Division of Research April, 1992 School of Business Administration VELOCITY MANUFACTURING COMPANY Working Paper #684 Dennis G. Severance The University of Michigan and Jack Muckstadt Cornell University Dennis G. Severance, Andersen Consulting Professor, Computers and Information Systems, The University of Michigan Jack Muckstadt, Professor and Director, School of Operations Research and Industrial Engineering, Cornell University FOR DISCUSSION PURPOSES ONLY None of this material is to be quoted or reproduced without the expressed permission of the Division of Research COPYRIGHT 1992 The University of Michigan School of Business Administration, Ann Arbor, Michigan 48109-1234

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VELOCITY MANUFACTURING COMPANY Introduction Background The Velocity Manufacturing Company is a second tier supplier in the U.S. hydraulic hose and fittings market with annual sales of $10 million. The total 1991 market of $980 million dollars is divided into three segments (industrial, aerospace and military), each of which were serviced by three distribution channels (direct sales to large OEMs, distributor sales to small OEMs, and distributor sales to after-market maintenance and repair). Historically, Velocity Manufacturing has concentrated on direct sales to aerospace OEMs with only 8% of its business coming from sales through distributors. Table 1 shows that Parker-Hannifin and Aeroquip dominated the hose and fitting market in 1991. They lead the industry in market share, per unit production and distribution costs, and production capacity; and they dictate the industry standards for product variety, quality, customer service and price. Price reductions led by these companies in the mid-1980's have squeezed margins, driven out many small competitors, and steadily eroded Velocity's market share to the point that they now run a single shift operation. Realistically, Velocity has little hope of regaining share on the basis of price. While factory programs begun in 1989 to modernize manufacturing practices have significantly improved profitability, management believes that much more needs to be done. They fear that an anticipated increase in material costs, coupled with another round of price cuts by competitors, might deal a death blow to Velocity.

2 The Aerospace Product Line The typical product sold by Velocity to the Aerospace industry is shown in Figure 1. This assembly kit consists of two sections of hydraulic hose, each of which is capped with two metal fittings. The assemblies are designed to snake around engine or machine components in order to connect a hydraulic pump to one or more actuators that it powers. An individual end fitting consists of one of six sizes of machined components brazed to one of three styles of metal tubing. Once fabricated, a hose assembly is painted and labeled for ease of visual recognition, tagged to identify the assembly uniquely, and capped to protect its end fittings. Aerospace hose assemblies are expensive. The product line differs from related industrial products because of special requirements for light weight, compact size, high strength and heat tolerance. In addition, strict quality and inspection procedures are demanded and component traceability is required. Expensive exotic metals are used to achieve the special performance requirements. Relatively small lot sizes and long production cycle times give rise to low production throughput rates; and, yield problems exist. As a result, the manufacturing cost of an assembly is typically on the order of $2100. While the profit margin varies depending upon the aggressiveness with which a contract is pursued, the average selling price of an assembly in 1991 was $2,215. Table 2 summarizes Velocity's costs and profit margins for the last three years. Mac 3/4/92 Velocity

3 Table 1 r^fnrnrn ratia=n KAarkLt.Qhnran Anlnvoio %.VVI I L/C1LI VW VICaI rL IC.A11AC r- 1C 31 ol Company Parker Hannifin Aeroquip Weatherhead Imperial Velocity Others % Market Share 33 30 17 14 2 5 Table 2 Margins and Average Cost per Aerospace Assembly (in $) 1989 1990 1991 Direct Labor 119 123 125 Purchased Material 1,477 1,418 1,389 Fixed Manufacturing Cost 322 365 278 Factory Cost 1,917 1,905 1,792 Sales Price 2,377 2,288 2,215 Gross Margin 460 383 423 SG&A 371 332 298 Interest Expense 76 57 37 Selling Margin 13 -6 88 Mac 3/4/92 Velocity

PART NUMBER: ZIIJ COMPONENT 2 CAP COMPONENT 3 o Ho 0 COMPONENT 1 LABE COMPONENT 4 Cb\ /~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~r 0I 1 i

