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Barbco Engineering Co. Strategy-Driven Costing and Lean Management HISTORY, CHANGE, AND ENSUING LOSS Reading the 2008 financial statements, Barb...


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Barbco Engineering Co.: Strategy-Driven Costing and

 

Lean Management

 

HISTORY, CHANGE, AND ENSUING LOSS

 

Reading the 2008 financial statements, Barb Lutz’s sons knew their company was in trouble. Their family-owned

 

California manufacturing company had just experienced a reported loss of $350,000—a loss that was approximately

 

one-third of the company’s equity. The company is small, with $4-6 million in sales. Although it had sought business

 

with original equipment manufacturers (OEMs), sales are primarily to custom-designed equipment end-users. Sales

 

are obtained through bids based on the custom design characteristics of the parts Barbco manufactures.

 

The company is now in its second generation of family management and adheres to the same strategy initiated by Barb

 

Lutz, the company’s founder—making sales by adding value to customers’ equipment. Its foundry-castings business

 

segment is largely outsourced for manufacturing and is not the focus of this case. Barbco’s other activity, and now its

 

largest business segment, is the manufacture of uniquely specified steel blades that are bolted to the edges of customers’

 

heavy equipment, such as road grader original-equipment blades or earth-moving tractor buckets. Barbco’s engineers

 

work with customers and add their expertise to design the application of tungsten carbide to these add-on blades (called

 

“bolt-ons”). Their unique tungsten carbide process hardens the edge and saves the equipment from abrasion and wear.

 

The manufacturing process is called “tungsten carbide impregnating,” or TCing.

 

Barbco competes based on custom-design engineering, timely delivery, and its proprietary manufacturing process. It adds

 

value to customers’ equipment, since its relatively inexpensive bolt-ons extend the life of the much more expensive OEM

 

equipment. For example, a $3,000 Barbco bolt-on protects a $50,000 tractor bucket. Generally, it takes two to three times

 

longer for a Barbco-TCed blade to wear out compared to competitors’ replacement blades. Thus Barbco’s blades lengthen

 

the in-service time of heavy equipment, and Barbco’s currently fast cycle time helps customers avoid extended downtime

 

for difficult-to-replace blades.

 

Barbco has a strategic advantage with the process that melts the bolt-on blades’ edges and impregnates them with

 

tungsten carbide. Its TCing operations are in-house, and it typically processes small orders with lot sizes of 1 to 10

 

units. Single-unit orders are common. Barbco was profitable from the beginning, and has always focused its efforts on

 

its competitive advantage in designing custom products. For its TCing business, it historically paid little attention to

 

critically evaluating and managing materials sourcing, its manufacturing processes, cost control, and job profitability. It

 

wasn’t until the 2008 financial loss that Barbco’s owners were forced to deal with fundamental business changes in the

 

nature of their business and the importance of operating issues, job profitability, and information support. 1 PROBLEMS UNDERLYING THE FINANCIAL LOSS

 

At the time of the financial loss, Barbco had problems with on-time delivery. This is an important competitive factor for

 

Barbco since lead-time impacts downtime for customers’ key equipment. Unfortunately, Barbco’s lead-times were

 

irregular and often too long.

 

The information system for managing inventories worsened the problem. Inventory records were less than 25% accurate.

 

Additional delays occurred because personnel had to recount inventories and pick and tag them for delivery to specific

 

customers. For its TCing business, in-house manufacturing time was inconsistent and, consequently, delivery delays were

 

common. Lead-times from sale to delivery varied from five to eight weeks. Sales would increase until lead-time reached

 

eight weeks, and then orders dropped off. When lead-time returned to five weeks, sales would again increase.

 

The manufacture of TCed blades followed the de facto operating rule of “sell 1 ... make 12; somebody will buy the

 

inventory.” TCing cost control focused on purchasing materials in large quantities at low-bid, maximum-discount prices, and

 

on reducing manufacturing setup costs by producing larger-than-needed lots. Since half of the finished blades did not turn over

 

in 12 months, there were large inventories.

 

TCing was run at full capacity, with 3 shifts and 40 people. The focus was on meeting sales demand, not on fully

 

integrated process management, job profitability, or cost control. Barbco was making so much money before 2008 that

 

the owners did not think better management was necessary. Prior to the financial loss, the practice in product pricing was

 

to set prices at the cost of materials plus overhead and profit. Minimum bid prices for Barbco’s TCing sales were

 

targeted at 181% of expected materials cost. Thus, a casting with materials that cost $400 was sold for a minimum of

 

$724. Managers were free to base bids on their judgment of competitive market conditions, but were expected to keep

 

in mind the minimum-bid targets. Often, market prices greatly exceeded these minimums, and management thought

 

all of its jobs were making a lot of money.

