11 BUSINESS PROCESS IMPROVEMENT

11.1 VALUE-CHAIN ANALYSIS

Value and Customers’ Perceptions

To remain on the market, a product must provide value to the customer and a profit to
the seller.
• Customers assign value to a product. The producer can affect the customers’
perception of value by differentiating the product and lowering its price.
• The producer’s profit is the difference between its costs and the price it charges for the
product. Thus, by keeping costs low, the producer has more flexibility in pricing.
 11.1 VALUE-CHAIN ANALYSIS
The Value Chain

1. The value chain is a model for depicting the way in which every function in a company
adds value to the final product.

Value-Added and Nonvalue-Added Activities

• A value-added activity increases the value of a product or service to the customer.
Examples include assembling the product and shipping it to the customer.
• A nonvalue-added activity does not increase the value of a product or service to the
customer even if this activity is necessary. Examples include inspection for testing and
inventory storage costs.

A direct cost can be specifically associated with a single cost object. Direct costs usually
are classified as either value-added or nonvalue-added.
 11.1 VALUE-CHAIN ANALYSIS

The Value Chain

2. A value chain depicts how costs and customer value accumulate along a chain of
activities that lead to an end product or service.

A value chain consists of the internal processes or activities a company performs:

R&D, design, production, marketing, distribution, and customer service.

3. Another view is that the value chain consists of all of the value-creating activities
leading to the ultimate end-use product delivered into the final consumers’ hands.
• In other words, a value chain is a firm’s overall chain of value-creating (value-added)
processes.
 11.1 VALUE-CHAIN ANALYSIS
The Value Chain
4. Primary activities deal with the product directly. Support activities lend aid to the
primary activity functions.

Customer retention is an important objective of Value added and profit maximizing processes
because customer base is the key intangible asset.
 11.1 VALUE-CHAIN ANALYSIS
Value-Chain Analysis
Value-chain analysis is a strategic analysis tool that allows a firm to focus on those
activities that are consistent with its overall strategy.

• Value-chain analysis allows a firm to decide which parts of the value chain it wants to
occupy and how each activity then contributes to the firm’s competitive advantage by
adding customer value or by reducing costs.

Because the value chain identifies and connects the organization’s strategic activities,
value-chain analysis improves the firm’s knowledge of its relations with customers,
suppliers, and competitors. It also facilitates the strategic determination of the phase(s) of
the industry’s value chain in which the firm should operate.
 11.1 VALUE-CHAIN ANALYSIS
Value-Chain Analysis
Step 1
Identify the firm’s value-creating activities.
Step 2
Is to determine how each value-creating activity can produce a competitive advantage for the firm.
This step has multiple sub-steps.
a) Identify the firm’s competitive advantage (e.g., cost reduction, product differentiation) so that the
firm’s position in the industry’s value chain can be clarified.
b) Identify the ways in which the firm’s value-creating activities can generate additional customer value.
c) Identify activities that are candidates for cost reduction or, in the case of noncore competencies,
outsourcing.
d) Identify value-adding ways in which the firm’s remaining activities can be linked.

Value-chain analysis is a team effort. Management accountants need to collaborate with engineering,
production, marketing, distribution, and customer service professionals to focus on the strengths,
weaknesses, opportunities, and threats identified in the value chain analysis results.

• Value-chain analysis offers an excellent opportunity to integrate strategic planning and management
accounting to guide the firm to survival and growth.
 11.1 VALUE-CHAIN ANALYSIS
Supply Chain
The supply chain is the flow of materials and services from their original sources to final
consumers. Moreover, it usually encompasses more than one firm.
• Firms seeking to improve performance and reduce costs must analyze all phases of the
supply chain as well as the value chain.

Purchasing Function
Firms seeking to improve performance and reduce costs must analyze all phases of the
supply chain as well as the value chain. Thus, a firm must reduce the cost of, and increase
the value added by, its purchasing function.
Purchasing is the management function that concerns the acquisition process. It includes
choice of vendors, contract negotiation, the decision whether to purchase centrally or
locally, and value analysis. The process is initiated by purchase requisitions issued by the
production control function.
 11.1 VALUE-CHAIN ANALYSIS
Purchasing Function
Purchase requisitions ultimately result from insourcing vs. outsourcing (make vs. buy)
decisions made when production processes were designed.