4 The Manufacturing and Assembly Process Figure 2 illustrates the flow of material through the manufacturing process. Components and raw materials are received from suppliers and placed in the stockroom to support a production process which flows through four manufacturing sectors. In the first sector, fittings are machined from blanks, joined with a tube and braze ring, and passed through a braze oven. The resulting end fittings are then inspected and sent to the stock room to await the hose assembly process of Sector 2. Specialized jigs and crimping tools are used in Sector 2 to attach the end fittings to hoses in specified configurations for particular end products. These "raw" hose assemblies are visually inspected and returned to the stockroom to await customization for some specific customer requirement. In the third sector the assemblies are painted and labeled for ease of identification, tagged to identify the specific assembly uniquely, and capped to protect the end fittings. The now customized assembly is inspected for cosmetic defects and returned to stock once more. The assemblies are pressure tested in the Finishing sector; if they pass, they are cleaned, packaged and certified as ready for shipment to a customer. The 1989 valuation of Velocity's manufacturing equipment is given in Table 3; their operating characteristics are summarized in Table 4. Prior to 1990, factory operations at Velocity were scheduled by a material requirements planning (MRP) system using a six-month demand forecast. Lot sizes were determined using economic order quantity (EOQ) logic and runs of 3 to 12 months of supply were typical. While flow time through the factory was measured in weeks, a "red-alert" job could be moved through in a day or two Mac 3/4/92 Velocity

MATERIAL FLOWS UPPLIES RECEI VING SUPPLIERS o DEPARTMENT _FPA 'fnEI,, SHIPPING STOCKROOM m- DEPARTMEN IT C USTOMERS / II FABRICATION (SECTOR 1) ASSEMBLY (SECTOR 2) CUSTOMIZATION (SECTOR 3) PACKAGING (SECTOR 4) 110 BLANK 210 FITTING/HOSE ASSEMBLY 310 ASSEMBLY 410 PROOF MACHINING CUSTOMIZATION TESTING 120 TUBING 220 INSPECTION FABRICATION 320 INSPECTION 420 CLEAN AND DRY 130 BRAZING 140 INSPECTION 430 PACKAGING FIGURE 2.

VELOCITY'S EQUIPMENT LIST IIOP'N NAME PUR-COST ' 91-BOOK-VAL '91 SALVAGE PUR-YR LIFE SECTOR1 110 LATHE1 $400,000 $109,091 $350,000 1986 10 110 LATHE2 $420,000 $45,818 $320,000 1984 10 120 FIXTURE $10,000 1 $2,727 $25,000 1986 10 130 BRAZ-OVN1 $150,000 $16,364 $100,000 1984 10 ___130 BRAZ-OVN2 $150,000 $16,364 $100,000 1984 10 140 TESTER $40,000 $10,909 $23,000 1986 10 SECTOR2 210 OLD-FIX $70,000 $19,091 $25,000 1986 10 _220 TESTER $50,000 $13,636 $35,000 1986 10 SECTOR3 310 FIXTURE $80,000 $21,818 $25,000 1986 10 320 TESTER $20,000 $5,455 $20,000 1986 10 SECTOR4 410 TESTER $50,000 $13,636 $25,000 1986 10 ____. 410 TESTER $50,000 $13,636 $25,000 1986 10 ____ | 420 DRYER $10,000 $2,727 $2,000 1986 10 430 PACKAGER $15,000 $4,091 $15,000 1986 10 __TOTAL $1,515,000 $295,364 $1,090,000________ TABLE 3,

EQUIPMENT PROCESS RATES AND RELIABIL 1W BATCH RUNNING TIME SET UP TIME MTTF MTTR OPERATION SIZE PART (SEC/BATCH) (SEC) (SEC) (SEC) 110 LATHES (2)1 1 1 10 25 30 5 2 11 29 3 11 29 4 12 34 5 12 34 6 12 34 120 ASSEMBLY 1 -all 5 5 5 30,000 3 130 BRAZE OVENS(2) 8 all 60 10 45,000 7 140 INSPECTION 1 1 7 7 75,000 5 2 7 7 3 8 8 4 8 9 5 8 9 6 8 9 210 ASSEMBLY 1 all 28 5 50,000 10 220 INSPECTION 1 all 21 7 600 25 310 ASSEMBLY 1 all 23 5 80,000 15 320 INSPECTION 1 all 15 8 4,000 180 410 INSPECTION 1 all 17 10 2,000 200 420 CLEAN AND DRY(2) 1 all 45 5 500,000 1 430 PACKAGE 1 all 15 0 500,000 1 Table 4. I

5 under the watchful eye of the plant expeditors. These experienced "fire fighters" met weekly with plant management to decide how best to react to Marketing 's current list of "hot orders," orders that were to be given "special priority" in order to gain or hold a key account. The operating impact of this "customer focus" within the plant was disastrous. When scheduling production it seemed that everything was promised yesterday. As the production controller rushed past-due jobs to completion, in-process jobs were interrupted often making them late as well. While the company in 1989 maintained 107 days of inventory and absorbed $85,000 in express transportation charges, customer service, as measured by order fill rate, was only 60%. (The unofficial sales motto read: "If we have it, you don't want it; and if you want it, we don't have it".) Customers were irate but had little recourse. Pulling an order from a supplier to give to another supplier once you discovered that the order was late would only make it later. Switching the next order to a new supplier as a penalty for late delivery occurred sometimes; however, the problem of late deliveries was endemic to the industry so switching suppliers often accomplished little. All a customer could really do was to maintain safety stock on critical parts, and/or pad delivery dates for future requirements, and/or request "immediate delivery" of any requirement that was within the normal delivery lead time. Velocity's customers typically did all three. Velocity as a result knew relatively little about the real demand and needs for their products. Mac 3/4/92 Velocity

