Modern Business Environment – CA Final SCMPE Study Material

Modern Business Environment – CA Final SCMPE Study Material is designed strictly as per the latest syllabus and exam pattern.

Modern Business Environment – CA Final SCMPE Study Material

Question 1.
(Components of Cost of Equity)
Classify the following items under appropriate categories of quality costs, viz., Prevention Costs (PC), Appraisal Costs (AC), Internal Failure Costs (IFC) and External Failure Costs (EFC):
(i) Unplanned replacement to customers
(ii) Correction of a bank statement
(iii) Design review
(iv) Equipment accuracy check
(v) Staff training
(vi) Reprocessing of a loan operation
(vii) Product liability warranty
(viii) Product acceptance
(ix) Wastage of material
(x) Planned maintenance of equipment
(You may opt for the following format and fill in the appropriate Roman numerals under each column):

Answer:
Appropriate Categories of Quality Costs

Question 2.
(Cost of Quality) RAX is a market manufacturing organization produces and sells a single product. The cost data per unit for the year 2021 is predicted as below:

	₹ per unit
Direct Material	35
Direct Labour	25
Variable Overheads	15
Selling Price	90

RAX has forecast that demand for the product during the year 2021 will be 28,000 units. However, to satisfy this level of demand, production quantity will be increased?
There are no opening stock and closing stock of the product.
The stock level of material remains unchanged throughout the period.

The following additional information regarding costs and revenue are given:

• 12.5% of the items delivered to customers will be rejected due to specification failure and will require free replacement. The cost of delivering the replacement item is ₹ 5 per unit.
• 20% of the items produced will be discovered faulty at the inspection stage before they are delivered to customers.
• 10% of the direct material will be scrapped due to damage while in storage. Due to above, total quality costs for the year is expected to be ₹ 10,75,556.

The company is now considering the following proposal:
1. To introduce training programs for the workers which, the management of the company believes, will reduce the level of faulty production to 10%, This training program will cost ₹ 4,50,000 per annum.
2. To avail the services of quality control consultant at an annual charges of ₹ 50,000 which would reduce the percentage of faulty items delivered to customers to 9.5%.
Required
(i) PREPARE a statement of expected quality costs the company would incur if it accepts the proposal. Costs are to be calculated using the four recognised quality costs heads.
(ii) Would you RECOMMEND the proposal? Give financial and non-financial reasons. [MTP Oct. 2018/RTPNov. 2021]
Answer:
(i) Statement of‘Expected Quality Costs’

Particulars	Current Situation (₹)	Proposed Situation (₹)
Prevention Costs	—	4,50,000
Appraisal Costs	—	50,000
External Failure Costs	3,20,000	2,35,120
Internal Failure Costs	7,55,556	3,91,538
Total Quality Costs	10,75,556	11,26,658

Workings
External Failure Cost

Internal Failure Cost

(ii) Recommendation
On purely financial grounds RAX should not accept the proposal because there is an increase of ₹ 51,102 in quality costs. However there may be other factors to consider as the company may enhance its reputation as a company that cares about quality products and this may increase the company’s market share. On balance RAX should accept the proposal to improve its long-term performance.

Question 3.
(Optimal Cost of Quality)
Gaur Hari Ltd. produces and sells a single product. Presently the company is having its quality control system in a small way at an annual external failure and internal failure costs of ₹ 4,40,000 and ₹ 8,50,000 respectively. As the company is not able to ensure supply of good quality products upto the expectations of its customers and wants to manage competition to retain market share considers an alternative quality control system. It is expected that the implementation of the system annually will lead to a prevention cost of ₹ 5,60,000 and an appraisal cost of ₹ 70,000. The external and internal failure costs will reduce by ₹ 1,00,000 and ₹ 4,10,000 respectively in the new system. All other activities and costs will remain unchanged.
Required
(i) EXAMINE the new quality control proposal and recommend the acceptance or otherwise of the proposal both from financial and non-financial perspectives.
(ii) What is your ADVICE to the company, if the company wants to achieve zero defect through a continuous quality improvement, program?
(iii) SUGGEST a suitable quality control level at a minimum cost. [May 2018](I0 Marks)
Answer:
(i) Implementation of new system will reduce costs of the non-conformance (internal and external failure) by ₹ 5,10,000 (-40%). However, this will also increase costs of conformance by ₹ 6,30,000. There is inverse relationship between the costs of the conformance and the costs of non-conformance. Gaur Hari Ltd. should try to avoid costs of non- conformance because both internal and external failure affect customer’s satisfaction and organisations profitability. The company should focus on preventing the error such that it ensures that product is of good quality when it reaches the customer at the very first instance. This enhances the customer experience and therefore eliminating the scope for external failures like sales returns and warranty claims. Better quality can yield further sales. Therefore, an increase in spending on quality measures is justified since it not only yields significant improvements to quality but also brings in more sales orders.

Accordingly, from the financial perspective point of view the new proposal for quality control should not be accepted as it will lead to an additional cost of ₹ 1,20,000 (₹ 6,30,000 – ₹ 5,10,000). However, from non-financial perspective point of view as stated above the company should accept the new proposal.

(ii) It is possible to increase quality while at the same time reducing both conformance and non-conformance costs if a programme of aiming for zero defect/and or continuous improvement is followed. Zero defect advocates continuous improvement. To implement this elimination of all forms of waste, including reworks, yield losses, unproductive time, over-design, inventory, idle facilities, safety accidents, etc. is necessary.

(iii) To achieve 0% defects, costs of conformance must be high. As a greater proportion of defects are accepted, however, these costs can be reduced. At a level of 0% defects, cost of non-conformance should be nil but these will increase as the accepted level of defects rises. There should therefore be an acceptable level of defects at which the total costs of quality are at a minimum

Question 4.
(Cost of Quality; SIT) A manufacturing organization Brain Grain is producing a single product RAXY which require three component.
Brain Grain purchases each of these component from three suppliers AZ Ltd, BZ Ltd and CZ Ltd. The following information are available;

If the defectives are not detected they are utilized in production earning a damage of ₹ 200per 100 units of the component. Total requirements is 12,000 units of the components,
The company intends to introduce a system of inspection for the components on receipt. The inspection cost is estimated at ₹ 26 per 100 units of the components. Such as inspection will be able to detect only 90% of the defective components received. No payment will be made for components found to be defective in inspection,
Required
(i) ADVICE whether inspection at the point of receipt is justified
(ii) Which of the three suppliers should be asked to supply? [Nov. 2018](10Marks)
Answer:
(i) A. Statement Showing Effective Cost before Inspection

Particulars	AZ Ltd.	BZ Ltd.	CZ Ltd.
Units Supplies (Nos.) Defectives Expected (Nos.)	12,000 360	12,000 600	12,000 240
Costs: Purchase of Components Add: Production Damage on Defective Components (@₹ 200 per 100 compo­nents)	28,800 720	28,080 1,200	31,200 480
Total	29,520	29,280	31,680
Good Components (Nos.) Cost per 100 Good Components	11,640 253.61	11,400 256.84	11,760 269.39

B. Statement Showing Effective Cost after Inspection

Particulars	AZ Ltd.	BZ Ltd.	CZ Ltd.
Units Supplies (No.s) Defects Not Expected (No.s) Defectives Expected (No.s) Components Paid For	12,000 36 324 11,676	12,000 60 540 11,460	12,000 24 216 11,784
Costs: Purchase of Components Add- Inspection Cost	28,022.40 3,120.00	26,816.40 3,120.00	30,638.40 3,120.00
Add: Production Damage on Defective Components (@₹ 200 per 100 components)	72.00	120.00	48.00
Total	31,214.40	30,056.40	33,806.40
Good Components (Nos.) Cost per 100 Good Components	11,640 268.16	11,400 263.65	11,760 287.47

ADVICE Whether Inspection at the Point of Receipt is Justified
On comparing the cost under situation, A and B shown above, we find that it will not be economical to install a system of inspection.
Further we also need to consider that presently many organizations are undergoing Just in Time (JIT) implementation. JIT aims to find a way of working and managing to eliminate wastes in a process. Achievement of this is ensured through eliminating the need to perform incoming inspection. Inspection does not reduce the number of defects, it does not help in improving quality. In general inspection, does not add value to the product. It simply serves as a means of identifying defects the supplier has failed to recognize subsequent to the manufacturing of the product.
As a matter of fact, organizations implementing JIT are seeking eventually to eliminate the need for performing incoming inspection activities through a combination of reducing the supplier base, selection through qualification and vendor development. Vendor development and its proper management seeks to assist the supplier who maintains an interest in striving to provide 10096 defect-free materials and parts.
So, to decision whether inspection at the point of receipt is justified or not will also depend on Qualitative factors as well.

(ii) On comparing the buying cost of components under different situations, as analysed and advised above, if company decides not to install a system of inspection, supplier AZ would be cheaper otherwise supplier BZ would be cheaper and company may choose supplier accordingly.

Note:
This question can also be solved by assuming receipt of good components as requirement ie. 12,000 units.

Question 5.
(Cost of Quality) Olive Ware Private Ltd. manufactures electronic components for cars. Car manufacturers are the primary customers of these products. Raw material components are bought, assembled and the electronic car components are sold to the customers.

Selling price	₹ 2,500 per unit
Raw material cost	₹ 900 per unit
Assembly & machine cost	₹ 500 per unit
Delivery cost	₹ 100 per unit
Contribution	₹1,000 per unit

The customers due to defects in the product return 5,000 units each year. They are replaced free of charge by Olive Ware. The replaced components cannot be repaired and do not have any scrap value. If these defective components had not been supplied, that is had the sale returns due to defective units been nil, customers’ perception about the quality of the product would improve. This could yield 10% increase in market share for Olive ware that is demand for its products could increase to 150,000 units per annum.
Required
(i) ANALYZE, the cost of poor quality per annum due to supply of defective items to the customers.
(ii) The company management is considering a proposal to implement an inspection process immediately before delivery of products to the customers. This would ensure nil sales returns. The cost of having such a facility would be ₹ 2 crores per annum, this would include materials and equipment for quality check, overheads and utilities, salaries to quality control inspectors etc. ANALYZE the net benefit, if any, to the company if it implements this proposal.
(iii) Quality control investigations reveal that‘defective production is entirely on account of inferior quality raw material components procured from a large base of 30 suppliers. Currently there is no inspection at the procurement stage to check the quality of these materials. The management has a proposal to have inspectors check the quality control at the procurement stage itself. Any defective raw material component will be replaced free of cost by the supplier. This will ensure that no product produced by Olive Ware is defective. The cost of inspection for quality control (materials, equipment, salaries of inspectors etc.) would be ? 4 crore per annum. ANALYZE the net benefit to the company if it implements this proposal? Please note that scenarios in questions (ii) and (iii) are independent and not related to each other.
(iv) Between inspection at the end of the process and inspection at the raw material procurement stage, ADVISE a better proposal to implement (a) in terms of profitability and (b) in terms of long term business strategy? [RTP May 2019](20 Marks)
Answer:
(i) Customer demand for Olive Ware’s products is 1,00,000 units per annum. However, 5,000 defective units supplied are to be replaced free of charge by the company. Therefore, the total number of items supplied to customers per annum = 1,00,000 + 5,000 units = 1,05,000 units. The cost of replacement would include raw material cost, assembly & machining cost and delivery cost of 5,000 units = 5,000 units X j (900+500+100) per unit = 5,000 units × ₹ 1,500 per unit = ₹ 75,00,000 per annum.

Further, had the sale returns not happened, market share would have increased by 50,000 units. Contribution is ₹ 1,000 per unit, for 50,000 units contribution would be ₹ 5,00,00,000. Therefore, the ) cost of poor quality per annum = cost of replacement + contribution from lost sales = ₹ 75,00,000 + ₹ 5,00,00,000 = ₹ 5,75,00,000 per annum.

(ii) Inspection at the end of the process would detect defects before delivery to the customers. This would ensure that the sale returns would be nil. Given in the problem, 5,000 units supplied are defective and would ig need to be replaced, in other words, they need to be manufactured again. In other words, inspection after production, before delivery to customers would not prevent production of defective units. However, compared to the current scenario, since these defective units have not yet been delivered to the customer, the cost for additional delivery of replaced products would be saved. This savings in the extra delivery cost = 5,000 units × ₹ 100 per unit = ₹ 5,00,000 per annum. Further, had the sale returns not happened, market share would have increased by 50,000 units. Contribution is ₹ 1,000 per unit, for 50,000 units it would be ₹ 5,00,00,000 per annum. However, additional failure cost for 2,500 units due to increase in sales from 1,00,000 to 1,50,000 units would be incurred. Since these defective units have not yet been delivered to the customer, this cost would be net of delivery cost. This additional failure cost = 2,500 units × ₹ 1,400 per unit = ₹ 35,00,000 per annum. Therefore, the total benefit from the inspection process before delivery to customers = savings on delivery costs + contribution from incremental sales – additional failure cost = ₹ 5,00,000 + ₹ 5,00,00,000 – ₹ 35,00,000 = ₹ 4,70,00,000 per annum. The cost to the company to maintain good quality of its products through inspection = ₹ 2,00,00,000 per annum. Therefore, the net benefit to the company would be ₹ 2,70,00,000 per annum.
His question can also be solved by taking 7,895 defectives on 1,50,000 good units. For 95,000 good units, gross production is 1,00,000 units. For, 1,50,000 good units, gross production would be 1,57,895 units (1,00,000/95,000 × 150,000). Therefore total defective units will be 7,895.

(iii) Inspection of raw material at the procurement stage could entirely eliminate defective production. The benefit would be two-fold, the current replacement cost for 5,000 units will no longer be incurred. Secondly, due to better customer perception, market share would increase, resulting in an increased contribution/revenue to the company. In other words, the cost of poor quality will be nil.

As explained in solution (i), the cost of poor quality per annum = cost of replacement + contribution from lost sales = ₹ 75,00,000 + ₹ 5,00,00,000 = ₹ 5,75,00,000 per annum. This would be the benefit by implementing the proposal.
Olive Ware has to incur an inspection cost to ensure this highest standard of quality (0% defects) which would cost ₹ 4,00,00,000 per annum. Therefore, the net benefit to the company would be ₹ 1,75,00,000 per annum.

(iv) (a) The proposal to implement inspection immediately before delivering goods to the customers results in a net benefit of ₹ 2,70,00,000 per annum. Alternately, the proposal to implement inspection at the raw material procurement stage results in a net benefit of ₹ 1,75,00,000 per annum. Therefore, from a profitability point of view, inspection immediately before delivery of goods to the customer would the preferred option.

