Supply Chain Cost Control Using Activity-Based Management (Supply Chain Integration) (Sameer Kumar, Mathew Zander)

Supply Chain
Cost Control
Using
Activity-Based
Management
SUPPLY CHAIN INTEGRATION SERIES
Modeling, Optimization, and Applications
Sameer Kumar, Series Advisor
University of St. Thomas, Minneapolis, MN
Supply Chain Cost Control Using Activity-Based Management

Sameer Kumar and Mathew Zander
ISBN: 0-8493-8215-7
Financial Models and Tools for Managing Lean Manufacturing
Sameer Kumar and David Meade
ISBN: 0-8493-9185-7
Additional Titles in
RESOURCE MANAGEMENT SERIES
Handbook of Supply Chain Management, Second Edition Collaborative Manufacturing: Using Real-Time
by James B. Ayers Information to Support the Supply Chain
ISBN: 0-8493-3160-9 by Michael McClellan
ISBN: 1-57444-341-0
The Portal to Lean Production: Principles
& Practices for Doing More With Less The Supply Chain Manager’s Problem-Solver:
by John Nicholas and Avi Soni Maximizing the Value of Collaboration and Technology
ISBN: 0-8493-5031-X by Charles C. Poirier
ISBN: 1-57444-335-6
Supply Market Intelligence: A Managerial Handbook for
Building Sourcing Strategies Lean Performance ERP Project Management:
by Robert Handfield Implementing the Virtual Supply Chain
ISBN: 0-8493-2789-X by Brian J. Carroll
ISBN: 1-57444-309-7
The Small Manufacturer’s Toolkit: A Guide
to Selecting the Techniques and Systems to Integrated Learning for ERP Success:
Help You Win A Learning Requirements Planning Approach
by Steve Novak by Karl M. Kapp, with William F. Latham and
ISBN: 0-8493-2883-7 Hester N. Ford-Latham
ISBN: 1-57444-296-1
Velocity Management in Logistics and Distribution:
Lessons from the Military to Basics of Supply Chain Management
Secure the Speed of Business by Lawrence D. Fredendall and Ed Hill
by Joseph L. Walden ISBN: 1-57444-120-5
ISBN: 0-8493-2859-4
Lean Manufacturing: Tools, Techniques,
Supply Chain for Liquids: Out of the Box Approaches to and How to Use Them
Liquid Logistics by William M. Feld
by Wally Klatch ISBN: 1-57444-297-X
ISBN: 0-8493-2853-5
Disassembly Modeling for Assembly, Maintenance,
Supply Chain Architecture: A Blueprint for Networking Reuse, and Recycling
the Flow of Material, by A.J.D. Lambert and Surendra M. Gupta
Information, and Cash ISBN: 1-57444-334-8
by William T. Walker
ISBN: 1-57444-357-7 Back to Basics: Your Guide
to Manufacturing Excellence
ERP: Tools, Techniques, and Applications for by Steven A. Melnyk and
Integrating the Supply Chain R.T. Chris Christensen
by Carol A. Ptak with Eli Schragenheim ISBN: 1-57444-279-1
ISBN: 1-57444-358-5
Enterprise Resource Planning and Beyond:
Integral Logistics Management: Planning and Control of Integrating Your Entire Organization
Comprehensive Supply Chains, Second Edition by Gary A. Langenwalter
by Paul Schonsleben ISBN: 1-57444-260-0
ISBN: 1-57444-355-0
Restructuring the Manufacturing Process:
Introduction to e-Supply Chain Management: Engaging Applying the Matrix Method
Technology to Build by Gideon Halevi
Market-Winning Business Partnerships ISBN: 1-57444-121-3
by David C. Ross
ISBN: 1-57444-324-0 Inventory Classification Innovation:
Paving the Way for Electronic Commerce
Supply Chain Networks and and Vendor Managed Inventory
Business Process Orientation by Russell G. Broeckelmann
by Kevin P. McCormack and William C. Johnson ISBN: 1-57444-237-6
with William T. Walker
ISBN: 1-57444-327-5
Supply Chain
Cost Control
Using
Activity-Based
Management
Sameer Kumar
St. Thomas University, Minneapolis,
Minnesota, USA
Matthew Zander
Consultant, Rochester, Minnesota, USA
Boca Raton New York
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Library of Congress Cataloging-in-Publication Data
Kumar, Sameer.
Supply chain cost control using activity based management / by Sameer Kumar
and Mathew Zander.
p. cm. -- (Supply chain integration series)
Includes bibliographical references and index.
ISBN 0-8493-8215-7
1. Business logistics. 2. Activity-based costing. 3. Contracting out--Manage-
ment. I. Zander, Matthew. II. Title. III. Series.
HD38.5.K86 2006
658.7068’1--dc22 2006040492
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AU8215_C000.fm Page v Wednesday, June 14, 2006 1:41 PM
Dedication
To our families and friends

AU8215_C000.fm Page vi Wednesday, June 14, 2006 1:41 PM
AU8215_C000.fm Page vii Wednesday, June 14, 2006 1:41 PM
Preface
Outsourcing has become a predominant practice, and the cost of procured

components now makes up the majority of the cost in manufactured
products. The literature provides a method for supply-chain cost evaluation
called total cost of ownership and suggests the use of activity-based costing
to quantify it. Activity-based management can be used to manage activity-
based costs. This book discusses the competitive advantage that cost
analysis and management can bring to the companies within a supply
chain. It addresses a number of strategies for evaluating the total cost
inherent in a customer-supplier relationship and proposes a model, using
total cost of ownership (TCO), activity-based costing (ABC), and activity-
based management (ABM) for analyzing and controlling supply-chain
costs. It uses industry survey data to examine whether these techniques
are being used in real life, which factors affect their usage in the supply
chain, and whether they are producing results. Descriptive and statistical
analyses of the data are used to validate these observations, and a versatile
game theory matrix is combined with the survey results to suggest cost
reduction strategies in competitive environments and predict the outcomes
of these strategies. The results show the importance of partnerships in
applying activity-based management principles to suppliers and the pos-
itive results that use of activity-based management can have on elements
of the total cost of ownership.
Key Features
The book suggests the application of activity-based management methods
to manage product and service costs at suppliers and subsuppliers levels
vii
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viii Supply Chain Cost Control Using Activity-Based Management
and studies whether these methods are being used in industry in producing
meaningful results.
The key selling points of this book that will distinguish it from others
on the topic include:
It extends the total cost of ownership concept into the supply chain.
It studies actual effect of activity-based management concepts on
supplier related costs and overall competitiveness.
It studies actual effect that supplier partnerships have on applying
activity-based management principles to supplier-related costs.
It examines how interaction with competitive players in the
marketplace will affect adoption of cost evaluation and manage-
ment methods based on total cost of ownership and total life
cycle cost. Game theory can provide us with a tool to examine
these interactions.
It examines whether offshoring knowledge work increases share-
holder value.
It evaluates differences in elemental task learning curves in a
production line.
It presents major trends in supply chain innovations.
Contribution of the Book

Having an accurate assessment of the costs of doing business is a key to
staying in business. Seems pretty fundamental, but when a supplier in a
supply chain is working to create, design, and produce a piece of an
automobile or something some other firm will assemble and market,
understanding the real costs is often a moving target.
Keeping an accurate picture of these costs becomes even more impor-
tant as the members of supply chains become dependent on each other
and the industry they supply. This dependency actually has a cost asso-
ciated with it — a cost that is just beginning to be acknowledged. This
cost assessment beyond just purchasing and inventory costs is referred to
as a total cost of ownership.
Understanding the concept of total cost of ownership in a supply chain
escapes traditional cost accounting practices because traditional cost
accounting simply assigns costs to products and service lines. Activity-
based management is the only system that allows a manger to correctly
assess the costs involved in a tightly knit supply chain and enables
managers to understand not only the total cost of ownership, but how
these costs can and should be allocated in a supply chain for a member
of the supply chain to remain competitive and profitable.
AU8215_C000.fm Page ix Wednesday, June 14, 2006 1:41 PM
Preface ix
Organization of the Book

This book covers the subject of supply-chain cost contr ol through
activity-based management by addressing various related topics in the
following chapters:
Chapter 1 Activity-Based Management and Total Cost of Ownership
— An Overview
This chapter sets the stage for the research reported in this book. The
relationship between activity-based management and total cost of owner-
ship is also introduced. Some of the key factors with influence on total
cost of ownership in a supply chain that are described include outsourcing,
learning curves and supply chain costs analysis and control.
Chapter 2 Major Trends in Supply-Chain Innovations
This chapter exposes readers to significant trends taking place in innova-
tive supply-chain initiatives for a better appreciation of supply-chain costs.
It reviews the concept of the acceleration principle and its effects on the
manufacturing environment and also presents how various supply-chain
structures are forming across various industries.
Chapter 3 Elemental Task Learning Curve in a Production Line
This chapter presents an overview of learning curve with a focus on
elemental task learning curves in a production line. It helps in improved
product and process understanding when profits will occur based on plant
size and cumulative output.
Chapter 4 Offshoring Knowledge Work to Increase Shareholder Value
This chapter seeks to report how offshoring knowledge work has
become an important aspect of the American economy and the challenges
companies should consider before making the conversion. It is observed
that the benefits of utilizing low-cost labor in other countries not only
result in direct savings, but indirect savings as well. These indirect savings
are realized by reinvesting in more value-added activities across the
organization. Through a case study, it is shown how one company that
has announced it has offshored its work has relatively better year-to-year
performance than the other using the DuPont financial analysis model.
Chapter 5 Integrated Total Cost of Ownership and Activity-Based
Management Process Model
This chapter addresses a number of strategies for evaluating the total
cost inherent in a customer-supplier relationship and proposes a model,
using total cost of ownership (TCO), activity-based costing (ABC), and
activity-based management (ABM) for analyzing and controlling supply
chain costs, which can be integrated into a balanced scorecard (BSC)
management system. A hypothetical model, which is the basis of the TCO
process model, is also proposed. Eleven hypotheses are evaluated and
validated as part of this study.
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x Supply Chain Cost Control Using Activity-Based Management
Chapter 6 Methodology for Analysis

In this chapter the survey construct is described in detail. This includes
the attributes of subjects surveyed, survey instrument design, sample size,
profile of the survey participants’ organizations, and the organization of
the survey. Survey results were tallied at the macro level.
Chapter 7 Analysis and Findings
This chapter presents an analysis of the hypothetical model using
descriptive and statistical analyses of data gathered from a detailed survey
of companies in various industries. The results obtained from the analysis
are summarized. This is followed by a game theory analysis of the same
data to determine dominant TCO evaluation and management strategies.
Chapter 8 Conclusion and Recommendations
Finally, significant results realized from the research study show the
importance of partnerships in applying activity-based management prin-
ciples to suppliers and the positive results that use of this approach can
have on the total cost of ownership in a supply chain. Limitations of this
analytical work are outlined and a number of recommendations for future
possibilities to further investigate this topic are described.
References
The book provides a comprehensive list of up-to-date references on this
topic to enable readers to study various subtopics more in depth.
Appendix
The survey instrument used and the data collected from participants in
various industries are also included.
Acknowledgments
The authors would like to thank all those who helped us in bringing out
this book for publication. First and foremost we have greatly benefited
from the wealth of a vast array of published material on the subjects of
supply-chain cost, activity-based management, offshoring, learning curves,
total cost of ownership, and supply-chain management.
We would like to thank the reviewers of the manuscript of the book.
The contents of this book have benefited immensely from their valued
insights, comments, and suggestions.
AU8215_C000.fm Page xi Wednesday, June 14, 2006 1:41 PM
Preface xi
The authors are especially grateful to the participants of industry

surveys whose valued contributions facilitated enhanced understanding
of the focus of this book. Their efforts in providing quality responses to
questions were significant in validating research postulates. This book is
largely based on information derived from the analysis of survey data.
Names of participants are not listed here due to confidentiality of surveys
conducted. Both authors are indebted to their families, parents, and
friends for their support.
Finally, we wish to thank our editor, Raymond O’Connell, and the
entire production team at the Taylor & Francis Auerbach group for their
assistance and guidance in successful completion of this book.
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AU8215_C000.fm Page xiii Wednesday, June 14, 2006 1:41 PM
About the Authors
Sameer Kumar is a professor and Qwest Endowed Chair in global

communications and technology management in the College of Business
at the University of St. Thomas, Minneapolis, Minnesota. Prior to this
position he was a professor of engineering and technology management
at the University of St. Thomas. Before joining St. Thomas, Dr. Kumar
was a professor of industrial engineering in the Department of Industrial
Management, University of Wisconsin–Stout. His major research areas
include optimization concepts applied to design and operational manage-
ment of production and service systems.
He has been actively involved in a wide variety of challenging industry
projects for more than 25 years in the United States and India. He has
published and presented articles in various research journals and confer-
ences. He is a registered professional engineer, certified manufacturing
technologist, certified manufacturing engineer, and certified plant engineer,
and has earned master’s degrees in mathematics (University of Delhi),
computer science (University of Nebraska), and industrial engineering and
operations research (University of Minnesota). He received his Ph.D. in
industrial engineering from the University of Minnesota.
Matthew Zander is a procurement quality engineer at IBM where he

supports its engineering and technology services (E&TS) group in Rochester,
Minnesota. He graduated from Michigan Technological University in Hough-
ton with bachelor of science degrees in mechanical engineering and scientific
and technical communications and from the University of St. Thomas in St.
Paul, Minnesota, with a master’s degree in manufacturing systems engineer-
ing. He has previously worked in procurement cost engineering and server
software system documentation at IBM and held quality system internship
positions at Super Steel Products Corporation in Milwaukee, Wisconsin, and
General Motors Corporation Technical Center in Warren, Michigan.
xiii
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AU8215_book.fm Page xv Thursday, May 18, 2006 3:19 PM
Contents
1 Activity-Based Management and Total Cost of

Ownership — An Overview.........................................................1
Introduction ....................................................................................................... 1
References.......................................................................................................... 8
2 Major Trends in Supply-Chain Innovations ............................11

Introduction ..................................................................................................... 11
Influencing the Manufacturing Environment ................................................ 14
The Acceleration Principle ........................................................................ 14
Lead Time and Inventory Reduction Syndromes ............................... 14
Supply-Chain Structure ................................................................................... 15
References........................................................................................................ 22
3 Elemental Task Learning Curves in a Production Line ..........23

Introduction ..................................................................................................... 23
Learning Curves .............................................................................................. 24
Balancing Cycle Times ................................................................................... 27
Interrelationships of Elemental Task Learning Curves and Line Balance.. 28
Organizational Learning.................................................................................. 32
Conclusion ....................................................................................................... 33
Recommendation............................................................................................. 33
References........................................................................................................ 34
4 Offshoring Knowledge Work to Increase Shareholder

Value ............................................................................................35
Introduction ..................................................................................................... 35
Knowledge Work ............................................................................................ 37
Drivers of Knowledge Work Offshoring ....................................................... 37
Benefits to Business........................................................................................ 42
Economic Implications ................................................................................... 44
xv
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xvi Supply Chain Cost Control Using Activity-Based Management
Drawbacks and Risks ..................................................................................... 45

Offshore Locations .......................................................................................... 46
Case Study ....................................................................................................... 48
Conclusion ....................................................................................................... 52
References........................................................................................................ 53
5 Integrated Total Cost of Ownership and Activity-Based

Management Process Model ......................................................55
Introduction ..................................................................................................... 55
Literature Analysis ........................................................................................... 56
Process Models................................................................................................ 67
Hypothetical Model......................................................................................... 70
Game Theory .................................................................................................. 74
References........................................................................................................ 75
6 Methodology for Analysis..........................................................79

Introduction ..................................................................................................... 79
The Survey Construct ..................................................................................... 79
Data Analysis................................................................................................... 83
7 Analysis and Findings................................................................89

Introduction ..................................................................................................... 89
Hypothesis Testing.......................................................................................... 89
Results ............................................................................................................ 140
Game Theory Analysis ................................................................................. 146
8 Conclusions and Recommendations ......................................153
Appendix A
Survey Instrument ............................................................................157
Appendix B
Survey Data .......................................................................................167
Index..................................................................................................217
AU8215_book.fm Page 1 Thursday, May 18, 2006 3:19 PM
Chapter 1
Activity-Based
Management and Total
Cost of Ownership —
An Overview
Introduction
This book explains the competitive advantage that cost analysis and
management can bring to the companies within a supply chain. It
addresses a number of strategies for evaluating the total cost inherent in
a customer–supplier relationship and proposes a model, using total cost
of ownership (TCO), activity-based costing (ABC), and activity-based
management (ABM) for analyzing and controlling supply-chain costs that
can be integrated into a balanced scorecard (BSC) management system.
Industry survey data is examined using descriptive and statistical analyses
to determine whether these techniques are being used in real life, which
factors affect their usage in the supply chain, and whether they ar e
producing results.
Whereas most businesses and enterprises conduct some form of bud-
geting and trend analysis to plan and forecast, many tools and techniques
have evolved over the years to measure performance, control costs, and
improve service. Some of these management tools include ABC, ABM,
1
2 Supply Chain Cost Control Using Activity-Based Management
1.
Customers
served Activities Resources Costs
by consume have
2.
Costs
assigned Resources
assigned Activity Costs
to to Pools Objectives
Figure 1.1 Activity-based costing model.
benchmarking, process improvement, process reengineering, Total Quality