6 The "Born Again" Revitalization Project In mid-1989, Velocity had realized that this industry wide delivery "problem" was actually an opportunity to differentiate itself in the market place. Management reasoned that if they could promise customers fast delivery and consistently deliver on that promise, then they might capture market share or command a premium price, or both. With this strategic objective in mind, they set off to "re-engineer" their manufacturing and distribution operations. They focused on aerospace OEMs which were the most important portion of their business. Rallying around the banners of "Worldclass Customer Service" and "Total Quality Management," they began experimenting with electronic data interchange (EDI) with customers, just-in-time (JIT) delivery scheduling from suppliers, and pull manufacturing of small lot sizes driven by KANBANs in a focused factory. Some changes were accomplished quickly; others were taking forever; some were easy; and, others were painful. It was clear to everyone in 1989 that inventory was a problem that needed immediate attention. There was $2.6 million invested in inventory, but it never seemed to be what the customer needed. A multi-functional task force was formed to study the problem in September of 1989. Three major recommendations emerged to reduce raw materials, work-in-process and finished goods inventories. First, a "vendor partnership" program was instituted to reduce raw material stocks. There were two primary reasons for the inventories: large cycle stocks resulted from large "economic" reorder quantities, and large safety stocks were Mac 3/4/92 Velocity

7 maintained to protect against variations in delivery lead time and product quality. Velocity decided to strike exclusive and long term contracts with suppliers who were willing to work with them to find opportunities to reduce Velocity's material cost. Eventually, the number of vendors was cut by half. Those who remained had agreed to a "4-2-2 price reduction" program for 1990 -1992. In addition, they had agreed to ship materials in smaller lots, with higher frequency and shorter lead times than they had historically. The "agreement" was starting to founder, however. The preferred suppliers were balking at the final 2% price reduction for 1992, and claimed that in fact they should be asking for a 6% increase in 1992 in order to make a "fair" profit from Velocity's business.Table 5 provides current raw material prices and lead times for the vendors. Work in process and finished goods were also reduced through smaller lot sizes within the plant. While reluctant at first, factory management agreed to a two year experiment with a modified version of Just-in-Time manufacturing. Starting in January of 1990 they were to produce no more than two weeks of supply for any A-item (high volume) component or product and no more than four weeks supply of anything else. The program had dramatically increased the number of machine setups, thereby reducing the time available for production and consuming nearly all of the factory's reserve manufacturing capacity. Manufacturing management felt that a sudden surge in demand at this point in time would bring the plant to its knees. Production control had warned management that to run the factory reliably beyond the two year trial period, either more equipment and operators or the resumption of a second shift would be necessary if the small lot scheduling were to continue. Mac 3/4/92 Velocity

VENDOl PRICES AND LEAD TIME DA TA BLANKS VENDOR 0Di TRF8iLJTiN //V D' YS 0.4. AVERAGE PRICE (SQUARES) NAME 1 2 3 4 5 (days) ($) RED A 1/4 1/4 1/4 1/4 3.5 184.00 i-O NAP^^^O B 1/2 /2 2.5 193.20 p\ ^^^'C 1 2 196.90 _^ | BLUE *A 1/3 1/3 1/3 4 220.80 B 1/3 1/3 1/3 3 234.00 C 1 2 238.50 ORANGE * A 1/2 1/2 4.5 294.40 C 1 2 338.60 YELLOW *A 1/3 1/3 1/3 4 257.60 B 1/4 1/4 1/4 1/4 3.5 273.10 C 1 2 278.20 WHITE *A 1/3 1/3 1/3 4 276.00 B 1/2 1/2 3.5 292.60 C 1 2 300.8 PINK *A 1/2 1/2 4.5 368.00 C 1 2 415.80 MATERIAL VENDOR 2 3 4 5 6 7 8 AVERAGE PRICE DOTS:R, B, G * D 1/5 1/5 1/5 1/5 1/5 5 $ 49.80 0, 90, 45 degree END FITTING E 1 /2 1/2 3.5 $ 54.70 BASE PLATES * F 1/4 1 /4 1 /4 1/4 3.5 $ 211.50 HOSE KIT G 1 2 $ 228.40 DOT:1 CArP * H 1 5 $ 6.22 DOTS:2 & 3 * I 1/4 1/4 1/4 1/4 6.5 $ 12.44 RED PAINT GREEN PAINT 1J /2 1/2 5.5 $ 12.81 DOTS:4 & 5 * K 1/3 1/3 1/3 4 $ 12.44 CUSTOM LABEL STANDARD LABEL L 1/2 1/2 2.5 $ 13.06 DOTS:6 & 7 * M 1 /5 1 /5 1 /5 1/5 1/5 5 $ 12.44 METAL TAG PLASTIC TAG N 1 5 $ 12.93 Table 5.