(b) The drawback of inspection at the end of the production process is that (1) it cannot prevent production of defective goods and (2) information regarding the root cause of defective production, in this case, supply of defective raw materials will not get tracked. Therefore, inspection at the end of production does not contribute to resolving the root cause of defective production. On the other hand, inspection at the procurement stage can eliminate production of defective goods. This will ensure a much higher quality of production, better utilization of resources and production capacity. Therefore, from a long-term strategy point of view, inspection at the raw material procurement stage will be very beneficial. Currently the cost of ensuring this highest quality of production (0% defects) is ₹ 4 crores per annum. The cost of ensuring 100% quality is quite high, such that the net benefit to the company is lesser than the other proposal. However, due to its long-term benefit, Olive Ware may consider some minimum essential quality control checks at the procurement stage. Although j selective quality check might not ensure complete elimination of defective production, it can contribute towards reducing it. At the same time cost of selective quality check would not be so high as to override its benefits. To determine the extent of quality control inspection, Olive Ware should determine its tolerance limit for defective production and do an analysis of the quality cost trade-off.

Question 6.
(Cost of Quality; TPM; TQM) Star Automobile Group is among top 20 business houses in India. It has been founded in the year 1940, at the height of India’s movement for independence from the British, the 1 group has an illustrious history. Star’s footprint stretches over a wide range of industries, spanning automobiles (two wheelers manufacturer and three wheelers manufacturer). Star’s headquarter is located at Hyderabad. Bike Production is one of segment of Star Group. Management of Star wants to analyse the following actual information for the April:

Cost Data
Customer Complaints Centre Cost	35 per hr.
Equipment Testing Cost	18 per hr.
Warranty Repair Cost	1,560 per bike
Manufacturing Rework Cost	228 per bike

Volume and Activity Data:

Bikes Requiring Manufacturing Rework	3,200 bikes
Bikes Requiring Warranty Repair	2,600 bikes
Production Line Equipment Testing Time              .	1,600 hrs.
Customer Complaints Centre Time	2,000 hrs.

Additional Information
Due to the quality issues in the month, the bike production line experienced unproductive ‘down time’ which cost ₹ 7,70,000. Star carried out a quality review of its existing suppliers to enhance quality levels during the month at a cost of ₹ 1,25,000.
Required
(i) PREPARE a statement showing ‘Total Quality Costs’.
(ii) ADVISE any TWO measures to reduce the non- conformance cost. [RTP Nov. 2019][Afov. 2021]
Answer:
(i) Statement Showing ‘Total Quality Costs’

Particulars of Costs	₹
Prevention Costs
Supplier Review	1,25,000
Appraisal Costs
Equipment Testing (₹ 18 × 1,600 hrs.)	28,800
Internal Failure Costs
Down Time	7,70,000
Manufacturing Rework (₹ 228 × 3,200 bikes)	7,29,600
External Failure Costs
Customer Complaints (₹ 35 × 2,000 hrs.)	70,000
Warranty Repair (₹ 1,560 × 2,600 bikes)	40,56,000
Total Quality Costs	57,79,400

(ii) The reporting of quality costs highlights the cost of quality activities at Star. The total quality costs statement clearly displays the relationship between conformance costs (prevention and appraisal costs) and non-conformance costs (internal failure and external failure costs) and the drivers of a reduction in the overall spending on quality. Statement indicates that only 2.16% of the total quality cost is the cost of preventing quality problems while 0.50% is the cost of appraisal activities. Thus, prevention and appraisal costs make up only 2.66% of total quality costs. In contrast, 97.34% of quality control costs are incurred for internal and external failure costs. Following two measures can be used to reduce non-conformance cost:

Total Productive Maintenance (TPM) is a system of maintaining and improving the integrity of production and quality system through keeping all equipment in top working condition so as to avoid breakdowns and delays in manufacturing processes. It involves identifying machines in every division (including planning, manufacturing, maintenance) and then planning & executing a maintenance programme covering their entire useful life.

In this scenario, TPM will help in reducing internal failure cost (i.e., downtime and manufacturing rework cost), which constitutes 25.95% of total quality cost, by keeping all equipment in good working conditions so that there is no downtime or machine breakdown and ensuring that all equipment run smoothly. If machines work properly, the chances of rework will reduce, ultimately will also reduce chances of warranty repair and cus-tomer complaints (comprising 71.39% of total quality cost which is major part of total quality cost).

Total Quality Management (TQM) aims at improving the quality of organisational output, including goods and services, through continual improvement of internal practices. Its objective is to eradicate waste and increase efficiency without compromising with the quality. It requires that company maintain this quality standards in all aspects of business by ensuring that things are done right the first time so that defects and waste are eliminated from operation.

It appears that Star is not a TQM company at present due to huge disparity between conformance costs and non-conformance costs. In order to make Star to be successful, all staff at Star must be engaged in the improvement process and share in the continuous improvement ethos. In order to establish a reputation as a high-quality bike manufacturer Star must ensure staff are focused on quality and attitudes changed toward the importance of conformance activities, for instance, Star can conduct third party inspection of raw material at supplier’s workplace leading to maintenances of quality standards.

Overall, while applying above two measures, in the Star, consid-eration must therefore be given to the optimum balance between the costs of conformance and the costs of non-conformance.

Question 7.
FIZI is a new banking company which is about to open its first branch in INDIA. FIZI believes that in order to win customers from the market, it needs to offer potential customers a new banking experience. Other banking companies are focusing on interest rates and bank charges, whereas FIZI believes that quality and timely availability of service is an important factor to attract customers.
Required
EXPLAIN how Total Quality Management would enable FIZI to gain competitive advantage in the banking sector. [RTP May 2018]
Answer:

• Total Quality Management is a management philosophy.
• It concerns itself with managing processes and people to make sure that the customer is satisfied at each and every stage.
• This means making the needs of the customer the priority, expanding the relationship beyond traditional services and incorporating the customer’s needs in the company’s business plan and corporate strategy.
• In TQM, the concept of “quality” is perceived exclusively from the frame of reference of the customer.
• These customers can be internal, such as, those working in another department and there can be external customers who are the end recipients of the product or services.
• The organisation should attempt for continuous improvement in the quality that it delivers with the ultimate aim of achieving zero defects in this quality.

TQM should be view as an investment rather than as a cost that should be minimised. There are many ways in which investment can be made in TQM.:

• fine-tuning the product mix,
• fine-tuning of the processes of ensuring quality,
• introducing employee development programmes with the nature of an academic course,
• empowering the employees professionally and personally,
• improving the top management commitment to quality,
• monitoring of the performances and proper rewarding based on achievements,
• ensuring the customer satisfaction etc.

FIZI could provide its employees with training in the technical aspects of banking practice as well as in customer care.

• Customers would thus get a better service not only technically but also from a customer care perspective.
• This should lead to smaller customer complaints and greater customer satisfaction.
• It could also motivate customers to recommend others to use , this bank.
• TQM also requires FIZI to respond to its customer’s requirements immediately for example by providing more staff to reduce the lengths of queues in festive/seasonal/busy time.
• If Bank could also be opened for longer hours to allow customers to complete their bank related requirements and have meetings with bank employees at a time that is more convenient for the customer, this would lead to more satisfaction to customers.
• In long run, if bank continue to follow TQM, the bank would I have higher profits and competitive advantage in banking sector despite incurring additional expenditure to improve quality.

Financial perspective – Required Cost
Non-Financial Perspective – Long term, its Good

Question 8.
(Total Quality Management) Kasan Ltd. is a manufacturing company, which is engaged in production of wide range of consumer products for home consumption. Among its all product CFL lamp are its most efficient and environmental friendly product. Kasan has a quality control department that monitor the quality of the products produce by company.
As per the recent cost of poor quality report, the current rejection rate for CFL lamps is 5% of units input. 5,000 units of input go through the process each day. Each unit that is rejected results in a ₹ 200 loss to the Kasan Ltd. company. The quality control department has proposed few changes to the inspection process that would enable early detection of defects. This would reduce the overall rejection rate from 5% to 3% of units input. The improved inspection process would cost the company ₹ 15,000 each day.
Required
(i) ANALYSE the proposal and suggest if it would be beneficial for the Kasan to implement it.
(ii) After implementation, ANALYSE the maximum rejection rate beyond which the proposal ceases to be beneficial? [MTP Oct. 2020; MTP April 2019]
Answer:
(i) Analysis of the proposal to make changes to the inspection process: The Kasan company wants to reduce the cost of poor quality on account of rejected items from the process. The current rejection rate is 5% that is proposed to be improved to 3% of units input.
The expected benefit to the company can be worked out as follows: The units of input each day = 5,000. At the current rate of 5%, 250 units of input are rejected each day. It is proposed to reduce rejection rate to 3%, that is 150 units of input rejected each day. Therefore, improvements to the inspection process would reduce the number of units rej ected by 100 units each day. The resultant cost of poor quality would reduce by ₹ 20,000 each day (100 units of input × ₹ 200 cost of one rejected unit).
The cost of implementing these additional controls to the inspection process would be ₹ 15,000 each day.
The net benefit to the company on implementing the proposal would be ₹ 5,000 each day. Therefore, the Kasan company should implement the proposal.

(ii) Analysis of maximum rejection rate beyond which the proposal ceases to be beneficial
The cost of improving controls to the inspection process is ₹ 15,000 each day. The number of units of input processed each day is 5,000. The cost of rejection is ₹ 200 per unit.
It makes sense to implement the improvements to controls only if the benefit is greater than the cost involved. To find out the point where the benefits equal the cost, solve the following equation.
Let the number of reduction in rejections each day due to improved controls be R. At ₹ 200 per unit, benefits from reduction in rejection would be ₹ 200 × R.
At what point, would this be equal to the cost of control of ₹ 15,000 per day?
Solving ₹ 200 × R = ₹ 15,000; R = 75 units. That is if the improvements to inspection process control reduces the number of rejections by 75 units each day, the benefit to the Kasan company would be ₹ 15,000 each day.
That is if the rejection rate improves by 1.5% (75 units/5,000 units) then the benefits accruing to the company will equal the cost incurred.
In other words, when the rejection rate is 3.5% (current rate 5% – improvement of 1.5% to the rate) or below, the proposal will be beneficial. In this range, the savings to the cost of poor quality will be more than the cost involved. For example, as explained above, when the improved rejection rate is 3%, the net benefit to the company is ₹ 5,000 each day.
Beyond 3.5% rejection rate, the proposal will result in savings to the cost of poor quality that is less than the cost involved of ₹ 15,000 each day.

Question 9.
Delicious Box Ltd. is a manufacturer and supplier of android set up boxes for various DTH operators. This is very popular with the operators as it converts normal TV to a smart TV. To ensure supply of good quality products to meet the expectations of the viewers, it has set up quality control department that regularly conducts quality inspection and submits its report to the management on weekly basis.
As per the latest quality inspection report submitted by the department, it reflects that the current rejection rate is 7% of units input into the manufacturing system due to poor quality. 3,000 units of input go through the process every day. As per analysis, for each rejection, there is loss of ₹ 150 to the company. The management is very much worried due to high rate of rejection of input units.
The management has asked for suggestions from the quality control department in this regard. The department has suggested implementation of new system for inspection for early detection of defective units. This change would result in drop of rejection rate to 4% from earlier 7%. The cost of new system will be ₹ 12,000 per day.
Required
(i) ANALYSE the Proposed new system for inspection and suggest if it would be beneficial for the company.
(ii) Also CALCULATE the minimum reduction in number of rejections each day upto which the proposed system will be beneficial. [Nov. 2020](5 Marks)
Answer:
(i) Analysis of the Proposal
DTH Box Ltd. wants to reduce the cost of poor quality on account of rejected items from the manufacturing system. The current rejection rate is 7% that is proposed to be improved to 4% of units input.
The expected benefit to the company can be worked out as follows: The units of input each day = 3,000. At the current rate of 7%, 210 units of input are rejected each day. It is proposed to reduce rejection rate to 4%, that is 120 units of input rejected each day. Therefore, new system would reduce the number of units rejected by 90 units each day. The resultant cost of poor quality would reduce by 1 13,500 each day (90 units of input X ₹ 150 cost of one rejected unit).
The cost of implementation of the new system on the inspection pro-cess would be ₹ 12,000 each day.
The net benefit to the DTH Box Ltd on implementing the proposal would be ₹ 1,500 each day. Therefore, the company should implement the proposal.

(ii) Let the number of reductions in reactions each day due to proposed system be X. At ₹ 150 per unit, benefits from reduction in rejection would be ₹ 150 × X.
Point, at which this will be equal to the cost of new system of 12,000 per day: Solving ₹ 150 × X = ₹ 12,000; X = 80 units
Therefore, minimum reduction in number of rejections each day up to which the proposed system will be beneficial is 80 units.
.
Question 10.
(Cost of Quality, TQM)
ORG is a Smart TV manufacturer. Smart TV is a technological convergence of computers, television sets and set-top boxes provided through traditional broadcasting media. It is relatively a new company in the market and the directors are keen to establish a reputation of high quality.
The CEO of the company has heard that “There is no better cost to eliminate than the cost of poor quality”
The board of directors decided in the board meeting to establish a culture of Total Quality Management at the company. For this purpose they have collected the following actual information for the most recent quarter of the current year:

Cost data	$
Customer support centre cost per hour	116
Equipment testing cost per hour	60
Manufacturing rework cost per TV	760
Warranty repair cost per TV	5,200
Volume and activity data
TVs requiring manufacturing rework	800 TVs
TVs requiring warranty repair	650 TVs
Customer support centre time	500 hours
Production line equipment testing time	400 hours

Additional information
ORG during the quarter, undertook a quality review of its existing suppliers at a cost of $1,20,000.
The TV production line experienced periods of unproductive ‘down time’ due to the quality issues in the quarter which cost $750,000.
Required;
(a) PREPARE a Cost of Quality report using four recognized quality cost headings for ORG.
(b) Explain how a Cost of Quality report would support the development of a TQM culture at ORG.
Answer:
(a) Cost of Quality Report

	Volume	Rate $	Cost $
Prevention costs
Supplier review			120,000
Appraisal costs
Equipment testing	400	60	24,000
Internal failure costs
Down time			750,000
Manufacturing rework	800	760	608,000
Total internal failure costs			1,358,000
External failure costs
Customer support	500	116	58,000
Warranty repair	650	5,200	3,380,000
Total external failure costs			3,438,000
Total quality costs			4,940,000

(b) A Total Quality Management (TQM) culture is one where all depart-ments and staff are committed to a process of continuous improve-ment. The aim of the organization is to achieve a zero defect position where products are produced on a consistently high quality basis and the focus of the organisation is on improving processes to attain this state.
The quality costs report highlights the cost of quality activities at ORG. Highlighting the quality activities and reporting on money spent on quality failures helps to strengthen the TQM.
Quality is concerned with conformance to specification; ability to satisfy customer expectations and value for money. Recognizing the importance of cost of quality is important in terms of continuous improvement. The quality cost report display the relationship between conformance costs (prevention and appraisal costs) and non-confor-mance costs (internal failure and external failure costs) and the drivers of a reduction in the overall spending on quality.