Management (TQM), balanced scorecard, and Six Sigma.
Activity-based costing (ABC) is a procedure that measures the cost of
objects, such as products, services, and customers. ABC first assigns
resource costs to the activities performed by the organization, and activity
costs are then assigned to the products, customers, and services that
benefit from or create the demand for the activities (Kidwell et al., 2002).
Morse et al. (2003, pp. 184–185) summarize the concepts underlying ABC
(see Figure 1.1):
1. Activities performed to fill customer needs consume resources that

cost money.
2. The cost of resources consumed by activities should be assigned
to cost objectives on the basis of the units of activity consumed
by the cost objective. A cost objective is typically a product or
service provided to the customer.
ABC is a relatively new approach to cost assignment. However, because

of its ability to provide more detailed and relevant analysis of costs for
internal decision making, it is gaining recognition as being superior to
cost assignment systems traditionally used for financial reporting. On the
other hand, each ABC system needs to be designed to fit the needs and
circumstances of a particular organization, which make the implementation
of ABC systems expensive and time consuming. As a result, some com-
panies decide to only develop ABC data for processes that management
deems critical for success (Morse et al., 2003, p. 191).
Activity-Based Management and Total Cost of Ownership 3
ABC data enables managers to engage in ABM. ABM consists of

performing activities more efficiently, eliminating activities that do not
add value for customers, improving delivery of services, and developing
better relationships with customers and suppliers. The goal of ABM is to
satisfy customer needs while making fewer demands on organizational
resources (Kidwell et al., 2002). ABM focuses managerial attention on
what is most important among activities performed to create value for
customers. One way to do this is to classify each activity as value-added
or non-value-added. Management can evaluate and either streamline,
reduce, or eliminate non-value-added activities to save time and money.
Once this is done, it can then address the more difficult task of reducing
cost for value-added activities (Morse et al., 2003, pp. 193–194). Again,
ABM is a major undertaking, and, in spite of its benefits, adoption remains
low because of the time and resources involved in successful implemen-
tation (Gourdie, 2001).
Benchmarking is the process of studying and comparing how other
organizations perform similar activities and processes. The other organi-
zations are generally selected because of their excellent performance of
the benchmarked process (Kidwell et al., 2002). It encompasses both
measurements and practices into a systematic and disciplined approach
that stresses emulating (or “creatively swiping”) and implementing best
practices (Kolarik, 2002). When executed well, benchmarking reveals gaps
between the performance of the benchmarker and that of the bench-
marked “best practices” leader, and often suggests what needs to be done
to close these gaps (Stauffer, 2003). One of the biggest mistakes made
when beginning a benchmarking endeavor is looking only at companies
within the same industry or benchmarking the competition. But what if
the competition is worse than one’s own company? Instead, the bench-
marking team should evaluate a company that is well known for being
a good model of successful business practices and processes. Another
mistake companies make is measuring what is easy rather than what is
needed (Stauffer, 2003; Forst, 2003). But this can fail to provide actionable
information, something that is sufficiently detailed for a unit manager to
make changes that improve performance. Instead, a company should
examine the factors that are most important to a customer, and then
identify companies that excel in each factor.
With process improvement, or continuous improvement, an organiza-
tion’s employees constantly evaluate products, services, and processes,
seeking ways to do better. Some companies have the goal of drastically
reducing costs or radically improving quality or service. In such cases, it
may be necessary to reinvent or reengineer a process instead of simply
improving it (Morse et al., 2003). Process reengineering is a technique that
has been described as “the fundamental rethinking and radical redesign
of business processes to achieve rapid and dramatic improvements in

critical contemporary measures of performance, such as cost, quality,
service, and speed” (Hammer and Champy, 1993). Based primarily on the
works of Thomas Davenport, J.E. Short, and Michael Hammer, reengineer-
ing creates new processes to displace the old ones (Selladurai, 2002).
Reengineering was embraced in the 1990s with its promises, but then
disappeared around 1997 when, in spite of how good it sounded, it was
too vague and technologically challenging for users to apply successfully
(Clermont, 2001). Today, it has reappeared under different names owing
to the ease of accessing information via the Internet, as well as the new
generation of powerful, flexible software packages that enable companies
to integrate systems and extract real-time information.
TQM, based on the ideas of Edward Deming, Joseph Juran, and Philip
Crosby, aims to improve the processes within an organization by empha-
sizing continuous quality improvement through focus on implementing
incremental change with minimal variation to existing processes (Selladu-
rai, 2002). It is a management-led, organization-wide commitment to
quality, as defined by both internal and external customers. It requires
the development of a clear vision of what the organization does, what its
values and goals are, and how it is going to achieve them. TQM focuses
on understanding customers and their needs, as well as the needs of
employees, while focusing on processes (Kidwell et al., 2002). It also
proclaims the values of teamwork and employee participation, the use of
reasoning-based statistical analysis of factual data, and the training of
employees and managers across the organization. Although TQM has its
share of critics, many others have expressed strong and continued support
of the management technique (Selladurai, 2002).
A balanced scorecard, established by Robert Kaplan and David Norton
in the early 1990s, is a set of measures that give top managers a fast but
comprehensive view of the business. It complements traditional financial
measures with other nonfinancial, operational measures. Based on a firm’s
overall strategy, the scorecard typically contains a diverse set of 16 to 28
measures, commonly organized into four categories (see Figure 1.2):
customer satisfaction, internal processes, and the organization’s learning
and growth activities — operational measurements that are the drivers of
future financial performance (Kaplan and Norton, 2005; Gumbus, 2005;
Kidwell et al., 2002; Salterio and Webb, 2003; Jensen and Sage, 2000).
Four processes are involved in managing a balanced scorecard, and
they follow the “plan, do, check, and act” sequence of Shewart and
Deming in an iterative manner: business planning, feedback and learn-
ing, clarifying and translating the vision, and communicating and linking
(Jensen and Sage, 2000). The balanced scorecard can help management
form a link between long-term strategic objectives and short-term actions
Financial Perspective
Objectives: Measures:
Improve Return on
profitability Investment
Customer Perspective Internal Business Process Perspective

Objectives: Measures: Objectives: Measures:
Improve customer Repeat sales; Improve Orders filled
loyalty Response time processing quality w/out error; On-
per customer time delivery
request
Learning and Growth Perspective

Objectives: Measures:
Improve staff Employee
skills productivity;
Hours of
training/employee
Figure 1.2 Categories of a balanced scorecard.
(Kidwell et al., 2002). Proponents of the scorecard claim that it clarifies

and translates the firm’s vision and strategies, communicates and links
strategic objectives and measures, enhances strategic feedback and
learning in the firm, and helps plan, set targets, and align initiatives.
The success of planning, target-setting, and aligning performance mea-
sures to strategic initiatives often depends on whether the managerial
performance evaluation system directs managers’ attention to those
areas. They found that if the manager’s compensation was tied to the
results of the scorecard, the likelihood of the success of the objectives
being met was increased.
Six Sigma is a business improvement approach that seeks to find and
eliminate causes of mistakes or defects in business processes by focusing
on outputs that are of critical importance to customers. As a result, process
performance is enhanced, customer satisfaction is improved, and the
bottom line is impacted through savings and increased revenue (Bisgaard
et al., 2002). It is a strategic approach that works across all processes,
products, and industries. Six Sigma is also a measure of process perfor-
mance. The ability to produce products and services with only 3.4 defects
per million would yield a Six Sigma process that is considered to be
world-class performance for many processes (Knowles et al., 2005; Meyer,
2005; Folan and Browne, 2005).
Some believe these management tools and techniques are helpful in

meeting the challenges of increased accountability, whereas others dismiss
them as merely a fad (Kidwell et al., 2002, pp. 63–66). Many of the
performance tools, including benchmarking, continuous improvement,
reengineering, TQM, and Six Sigma, are variations of emulating how others
do business. However, with most initiatives implemented by companies
eager to outshine and outperform the competition, the emphasis is placed
on instilling a new work culture within an existing one, without the benefit
of a theoretical foundation to justify, tailor, and guide this superposition.
Kolarik (2002) believes this may be the reason for the relatively low
success rates associated with these well-intended efforts.
Recently, the term outsourcing has taken on a distinct and politically
charged definition: the exportation of labor, both manufacturing and
technical services, to overseas locations such as China and India where
labor costs are lower than in the United States. This is just the latest
permutation, however, on a process that has been ongoing for several
decades. In this larger context, outsourcing means taking activities that
exist within the company or firm and transferring them to a supplier
company or agency outside of the original company. For example, a
manufacturing operation that was once vertically integrated into the com-
pany’s operations could be contracted out to another manufacturing
company that specializes in that type of manufacturing activity. Even the
supplier management activity itself can become a target of outsourcing
(Maltz and Ellram, 1999).
Companies outsource for numerous reasons. The outsourced supplier
specializes in the activity and can conduct it much more efficiently than
the purchasing company. This sometimes means that the purchasing
company can gain access to supplier-owned technology that it might not
otherwise have (Tully, 1994; Ehie, 2001; Angeloni, 2002). Eliminating the
activity in the original company frees up fixed resources such as labor
and overhead (Ehie, 2001; Angeloni, 2002). It provides the flexibility to
switch product offerings on a relatively short-term basis through workforce
balancing and accelerated product development (Tully, 1994; Ehie, 2001).
Costs can be reduced by taking advantage of the contracted manufacturer’s
economy of scale (Ehie, 2001).
Whereas many companies once had monolithic vertical supply struc-
tures (own facilities that produced parts and subassemblies), most now
focus on their core business, often just developing and marketing their
end product. Parts and subassemblies are manufactured, and often
designed, by suppliers and vendors. Some do not even view themselves
as manufacturers anymore but as service providers, providing a linkage
between end consumers and the manufacturer. This is particularly true in
the electronics and automotive industries, in which the modularity of the
products allows for easy outsourcing of manufacturing (Tully, 1994),

though recent downturns in the electronics market are pushing contract
manufacturers to diversify into other industries (Serant, 2002).
This has led to the development of supply chains, interconnected and
highly dependent networks of companies that take products and services
from concepts and raw materials all the way to the end customer. These
organizations really came to prominence in the 1980s, as companies sought
to enhance competitiveness by containing costs, enhancing product value,
compressing the time to market, creating channel efficiency, and becoming
more responsive to customers (Cavinato, 1991). As the outsourcing trend
continues, companies will not merely compete against each other, entire
supply chains will. The new strategy of supply chains will use a new set
of principles: the only entity that puts money into the supply chain is the
end customer, and the only viable solutions ensure that every element of
the supply-chain profits. Therefore, supply-chain management is about
economic value and total content; price is not the only issue anymore
(Handfield, 2002, Johnston, 2004).
To stay competitive, the companies that sit within these supply chains
will need to understand and influence the costs within their supply chains.
Marien and Keebler (2002) have suggested that there are six stages of
cost focus in a company’s supply chain.
Stage 1: Functional cost minimization — functional areas look to

reduce their individual costs, often with cost penalties elsewhere
in the system.
Stage 2: Lowest delivered cost — company looks to minimize costs
on acquired and delivered goods and services, often by looking
at trade-offs in purchasing, transportation, and asset management.
Stage 3: TCO — company begins to examine inventory and asset
carrying costs.
Stage 4: Enterprise value-add costs of sales — company begins to
look at the costs beyond the mere costs of material ownership,
e.g., sales and marketing, engineering, technical support, IT, etc.
Stage 5: Interenterprise value-add cost with immediately adjacent
trading partners — examines trade-offs and best working relation-
ships with the immediate customer and supplier in the supply chain.
Stage 6: Lowest end-user-delivered supply-chain cost — examines
trade-offs and services between all members of the supply chain
with focus on the ultimate end user.
The supply-chain cost perspective is migrating toward a total view of

the system both upstream and downstream, beyond just purchasing and
inventory costs (Handfield, 2002).
In this environment, purchasing takes on a critical role. In most supply-

chain situations, procurement organizations become the manager of the
wide and varied relationships with vendors, channeling communications
from customer to vendor and leveraging buying power to the company’s
advantage (Cavinato, 1991). They manage increasing amounts of the com-
pany’s overall expenses. Cavinato (1992) estimated that the cost of pro-
curement specification and acquisition is 55 to 60 percent of the total cost
in manufacturing firms. Carr and Ittner (1992) estimate that purchase mate-
rials, components, and subassemblies represent over 70 percent of manu-
facturing expense; Ellram (1995) placed it at 63.5 percent of total cost in
manufacturing firms and 25 percent in nonmanufacturers. More recently,
Handfield (2002) puts the cost of managing the supply chain at 56 percent
of revenue in average manufacturing companies, increasing as one looks
at more high-technology industries. Also, each dollar cut from the cost of
purchasing generates the same bottom-line effect as increasing sales by $17
(Handfield, 2002). In a competitive worldwide market with thinning mar-
gins, purchasing finds itself under pressure to reduce procurement costs.
References
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overhead and increase yields, Military and Aerospace Electronics, August
2002, p. 30.
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Six Sigma quality, ASQ’s Annual Quality Congress Proceedings, 701–704.
Carr, L.P. and Ittner, C.D. (1992), Measuring the cost of ownership, Cost Manage-
ment, Fall, 42–51.
Cavinato, J.L. (1992), A total cost/value model for supply chain competitiveness,
Journal of Business Logistics, 13(2), 285–301.
Cavinato, J.L. (1991), Identifying interfirm total cost advantages for supply chain
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a survey study, Production and Inventory Management Journal, Fall,
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link, Journal of Cost Management, 8(4), 22–30.
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mance measurement system, Production Planning and Control, 16(6),
531–544.
Forst, L. (July 2003), Benchmarking success hinges on internal data, Industrial
Management, 20–23.
Gourdie, S. (November 2001), Tools of the Trade, Financial Management (CIMA),

38–39.
Gumbus, A. (2005), Introducing the balanced scorecard: creating metrics to mea-
sure performance, Journal of Management Education, 29(4), 617–630.
Hammer, M. and Champy, J. (1993), Reengineering the Corporation: A Manifesto
for Business Revolution, New York: Harper Business.
Handfield, R. (December 2002), Reducing Costs across the Supply Chain, Optimize,
54–60.
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of organizational performance measurement systems, Information Knowl-
edge Systems Management, 2(1), 164–174.
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Business School — Working Knowledge. Available at http://working
knowledge.hbs.edu/item.jhtml?id=4170&t=operations.
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Drive Performance, Harvard Business Review, 83(7–8), 172–180.
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management techniques: an international comparison, The CPA Journal,
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for the application of Six Sigma methodologies to supply chain improvement,
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Supply Chain Management, 35(2), 4–17.
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can’t measure the performance of the firm?, Journal of Management
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Chapter 2
Major Trends in
Supply-Chain Innovations
Introduction
New supply-chain initiatives inundated the marketplace in the past decade,
starting with just-in-time inventory management to collaborative product
commerce (see Table 2.1). Supply-chain programs launched have been
successful in saving billions of dollars for a large number of companies
though such programs failed to achieve optimal results for some compa-
nies (Koch, 2004). Successful supply-chain initiatives can make it possible
for companies to meet customer needs more quickly, less expensively,
and through more channels. Better-quality and more reliable goods can
reach the market sooner. Mass-customized products and services can
become a reality (McVey and Cundiff, 2005; Ertek and Griffin, 2002; Koch,
2002; Iyer and Bergen, 1997).
Essentially, five major supply-chain management (SCM) innovations
trends are currently taking shape (Poirier and Quinn, 2004):
The front end of the supply chain is becoming as important as the

back end in maximizing total economic yield. Historically, SCM
dealt largely with vendors, making companies focus on improving
logistics or the back end of the supply chain. Demand now
manifests itself in many more ways — through online marketplaces
or partnerships — causing companies to increase their emphasis
on the supply chain’s front end. As a result, front-end SCM —
11
Table 2.1 A Decade of Supply-Chain Initiatives

Year/Period Initiatives
1992 Lean manufacturing/just-in-time

Third-party logistics
Quality circles
Manufacturing resource planning II
Warehouse management
Manufacturing execution systems
During 1993–1994 Supplier integration
Manufacturing outsourcing
Total Quality Management
During 1994–1995 Product data management
During 1995–1996 Integrated product and process development
Advanced planning and scheduling
During 1996–1997 Enterprise resource planning
1997 Six Sigma
1998 Product life cycle management
During 1998–1999 Integrated supply chain
Collaborative planning
1999 Customer relationship management
During 1999–2000 eProcurement
eFulfillment
2000 Exchanges
2001 Collaborative product commerce
understanding and responding to customer needs — is becoming

an inextricable part of supply-chain strategy. Companies with front-
end capabilities should be better able economically to make what
the market wants and sell what they have in stock, thus enhancing
top-line and margin growth.
As companies migrate from internal-only to extended supply chains,
collaboration is becoming the most strategic capability. Companies
that manage their businesses the old-fashioned way — by taking
orders, buying supplies, building products, and shipping them from
the warehouse — may lose out to businesses that focus their
energies on design, brand management, sales, and marketing, and
outsource the rest. Supply chains are becoming complex for any
one entity to manage in a competitively dominant way.
Assets and functions that are not core to value delivery may be
entrusted to specialists. Companies usually outsource noncore func-
tions to the lowest bidder. This is becoming a riskier strategy,
Major Trends in Supply-Chain Innovations 13
because vendors operating on slim margins are increasingly unable

to match the types or levels of service offered by other operators.
Leading companies are finding new ways to do business, perhaps
through shared-profit arrangements in which suppliers benefit from
their success. Companies can substitute new, variable-cost out-
sourcing contracts for owned fixed assets such as trucks and
warehouses, thus reducing capital on the books and using only
the capacity that is needed rather than owning the excess.
The greatest margin potential may occur after a product ships, as
service and support become as important as the product itself. With
more customers seeking solutions instead of specific products or
brands, a growing number of goods are becoming commodities
that are mass-produced, low-priced products. Responding to this
trend, supply-chain winners are working harder to bundle great
products with strong service offerings, thereby maximizing long-
term customer profitability and catering to customers’ increased
emphasis on total cost of ownership. Customers are increasingly
purchasing those products that are conduits for content or services
that exceed the intrinsic value of the product itself (Dumond, 2000).
Further, business customers are changing their focus from procur-
ing a product based on its attributes alone to valuing the total
service provided, such as maintenance and operational reliability.
As a result, connecting product sales to the service network is
becoming a prime value driver for many companies. supply-chain
executives are needed to deliver not only the initial product, but
also an ongoing stream of products and services to the consumer
— often through different channels and even different locations.
These changes have added complexity to most companies’ supply-
chain operations, but they also have become a major source of
revenue and profit growth.
The ability to integrate new and innovative capabilities with cor-
porate business models is driving higher levels of value creation.
A company’s ability to adapt and change itself is becoming even
more critical. Part of the reason is collaboration. Companies
positioned to work efficiently with multiple partners are getting
most of the action, and those that are difficult to work with are
being ignored. Rapid and virtual partnering also is the key to
new SCM strategies, as the best integrators work together to attain
the biggest prizes.
The rest of the chapter examines the influence of acceleration principle

on manufacturing environment and describes how the structure of supply
chain is evolving.
Influencing the Manufacturing Environment

The following section describes the effects of acceleration principle on
the manufacturing environment.
The Acceleration Principle

Jay Forester at MIT created a management training exercise in the 1950s
called “The Beer Game” (Sherman, 1997). It was designed to simulate
how products and information flow through multiechelon supply chains.
The result of this simulation is what has been called the “Forester’s Effect,”
or the acceleration principle. Simply stated, a 10 percent change in the
rate of sale at the retail level can result in a 40 percent change in demand
for the manufacturer. The acceleration principle results in two side effects
that are described in the following subsections.
Lead Time and Inventory Reduction Syndromes

All business organizations involve two flows: material and information.
The Beer Game only exposes the top layer of problems that manufacturing
firms face today with managing these flows. Functional silos within each
company affect the flow of information and materials in the same manner,
as multiple companies do in the supply chain. Batch pr ocessing of
information creates an acceleration principle within the organization.
Distorted demand data and delayed information become commonplace,
creating several other conditions. The first is a reaction typical of purchas-
ing personnel and production planners. This reaction is referred to as the
“lead time (or safety stock) syndrome,” and is illustrated in Figure 2.1.
The effect continues to escalate and soon leads to the fatal mistake of
increasing capacity based on this condition. This capacity increase is not
without a corresponding cost increase.
Eventually, the overload is relieved because increased capacity floods
the supply chain, causing the second effect from distorted demand data,
“the inventory reduction syndrome,” as shown in Figure 2.2. This effect
is the result of the organization addressing excess inventory created by
the first syndrome. Without process change, these two syndromes feed
each other in a continuous loop. Eventually, another silo is established
in the organization specifically chartered to run promotions, targeted at
reducing excess inventory with the hope of increasing market share. This
action is equally as fatal as increasing capacity. The organization has now
combined perpetual reductions in sales prices from the inventory reduction
syndrome with increasing production costs from the lead time syndrome
(Plossl, 1991).
Orders Exceed Capacity in

House or at Supplier
Shortage Increase Lead Times Are Increased
Increase lead Times / Safety

Lead Times Get Longer Stock and More Orders Are
Released
Backlogs Get Larger
Figure 2.1 The lead time/safety stock syndrome.
Capacity Exceeds Demand
Capacity Needs Are Inventory Becomes

Established on Artificial Excessive
Demand
Production / Purchasing Plan Sales Promotions Create