 

TC MANUFACTURING PROCESSES BEFORE THE LOSS

 

Before 2008, the manufacture of TCed blades was a traditional job shop with many functional workstations and multiple

 

jobs passing through production. See Exhibit 1 for the shop-floor layout. First, suppliers delivered large heavy steel

 

plates to the cutting station’s incoming inventory rack. “Hunt-and-peck” was required to sort through the incoming

 

inventory and find the next job. Then an overhead crane moved the plates to workers, who cut them to rough dimensions

 

and placed the processed materials on an outgoing rack. Forklift trucks moved the materials from cutting to beveling,

 

and so on through the production process. Each machine center built-up inventory on incoming and outgoing racks—

 

as opposed to what would be required for single job flows through the workstations. The average job used 80% of its

 

labor time in setup. Rework was high with, for example, 50% of bolt holes being drilled out-of- specification. Workers

 

positioned materials by hand at each station, leading to crushed fingers and very high workers’ compensation insurance

 

costs. 2 KEYSUCCESS FACTORS

 

In order of importance, Barbco’s key success factors are quality, on-time delivery, and cost. With quality defined

 

as wear life and custom specifications, Barbco’s products had no problems with quality. Delivery, however, was a

 

problem. Barbco’s markets are very sensitive to lead-time, and Barbco had long lead-times. With its previous

 

systems design, Barbco was in a constant cycle of losing and gaining sales as lead- times stretched and shrunk. An

 

asphalt plant in Southern California, for example, discontinued Barbco’s products because Barbco could not

 

deliver on time. The failure to deliver one part idled the customer’s entire plant. A part costing $2,000 idled a plant

 

that cost $20 million! Barbco temporarily reduced lead-time by opening a second plant in Georgia. Yet when this

 

plant’s pipeline filled, the old cycle resumed. Still, Barbco produced and sold 100% of its capacity. There was no

 

alarm until the $350,000 loss in 2008; then the cost became a problem also. Hughes would have to address these

 

failures while maintaining quality.

 

THE CONTROLLER AS A CHANGE AGENT

 

Historically, Barbco had no controller charged with ongoing analysis of operations, job profitability, or costs. Following

 

3 the 2008 loss, the Lutz brothers created a new position of controller to design and initiate the needed manufacturing,

 

information, and analysis changes. They hired Vern Hughes, whose background included five years in public

 

accounting and nine years in manufacturing. Hughes had in-depth knowledge of costing systems and significant largefirm experience.

 

The new controller developed some key ideas focusing on customer value and process simplification. Hughes would

 

maintain the quality of custom designs, Barbco’s competitive advantage in TCing, but improve on delivery strategies

 

related to manufacturing cycle times and costs. Consistent with a belief in simplicity, Hughes thought many of the

 

firm’s practices only obscured the management process. Consequently, he sought ways to simplify management and

 

better control costs. He also looked for ways to improve purchasing, increase control of inventory, and reduce cycle time.

 

NEW PURCHASING AND INVENTORY CONTROL

 

Hughes proposed mutually helpful linkages with Barbco’s major suppliers of steel (for TCed blades). The plan was

 

to source materials 100% from suppliers who could meet strict price, material specification and delivery requirements.

 

Rush orders were ended. All purchases of a given material are now at an annually negotiated price, regardless of the

 

individual orders’ unit volume. As a result, blanket discounts based on annual purchase volumes are given to Barbco,

 

and average materials prices have dropped 15%, discounted for guaranteed sales. Suppliers delivered steel precut to

 

job specifications eliminating Barbco’s cutting operation. All steel deliveries were in a three-day window.

 

Although no longer a dominant source of business, foundry casting’s activity also benefited from these changes. The

 

same materials sourcing methods used in TCing are now used for wholesaled parts, and Barbco receives four-week

 

delivery for foundry castings. Also regarding foundry castings, Hughes introduced cycle counting where 100 items

 

making up 80% of sales volume are counted every four weeks. Inventory not turning over in 12 months is deeply

 

discounted to sell, or scrapped. Wall-to-wall inventory counts are made every 90 days. Additionally, Barbco reduced

 

5,000 castings part numbers to 1,200 stockable items, with all other items purchased only when sold. Inventory count

 

accuracy improved rapidly, costs were reduced, and the changes successfully rid the company of many of its management

 

headaches.