Question 11.
(Total Quality Management)
PRADO is a chocolates manufacturing company however due to some quality reason company has incurred huge losses and fall in market reputation. For the purpose of improvement of profitability the financial manager of PRADO has advise the company to implement TQM.
The company has provided the following information to the board of director in Extraordinary general meeting. This information contain list of performance measurement before the implementation of a Total Quality Management Programme (Pre-TQM) and after its implementation (Post-TQM).

	Pre-TQM performance %	Post-TQM performance %
Returns by customers due to packaging defects	5	2
Rejections on final inspection	6	4
Losses in production	3	1

Required
(i) CALCULATE how many units must be input to the process to achieve final sales of 2,000 units:
(a) before the TQM programme
(b) after the TQM programme
(ii) COMMENT on the implementation of TQM in PRADO Company.
Answer:
(i) Calculation of input to the process to achieve final sales of 1,000 units before and after TQM programme.

Performance
	Pre-TQM Units	Post-TQM Units
Sales Packaging Failures	2,000,100	2,000,40
Rejected Units	2,100,134	2,040,86
Process losses	2,234,70	2,126,22
Units to be input	2,304	2,148

(ii) Comment: The TQM improvements have led to a reduction of about 796 (156/2,304) in the quantity of units that need to be input to produce 2,000 units of output.
TQM is “integrated and comprehensive system of planning and controlling all business functions so that products or services are produced which meet or exceed customer expectations. TQM is philosophy of business behaviour, embracing principles such as employee involvement, continuous improvement at all levels and customer focus, as well as being a collection of related techniques aimed at improving quality”.
TQM requires ensuring that things are done right the first time and that defects and waste are eliminated from operations.

Question 12.
(Cost of Quality; TPM; TQM; JIT)
Mega Bike (MB) is large national bike manufacturing organisation established in the year 2003. Mega Bike has a strong position in the market and has also traditionally achieved a good market share however facing tough competition. The Board of Mega Bike recognises that it needs to make fundamental changes to its production approach in order to combat increased competition from foreign manufacturers. Mega Bike is now being seen as non-lucrative, pollutive and with less safety features in comparison to the foreign bikes. The Board plans to address this by improving the quality of its bikes as well as financial performance.
The components are sourced directly by Mega Bike. Suppliers are located worldwide. Suppliers are evaluated on an ongoing basis, including an assessment of whether to utilise new or alternative suppliers to improve capacity and performance. The company is having lot of components piled up in stock and few of them are becoming obsolete. There is lots of reworking as both internal and external failure are more, so the wastage of resources in reworking needs to be controlled. The Board is convinced S that Lean Manufacturing is the best approach to be adopted.
In Mega Bike, production process is grouped by function and production teams comprised a number of permanent members, who had acquired their positions through seniority and a few newly selected specialist staff who had yet to discuss their position in any team.
The process of making a bike can be roughly divided into stamping, welding, painting, assembly and inspections, which takes about 11-12 hours in total. The standard time to manufacture a similar bike in industry is 8-9 hours. The nature of end product demand is unstable due to economic factors. However, Mega Bike forecasts demand based on its internal policies and historical trends. Mega Bike sells its bikes in retail stores located in over 10 metro cities. It focuses on building close relationships with retailers, working with them to sell its bikes in a compelling manner.
Enclosed Annexure
Required:
You are newly appointed to Management Accounting Department of MB, Chief Management Accountant asked you to draft a report for CEO, containing-
(i) ANALYSIS of quality costs and ADVISE on two measures to reduce the non-conformance cost,
(ii) ADVISE on implementation of just-in-time purchasing and production
Annexure
Statement Showing ‘Total Quality Costs

Particulars of Costs	₹
Prevention Costs Supplier Review	2,50,000
Appraisal Costs Equipment Testing (₹ 36 × 1,600 hrs.)	57,600
Internal Failure Costs Down Time Manufacturing Rework (₹ 456 × 3,200 bikes)	15.40,000 14,59,200
External Failure Costs Customer Complaints (₹ 70 × 2,000 hrs.) Warranty Repair (₹ 3,120 × 2,600 bikes)	1,40,000 81,12,000
Total Quality Costs	1,15,58,800

Answer:
Addressed to: Office of CEO, Mega Bikes
Dated -6th May, 2020
Report
Analysis of Quality Costs
The reporting of quality costs highlights the cost of quality activities at MB, The total quality costs statement clearly displays the relationship between conformance costs (prevention and appraisal costs) and non-conformance costs (internal failure and external failure costs) and the drivers of a reduction j in the overall spending on quality. Statement indicates that only 2.16% of the total quality cost is the cost of preventing quality problems while 0.50% is the cost of appraisal activities. Thus, prevention and appraisal costs make up only 2.66% of total quality costs. In contrast, 97.34% of quality control costs are incurred for internal and external failure costs.

Two measures to reduce non-conformance cost
Total Productive Maintenance (TPM) is a system of maintaining and improving the integrity of production and quality system through keeping all equipment in top working condition so as to avoid breakdowns and delays in manufacturing processes. It involves identifying machines in every division (including planning, manufacturing, maintenance) and then planning & executing a maintenance programme covering their entire useful life.

In this case, TPM will help in reducing internal failure cost (Le., downtime and manufacturing rework cost), which constitutes 25.95% of total quality cost, by keeping all equipment in good working conditions so that there is no downtime or machine breakdown and ensuring that all equipment run smoothly. If machines work properly, the chances of rework will reduce, ultimately will also reduce chances of warranty repair and customer complaints (comprising 71.39% of total quality cost which is a major part of total quality cost).

Total Quality Management (TQM) aims at improving the quality of organsational output, including goods and services, through continual improve-ment of internal practices. Its objective is to eradicate waste and increase efficiency without compromising with the quality. It requires maintaining quality standards in all aspects of business by ensuring that things are done right the first time so that defects and waste are eliminated from operations.

It appears that MB is not a TQM company at present, due to huge disparity between conformance costs and non-conformance costs. In order to make MB to be successful, all staff at MB must be engaged in the improvement process and share in the continuous improvement ethos. In order to establish a reputation as a high- quality bike manufacturer MB must ensure, staff is having attitude towards the importance of conformance activities, for f instance, MB can conduct third party inspection of components at supplier’s j workplace leading to maintenances of quality standards.

Overall, while applying above two measures, in the MB, consideration must therefore be given to the optimum balance between the costs of conformance and the costs of non-conformance.

Implementation of Just in Time
Just in time purchasing and production technique will put an end to the harrowing task of inventory management. In this form of pull system, purchasing of components and production of bikes will be based on customer demands and MB will have to accordingly coordinate with its suppliers to supply the right quantity of components required at the right time. JIT inventory management calls for having the inventory as and when needed also taking care of massive holding cost suffered related to large build ups. In this environment, MB will also be able to reduce the manufacturing time around 3 hours by streamlining the flow of information in entire supply chain.

Mega is assessing alternative suppliers on continuous basis to improve capacity and performance. It means it is changing sources of material regularly
or using multi-suppliers. In contrast, JIT is based on reduced number of supplier and move towards single sourcing. It is easier to develop long term cooperative relationships with a smaller number of suppliers. The quality of internal services and an organisation’s ability to provide quality products or services to its customers depends upon this relationship. However, this relationship is obviously missing in MB.
MB has close relationship with the retailers but relationship with suppliers is equally important.

It appears that firm is also importing its requirements from abroad. In JIT environment, it is important that suppliers are, to the extent practical, located in close proximity to the manufacturing plant. Carefully selected suppliers are capable of delivering high quality materials in a timely manner, directly at the shopfloor, reducing the material receipt time. Therefore, selection of right supplier located in close proximity to the manufacturing plant is vital for the proper implementation of JIT.

It is also important to note that every supplier is different, but the MB has to be able to view each as one of its part only. The supplier’s network must be able to call up and communicate directly with the MB’s network, obtaining manufacturing schedules and product specification in real time. ERP and other sources of electronic data interchange between supplier and MB will act as backbone in supporting the JIT activity.

On the whole, MB’s management has to treat suppliers as partners with significant influence on the success of the organization.
The functional division is less appropriate in JIT environment. JIT produc-tion requires multi- skilled teams. In MB, teams need to be formed to work by product ie., type of bike rather than by the type of work performed. In addition, staff will need training to work in the new teams, measures surrounding the amount and effectiveness of training will be required. A JIT system works best when employees pitch in with suggestions for improvements. The performance can be measured by computing the number of ideas per worker, the number of ideas suggested in total, the number of ideas implemented, or the proportion of ideas suggested that are implemented.

MB forecasts demand based on its internal policies and historical trends. Today demand in every sector of the market changes by leaps and bounds, so using historical data is not at all recommended. Demand forecasts should be pulled by current market trends and prediction of future market sentiments. However, in case of MB, demand is unstable. In this case, in order to prevent stock-outs, inventory managers can only increase the Kanban numbers of each product; the greater are the variations, the greater is the need of Kanban cards and, thus, the higher is stock level and need more working capital per rupee of sales.

Conclusion
The Board desires to improve the quality as well as financial position which can be achieved through successfully implementation of quality control and lean system. However, the factors discussed above should be taken care of. It is worthwhile to note that any return on investment in proposed system must be viewed long term rather than short term since optimum results may not be realized until the system has been in place for some time.
Further details can be tabled on requisition basis. Closure of Report
Chief Management Accountant
(For Management Accounting Department)
Mega Bikes

Question 13.
(The Business Excellence Model)
As a guest lecturer at a symposium for Business Excellence where you are giving a lecture on “Sustaining Business Excellence”. A manufacturer of a fashion clothing line is one of the participants at the symposium. He has the following query:
“We are an apparel company that manufacture and sell our fashion clothing and accessories directly through 30 stores spread across India. Shortly we are planning to establish similar outlets overseas. Our business is under constant change due to changing customer trends. At the same time, we are the largest company in our industry segment in India, both in terms of market share and profits. We have a satisfied base of customers who are loyal to our brand. Shareholders are also satisfied stakeholders due to good returns provided on their investments. What would be the relevance of Business Excellence model to our company?
Thank you!”
You are required to frame an appropriate response to this query. Required
(i) EXPLAIN the importance of business excellence to an organization,
(ii) LIST the tool available to achieve and sustain excellence.
(iii) APPLY the fundamentals of EFQM model on the apparel company.
(iv) EXPLAIN the relationship between various criteria of the model in general terms. [RTP May 2019]
Answer:
(i) Business Excellence is a philosophy for developing and strengthening the management systems and processes of an organization to improve performance and create value for stakeholders. Stakeholders in an organization are not limited to shareholders (business) alone. They include also customers, employees (people) and society. What an organization does impact all the stakeholders in different ways, yet they are all interlinked to each other. Customers’ needs are of paramount importance to companies. Yet given uncertain conditions, shareholders demand challenging return on their investments. Employees need more from their company than just their pay-check. They want the company to enable to grow their knowledge and experience that can improve their career growth. Society expects companies to operate ethically and for the overall betterment of the society and environment.

For several years businesses have been operating under challenging circumstances. For example, landline phones have been entirely replaced by mobile phones. Television programs can be watched seamlessly on internet enabled mobile phones. Not just this, today’s smartphones have computing capability much more than the computers that were used in Apollo Mission to send the first man to moon! The proliferation of mobile phones has changed not just the telecom industry but also others like communication, banking, e-commerce etc. The pace of change is both exhilarating and challenging.

To manage this complex scenario, a company cannot focus on only one aspect of their operations. Optimize processes, delivery quality to customers, manage employee talents, earn required return on investment while managing to be a socially responsible organization. In short, the company should achieve excellence in all aspects of its operations. This is business excellence. Business excellence principles emerged because of development of quality drive into traditional business management. It is imperative not just to achieve excellence but also to sustain it.

Business excellence models are holistic tools that help companies develop stakeholder focused strategy. Each operation within a company enables a corresponding result. Business models present a formal, standardized cause effect relationship between different operations (enablers) and their resultant consequences. If the company want to achieve a different result, it has to do things differently. This can be better analysed through these models. Continuous improvement on various operations will ultimately lead to excellence. More importantly, these models need to be used to sustain and maintain excellence to retain their competitive advantage. They are not to be taken as one time exercise by the company. Assessments using this model have to be made periodically so that timely action can be taken to achieve the desired result.

(ii) Some of the popular business excellence models are
(i) the European Foundation Quality Management (EFQM) model
(ii) Baldrige Criteria for Performance Excellence
(in) Singapore BE Framework
(iv) Japan Quality Award Model and
(iv) Australian Business Excellence Frame-work.

(iii) The apparel company is a well-established player in the industry. It is a growing company that is looking to expand its operations overseas.
To achieve business excellence in this environment, the company could adopt the EFQM model, which is a popular model.
The EFQM model was developed by the European Foundation for Quality Management. The model provides an all-round view of the organization and it can be used to determine how different methods fit together and complement each other. It can help the company understand the cause and effect relationships between what their wl organization does and the results it achieves. Creating an EFQM Management Document gives the organization a holistic overview of its g* strategic goals, the key approaches it has adopted and the key results § it has achieved.

The fundamental concepts for excellence are the basic principles that describe the essential foundation for any organization to achieve sus-tainable excellence. With respect to the company they can be detailed as below:
(a) Adding value to customers: Companies need to understand their customers, their needs, anticipate their needs and make use of opportunities to fulfil their expectations. In the current case, fashion apparel business is ever changing and dynamic due to the changing trends in customer’s tastes. This could differ across locations within India and abroad. In the era of e-commerce, competition would be cut-throat. Before going to “how” it can meet customer’s needs, the company should be clear on “what” need of the customer it can satisfy. For example, should the company cater to Indian apparel market, western apparel market, men or women or children apparel market etc. Once the “what” is clear, the company should have mechanisms in place to find out and anticipate customer tastes. Accordingly, it should structure its operations to add value to the customers in terms of quality, availability, support, and experience.