Using Historical Trends Artificial Demand
This Artificial Demand

Reduces Inventory
Figure 2.2 Inventory reduction syndrome.
In a growing market, the combination of these two effects is consumed

by the growth in demand. Companies can survive and even flourish
during this growth period, in spite of the oscillating cycle to focus on
reducing inventory during one time period, then expedite product regard-
less of cost during the next period. When the market experiences a
plateau or drops off at this time, the organization can spiral itself right
out of existence.
Supply-Chain Structure
A new trend in SCM is to structure the supply chain less rigidly and more
flexibly. These new flexible supply chains are sometimes called virtual
supply chains (Poirier and Reiter, 1996) or value web. A value web is a
constantly evolving virtual enterprise in which members regularly reform
their services, evaluate their customer relations, and coinvent products
and services with customers. Most of the Fortune 1000 enterprises are
already utilizing some form of value web management (VWM), ranging
from ERP to Web sites, but the real power of VWM will be unleashed
when these forms converge. VWM represents another plateau of excellence
in enterprise design and performance (Andrews and Hahn, 1998).
A company’s supply-chain structure may depend on the maturity of
their markets, products, customer relationships, etc. A start-up group may
have to begin with a loose virtual chain in which there is no formal long-
term supplier organization. They will not have the steady business that
large, existing firms have, so they bid their suppliers on a job-by-job
basis. They need a competitive advantage to charge a higher price to
compensate for their high initial costs. As they gain market share and
work with their suppliers to find ways to lower costs, they can either
make an optimized rigid chain with dedicated suppliers, or perfect their
virtual chain. Either way, their costs will decrease as volumes go up,
supplier–firm cooperation increases, and all firms determine ways to
lower operational and inventory costs.
Small (flexible, low-volume, start-up) firms favor working with small
(flexible, low-volume, start-up) suppliers with excellent service. Small firms
need a product performance advantage to overcome the lowest-price
pressure. It would be very difficult for a start-up to create the lowest-
price product in the market without a technical breakthrough in production
costs, because initial supply-chain costs will be high. Their low volumes
do not allow them to carry large inventories (high service) or low price
(economies of scale).
Large firms favor working with other large firms with similar rigid
structures, economies of scale, strict quality systems, and proven records
of accomplishment. They can handle larger inventories (better service)
and get lower prices from economies of scale (if the orders are there).
An exception might be a strong cross-functional team in a large firm that
is given relative autonomy and acts like an entrepreneurial start-up. They
might be able to gain the benefits of both large firms (economies of scale,
strict quality systems, better service, and a proven track record) while still
being lean and responsive.
In addition, the maturity of the market influences decision. In a mature
market, suppliers will already have good operational efficiency built into
their business model. This lessens the entry cost into that market for start-
ups. However, the start-up will still need an advantage to overcome the
lessened, but still-real price difference. The choice between a rigid or
virtual supply chain in a mature market would depend on the number of
Table 2.2 Purchasing Excellence versus Supply-Chain Management

Purchasing Supply-Chain Management
Functional excellence Enterprise impact

Tactical/transactional Strategic
Focus on better buying Focus also on linkages with multiple
People purchasing experts business elements
Measures are tactical and Broad business knowledge and skills
internalized Measures with business impact and
Communicating with suppliers cross-functional goals
Integrating suppliers
quality suppliers that fit the particular needs of the customer in the relevant
market niche. With only one or just a few quality suppliers, a virtual chain
may not be feasible, and a rigid chain may be necessary.
Many in industry may take the view that SCM is merely good purchas-
ing. SCM is in fact the linking of the business elements such as supplier,
buyer, and customer, and aligning them to better achieve mutual business
goals. Table 2.2 differentiates purchasing excellence from SCM.
The supply marketplace has changed the need for suppliers to under-
stand complex customer organization to be effective. Relationships
between suppliers and customers have become more complex. Figure 2.3
depicts relationships in the past and as they are today.
As a result, suppliers are reducing their customer base. They are
focusing on competencies, market segmentation (essentially to make sure
who they can serve best), identifying strategic customers (only strategic
customers are served directly whereas others are served through distrib-
YESTERDAY TODAY/FUTURE
MANUFACTURING
MANUFACTURING DESIGN
CUSTOMER DESIGN
SUPPLIER
SUPPLIER QUALITY MARKETING
TOP
STRATEGIC SUPPLY MANAGEMENT
PURCHASING MANAGEMENT TACTICAL
ACQUISITION
MANAGEMENT
Figure 2.3 More complex relationships between supplier and customer today.
YESTERDAY TODAY/FUTURE
Supply Base Customer Base
A B C D A B C D
CUSTOMER CUSTOMER
“Buy from me ! “Sell to me!

Here is why…” Here is why…”
Figure 2.4 Shows era of reverse marketing.
utors), sharing technology roadmaps, and integrating their global supply

chains so that strategic customers get materials and services with minimum
effects of any allocations. As such, customers need to be perceived as
significant to their suppliers for the best service.
There has been worldwide allocation of critical materials and services.
Thus, the challenge is whether a customer (a manufacturer of consumer
product) is able to get all the strategic materials it needs to support its
growth. A customer needs to grow its business without supply constraints.
Two major issues confront a customer in the supply marketplace. The
first is whether a customer (manufacturer) can easily meet its rapidly
changing time-to-market goals. The second is whether suppliers are play-
ing a bigger role in the success of new products. Clearly, cycle times for
introducing new products are shrinking. Suppliers are managing their
globally distributed customers as one customer. Customers should also
manage their globally distributed suppliers as one supplier. Customers
must leverage their global business and buying power effectively. There-
fore the question is, how should we react? With all these changes occur-
ring, do we think there is the need to have a strategy for supply? One
interesting strategy is reverse marketing, proposed by Michiel R. Leenders
of the University of Western Ontario. As shown in Figure 2.4, the buyer
was passive in the past, whereas the buyer is now more proactive. As a
result, suppliers are now reducing their customer base.
So, the supplier relations in the 2000s have been more strategic in
nature, multifunctionally integrated with increased sharing of information
and technology. Such relationships have been less legally binding, with a
focus on improving the process, and involve total cost, cycle time, and
Table 2.3 Elements of a Successful Partnership Alliance

Partnership Elements
Commitment
Long term
For better or worse
Resource sharing (not just material)
Need companywide buy-in, not just a supply or sales program
Communication
Open
Multifunctional
Frequent
Trust
Understanding of each other’s businesses
Demonstrated mutual benefit
Extra value achieved by both parties
Beyond traditional buy/sell relationship
quality goals for the life of the product. Finally, such interactions are more
focused on solutions while recognizing the benefit of a “win-win” approach.
We see more and more partnering strategy among customers and
suppliers resulting in forming supplier alliances. The latter is the process
of partnering with key suppliers to bring them on the manufacturer’s
(customer) team as an extension, not only of its business, but also of the
customer’s commitment to world-class excellence in the products and
services provided to the manufacturer’s customers. The selection criteria
include the following: Every supplier cannot be an alliance partner, and
suppliers of strategic value should be the candidates for strategic alliance.
Such suppliers should be unique or at least possess preferred capabilities,
and also be technology leaders and have similar goals as the manufacturer.
The selection process may include obtaining supplier commitment and
the nomination and approval of the supplier by customer’s cross-functional
steering committee which consists of supply management, development
engineering, new-product-introduction engineering, manufacturing, and
marketing. The customer’s (manufacturer’s) and supplier’s commitment to
supplier alliance partnership include a mutually beneficial relationship,
open and honest communication, professional and ethical conduct, accu-
rate and timely performance feedback, first opportunity to supply new
designs, and being involved in customer’s business and a long-ter m
relationship. Table 2.3 lists the characteristics of healthy customer–supplier
alliance partnership.
From this partnership, the customer should strive to realize value from
suppliers. Value may be defined as the ratio of benefits to costs incurred.
Table 2.4 A Win-Win Scenario between Customer and Supplier

Releases
Consignment Direct Floor from Rolling Resident at
Inventory Stocking Forecast Customer
More business X X X
Access to new designs X
Stabilized production X X X
Fewer transactions X X X
Quicker payments X
Less selling expense X X X
Assured sales X X X
Access to information X X
earlier
So, the customer needs to reengineer its mindset and allocation of time
and resources to improving benefits versus just focusing on the price it
pays to the supplier. The value from suppliers will result in customized
supply solutions. In other words, customers would like to be beneficiaries
of solutions to their business problems, and not just a box delivered to
their dock. Suppliers should be working with customers on lead times to
establish rapid replenishment times and also to reduce the number of
transactions it takes to do business. To achieve such goals would require
suppliers working closely with customers in establishing joint business
operating systems such as Kanban, Faxban, floor stocking, rolling forecasts,
capacity reservation, and consignment inventory. They can utilize the
following steps for each item or commodity: (1) Create a demand profile,
(2) Create a supply profile, (3) Evaluate and establish improvement goals,
and (4) Develop customized supply solutions to meet the goals. The point
is, if a customer wants a world-class supplier, it must itself be a world-
class customer. Table 2.4 provides conditions to attain win-win scenario.
If a customer (manufacturer) wants to improve the flow of materials
from its suppliers, the customer in turn must improve the flow of infor-
mation to its suppliers, as Figure 2.5 illustrates.
A company should organize for success by choosing the following
guidelines:
1. Organizational level at supply management equals to engineering,

manufacturing, and marketing; not a subset of another function
and no filtering of communications.
2. Segment supply management into strategic elements such as:
a. Strategic, tactical, transactional
Material or Services
CUSTOMER SUPPLIER
(MANUFACTURER)
Information
Figure 2.5 Be a world-class customer.
b. Future oriented versus today oriented

c. Technical, administrative
d. Colocate people for success
e. Get the best people: A new profile of the supply professional
i. Degreed: Supply chain, operations management, or
engineering
ii. MBA for business and financial basics
iii. Strong interpersonal skills, creative, innovative, etc.
f. Positive, supportive, involving, and challenging work environment
Table 2.5 provides a list of traditional and SCM performance measures.
Table 2.5 Traditional and SCM Performance Measures List

Traditional Measures SCM Measures
On-time delivery Percentage of components on new

Incoming quality defects product from preferred suppliers
Supplier price reductions Percentage of total expenditures from
Supplier lead time preferred suppliers
Dollars and number of purchase Number of customer quality issues
orders per buyer because of suppliers
Product cost reduction
Number of resident suppliers
Working capital reductions
Operating profit impact from supplier
cost reductions
Number of business initiatives jointly
sponsored by supply and other business
functions
Material replenishment cycle time
In summary, measures of success in SCM should be more strategic,

has higher-level business impact, requires cross-functional participation
and cooperation, should be reported broadly, and should lead to change.
References
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value webs, Strategy and Leadership, 26(3), 6–11.
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Chapter 3
Elemental Task
Learning Curves in a
Production Line
Introduction
There have been many studies of learning curve impact in manufacturing
processes; almost all of them look at the aggregate decreased production
cost due to learning curve impacts. Similarly, the study of balancing
production line elements by cycle time has been near exhaustive. But,
the interrelation of line balancing and elemental task learning curves,
along with the related concept of throughput time, has received little
attention (Smunt and Watts, 2003). As background for the ultimate hypoth-
esis, this chapter will briefly explain the learning curve concept and the
concept of elemental task line balancing. It will then postulate that a line’s
aggregate learning curve is a function disproportionately impacted by the
line’s elemental task with the worst learning curve. It will then hypothesize
that learning curves for elemental tasks are not static and can be manip-
ulated to achieve better line balancing and, ultimately, further cost reduc-
tion through decreased throughput time. Ultimately, it concludes that
owing to elemental task learning curves, a line design must be flexible
enough to change to achieve proper balance and to achieve continuing
improvement in throughput time.
23
Learning Curves
Citing Linda Argote’s textbook on organizational learning, Macher and
Mowery (2003) indicate that the literature on “learning by doing” and
manufacturing performance is extensive. The basic theory is that experi-
ence lowers cost or speeds up production. As Farghal and Everett (1997)
noted, the time or cost required to perform one cycle is less than that
required to perform the previous cycle. The learning curve was adapted
from historical observations that individuals (or organizations) that perform
repetitive tasks exhibit an improvement over time.
The learning curve measures the impact of workers’ experience on
the costs of production. It describes the relationships between a firm’s
cumulative output and the amounts of inputs needed to produce a unit
of output.
Learning (or experience) curve theory has a wide range of applications
in the business world. In manufacturing, it can be used to estimate the
time for product design and production, as well as costs. Learning curves
are important and are sometimes overlooked as one of the trade-offs in
just-in-time systems, in which sequencing and short runs achieve lower
inventories by forfeiting some benefits of experience from long product
runs. Learning curves are also an integral part in planning corporate
strategy, such as decisions concerning pricing, capital investment, and
operating costs based on experience curves.
Learning curves can be applied to individuals or organizations. Indi-
vidual learning is improvement that results when people repeat a process
and gain skill or efficiency from their own experience. Organizational
learning results from practice as well, but it also comes from changes in
administration, equipment, and product design. In organizational settings,
we expect to see both kinds of learning occurring simultaneously and
often describe the combined effect with a single learning curve.
The first application of the learning curve involved manufacturing
processes that were highly labor intensive (Wright, 1936). It was reported
that as cumulative output increased, unit labor costs decreased. Subsequent
commentators argue that learning curves have more impact on costs when
the actions in which the learning curve is measured involve labor-intensive
tasks (Globerson and Shtub, 1984). Be that as it may, studies have
determined that the learning effects (resulting in the learning curve) come
from three sources. First, the labor force will accumulate experience over
time, which will reduce the labor input needed to produce the same level
of output. Second, management will gain experience and will improve
management processes, such as modifying workstation assignments. Third,
the industry in general might gain expertise or technical ability, such as
advancements in-process techniques (Lundmark, 2003; Air Force, 2005).
Elemental Task Learning Curves in a Production Line 25
Hours of labor
per product lot
10
0 10 20 30 40 50 60 70
Figure 3.1 The production line learning curve.
In addition to what were the sources of the learning curves’ effects,

empirical studies yield three conclusions on learning curves:
1. The time required to perform a task decreases as the task is

repeated (basic theory).
2. The amount of improvement decreases as more units are produced
(theory of diminishing rate of return).
3. The rate of improvement has sufficient consistency to allow its use
as a prediction tool.
The consistency of improvement noted here has been found to exist

in the form of a constant percentage in time required over successively
doubled quantities of units produced. The constant percentage by which
the costs of doubled quantities decrease is called the rate of learning.
Thus, if it took 10 hr to produce the n-th unit and 8 hr to produce double
the n-th unit, the learning curve would be described as a curve with an
80 percent slope. Representations of a sample learning curve (Figure 3.1)
and a typical learning curve equation for a production line (Equation 3.1)
are provided.
In Figure 3.1, the horizontal axis measures the cumulative number of
lots of a product the firm has produced. The vertical axis measures the
number of hours of labor needed to produce each lot. The learning curve
in Figure 3.1 is based on the following relationship:
L = a + bN–λ (Equation 3.1)

where N = cumulative units of output produced, L = labor input per unit

of output, a, b, and λ are constants, a and b are positive, and λ is between
0 and 1.
If N = 1, L = a + b, and this measures labor input to produce the first
unit of output.
If λ = 0, labor input remains constant as the cumulative level of output
increases, so there is no learning.
If λ > 0 and N increases, L approaches a, and a represents minimum
labor input per unit of output after all learning has taken place. The larger
the λ, the more important the learning effect. It may be noted that new
firms may experience a learning curve, not economies of scale. On the
other hand, older firms have relatively small gains from learning. Figure
3.2 differentiates between economies of scale and learning.
The learning curve implies that the labor requirement falls per unit and
costs will be high at first and then will fall with learning. We apply learning
curves to determine if it is profitable to enter an industry and also to
determine when profits will occur, based on plant size and cumulative output.
However, for the learning curve concept to have impact, besides having
a labor component, the production line must not be automatically paced.
If it is, improvement will be limited (Fast.faa.gov, 1998). Here, we assume
cycle times that are process paced. If the production process is automat-
ically controlled in that in-process units are transferred between elemental
task work stations at predetermined times, without regard to process cycle
times, elemental task learning curves will have little impact on overall
throughput time. It is also important to note that the smaller the batches
the greater the learning effect. This is true because production in smaller
Cost
($ per unit
of output)
A Economies of Scale -
reversible
B
Learning Average Cost E
C
Average Cost EL
Output
Figure 3.2 Economics of scale versus learning (E: economy of scale; EL: economy
of scale and learning).
batches provides better opportunities for learning and will therefore reduce
the overall time to produce the same number of units when compared
to production with larger batches.
Balancing Cycle Times

A couple of the key aspects of production planning are throughput time
and cycle time. Throughput time is the length of time, including delays,
required for materials or a customer to move through a defined value-
adding process. For simplicity, it will be considered the time it takes raw
materials to be transformed into finished goods (aggregate of all cycles).
Cycle time is the time it takes for an in-process good to move through its
next value-adding activity. Just as delays at any given cycle account for
addition to throughput time (and inventory cost), reductions in cycle time
also reduce the throughput time. It is axiomatic that the desire of manu-
facturers is to have uniform (balanced) cycle times throughout production
of a product, and to achieve the lowest possible cycle time. Although lot
size also is relevant in this inquiry, for purposes of this analysis, it will
be assumed that the lot size is 1, and that no buffer stock will be utilized
at work stations. Although a buffer stock could be utilized to offset the
differing cycle times, buffer stocks equate to inventory, and thus, may be
considered an unnecessary additional cost. It has been found that the
objectives gained (also lost if not balanced) from a balanced line include:
1. Regular material flow