 

NEW TCING CELL

 

Operating system simplicity, timeliness, and continuous improvement were key elements for Hughes’ new system.

 

In TCing, Hughes moved to principles of just-in-time inventory management (JIT) to improve the supply-todelivery cycle time. Goals were to improve finished-product delivery times and simplify management of the TCing

 

process. Barbco changed from a traditional functional layout to what Hughes calls an “in-line” (straight-line, singleunit flow) system—an approach that is similar to lean manufacturing. 4 By having vendors supply steel precut to specifications, which was a major dangerous activity for Barbco, the cutting operation

 

was eliminated. Hughes regrouped the remaining production activities into two activity centers—tungsten crushing and

 

conversion processing. Tungsten is crushed from scrap parts, and tungsten chips are merged with steel blades in a conversion

 

processing cell. A single building houses conversion processing as one JIT manufacturing cell. See Exhibit 2 for the

 

conversion-processing layout after the change.

 

The conversion-processing cell combines five of the previous manufacturing activities: (1) beveling, (2) bolt- hole

 

cutting, (3) tungsten impregnating, (4) steel blade straightening, and (5) drilling. Process management focuses on keeping

 

the tungsten-impregnating machine running at average available capacity, defined as maximum capacity net of average

 

downtime for repairs and maintenance. Average available capacity works out to be 80% of maximum capacity.

 

Thus, actual runtime below 80% signals that profits are below what is possible.

 

The processing flow uses conveyors for a single-unit production line through the five activities. New materials- flow

 

equipment allows each process operator to receive and mechanically position each job. Forklifts bring steel to the

 

beginning of the line, and remove finished product at the end. The elimination of manual positioning lessens setup time

 

and reduces in-process inventory.

 

Following Theory of Constraints (TOC) principles, tungsten impregnating is deliberately designed to be the bottleneck, or

 

capacity-limiting process. The other four activities in processing have excess capacity so that they do not limit throughput.

 

Consequently, these design features create an unbalanced cell. Tungsten impregnating is the only constraining process, and

 

the JIT cell serves this process.

 

LEAN JIT CELLS

 

This design approach is in contrast to most lean cells that can reduce costs by striving for a balanced workflow to

 

minimize unit costs. Instead, Hughes used an insight from the Theory of Constraints to build a cell focusing on the

 

value of the core competency—TC. The strategy was to focus on the core value of “wear capabilities.” TOC claims

 

perfect balance is impossible and there is always a bottleneck, or constraint, that forms the focus for value creation and

 

the center of management attention. Hughes applied the same concept of managing the constraint by deliberately

 

designing the strategic core competency—TC as the constraint.

 

Barbco’s cell was designed to have excess capacity in the non-TC activities to assure TC could be run at full capacity.

 

Thus, the TC machine is the focus for all management activity, since it sets the capacity for the entire cell. In Hughes’

 

system, changes at non-constraints were evaluation by their impact on the TC activities. Overall, the operating system’s

 

simplicity facilitates effective process management and continuous improvement. This simplicity is a key factor

 

underlying increased profits. Specific savings were dramatic. 5 After changes in inventory sourcing and operations, average inventory levels dropped from $80,000 to $6,000.

 

2. After process redesign, worker injuries were dramatically reduced, and workers’ compensation insurance costs

 

fell by more than 60%. This paid for the additional new production equipment.

 

3. Manufacturing labor fell 40%—from three shifts to one, and from 40 to 20 people.

 

4. Lead order time dropped from maximums of eight weeks to a maximum of eight days.

 

5. Manufacturing defects fell from 25% to one per week.

 

1. However, these were only the short-term results. Over the long term, continuous incremental improvements led to

 

sustainable competitive advantage.

 

Market Prices -> Job Profitability -> Product/Process/Cost Improvement

 

For the TCing business, Hughes installed an information, analysis, and control system to maintain and continuously

 

improve key areas of competitive focus and advantage. While Barbco’s key success factors are product quality, on-time

 

delivery, and cost, its continuous improvement (CI) system may be the company’s ultimate competitive advantage.