The choice of vendors depends on price, quality, delivery performance, shipping costs,
credit terms, and service. Purchasers with a competitive orientation and considerable
economic power may be able to extract very favorable terms from vendors.

Purchasers with a cooperative orientation adopt a longer-term approach: supply chain

coordination. The purchaser and the vendor are viewed as committed to a partnership
involving joint efforts to improve quality.
 11.1 VALUE-CHAIN ANALYSIS
Purchasing Function
Supply-chain analysis and coordination should extend to all parties in the chain, from
initial sources of materials to retailers.
• Coordination has special relevance to inventory management. By sharing information
among all parties, demand uncertainty is reduced at each level, with consequent
decreases of inventory at each level, minimization of stockouts, and avoidance of
overproduction and rush orders.

Value-chain and supply-chain analysis should be used to meet customer requirements for
better performance regarding such critical success factors as

1) Cost reduction
2) Efficiency
3) Continuous improvement of quality to meet customer needs and wants
4) Minimization or elimination of defects
5) Faster product development and customer response times, and
6) Constant innovation.
 11.1 VALUE-CHAIN ANALYSIS
To achieve value chain analysis, a company will need value engineering.

Value engineering Is a means of reaching targeted cost levels. Value engineering is a

systematic approach to assessing all aspects of the value chain cost buildup for a product.
• The purpose is to minimize costs without reducing customer satisfaction. For this
purpose, distinguishing between cost incurrence and locked in costs.
• Cost incurrence is actual use of resources but locked in cost will result in use of
resources in the future as result of past decision.
• Value engineering emphasis on cost reduction at the design level that is before they are
locked in.

Life cycle costing is sometimes used as basis for cost planning and product pricing.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS

1. Process Analysis
Process analysis is a means of linking a firm’s internal processes to its overall strategy.
Types of Processes:

1) Continuous, such as candy bars produced by machinery

2) Batch, such as beer brewing
3) Hybrid, in which both continuous and batch processes are used
4) Make-to-stock, such as automobile assembly
5) Make-to-order, such as deli sandwich making
 11.2 OTHER PROCESS IMPROVEMENT TOOLS

Process Interdependence
• The degree of interdependence among the stages in a process is referred to as “tightness.”
• A tight process is one in which a breakdown in one stage brings the succeeding stages to a
halt. This is characteristic of continuous processes that do not have buffer work-in-process
inventories.
• A loose process is one in which subsequent stages can continue working after a breakdown
in a previous stage. This is characteristic of batch processes and any others with extensive
work-in-process inventories.

Bottlenecks
One part of the process is almost always the slowest, referred to as the “bottleneck.”
• The bottleneck issue only arises when demand for the firm’s product is sufficient to absorb
all of the output. When a production line is running at less than full capacity, bottlenecks
can be avoided.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS

2. Process Value Analysis

Process value analysis is a comprehensive understanding of how an organization generates its
output. It involves a determination of which activities that use resources are value-adding or
nonvalue-adding and how the latter may be reduced or eliminated.

This linkage of product costing and continuous improvement of processes is activity-based

management (ABM). ABM redirects and improves the use of resources to increase the value
created for customers and other stakeholders.
• ABM identifies the key activities performed in an organization and focuses on
understanding what causes costs to occur.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS

ABM uses include the following:

i) Strategic analysis explores various ways a company can create and sustain a competitive
advantage in the marketplace.
ii) Benchmarking is a methodology that identifies an activity as the standard by which a
similar activity will be judged.
iii) Operations analysis seeks to identify, measure, and improve current performance of key
processes and operations within an entity.
iv) Profitability/pricing analysis assists a company in analyzing the costs and benefits of
products and processes and prelaunch analysis and improvement of product profitability.
v) Process improvement focuses on identifying the causes of variation, waste, and inefficiency.
Process improvement includes both incremental and quantum change efforts that seek to
increase the value created per resources consumed by an organization.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS

A continuous improvement process (CIP) is an ongoing effort involving management and

workers to improve products, services, or processes.
• CIP efforts can lead to “incremental” improvement over time or “breakthrough”
improvement all at once.
• Delivery (customer valued) processes are constantly evaluated and improved in light of
their efficiency, effectiveness, and flexibility.
• The purpose of CIP is the identification, reduction, and elimination of suboptimal processes
to improve efficiency.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
Kaizen
Is the Japanese word for the continuous pursuit of improvement in every aspect of organizational operations.
For example, a budget prepared on the Kaizen principle projects costs based on future improvements. The
possibility of such improvements must be determined, and the cost of implementation and the savings
therefrom must be estimated.
Key features of Kaizen include the following:
1. Improvements are based on many small changes rather than the radical changes that might arise from
research and development.
2. Ideas come from the workers themselves, so they are less likely to be radically different and therefore are
easier to implement.
3. Small improvements are less likely to require major capital investment than major process changes.
4. The ideas come from the talents of the existing workforce, as opposed to using research, consultants, or
equipment–any of which could be expensive.
5. All employees, including management, should continually seek ways to improve their own performance.
6. Workers are encouraged to take ownership of their work and can help reinforce teamwork, thereby
improving worker motivation.

The key features of Kaizen are the more tactical elements of CIP. The more strategic elements include deciding
how to increase the value of the delivery process output to the customer (effectiveness) and how much flexibility
is valuable in the process to meet changing needs.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
An activity analysis
determines what is done, by whom, at what cost in time and other resources, and the value added by each
activity.
A value-added activity is necessary to remain in business. For example, a manufacturer would deem the
conversion of raw materials into salable products a value-added activity.
• Such an activity may be mandated (e.g., a regulatory requirement) or discretionary. The latter produces some
changes not otherwise achievable that enables other activities to occur.

A value-added cost is incurred to perform a value-added activity without waste. Most types of direct labor would
be considered value-added cost because the costs are being incurred to directly produce the product.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
3. Business Process Reengineering (BPR)
BPR is a complete rethinking of how business functions are performed to provide value to
customers, that is, radical innovation instead of mere improvement, and a disregard for
current jobs, hierarchies, and reporting relationships.
• Technological advances have increased the popularity of business process reengineering.

A process is how something is accomplished in a firm. It is a set of activities directed toward

the same objective. Reengineering is process innovation and core process redesign. Instead of
improving existing procedures, it finds new ways of doing things. Thus, reengineering should
be contrasted with process improvement, which consists of incremental but constant changes
that improve efficiency.
• Accordingly, BPR techniques eliminate many traditional controls. They exploit modern
technology to improve productivity and decrease the number of clerical workers. Thus, the
emphasis is on developing controls that are automated and self correcting and require
minimal human intervention.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
3. Business Process Reengineering (BPR)
The emphasis therefore shifts to monitoring internal control so management can determine
when an operation may be out of control and corrective action is needed.

Part of the BPR process involves looking at possible alternatives and determining the cost
of those possible alternatives compared to the costs of maintaining the same processes.
To do this, the management accountant must determine
1. The cost to reengineer the process, and
2. The expected savings.
Some desirable alternatives may actually increase total costs. For example, more expensive
materials could lead to higher product quality. While this will increase total costs, it may be
necessary to maintain/increase market share.
• In situations like these, the management accountant would determine the savings
attributed to possible alternatives compared to maintaining the same processes.
• After determining the cost and savings of BPR, the company must look at all of its goals and
needs overall to determine if it should invest in a possible alternative.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
3. Business Process Reengineering (BPR)
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
3. Benchmarking
The IMA’s Statement on Management Accounting (SMA) Effective Benchmarking, issued in
July 1995, describes techniques for improving the effectiveness of benchmarking, which is a
means of helping companies with productivity management and business process
reengineering.

“Benchmarking involves continuously evaluating the practices of best-in-class organizations

and adapting company processes to incorporate the best of these practices.” It “analyzes and
measures the key outputs of a business process or function against the best and also identifies
the underlying key actions and root causes that contribute to the performance difference.”