2. Maximum usage of manpower and machine capacity
3. Minimum process times
4. Minimizing slack times
5. Minimizing workstations
6. Distribute slack times to workstations
7. Reduce productions costs (Ozgurler et al., 2003)
Production lines consist of workstations that handle work in progress,

add value to the work, and pass to the next workstation until the product
is complete. In other words, it is a sequence of workstations, connected
together by a material handling system, which is used to assemble com-
ponents into a final product. At each station, the value added to the work
in progress takes a certain amount of time. This is called cycle time. Line
balancing involves partitioning the total time it takes for raw material to
become a finished good, among a certain number of workstations, which
have approximately the same cycle times (Becker and Scholl, 2006). It
should be noted that the number of workstations is a number determined,
in some circumstances, by the demand for the product and the lead time
allowed. For example, if the market demand requires 40 units to be
produced each day and the line will operate for 8 hr a day, then the 480
min of line time must be divided by 40 (units produced) to derive a cycle
time of 12 min. The result is that every 12 min, one unit must be produced.
If the unit requires 48 min to make, the line might be designed to have
four workstations with 12 min of value-adding work each.
Each task that must be done at a particular workstation takes a number
of time units to complete. Frequently, the design of a production line has
assumed that conditions at the design phase of balancing will continue
and eventually become the operating conditions throughout the life of
the production line (Ozgurler et al., 2003). As noted later, when elemental
task learning curves are factored into a production line with varying
elemental task learning curves, the impact of these learning curves will
frequently cause an unbalanced line.
Interrelationships of Elemental Task Learning Curves

and Line Balance
Because the goal of line balancing (as explained earlier) is to have
balanced elemental task cycle time, in a balanced line, the pace of
production is controlled by elemental task cycle times. If a line has
elemental tasks that all have the same learning curve, the line would
remain balanced throughout the production run on this basis, and the
performance of time it takes for each elemental task would remain the
same (Globerson and Shtub, 1984). If we assume that elemental tasks
have different learning curves, units produced will take varying times to
complete (except in the single instance that the slopes of all elemental
learning curves intersect at a single future unit of production, which in a
multiple task line of production would be improbable). Then, over time,
each element task will take a different amount of time to complete
(Globerson and Shtub, 1984). Globerson and Shtub’s research looked at
two tasks with different learning curves. They concluded that an equilib-
rium point existed at which the two learning curves intersected. It was
an overly simplistic model of a production line. Assuming that multiple
tasks are involved in production, one can safely assume multiple elemental
task learning curves. If this is the case, then it is highly unlikely that all
of the curves would intersect at a single point, thus yielding an equilibrium
point. It is more likely that the curves intersect each other at different
points and no single equilibrium point could be ascertained. Figure 3.3
shows that when the line has just two varying elemental task learning
curves, it is possible to ascertain the equilibrium (optimum) unit amount.
Time Needed to Complete Task 50
40
30
20
10
0
0.5 1 2 3 4 8
Number of Units Produced (100's)
Learning Curve Task 1 Learning Curve Task 2
Figure 3.3 Optimum units to produce in a line with two elemental tasks with
varying learning curves.
60
Time Needed to Complete Task
50
40
30
20
10
0
0.5 1 2 3 4 8
Number of Units Produced (100's)
Figure 3.4 Multiple elemental tasks with varying learning curves.
Figure 3.4 indicates how this task is complicated when the line has multiple
elemental task learning curves.
The analysis presented is based on the assumption of a lot size of 1.
The elemental task cycle times would control pace of production. Thus,
the elemental task learning curves would impact cycle times and total
throughput time. Thus, if elemental task learning curves are not the same
in an initially balanced line, the line will become imbalanced.
When Globerson and Shtub analyzed the equilibrium optimum unit

number on differing learning curves of elemental tasks in production,
their study fixed elemental tasks and the learning curve associated with
each element and tried to adjust the number of repetitions that would
maximize the entire line utilization based upon each elemental tasks’
learning curve. This analysis, although not stated in these terms, shows
that at future units of production there will be an excess capacity at one
or more elemental tasks. Although their analysis of optimum production
quantity, given the changing capacities of the elements because of learn-
ing, is a worthy one, a more basic question is begged. Why should the
line remain static if excess capacity appears at an element task compared
to other element tasks, and why does the line become unbalanced? If a
line were not in balance due to other capacity issues (a particular elemental
task is used on another production line and is doing double duty) a
manager would add capacity elsewhere or reduce capacity at certain point
to balance the line. Viewing elemental task learning curves as a capacity
variable would require similar actions.
Considering learning curves as a part of a capacity variable in a
production line, it is clear that, based on the aforementioned analysis, the
greatest element cycle time determines the cycle time for the entire pro-
duction. The same concept holds true for elemental task learning curves.
For instance, suppose a three-workstation production line is used as an
example. In this example, two of the three elements have a learning curve
of 70 percent, whereas the third has a curve of 80 percent. For the sake
of this analysis, it is assumed that the learning curve rate is known at the
start of production. In actual situations, the actual learning rate per ele-
mental task would most likely be unknown at the beginning of production.
As data is collected during initial production, one may be able to come to
approximate learning curve rates per elemental task using the learning
curve equation. Although cycle times per element at the start of production
may be equivalent, at two times the n-th unit, two elemental tasks take
70 percent as much time to complete, and the third takes 80 percent as
much time to complete. Because learning curve theory considers the
aggregate decreased production time of the n-th unit to assigning a learning
curve rate for the entire production, by considering the elemental tasks’
varying learning curves, one can understand how the worst elemental task
learning curve may have a disproportional impact on the entire production’s
learning curve. Thus, at the n-th unit, the learning curve for the entire
production is 73 percent, despite the fact that the majority of the production
has a 70 percent learning curve (Figure 3.5). This also has significant
ramifications depending on where the 80 percent learning curve elemental
task is located in the production line. For instance, in the example used,
if the elemental task with the 80 percent learning curve is the second or
Step 1: 10 min/ 70% LC Step 2: 10 min/ 70% LC Step 3: 10 min/ 80% LC
1 2 3
At nth unit, cycle time for 1 and 2 is 7 minutes, while cycle time for 3 is 8 minutes. It takes 22
minutes to complete 1 unit of production. Inventory will start accumulating before step 3.
Aggregate learning for the entire production is 73%.
Figure 3.5 Initial line design when 80 percent learning curve task is last in
sequence.
1 2 3
Suppose the 80% LC task is the 2nd task. At nth unit, cycle time for 1 and 3 is 7 minutes, while
cycle time for 2 is 8 minutes. It takes 23 minutes to complete 1 unit of production, because task 3
waits 1 minute each cycle for task 2 to complete. Inventory will start accumulating before step 2
and step 3 will experience idle time. Aggregate learning for the entire production is 77% instead
of 73% percent.
Figure 3.6 N-th unit effects when 80 percent learning curve task is the task in
the middle of the sequence.
first task, the entire production will have 77 percent and 80 percent learning
curve, respectively (see Figure 3.6 and Figure 3.7).
To take the example further, assume that it originally takes 10 min for
each of the three stations to complete its assigned tasks. Suppose, owing
to machinery upgrade, station 1 was able to complete its tasks in 7 min.
Suppose that station 2 could complete its tasks in 8 min owing to learning
curve effects. Also assume that because of learning curve effects, station 3
could complete its tasks in 7 min. The questions would become, would
station 3 actually complete its tasks in 7 min, even though it receives its
work in progress every 8 min? Although it could be argued that learning
effects take place in a vacuum, it is equally plausible that learning is the
product of necessity. It could be argued that humans, by nature, would not
seek to learn or improve for the sake of it alone. In the previous example,
station 3 has 8 min to complete its tasks before a new batch of work in
progress arrives. Rather than learn and have 1 min of downtime per cycle,
1 2 3
Suppose the 80% LC task is the 1st task. At nth unit, cycle time for 2 and 3 is 7 minutes, while cycle time
for 1 is 8 minutes. It takes 24 minutes to complete 1 unit of production, because tasks 2 and 3 wait 1
minute each cycle for task 1 to complete. Step 2 and step 3 will experience idle time. Aggregate learning
for the entire production is 80%.
Figure 3.7 N-th unit effects when 80 percent learning curve task is the task in
the beginning of the sequence.
it is plausible that station 3 will never achieve the learning curve effects it
is capable of because there is no need for it. Even if it did achieve its
capable learning, the cycle time would still be constrained by workstation
2, and the cycle time for the product and learning curve for the product
would be constrained by the lowest common denominator, or workstation 2.
By considering the impacts on cycle time of individual elemental
learning curves in a production line, one may understand how elemental
task learning curves interrelate with elemental capacity. When elemental
capacity of a line becomes unbalanced because of elemental task learning
curve effects, the result will be a bottleneck somewhere in the line. In
Goldratt’s Theory of Constraints, this bottleneck is a capacity restraint that
must be resolved without creating additional capacity restraints elsewhere.
Historically, the bottleneck was considered a failure of engineered
work flow (Bassett, 1995). The initial response was to manipulate work
flow and allow for large buffer stock accumulation at each workstation.
Although this may remedy the bottleneck issues, it may create other
negative effects (Bassett, 1995). The new model of production assumes
that bottlenecks are inevitable, and their occurrence must be anticipated
and resolved rapidly (Bassett, 1995).
Organizational Learning
It is commonly known that organizational learning is critical to sustaining
a competitive advantage. For the individual, it is easy to conceptualize
how knowledge is acquired and retained and how this results in an
individual learning effect. Certainly, a main source of organizational learn-
ing is the individual learning of the employees. An organization also
acquires knowledge in its technology, its structure, documents that it
retains, and standard operating procedures. For example, as a manufac-
turing unit becomes experienced, knowledge is embedded in software

and in tooling used for production. Knowledge can also be embedded in
the organization’s structure. For example, when an organization shifts its
operations research group from a functional organization centralized in
one area to a decentralized organization in which individuals are deployed
to particular parts of the plant floor, knowledge about how to become
more productive is embedded in the organization’s structure. Knowledge
can depreciate if individuals leave the organization. Knowledge can also
depreciate if technologies become inaccessible or difficult to use.
Conclusion
Understanding learning curve theory and elemental task learning curve
impacts will allow one to anticipate when and where the capacity shortage
(bottleneck) will emerge and allow for the quick resolution to it. Ultimately,
varying elemental learning curves within a production line must be con-
sidered to be capacity variables, much like the more commonly thought
of capacity constraints. Once it is accepted that learning impacts alone
can cause line imbalance, managers may be able to better understand
how to rebalance the line and reduce unnecessary cost.
By anticipating which elemental tasks are learned at a slower rate than
others, a prudent manager takes the necessary steps to keep the line
balanced as much as possible. These steps may include adding capacity
to the “slow learning” elemental tasks to keep the cycle time in pace with
the “faster learners.” It may also include attempting to increase the rate
of learning through a “continuous improvement” management approach
to the particular elemental processes to attempt to balance each tasks’
learning curve (and by doing so, the entire process) (Zangwill and Karitor,
1998). One might also initiate adjustment of elemental tasks to rebalance
the line, at least for the short term. This readjustment may also include
an attempt to cause slow learning tasks to be “endloaded” in the produc-
tion process to have the minimal impact on other elemental tasks. End-
loading would attempt to keep the earlier tasks in a line balanced so that
unbalanced tasks impact the minimum number of sequential tasks that
follow them. This approach would also highlight the bottleneck in the
line based on learning curve effects.
Recommendation
Whatever approach is taken by management, the critical focus of this
chapter is on the awareness of the issue. A prudent manager will account
for learning curve variables when designing a production line and should,
among other data collected, collect initial run data in an attempt to identify
elemental task learning curves. Using data acquired through production
and based on previous research in the learning curve field, managers
could predict where and when (what unit of production) the elemental
task learning curve effects will cause a capacity imbalance between some
elemental tasks, which will negatively impact the entire production pro-
cess. With the benefit of observing a line process and collecting data, one
would be able to more clearly quantify the issue and develop equations
for predicting bottleneck appearance by units of production.
References
Air Force (2005), The Learning Curve. Available at http://ax.losangeles.af.
mil/se_revitalization/aa_functions/manufacturing/Attachments, pp. 1–29.
Bassett, G. (1995), The new training: operations methods for high performance,
Human Resources Development Quarterly, 6(3), 297–306.
Becker, C. and Scholl, A. (2006), A survey on problems and methods in generalized
assembly line balancing, European Journal of Operational Research, 168(3),
694–715.
Farghal, S.H. and Everett, J.G. (March 1997), Learning curves: accuracy in predict-
ing future performance, Journal of Construction Engineering and Manage-
ment, 123(1), 41–45.
Fast.faa.gov (1998), Direct Labor, 1–18. Available at http://fast.faa.gov/pricing/98-
30-c7.htm.
Globerson, S. and Shtub, A. (1984), The impact of learning curves on the design
of long cycle time lines, Industrial Management, 26(3), 5–100.
Goldratt, E.M. (1990), Theory of Contraints, North River Press, Great Burlington,
M.A.
Lundmark, R. (November 2003), On the Existence of Learning Effects in Swedish
Kraft Paper Mills, International Institute for Applied Systems Analysis,
Sweden, p. 27.
Macher, J.T. and Mowery, D.C. (2003), Managing learning by doing: an empirical
study in semiconductor manufacturing, The Journal of Product Innovation
Management, 20(5), 391–410.
Ozgurler, M., Guneri, A.F.G., and Gulsun, B. (2003), A Simulation Approach to
Line Balancing in Discrete Mass Production Flow System and an Applica-
tion, Society of Manufacturing Engineers, Dearborn, MI.
Smunt, T.L. and Watts, C.A. (2003), Improving operations planning with learning
curves: overcoming the pitfalls of “messy” shop floor data, Journal of
Operations Management, 21(1), 93–107.
Wright, T.P. (February 1936), Learning curve, Journal of Aeronautical Sciences.
Zangwill, W.I. and Karitor, P.B. (1998), Toward a theory of continuous improve-
ment and the learning curve, Management Science, 44(7), 910–920.
Chapter 4
Offshoring Knowledge
Work to Increase
Shareholder Value
Introduction
CIO Magazine estimates that approximately one half to two thirds of
Fortune 500 companies in the United States have already outsourced
(offshored) IT to India, because it is one of the best ways to cut mainte-
nance and application development, or knowledge work, costs (Koch,
2003). Many consulting companies and IT organizations are reporting that
this trend will continue similar to the offshoring of manufacturing jobs
before them. The benefits of utilizing low-cost labor in other countries
not only result in direct savings, but indirect savings as well. These indirect
savings are realized by reinvesting in more value-added activities across
the organization.
Obviously, if there were only benefits, more companies would seek
to outsource their processes to lower-cost countries. This chapter seeks
to report on the reasons why offshoring knowledge work has become
such an integral part of the American economy and the challenges that
companies should consider before making the conversion. The chapter is
written as a guide for future CEOs (or other senior managers) and seeks
to answer the question that leaders should be asking: “Can offshoring
35
Table 4.1 Number of U.S. Jobs Moving Offshore

Job Category 2000 2005 2010 2015
Management 0 37,477 117,825 288,281

Business 10,787 61,252 161,722 348,028
Computer 27,171 108,991 276,954 472,632
Architecture 3,498 32,302 83,237 184,347
Life sciences 0 3,677 14,478 36,770
Legal 1,793 14,220 34,673 74,642
Art, design 818 5,576 13,846 29,639
Sales 4,619 29,064 97,321 226,564
Office 53,987 295,034 791,034 1,659,310
Total 102,674 587,592 1,591,101 3,320,213
knowledge work increase shareholder value?” At the end of this chapter,

we will introduce a case study of Best Buy and Staples and show how
one company that has announced that it has offshored IT work has better
year-over-year performance using the DuPont model of the return on net
worth (RONW) than the other.
Between 1950 and 2003, jobs in the manufacturing sector fell from 34
to just 12 percent of total U.S. jobs. Companies such as Zenith and RCA
that did not show flexibility and adopt new strategies fell, whereas others
such as IBM, GE, and Intel, which embraced the offshoring phenomenon
have flourished (Karmarkar, 2004, p. 2). Today, the service sector is facing
the same challenges that manufacturing experienced in the past. Forrester
Research predicts that nearly 3.5 million jobs will be moved offshore
between 2003 and 2015 (Table 4.1). In 1990, Uday Apte from Southern
Methodist University estimated that “10 percent of American service sector
jobs had the potential to be outsourced, moved offshore, or automated
(Karmarkar, 2004, p. 1).” This alarming statistic tells not only the employees
in these areas that their job could potentially be in danger, it also signals
to company leaders that they should be well-informed of this phenomenon
to remain competitive.
As mentioned earlier, the following analysis seeks to answer the
question that CEOs need to be asking: “Can offshoring knowledge work
increase shareholder value?” First, definitions of knowledge work will be
presented along with the types of jobs potentially affected. Next, drivers
of this trend, along with economic benefits and business risks, will be
discussed. Here, leaders can determine if the potential cost savings out-
weigh the potential hazards along the way.
Offshoring Knowledge Work to Increase Shareholder Value 37
Knowledge
Services and Reasearch and
Decision Analysis Development
Figure 4.1 Offshoring opportunities across the organization. (From McKinsey

and Company [2003], Offshoring: Is It a Win-Win Game?, McKinsey Global
Institute. Available at http://www.mckinsey.com/knowledge/mgi/reports/Off-
shoring/offshore.asp.)
Knowledge Work
Knowledge work includes such business processes as application out-
sourcing, business process outsourcing (BPO), data center services, as
well as many other functions. These processes and services are higher up
the corporate complexity ladder than functions such as data entry or
transaction processing. The types of jobs listed here include such white-
collar positions as software developer and software engineer.
Figure 4.1 shows how these offshoring opportunities across the orga-
nization fit in, as well as how increasingly complex these roles become.
The farther you move to the right of the graph, the more highly skilled
the workers need to be. Interesting to note is that as these positions move
to the right, they become more aligned with defining business strategy
and corporate objectives, and not simply receiving delegate mandates
from above.
As offshoring becomes more accepted, CEOs who offshore need to
understand the implications that this process has on their organizations.
Otherwise, as will be mentioned later, their organizations are subject to
being opened up to security breaches, as well as technological “brain drain.”
Drivers of Knowledge Work Offshoring

To better understand why offshoring knowledge work has proliferated,
CEOs need to know the drivers. Some of the main reasons can be attributed
to technological advances: fiber-optic cables, commoditization of personal

computers (PCs), the Internet, and shared software. With the hype of the
dot.com era, many companies such as Global Crossing invested heavily
in laying fiber-optic cables around the world and eventually drove down
the cost of transmitting voice and image data (Friedman, 1998, p. 3). This
allowed for the cheap and instantaneous connectivity of people anywhere
around the world. Now, software developers no longer need to be at the
same physical location as their employer.
A second technological driver is the commoditization of PCs, allowing
more and more people to own devices that allow for communication and
analyses. With lower prices, a person in India or China can now buy a
laptop and begin programming from their local Starbucks. These functions
help facilitate workers in foreign countries to interact with counterparts
in other parts of the world.
Table 4.2 shows that there are millions of people around the world
who are Internet users. With the advent of the Internet and the subsequent
initial public offering of Netscape, people can connect and share infor-
mation and data with others around the world (Friedman, 1998, p. 3).
This along with other shared software programs like Microsoft Windows
allowed for the people-to-people and application-to-application connec-
tivity. Now, reports can be digitized, disaggregated, and shifted to any
place in the world where labor is cheaper (Friedman, 1998, p. 4).
Another driver supporting the spread of offshored knowledge work is
the increased number of people speaking and writing English. The success
of American businesses has led people around the world to pick English
as their second language. Although this can be seen as a positive devel-
opment, others may now see this in a negative light. Now, children around
the world not only learn their own language and culture, but also the
American language and culture. In essence, these people are now becom-
ing more qualified to take away jobs that have been traditionally American.
Table 4.2 shows the literacy rates and many other statistics for many
countries. Although it does not specify the number of English-speaking
citizens, it does tell that other countries are catching up with America in
the number of people who are literate. This shows that there are millions
of people around the world who are fast becoming competitors for
software developers, and potentially new employees for CEOs.
Shortage of labor is another driver to offshore knowledge work. It has
been well documented that the American economy will have an increase
in the number of baby boomer retirees soon. To employers, this means
that a lot of their current employees will be leaving the workforce. Figure
4.2 shows this shortage and indicates there will be a need to look
elsewhere for employees.
Table 4.2 Data for Selected Countries
Percentage
of
Telephones GDP — Population
Population Labor Internet Literacy — Mobile Per Capita Employed Unemployment
Country Population Growth Force Users Rate Cellular — in PPP in Services Rate
Brazil 186,112,794 1.11 82,590,000 14,300,000 0.86 46,373,300 $7,600 0.53 0.12
Chile 15,980,912 1.01 6,000,000 3,575,000 0.96 6,445,700 $9,900 0.63 0.09
China 1,306,313,812 0.57 778,100,000 94,000,000 0.91 269,000,000 $5,000 0.28 0.10
Czech 10,241,138 –0.05 5,250,000 2,700,000 0.99 9,708,700 $15,700 0.60 0.10
Republic
Hungary 10,006,835 –0.25 4,164,000 1,600,000 0.99 6,862,800 $13,900 0.65 0.06
India 1,080,264,388 1.44 472,000,000 18,481,000 0.6 26,154,400 $2,900 0.23 0.10
Kenya 33,829,590 1.14 11,450,000 400,000 0.85 1,590,800 $1,000 N/A 0.40
Malaysia 23,953,136 1.83 10,260,000 8,692,100 0.89 11,124,100 $9,000 0.50 0.04
Philippines 87,857,473 1.88 34,560,000 3,500,000 0.93 15,201,000 $4,600 0.40 0.11
Poland 38,635,144 0.02 16,920,000 8,970,000 0.99 17,400,000 $11,100 0.50 0.20
Russia 143,420,309 –0.45 71,680,000 6,000,000 0.99 17,608,800 $8,900 0.65 0.09
South Africa 44,344,136 –0.25 16,350,000 3,100,000 0.86 16,860,000 $10,700 0.45 0.31
Thailand 65,444,371 0.91 34,900,000 6,031,300 0.93 16,117,000 $7,400 0.37 0.02
United States 295,734,134 0.92 147,400,000 159,000,000 0.97 158,722,000 $37,800 0.76 0.06
Venezuela 25,375,281 1.44 11,380,000 1,274,400 0.93 6,463,600 $4,800 0.64 0.18
2003 2012
100% = 277.8 million 312.3 million
28
34
Over 55 years
25-54 years
Under 24 years
44
39
28 27
Figure 4.2 U.S. decline in working age population. (From McKinsey and
Company [2003], Offshoring: Is It a Win-Win Game?, McKinsey Global
Institute. Available at http://www.mckinsey.com/knowledge/mgi/reports/
Offshoring/offshore.asp.)
Fortunately for people in the knowledge work area, the Bureau of

