued)

The discussion continues.

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You: If there is insufficient investment in conformance costs, it results in the occurrence of

product failures. The nonconformance costs that are incurred as a result of these failures are
much more costly to the organisation.
Internal failure costs occur when there has been a quality failure, identified before the finished
product reaches the customer.
Examples of internal failure costs include the costs of reworking a defective unit or, alternatively,
the cost of scrapping defective units. Sometimes this cost can be offset if there is an option to
sell a sub-standard product. This can be done by marking goods as ‘seconds’ and selling them as
such to the public. Overall, the return is always less than if a ‘good’ unit had been sold.
External failure costs are possibly the worst outcome. These are the costs that follow a customer
taking receipt of faulty product.
External costs can be quite high—an example might be one related to the costs of dealing with a
return by a customer. Another is a product recall from a series of customers, if a defective batch
has not been identified in time. The cost may escalate considerably if, as a consequence, the
customer experienced injury, illness, or worse. In such cases, there is often a lawsuit brought
against the manufacturer.
We can expect that the more we spend on prevention and appraisal, the lower the failure costs
are. It is worth tracking these costs over time. At some level, there is a point at which the extra
money spent on prevention or appraisal yields little or no improvement or reduction in failure
costs.
Benji: That is very useful information.It seems to me that a Kaizen approach fits best with the
TQM philosophy that we are trying to implement here at Benji’s Chocolates. There is certainly
room for improvement in our production processes so we should get started with cost of quality
reporting as soon as possible.

Conclusion
Process re-engineering involves a large scale, one-off overhaul of an organisation’s business
processes. This exercise might arise as a result of falling profits, a decrease in customer demand
(there may be environmental concerns about a product using too much plastic or paper) or a
major inefficiency identified by an employee.

A substantial amendment to the business process is made to ensure

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it is efficient and
the products satisfy customer needs.

By focussing on customer requirements, bottlenecks and non-value adding activities can be

eliminated and processes can be streamlined.

In contrast to process re-engineering, Kaizen is a philosophy of continuous improvement within

an organisation.

This approach requires a fully trained workforce that applies the Kaizen culture throughout the
organisation. Kaizen is associated with a series of small steps to improve the business
processes, rather than a single fundamental change.

To improve quality in business processes, costs of quality are incurred, both due to the
improvements being made as well as when quality failures arise. These costs are classified as
either of the following:
Costs of conformance — Costs incurred to avoid failure or to ensure the product or service
is of the required standard and quality
Costs of nonconformance — Costs incurred as a result of the product or service failing to
achieve the required standard and quality

External failures can be harmful to an organisation as revenue, profit and reputation are adversely
affected. Therefore, careful monitoring of costs of quality should be undertaken on a regular
basis.

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