(b) Creating a sustainable future: Society and environment (People and Planet of Triple Bottomline concept) play a major role in ensuring the sustainability of business. A company should have as much positive impact on its surroundings and try to minimize any negative impact on the same. Here, the company should assess the environmental impact of its operations, measures to minimize adverse impacts, business impact on the society etc. For example, leather is contended to be harmful to the environment since it requires the skin of animals specially cattle hide, needs huge amount of energy and chemicals to process it. This has a negative environmental impact. As regards societal impact, suppliers of cloth to the apparel company should not indulge in labor malpractice like child labor and should adhere to safety standards within its factories. The company should procure cloth only from suppliers who adhere to such standards.

(c) Developing Organizational Capability: Companies need to man age change within the organization and beyond. The company should identify “what it is capable of being great at?” in order to differentiate it from its competitors. For example, the apparel company may have the capability of tracking its inventory at the stores on real time basis. As soon as the inventory falls below a certain level, the stores issues fresh products to stock up. This ensures that there are no stock outs at the retail outlet. This ability to track inventory real time and ability to stock up quickly may be unique to the company that gives it a competitive edge. Another can be the ability to quickly change the apparel production to meet changing trends. Likewise, the company should identify and develop unique capabilities to have a competitive edge in the market.

(d) Harnessing creativity and innovation: Continuous improvement and innovation brings value to the company. The company should promote a working environment that enables and appreciates creativity and innovation. For example, new apparel designs can be promoted to test the market. If found feasible, the company can go for mass production of the same.

(e) Leading with vision, inspiration, and integrity: The tone at the top defines the rest of the company. The leaders and management of the company should have a clear vision of what the company wants to achieve, develop strategy to achieve it, work with integrity and ethics. Leaders shape the future of the organization.

(f) Managing with agility: Agility would be the capability to identify and effectively respond to opportunities and threats. For example, although the apparel company is in an expansionary phase, it should consider the threat, yet opportunity of using e-commerce as a platform to reach out to customers directly. Brick and mortar stores are becoming largely redundant due to online platforms, a threat the company should recognize and act upon.

(g) Succeeding through the talent of people: An organization is only as good as the people who work in it. There should be an atmosphere of teamwork that enable achievement of organizational and personal goals. Performance evaluation, reward and recognition programs, training and talent network are ways to cultivate talent within the organization.

(h) Sustaining outstanding results: Use of EFQM model is not a onetime exercise. Constant and periodic evaluation is required to keep up and sustain excellence.

(iv) The criteria of the model are comprised of 5 enablers and 4 results. Enablers covers what an organization does (its objective) and how it does it (strategy, use of resources to achieve it).
(a) Leadership: A leader defines the organization’s culture. They enable the organization to achieve its goals by taking the correct decisions at the correct time. To do this they should have sufficient skill, work as per the company’s code of conduct and should be ethical in their dealings.
(b) Strategy: Operations should be planned and directed as per a clearly defined strategy. The company’s vision and mission statement with respect to its various stakeholders are the goals that the organization wishes to achieve. Strategy (plan) enables the company to achieve these goals.
(c) People: Excellence is possible only if the people working in the company wish to achieve it. They must be motivated, recognized, and managed to enable them to work towards the company’s vision and mission. The work culture should be that this opens up opportunities for personal development as well. This would cultivate a bond with the organization, which enables people working within to strive for excellence.
(d) Partnerships and resources: Effective management of partnerships that the company has with other organizations is critical to success. Partners could be external vendors, suppliers, and service providers. The services of partners enable business to operate smoothly. Resources, both tangible and intangible should be managed optimally. Tangible resources can be financial (cash, bank accounts) and physical assets (machinery, building, land etc.). Intangible resources would be intellectual property rights, information technology, licenses etc. Proper management of resources enables optimal results.

(e) Processes, Products, and Services: A company exists because of its processes, products, and services. They should be managed and continuously improved to create value to the stakeholders.
Results are what the organization achieves following its operations and decisions. As explained before, the stakeholders of the company are investors (business), people (employees), customers and society. In order to track performance, the company has to develop Key Performance Indicators (KPI)s for each of the stakeholder groups. Results should be tracked periodically. Changes to targets and benchmarks should be continuously made to reflect the current objectives that the company wants to achieve. Some of the results that the company can look at are:
(a) Customer results: Are the customers of the company satisfied with the products and service? How does the company fare in terms of brand loyalty? Is the customer base growing to indicate increasing market share?
(b) People results: Does the company have skilled and motivated employees? What is the employee turnover with reasons for the same? Does the company have proper access to hire required talent? Are the employees motivated, trained, recognized, and rewarded for their performance? What is performance measurement system, is it robust and accurate to measure performance?
(c) Society results: Is the company a good corporate citizen. Are the objectives of corporate social responsibility being met? If the organization is a not for profit organization, is it meeting its objectives and goals?
(d) Business results: Is a for profit organization achieving the required return on investment, profitability that the shareholders and other investor demand? Has the company been able to manage financial and other risks properly?
Enablers enable achievement of results. EFQM model documents this flow and symbiosis in a structured way. It highlights the strength and weakness of the enablers. With this information, the company can alter its operations and strategy to achieve desired results. On assessment, there is a flow from results to enablers. If the results have been achieved, enablers continue to operate status quo. If the results fall short of targets, changes have to be made to enablers to improve performance.

Therefore, it can be concluded the EFQM model encourages constant self- assessment to achieve excellence.
When a company wins an excellence award based on a business excellence model, it gains in stature within the industry. This recognition could work to its advantage financially and otherwise.

Question 14.
(Theory of Constraint)
R Plus Security (RPS) manufactures surveillance camera equipment that are sold to various office establishments. The firm also installs the equipment at the client’s place to ensure that it works properly. Each camera is sold for ₹ 2,500. Direct material cost of ₹ 1,000 for each camera is the only variable cost. All other costs are fixed. Below is the information for manufacturing and installation of this equipment:

Particulars	Manufacture	Installation
Annual Capacity (camera units)	750	500
Actual Yearly Production and Installation (camera units)	500	500

Required
The questions below are separate scenarios and are not related to each other.
(i) IDENTIFY the bottleneck in the operation cycle that RPS should focus on improving. Give reasoning for your answer.
(ii) An improvement in the installation technique could increase the number of installations to 550 camera units. This would involve total additional expenditure of ₹ 40,000. ADVISE RPS whether they should implement this technique?
(iii) Engineers have identified ways to improve manufacturing technique that would increase production by 150 camera units. This would in* volve a cost ₹ 100 per earner a unit due to necessary changes to made in direct materials. ADVISE RPS whether they should implement this new technique. [RTP May 2018/2020]
Answer:
The feedback of information relates to the reporting of things that have happened in the past. For example,
(i) Identification of Bottleneck: Installation of cameras is the bottleneck in the operation cycle. The annual capacity for manufacturing and installation are given to be 750 camera units and 500 camera units respectively. Actual capacity utilization is 500 camera units, which is the maximum capacity for the installation process. Although, RPS can additionally manufacture 250 camera units, it is constrained by the maximum units that can be installed. Therefore, the number of units manufactured is limited to 500 camera units, subordinating to the bottleneck installation operation. Therefore, RPS should focus on improving the installation process.

(ii) Improving Capacity of Installation Technique: Every camera sold increases the through put contribution by ₹ 1,500 per camera unit (sale price ₹ 2,500 per camera unit less direct material cost ₹ 1,000 per camera unit). By improving the current installation technique an additional 50 camera units can be sold and installed. This would involve total additional expenditure of ₹ 40,000. Hence, the incremental benefit would be:

Particulars	Amount (₹)
Increase in throughput contribution (additional 50 camera units ₹ 1,500 per camera unit)	75,000
Less: Increase in total expenditure	40,000
Incremental benefit	35,000

Since the annual incremental benefit is ₹ 35,000 per annum, RPS should implement this improvement to installation technique, the current bottleneck operation.

(iii) Improving Manufacturing Capacity: Every camera sold increases the throughput contribution by ₹ 1,500 per camera unit (sale price ₹ 2,500 per camera unit less direct material cost ₹ 1,000 per camera unit). By improving the current manufacturing technique an additional 150 camera units can produced. This would involve a cost ₹ 100 per camera unit due to necessary changes to made in direct materials. Therefore, number of units manufactured can increase to 650 camera units. However, production of 150 camera units will not translate into additional sales, because each sale also requires installation by RPS. In a year only 500 camera installations can be made, leading to an inventory pile up of 150 camera units. This is detrimental to RPS, since it does not earn any contribution by holding inventory. Therefore, RPS should not go ahead with the proposal to improve the manufacturing technique.

Question 15.
(Theory of Constraints)
Shrya Steel Company produces three grades of steel – Class i, Class ii and Class iii grade. Each of these products (Grades) has high demand in the market and company is able to sell as much as it can produce these products.
The furnace operation is a bottle-neck in the process. The company is running at 100% of capacity. The company wants to improve its profitability. The variable conversion cost is ₹ 100 per process hour. The fixed cost is ₹ 48,00,000. In addition, the Cost Accountant was able to determine the following information about the three products (grades):

	Class i Grade	Class ii Grade	Class iii Grade
Budgeted Units Produced	6,000	6,000	6,000
Total process hours per unit	12	12	10
Furnace hours per unit	6	5	4
Unit Selling Price	₹ 3,600	₹ 3,400	₹ 3,000
Direct Material cost per unit	₹ 2,100	₹ 1,900	₹ 1,720

The furnace operation is part of the total process for each of these three products. Thus furnace hours are the part of process hours.
Required
(i) DETERMINE the unit contribution margin for each product.
(ii) Give an ANALYSIS to determine the relative product profitability, assuming that the furnace is a bottleneck.
(iii) Managements wishes to improve profitability by increasing prices on selected products. At what price would Class i and Class ii grades need to be offered in order to produce the same relative profitability as Class iii grade steel? [May 2018](20 Marks)
Answer:
(i) Contribution Margin per unit

(ii) The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Company should use the contribution margin per bottleneck hour to determine relative product profitability, as follows:

Particulars	Class i	Class ii	Class iii
	Grade	Grade	Grade
Contribution Margin per unit (₹)	300	300	280
Furnace Bottleneck hrs. per unit	6	5	4
Contribution Margin per furnace hour	50	60	70

Analysis
The Class i and Class ii Grade steel have the highest contribution margin per unit (₹ 300); however, the Class iii grade has the highest contribution margin per furnace hour (₹ 70).
Thus, using production bottleneck analysis indicates that the Class iii Grade is actually more profitable at a ₹ 70 contribution margin per furnace hour than Class i Grade’s ₹ 50 or Class ii Grade’s ₹ 60 contribution margin per furnace hour.
Therefore, the company would want to sell product in the following preference order:
I. Class iii Grade
II. Class ii Grad
III. Class i Grade

(iii) One way is to revise the pricing would be to increase the price to the point where all three products produce profitability equal to the highest profit product. This would be determined as follows:

Contribution Margin per furnace hour for Class iii Grade

Or, ₹ 420 = Revised Price of Class i Grade – ₹ 3,300
Class i grade steel would require a revised price of ₹ 3,720 in order to deliver the same contribution margin per bottleneck hour as does Class iii Grade steel.
Contribution Margin per furnace hour for Class iii Grade

Class ii grade steel would require a revised price of ₹ 3,450 in order to deliver the same contribution margin per bottleneck hour as does Class iii Grade steel

Question 16.
(Throughput Accounting)
Naya company produces three products Le, Mi and Ne. The capacity of Naya’s plant is restricted by process in machine M2. Process in Machine M2 is expected to be operational for eight hours per day and can produce 1,200 units of Le per hour, 1500 units of Mi per hour, and 600 units of Ne per hour.
The Selling prices and material costs for each product are as follows:

Product	Selling price $ per unit	Material cost $ per unit	Throughput $ per unit
Le	75	40	35
Mi	65	20	45
Ne	150	50	100

Operating costs are $360,000 per day.
Required
(a) Calculate the profit per day if daily output achieved is 6,000 units of Le, 4,500 units of Mi and 1,200 units of Ne.
(b) Calculate the Throughput Accounting ratio for each of the product. :
(c) In the absence of demand restrictions for the three products, advise Naya management on the optimal production plan.
Answer:
(a) Calculation of profit per day if daily output achieved is 6,000 units of Le, 4,500 units of Mi and 1,200 units of Ne.
= Throughput contribution – Operating costs
= [($35 × 6,000) + ($40 × 4,500) + ($100 × 1,200)] – $360,000
= $150,000 (Profit per day)

(b) Calculation of TA ratio for each of the product.
TA Ratio = \(\frac{\text { Throughput per factory hour }}{\text { Operating costs per factory hour }}\)

Product	Throughput per factory hour	Operating Cost per factory hour	TA Ratio
Le	₹ 35 × 1,200 = $ 42,000	₹ 45,000	0.93
Mi	₹ 45 × 1,500 = $ 67,500	₹ 45,000	1.50
Ne	₹ 100 × 600 = $ 60,000	₹ 45,000	1.33

= Operating costs per factory hour = $360,000/8 = $45,000

Note
(c) If it is not possible to increase the number of factory hours available, priority should be given to making and selling Product Mi, since it has the highest TA ratio. If only Product Mi is made and sold (since there is no restriction on sales demand), total output per day would be (1,500 × 8 hours) = 12,000 units of Product Mi. Total throughput would be $540,000 (= 12,000 units × $45) per day. Total profit per day would be $540,000 – $360,000 = $180,000.
This is $30,000 more per day than the profit from the production mix in the answer to part (a).