8 A third initiative to reduce inventory had been simple to execute, but difficult to sell. A detailed analysis of 1989 inventories by the task force revealed that $480,000 of current stock was in product that had experienced no sales activity in the past 12 months and was not likely to have any ever. While the auditors had been willing to turn their eye to the condition, these materials were accruing significant holding costs (15 percent/year plus working capital expense) and the task force recommended that they be scrapped. Because of the impact that such a write-off would have on current earnings and shareholder equity, management resisted. Eventually a compromise was reached. Any product "with no activity in the past 24 months and little prospect of sale in the future" would be scrapped. A total of $295,000 was written-off in 1990. The work force to date had been reasonably supportive of changes required to reduce Velocity's labor costs. Process redesign and job reclassification suggestions made over the past two years, by the Employee Involvement Program and Corrective Action Teams, had already increased factory productivity by more than 30 percent. The additional work load created in purchasing, receiving, inspection and accounts payable because of the increased number of vendor deliveries had added two new staff positions. Simultaneously, however, seven positions had been eliminated in inspection and expediting by expanding the responsibilities of other jobs. And, the individuals in these positions had been retrained for other jobs available from normal turnover. Mac 3/4/92 Velocity

9 Factory overtime had been reduced from nearly 20% to less than 1% by reorganizing the manufacturing sectors into focused workcells. By cross training workcell members in shop floor operations, materials handling, sector stock management, work releases and shop floor data collection, it was possible to shift resources around during the day as needs or backlogs occurred. Current staffing levels and salaries for the plant are summarized in Table 6. Any attempt, at this point, to further reduce manufacturing cost by cutting back on the labor force would be both painful and potentially counter productive. Management decided to move carefully in this area for three reasons. First, it was important that everyone in the plant be committed to and supportive of the changes taking place; second, their ideas and energy would be required to make change happen; and finally, if "Born-Again" succeeded as hoped, even more people would be needed to handle the expected increase in manufacturing volume. By most measures, "Born-Again" had been a resounding success. The financial statements in Tables 7 a, b, c together with the summary performance statistics of Figure 3 and Table 8 reflect the dramatic improvements that had occurred during the past two years. Inventories had been slashed to 34 days; manufacturing costs had dropped by 7%; unit cost was down by 10%; and even with a price reduction of 7% (led by the competition), selling margins had increased by 600%. With the improvement in profit and the reduction in inventory, RONA (return on net assets), the internal measure upon which management bonuses were paid, had jumped from 7% to 18%. Projecting the current business conditions forward, it was estimated that by simply holding Mac 3/4/92 Velocity

VELOCITY'S STAFFING LEVELS AND SALARIES TITLE SALARY ADMIN SEC1 SEC2 SEC3 SEC4 BASE BENEFITS TOTAL GenMngr 50000 1 50000 20000 70000 FactoryMngr 50000 1 50000 20000 70000 Marketing 39000 3 1117000 46800 163800 Sales/Order 27000 4 108000 43200 151200 Engr/Rsch 40000 2 80000 32000 112000 Acct 30000 2 60000 24000 84000 ProdCntl 35000 4 140000 56000 196000 MtlMngr 35000 1 35000 14000 49000 Procure 30000 1 30000 12000 42000 Rec/Stk/Shp 25000 5 125000 50000 175000 Maint 30000 2 0_ ____60000 24000 84000 Mach/Asmbr 34000 5 2 2 3 408000 163200 571200 ____________ _____ __I I I 1263000 505200 1768200 TABLE 6.

