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In 2008, the world economy crashed and so did the “Big Three” US car manufacturers. General Motors (GM) filed for bankruptcy, Ford Corporation reported a $12.7 Billion loss, and later in 2009 Chrysler went into bankruptcy protection. However, their Japanese counterpart, Toyota Motor Company, sustained its leadership in the car industry. Toyota Motor Company considered “this headwind as a valuable opportunity to turn it into a more flexible and stronger company…” (The Auto Channel, 2008).
U.S. car manufacturers had structural limitations imposed on their operational flexibility. Despite lower consumer spending, the companies decided that cutting production was not the solution. They operated under a traditional manufacturing system, and because of costs, mainly inventory and labour, manufacturers had no leeway for making cuts. For example, GM’s structural limitation was evident in the Arlington manufacturing site. To keep pace with technology and product innovation, GM had to build a new separate building for its body shop rather than modernize the existing facility. Thus the transfer of production from the body shop to the final assembly endured more motion and consumed more time than under optimal conditions. But, GM could not afford to shut down the site for renovation due to extensive committed labour costs. Adding to its operational inflexibility were transportation costs associated with pre-existing contracts with suppliers, 78% of which were scattered in Michigan, Canada, and Mexico (Hawkins & Shirouzu, 2006).
Notwithstanding restructuring efforts, the U.S. government had to interfere to bail out the car industry. The U.S. government authorized $10 billion in aid to Chrysler, which led to its ownership of 8.6% of the company’s equity (Durbin, 2011) and $50 billion to General Motors Co. which entitled the government to control 61% of its equity (Beach, 2014). Ford refused the government offer for bailout. “At a deeper level, the question is whether GM and Ford—the companies that perfected mass production -can fundamentally change their culture to the new lean production system” (Schifferes, 2007).
In 2004 GM embarked on a restructuring plan to go lean in its operations by introducing a global manufacturing system. For decades GM has been using the mass assembly-line technique, whereby “each division had its own manufacturing processes, its own parts, its own engineering, and its own stamping plants” (Holstein, 2009). The new manufacturing system would use the same production procedure across the global plants. The plants restructuring would encompass flexibility for each type of vehicle, integrating design and manufacturing to gain efficiencies. The flexibility is based on sharing a “common platform, including engines and transmissions” (Schifferes, 2007) for each type of car (small, medium, or truck). However, supplier relationships remained a major problem for production, which constituted 85% of car makeup. Many suppliers who were pressured to reduce cost shifted their production outside the U.S. This in turn had tremendous effects on GM’s transportation costs. Ford also faced legacy cultural problems in trending towards lean production.
Further restructuring efforts were applied by the car manufacturers after government intervention in 2008. All of the restructuring involved cost cuts, with the manufacturers shutting down plants, reducing production, dropping product lines, and laying-off workers. Chrysler took on two restructuring efforts by cutting 1.1 million vehicles and 26,000 workers (Welch, 2008). GM planned to reduce its manufacturing plants from 47 to 33. In addition, it entered into negotiations to sell its Saab brand and its transmission plant in France. It also planned to phase-out its Saturn brand and cut 47,000 jobs (Vorman, 2009). Ford, which was losing money from its core car and truck business, decided to close five manufacturing plants including Cleveland Casting Plant and Maumee stamping plant and 35,000 jobs cuts (Schoenberger, 2011).
On the other hand, Toyota had maintained a TPS (Toyota Production System) operating system, grounded on a lean rather than traditional manufacturing system. In the face of economic crisis, Toyota promptly adapted its production, whereby it perceived the economic crisis as an opportunity to “develop human resources and thus work to establish a company with true strength and long-term stability. To this end, we will aim to eliminate waste and review the process and structure of every aspect of our operations” (The Auto Channel, 2008). A key to the effectiveness of lean operations is to use freed capacity resulting from eliminating waste in the manufacturing processes. Waste involves any activity that does not add value to the customer but rather adds to the costs of production. Toyota believes that management efficiency lies in eliminating or reducing those non-value added activities, such as storing merchandise inventory,
“A tale of two auto plants'' illustrates the competitive advantage of Toyota’s production system in San Antonio, Texas, where Toyota applied a system of waste reduction, continuous improvement, and just-in-time inventory (Hawkins & Shirouzu, 2006). Although both factories were located in the heart of Texas—GM in Arlington and Toyota in San Antonio—each had a different structural and operational system. GM’s factory had been in operation in Arlington for over 50 years, employing 3,000 workers. Despite renovation efforts in 2000, unlike Toyota, GM was bound by its long-term workers’ benefits, high wages, and layout constraints. It had to use long conveyers to transport its production from one process to the other, which consumed unnecessary throughput time. Older machinery meant more breakdowns and idle labour hours. Its suppliers were dispersed causing high transportation costs and potential for delivery delays.