Labor and Statistics predicts that there will be a need for people with
technical skills (Table 4.3). As you can see, four out of the top ten types
of jobs will require knowledge work expertise. From software publishers
to management consultants, there will be a need to hire these roles in
the years to come. Unfortunately though, as stated earlier, a shortfall in
the total number of applicants could still be an issue.
Another driver that increases the practice of offshoring knowledge
work is the use of automation in business processes. Figure 4.3 shows
research done by Forrester that indicates there will be an increased need
for knowledge work personnel owing to changes because of the use of
the Internet. Think of the number of companies that have pushed their
services out to their customers. Now, people can make airline reservations,
bank, and shop online. This means that there is now a much greater need
for software engineers and business process consultants who can help
design such systems.
A final reason for the increased use of offshored knowledge workers
is the sheer size of countries such as India and China (Table 4.4). These
two countries graduate more students from universities with computer
science degrees than the United States. This fact alone shows that more
Table 4.3 Bureau of Labor Statistics, Employment Projections, 2002–2012

Annual Growth Rate
Industry 2002 2012 (Percentage)
Software publishers 256 430 5.3

Management and technical consulting 732 1,137 4.5
services
Community care facilities for the 695 1,077 4.5
elderly
Computer system design 1,163 1,798 4.5
Employment services 3,249 5,012 4.4
Rehabilitation services 1,269 1,867 3.9
Ambulatory health care 1,444 2,113 3.9
Water and sewage systems 49 71 3.9
Internet and data processing 529 773 3.9
Child day care services 734 1,050 3.6
Figure 4.3 Changing corporate models. (From Forrester Research.) Base: 182
sell-side E-commerce decision makers at North American companies.
Table 4.4 Workers of the World

United States India China
Total population 0.29 billion 1.07 billion 1.30 billion

Civilian labor force 147 million 470 million 744 million
Percentage of population under 35 53 41
the age of 25
Number of college graduates per 1.3 million 3.1 million 2.8 million
year
Number of computer science 53,000 75,000 50,000
graduates per year
As a percentage of population 0.0200 0.0070 0.0004
Cost of cup of gourmet coffee $1.68 $0.50 $1.00
Percentage of country with 100 60 98
electricity
Percentage of population below 12 25 10
poverty line
Illiteracy rate (percentage) 5 35 15
Source: From McKinsey and Company (2003), Offshoring: Is It a Win-Win Game?,

McKinsey Global Institute. Available at http://www.mckinsey.com/knowledge/
mgi/reports/Offshoring/offshore.asp.
emphasis needs to be placed by American CEOs on the highly skilled

and growing labor force outside of this country.
Benefits to Business
Although the drivers may present the need for knowledge work, senior
executives will not pursue offshoring unless benefits can be realized. A
Star Tribune survey of 252 executives of Minnesota companies revealed
many of the reasons why they offshore (Table 4.5). For services, by far
the greatest reason is to control costs. Table 4.6 shows comparable U.S.
and Indian jobs by category. Although this study shows a saving of 80
percent on average, other estimates show net savings of between 25 and
40 percent (ADTmag.com, Earls, p. 2). Still, at even a 25 percent reduction
in costs, companies should very seriously consider the use of offshored
IT labor.
Table 4.7 shows another graph that the Star Tribune presented on
what $1 spent on labor will cost in other countries. Note that all of the
European labor costs were higher than the United States, and all South
American and Asian countries’ costs were lower. This takes into consid-
Table 4.5 Reasons to Offshore (Executive Survey of 252

Minnesota Companies)
Reason Production Services
Increase competitiveness 79 53
Reduce or control costs 77 71
Increase revenue potential 56 46
Get closer to customers 28 17
Quality of overseas workers 12 25
Reduce time to market 11 10
Free up resources in Minnesota 10 12
Resources not available internally 7 17
Have 24 × 7 operations 4 27
Source: From Star Tribune, Minneapolis-St. Paul, MN, Septem-

ber 5, 2004.
Table 4.6 Wage Comparison — United States and India

United States India
Telephone operator $13 Less than $1

Medical transcriptionist $13 $2
Payroll clerk $15 $2
Legal assistant/paralegal $18 $7
Data entry clerk $20 $2
Accountant $23 $11
Financial researcher/analyst $34 $11
Software developer $60 $6
Software engineer $120 $18
eration the direct savings of labor wage rates, as well as the savings that
companies receive by not having to pay for benefits.
Another benefit to companies is the increased competitiveness afforded
by having operations open around the clock. Now, a business process
consultant can design a project in the United States and assign tasks to
others around the globe. While we are asleep in the United States, people
in other countries can be working on the project during their waking
hours. Also, a combined 24 × 7 operation with decreased costs allows for
companies to have customer service representatives available to answer
questions, should the need arise after typical business hours.
Also, by offshoring certain functions, internal resources are freed up
to work on more “value-added” needs. This provides for a decreased time
Table 4.7 One Dollar Spent on Labor

United States 100
Brazil 12
Canada 75
Mexico 12
Australia 72
Japan 89
Sri Lanka 2
Belgium 107
Switzerland 113
Germany 114
France 81
Source: From Star Tribune, Minneapolis-St.

Paul, MN, September 5, 2004.
to market new products or services, and should result in additional positive

revenues.
Economic Implications
A CEO may want to know if offshoring in general is bad for the economy.
Global Insight states that offshoring IT software decreases costs, lowers
inflation, increases productivity, and lowers interest rates. This boosts
business and consumer spending and increases economic activity (ITAA
report, p. 1). They support this later in their analysis by showing that,
on average, most industries will experience a growth in the number of
net new jobs (Table 4.8). All in all, they predict that by 2008, over
300,000 net new jobs will have been cr eated directly owing to the
benefits that U.S. companies receive from offshoring IT work.
McKinsey and Company (2003) also tells of similar findings in their
report entitled Offshoring: Is It a Win-Win Game? In it, they show that
although the United States may be losing 3.3 million jobs over the next
decade because of offshoring, the net benefits to the U.S. companies by
direct cost savings and internal resource redistribution will substantially
outweigh the losses. Figure 4.4 shows a graph in the study and the benefits
of offshoring IT work to India. It shows that U.S. companies will capture
economic value through several different channels: reduced costs,
increased revenues, repatriated earnings, and the redeployment of addi-
tional labor (McKinsey, 2003, p. 7). To executives, these are the reasons
why they should seriously consider offshoring knowledge work.
Table 4.8 Number of Net New Jobs Created because

of Offshoring
Number of Net
New Jobs
Industry Sector 2003 2008
Natural resources/mining 1,046 1,182

Construction 19,815 75,757
Manufacturing 3,078 25,010
Wholesale trade 20,456 43,359
Retail trade 12,552 30,931
Transportation and utilities 18,895 63,513
Publishing and software –24,860 –50,043
Financial services 5,604 32,066
Professional and business services 14,667 31,623
Education and health services 18,015 47,260
Leisure, hospitality, and other services 4,389 12,506
Government –3,393 4,203
Total employment 90,264 317,367
Source: From Anonymous (March 2004), Executive Summary: The

Comprehensive Impact of Offshore IT Software and Services
Outsourcing on the U.S. Economy and the IT Industry, Informa-
tion Technology Association of America and Global Insight. Avail-
able at http://www.itaa.org/itserv/docs/execsumm.pdf.
Drawbacks and Risks

Until now, we have painted a positive picture as to why offshoring should
increase shareholder value. However, if all there was were benefits, then
all companies would be taking advantage. Unfortunately, there are many
drawbacks and risks that are associated with offshoring a company’s IT
work. The first risk to a company is that their data will now be residing
in someone else’s hands. Chances of security breaches increase with the
time that data takes to be transferred over cables. Also, because the data
is now in another country, a company may not have control over what
happens to it.
Another drawback to offshoring work is that a company is potentially
training a new global competitor. Now, not only does the new company
have your files, they also have your current business processes and your
customers’ names. Also, as more and more knowledge is exported to
the overseas partner and away from the U.S. headquarters, it will be
Further value creation potential through:

Increased global competitiveness of U.S.
business
Multiplier efffect of increased national savings 1.12-1.14
0.45-
0.04 0.67 0.47
0.58
0.05
Savings Import of U.S. Transfer of Total Value from U.S. Potential for
accrued to goods and profits by U.S. direct labor total value
U.S. services by providers in benefit reemployed creation in
investors providers in low-wage retained the U.S.
and/ or India country to in the economy
customers parent U.S.
Current direct benefit* Potential future

benefit
Figure 4.4 Value potential accrued to the United States. (From McKinsey and
Company [2003], Offshoring: Is It a Win-Win Game?, McKinsey Global Institute.
Available at http://www.mckinsey.com/knowledge/mgi/reports/Offshoring/
offshore.asp.)
increasingly difficult to bring back the laid-off talent to rebuild the

infrastructure here.
Recently, especially last year during the Presidential race, firms based
in the United States were criticized for offshoring work. This bad publicity
could lead to decreased sales by boycotting customers, as well as through
isolation from U.S. suppliers. Having to hire public relations personnel to
communicate with the media could negate all cost savings.
Other risks have to do with the offshored country. Not every country
has a stable infrastructure, including roads, telecommunications, and elec-
tricity. A loss in power or cut fiber cables could isolate the offshored
group from its U.S.-based counterpart. Also, political or economic unrest
in foreign countries could spell trouble to offshored operations. Instability
in some areas of the world could lead to data and people being taken
hostage and held for ransom.
Offshore Locations
Once CEOs consider offshoring knowledge work, which country should
they choose? Consulting firm A.T. Kearney did a study entitled the Offshore
Table 4.9 A.T. Kearney Country Evaluation Metrics for Offshoring

Category Subcategories
Financial structure Compensation costs

Infrastructure costs
Tax/regulatory costs
People skills and availability Business process experience
Labor force availability
Education and language
Attrition rates
Business environment Economic/political environment
Country infrastructure
Cultural adaptability
Security of intellectual property
Source: From A.T. Kearney Country Location.
Table 4.10 Top 20 Countries to

Offshore Work
India Hungary
China New Zealand
Malaysia Thailand
Czech Republic Mexico
Singapore Argentina
Philippines Costa Rica
Brazil South Africa
Canada Australia
Chile Portugal
Poland Vietnam
Source: From A.T. Kearney.
Location Attractiveness Index, in which they evaluate several weighted

categories (Table 4.9) to come up with the list of countries (Table 4.10).
The categories include financial structure, people skills and availability,
and business environment. Financial structure includes the subcategories
of compensation, infrastructure, and tax/regulatory costs. People skills and
availability evaluates the countries by business process experience, labor
force experience, education and language, and attrition rates. The business
environment category looks at economic and political environment, coun-
try infrastructure, cultural adaptability, and security of intellectual property.
Most of these areas have been presented earlier, and should definitely be
considered prior to offshoring knowledge work.
Sales
Staples - 2001 Gross 10,674
(in 000s) Margin
2,794
Net Profit COGS
Net Profit
719 7,879
Margin
0.07 Direct
Net Worth = Assets – Liabilities Expenses
10,674 1,038
Sales
2,075
Return on Financial Return on Total
Expenses 1,038
Net Worth Leverage Assets Indirect
0.41 = 2.26 × 0.18 Expenses
Net Profits = Total Assets × Net Profit
Net Worth Net Worth Total Assets Inventory
Sales 1,640
10,674 Current
Assets Accounts
2.68 2,356 Receivable
Asset 298
Turnover 3,989
Total Other
Assets 1,633 419
Fixed
Assets
Figure 4.5 DuPont financial analysis — Staples, 2001.
Many of the countries listed are probably not unusual. India tops the
list, with China right behind. However, some of the other countries listed
in the top 20 may surprise people. Malaysia came in third, with Chile and
Poland coming in the top 10. In the end, the list shows that there are
many countries from which to select and that CEOs should carefully
consider the benefits and risks of each prior to making any decisions.
Case Study
To see if there is an increased likelihood that offshoring knowledge work
could increase shareholder value, we used the DuPont system of financial
analysis on two comparable companies from the years of 2001 through
2004 (Figure 4.5 through Figure 4.12). The companies selected are both
U.S.-based multibillion dollar corporations in the retail sector. One, Best
Buy, has stated they have been using offshore development since at least
the early 2000s (TATA Web site). The other, Staples, has no release that
we could find, announcing they are using offshored work. Obviously, this
analysis is not meant to be a definitive statement on the benefits of
offshoring because there are many other variables not included. Rather,
it is intended to be a discussion topic of reference.
As we can see in the preceding models (Figure 4.5 through Figure
4.12), over the time period, Staples did not have an increase in its Return
Sales
(in 000s) Margin
2,813
Net Profit COGS
Net Profit 757 7,932
Margin
0.07 Direct
10,744 1,028
Sales
2,056
Expenses 1,028
0.37 = 1.99 × 0.18 Expenses
Sales 1,460
10,744 Current
Assets Accounts
Asset 339
Turnover 4,093
Total Other
Assets 1,690 605
Fixed
Assets
Sales
(in 000s) Margin
3,209
Net Profit COGS
Margin
0.08 Direct
11,596 1,129
Sales
2,259
Expenses 1,129
0.36 = 2.15 × 0.17 Expenses
Sales 1,555
11,596 Current
Assets Accounts
Asset 364
Turnover 5,721
Total Other
Assets 3,004 798
Fixed
Assets

Sales
(in 000s) Margin
3,897
Net Profit COGS
Net Profit 1,081 9,284
Margin
0.08 Direct
13,181 1,408
Sales
2,816
Expenses 1,408
0.30 = 1.78 × 0.17 Expenses
Sales 1,466
13,181 Current
Assets Accounts
Return on Net Worth has decreased Receivable
2.03 3,479
Higher Net Profit Margin than BBY Asset 410
Turnover 6,503
Total Other
Assets 3,024 1,603
Fixed
Assets
Sales
Best Buy - 2001 Gross 15,327
(in 000s) Margin
3,227
Net Profit COGS
Margin
0.05 Direct
15,327 1,227
Sales
2,455
Expenses 1,227
0.42 = 2.66 × 0.16 Expenses
Sales 1,767
15,327 Current
Assets Accounts
Asset 209
Turnover 4,840
Total Other
Assets 1,911 953
Fixed
Assets
Figure 4.9 DuPont financial analysis — Best Buy, 2001.

Sales
(in 000s) Margin
4,739
Net Profit COGS
Net Profit 1,246 14,858
Margin
0.06 Direct
19,597 1,747
Sales
3,493
Expenses 1,747
0.49 = 2.93 × 0.17 Expenses
Sales 2,258
19,597 Current
Assets Accounts
Asset 247
Turnover 7,375
Total Other
Assets 2,764 2,106
Fixed
Assets
Sales
(in 000s) Margin
5,546
Net Profit COGS
Net Profit 1,320 15,400
Margin
0.06 Direct
20,946 2,113
Sales
4,226
Expenses 2,113
0.48 = 2.81 × 0.17 Expenses
Sales 2,046
20,946 Current
Assets Accounts
Asset 312
Turnover 7,663
Total Other
Assets 2,796 2,509
Fixed
Assets