Question 17.
(Throughput Accounting Ratio)
Oppi Popcorn Manufactures readymade popcorn packets that has a selling price of ₹ 40. The material costs are ₹ 16 per unit of readymade popcorn packets. Total operating expenses each month are ₹ 240,000
Machine capacity is the key constraint on production. There are only 1200 machine hours available each month, and it takes six minutes of machine time to manufacture each unit of Readymade popcorn packets.
Required
(a) Calculate the throughput accounting ratio for oppi.
(b) List how this ratio might be increased?
Answer:
(a) Throughput per unit of Packet of Popcorn = ₹ 40 – ₹ 16 = ₹ 24.
Machine time per unit of Packet of Popcorn = 6 minutes = 0.10 hours.
Throughput per machine hour = ₹ 24/0.10 = ₹ 240.
Operating expenses per machine hour = ₹ 2,40,000/1200 Hours = ₹ 200
TA ratio for Oppi = ₹ 240/₹ 200 = 1.20

(b) In the following cases it might be possible for Oppi to increase the Throughput Accounting ratio
(i) Raise the selling price for readymade popcorn packet for each unit sold, to increase the throughput per packet.
(ii) Improve the efficiency of machine time used, and so manufacture Popcorn packet in less than six minutes.
(iii) In order to reduce the operating expenses per machine hour, find ways of reducing total operating

Question 18.
RIYAN. Ltd. manufactures three products. The material cost, selling price and bottleneck resource details per unit are as follows:

Particulars	Product A	Product B	Product C
Selling Price (₹)	66	75	90
Material and Other Variable Cost (₹)	24	30	40
Bottleneck Resource Time (Minutes)	15	15	20

Budgeted factory costs for the period are ₹ 2,21,600. The bottleneck resources time available is 75,120 minutes per period.
Required
(i) Company adopted throughput accounting and products are ranked according to ‘product return per minute’. Select the highest rank product.
(ii) CALCULATE throughput accounting ratio and COMMENT on it.
Answer:
(i) Calculation of Rank According to ‘Product Return per minute’

Particulars	A	B	C
Selling Price	66	75	90
Variable Cost	24	30	40
Throughput Contribution	42	45	50
Minutes per unit	15	15	20
Contribution per minute	2.8	3	2.5
Ranking	II	I	III

(ii) Ranking Based on ‘TA Ratio’

Contribution per minute	2.80	3.00	2.50
Factory Cost per minute(2,21,600/75,120)	2.95	2.95	2.95
TA Ratio (Cont. per minute/Cost per minute)	0.95	1.02	0.85
Ranking Based on TA Ratio	II	I	III

Comment
Product B yields more contribution compared to average factory” contribution per minute, whereas A and C yield less.

Question 19.
Shooter Limited produces three products S, 0 and L which use the same resources but in varying quantities. Product S uses one unit of component P which is purchased from outside suppliers at, ₹ 120 per unit. Details of the three products are as follows :

	S	Q	L
Annual Demand (units)	9,000	5,700	7,800
	Per unit ₹	Per unit ₹	Per unit ₹
Selling Price	310	275	224
Component P	120	–	–
Direct materials (₹ 8per kg.)	24	32	24
Skilled labour (₹ 40 per hour)	20	60	40
Unskilled labour (₹ 24per hour)	18	24	36
Variable Overhead (₹ 6 per machine hour)	18	24	24
Annual fixed costs are 115,00,000

Maximum availability of skilled labour is 16,200 hours. Other resources are sufficient to meet the annual demand/sales.
Engineering division of the company came forward with a proposal to make the component ‘P’ in house with the following costs break up :

Direct materials (₹ 8 per kg.)	₹ 24
Skilled labour (₹ 40 per hour)	₹ 40
Unskilled labour (₹ 24 per hour)	₹ 8
Variable Overhead (₹ 6 per machine hour)	₹ 18
	₹ 90

For in-house making of the component ‘P’ there will not be any change in the annual fixed costs of the company. The company can either buy | the component ‘P’ or make it in house.
Required
RECOMMEND the optimum production plan and profit for the year. Show calculation in support of your answer [Nov. 2019] (10 Marks)
Answer:
(a) Option-1
Shooter Ltd. produces 3 products Product S, Product Q and Product L. Each unit of Product S requires one unit of component P, which is currently procured from the external market at ₹ 120 per unit. There is a constraint in terms of skilled hours available for production, the maximum available is 16,200 hours. Given this constraint, the production plan should be based on the contribution derived per skilled labor hour spent on each product.

Calculation of skilled hour requirement for each of the products and component P

Particulars	S	Component P	0	L
Skilled Labour Cost per unit	20	40	60	40
Skilled Labour Rate per hour	40	40	40	40
Skilled Hours per unit (Step 1/ Step 2)	0.5	1	1.5	1

Note: When component P is manufactured, in-house Product S would require 1.5 hours of skilled labor hour per unit.
Contribution per unit and contribution per skilled hour (when component P is purchased)

Particulars	S Per unit ₹	Q Per unit ₹	L Per unit ₹
Selling Price	310	275	224
Variable Cost
i. Component P (purchased)	120	0	0
ii. Direct Materials	24	32	24
iii. Skilled Labor	20	60	40
iv. Unskilled Labor	18	24	36
v. Variable Overhead	18	24	24
Total Variable Cost (Sum of steps i to v)	200	140	124
Contribution perunit(Step 1 – Step 2)	110	135	100
Skilled Hour per unit (refer skilled hour table – Step 3)	0.5	1.5	1
Contribution per skilled hour (Step 3/Step 4)	220	90	100
Ranking Based on Contribution per skilled hour	1	3	2

Based on this, Shooter Ltd. would first produce Product S, then Product L and then Product Q. The constraint of 16,200 hours of skilled labor has to be taken into account while drawing up the production plan. Production plan as per above ranking will be as below:

First, 9,000 units Product S is produced, this requires 4,500 hours of skilled labor. After production of Product S, 11,700 hours of skilled labor remain. (16,200 hours – 4,500 hours). Next 7,800 units of Product L can be produced, for which the skilled hours used are 7,800 hours. The remaining 3,900 hours would be used to produce Product Q.
Volume of Product Q that can be produced in 3,900 hours = 3,900/1.5 hours per unit = 2,600 units.
Therefore, profitability of Shooter Ltd. when component P is purchased:

(b) Option-2
Contribution when component P is manufactured in-house.
It may be noted that Product S requires 0.5 hours and component P would require 1 hour of skilled labor per unit. If component P, a part of Product S is manufactured in-house, then Product S would in all require 1.5 hours of skilled labor per unit.

Based on this, contribution per unit and contribution per skilled hour if component P is manufactured is:

Note 1
Component P has a variable cost, sum of direct material + skilled labor + unskilled labor + variable overhead, given to be ₹ 90 per unit
Each unit of Product S requires 1 more hour of skilled labor to manu-facture component P. Skilled labor is a limited resource that costs ₹ 40 per hour. The savings Shooter Ltd. earns by manufacturing component P in-house is only ₹ 30 (external purchase cost is ₹ 120 per unit – cost of manufacturing component P in-house is ₹ 90 per unit). Therefore, it is profitable to purchase component P from the external market. For further analysis, the impact of producing component P in-house would be:

Based on the revised ranking, Shooter Ltd. would first produce Product L, then Product S and then Product Q. The production plan is component P is made in-house would be

First, 7,800 units Product L is produced, this requires 7,800 hours of skilled labor. After production of Product L, 8,400 hours of skilled labor remain. (16,200 hours – 7,800 hours). The remaining 8,400 units would be used to produce Product S. Volume of Product S that can be produced in 8,400 hours = 8,400/1.5 hours per unit = 5,600 units. In this constraint, Product Q cannot be produced.

The profitability of Shooter Ltd. if component P is manufactured in house:

When component P is purchased, annual profits would be ₹ 6,21,000. When component P is manufactured in-house, annual profits would be ₹ 64,000, a reduction of ₹ 557,000 per year. Therefore, component P has to be bought externally. Optimum production plan would be
Product S – 9,000 units;
Product Q – 2,600 units;
Product L – 7,800 units;
The decision to outsource make or buy decision might have strategic implications for the Shooter and should be formulated from strategic perspective with senior management’s involvement.

Question 20.
Xtream Digital Solutions (XDS) is a renowned name for manfacturing a wide variety of digital stationery products for office and academic use. The ‘Abacus division’ of XDS is engaged in the production ef basic calculators, capable of academic and commercial use. Presently Abacus is manufacturing only three models, named C-100, C-125, and €-500. These calculators are sold to customers through wide-spread retailers and distributors’ network across the country.
During manufacturing process, each calculator needs to pass through various steps, before it gets ready. PC-IA is the essential step and performed manually, where processing chip is being installed, activated, and tested. The production capacity of Abacus is constraint by PC- IA. The basic information pertaining to top-line and the prime cost is as follows , (Amount in ₹)-

Particulars	C-100	C-125
Sale price per unit	140	200
Material cost per unit	72	104
Labour cost per unit	30	52.5

All the process and division at XDS are operating for a single shift of 8 hours in a day. Conversion cost per hour (including labour cost) is 5600. The standard out-put for PC-IA during a day is the processing of either 800 units of C-100 or 560 units of C-125, or 320 units of C-500. XDS is capable of sale more than, what they are presently capable to produce in all range of models. The CEO of XDS recently attended a science fair, Robo-tech 4.0; where he saw a Robot developed by Synergy Robotics Limited, capable to assembly including installation of processing chip to any sort of device.
Required
Management hired you as cost consultant, advice on following aspects
(i) On a random day if 480 units, 140 units and 120 units of C-100, C-125, and C-500 respectively are produced and sold, CALCULATE at what efficiency level current constraint (bottleneck) is operational. INTERPRET the same. COMPUTE profit earned during such day.
(ii) FIND production of which model is more beneficial, considering the ranking (based upon throughput performance ratio).
(iii) APPLY Goldratt’s five steps to remove the bottleneck at Abacus.
Answer:
(i) Efficiency level can be measured with help of Efficiency Ratio, which is one among the control ratios.
Efficiency ratio indicates the degree of efficiency attained in produc-tion. It is expressed in term of standard hours for actual production as a percentage of the actual hours spent in producing that work.
= \(\frac{\text { Standard hours for actual production } * 100}{\text { Actual hours worked }}\)
= (9.8/8) × 100
= 122.5%
Working Note – Standard hour required for actual production.

Interpretation – 122.5% signifies that efficiency (usage) of exploiting bottle-neck activity is 22.5% better than the standard use. PC-IA is producing out-put which require 9.8 hours, in 8 hours.
Profit earned during the day

Particulars	Amount in
Revenue [(480 × 140) + (140 × 200) + (120 × 450)]	1,49,200
Less: Material Cost [(480 × 72) + (140 × 104) + (120 × 200)]	73,120
Lass/Conversion Cost (including labour cost) [5,600 × 8hrs.]	44,800
Profit	31,280

(ii) Statement of ranking, based upon throughput performance ratio (using throughput contribution)

Considering the throughput performance ratio (or TA ratio) and ranking above most beneficial model to produce is-C-500 followed by C-100 and
TA Ratio = Throughput Contribution/Conversion cost Throughput accounting developed by Galloway and Waldron which use the term factory cost and completely relay upon the Goldratt’s theory of constraints which use the term operating expenses, but the meaning of factory cost and operating expenses used at both places are identical.
Theory of constraints consider short-run time horizons and assume other current operating cost to be fixed costs.

(iii) Application of Goldratt’s five steps to remove the bottleneck at Abacus
Goldratt’s theory of constraints describes the following mentioned five steps process of identifying and taking steps to remove the bottlenecks that restrict output.
1. Identifying the System Bottlenecks – At Abacus division of XDS, PC-IA is bottleneck
2. Exploit the Bottlenecks – Bottleneck activities’ capacity must be fully utilised. Although the efficiency of bottleneck activity is al-ready 122.5% but further attention on the possibility to enhance the flow of products from bottleneck activity is needful.
3. Non-bottleneck activities are subordinate – Bottleneck activity should setup the pace for non-bottleneck activities. Abacus shall plan its production keeping PC-IA at the centre point, because even if the efficiency of other activities which are non- bottleneck enhanced beyond current level; the output can be maximum possible by PC-IA.
4. Elevate the bottleneck – Eliminate the bottleneck by enhancing the capacity and efficiency. Major change (business reengineer-ing) or continuous minor change (kaizen) may do. In the case of Abacus, the introduction of the robot may be a way to elevate the bottleneck.
Note – There will always be one bottleneck in the system, if such bottleneck is eliminated then a new constraint emerges as a bot-tleneck. Hence this process continues. Ultimately improvement is a never-ending continues process.
5. Repeat the process – Apply step 1 to new bottleneck activity which emerges at Abacus and repeat the process.

Question 21.
ZED produces two types of products ZP and DP at its manufacturing plant. Both the products are produced using the same materials, machinery and skilled labour. Machine hours available for the year is 4,000 hours.
Information relating to products are as follows:

Particulars	ZP	DP
Selling Price per unit	₹ 16,000	₹ 4,000
Material Costs per unit	₹ 7,000	₹ 1,200
Machine Hours per unit	1.6 hrs.	0.8 hrs.
Maximum Annual Demand	2,000 units	1,600 units
Online Booking (already accepted for)	400 units	1,200 units

Due to poor productivity levels, late order and declining profits over recent years, the CEO has suggested the introduction of throughput accounting in the company.
The total of all factory costs is ₹ 1,42,60,000, excluding material.
Required
(i) Using throughput accounting, PREPARE statement to determine the optimum production mix and maximum profit for the next year.
(ii) CALCULATE the amount of profit lost due to acceptance of online booking of the products.
(iii) RECOMMEND the options to be followed in order to avoid any loss of profit.
(iv) LIST various ways through which price customization could be done.
(v) Given that products ZP and DP are respectively in ‘maturity stage’ and ‘introduction stage’ of their life cycle. STATE the most appropriate pricing policy that could be followed by the ZED for ZP and DP as per their life cycle. . [RTF Nov. 2020]
Answer:
(i) Statement Showing Machine Hours

Product	Maximum De­mand	Machine Hours/ Unit	Total Machine Hours
ZP	2,000 units	1.6	3,200
DP	1,600 units	0.8	1,280
Total machine hours required to meet maximum demand			4,480
Machine hours available			4,000
Shortage of machine hours			480

‘Machine hours’ is the bottleneck activity.

Particulars	ZP	DP
Selling Price per unit	₹ 16,000	₹ 4,000
Less: Material Costs per unit	₹ 7,000	₹ 1,200
Throughput per unit	₹ 9,000	₹ 2,800
Machine Hour Required per unit	1.6	0.8
Throughput Return per hour	₹ 9,000/1.6	₹ 2,800/0.8
	= ₹ 5,625	= ₹ 3,500
Throughput Accounting (TA) Ratio	5,625/3,565	3,500/3,565
(throughput return per hour/cost per factory hour)	= 1.58	= 0.98
Ranking	I	II

Cost per factory hour = ₹ 1,42,60,000/4,000 hrs. = ₹ 3,565

Optimum Production Plan

(ii) Had there been no online booking first product ZP should be produced = 2,000 units using 3,200 machine hours (2,000 × 1.6). Because of online booking already accepted for 1,200 units of product DP, unfulfilled demand of product ZP = 2,000 – 1,900 = 100 units.