VELOCITY MANUFACTURING'S BALANCE SHEET *** BALANCE SHEET *** I1 1989 1990 10991 ASSETS........ I I $6,396,499 $4,961,667 $3,783,158 CURRENT ASSETS $4,016,378 $2,969,970 $2,134,530 CASH....."____ $122,350 $139,055 $150,000 ACCOUNTS RECEIVABLE $1,313,713 $1,254,517 $1,212,048 INVENTORY I 1 $2,580,315 $1,576,399 $772,482 RAW MATERIAL $944,298 $538,771 $133,244 WORK IN PROCESS $622,149 $524,755 $427,360 FINISHED GOODS $1,013,868 $512,873 $211,878 LONG TERM ASSETS I|$2,380,121 $1,991,697 $1,648,628 PROPERTY II| $325,000 $325,000 $325,000 PLANT ________$1,620,667 $1,371,333 $1,139,810 EQUIPMENT II $434,455 $295,364 $183,818 LIABILITIES ________$4,461,299 $3,444,285 $2,425,368 CURRENT LIABILITIES $3,043,413 $2,107,094 $1,366,145 SHORT TERM DEBT $2,322,284 $1,418,759 $695,234 ACCOUNTS PAYABLE $544,052 $518,207 $506,842 PAYROLL DUEI _ $80,248 $75,488 $70,728 OTHER ACCRUALS $96,830 $94,640 $93,341 LONG TERM LIABILITIES $1,417,886 $1,337,192 $1,059,223 LONG TERM DEBT II$1,417,886 $1,337,192 $1,059,223 SHAREHOLDER EQUITY I____. $1,935,200 $1,517,382 $1,357,790 TABLE 7a I

VELOCITY MANUFACTURING'S INCOME STATEMENT *** INCOME STATEMENT ***.| 1989 1990 1991 REVENUES ____ $10,947,608 $10,454,306 $10,100,400 SALES _$10,947,608 $10,454,306 $10,100,400 EXPENSES...$10,889,365 $10,484,003 $9,699,720 MANUFACTURING COSTS $8,829,687 $8,705,699 $8,172,979 VARI MANUFACTURING COSTS r $7,348,998 $7,037,358 $6,906,726 MATERIALV J $6,800,646 $6,477,582 $6,335,526 DIRECT LABOR [ $548,352 $559,776 $571,200 FIXED MANUFACTURING COSTS $1,480,689 $1,668,341 $1,266,253 MANAGEMENTZ $67,200 $68,600 $70,000 PRODUCTION CONTROL $188,160 $192,080 $196,000 MATERIALS MANAGEMENT $47,040 $48,020 $49,000 PROCUREMENT $40,320 $41,160 $42,000 RECEIVE/STOCK/SHIP $96,000 $135,500 $175,000 UTILITIES/TAXES/INSUR $289,550 $298,237 $307,184 DEPRECIATION $433,779 $388,424 $343,069 INSPECTION/EXPEDITING $238,000 $119,000 MAINTENANCE |.......$80,640 $82,320 $84,000 OBSOLETE INVENTORY $295,000 1 SELLING AND ADMINISTRATION $1,708,884 $1,516,897 $1,358,247 ADMINISTRATION $67,200 $68,600 $70,000 MARKETING | ____ $157,248 $160,524 $163,800 SALES/ORDER ENTRY $145,152 $148,176 $151,200 ENGINEERING/RESEARCH $107,520 $109,760 $112,000 ACCOUNTING |....__ $80,640 $82,320 $84,000 INVENTORY HOLDING COSTS $387,047 $236,460 $115,872 EXPEDITED FREIGHT $85,325 $62,890 $35,150 LIABILITY/WARRANTEE $678,752 $648,167 $626,225 OPERATING INCOME $409,037 $231,710 $569,174 INTEREST EXPENSE $350,794 $261,407 $168,493 SHORT TERM INTEREST $209,006 $127,688 $62,571 LONG TERM INTEREST $141,789 $133,719 $105,922 INCOME BEFORE TAXES $58,242 ($29,697) $400,680 INCOME TAXES(AT 40%) $23,297 ($11,879) $160,272 NET INCOME $34,945 ($17,818) $240,408 DIVIDENDS PAID _$400,000 $400,000 $400,000 INCREASE IN RETAINED EARNINGS ($365,055) ($417,818) ($159,592) TABLE 7b

VELOCITY MANUFACTURING'S CASH FLOW STATEMENT *** CASH FLOW STATEMENT ***I 1989 1990 1991 CASH FROM OPERATIONS $196,270 $1,400,924 $1,412,439 NET INCOME $34,945 ($17,818) $240,408 DEPRECIATION $433,779 $388,424 $343,069 DECLINE IN RECEIVABLES ($32,490) $59,196 $42,469 DECLINE IN INVENTORY ($270,350) $1,003,917 $803,917 INCREASE IN PAYABLES $23,650 ($25,845) ($11,364) INCREASE IN ACCRUALS $6,735 ($6,950) ($6,060) CASH PROVIDED BY FINANCING ($317,465) ($1,384,219) ($1,401,494) INCREASE IN S-T DEBT $17,535 ($903,525) ($723,525) INCREASE IN L-T DEBT __$65,000 ($80,694) ($277,969) LESS DIVIDENDS PAID ___ ($400,000) ($400,000) ($400,000) CASH USED BY INVESTMENT_____ NET CASH FLOW I I ___($121,195) $16,705 1 $10,945 TABLE 7c