Sales
(in 000s) Margin
6,582
Net Profit COGS
Net Profit 1,689 17,965
Margin
0.07 Direct
24,547 2,447
Sales
4,893
Expenses 2,447
0.49 = 2.53 × 0.20 Expenses
Sales 2,607
24,547 Current
Assets Accounts
Net Profit Margin has increased
Return on Net Worth has increased
Asset 343
Rerutn on Assets has increased 8,652
Turnover
Total Other
Assets 2,928 2,774
Fixed
Assets
on Net Worth. Best Buy, however, showed consistent gains year after year
in Return on Net Worth, Profit Margin, and Return on Assets. This seems
to indicate that Best Buy may have experienced these increases through
the lower costs realized from offshored knowledge work.
Conclusion
Although this chapter cannot definitively answer the question whether
offshoring knowledge work can increase shareholder value, hopefully the
insights gained have posed questions to CEOs, inducing further reviews.
Whatever a CEO does, one thing is for certain. In a globally competitive
service economy, if this leader does not focus on providing the best
service to customers at the best price, while returning the highest value
to shareholders, then that person will not be around for long.
In the end, although offshoring knowledge work is similar to offshor-
ing manufacturing work in many ways, one way they are not is that
knowledge work cannot simply be transferred to the country with the
lowest cost of labor. Although language and cultural barriers are much
higher in the information age than they were earlier, offshoring knowl-
edge work has the scope to provide far greater benefits to the global
society through increased learning and communication.
References
Aberdeen Group (August 6, 2003), Global Sourcing: What You Need to Know to
Make It Work. Available at http://www.aberdeen.com/2001/research/
08030004.asp.
Anonymous (March 2004), Executive Summary: The Comprehensive Impact of
Offshore IT Software and Services Outsourcing on the U.S. Economy and
the IT Industry, Information Technology Association of America and Global
Insight. Available at http://www.itaa.org/itserv/docs/execsumm.pdf.
Anonymous. (September 5, 2004), Executive Survey of 252 Minnesota Companies,
Star Tribune, Minneapolis-St. Paul, MN. Available at http://www.star
tribune.com.
Forrester Research. (2005), Changing Corporate Models Available at http://
www.forrester.com.
Friedman, D.D. (October 1998), Price Theory: An Intermediate Text [electronic
version]. Available at http://daviddfriedman.com/Academic/Price_Theory/.
Karmarkar, U. (June 2004), Will You Survive the Services Revolution?, Harvard
Business Review. Available at http://search.epnet.com/direct.asp?an=
13208542&db=buh, Will You Survive the Services Revolution? (login is
required).
Kearney, A.T. (2005), Selecting a Country for Offshore Business Processing —
Where to Look. Available at http://www.atkearney.com/.
Koch, C. (September 1, 2003), Offshore Outsourcing — Special Report, CIO
Magazine. Available at http://www.cio.com/archive/090103/backlash.html.
McKinsey and Company (2003), Offshoring: Is it a Win-Win Game?, McKinsey
Global Institute. A vailable at http://www.mckinsey.com/knowl-
edge/mgi/reports/Offshoring/offshore.asp.
Chapter 5
Integrated Total
Cost of Ownership
and Activity-Based
Management
Process Model
Introduction
In highly competitive worldwide industries, companies need a strategic
edge to gain and maintain market share. Traditionally, companies choose
to compete using one of five factors: price, dependability, innovation,
quality, or flexibility (Hayes and Wheelwright, 1984). Effective control of
bottom-line cost can provide opportunities to exploit a number of these
factors. Obviously, lower costs can allow a company to offer lower prices
without sacrificing profit margins. Also, lower costs mean that more profits
can be invested on developing new products or on improving product
quality and dependability. To gain improved understanding, we begin
with reviewing the professional literature on total cost of ownership (TCO)
and activity-based management, and the interconnections suggested
between them.
55
Literature Analysis
Because procured components and services make up such a large part
of the overall cost of a product in these competitive industries, it makes
sense to examine them and to try to control their contribution to the
overall cost. TCO is a process of analyzing supply-chain activities and
their associated costs. It was proposed by Ellram and Siferd (1993), but
the general concept has been around prior to 1993 under a number of
different names: total cost (Cavinato, 1991; Cavinato, 1992), life-cycle
costing (Jackson and Ostrom, 1980), cost-based supplier performance
evaluation system (Monczka and Trecha, 1988), cost of ownership (Carr
and Ittner, 1992), zero base pricing (Burt et al., 1990), and product life-
cycle costs (Shields and Young, 1991). All of these concepts are structured
around three basic supporting ideas: (1) that cost must be examined from
a long-term perspective beyond just the initial price, (2) that purchasing
must consider the effects of other business functions on the value of a
specific purchase, and (3) that purchasing must understand the cost
impacts of all purchasing activities (Ferrin and Plank, 2002). For example,
Ellram (1994) estimated that the purchase price only accounts for 35
percent of the TCO in manufacturing equipment. This concept too is not
new to the 1980s and 1990s; purchasing management sources from as far
back as 1928 have been emphasizing the importance of looking beyond
initial purchase prices (Ellram and Siferd, 1993). The U.S. Department of
Defense (DOD), in particular, started using total cost principles for its
procurement activities, starting in the early 1960s (Shields and Young,
1991). Prior to the outsourcing trend that exists today, much of this early
focus on life-cycle costing was aimed at equipment and capital purchases,
usually examining maintenance and energy costs for two or more alternate
equipment purchases (Jackson and Ostrom, 1980).
Zero base pricing (ZBP) is a total cost method developed and trade-
marked by Polaroid in the early 1980s. It is based on the “all-in-cost”
concept, in which the all-in-cost equals the acquisition price plus the “all
in-house” costs. The all in-house costs are described as all of the costs
needed to convert the purchased material to the finished product, includ-
ing any costs from the field failure of the final product owing to defects
in the original purchased materials. In ZBP, each cost area consists of
avoidable and unavoidable cost components. ZBP works by identifying
the avoidable cost components and eliminating them. The model looks
at the supplier cost areas of profit, general and administrative costs, factory
overhead, labor, and materials, and at the in-house cost areas of customer
returns and lost sales, warranty, service and field failures, scrap, process
yield losses, rework, lost production, production, storage, inspection and
testing, and incoming transportation. Avoidable cost reduction is carried
Total Cost and Activity-Based Management Process Model 57
out by looking at six cost and quality drivers: tolerances, specifications,

materials, the process and requirements placed on it, design for automa-
tion, and ease of manufacture. The system places a heavy emphasis on
supplier negotiation and early supplier involvement in the design process
to maximize cost savings (Burt et al., 1990).
Cost management literature of the 1980s defined life-cycle costing (LCC)
as all the costs that the producer will incur over the product’s life cycle;
Shields and Young (1991) expanded this definition to include all of the
costs incurred by the end consumer and called it product life-cycle costing
(PLCC). Though they did not go into great detail defining the specific
mechanics of the system, Shields and Young pushed the idea from being
a mere cost estimating tool to a cost management system. They, describing
a product life-cycle cost management (PLCCM) system that takes a product-
centric view of costing, focused on creating long-term success in compet-
itive markets through the production of innovative, quality products with
short lead and delivery times. As such, the system they describe has a
very strategic focus, attempting to align the company structur e and
employee behaviors to the PLCCM to maximize its benefit.
Cavinato (1991, 1992), whose focus appears to be on supply chains
and how the different agents in the supply chain add value to the final
product, developed a model called total cost. Similar to TCO, total cost
looks at all of the costs associated with a product, but it does so from
the perspective of a make/buy type of decision — i.e., comparing the
costs at the supplier to the costs at the customer to determine which can
make the product for the lowest total cost. It does this by comparing six
cost factors: lowest labor rate, most effective process, most capital avail-
able, lowest cost of capital, highest tax rate, and most investment tax
credits and depreciation available for use (Cavinato, 1991). He later creates
a total cost/value model that advocates collecting costs in ten key areas:
traditional basic input costs, direct transactional costs, supply relational
costs, landed costs, quality costs/factors, operations/logistics costs, indirect
financial costs, tactical input factors, intermediate customer factors, and
strategic business factors, but he does not discuss any mechanism for
actually estimating those costs.
Carr and Ittner (1992) codified a cost model, called cost of ownership,
that included five main cost items: purchase price, costs of purchasing,
costs of holding, costs of poor quality, and costs of delivery failure. Similar
to Cavinato, they do not recommend a specific costing mechanism, but
instead give examples of four manufacturers’ cost of ownership systems.
Each example involves a cost ratio method in which the total of the five
cost areas is divided by the purchase price to get a cost index for each
supplier. The user can then multiply this index against future purchase
prices to estimate the probable cost of ownership (Carr and Ittner, 1992).
Monczka and Trecha (1988) had earlier proposed a similar cost ratio
system that they called cost-based supplier performance evaluation system
(CBSPES). In CBSPES, the purchased price is added to “nonperformance
costs,” mostly quality and logistics costs, and divided by the purchase
price to get an index that can be averaged to achieve an overall one for
each supplier. CBSPES advocated the use of events with standardized costs
to determine nonperformance costs. For example, scrapping a lot of
material or returning materials to a supplier has a standard cost to the
quality department. CBSPES is unique for a total cost system in that it
utilizes a second rating system to capture subjective service factors that
might not have an easily identifiable cost such as willingness to share
data and responsiveness of communications (Monczka and Trecha, 1988).
Originally, Ellram and Siferd (1993) described TCO as “all costs asso-
ciated with the acquisition, use, and maintenance of an item.” To aid in
determining these activities, they break them into six broad categories:
quality, management, delivery, service, communications, and price. They
differentiated TCO from ZBP by focusing TCO on internal customer costs,
whereas ZBP is focused on costs at the supplier (Ellram and Siferd, 1993).
It differs from Cavinato’s total cost concept in that it actually provides a
more specific method for collecting the costs using activity analysis. Ellram
(1993) soon revised TCO to include capital equipment, maintenance,
repair, and operating supply (MRO) items and services in addition to
purchased components and materials. She also recommended organizing
activities into generalized pretransactional, transactional, and posttransac-
tional categories, getting away from the previously described six functional
categories. Another change was the suggestion that only significant cost
components, those that account for most of the probable TCO, warrant
tracking (Ellram, 1993).
More recent articles regarding TCO deal not so much with the theory
behind it and its importance, but with the disappointing implementation
of it. Recent studies (Milligan, 1999; Ellram and Siferd, 1998; Ferrin and
Plank, 2002) have indicated that although many companies utilize TCO
principles, they currently do not use them systematically or evenly. Often,
TCO usage is an informal process in which data has to be collected from
numerous sources, often manually or with less-than-optimized IT systems
(Milligan, 1999). This informal process often produces vague, untrustwor-
thy, and inaccurate results that inspire less confidence in the TCO system
(Milligan, 1999). Many companies do not apply it to all of their purchasing
decisions; some apply it routinely, whereas others used it only for high-
priority or high-cost items (Milligan, 1999; Ellram and Siferd, 1998). Some-
times, rather than using a general TCO model, companies develop unique
TCO models for specific purchasing decisions (Ellram, 1994). There is a
great deal of evidence that a single TCO model with a specific set of cost
drivers cannot be applied to all TCO users. Instead, TCO guidelines should
be general because they will be customized by the user (Ferrin and Plank,
2002; Ellram and Siferd, 1998).
For the remainder of this research study, the term TCO will take the
Ellram concept of an all-encompassing cost of ownership, one that
attributes cost from many areas of the business to the cost of supplied
goods, but it will also include analysis of supplier cost structures and
expand beyond purchased components to include services. Understanding
supplier costs through ABC can help us determine ways of eliminating
costly activities, reducing occurrences of activities, and reducing cost driver
rates (Lere and Saraph, 1995).
TCO focuses on analyzing supply-chain activities and their associated
costs. This requires the use of systematic tools to determine activities,
estimate their costs, and manage them. Over time, numerous cost estima-
tion methodologies have developed. Zhang and Fuh (1998) describe six
different costing methods:
Traditional detailed-breakdown cost estimation — a detailed sum-

mation of all the costs (material, direct labor, overhead, etc.) that
occur in the manufacturing process.
Simplified breakdown cost estimation — simplified cost method
for use prior to the development of the detailed process plan. It
assumes use of optimum manufacturing method regardless of the
equipment and process that will actually be used. Because of its
use of empirical equations, it is often difficult to correlate with
actual costs.
Group technology (GT)-based cost estimation — utilizes a base cost
for a group of similar products and a set of cost variables such as
size, length, or number of features, and then establishes linear
relationships between the final cost and the variable-cost factors.
Cost estimation based on cost functions or cost increase functions
— useful for a similar group of products, this method combines
the technical and economic elements into a single functional equa-
tion of the overall cost. Coefficients of this equation are then
determined by feeding historical data into a regression analysis.
Activity-based cost (ABC) estimation — described in detail in the
following text.
Neural network approach to early cost estimation — uses a back-
propagating neural network (a series of layered algorithms with an
input layer, an output layer, and a number of “hidden” layers between
them equal to the number of inputs) that can be set up with historical
cost data and then adjusted or “trained” as additional cost information
becomes available or the manufacturing situation changes.
Historically, use of the traditional costing method prevailed; cost esti-

mates used a cost allocation system in which overhead costs were applied
to the manufacturing process on the basis of direct labor hours or direct
machine hours. This cost was then added to the direct labor cost and raw
material cost to arrive at a total cost for the pr oduct. This produced
adequate cost estimates when direct manual labor made up the major
portion of the cost. In recent years, however, more production has become
automated, reducing the amount of direct manual labor on a product. In
the 1990s, conventional wisdom held that direct labor comprised only 5
to 10 percent of a typical product’s cost, and over 50 percent of the cost
could be attributed to overheads (Porter, 1993). The continued use of
traditional cost systems with a direct labor allocation basis now distorts
cost estimates in many situations.
Activity-based costing (ABC) is an activity-focused cost estimation and
analysis method that seeks to provide a more accurate allocation of indirect
overhead costs and complements the activity focus of TCO well (Porter,
1993; Ellram 1995). This methodology can be used to analyze the supply-
chain-related costs both at the purchasing company and at the supplier.
In fact, as companies push to outsource more and more of their compo-
nents and services, it becomes more important that they apply ABC analysis
to their suppliers’ activities and understand their costs.
The development of ABC took place in the context of the Harvard
Business School in the early and mid-1980s, when American business
was under threat from global markets, primarily the Japanese (Jones and
Dugdale, 2002). Independent studies by Robin Cooper, Robert S. Kaplan,
and H. Thomas Johnson and the Computer-Aided Manufacturing, Inter-
national (CAM-I) organization all followed along similar threads, looking
at revamping cost accounting systems to better account for overhead
costs (Jones and Dugdale, 2002). In a series of articles, Kaplan argued
that management accounting methods and practices had become irrel-
evant and obsolete in modern manufacturing. This work cumulated in
a 1987 book with Johnson, Relevance Lost, which details the decline in
management accounting (Lukka and Granlund, 2002). At the same time,
articles by Kaplan and Cooper argued that traditional costing systems
were also ineffectual, producing biased information in a modern man-
ufacturing environment. These paved the way for ABC, which Kaplan
and Cooper introduced in a Harvard Business Review article in April
1988, based largely on their work with companies such as John Deere,
Scovill, Hewlett-Packard, and Siemens, where ABC-type systems were
being developed (Lukka and Granlund, 2002). The original definition of
ABC, sometimes called “first-wave ABC,” assumes that activities are
controlled, allocation of cost is exact and complete, and the results are
described as “more accurate” (Jones and Dugdale, 2002). A series of
articles by Cooper outlined the ABC process in detail (Cooper, 1988a,

1988b, 1989a, 1989b).
At its central core, the concept of ABC revolves around developing a
more accurate cost model of manufactured goods. A traditional volume-
based cost system can generate distortions and bias when applied to
diverse production volumes, part sizes, complexities, materials, and setup
requirements. Use of ABC is aimed at eliminating these biases. Although
traditional costing systems focused on the product and usually allocated
costs on the basis of direct labor hours, machine hours, and material costs,
ABC is focused on activities and how products use activity resources. It
generates more accurate results by allocating costs from a wide variety of
cost bases (Cooper, 1988a).
There are some basic steps to implementing an ABC cost model:
1. Determine activities.
2. Develop cost pools.
3. Develop cost drivers.
4. Determine pool rates.
Activities must be identified so that they can become the bases for the
ABC cost model. This is accomplished by looking at all of the actions involved
in the process and combining related ones into activities. It is important
because measuring the costs associated with each individual action would
be prohibitively expensive and time consuming (Cooper, 1989b).
Process mapping is a useful tool in the activity identification process.
It consists of devising charts that map the flow of the activities in a process.
This often points out wasteful and redundant activities, and can be a
useful activity in and of itself. For example, a recent process-mapping
case study involving a company that ships parts across the U.S.–Mexico
border resulted in 70 percent reductions in transit time and safety stocks.
Key activities in developing the process map included visiting all of the
locations where activities were taking place, observing them first hand,
and having meetings where all of the players in the process met to
understand in detail how each step in the process works and how they
interact. They then redesigned the process for maximum speed and
reliability. Key to this process was seeing activities first hand, conducting
face-to-face meetings with every part of the supply chain, and being
willing to listen and act on supplier suggestions (Gooley, 2003).
Once the types of activities have been determined, these need to be
categorized into homogeneous centers of expense, called cost pools. These
pools are often broken down into department or function, but care must
be given to not group together activities that one wants to allocate
separately. For example, there could be a quality department cost pool,
but if inspection and rework were identified as separate activities in the

first step, they need to be maintained as separate cost pools. If the cost
system developer needs to add more accuracy to their ABC system at a
later time, the activity pools can be decomposed into smaller sets of
activities (Ben-Arieh and Qian, 2003).
Each pool then has an amount of cost assigned to it, often at a periodic
rate. For example, a quality department cost pool would consist of the
annual cost of the quality department — department wages and benefits,
equipment costs, training, etc. This allocation of cost to cost pools is called
first-stage allocation (Cooper, 1989b).
After the cost pools have been developed, cost drivers need to be
determined. Cost drivers are the basis on which each activity cost pool
is allocated. In ABC, any basis can be chosen, but the emphasis is on
reasonable indicators that are easy to measure. Factors that affect the
selection of cost drivers include the cost of measuring the driver, the
degree to which the cost driver and the consumption rate of the activity
are correlated, and what behaviors one intends to get from selecting a
particular cost driver (Cooper 1989a). The number of required cost drivers
goes up if the requirements for accuracy, the degree of product diversity,
the relative cost of activities, or the degree of volume diversity increase
or the cost drivers correlate poorly to consumption rates (Cooper 1989a).
Some experts suggest using five or fewer cost drivers to avoid overanalysis,
but more sophisticated softwares are allowing companies to measure more.
Strong buy-in from IT personnel is required to make these systems work
(Marshall, 2002). Babad and Balachandran (1993) developed a model for
optimizing the number of cost drivers used in an ABC system through a
cost–benefit trade-off between loss of accuracy and the cost of measuring
the cost drivers. In this model, multiple activities are merged under single
cost drivers, and management can add weight to cost drivers that it feels
are more important. The allocation of cost pools into cost drivers is called
second-stage allocation (Cooper, 1989b).
Once the cost drivers have been determined, the cost pools can be
divided by them to determine pool rates. These pool rates are then used
to determine the costs of particular products.
Early in its history, ABC competed fiercely with E. Goldratt’s theory of
constraints (TOC) for hearts and minds of accountants and management
(Jones and Dugdale, 2002). TOC deals with identifying the constraint in
a process, often called a bottleneck, which limits the throughput of the
entire process. TOC advocates removing the constraint and moving on to
the next bottleneck that emerges, continually improving the throughput
of the process. On a fundamental level, TOC and ABC oppose each other.
TOC is focused on immediately removing constraints and thus has a very
short-term focus — labor and overhead are fixed-period costs. ABC has
a much more long-term focus, in which labor and overhead are flexible
costs that can be adjusted over time. ABC does not include opportunity
costs for bottlenecks and fixed-capacity operations (Kee, 2001). Others
have argued, similarly, that if an ABC system does not include measures
of intangibles such as improved quality, improved cycle times, flexibility,
reduced wait times, utilization, and reduction of inventory, ABC analysis
of advanced manufacturing systems (AMS) will be as unfairly distorted
because it will only include the high overhead and setup costs inherent
in such a system (Park and Kim, 1995).
First-wave ABC, in which more accurate costs could be determined
from exact allocations, led to conflict within the accounting community,
and many felt that allocation methods could never be exact. Others felt
that allocating certain costs on a per-unit basis was counterproductive
when some activities such as R&D and factory tax payments were really
aimed at maintaining the overall manufacturing enterprise (Jones and
Dugdale, 2002).
By 1991, a different interpretation of ABC had emerged. Kaplan and
Cooper, in a 1991 article, switched the emphasis of ABC from developing
accurate per-unit costing to developing a better understanding of the
product cost hierarchy. They divided activities into unit, batch, product-
sustaining, and facility-sustaining levels. Product cost is then described as
a sum of the unit, batch, and product-sustaining costs. In this second
definition of ABC (sometimes called second-wave ABC), the focus is on
resources instead of activities, costs are “sufficiently accurate” instead of
“more accurate,” and estimation and contribution margins are acceptable
parts of the model. As it moved into the 1990s, the two differences between
the first- and second-wave ABCs caused some confusion among the
accounting academic community as some tried to bridge the gap between
them, some discounted ABC theory as a whole, and others chose to ignore
the redefinition (Jones and Dugdale, 2002). For example, Johnson, one
of the originators of ABC literature, soon became a detractor of the system.
He argued that controlling activities to control cost via ABC really only
works in the short term; it will not help competitiveness or long-term
profitability because it places emphasis on altering the product and process
mix to the firm’s benefit and not on altering how activities are performed
to the customer’s benefit (Johnson, 1991).
This growth and change in ABC theory is presented in the format of
the ABC literature. During the late 1980s and early 1990s, there was a
plethora of consulting research articles, aimed at “selling” ABC to American
and European companies. Consulting research accounts for approximately
85 percent of the literature to date. They often include unsystematic
research, gross generalization, and selective arguments (Lukka and
Granlund, 2002).
Much of the ABC literature in the mid- and late 1990s reflects basic
research. These articles look to analyze ABC from an unbiased, scientifi-
cally vigorous point of view. Examples include mathematical modeling,
statistical surveys, and conceptual clarification articles. This basic research
and consulting research is balanced out with critical research articles on
ABC that aim to address the sociological ramifications that ABC produces.
Oddly, it also tends to use generalizations and less scientifically rigorous
arguments. The literature in this field appears to be very asymmetric and
fractured between geographic locales (United States and European) and
genres (consulting research, basic research, and critical research), with
little communication between these groups. This leads to less accumulation
of knowledge than would be found in most scientific fields, hindering
research in the area (Lukka and Granlund, 2002).
During the 1990s, the literature on ABC has gradually switched over
into areas such as application possibilities, lessons learned, implementation
instructions, and linking ABC to other popular management strategies
(Lukka and Granlund, 2002).
The early implication of an ABC system (Cooper and Kaplan, 1988) is
that if one understands the cost structure behind their manufacturing
activities, they can then manage those activities to reduce the overall cost.
For example, if one product costs more than other products to make for
a similar amount of revenue, that product could be dropped in favor of
the more cost-effective ones. If redundant activities occur, doubling the
cost to the product, ABC could help identify them, and they could be
eliminated for cost savings. Costly processes can be redesigned. Johnson
(1991) introduced the term activity-based management (ABM) to describe
management based on ABC. Sometimes the combined use of ABC and
ABM is abbreviated as ABC/M. Kaplan, Cooper, and Johnson tempered
the idea of ABM by stressing the avoidance of automatic decisions (Cooper
and Kaplan, 1988) and the limitation of strictly financial-based decisions
(Johnson, 1991) in ABM. As the theory unleashed into the environment
of management philosophy consultants of the early 1990s, much of this
tempering became lost on the general audience, and close, automated
links were established between ABC and ABM (Jones and Dugdale, 2002).
The emphasis of the ABM literature soon came to identifying and elimi-
nating non-value-adding activities (Jones and Dugdale, 2002; Lukka and
Granlund, 2002), often staff functions and similar overhead activities
(Armstrong, 2002).
There are numerous examples of authors linking ABC with other
management strategies. Crance et al. (2001) proposed combining ABC
with statistical process control (SPC). Processes naturally experience some
amount of variance. ABC and ABM systems that do not take this into
consideration may create warning signals whenever there is fluctuation
in a cost activity. SPC can be used to determine normal variance in a cost

