Part proliferation: role for activity based costing An article in the Wall Stree

Question

Part proliferation: role for activity based costing An article in the Wall Street Journal by Neal Templin and Joseph B. White (June 23, 1993) reported on the major changes occuring at General Motors (GM). Its new chief executive officer, John Smith, had been installed after the board of directors requested the resignation of Robert Stempel, the previous chief. Smith's North American Strategy Board identified 30 components that could be simplidied for 1994 models. GM had 64 different versions of the cruise control/ turn signal mechanism. It planned to reduce that to 24 versions the next year, and the following year to just 8. The tooling for each one costs GM's A.C. Rochester Division about $250,000. Smith said, "We've been talking about too many parts doing the same job for 25 years, but we weren't focused on it." (Note that the tooling cost is only one component of the cost of proliferating components. Other costs include the design and engineering costs for each different components, purchasing costs, setup and scheduling costs, plus the stocking and service costs for every individual component in each GM dealership around the US). GM's proliferation of parts was mind boggling, GM made or bought over 139 different hood hinges, compared with one for Ford. Saginaw's Plant Six joggled parts for 167 different steering columns- down from 250 the previous year but still far from the goal of fewer than 40 by decade's end. This approach increased GM's costs exponetially. Not only did the company pay far more engineers than competitors did to design steering colomns, but it also need extra tools and extra people to move parts around, and it suffered from quality glitches when workers confused one steering column with another.

Requirements: In 500 words or more explain A. How could an inaccurrate and distorted product costing system contribute to the overproliferations of parts and components at General Motors? and B. What charactoristics should a new cost system have that would enable it to signal accurately to product designers and market researchers about the cost of customization and variety? Please cite or list references used to receive the information.

Explanation / Answer

Traditional cost system, which assigns direct materials and direct labor to products, and allocates factory support based on direct labor, cannot signal the cost of component and product variety. Marketing research may identify that consumers like to choose from a variety of options (especially when the alternatives are available without any cost associated with choosing; e.g., you can have any color of this or any variety of that). In this situation, product engineers can design lots of varieties and options. The cost system assigns cost only on the direct labor and materials content of these options. Thus making one million units of one steering column appears to cost the same as making 100,000 of 4 different steering columns, 10,000 each of 30 other steering columns, and 1,000 each of 300 other columns. But making 334 steering columns in batch sizes ranging from, for example, 100 to 10,000, and designing and supporting 334 different steering columns is much more expensive than just producing 5 or at most 40 different columns. A traditional cost system would report that production costs of labor and materials for the 1,000,000 steering columns is the same whether they are produced in 5 varieties, 40 varieties, or 334 varieties. Thus model and component proliferation is virtually impossible to stop when companies cost products using traditional cost systems.

In order to understand the cost of variety, the new cost system should identify the cost of introducing new varieties, colors, and options. The cost system will show the cost of setting up or changing over to make the new variety, color and option, a cost that will be independent of the number of units produced after the setup. Also the new cost system will show the cost of designing and supporting each new variety, color, and option (technically, in ABC terms, called the “product-sustaining” costs) that will be independent of the number of units produced. With the more accurate understanding of the costs of resources that perform batch and product-sustaining activities, the product engineers and marketing managers can jointly make better decisions on whether the higher cost of introducing another customized option will be compensated with higher sales volumes and/or higher margins.

As a specific example, one of General Motors’ competitors examined the cost of how many wire harnesses it used in a given car model. Currently it was producing 12 different wire harnesses, a number that seemed optimal using its traditional cost system. The ABC system—which incorporated the economics of batch production and product-sustaining expenses—revealed that the optimal number of harnesses was 5 or 6. And when the cost of stocking and servicing all the dealerships was incorporated into the analysis, the optimal number dropped to 2. In effect, the apparent savings in direct materials and labor from having customized wire harnesses for individual combinations of car options was far lower than the much higher support costs triggered by high engineering, production support, and service resources associated with having to produce, stock, and service 12 different wire harnesses for a single car model.

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