Machine Hrs. Required for 100 units of ZP (100 × 1.6)	160 hrs.
Throughput Lost for Product ZP (160 hrs. × 5,625)	₹ 9,00,000
Throughput Return Earned for Product DP (160 hrs. × 3,500)	₹ 5,60,000
Throughput lost	₹ 3,40,000

(iii) Recommendation Option-1
Throughput accounting ratio is the throughput return earned in an hour divided by the factory cost (labour and overheads) incurred by the factory in one hour. Factory cost is generally fixed in nature. A ratio above 1 signifies that the throughput return is greater than the factory cost and therefore the product is profitable. Product ZP has a throughput accounting ratio of 1.58 while Product DP has a throughput accounting ratio of 0.98, this indicates that hourly return from Product ZP can cover the hourly factory cost it is profitable. Product DP does
not yield enough hourly return to cover the hourly factory cost, it is not profitable. Therefore, ZED should consider ways of improving throughput accounting ratio of Product DP (i.e. above 1.0). TA ratio could be improved by:

• Increasing the selling price of the Product DP but the demand may fall.
• Reducing the material cost per unit as well as operating costs. However, there may be quality issues.
• Improving efficiency e.g. increase number of units that are made in each bottleneck hour.
• Raising up bottleneck so that more hours are available of bottleneck resource.

Option-2
ZED has to prioritize production of Product ZP since it is more profitable than Product DP. As per the throughput accounting ratio, Product DP does not yield sufficient return per hour to cover the hourly overhead cost therefore, gets second priority over Product ZP. Since machine hours are the bottleneck, if production for entire 4,000 hours is focused on Product ZP, return yielded would be sufficient to cover the factory overheads. However, Product ZP has a maximum demand of 2,000 units, that requires 3,200 machine hours (2,000 units X 1.6 hours per unit of production). Remaining 800 machine hours can be devoted to Product DP, during which 1,000 units can be produced (800 machine hours/0.8 hours per unit). Maximum demand for Product DP is 1,600 units. Therefore, the balance demand of 600 units of Product DP will remain unsatisfied.
However, to meet unsatisfied demand of Product DP, ZED may consider the option of sub-contracting either a part of whole of theproduction of Product DP. This way it can meet the entire demand for Product DP for 1,600 units. If it subcontracts the entire production of Product DP, it can also scale down its in-house capacity. Sub-contracting decision requires suitable cost benefit analysis. Moreover, the risk associated with outsourcing like unsatisfactory quality and service or failure of supplier cannot be ignored.
Overall, to enhance profitability or avoid any type of loss of profit, ZED may consider the options recommended above with a long-term perspective.

(iv) Pricing of a product is sometimes customized keeping taste, preference, and perceived value of a customer into consideration. Price customization is done in the following ways:

• Based on product line: When products are customized as per the customer’s requirements, pricing can be adapted based on the customer’s specifications. Standard products can have a base price, to which the company can top-up charges to any additional customization.
• Based on customer’s past behaviour: Customers with good payment record have established their credit-worthiness. To sustain business, they may be extended additional discounts as compared to other customers.
• Based on demographics: Different pricing strategies may be adopted based on age or social status. For example, railway fare discounts for senior citizens or concessional price tickets for military personnel.
• Based on time differential: Different price for different time periods. If a customer extends a long-term contract, an additional discount may be extended since business is contracted for a longer period of time. Example, discounted price for data usage provided by a broadband service provider if subscription paid for six months or more.
• Apart from the above accounting principles, other macro economic and legal factors should also be given importance while chalking out a pricing strategy.

(v) The life-cycle of a product has 4 stages namely Introductory stage, Growth stage, Maturity stage and Decline stage.
Product ZP is given to be in the maturity stage. This third stage of product life cycle is characterized by an established market for the product. After rapid growth in sale volume in the previous stages, growth of sales for the product will saturate. Competition would be high due to large number of rivals in the market, this may lead to decreasing market share. Unit selling price may remain constant since the market is well established. Occasional offers may be used to tempt customers, otherwise this stage will mark consolidation of the market. Product DP is in the introduction stage, the first stage of product life cycle. Penetration pricing is adopted to charge a low price in the initial stage for penetrating the market as quickly as possible. For a new product this low price strategy will popularize the product. Once the market is established, the price may be increased. Penetration pricing will be suitable when:

• Demand for the product is elastic, more demand when prices are low.
• Large scale production of the product yields economies of scale.
• Threat of competition requires prices to be set low. It serves as an entry barrier to prospective competitors as well.

However, if Product DP is a highly innovative product, it may adopt Skimming price policy. The product with unique features will differentiate it from other products leading to a revolutionary impact on market and customer behaviour. Customers may not mind paying a premium for the unique product offering. Focus may be on promoting the product to gain market share. Skimming price policy may work when:

• There seem to be no competitors providing similar products.
• Demand is inelastic.

Over time, competitors can reverse engineer and offer similar products. Therefore, the price may be lowered in the long run to retain market share.

Question 22.
(Case Study)
Power Electronics manufactures and sells various electronic goods like mobile phones, laptops, televisions, refrigerator etc. The company sells f these goods through the 30 stores situated in different parts of the country. The store managers place a request to the centralised team situated I in Mumbai on a monthly basis. One store can send only one requisition per month.
The requirements of the stores are forwarded to the production planning team which is responsible for scheduling

the manufacturing of these prod-ucts. Once the goods are manufactured, the goods are sent to a central warehouse in Mumbai and are dispatched to different stores according to the store requirements. The time taken from placing a request from store to the delivery of product to the store takes about 30-40 days on an average. In the process the company procures parts from more than 100 vendors. The company has faced quality related issues with many vendors leading to delay in production.
The average holding period of inventory in Power Electronics is very high at 45 days as against an industry average of 15 days. Since the order to delivery time at a store is very high, the company has traditionally allowed high inventory holding to reduce the stock outs at store level. The company is under severe pressure to improve its working capital cycle.
A high amount of inventory held at each store also means that the products become obsolete quickly. In case of products like mobile phones, new and upgraded versions are available in the market as early as six months from the date of initial launch of a particular model. A significant portion of inventory of mobile phones becomes obsolete every year. The company generally resorts to a discounted sale to liquidate such obsolete models. The management at Power Electronics has identified e-commerce as an opportunity for faster growth, both in terms of revenues and profitability. The company is considering launch of its own e-commerce website to sell all products which are currently being sold in physical stores. Depending upon the success of online sales, the company might choose to optimize and close certain physical stores in the next couple of years.
The management of the company is cognizant of the fact that existing inventory procurement and management system will not fit in the new e-commerce business. E-commerce works on a inventory light model and quick as well as on time delivery of products of the customers. The fact that customers could be from a location other than those where Power Electronics has physical presence makes the matter complex.
Required
The company is considering implementation of a supply chain management system. Will a supply chain management system be of use to Power Electronics in light of the e-commerce venture? You are required to EXPLAIN the concept of Supply Chain Management and EVALUATE the applicability of in the current case. [MTP Oct. 2020]
Answer:
Issue
Power electronics manufactures and sells various electronic products through its physical stores. The existing manufacturing system does not take into consider the demand of products in the market. Store managers are allowed to submit only one order per month. A high level of inventory can be seen at Power Electronics as compared to the industry average. The store managers tend to keep high level of inventories as a safeguard against stock-outs. Whereas, keeping inventory to meet customer requirement is good, high level of inventories due to inefficient processes is not advisable.
The company also has a longer working cycle because of a long order to deliver time and excess holding of inventory. A significant amount of working capital is blocked due to this practice. Technology changes rapidly and the company is expected to roll out latest products in the market. A product like mobile gets outdated very soon and the company has to resort to discounted sales. This results in financial losses to the company.
The company has identified an opportunity in e-commerce. E-commerce businesses require leaner models and faster response time. The production must be based on the demand from the customer and not on an ad hoc basis.
In the following paragraphs, the importance of supply chain management (SCM) and its applicability in the current case is discussed.

Supply Chain Management (SCM)
Supply Chain Management can be defined as the management of flow of products, services and information, which begins from the origin of products and ends at the product’s consumption at consumer’s end. SCM also involves movement and storage of raw material, work-in-progress and finished goods. In other words, supply chain management involves management of all activities associated with moving goods from the raw materials stage to the end user. An important objective of SCM is to cor-relate the production and distribution of goods and services with demand of the product.

The following are the various activities which an organisation carries out to meet the customer requirements (Primary activities under value chain model) –

• Inbound Logistics covering procurement and related activities.
• Operations covering conversion of rawr materials into finished products
• utbound Logistics covering movement of products from plants to end users
• Marketing and Sales
• Service

Supply Chain Management looks each of the above activities as integrated and interrelated to each other. None of the activities can be looked in silos.
In the case of Power Electronics, there is a restriction on number of orders which a store manager can place. This would lead to excess ordering because of the fear of stock-outs.
The customer demand is completely ignored and hence the production is not in sync with the market demand. This could lead to excess production, higher inventory holding and longer working capital cycles.

The facts presented in the case indicate the following problems at Power Electronics:

• Production planning is not based on customer demand & is done on an ad-hoc basis.
• Inventory Holding period is very high (45 days against an industry average of 15 days).
• The working capital cycle is longer.
• The time take to fulfil an order from the store is very high.
• The production is dispatched to a central warehouse for further deliveries to the stores. This could be an inefficient process.
• Liquidation of products at discount for products with low shelf life.

SCM Process and applicability to Power Electronics
The SCM process is explained below:

• Plan – The first step in SCM process is to develop a plan to address the requirements of the customer. Power Electronics must shift its focus from ad hoc and predetermined production planning to understanding the requirements of customers. Production must be planned based on the demand of products. The focus must be on producing what the customer wants.
• Develop (procure) – In this step, the materials required for production is sourced from various suppliers. A good relationship with supplier is required to ensure that the parts/materials are received as and when required by the production team. It is also important that the vendors supply quality material which is not the case in Power Electronics. The company must select suppliers which are dependable and can deliver quality products in the stipulated time. The company must focus in reducing the lead time required for sourcing materials which will reduce the inventory holding period.
• Make – The third step is making or manufacturing the products required by the customer. This is quite different from the existing practice in Power Electronics where store managers are allowed to place only one order. This would mean that the company is not considering the ever changing demands and tastes of the customers.
• Deliver – The fourth stage is to deliver the products manufactured for the customers. This stage is concerned with logistics. The time required to deliver to the store in case of Power Electronics is very high. The company must evaluate if the centralized warehouse is causing delay in delivery of products to the stores.

Logistics is one of the important component of the entire supply chain process. Right from procurement of material, movement of raw material in the plants and final delivery of products of customers, logistics play a critical role. An excellent system must be in place to ensure that the movement of materials and final product are uninterrupted.
Warehousing also plays an important role in today’s business environment. The company has a centralised warehouse to meet the needs of all its stores.
This would not be the most efficient way. The company must evaluate creation of additional storage facility which would ensure timely delivery of goods to the stores. Newer products can reach the market faster.

Benefits of SCM to Power Electronics
SCM looks at the entire value chain process as an integrated process. There is a seamless flow of information and products between suppliers and customers. The customer’s requirements would be captured to plan the production. The suppliers would be intimated to supply the materials according the production plan. An effective logistics system ensures that movement of materials is seamless. Power Electronics can also consider implementing an integrated ERP which would also interact with vendors on real time basis.

The following benefits of SCM can be envisaged for Power Electronics –

• Better Customer Service as customer is supplied with what he/she wants in the minimum time.
• Better delivery mechanism for goods.
• Improves productivity across various functions and departments.
• Minimises cost (both direct and indirect).
• Reduces the inventory holding time and improves the working capital cycle.
• Enhances inventory management and assists in implementation of JIT systems.
• Assists companies in minimising wastes and reduce costs.
• Improves supplier relationship.

E-Commerce and SCM
The SCM is the backbone of E-commerce industry. Customers buying products online want deliveries to be faster. Another distinct feature of e-commerce is that buyers could be located in any corner of the country and not just restricted to the cities where Power Limited has physical presence. This definitely means that the company must have an effective Supply Chain Management in place which could meet the customer’s requirement.
The existing practice of one order per month from each store would not work in the e -commerce space. Orders can come at any time and from anywhere. Supply Chain Management would be required for success of e-commerce business.

Customer Orders
The company must have an effective mechanism to capture customer orders and feed it into the production planning on a real time basis. An integrated
ERP system would be required for this purpose. Any delay in intimating the production team would mean delay in production and delivery which would not be taken positively by the customers. The existing system of one order per month from a store would not fit the purpose. A real time flow of information would mean lower inventory holding.

Procurement
The material requirements must be communicated to suppliers seamlessly. The company must identify those vendors who can deliver quality materials in the required time frame. A delay in supplies would delay the production process. A company cannot afford this in e-commerce business. Automatic exchange of information using EDI (Electronic Data Interchange) or Integrated ERP systems would ensure that the vendors receive material requirements in a timely manner.

Production
As discussed earlier, the production must be in accordance with the customer order. This requires a shift in approach of the production team. Business environments have shifted from “Customer will buy what we produce” to “We have to produce what the customers require”. The company would ideally not produce products to store them and sell later.

Logistics
Logistics would be the backbone of entire e-commerce set up. Right from sourcing of materials to delivery of products at the customer’s door step, logistics would play an important role. If the company has an in-house logistics facility, the logistics team must be trained with the requirement of the new business. If the company has outsourced the logistics, vendors must be briefed about the requirements of the e-commerce. The company might have to tie up with new logistic vendors to avoid, any delay in deliveries.

