Today, managers know that inspection cannot catch problems built into the system. The traditional inspection process does not result in improvement and does not guarantee quality. In fact, according to Deming, inspection is a limited, grossly overused, and often misused tool. He recommended that management stop relying on mass inspection to achieve quality and advocated instead either 100 percent inspection in those cases where defect-free work is impossible or no inspection at all where the level of defects is acceptably small.

Some organizations rely on subordinates or managers to detect the significant deviations between standards and performance that signal exceptional issues. Other organizations establish rules to ensure that exceptional issues surface as a matter of normal operating procedure. Setting rules must be done carefully to ensure that all true deviations are brought to the manager’s attention.

Two examples of rules based on the exception principle are the following:48

1. A department manager must immediately inform the plant manager if actual weekly labor costs exceed estimated weekly labor costs by more than 15 percent.

2. A department manager must immediately inform the plant manager if actual dollars spent plus estimated dollars to be spent on a special project exceed the funds approved for the project by more than 10 percent.

Although these two rules happen to focus on production-related expenditures, detecting and reporting significant rules deviations can be established in virtually any organizational area.

If appropriately administered, the management-by-exception control technique ensures the best use of managers’ time. Because only significant issues are brought to managers’ attention, the possibility that managers will spend their valuable time working on relatively insignificant issues is automatically eliminated.

Of course, the significant issues brought to managers’ attention could be organizational strengths as well as organizational weaknesses. Obviously, managers should try to reinforce the first and eliminate the second.

Break-even analysis typically involves reflection, discussion, reasoning, and decision making relative to the following seven major aspects of production:

1. Fixed costs—A fixed cost is an expense incurred by the organization regardless of the number of products produced. Some examples are real estate taxes, upkeep to the exterior of a business building, and interest expenses on money borrowed to finance the purchase of equipment.

2. Variable costs—An expense that fluctuates with the number of products produced is a variable cost. Examples are costs of packaging a product, costs of materials needed to make the product, and costs associated with packing products to prepare them for shipping.

3. Total cost—The total cost is simply the sum of the fixed and the variable costs associated with production.

4. Total revenue—Total revenue is all sales dollars accumulated from selling manufactured products or services. Naturally, total revenue increases as more products are sold.

5. Profit—Profit is defined as the amount of total revenue that exceeds the total costs of producing the products sold.

6. Loss—Loss is the amount of the total costs of producing a product that exceeds the total revenue gained from selling the product.

7. Break-even point—The break-even point is the level of production at which the total revenue of an organization equals its total costs—that is, the point at which the organization is generating only enough revenue to cover its costs. The company is neither gaining a profit nor incurring a loss.

Two somewhat different procedures can be used to determine the same break-even point for an organization: algebraic break-even analysis and graphic break-even analysis.

The following simple formula is commonly used to determine the level of production at which an organization breaks even:

In using this formula to calculate a break-even point, two sequential steps must be followed. First, the variable costs associated with producing each unit must be subtracted from the price at which each unit will sell. The purpose of this calculation is to determine how much of the selling price of each unit sold can go toward covering total fixed costs incurred from producing all units. Second, the remainder calculated in the first step must be divided into total fixed costs. The purpose of this calculation is to determine how many units must be produced and sold to cover fixed costs. This number of units is the break-even point for the organization.

Say a book publisher faces the fixed and variable costs per paperback book presented in Table 18.2. If the publisher wants to sell each book for $12, the break-even point could be calculated as follows:

This calculation indicates that if expenses and selling price remain stable, the book publisher will incur a loss if book sales are fewer than 14,800 copies, will break even if book sales equal 14,800 copies, and will make a profit if book sales exceed 14,800 copies.

Graphic break-even analysis entails the construction of a graph showing all the critical elements in a break-even analysis. Figure 18.5 is such a graph for the book publisher. Note that in a break-even graph, the total revenue line starts at zero.

Both the algebraic and the graphic methods of break-even analysis for the book publisher result in the same break-even point—14,800 books produced and sold—but the processes used to arrive at this point are quite different.

Which break-even method managers should use is usually determined by the situation they face. For a manager who desires a quick yet accurate determination of a break-even point, the algebraic method generally suffices. For a manager who wants a more complete picture of the cumulative relationships among the break-even point, fixed costs, and escalating variable costs, the graphic break-even method is more useful. For example, the book publisher could quickly and easily see from Figure 18.5 the cumulative relationships of fixed costs, escalating variable costs, and potential profit and loss associated with various levels of production.

Break-even analysis is a useful control tool because it helps managers understand the relationships among fixed costs, variable costs, total costs, and profit and loss within an organization. Once these relationships are understood, managers can take steps to modify one or more of the variables to reduce the deviation between planned and actual profit levels.50

Increasing costs or decreasing selling prices has the overall effect of increasing the number of units an organization must produce and sell to break even. Conversely, the managerial strategy for decreasing the number of products an organization must produce and sell to break even entails lowering or stabilizing fixed and variable costs or increasing the selling price of each unit. The exact break-even control strategy a particular manager should develop and implement is dictated primarily by that manager’s specific organizational situation.

Decision tree analysis, as you recall from Chapter 8, is a statistical and graphical, multiphased decision-making technique that contains a series of steps showing the sequence and interdependence of decisions. Decision trees allow a decision maker to deal with uncertain events by determining the relative expected value of each alternative course of action. The probabilities of different possible events are known, as are the monetary payoffs that would result from a particular alternative and a particular event. Decision trees are best suited to situations in which capacity decisions involve several capacity expansion alternatives and the selection of the alternative with the highest expected profit or the lowest expected cost is necessary.

Statistical process control, known as process control, is a technique that assists in monitoring production processes. Production processes must be monitored continually to ensure that the quality of their output is acceptable. The earlier the detection of a faulty production process occurs, the better. If detection occurs late in the production process, the company may find parts that do not meet quality standards, and scrapping or reworking these units is a costly proposition. If a production process results in unstable performance or is completely out of control, corrective action must be taken. Process control can be implemented with the aid of graphical charts known as control charts.

Value analysis is a cost control and cost reduction technique that helps managers control operations by focusing primarily on material costs. The goal of this analysis, which is performed by examining all the parts and materials and their functions, is to reduce costs by using cheaper components and materials in such a way that product quality or appeal is not affected. Simplification of parts—which lowers production costs—is also a goal of value analysis. Value analysis can result not only in cost savings but also in an improved product.

Value analysis requires a team effort. This team, if not company-wide, should at least include personnel from operations, purchasing, engineering, and marketing.

Computer-aided design (CAD) systems include several automated design technologies. Computer graphics is used to design geometric specifications for parts, whereas computer-aided engineering (CAE) is employed to evaluate and perform engineering analyses on a part. CAD also includes technologies used in process design. CAD functions to ensure the quality of a product by guaranteeing not only the quality of parts in the product but also the appropriateness of the product’s design.

Computer-aided manufacturing (CAM) employs computers to plan and program equipment used in the production and inspection of manufactured items. Linking CAM and CAD processes through a computer is especially beneficial when production processes must be altered, because when CAD and CAM systems can share information easily, design changes can be implemented in a short period of time.