Reference no: EM13948101

At the beginning of the last quarter of 2006, Microcom, Inc., a large consumer prodzucts firm, hired Leming Imai to take over one of its divisions. The division manufactured small home appliances and was struggling to survive in a very competitive market. Leming immediately requested a projected income statement for 2006. In response, the controller provided the following statement:

Sales	$25,000,000
Variable expenses	20,000,000
Contribution margin	$ 5,000,000
Fixed expenses	6,000,000
Projected loss	$ (1,000,000)

After some investigation, Leming soon realized that the products being produced had a serious problem with quality. He once again requested a special study by the controller's office to supply a report on the level of quality costs. By the middle of November, Leming received the following report from the controller:

Inspection costs, finished product	$ 400,000
Rework costs	2,000,000
Scrapped units	600,000
Warranty costs	3,000,000
Sales returns (quality-related)	1,000,000
Customer complaint department	500,000
Total estimated quality costs	$7,500,000

Leming was surprised at the level of quality costs. They represented 30 percent of sales, which was certainly excessive. He knew that to survive the division had to produce high-quality products. The number of defective units produced needed to be reduced dramatically. Thus, Leming decided to pursue a quality-driven turnaround strategy. Revenue growth and cost reduction could both be achieved if quality could be improved. By increasing revenues and decreasing costs, profitability can be increased.

After meeting with the managers of production, marketing, purchasing, and human resources, the following decisions were made, effective immediately (at the end of November 2006):

1. More will be invested in employee training. Workers will be trained to detect quality problems and empowered to make improvements. Workers will be allowed a bonus of 10 percent of any cost savings produced by their suggested improvements.

2. Two design engineers will be hired immediately, with expectations of hiring one or two more within a year. These engineers will be in charge of redesigning processes and products with the objective of improving quality. They will also be given the responsibility of working with selected suppliers to help improve the quality of their products and processes. Design engineers were considered a strategic necessity.

3. Implement a new process: evaluation and selection of suppliers. This new process has the objective of selecting a group of suppliers that are willing and capable of providing nondefective components.

4. Effective immediately, the division will begin inspecting purchased components. According to production, many of the quality problems are caused by defective components purchased from outside suppliers. Incoming inspection was viewed as a transitional activity. Once the division has developed a group of suppliers capable of delivering nondefective components, this activity will be eliminated.

5. Within three years, the goal is to produce products with a defect rate less than 0.10 percent. By reducing the defect rate to this level, marketing is confident that market share will increase by at least 50 percent (as a consequence of increased customer satisfaction). Products with better quality will help establish an improved product image and reputation, allowing the division to capture new customers and increase market share.

6. Accounting will be given the charge to install a quality information reporting system. Daily reports on operational quality data (e.g., percentage of defective units), weekly updates of trend graphs (posted throughout the division), and quarterly cost reports are the types of information required.

7. To help direct the improvements in quality activities, an aggressive continuous improvement program will be implemented. For example, for the year 2007, rework costs have a targeted future state value of 6 percent of the selling price per unit, a 25 percent reduction from the current state cost.