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Westra, D., M. L. Srikanth and M. Kane. 1996. Measuring operational performance in a throughput world. Management Accounting (April): 41-47.

Summary by Rosalyn Mansour
Master of Accountancy Program
University of South Florida, Summer 2002

Performance Measures Main Page | TOC Main Page

The purpose of this article to explain how a manufacturing enterprise, Foldcraft, determined it needed to switch from standard cost manufacturing to synchronous manufacturing and to describe the transition.

Foldcraft’s problems included excessive operating expenses, high inventory levels, average delivery performance, and an organizational structure that was too complex and inflexible. As a result of seasonal demand, Foldcraft often had to utilize many unskilled temporary personnel, which was not only expensive, but also added to its problems previously mentioned.

Foldcraft decided to create a team comprised of several management personnel and users of the processes along with business consultants brought in from the outside. Foldcraft chose business consultants that specialized in synchronous manufacturing to help it redesign its processes. According to the authors, such a synchronous manufacturing approach "views a manufacturing business as an uninterrupted flow of material from suppliers to customers" and "focuses improvement efforts on identifying and eliminating constraints that prevent material flow from generating more throughput with less expense." It further "seeks to align management structure, mind-set, methods, information systems and performance measures to remove waste from the flow (41)."

First, the team mapped the company’s business processes for the company’s entire operating cycle from development of products through accounts receivable (The authors referred to it as "brown-paper mapping" on a three foot high 1,000 foot long roll of brown wrapping paper). Each pertinent transaction was reviewed in detail so that the team had a thorough understanding of (1) the nature of the transaction (2) associated documentation (3) how the process was performing and any problems detected with the process (4) future goals for the process (5) steps Foldcraft could take to achieve its future goals for the process. By cataloguing these processes in such detail, Foldcraft was able to see how the underlying foundation that influenced the design of its existing processes was its operational and financial performance measures, which were based on standard costing.

Standard costing has many drawbacks as a tool for decision-making. First, it tends to encourage the buildup of unnecessary inventory because management is focused on machinery utilization and direct labor. This leads to ineffective management decisions because other important areas of consideration such as customer satisfaction and financial performance are overlooked. It also compels employees to perform only those tasks that yield the best utilization rates for the employee individually, which is not necessarily the best task for the employee from the standpoint of the organization as a whole. Furthermore, standard costing measurements are too untimely to correct problems when opportune.

Standard costing is useful when there is a long operating cycle (6-12 months), something that rarely exists in current economic conditions. In today’s shortened operating cycles, performance measurement systems based on synchronous manufacturing are more apropos.

The benefits of a synchronous manufacturing performance measurement system include: (1) performance measurements are easy to understand and (2) performance measurements tie directly to the general ledger. Synchronous manufacturing is based on the theory of constraints and encourages investing in resources that decrease bottlenecks as this will in turn decrease the length of the operating cycle. The decision whether to fill an order occurs in a few simple steps. First, will the order have to utilize bottlenecked resources? If not, the product will be made because the only cost incurred to produce the order is that of raw materials. If the order utilizes bottlenecked resources, then what is the impact? If the new order is more profitable than existing orders, then the product order is filled. If not, the new order is not filled.

To make the change from the standard cost way of manufacturing to a synchronous manufacturing (SM) system, Foldcraft had to make many changes. The first and most important step was to change its performance measurements. With the SM approach, traditional performance measurements such as revenue and profit are still applicable, but there was a shift from labor utilization emphasis to providing customer satisfaction at a profit. Emphasis was now on inventory, throughput (cash made by sales), and operating expenses. Financial ratios of interest became throughput per dollar of inventory and throughput per dollar of operating expense. As a result, emphasis is on producing products that have been sold rather than building inventory in an attempt to improve labor and utilization variances.

Another change that led to the success of the SM system was top management’s commitment to lead the organization using the SM approach for improvement and its related performance measurements. Management empowered employees to utilize the SM system for improvement by providing thorough training to all employees so that they understood the performance measurements and how they contributed to good performance. As a result of the implementation of the SM system, Foldcraft was able to more efficiently utilize its workforce.

Standard Cost Assumptions Versus The Facts*
Prior Assumptions Current Facts
Keeping people busy is the key to making money. A focus on labor utilization hinders cash flow due to high inventory and the emphasis on keeping people busy.
By keeping utilization high, employees help the company perform financially. High utilization does not correlate with profitability.
High labor utilization rates ensure high levels of customer satisfaction. High utilization of resources does not necessarily correlate with high customer satisfaction.
If managers release workers to other areas, they may not get them back when needed. Managers willingly release workers to go where the work is when measured by synchronous standards.
Traditional standards tell managers whether they are effective as a total enterprise. Traditional standards are subjective, inaccurate, and require constant monitoring.
Maximizing setups and building inventory is key to making money. Making only what customers order is the key to making money, and on-time delivery is the critical factor.
* Adapted from Table 2, p. 45.

The SM system also impacted the MIS department, production, and marketing departments. As a result of the SM system, the MIS department was able to eliminate many standard-cost based reports and instead able to implement the more timely and pertinent SM based reports.

The effect of the SM system on production was two-fold. First, production was able to eliminate the need for costly temporary personnel. Second, new measurements of profitability eliminated the need to consider overhead in marginal cost calculations. The SM system further considers labor a fixed cost of production so that marginal cost on all items produced allows for profit. The premise behind this methodology is that the monetary cost of a company to retain one employee for a certain number of hours a day is the same regardless of the units of outputs produced by the employee.

Because of the SM system, marketing was better able to have goals compatible with the production department, especially in the area of capacity and profitability. Performance measurements became timely and easy to understand so that marketing could now see to offer discounts to increase production during off-peak times of the year. In addition, since large reserves of inventory were eliminated and production was based on units sold, distribution became more consistent as decisions for allocating the inventory to sales orders was eliminated.

In 1995 alone, Foldcraft experienced staggering improvements such as reduced inventory and labor costs as well as increased cash flows. At the time the article went to press, it was expected that financial improvement would continue into the following year.

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