activity and prevent management from punishing process managers for
normally fluctuating costs (Crance et al., 2001). Robert Kee proposes
combining ABC with its early archrival TOC. He suggests an “operational
ABC,” which uses mixed-integer programming to take into account oppor-
tunity costs for bottlenecks and costs of unused capacity. This short-term-
focused operational ABC model can be married to a traditional ABC model
so that companies can make short- and long-term production decisions
that correlate and provide maximum profitability (Kee, 1995, 2001). Letza
and Gadd (1994) suggest that because ABC and Total Quality Management
(TQM) are both process-oriented philosophies and both deal with
employee empowerment, the two methods can complement one another.
In their opinion, total quality measures often fail because management
cannot prove their effectiveness using traditional cost accounting systems.
Clarke and Bellis-Jones (1996) also advocate using ABC and ABM in a
TQM environment. Traditional accounting methods can lead to inaccurate
cost assumptions, lack of employee empowerment, lack of customer focus,
and a reduced ability for management to make effectual changes — all
of which is anathema to a TQM organization. They emphasize that ABM
is not an accounting technique, but a management process that makes
opportunities for improvement apparent (Clarke and Bellis-Jones, 1996).
In the early 1990s, in addition to promoting ABC and ABM, Kaplan
began developing a management method called balanced scorecard (BSC)
with partner David Norton. BSC requires companies to develop key
indicators that support their goals and objectives regarding financial per-
formance, customer satisfaction, internal business processes, and innova-
tion and learning (Kaplan and Norton, 1992). These key indicators are
used to communicate the strategy and enforce behaviors that support the
strategy by tying incentives to those carefully considered key indicators.
Organizations within the company can then be further aligned to the goals
and strategies by developing their own set of tactical strategies and goals,
with their key indicators, which tie into the overall goals and strategies.
Results from BSC can be used as feedback to company and unit strategies
to test their effectiveness and suggest new strategies (Kaplan and Norton,
2001). BSC examines both financial and operational indicators, differenti-
ating it from ABM, which is strictly focused on cost. This does not mean
that the two ideas are incompatible; ABC data can be used to feed and
manage BSC systems (Tinkler and Dúbe, 2002; Maiga and Jacobs, 2003).
ABC provides critical linkages to BSC by examining operational activity
costs and customer profitability, and providing critical budgeting informa-
tion (Kaplan and Norton, 2001).
More recent literature has also been critical of ABC and ABM. Armstrong
(2002) believes that ABC and ABM have developed into a method to
challenge staff accountability and suggests that the destruction of the staff
department is the heart of ABM. Clearly targeting first-wave ABC allocation
principles, he argues that indirect costs, by virtue of being defined as
“indirect,” are not directly traceable, and therefore, no method can claim
to allocate indirect costs in a more accurate method; they simply choose
a more reasonable method. This is okay for ABC, but ABM couples this
information with value analysis and uses it to destruct staff activities that
cannot tie the value of their activities to individual products, e.g., research
and development activities are investments in the future of the whole
enterprise, unused capacity is not expended on a product, development
of supplier relationships helps the quality of product lines, etc. (Armstrong,
2002). Tsai (1998) gets around this by claiming that an activity is value
added if it satisfies an organizational need.
Others have simply argued that there may be situations in which ABC
is not cost effective to run. Estrin et al. (1994), for example, argue that
the benefits of an ABC system may be low if it does not produce results
that are significantly different from those of a less costly costing system
or if management does not use the information for significant decision
making. Cooper (1988b) ties the total cost of operating a cost measurement
system to three factors: cost of errors, cost of measurement, and product
diversity. A simple cost system has low measurement cost and high cost
of errors, whereas a more accurate system has the reverse. This creates
an optimal system somewhere between these two, in which the total cost
of the system is minimal. Product diversity correlates to the cost of errors
that in turn affects the total cost of the system. Any of the three factors
can adjust, changing the total cost of the system. The cost system can be
changed to meet the new optimal conditions, but there is usually a barrier
cost to transferring the systems. If the preexisting, traditional cost system
meets the optimal operational cost of the system, there may not be a need
to change (Cooper, 1988b).
One study suggests that if overhead costs, as a percentage of the
overall business, get smaller, ABC implementation may not be profitable
if overhead is less than 15 percent of the overall costs of the company
(Vokurka and Lummus, 2001). Others have argued that successful use of
ABC to increase profits for a firm is not necessarily based solely on
implementation, but also on how much manager expertise and private
information drives the product or process. In situations in which manager
expertise is high and the uncertainty about how much that private infor-
mation affects the system is low, implementation of ABC may actually
lower profits because managers who help implement and operate the
ABC system will bias the information to their division’s benefit, passing
on almost intangible informational costs to the overall company (Mishra
and Vaysmani, 2001).
External (Supplier)
Information
ABC Analysis
Gathering
Company Goals,
Balanced Objectives, &
ABM
Scorecard Strategies
Internal (Customer)
Information
ABC Analysis
Gathering
Figure 5.1 TCO process model with ABC/M and BSC.
Another complaint about ABC is that it creates a second set of books

for accountants to manage because the company must still maintain a
traditional set of GAAP accounting measures for external reporting. Recent
accounting scandals have made accountants hesitant to embrace ABC
(Katz, 2002), and government organizations must be careful that a home-
grown, internal ABC accounting system does not interfere with a legally
mandated public accounting system (Cone, 2002).
Process Models
Given this study’s definition of TCO as an all-encompassing cost of
ownership including supplier costs, the following process model, which
takes into account these elements (Figure 5.1), is proposed.
The proposed process model consists of two parallel ABC cost analysis
activities, internal at the customer and external at the supplier. The steps
in the process are detailed as follows:
1. Internal
a. Information gathering: Prior to the development of cost pool
and driver elements, the scope of activities involved in a process
and information about those activities must be determined. For

this process model, all activities related to procured components
and services need to be determined. Because these activities
can be very different at different companies, there is no definitive
list of activities to include. Flowcharting and process-mapping
techniques can be useful in identifying specific activities. The
following list is given as a starting place for these activities:
Design and development — What activities are related to
developing purchased component specifications? Examples:
component selection, supplier research.
Logistics — What activities and costs are related to shipping
the purchased components? Examples: expediting, carrier
costs, tariffs.
Quality/engineering — What customer activities are related
to ensuring a quality component or service? Examples: au-
dits, communications between the suppler and customer
manufacturing personnel, warranty, scrap, rework.
Purchasing — What activities and costs are related to sup-
plier development and purchasing administration? Examples:
purchase orders, supplier meetings, requests for quotes.
MRO — What activities and costs are related to maintaining
and repairing purchased items? Examples: inventory main-
tenance, replacement parts.
Disposal — What activities and costs are related to disposing
of the product after use? Examples: environmental fees.
b. ABC analysis: The information gathered about the internal activ-
ities is used to generate cost pools, cost drivers, and pool rates.
These are then applied to the components or services in ques-
tion to determine the internal cost structure that supports them.
2. External
a. Information gathering: This is the external version of Substep
a. of Step 1. Here, information is gathered about the manufac-
turing process or outsourced service at the supplier. This may
not be as easy as it sounds; many suppliers can only supply
manufacturing cost information in a traditional accounting for-
mat; others may be reluctant to give up this information without
a significant business incentive presented up front. Lere and
Saraph (1995) suggest acquiring process flowcharts of the sup-
plier’s activities for the product in question and breakdowns of
overhead data for the processes that manufacture those parts.
They also suggest asking the following questions:
How much is the cost of an average engineering change
order (ECO)?
What types and frequencies of setups are performed on the

batches of the part or product?
How are production control and scheduling activities and
their costs allocated to the part or the product?
How is initial product development activity charged to the
part or product?
How are machine maintenance and inspection activities
accounted for in part or product cost?
How are tooling and other capital expense charges account-
ed for? (Lere and Saraph, 1995)
b. ABC analysis: The information gathered about the supplier
activities is used to generate cost pools, cost drivers, and pool
rates. These are then applied to the components or services in
question to determine the supplier cost structure that supports
them.
3. ABM for cost reduction: The results of ABC analysis at the supplier
and the customer are combined and analyzed for opportunities to
reduce the TCO. This generally drives the three following activities:
a. Eliminating non-value-added activities.
b. Reducing occurrences of activities.
c. Reducing the pool rates for the cost drivers (Lere and Saraph,
1995).
4. Feed ABM data and results into a balanced scorecard (BSC) system:
In a BSC system, the company pursues its goals and objectives
through the use of key performance indicators, with primary
focuses in the financial, customer, internal business process, and
learning and growth arenas (Kaplan and Norton, 1992). BSC per-
formance indicators are designed to directly support the goals and
objectives and keep a balance of focus between operational and
financial goals. The results of the ABM and ABC efforts are impor-
tant inputs into the company’s BSC system, in which they can be
used as part of the key indicator set, be used to easily find the
sources of problem issues, and help determine trade-offs in stra-
tegic decision making (Kaplan and Norton, 2001; Tinkler and Dúbe,
2002; Maiga and Jacobs, 2003).
5. Feed performance of BSC indicators back into the ABC and ABM
processes and the company strategies: The performance of these
key indicators feeds back into the ABC and ABM processes to
direct attention to TCO evaluation and management activities that
directly support the company’s strategic goals and objectives. This
also offers a chance to determine the effectiveness of the TCO
evaluation and management methods and correct them as neces-
sary or as the supply-chain environment changes. Feedback from
Enabling
Total Life Cycle Costing and
Factors
Management Using TCO and ABC/M Potential for
Competitive
Advantage of
Suppliers and Products and
H11 Services
Customers +
Sharing Sensitive
Information
Total Overall Product Cost
H3
+
Cost of Procured Cost of Procured
H3 Components Services
+
H1
–
H4 ABM Applied to Procured Components
+
Frequency of
Communications H2
between Suppliers –
and Customers
Administrative
Total Cost of Cost of Supply
H4 Quality Chain
+ H7 Management
H5 +
+
ABM Applied to Procured Services
H5
+ Number of
Suppliers
H10
–
Existence of Long-
Term Supplier
Relationships H6
– Procurement
Involvement in
ABM Applied to Procurement Activities H8 Design and
+ Development
H9
+
Common
Component
Selection
Figure 5.2 Hypothetical model for TCO study.
the BSC is also useful in testing the effectiveness of company

strategy and suggesting changes (Kaplan and Norton, 2001).
Hypothetical Model
The TCO process model, depicted visually in Figure 5.1, leads to the
proposed hypothetical model, depicted visually in Figure 5.2, upon which
this TCO study is based. This hypothetical model is discussed and pre-
sented in this section.
An important part of the TCO process model is analysis of supplier
cost structures. Little of the existing ABC literature addresses costs of
purchased components and services, and when it does look at procure-
ment, it discusses departmental and administrative costs for procurement
activities, not the important cost of procured parts (Ellram, 1995; Lere and
Saraph, 1995). Research by Ellram (1995) showed that many ABC-based
systems only tracked administrative purchasing costs, generating informa-
tion that was not sufficient for making good purchasing decisions. Lere
and Saraph (1995) suggest applying ABC to supplier cost analysis. Given
the importance of purchased component costs to the overall bottom line
of most modern manufacturers, the following hypothesis is proposed:
H1: Application of ABM to procured components will reduce

the overall cost of procured components and ultimately the
total cost of the product.
Despite its origins in manufacturing, ABC is not limited to parts and

products. Recently, much has been done to apply ABC principles to service
industries and services within companies. For example, banks have used
ABC to determine the costs of transaction activities, help with customer
segmentation, and make outsourcing decisions (Rafiq and Garg, 2002).
The U.S. Marine Corps instituted ABC to realize cost savings in nonmilitary
functions such as housing and accounting (Cone, 2002). Companies in
India have recently used process mapping and ABM to analyze their HR
activities, determine non-value-adding steps that do not support strategy
and to eliminate them for efficiency and cost savings. It has allowed them
to maintain a tighter, constant focus on quality and to better align their
HR practices with corporate strategy (Process Mapping, 2002). Given the
ability to analyze services using ABC and the importance of outsourced
service costs to the overall bottom line of most modern manufacturers,
the following hypothesis is proposed:
H2: Application of ABM to procured services will reduce the

overall cost of procured services and ultimately the total cost
of the product.
World-class supply chains are dependent on the development of part-

nership-type supplier relationships, in which customers and suppliers work
together to each others’ mutual benefit and to achieve the full potential
of the relationship (Carr and Ittner, 1992). Zsidisin and Ellram (2001) find
that the critical features of these alliances are continual communication
flow and trust between the organizations. These features might be mea-
sured by a willingness to share sensitive information, frequency of com-
munication, and willingness to enter lengthy arrangements such as long-
term contracts. To support the process model, purchasing personnel will
need to get detailed information on activities, cost drivers, cost driver
rates, and units of cost drivers at their suppliers. This sensitive information
will be much easier to obtain in a partnership-type relationship (Porter,
1993; Ehie, 2001; Zsidisin and Ellram, 2001). Therefore, the following three
hypotheses are proposed:
H3: Willingness of suppliers and customers to share information

will positively affect the customer’s ability to apply ABM to
procured components and services.
H4: Frequency of communication with suppliers will positively

affect the customer’s ability to apply ABM to procured compo-
nents and services.
H5: Presence of long-term supplier relationship will positively

nents and services.
Every supplier relationship has a number of regular activities that need

to go with it: requests for quotes, purchase orders, qualifications and
verifications, payments, supplier reviews, etc. If one were to reduce the
number of suppliers, consolidating more of its procurement business in
a smaller number of key suppliers, then hypothetically there would be a
reduction in these activities. One of the primary benefits of ABM is the
ability to shift out costly redundant activities and eliminate them. ABM
should recommend supplier reduction (Porter, 1993). Therefore, the fol-
lowing two hypotheses are proposed:
H6: Application of ABM to procurement activities will lead to

a significant reduction in the number of suppliers.
H7: Reduction in the number of suppliers will significantly

reduce the administrative costs of supply-chain management.
If TCO advocates that purchasing must consider the effects of other

business functions on the value of a specific purchase (Ferrin and Plank,
2002), and ABM aims to manage these activities and costs, then other
areas of the business will be affected by ABM cost reduction efforts.
Design and development is a prime target for examination because it is
where 70 to 80 percent of the eventual cost is put into a product (Zhang
and Fuh, 1998). At that stage, cost reductions can be implemented before
much of the actual spending occurs. With more and more components
being outsourced, procurement needs to transform its role within the
organization from an administrative function where development and
manufacturing simply place orders, to an integral advisor in the develop-
ment and design process. At this stage, supply-chain professionals have
the flexibility to consider numerous procurement scenarios to determine
the most cost-effective one and can mitigate design issues that will cause
future problems (Rink and Fox, 2003), and ABM should recommend
procurement involvement at this level (Porter, 1993). Therefore, the fol-

lowing hypothesis is proposed:

a significant level of procurement involvement in the design
and development process.
With reductions in the number of suppliers, a natural outgrowth of

ABM in the design and development process will be the limiting of
common component selection (Porter, 1993). For example, in an assembly,
designers would be limited to a small selection of fasteners from a single
supplier’s catalog. This has numerous cost advantages: purchasing orders
and other administrative paperwork only has to be filed with one supplier,
fewer fastener bins need to be filled on the manufacturing floor, and a
simpler design means that fewer quality errors occur. Even if the number
of suppliers is not reduced, ABM of the procurement activities would
suggest the use of a recommended list of common components for design
and development. For instance, common component usage across product
lines can reduce setup times and facilitate the use of common manufac-
turing equipment, reducing overhead and cost (Tully, 1994). Therefore,
the following hypothesis is proposed:
H9: Application of ABM to procurement activities will limit

common component selection (fewer suppliers and customer
parts) during the design and development process.
Application of TCO analysis using ABM principles on procurement

activities must include an examination of the costs associated with the
quality of the product. These can come from a number of activities:
inspections, rework, scrap, warranty, and audits. In a BSC system, the
results of these activities can show up in key indicators such as warranty
or scrap cost, part defect counts, stop ships, customer dissatisfaction
ratings, or field failures. Even though many of these quality activities take
place after purchase, they are still associated with the total cost of the
component. From an ABM perspective, however, only activities that pre-
vent quality problems and only some activities that ensure conformance
are value added; other processes need to be minimized to reduce cost
(Tsai, 1998). Suppliers that have a history of producing parts with few
quality problems will come out as less expensive in a procurement ABC
analysis, and they will be selected over other suppliers. This reduces the
total quality costs for the company as scrap, rework, and warranty become
less of an issue with the quality supplier. ABM could also be used to
identify redundant activities such as multiple inspections of the same part.