Benchmarking is an ongoing process that entails quantitative and qualitative measurement of

the difference between the company’s performance of an activity and the performance by the
best in the world. The benchmark organization need not be a competitor.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
Phases in the benchmarking
1. Select and prioritize benchmarking projects.
• An organization must understand its critical success factors and business environment to
identify key business processes and drivers and to develop parameters defining what
processes to benchmark.
• The criteria for selecting what to benchmark relate to the reasons for the existence of a
process and its importance to the entity’s mission, values, and strategy. These reasons
relate in large part to satisfaction of end users or customer needs.
2. Organize benchmarking teams.
• A team organization is appropriate because it permits an equitable division of labor,
participation by those responsible for implementing changes, and inclusion of a variety of
functional expertise and work experience.
• Team members should have knowledge of the function to be benchmarked, respected
positions in the company, good communication skills, teaming skills, motivation to innovate
and to support cross-functional problem solving, and project management skills.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
Phases in the benchmarking
3. The benchmarking team must thoroughly investigate and document internal processes.
• The organization should be seen as a series of processes, not as a fixed structure. A process
is “a network of related and independent activities linked by the outputs they exchange.”
One way to determine the primary characteristics of a process is to trace the path a request
for a product or service takes through the organization.
• The benchmarking team must also develop a family of measures that are true indicators of
process performance and a process taxonomy, that is, a set of process elements, measures,
and phrases that describes the process to be benchmarked.

4. Researching and identifying best-in-class performance is often the most difficult phase.
The critical steps are setting up databases, choosing information-gathering methods (internal
sources, external public domain sources, and original research are the possible approaches),
formatting questionnaires (lists of questions prepared in advance), and selecting
benchmarking partners.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
Phases in the benchmarking

5. The data analysis phase entails identifying performance gaps, understanding the reasons
they exist, and prioritizing the key activities that will facilitate the behavioral and process
changes needed to implement the benchmarking study’s recommendations.
• Sophisticated statistical analysis and other methods may be needed when the study
involves many variables, testing of assumptions, or presentation of quantified

6. Implementation & Leadership

Leadership is most important in the implementation phase of the benchmarking process
because the team must be able to justify its recommendations. Moreover, the process
improvement teams must manage the implementation of approved changes.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
5. Costs of Quality
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
5. Costs of Quality
The IMA’s Statement on Management Accounting Managing Quality Improvements,
issued in 1993, describes four categories of costs of quality: prevention, appraisal,
internal failure, and external failure. The organization should attempt to minimize its total
cost of quality.

Conformance costs include prevention and appraisal, which are both financial measures of
internal performance

Prevention attempts to avoid defective output. These costs include preventive maintenance,
employee training, review of equipment design, and evaluation of suppliers. Providing quality
training to employees should reduce all types of quality costs.

Appraisal encompasses such activities as statistical quality control programs, inspection, and
testing.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
5. Costs of Quality
Nonconformance costs include costs of internal failure (a financial measure of internal
performance) and external failure costs (a financial measure of customer satisfaction).

Internal failure costs occur when defective products are detected before shipment.
Examples are scrap, rework, tooling changes, downtime, redesign of products or processes,
lost output, reinspection and retesting, expediting of operations after delays, lost learning
opportunities, and searching for and correcting problems.

The costs of external failure or lost opportunity include lost profits from a decline in market
share as dissatisfied customers make no repeat purchases, return products for refunds, cancel
orders, and communicate their dissatisfaction to others.
Thus, external failure costs are incurred for customer service complaints; rejection, return,
repair, or recall of products or services; warranty obligations; product liability claims; and
customer losses.
Environmental costs are also external failure costs, e.g., fines for nonadherence to
environmental law and loss of customer goodwill.
 11.2 OTHER PROCESS IMPROVEMENT TOOLS
5. Costs of Quality
To minimize environmental damage and its resulting costs, the International Organization for
Standardization has issued ISO 14000 standards to promote the reduction of environmental
damage by an organization’s products, services, and operations and to develop environmental
auditing and performance evaluation systems.
Rework costs $110,000 Internal Failure
Warranty repair costs 280,000 External failure
Product line inspection 95,000 Appraisal
Design engineering 300,000 Prevention
Supplier evaluation 240,000 Prevention
Labor training 150,000 Prevention
Product testing 65,000 Appraisal
Breakdown maintenance 70,000 Internal Failure
Product scrap 195,000 Internal Failure
Cost of returned goods 180,000 External failure
Customer support 35,000 External failure
Product liability claims 80,000 External failure