 

6 With its continuous improvement system, product design and production process improvements are driven by the value

 

of Barbco’s products to its customers. This is achieved by using profitability and not just costs to evaluate jobs. At

 

weekly production meetings, all jobs for the week are ranked by profitability, and the least profitable jobs are candidates

 

for detailed analysis. This approach uniquely merges market value and costs to identify activities to be investigated for

 

improvement.

 

This information supports a continuous improvement culture by identifying preferred activities for investigation that

 

should have a greater chance of improving strategic value since they are the least profitable jobs. Areas for change

 

may include product-design and manufacturing processes, pricing, and whether the product should even be

 

continued. This information connects technological adaptations directly to market value for the products.

 

Conversion processing costs are allocated by time on the TCing machine. Thus, TCing time becomes the focus for

 

cost improvement, and product redesign. By reducing a product’s use of TCing machine time, it is allocated less

 

cost and its profitability is increased. A secondary benefit of reducing a product’s use of TCing machine time is that

 

bottleneck TCing capacity is freed for other profitable sales/ production opportunities.

 

SETTING SALES PRICES

 

In determining bid prices, Barbco uses prices on competing products as a guide, but negotiates a price the market will

 

bear—a price that the customer accepts as fair. To achieve this, Dave Lutz, the president, designed a sales bidding

 

sheet (Exhibit 3) that isolates factors expected to create market value for the product as well as providing key

 

engineering specifications. It shows the various factors affecting production: tungsten crushing, setup, number of edges,

 

bolt-hole cutting, etc.

 

Sales staff first estimate, through experience and benchmarking, the market values of activities required by a job. The

 

values are then listed on the bidding sheet to explain pricing. The bidding sheet gives a market value rather than a

 

cost-plus price justification. It signals unusual job specifications requiring price negotiation and communicates to

 

customers the basis for pricing. Consequently, customers see prices as market-driven, rational, and fair. As a result of

 

this negotiation, changes to the value of Barbco’s products are readily apparent. In application, Hughes uses these

 

negotiated prices and the actual product cost, from his costing system, to compute the gross profit for each job to initiate

 

continuous improvement management in weekly meetings. This system and not individual insight drives CI. For

 

example, one product initially required a series of tungsten strips. Impregnating these strips as specified onto the steel

 

blade used several passes on the TCing machine. With costs assigned using time on the TC machine, this created a

 

reported loss on this job. Looking to future contracts for this product, Barbco worked with the customer to redesign the

 

product. In the future, it would use fewer tungsten strips that were more critically placed. The product then became

 

profitable, and the price remained competitive. 7 Exhibit 3

 

Bidding Sheet – Front End Loader Edges (FEL) A-36 8 THE COSTING SYSTEM

 

The “four-wall” costing system designed by Hughes allocates all JIT cell costs based on products’ consumption of TCing

 

machine time. The allocation rate equals total costs in the JIT conversion cell divided by average available capacity. This

 

cost assignment reflects “cause and effect” at a strategic level. While cell costs are operationally largely fixed they are not fixed

 

strategically. These costs are determined by the strategic choices about how to provide TCing capacity and service levels to

 

customers. There are several advantages of this costing system.

 

1. 2. 3. It keeps the primary cost-control focus on Barbco’s strategically determined value-adding capacity, which is the use

 

of its proprietary TCing machine.

 

It is consistent with the production system’s design that emphasizes a “value stream” approach to managing cell

 

throughput with a single capacity constraint. This design is different from a traditional functional layout where individual

 

processes within a production line are managed for efficiency, or targeted cost control. That is, the emphasis shifts to

 

optimizing a value stream and not individual components within the system.

 

It is simple and easily understood, thus facilitating the timely weekly production and analysis of cost reports and job

 

profitability. Barbco’s measurement of job profit equals negotiated market price minus materials cost and allocated cell costs. This

 

profit measure has several information features.

 

1. 2.

 

3. It captures the net benefit Barbco receives from using its key competitive TCing capacity on a particular job,

 

aligning strategy with operations.

 

It captures the value set by the market for Barbco’s premium product.

 

Jobs with the lowest profit margins are the starting point for weekly continuous improvement activities. Finally, if continuous improvement efforts fail through product redesign, process improvement, and rebidding the price, Barbco

 

will simply drop a product. Barbco’s owners have made a strategic decision to produce premium, high-value products and to

 

maintain this product image, pricing structure, and market niche. If low-profit products are turned away, this is an acceptable

 

effect of maintaining Barbco’s product and market focus. The Lutz brothers prefer to protect their long-term value, even if

 

this means not maximizing short-run profit. As a side benefit any idle capacity gives employees “time to tinker” and supports

 

the continuous improvement activities that have lead the company to its dominant position.

