What is Your Cost Model Costing You?

Greg Eckerman says that the way some manufacturers evaluate costs can leave them stuck with underperforming manufacturing equipment. He says this is particularly true of activity-based costing methods.

Mr. Eckerman, former COO of GlobalVantage, has been the managing director of the Six Sigma Academy. At AlliedSignal Aerospace, he led the company’s Design for Six Sigma program. He has consulted with companies on Six Sigma and Lean, and today works for metalworking technology company BlueSwarf. He also serves as an expert in the Lean Manufacturing Zone (taking your questions here).

He says one of the dangers of activity-based costing comes when the sum of the items treated as organization-wide costs becomes too large. Facilities overhead, marketing, executive personnel and other such costs all get added in equal measure to the costs of discrete manufactured parts—“spread across them like peanut butter,” he says. The problem with this is that manufacturing improvements tend not to be enterprise-wide.

No, manufacturing improvements tend to be focused. A faster machine is purchased for one operation. An accessory is added to avoid a setup. Such an investment might do its small share to affect overhead costs—reducing power consumption by reducing machining time, for example—but the impact gets diluted across the enterprise. Inaccurately quantifying the improvements might prevent the investment from being made. A more fitting analysis would compare the enterprise-wide accumulation of many manufacturing improvements against those enterprise-wide costs, but this doesn’t happen because of the way production improvements proceed one by one. At the extreme, the journey of 1,000 miles might never be taken, because no single step can be justified.

Then there are the savings invisible to costing. For example, BlueSwarf’s technology has to do with reducing chatter to increase throughput and quality. Mr. Eckerman helps integrate the technology into lean facilities. For a given application, the technology might make sense or might not—but there are several ways a facility’s cost model might overlook the potential benefits. Those benefits resulting from increased quality or speed could include: (1) capacity to bring outsourced work back home, (2) simplifying assembly for the customer because parts are more consistent, (3) putting off the next new machine purchase for a year or two, and (4) opportunity, because the freed-up capacity means the plant is ready for an additional product.

What all of those listed benefits have in common is that the cost impact probably cannot be known precisely. Yet the worth of those benefits is real. Mr. Eckerman says a more accurate cost model assigns some kind of value to these benefits, rather than treating their value as 0 by default.

Because of the quirks of costing models, he says he thinks the true value of manufacturing improvements is routinely understated by a factor of 3. That number is hard to prove.

Still, I think his argument intuitively resonates. Do you agree? Are manufacturers kept from investments they know are right by cost models they feel are wrong? Please e-mail me or add a comment below.