Question 23.
A clothing manufacturing company has a factory in Ahmedabad, making soft denim clothing for customers of all ages. It sells its clothing from its factory outlet store located within the city. Until 6 months back, the company had a business model wherein the products manufactured at its factory would be sent to its factory outlet store. Customers would visit the store and choose apparel suiting their tastes. Production was based on prediction of customer demand. This “made to stock” model has been placed for many years.
Few months back, the store manager noticed many customers exiting without making any purchases. Tracking this and after obtaining feedback from customers over sometime, it was found that many products were unacceptable to the customers’ tastes – either the shade or design of denim was not what they wanted or that the apparel was not of the correct fit for them. The management then decided to provide customers a choice of either choosing from their standard apparel range that has already been made (“made to stock” model) or to offer them a “made to order” option.
The company now displays its range of denim material at the factory outlet. Customers can go through the samples and choose the material of their choice. Company certified tailors would then take measurements based on the customers’ preferences. A detailed order customized to the customers’ needs would then be drawn up. The factory has set up a separate tailoring division that would stich the apparel specifically for these “made to order” sales. For this new machines and production line resources have been put in place.
Customized products are manufactured and be made available to the customer within 3 working days’ time from the date of placing the order. The customer comes to the store and picks up the apparel ordered. For delays beyond this timeline, the customer gets to pay 5% less on the order value. This is done to attract and maintain customers, who would other-wise choose to purchase apparel offered by rival competitors. Therefore, speed of delivery of the customized product is critical for the company. This is the main selling point for the company to operate the “made to order” business model.
If further modifications are needed due to errors on part of the company (quality/finishing issues), the apparel would need to be modified/restitched once again. The company will bear the cost of modification or replacement of garment.
This new “made-to-order” has been in place for the past 6 months. At the stage of project proposal, the management found it a lucrative option for the company because:
(i) Customers are willing to pay a higher price to have customized clothing as compared to the standard fitting.
(ii) It would attract more customers to the store
(iii) If the model works well, the dependence on the “made to stock” model can reduce. Savings in inventory stock, obsolescence and warehousing costs will benefit the company’s bottom-line.
Customers have been very enthusiastic in availing this customization facility/offered by the company. Sales have increased manifold in the last few months. Therefore, the management is interested to understand the metrics related to their “made to order” business mode to assess its success and risks. Some of the non-financial metrics are:

Required
ANALYZE the non-financial measures of quality of the division over the six-month period. Focus on the production performance, delivery cycle performance and customer satisfaction. [RTP Nov. 2020]
Answer:
Analysis of the operating data of the “made to order” at the business 1 store revealed the following:
Production Performance:
(i) Modifications to orders: This company has to bear the cost of modification/replacement of the garment incurred on account of error in its order taking or manufacturing process. Therefore, orders needing such modification should be kept at the minimum. Such instances were higher than 10% in the first three months. With experience, either in the order taking process or manufacturing process, these errors have reduced substantially in the later months. The managers of the order taking and manufacturing departments need to understand and constantly keep track of these errors in order to keep them at a bare minimum. Management may want to set a benchmark, financially in terms of the cost of modification and non- financially in terms of the acceptable threshold for such instances. Monthly tracking of this metric will help detection of errors earlier.

(ii) Production downtime: Production downtime normally occurs either due to break down of machinery or plant maintenance. It is unproductive time, reducing the machine’s capacity. It must be kept minimum. Downtime hours have been steadily increasing in the past 3 months, the overall monthly average being 91.67 hours. The production manager has to analyze and take corrective action at the earliest. Urgency of the issue can be compounded by the fact that sales orders under the “make to order” model have been increasing steadily over the last few months. In the latest month, 3896 of the overall sales was from this model. Therefore, the production capacity should be utilized optimally to ensure ability to meet delivery deadlines.

(iii) Labor Idle time: Labor Idle time due to unavailability of material is another unproductive waste of resource. The procurement department can address unavailability of material. On an average 20.5 hours of labor time is idle due to unavailability of the appropriate material. Appropriate steps with suppliers can lead to agreements to ensure seamless supply of material when required. This will enable the company to meet delivery deadlines given to customers.

Delivery Cycle Performance:
(i) On-time delivery: The orders need to be delivered to the store within 3 working days of placing order. The customer picks up the order from the store. Speed of delivery is critical to the company. Any delay beyond this timeline, the customer benefits by a 596 reduced price on the order as compensation for delay. Prompt delivery is also the company’s selling point to attract customers, who would otherwise patronize its rivals. On an average 596 of the orders are not delivered within time. Therefore, average delivery success rate is only 9596. The management has to take steps that this is kept to the minimum in order not to stem loss of revenue as also to build brand loyalty with the customer base.

Customer Satisfaction:
(i) Repeat orders by customers: Prompt, quality delivery of the customized order would ensure that customers return in future with further orders. Statistics shows that repeat orders have steadily increased, which is a very positive signal to the management. Initially, only 496 of the customers under this model placed repeat orders. This increased substantially. Now almost 63% of the customers who purchase under this model come back with more orders!
(ii) Sales mix: Popularity among customers for customized services is further validated by the steady increase in the ratio of such sales to the overall sales of the company from the factory outlet. Now, this model generates an average of 28% of the total sales from the outlet, with a likely projection of having a higher share in the overall sales mix. Therefore, the “make to order” model can be termed a success.

Workings

Question 24.
(Supply Chain Management)
Happy day Travels is a tour operator offering holiday packages to a variety of customers. They advertise and promote their packages using print advertising in newspapers and colourful brochures. A basic holiday package would include transport from the city to the destination, stay, food, attractions, or activities. Happy day Travels has been in business for the past 15 years. It has standard agreements with its suppliers based on which it has been offering standard holiday packages to its customers. Profitable business over these years has resulted in surplus cash that the company intends to reinvest in its business. Recently, the management has noticed increase in the number of complaints regarding these packages. This has resulted in lesser number of customers opting for these tours.
A study of these complaints has indicated that customer expectations from a holiday trip vary depending on their age group. Accordingly, Happy day Travels wants to offer customized holiday package trips that would suit the travellers’ expectations. It wants to increase the number of packages offered to customers in addition to adding variety to them. This would provide customers the choices from which they can customize 4 their holidays with the help of Happy day Travels.
The management wants to understand the need and importance of supplier chain management in a service organization such as itself.
Required
(i) DEFINE the objective Travels should have when considers incorporating the supply chain management framework into its business model.
(ii) IDENTIFY possible components of Happy day Travels’ upstream supply chain.
(iii) SUGGEST the key processes in the business model of Happy day Travels.
Answer:
(i) Happy day Travels is providing a service wherein it uses its assets, staff, and resources to provide customized travel packages to its customers. It should consider how to utilize its assets and staff to design and manage its supply chain such that it meets the customers ’demand in a cost-effective manner. Customers’ demand is uncertain due to
(a) customization of holiday packages to suit their individual expectations and
(b) sensitivity of travel to factors like economic prosperity, law, and order etc.
Business processes must be effectively coordinated across organizations and functions to meet the customers’ expectation in the best posable manner. The ability of Happy day Travels to respond to its customers’ demand defines its operational capacity. Having more capacity (capability) to meet customers’ demand helps it be more responsive and flexible. However, this has to be balanced with its ability to maintain an effective supply chain management. A supply chain is effective only when Happy day Travels and consequently the ultimate customer, is able to get the required level of service from its suppliers.

(ii) As mentioned in the problem, a basic holiday package would include transport from the city to the destination, stay, food, attractions, or activities. Accordingly, possible components of Happy day Travels upstream supply chain would include partnerships with:
(a) Transport providers – road, rail, and air travel providers. This includes travel to the holiday destination as well as the local transport within that location.
(b) Lodging and accommodation providers – hotels, bed, and break-fast providers etc.
(c) Local food producers and restaurants.
(d) Providers of tourist attractions and activities.

(iii) Key processes in the business model of Happy DayTravels would be: Information Flow
Information flow is critical at various stages:

• to understand expectations of customers
• to share this information with the suppliers of service with whom Happy Day Travels has partnership
• to establish clear service level agreements with these suppliers and to clearly define the scope of work
• to be able to monitor the performance of these suppliers. Performance has to be monitored because it will impact payment settlements with these suppliers
• to collect constructive feedback from customers about the performance of these suppliers

Capacity and Skills Management
Happy Day Travels has to develop the ability to cater to various expectations of its customers. It has to develop assets and skilled staff who can attract customers and help them customize their holiday packages. To enable this, the company has to invest in its organization, processes, assets and staff. As mentioned above in point (a), information flow is a key process in this business model. The company has to invest in , its processes to ensure that information flow is smooth and accurate. Similarly, it has to invest in assets like IT infrastructure, offices and aho develop a skilled staff who can provide quality service. Happy Day Travels should also have the ability to develop pool of suppliers who provide good quality service. Better capacity to cater to customers’ demand better will ensure that Happy Day Travel can develop and maintain its business efficiently. However, since building capacity and developing skills comes with a cost, that has to be balanced out with the revenue it generates.

Demand Management
Happy Day Travels will have to focus on how to generate demand for its products. In time with changing times, Happy Day Travels will have to change its marketing from print based advertising to online advertising in order to have a larger outreach to attract customers. The company should be able to manage variation in customers’ ex-pectations in a cost- effective way. As explained in point (b) above, this will be determined by the capacity of its operations and skills of its employees. Higher the capacity more the flexibility in its operations.

Customer Relationship Management
Customer segmentation and monitoring help in understanding cus-tomer’s needs in a better way and to focus on efforts to meet those needs through proper and timely communication of information with its service suppliers. However, the cost of maintaining this framework should not exceed the revenue that each customer segment generates. Accordingly, customer account profitability analysis should be prepared for each customer segment.

Supplier Relationship Management
As part of the customer relationship management, specific needs of customers would be identified. Based on these needs, potential suppliers who provide services of the requisite quality need to be identified. Service level agreements need to be drawn up after comprehensive rounds of negotiations. It is imperative to have a clear understanding with these suppliers regarding the quality service expected.

Service Delivery Management
Agreements with suppliers will help to ensure that expectations of customers of Happy Day Travels are being met. Service performance must be monitored, checked continuously for compliance. Any deviation from scope may have an impact on the payment settlement to be made with the supplier.

Cash Flow
As mentioned above, service delivery should be monitored to ensure that payment is made only to the extent the agreed quality of service is delivered. Periodic payments to suppliers should be made based on service level agreements. Similarly, cash inflow from customers should be monitored to avoid any bad debts. Pricing for packages should be based on the level of service offered. Again, clear understanding of the terms of contract is essential to avoid uncertainties.

All processes within the company are linked to each other. Under-standing the customers’ expectations have a direct impact on the supply chain. Therefore, proper co-ordination is required for smooth functioning of the organization and its supply chain.

Question 25.
(Customer Life time Value)
MultiCinema is a movie theater is located in a town with many colleges and universities around it. The town has a substantial student population, most of whom are avid movie goers. Business for MultiCinema has been slow in the recent years due to the advent of streaming websites, that show the latest and popular movies online. However, the management n of MultiCinema continue to feel students would still enjoy the watching movies on big-screen, along with the facilities and ambience that only a movie theater can offer. Accordingly, they have framed a plan to attract students by offering discounts on movie tickets.
The average time a student spends at the college or university is 4 years, which is the average duration of any course. For a nominal one-time subscription fee, MultiCinema plans to offer students discounts on movie tickets for a period of 4 years. By attracting more footfalls, MultiCinema targets to cross sell it food & beverages and souvenirs. This would help it sustain a reasonable revenue each year.
MultiCinema would attract attention to the plan by initially offering free tickets, food and beverage and gift vouchers. This one time initial expense, net of the one-time subscription fee collected, would cost ₹ 5,000 per student. On subscription to the plan, the viewership and purchases of each student is expected to be as follows:

Particulars	Years 1 and 2	Years 3 and 4
Spend on movie tickets per year	2,000	1,500
Spend on food and beverage per year	4,000	3,000
Spend on souvenirs and accessories per year	2,250	750

Assumptions
1. Only 50% of the subscribers are expected to visit the theatres in years 3 and 4.
2. Across all years, only 75% of the subscribers who visit the theatre are expected to buy food and beverage.
3. Only 25% of the subscribers who visit are expected to buy souvenirs in years 1 and 2, and 10% of them in years 3 and 4.
Given that PVIFA of ₹ 1 for 4 years at 10% = 3.169 and PVIFA of ₹ 1 for 2 years at 10% = 1. 735.
Required
CALCULATE the customer lifetime value per subscriber for the above plan. [RTP May 2019]
Answer:
Customer lifetime value per subscriber can be found by calculating the present value of the revenue that is generated over the period of 4 years. This netted out with the cost incurred to attract subscribers, would give the customer lifetime value per subscriber.

Note 1:
PVIFA (10%, 4 years) = 3.169 and PVIFA (10%, 2 years) is 1.735. Therefore, PVIF for years 3 and
4 = PVIFA (10%, 4 years) – PVIFA (10%, 2 years) = 3.169 – 1.735 = 1.434.

Note 2:
Only 50% of the subscribers are expected to attend in years 3 and 4. Out of those only 75% are expected to buy food and beverage. Therefore, only 38% of the subscribers (75% of 50% subscribers who visit) are expected to buy souvenirs in years 3 and 4.

Note 3:
Only 50% of the subscribers are expected to attend in years 3 and 4. Out of those only 10% are expected to buy souvenirs. Therefore, only 5% of the subscribers (10% of 50% subscribers who visit) are expected to buy souvenirs in years 3 and 4
Present value of total revenue generated over the four-year period by a customer is ₹ 12,393 while the corresponding expense is ₹ 5,000. Therefore, the customer lifetime value per subscriber is ₹ 7,393. MultiCinema has to multiply this with the expected number of subscribers each year, to find out if this would be a profitable proposition.

Question 26.
Ray Health Care Limited is a leading healthcare service provider in Mumbai, it has approximately 450 potential beds, it provides diagnostic and day care speciality facilities also. In its diagnostic centres they are using traditional devices for CT Scan and MRI which are not enough as per demand. Patients waited more than weeks for CT and MRI scans, this problem can cause delay in diagnosing illness; waste of time and other resources; not just in radiology but throughout the healthcare system.
Ray has planned to outsource CT Scan and MR1 services to Livlife, which has world-class international chain of diagnostic centre. Livlife promise to provide radiologist report within 24 hours. However, finance manager of Ray doubt that it will not be a profitable arrangement. For the satisfaction of Ray, Livlife has entered an agreement to provide its services to Ray with no guarantee of receiving payment.

Ray agree to the following conditions:

• Cost savings generated in first year, the same will be retained by Livlife.
• Cost savings generated in second and third year will be shared between Ray and Livlife at a ratio of 30%: 70%.
• Cost savings generated in the fourth year will be passed to Ray.
• Any cost savings generated by an idea proposed exclusively by Ray that does not require capital investment by Livlife will be immediately passed along to Ray.