Toyota, on the other hand, established its competitive advantage at its factory on lean operational and structural bases. The factory occupied one-third the space of GM’s factory. It employed workers at $35/hour, less than half the hourly wage of GM workers. Its new machinery saved Toyota on maintenance and breakdown costs. The necessary parts to complete production were enclosed within each vehicle to save time and motion and prevent errors. In addition, Toyota was able to convince 21 of its suppliers to establish their factories around its San Antonio site (Hawkins & Nouhiko, n.d.).
In 2014, the Big Three auto manufacturers turned their losses into profits. Restructuring, government bailout, and union negotiations resulted in cost cuts. The labour force was cut and wages were controlled, plants reduced, and unprofitable product lines dropped (AP Business Staff, 2011). According to Van Conway, a consultant and founder of turnaround firm Conway MacKenzie. “If all of us were to put ourselves back in 2009, could we imagine that GM could have done an IPO and these companies would be enjoying this level of profit? I don't think so” (AP Business Staff, 2011). Ford was the only company to gain customer’s confidence by surviving without governmental interference (Navellier, 2014). “Ford was leaner in its vision” (Lool, 2010).
Since 2006, Ford has invested in the future to meet customers’ preferences. The company improved the quality of its products, and invested in energy-saving electric and hybrid manufacturing plants (Lool, 2010). But it is still far from Toyota’s lean. For example, to ensure quality and reduce cost, Toyota “pull the cord,” i.e., stops the production line 2,000 times/week to fix quality problems, while Ford averages only 2 times/week (Schifferes, 2007). But Toyota remained the world's biggest car manufacturer with a sales increase of 16% and profits up by 90% to $17.9 billion (Petroff & Yan, 2014).
The primary purpose of accounting information, whether internal or external, is to provide management and investors with useful information to make sound decisions. “When standard cost accounting was developed in the early 1900s, most companies’ cost structures consisted of 60% direct labour, 30% materials and 10% overhead” (Kroll, 2004). Manufacturing cost structures included very little for overhead, therefore companies allocated overhead costs to products in the same proportion as direct labour. It was volume driven. For example, consider when a company is producing two products, a standard and a customized product. Although the customized product might consume more overhead in terms of indirect material and supervision, the overhead would be allocated equally to both products based on the number of units produced. This would understate the unit cost of the customized product. “Overhead was so insignificant that even if the allocation was incorrect, it wasn’t a big deal” (Kroll, 2004).
However, as machinery and processes in factories evolved, a new era of cost accounting arose. As manufacturers adjusted their approach to cost structures, they changed their cost accounting techniques and tools. Traditional used tools such as standard cost of sales and variance adjustments on the income statement (Table 1), budgeting and performance reports, and variance analysis and responsibility centres. Accountants could no longer use the direct labour cost driver as the trigger for all indirect manufacturing costs. Determining and selecting an appropriate cost driver for indirect costs became a must. Cost accounting tools using multiple cost drivers were adopted. For example, utilities expenses might be triggered by the number of machine hours and by the number of late night shifts. Later, ABC (activity-based costing) techniques were developed and used.
Activity-based costing (ABC)
ABC techniques analyse organizational operations into activities such as order processing, design changes, and customer relations. By doing so, some indirect costs, which are allocated as a product cost, become easily traceable to the identified activities. This reduces the allocation process, which in turn reduces allocation errors and improves product costing.
Chrysler claims that it saved hundreds of millions of dollars. ABC showed the true cost of certain parts Chrysler made was 30 times original estimates, “a discovery that persuaded the company to outsource the manufacture of many of those parts” (The Economist, 2009).
Lean costing systems
In lean operation and accounting, the company analyses the value stream: all activities from raw material purchases to conversion into finished product and customer delivery to identify and eliminate waste, and improve operational effectiveness. Seven general wastes are identified in lean operations:
Traditional cost accounting tools shift to value formation analysis tools (Maskell & Baggaley, 2001). “Traditional management accounting measurement systems focus on such issues as monthly variance reporting and earned hours, and are used for monitoring and judgment” (Maskell & Baggaley, 2007). Instead, lean tools focus and push for continuous improvement. Each working cell is provided with a set of performance measures and clear guidance and empowerment for immediate action to fix any problem it might face such as pulling the cord. Clear and timely information for decision-making is provided rather than monthly. Its focus is on the costing the value stream rather than the product itself. This in turn encourages continuous improvement (Institute of Management Accountants, 2014).
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