 

TIMELY CONTINUOUS IMPROVEMENT PERFORMANCE ANALYSIS

 

Barbco stresses timely continuous improvement driven by market prices. By using profitability rather than the costing

 

system alone to drive CI, the value of products to the customer drives specific continuous improvement efforts. Timely

 

weekly reports rank jobs by profitability. The least profitable are investigated first for continuous improvement efforts.

 

Importantly, the job-cost buildup is simple and easily understood by Barbco’s employees and facilitates analysis.

 

Exhibit 4 shows the weekly production and cost report used with this analysis. It includes Barbco’s weekly cost

 

buildup per job. Note the simplicity of this buildup and its culmination in a gross profit ratio. The ratio, as discussed

 

before, is used to maintain weekly accountability for each job, producing a threshold level of profitability. The

 

exhibit’s structure is explained below using the line 2 job data. 9 column 4:

 

date job processed 9-26-1995 column 5:

 

unit price $13.20 column 7:

 

cost of steel used

 

column 6:

 

inches of tungsten carbide used

 

cost per inch $2.60

 

5

 

$.17182 column 9:

 

cost of tungsten carbide 0.86 column 8:

 

conversion processing time used .097 cost per unit of time (station D rate) $76.72 column 10: cost of

 

conversion processing time used 7.44 column 11:

 

total cost per unit of product 10.90 column 12:

 

unit profit $2.30 column 13:

 

gross profit ratio 17.41%

 

(insignificant

 

rounding error

 

as shown) 10 THE CONTINUOUS IMPROVEMENT SYSTEM AND STRATEGY

 

Virtually all formal continuous improvement systems have four sequential steps.

 

1.

 

2.

 

3.

 

4. Activities for improvement must be selected.

 

Root causes for the activity performance as it exists must be determined.

 

Modifications must be discovered and implemented.

 

The impact of the change must be assessed. Barbco’s system follows the same pattern, with two advantages. First, the search process in step one is politically neutral.

 

The activities to be investigated are a result of accounting calculations and not personal judgment. Second, the system

 

provides a timely unambiguous assessment of the appropriateness of any changes. This allows timely assessment using

 

politically neutral criteria of profitability. Barbco’s system is process-based and apolitical, focusing attention on the

 

TCing machine, the strategically designated constraint. This is where change will be most beneficial to its strategic

 

plan. It is, by strategic design, the only constraint. 11 CONTINUOUS IMPROVEMENT CONTROL CHARTS

 

The control charts used by Barbco uniquely reflect this continuous improvement culture. Several weekly measures are

 

compiled to track performance trends (Exhibit 5). These are not merely the deviation from budget projections, as in

 

traditional budgeting systems, but rather focus on continuous improvement. Measures include gross profit percentages,

 

customer service (targeted as product delivery within eight days), and tungsten-steel inches impregnated. These

 

measures are highly correlated with the critical success factors of quality, delivery, and cost. They are used to evaluate

 

the continuous improvement activities. Each chart reflects trends over time using a 13-week moving average. Unlike

 

traditional budgeting standards, improvements are “unknown and unknowable.” Thus, the trend demonstrates the

 

success or failure of CI management over time.

 

The first chart is the “Gross Profit per Week” out of the manufacturing cell and does not include administrative

 

overhead costs. The data comes directly from the accounting report and tracks a cumulative 13-week moving average

 

(circles). This chart speaks to the overall progress of continuous improvement efforts reflected in profitability. This is a

 

combination of the costs and market value. The left-hand side on the vertical axis lists the profit percentages. The

 

horizontal axis just sets the time line.

 

The second graph refers to factory operations. This particular example was from the time the company had a second

 

facility in Georgia. The squares are the production for each plant and the circles are the 13-week cumulative average

 

TC output. Vertical axis is the number of TC inches and the time line is along the bottom. The graph speaks to

 

customer service. The bars are the percentage of orders completed on time and the squares are weekly orders shipped.

 

The circle is again a 13-week moving average.

 

All of these have the same goal of demonstrating how the company is progressing and improving. This is a distinctly

 

different application than i...

 


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