VELOCITY MANUFACTURING'S PERFORMANCE STATISTICS l1_ l1:7__ l1989 1990 1991 NET INCOME/TOTAL ASSETS (ROA) 0.01 0.06 OPERATING INCOME/NET ASSETS (RONA) 0.07 0.05 0.18 LIABILITIES/OWNERS EQUITY (D/E) 2.31 2.27 1.79 NET INCOME/OWNERS EQUITY (ROE) 0.02 -0.01 0.18 INVENTORY TURNS (INV/COGS) 3.4 5.5 10.6 INVENTORY DAYS (36 5/TURNS) 107 66 34 UNIT PRICE $2,377 $2,288 $2,215 TOTAL SALES $10,947,608 $10,454,306 $10,100,400 DIRECT LABOR COST/UNIT $119 $123 $125 MATERIAL COST/UNIT $1,477 $1,418 $1,389 VARIABLE COST/UNIT $1,596 $1,540 $1,515 FIXED MNFT COST/UNIT $322 $365 $278 FACTORY COST/UNIT $1,917 $1,905 $1,792 GROSS MARGIN/UNIT $460 $383 $423 SGA/UNIT I$371 $332 $298 INTEREST EXPENSE/UNIT $76 $57 $37 UNIT COST:: $2,365 $2,295 $2,127 SELLING MARGIN/UNIT __$13 ($6) $88 SELLING MARGIN(%) _0.5% -0.3% 4. 1% TABLE 8

VELOCITY PERFORMANCE FLOW TIME FOR RELEASED ORDER ''' " ' ' """"" " " ' ' ' ' ' " ""'' ' ' ' "' ' ' ' "' "' "" "" "" " ""' " ' " "' """"""" " ' " ' ""' ""' ' " ' ~~ 2 Ti'3 ~~~~~~ " "" " ' " "' ' ' ' ` ' '"" '''' '' ' I I I~I ~L~~~ ~)' I I ~)~~~ I I I I I~ L I I ~ I ~ I~~~ I L I I I ~ I I I I I I -.i ~~ ~ " ~ ~~ ~~ ~'~ ~~ ~ ~ ~ ~~ ~~~~ ~~~~ ~ ~ ~ ~~~ "" ' ~~~ ~ ~' ' I ' ~~ ~ 1~~~~~ ~ ~ ~ ~~ ~~~ ~ ~~~ ~~~ ~~1 ~~ ~ ~ ~ ~ ~ ' ~ ' ~ ~~ I r.r. r I r r r r r r r r r r 1. r r r.r r., r I r r r r I r.r r I.r r r.r r r r r r I r r ' ' ~~' r 1 s:::::::i''~:-';4'~1:'-'.-::; I 1.~~ '' '' ^, ""*'^"""Y;"""""'`"`" ' ' "'`.i: i '"' "'` ''"' `'' "^`''''~'''~''" .:' '"~ '`'`''' ' ' ' ' ' ' ' ' ' ' r ~~ ~~~.6.8 "" ' 6; 5 "" " " i '..:.,..................~.................. NORMAL PRIORITY PRIORITY- I RED ALERT BORN-AGAIN INVENTORY and FILL RATE 1 -8......:..... ';.;.: "::':.::...'.::::.:..". '.:.:i;..-.:;:.;:....... ~...::'. '..:.i." ' ' ' ' " '.. ~~~~~~~~~~~..:......:.' "":............ ~~~~~~~~~~~~~~~~~~~~~~~~~~.':..'.."........'...:...:.!~~~~~.....:..::... i. '..:-'.'!':."::'..i'i::.:::.:.'..'....:.... "......-'........;;:i;':.i'....:.-!;:;;'.'i'..."":-:.-;:'i::.'.i::.::.'.!:;.'::.:...:.-"..:::....'"-:............... "" ' ' ".....-... I ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~i i i 1 4 1987 1 988 1989 1 990 1991 PROCESS YIELD and CUSTOMER RETURNS IC 2.,2......~~...............~................ ~~~~ '' '':...:.'................".......... ~.... I I~ L~~~~~~ Irl I"I"" )'I"I' I'I'I'I'I"I 1~~11 '~ ~~~~1 1~..................................... "' ""' ' "' "' "' ' " " ' " ' ' ' " '............ ' ' ' ' "' ' "'.......... ~~ ~ ~ ~~~ ~ ': ~' ~~ ~ ~ ~~~ ~............................................... " " ' ' " ' '.......... ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ "" I f 1987 1 988 1989 1990 1 991 Figure 3,