Required
DISCUSS the agreement between Ray and Livlife. [RTPMay 2020]
Answer:
The agreement between Ray and Livlife is Gain Sharing Arrangement. Gain sharing (also known as cost saving sharing) arrangement is an approach to the review and adjustment of an existing contract, or series of contracts, where the adjustment provides benefits to both parties. A fundamental form of gain-sharing is where a supplier agrees to perform its side of the contract with no guarantee of receiving a payment. Instead, any payment received is based upon the benefits that emerge to the customer as a result of the successful completion of the supplier’s side of the bargain.
Livlife and Ray has also entered into such arrangement. This is clearly a risky stance for the supplier ie. Livlife, because-it could spend a fortune and walk away with nothing.
Alternatively, if the benefits to Ray are substantial, Livlife could find itself rewarded with a large return.
Cost savings might be attained from reducing the cost of supplies, imple-menting new skill and technologies, revised delivery time, improvements in operations etc.
The gain, benefit, or advantage to be shared is not necessarily financial, although financial benefits are expected to occur frequently. The Ray, for instance, will not necessarily take cost savings in the form of a lower contract value but might require a higher specification for medical treatment. However, to assess any financial benefit, both parties have to provide each other with access to relevant cost numbers to determine the basis for the assessment of the benefit and the calculation and sharing of the benefit.

Many contracts involving these arrangements have emphasis on greater openness and shared development and improvement. In the given case gain-sharing deals are, on the face of it, a win-win situation for both Ray and Livlife, interest of both are aligned. Livlife is trying to save costs of Ray while Ray is trying to get world class services.

Question 27.
(Case Study: Value Chain Analysis, Stage of Product Life Cycle, Outsourcing)
Jovial Hotels was established 10 years ago as a budget hotel in the vicinity of Mumbai airport. It provides accommodation for cost-conscious travelers visiting the city for short stay lasting a day or two. Typically, a room would provide comfortable beds, high speed internet connection, | air conditioning facility, coffee machine, fridge and free television service.
Food service based on a limited menu is provided on the premises. It g has few conference rooms that provide space for guests to hold business S meetings. This saves them precious time otherwise wasted in travelling on £ congested city roads. The hotel provides free shuttle service to and from the airport at specific times during the entire day. Hotel’s proximity to the airport, the free shuttle service and convenience of conducting work at the conference rooms have been marketed to attract guests to stay here. The guests also comprise of people who are in transit between airports. Also, when there are long- duration delays in flight operation due to which passengers need to be provided overnight accommodation, few airline operators host their guests here. Like all other guests, these airline operators are also interested in Jovial for its location and low-cost room rental.
Over the past decade, management of Jovial has ploughed in profits from this establishment to acquire similar properties in other major cities. They function based on business model similar to the original establishment in Mumbai. All of them are now functioning as well-established budget hotels near city airports for cost-conscious business travelers. In all, Jovial hotels have 18 properties spread over 15 cities. To keep its costs of operations within control, Jovial hotels has outsourced its cleaning and food service to specialized vendors. Cleaning service includes cleaning of kitchen crockery, bedding, laundry and housekeeping of premises. The entire set of activities related to preparation of food has been outsourced.
Vendor service has been satisfactory, barring few instances where guests have complained of unhygienic rooms or non-palatable food service. However, due to high guest volume and quick turnover of guests due to short stay periods, this has never been a hindrance to business.
This business model has been profitable since its establishment. Jovial Hotels has a sizeable market share in this segment. Competition has increased in the recent past. Price wars have put pressure on profit margins in this segment. The management plans to continue to operate in this segment to maintain its market presence. At the same time, to sustain business in the long term, the management of Jovial Hotels now wants to foray into developing properties for luxury resorts. Target guest segment are vacationing tourists interested in an enjoying a laid-back time in scenic places. These guests would not mind paying premium for availing good quality service.
Required
(i) IDENTIFY and EXPLAIN the various primary activities of Jovial in its value chain.
(ii) IDENTIFY and EXPLAIN the stage of product life-cycle.
(iii) EVALUATE the risks of outsourcing cleaning and food services for the luxury resort properties. [Nov. 2019 RTP] (20 Marks)
Answer:
(i) The five Primary Activities of Michael Porter’s Value Chain Model Inbound Logistics
Activities related to receiving, handling of materials from the supplier and their storage until further use later in operations. In the case of Jovial Hotels, materials would include food service received from the vendor. This needs to be stored and maintained properly until the item is ordered by the guest. Similarly, the vendor delivering freshly laundered crockery, bedding and laundry would be materials that [ need to be stored until their use to serve the guests. These are inbound I logistics for the hotel.

Operations
Activities related to converting inputs into production of output or service. In the case of Jovial Hotels, operations would include maintenance of hotel premises including guest rooms, conference rooms and common area. Activities related to ensuring cleanliness and safety of rooms, working order of facilities offered like TV and internet service, coffee machines, shuttle service are part of hotels operations.

Outbound Logistics
Storage and movement of the end product from the production line to the customer. In the case of Jovial Hotels, it includes activities such as maintaining “non- smoking” rooms as such, so that when the customer finally uses it comes across as a “non-smoking” room. Likewise, the food should be prepared in a professional manner, stored in such a way that it ensures customer satisfaction and safety. Therefore, the review of food items to remove the ones past expiry would be part of Outbound Logistics. Therefore, any activity relating to making sure that the guests get what they have ordered for, would be part of out-bound logistics.

Marketing and Sales
The activities related to communicating, selling, and delivering the product or service to the customer. In the case of Jovial Hotels, advertising its properties to the cost and time conscious traveller would be a marketing activity. Free shuttle service is a promotional activity to attract guests. Any agreement with airline companies to accommodate guests would also form part of this activity.

Service
All types of service such as after sale service, handling customer com-plaints, customer support, training etc. In the case of Jovial, service is one of the most important activities in their value chain model. Good service ensures happy guests. Therefore, all activities from front- desk, room service, catering, repair services, shuttle service would be included here. All employees have to trained to handle needs of the guests in an effective and efficient manner.

(ii) Product Life-cycle Stage of Jovial Hotels
“Budget Accommodation” to the cost and time conscious traveller is the current product offering of Jovial Hotels. Starting out with a single establishment, Jovial Hotels ploughed in profits to expand its business offering to other cities as well. The product has been well established in the past decade. Competition is intense indicating similar offering by rivals. Price wars have put pressure on profit margins. Jovial Hotels plans to continue in this segment due to its sizeable market share. This information indicates that Jovial Hotels is in the maturity stage of its product lifecycle. It has a well-established product, with a sizeable market share at the same time it is now facing competition. Business has hit a plateau. Hence, Jovial Hotels needs to improve its product offering to beat competition. The management’s plans to foray into luxury resort business is an indication of its future plans to sustain business.

(iii) Risks of Outsourcing Cleaning and Food Service under the Luxury Resort Model
Jovial Hotels is a budget accommodation provider to the cost and time conscious traveller. Primary feature of this model is “value for money”. To remain profitable the cleaning and food service has been j outsourced, which enables Jovial Hotels to keep the costs of operation low. There have been instances of dissatisfaction among guests as regards quality of cleaning and food service. However, since the turnover of guests is quick due to high volume and short stay period, it has not negatively impacted business.

In the luxury resort business, the target guests are travellers on leisure, The primary feature of this model would be “good quality of service ”.
Maintaining cleanliness of premises and food service are critical activ-ities in the operation of luxury hotels. Therefore, customer satisfaction . on these metrics is paramount to sustain and grow business. With the – ability to post reviews online on booking portals, any negative review (whether justified or not) can reach very easily to a large number of potential guests. This can negatively impact future business. Hence, Jovial Hotels has to ensure that the quality of service that it provides in terms of cleanliness and food should meet and beat the guest’s expectation.

Outsourcing these services to well established vendors is advantageous since the focus can remain on improving guest experience. It may also | be cost advan tageous in many cases. However, there a number of risks in this model. Detailed service level agreements need to be drawn up to ensure that the required quality of service is being provided. Jovial j Hotels should be able to monitor the performance of these vendors, j In cases of non-delivery of the required level of service, the agreement ] should provide for means of redressal. This could vary from compensation for any loss in business to immediate termination of service. ! Jovial Hotels should ensure that it can easily and economically switch service providers if required. For this it has to identify alternate vendors who can provide the same level of service as the current ones. The j other risk in outsourcing could be of instances where well performing vendors could go bankrupt and shut shop. In such cases, Jovial Hotel’s operations could be immediately impacted since such services can no longer be availed from these vendors. Again, list of alternate service providers is a necessary back-up that the hotel should have.

Alternatively, since these are very critical activities to business operations, Jovial Hotels may choose to have complete control over them. This can be achieved by having in-house departments that cater to cleanliness and food service. Control over factors such as input material used, the performance of service, equipment used, training of staff and other essential activities can ensure that the required service quality can be achieved Better service enhances guest experience. Compared to outsourcing, this might be a costlier option. However, since the guests are ready to pay a premium for service quality, within reasonable limits cost need not be a primary concern for Jovial Hotels for this business model.

Question 28.
(Case Scenario) Nitco Tiles Production Limited (NTPL) is large manufacturer of floor tiles and interlocking tiles. NTPL enjoyed reasonable market share and brand reputation up till couple of year ago. Since then, NTPL is facing problem of decline in productivity. NTPL deals in variety of tiles with different brand-name, some of their brands are in development stage and some in maturity. Majority of customer are from middle class, who are price sensitive; hence cost of production is critical aspect for NTPL and resultantly productivity too become critical factor.
Workers at NTPL are allocated with specific roles and responsibilities. Workers are supposed to work strictly according to specific set of guidelines provided by superior. Workers used to complain about job role allocations, because allocations are not as per skill set of workers. In some of case task become monotonous; as learning curve exhausted. Management and operational decision are centralised in nature, participation of workers is limited up-to day end report only.
Remunerations at NTPL are paid based on hourly rate. Hourly rate is fixed based upon number of years of working in NTPL, irrespective of importance of task allocated to such worker. Since payment are fixed in nature hence workers at NTPL are hardly concern about quality. Some of skilled workers are getting less pay in comparison to other staff. NTPL recently retrench some of senior workers, who possess reasonable operational skills; but not good in technology part which is essential to operate machines; recently installed at NTPL plant.
Since there are varieties of tiles available in stock that’s too with different design, hence in past there are handful instances where material delivered to customer was different from what being ordered. Due to large volume of inventory at store, some category of tiles is further manufactured even lying available in store and stock of some remains always short.
Required
You are newly appointed to Management Accounting Department of NTPL, Management Accountant asked you to draft a report for CEO, containing brief explanation to
(i) Productivity, stating in context of what it should be measured?
(ii) Productivity enhancement techniques, which can be applied at NTPL in order to enhance productivity?
Answer:
Addressed to:
Office of CEO,
Nitco Tiles Production Limited (NTPL). Dated -11th April, 2020
Report
Report on Productivity Enhancement Techniques
(i) Productivity – Productivity is all about efficient and effective use of all resources. Resources can be time, people, knowledge, information, finance, equipment, space, energy and material.
Productivity is usually linked to ‘time and motion’, in order to

• Put pressure on worker to perform faster.
• Increase the productivity either by increasing the value or reducing the time required to create that value.

Note – Responsibility of productivity is largely on the person who organising the work rather individual worker.

(ii) Productivity Improvement Techniques
(a) Value Analysis/Engineering – Value engineering improve value of product at every state of product life cycle; Since products of NTPL is lying either in development stage or in maturity stage, hence

• At development stage – NTPL can reduce cost without reducing quality by establishing design and processes accordingly.
• At maturity stage – NTPL can reduce cost by replacing costly component with cheaper one. But may result in reduction in quality to some extent, hence consumer behaviour is important. Since customer base is price sensitive hence this strategy may work.

(b) Quality Circles – Quality circle is small group of employees, usually in size of 5-6 members in order to-

• Meet regularly to identify, analysis and solve problem of their departments.
• Advice the management to implement new methods to solve work-related problems.

Since NTPL facing criticism from worker class and method of working is selected by superior hence quality circle can be solu-tion to these problematic aspects.
Note – This technique originated in Japan in 1960s

(c) Financial & Non-Financial incentives – Incentives are real cause of motivation to worker and may be financial and non-financial in nature.

• Financial incentive includes better wages and salaries, bonus etc.
• Non-financial incentive includes better working condition, welfare facilities, worker participation in management.

Since the incentive scheme is not linked to employees’ productivity and skill hence redrafting of incentive schemes incorporating financial and non-financial incentives can promote productivity.

(d) Operations Research – Management at NTPL need to incorporate operation research and technique thereof in the decision-making process. Use mathematical & scientific methods may solve the problems of productivity (by using techniques such as LPP etc).

(e) Training – Rather than retrenching the employees who are operationally sound and weak in using the technology, they must be trained on technological part. Training is process of knowledge & skill enhancement of employee and will result in increased efficiency of employee.

(f) Job Enlargement & Job Enrichment – Job Enlargement is hor-izontal expansion of job which increase the varieties of job & work knowledge (make job interesting and satisfying), whereas Job Enrichment is vertical expansion of job which makes routine job more meaningful and satisfying. With this NTPL can solve the problem of monotonous nature of task and can enhance the productivity.

(g) Job Evaluation – In order to enhance the productivity, NTPL should do job evaluation. Fixing value of each job in the organ-isation. This is essential for moral boosting for employees.

(h) Inventory Control & Material Management – Optimum usage of material in manufacturing process need to be ensured by NTPL, whereas overstocking and under-stocking should be avoided, through

• Scientific Purchase
• Systematic Store Keeping
• Proper Inventory Control, etc.

Because overstocking may result in blockage of fund, chance of misuse/mishandling & spoilage of material and under-stocking results in shortage or sale out situation which result in loss of contribution.

(i) Quality Control – NTPL should ensure identification of causes of quality deviation & correction thereof, in order to produce goods with quality at lowest prices & to reduce wastage.

(j) Human Factor Engineering – Understanding of technology and human requirement (psychological & physiological character), of task and worker both; in order to ensure fitment of job to men; to increase human efficiency & wellbeing. NTPL can do skill mapping as part of this technique.
Further details can be tabled on requisition basis. Closure of
Report
Signature
(For Management Accounting Division)
Nitco Tiles Production Limited.