10 course, the natural depreciation of plant and equipment over the next few years would allow management to exceed their RONA goal of 24%. There was a tendency by many to relax. There was pressure, however, from some to do much more. Tougher Decisions Ahead The resident skeptics observed that Velocity management to date had simply picked the low lying fruit. The changes over the last two years had been relatively obvious and largely self-funding. They had inconvenienced no one, with the possible exception of the vendors (who had traded margin for volume) and seven shop floor employees (who had switched positions for job security). Proposed changes now on the table were more problematic. Capital investment would be needed; everyone's job might change; and jobs could be eliminated. In searching for methods for improving current operations, the task force had focused on two separate goals. An acceptable proposal could either reduce the current cost of an activity or operation (thereby reducing total cost to increase profit margin), or enhance the customers' perception of the product (thereby improving margin through a higher price, or improving total profit through increased market share). Six of the nine current proposals involved investments in process equipment. When the task force's process engineers completed their analysis of the Velocity plant, they concluded that Sector 1 was the process " Herbie," that is, Mac 3/4/92 Velocity

11 the bottleneck activity that gated the speed of material flow through the rest of the factory. If the pace of production through the plant was to improve, then work needed to begin in this sector. There were five sets of proposals to increase the production rate of Sector 1. 1. Increase the running speed of the current equipment thereby producing more units per hour. a) By adjusting the speed and feed rates on the lathes, it was estimated that production rate could be increased by 10% while yield would drop by 3%. b) By modifying the current lathes at a cost of $100,000 each, it would be possible to run them at a 25% faster rate with no additional yield loss. Setup for the modified equipment, however, would take 15% longer. 2. Reduce setup time of the current equipment. thereby increasing the number of hours for production. By buying an additional fixture ($1,000) for each lathe it would be possible to setup for the next part while the equipment was running. This would reduce the run time lost to setup by 80%. 3. Reduce the hours of breakdown and repair on current equipment. thereby increasing the number of hours for production. Changes to the equipment maintenance plan (executed during the off-shift) could reduce the break down frequency of Sector 1 lathes by 75%. The change effort would have a fixed cost of $40,000 per Mac 3/4/92 Velocity

12 lathe plus a recurring incremental maintenance cost of $5,000 per lathe per year. 4. Improve the yield rate of the current equipment thereby reducing the number of run hours required to produce a given order. a) Data show that 26% of yield losses are due to process control problems on the lathes in Sector 1. A new $70,000 control added to each lathe could reduce the failure rate to 1 per 5,000 processed pieces. b) Data also show that 21% of Sector 1 failures are caused by process variations in the oven. With a proper combination of temperature cycle, cycle length and cool down period, process defects could be virtually eliminated. Improved operator training ($2,000) and a new control ($9,000) are needed. 5. Add additional equipment to the sector. thereby increasing the number of hours available for production. a) Add a new $300,000 CNC lathe whose run speed is 50% longer than that of the current equipment, but whose setup time is nil. Maintenance cost on the lathe would be $15,000 per year; however tooling costs should be reduced by an equivalent of $1.10 per unit produced on this type of lathe. b) Purchase a $50,000 robot to insert the tube and braze ring into the machined components in preparation for their loading into the oven. The robot's run time is 2 seconds per unit and its Mac 3/4/92 Velocity

13 setup time is effectively zero. Annual maintenance costs are estimated at $4,000. c) Buy a new test station for $13,000 that reduces test time per piece in Sector 1 by 20%. A sixth proposal was made by a task force assigned to investigate the causes of yield loss. They discovered that the test equipment in Sector 4 was much less reliable than realized. The process was producing both Type I and Type 11 test errors. Approximately 3% of units shipped were being returned by customers as defective. In addition, a careful laboratory analysis of a large sample of scrapped parts revealed that 7% of them actually functioned properly. Expensive ($50,000) new test equipment now on the market could virtually eliminate both types of error. While the preventative maintenance cost for the equipment is high ($5,000 per year), the unit is very reliable and fast to repair if properly maintained. While the new test procedure would take 10% more time to process each piece, the cleaning operation of Sector 4 could be eliminated with this new equipment. This task force also uncovered a separate alarming fact. Nearly 48% of all yield loss in Sector 1 could be traced to defects in the machining blanks supplied by the "preferred" Vendor A. This fact was discovered by accident. Three times in the past two years Vendor A was unable to meet production requirements and Velocity was forced to pay the premium prices of Vendor C. Each time there was an unexpected increase in yield several weeks later as Vendor C's material was drawn from stock. A connection between these events had not been made until the task force studing the root causes of scrap, rejects Mac 3/4/92 Velocity

14 and returns had discovered it. On the basis of their findings, the task force proposes that all new orders for machining blanks be given to Vendor C, whose defect rate is 1 per 1000 units. The eighth recommendation was put forward by the Data Processing task force. In an effort to simplify purchasing, production control and warehousing operations and in order to increase inventory record accuracy, they proposed development of a computer system which would provide production controllers with on-line access to inventory data. The present production scheduling system relies upon the production controllers' recollection of yesterday's stock levels and scheduled replenishments. The actual availability of material is confirmed only after a tentative schedule is developed and translated into its required components using a bill of materials "explosion" and consolidation process. Typically, the daily schedule must be redrawn before it can be released, and this iterative process has delayed the start of a shift on several occasions. Moreover, the task force estimates that 40 percent of past due orders can be traced to hasty decisions made by production controllers as they sat "under the gun" to release work for the start of a shift. The problem is compounded as these past dues escalate to "red alert" status: scheduling becomes more complex and time consuming; components are withdrawn from stock without inventory record update; capacity is lost to unplanned setups; and finally, interrupted jobs themselves become late and create the next "red alert." It is hoped that by using the new system to "informate" the decision process and to provide expert advice to the production controllers, this cycle of problems can be broken. An outside consulting firm will design and implement Mac 3/4/92 Velocity

15 the new system for $125,000 and they estimate that annual maintenance and operating costs will run about $25,000. A ninth and final recommendation was delivered by the marketing task force who had been charged with developing a two year marketing strategy to increase market share. This team analyzed historical sales by customer and product (summarized by Figure 4) and commissioned a market survey of current and potential customers. They concluded that Velocity would not gain market share with price reductions which could be matched easily by competitors. They found, however, that customers were very sensitive to delivery, reliability and speed improvements, which if achieved, would be much harder for competitors to duplicate. Their report ( summarized in Table 9) concludes that if, for example, Velocity were to: a) improve on-time delivery performance to 95%, b) guarantee one-day production lead times, and c) reduce current prices by 5%, then Velocity should be able to increase unit sales by 32% next year and then grow at about 12% per year for the next four years. This last proposal is considered the most radical of the nine. It will require substantial investments in capacity, inventory, quality, and information systems, while simultaneously reducing prices. Moreover, for the plan to succeed, Velocity will have to take market share from aggressive competitors who might attempt to hold share by additional price reductions. Serious consideration by Velocity's management committee would require a complete analysis of the Mac 3/4/92 Velocity

16 total manufacturing system needed to support such a proposal. The analysis would have to contain, at a minimum, the following items: 1. Plant Layout 2. Equipment Plan 3. Production Control System 4. Inventory Plan (WIP,FIN, RAW) 5. Yield Analysis (1st pass yields) 6. Information System 7. Performance Measurement System 8. Manpower Plan 9. Vendor Plan 10. Projected Financial Statements 11. Projected Cash Flow Analysis 12. Projected Performance Statistics. Your assignment is to develop an action recommendation for Velocity's management committee and then to prepare a detailed analysis with which to explain and justify your proposal. Mac 3/4/92 Velocity

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HOSE and FITTING MARKET ANALYSIS (SENSITIVITY TO PRICE AND DELIVERY WI 1-SHIFT LEAD TIME) ~ ".: ' ~; TARGET. HERE:' ': - '....1SHIFT LEAD TIME-......... 95% ON-TIME DELIVERY '.- -.- - -5%: -PRICE REDUCGTIO:- -: yIELD.: 32%.GRO:!l: --. ---,: | 12%/yr-F 4 YEARS 160 - NEXT Z 0 (5 k 140 - 120 -100 -80 -60 -40 -20 - 0 \ PERCENT PRICE REDUCTION % GROWTH YEAR 1 ON-TIME DELI VERY (%) 80 85 90 95 98 99 100 ~ 0 5 6 8 18 32 40 65 2 10 11 13 24 39 60 85 C 5 25 26 26 32 60 75 90 10 60 60 61 70 90 105 120 ~c 15 100 105 112 123 135 140 145 % GROWTH YEARS 2 to 4 ON-TIME DELIVERRY (%);~ " 80 85 90 95 98 99 100 ___ 0 5 5 6 9 12 14 20 ~ 2 | _7 7 7 10 14 19 25 ~ _5 _10 11 _11 _12 _19 23 _26 LLI 10 19 19 19 15 27 30 34 15 29 30 32 35 38 39 40 Table 9.

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