Therefore, the following hypothesis is proposed:
H10: Application of ABM to procurement activities will reduce

total quality costs.
Just as a company should apply cost evaluation and management

activities to their suppliers, they must realize that their customers will be
applying similar activities to the company’s products and services. It is
to their advantage to examine the life-cycle costs incurred throughout
the entire supply chain, from suppliers to customers, beyond just their
TCO. This allows them to develop and offer products and services that
are cost effective to the eventual customer, strengthening the competitive
advantage of the entire supply chain. Therefore, the following hypothesis
is proposed:
H11: Cost evaluation and management of the total life-cycle

cost of the product or service will strengthen the competitive
advantage of the product or service.
Game Theory
Game theory is an area of strategic thinking that looks at mathematically
predicting strategies in situations in which outcomes are based on the
interdependence of the different participants’ actions. It began in 1944,
when mathematician John Von Neumann and economist Oskar Morgen-
stern published Theory of Games and Economic Behavior, and it has
become an important tool for business strategists since then (Brandenburg
and Nalebuff, 1995).
The simplest versions of game theory revolve around two-person
games such as rock-paper-scissors or the classic prisoners’ dilemma. In
these scenarios, two participants simultaneously choose a strategy without
foreknowledge of their competitor’s strategy. With a limited number of
strategies available to each player, the outcomes for all of the possible
strategy choices can be arranged into a payoff matrix. Table 5.1, for
example, shows the payoff matrix for rock-paper-scissors. This rock-paper-
scissors is an example of a zero-sum game, in which a win for one player
results in an equal and opposite loss for the other player.
Dominant strategies develop in games when one of the strategies
provides an optimal solution regardless of what the other player does
(Brickley et al., 2004, pp. 226–254). For example, in Table 5.2, Player 1
and Player 2 will always choose Strategy A because it has the biggest
Table 5.1 Game Theory Payoff Matrix for

Rock-Paper-Scissors Game
Player 2
Rock Paper Scissors
Player 1 Rock 0, 0 –1, 1 1, –1

Paper 1, –1 0, 0 –1, 0
Scissors –1, 1 1, –1 0, 0
Table 5.2 Sample Game Theory Payoff

Matrix
Player 2
Strategy A Strategy B
Player 1 Strategy A 1, 1 2, 0
Strategy B 0, 2 1, 1
potential payoff. The outcome of rock-paper-scissors exclusively depends

on the interaction between the two players, so that game has no
dominant strategy.
Game theory can get more complex from here, looking at the use of
multiple strategies, interactions between multiple players, and sequential
strategic decisions in games with multiple rounds (Friedman, 1998). In
Chapter 7, we further analyze a number of competitive business scenarios
to determine dominant TCO management strategies.
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Chapter 6
Methodology for Analysis
Introduction
This chapter presents details on a survey construct used for gathering
industry information. This includes the attributes of surveyed subjects,
survey instrument design, sample size, profiles of the survey participants’
organizations, and the organization of survey. Survey results were tallied
at the macro level.
The Survey Construct

To test the hypothetical model, a survey was administered or e-mailed to
255 engineering and business professionals during the months of March
and April, 2004. A total of 141 surveys were received, representing at least
62 companies and 3 government and municipal agencies, and resulting
in a return rate of 55 percent. Table 6.1 shows the profile of the survey
responses by their organizations’ revenue, number of employees, and the
tally of respondents that reported whether their organization is an OEM,
contract manufacturer, or contracted service provider. The largest number
of respondents reported revenues of $100 to $500 million and $1 to $5
billion, employee workforces of 50 to 200, 1,000 to 5,000, and greater
than 10,000, and claimed to be OEMs. Industries surveyed included the
following: automotive (component manufacturing), medical device (car-
diac rhythm management, neurological devices, stents, hearing aids),
aerospace (aircraft sensors, military fighter aircraft), industrial (generators,
79
Table 6.1 Company Profile of Survey Respondents

Percentage of
Category Tally Surveys
Revenue
$0–5M 5 3.5
$5–10M 3 2.1
$10–25M 13 9.2
$25–50M 13 9.2
$50–100M 13 8.5
$100–500M 26 18.4
$500M–1B 8 5.7
$1–5B 31 22.0
>$5B 18 12.8
Missing value 12 8.5
Number of Employees
0–50 4 2.8
50–200 27 19.1
200–500 11 7.8
500–1,000 11 7.8
1,000–5,000 37 26.2
5,000–10,000 19 13.5
>10,000 28 19.9
Missing value 4 2.8
OEM or Contract
OEM 87 62
Contract manufacturer 36 26
Contract service provider 11 8
filters, paints, adhesive products, fluid power distribution, pumps, spraying

equipment), home construction and furnishings (windows, porch doors,
fireplaces), military (armored vehicles, fighter aircraft, naval guns, subma-
rine repair), heavy machinery (irrigation, harvesting equipment, lawn
maintenance equipment), and electronics (hard disk drives, microelectron-
ics fabrication, flexible circuitry, business equipment, electrical enclosures).
Table 6.2 tallies the survey respondents by industry and their organizations
by industry. The largest numbers of respondents come from the industrial,
medical device, and electronics industries, with 28, 24, and 17 surveys,
respectively, representing 23 industrial manufacturers, 12 medical device
manufacturers, and 11 electronics manufacturers.
Methodology for Analysis 81
Table 6.2 Industry Profile of Survey Respondents

Percentage of
Industry
Industrial 28 19.9
Medical devices 24 17.0
Electronics 17 12.1
Home construction and furnishings 11 7.8
Military 7 5.0
Services 6 4.3
Office products 5 3.5
Automotive 3 2.1
Aerospace 3 2.1
Memorabilia 2 1.4
Financial services 2 1.4
Health 2 1.4
Heavy machinery 2 1.4
Municipal 1 0.7
Research 1 0.7
Recreational vehicles 1 0.7
Retail fixtures 1 0.7
Advertising 1 0.7
Utilities 1 0.7
Printing 1 0.7
Food and beverage 1 0.7
Missing value 21 14.9
Respondent Companies by Industry

Industrial 23 28.0
Medical devices 12 14.6
Electronics 11 13.4
Home construction and furnishings 2 2.4
Military 4 4.9
Services 6 7.3
Office products 3 3.7
Automotive 3 3.7
Aerospace 3 3.7
Memorabilia 1 1.2
Financial services 2 2.4
Health 2 2.4
Heavy machinery 2 2.4
Municipal 1 1.2
Table 6.2 Industry Profile of Survey Respondents (Continued)

Percentage of
Research 1 1.2
Recreational vehicles 1 1.2
Retail fixtures 1 1.2
Advertising 1 1.2
Utilities 1 1.2
Printing 1 1.2
Food and beverage 1 1.2
A preliminary survey construct was tested with four known profession-

als prior to the general survey process to highlight clarity and usability
issues, leading to minor alterations in the survey construct. The survey
instructions were again altered for clarity after a review of some of the
early survey results indicated that not all of the surveys were filled out
correctly. A sample of the survey is included in Appendix A.
Respondents were asked to rate the frequency of 31 activities within
their company or business unit that related to the hypothetical model.
Frequency categories were provided as follows:
Never — The activity never occurs.

Infrequently — The activity is conducted less than once per year.
Sometimes — The activity is conducted once per year.
Often — The activity is conducted twice or more per year.
Always — The activity is systematically conducted.
Where appropriate, respondents were asked to also provide an approx-

imate percentage increase or percentage reduction of the activity over the
previous five-year time span. They were also asked for an approximate
percentage of their company’s overall products or services that were
outsourced to suppliers. Questions were included to cover both the OEM
and supplier points of view because respondents could come from either
category or count themselves as both. Definitions of key terms such as
TCO, ABC, and ABM were included in the survey for the convenience of
the respondent.
The survey results were entered into a spreadsheet. Numerous survey
respondents did not answer all of the questions, so a number of calcula-
tions were added to determine whether each response survey provided
enough information to test each hypothesis and calculate the percentage
of surveys that supported each hypothesis. This information was then
used to determine which respondents should be targeted with a follow-

up e-mail to fill in the unanswered questions. A total of 59 follow-up e-
mails were sent out, yielding 32 follow-up responses. A tally of the survey
results after this follow-up process is presented in Table 6.3 and Table
6.4. Table 6.3 displays all of the frequency responses in the 31 activities
on the survey. Table 6.4 displays the quantified percentage reductions or
increases over the last five years for ten of the activities on the survey.
Data Analysis
Because the survey is designed to test the hypothetical model, the results
of questions that indicate proposed causal activities and those of questions
that indicate the hypothetical resultant activities are compared to test the
hypotheses. Descriptive statistical data and statistical analysis are used to
analyze and quantify these comparisons and ultimately test the hypothet-
ical model.
Table 6.3 Tally of Survey Results — Frequency Data
Frequency Data
Missing
Survey Questions Never Infrequently Sometimes Often Always Value
1 Company uses an ABC system to determine the cost of 38 24 22 24 20 13

its internal processes
2 Company uses an ABC system to determine the costs 55 19 15 15 18 19
of externally supplied components
3 Company uses an ABC system to determine the costs 53 19 21 17 11 20
of externally supplied services
4 Customers use an ABC system to determine the cost of 37 21 14 19 13 37
the product or services that we provide to them

5 Company uses a cost estimating method other than 25 11 31 23 27 24
ABC to determine the TCO of the products or services
that it purchases
6 Customers use a cost estimating method other than 31 8 28 24 13 37
ABC to determine the TCO of the products or services
that they purchase
7 Company uses ABM methods to manage its internal 40 17 31 22 13 18
processes
8 Company applies ABM methods to our component 52 23 15 19 6 26
suppliers
9 Company applies ABM methods to our service 55 18 13 18 8 29
providers
10 Customers apply ABM methods to my products or 45 14 21 16 10 35
services
11 Company examines and manages the total life-cycle 29 23 20 29 26 14
costs of its products or services
12 Customers examine and manage the total life-cycle 21 18 28 19 23 32
costs of their products or services
13 Suppliers examine and manage the total life-cycle costs 18 34 25 18 12 34
of their products or services
14 Company is positioned competitively in its primary 2 2 12 37 86 2
markets
15 Company is willing to enter into nondisclosure 16 13 29 40 34 9
agreements and share sensitive information with its
suppliers
16 Company is willing to enter into nondisclosure 21 20 32 37 23 8
agreements and share sensitive information with its

customers
17 Employees communicate frequently with each core 2 7 27 52 47 6
supplier
18 Employees communicate frequently with each 1 17 19 38 62 4
customer
19 Company enters into long-term relationships with its 3 7 25 61 41 4
suppliers
20 Company enters into long-term relationships with its 1 7 13 53 60 7
customers
21 Procurement personnel play a significant part in the 9 23 35 33 33 8
design and development process
22 Company has reduced its number of suppliers 19 20 28 26 11 37
23 Company has reduced the overall cost of purchased 8 17 25 33 22 36
components
Table 6.3 Tally of Survey Results — Frequency Data (Continued)
Frequency Data
Missing
Survey Questions Never Infrequently Sometimes Often Always Value
24 Company has reduced the overall cost of externally 15 18 33 22 13 40

contracted services
25 Company has reduced the costs of administrating its 19 19 26 25 9 43
supply chain
26 Company has reduced the total cost of quality of its 15 15 28 33 17 33
products or services
27 Company has reduced the costs of managing its 29 20 26 19 8 39
customer relationships
28 Company has increased the number of long-term 13 20 31 31 14 32
relationships with its suppliers
29 Company has increased the number of long-term 10 13 22 42 24 30
relationships with its customers
30 Company’s products or service offerings have become 25 16 19 41 11 29
more standardized
31 Component set used to design new products has 16 18 19 40 14 34
become more standardized
Table 6.4 Tally of Survey Results — Percentage Data
Percentage Data
Missing Average
Survey Questions 0–25 26–50 51–75 76–100 Value Value
Amount of company’s overall products or services 71 24 4 6 36 23.08

outsourced to suppliers
Percentage Reduction
<0 Missing Average

Over the Last Five Years (Increase) 0–25 26–50 51–75 76–100 Value Value
22 Company has reduced its number of suppliers 5 65 11 1 2 57 15.15

23 Company has reduced the overall cost of 0 72 9 0 1 59 13.98
purchased components
24 Company has reduced the overall cost of 3 64 3 2 2 67 10.47
externally contracted services
25 Company has reduced the costs of administrating 1 56 15 1 1 67 14.49
its supply chain
26 Company has reduced the total cost of quality of 0 62 9 2 0 68 14.51
its products or services
27 Company has reduced the costs of managing its 7 60 2 0 0 72 5.94
customer relationships
Table 6.4 Tally of Survey Results — Percentage Data (Continued)
Percentage Increase
<0 Missing Average
(Increase) 0–25 26–50 51–75 76–100 Value Value
28 Company has increased the number of long-term 3 68 10 1 0 59 12.72

relationships with its suppliers

29 Company has increased the number of long-term 1 61 13 2 2 62 22.13
relationships with its customers
30 Company’s products or service offerings have 3 58 11 3 0 66 14.24
31 Component set used to design new products has 3 57 9 6 2 64 19.36
AU8215_C007.fm Page 89 Wednesday, June 14, 2006 1:44 PM
Chapter 7
Analysis and Findings
Introduction
This chapter provides the analysis of the hypothetical model that employs
descriptive and statistical analyses of data gathered using the survey
instrument. These results are summarized at the end of this chapter in
Table 7.10. The following section provides detailed analysis of the pro-
posed hypotheses that are part of the hypothetical model described in
Chapter 5.
Hypothesis Testing
Results of statistical analysis of the industry data that was gathered as
part of this study was used to validate the proposed hypotheses (H1
through H11).
H1: Application of ABM to procured components will reduce

the overall cost of procured components and ultimately the
total cost of the product.
Figure 7.1 shows that a large number of respondents reported that

they never applied ABM to procured components, yet it also shows that
the majority also reduced the costs of their procured components over
the last five years on a “Sometimes” (one per year) or better frequency.
Table 7.1 shows the relationships in the survey sample between the
89
Overall Frequency of Survey Respondents
60
52
50
40 33 Company applies ABM
30 25 methods to component
23 17 22
20 8 suppliers
15 19
10
Company has reduced
0 6
the overall cost of
Never
purchased components
Infrequently
Sometimes
Often
over the last five years
Always
Figure 7.1 Side-by-side comparison of survey respondents who use ABM and
who have reduced purchased component costs.
frequency of the application of ABM to procured components and the

frequency with which the company has been able to reduce the cost of
procured components. This information is then broken down graphically
in Figure 7.2, in which the frequency with which the company has been
able to reduce the cost of procured components is grouped by the
frequency of ABM usage to achieve that goal. This chart seems to suggest
that there is little correlation between the two frequencies; e.g., never
using ABM on procured components produces a wide range of responses
in the frequency of cost reduction.
Even if most companies are attempting to reduce the costs of procured
components independently from their application of ABM to procured
components, the frequency of these activities does not ensure sizable
reductions in cost. To determine this, one needs to look at the reported
percentage reductions in cost and correlate them back to the frequency
of ABM application to procured components. Figure 7.3 displays the
mean values of the percentage reduction in the procured component
costs. Companies that “Often” (twice or more per year) apply ABM to
procured components reported a 20 percent mean reduction in these
costs over the last five years, versus only 11 percent for those that “Never”
applied ABM.
The difference between “Sometimes,” “Often,” and “Always” (system-
atically) might be somewhat arbitrary in some situations, so it is helpful
to examine the percentage reduction in procured component costs results
for those who simply use ABM on their procured components versus
Table 7.1 Crosstabular Count of Reduced Purchased Component Costs and ABM Application
to Purchased Components
Count of Reduced Purchased
Component Costs Reduced Purchased Component Costs
ABM Applied to Procured Grand
Components Never Infrequently Sometimes Often Always Total
Never 4 8 9 8 12 41
Infrequently 4 2 3 8 1 18
Sometimes 0 4 2 3 4 13
Often 0 0 4 9 2 15
Always 0 2 1 1 1 5
Grand Total 8 16 19 29 20 92
Analysis and Findings 91
Frequency of Procured Component Cost

Reductions over the Last 5 years
Number of Survey Respondents
14
12
12
10 9 9 Never
8 8 8 Infrequently
8
Sometimes
6
4 4 4 4 4 Often
4 3 3
2 2 2 2 Always
2 1 111
0 00 0
0
er
tly
s
es
fte
ay
ev
en
im
w
N
qu
et
Al
m
fre
So
In
Uses ABM on procured components
Figure 7.2 Frequency of procured component cost reductions over the last five
years stratified by the frequency of ABM usage.
Mean Percent Reduction of Procured Component

Costs
25%
20%
20% 17%
16%
15% 13%
11%
10%
5%
0%
Never Infrequent ly Sometimes Oft en Always
Uses ABM on Procured Com ponents
Figure 7.3 Mean reported percent reduction of procured component cost based
on frequency of ABM usage.
Mean Percent Reduction of Procured Component

Costs
20%
18%
18%
16%
14% 13%
12%
10%
8%
6%
4%
2%
0%
Infrequent or less Sometimes or more
Uses ABM on Procured Components
Figure 7.4 Mean reported percent reduction of procured component cost based
those who do not. If all of the “Never” and “Infrequent” users and all of
the “Sometimes” or better users are pooled together as in Figure 7.4, this
results, respectively, in 13 percent and 18 percent reduction in procured
component costs, indicating a 5 percent advantage to applying ABM on
procured component costs. These mean percentage reductions in cost,
however, can be biased by outlying extreme cases, so it becomes important
to look at the median results. Figure 7.5 and Figure 7.6 place the median
values for the percentage reduction in procured component costs, dem-
onstrating them as stem-and-leaf diagrams and box plots, respectively.
These charts and tables indicate that there is a distinct advantage again
for those who apply ABM to procure components Often, where the median
reduction in cost is 20 percent, over all other frequencies of application,
which get a 10 percent median reduction in cost. If, however, we boil
percentage reduction in procured component costs down to Infrequent
or less ABM application versus regular ABM application (Sometimes or
more often), as is done in Figure 7.7, there is no difference in the medians,
only the range of percentage reductions in procured component cost
increases. A detailed validation of this is shown in Table 7.2, which
summarizes the descriptive statistical information from Figure 7.5, Figure
7.6, and Figure 7.7.
The percentage cost reductions for procured component results do
not meet the expectations of H1, as the mean and median results for
Always applies ABM to procured components are both less than the
Often, which applies ABM to procured components results. A possible
Never Stem-and-Leaf Plot Often Stem-and-Leaf Plot
Frequency Stem & Leaf Frequency Stem & Leaf
7.00 0 . 0000033 1.00 0 . 0

8.00 0 . 55555555 1.00 0 . 5
8.00 1 . 00000000 5.00 1 . 00000
6.00 1 . 555555 .00 1 .
3.00 2 . 000 4.00 2 . 0000
2.00 2 . 55 2.00 2 . 55
2.00 Extremes (>=40) .00 3 .
.00 3 .
Stem width: 10.00 1.00 4 . 0
Each leaf: 1 case(s) 1.00 Extremes (>=50)
Stem width: 10.00

Each leaf: 1 case(s)
Infrequently Stem-and-Leaf Plot Always Stem-and-Leaf Plot
2.00 0 . 00 1.00 0 . 0
4.00 0 . 5556 1.00 0 . 5
2.00 1 . 00 .00 1 .
2.00 1 . 55 1.00 1 . 5
2.00 2 . 00 .00 2 .
.00 2 . .00 2 .
2.00 3 . 00 1.00 3 . 0
1.00 Extremes (>=90)
Stem width: 10.00
Stem width: 10.00 Each leaf: 1 case(s)
Sometimes Stem-and-Leaf Plot
Frequency Stem & Leaf
.00 0 .
3.00 0 . 555
2.00 1 . 00
.00 1 .
1.00 2 . 0
.00 2 .
.00 3 .
1.00 3 . 5
1.00 4 . 0
Stem width: 10.00

Figure 7.5 Stem-and-leaf plots of reported percent reduction of procured com-

ponent cost based on frequency of ABM usage.
100.00
100.00
80.00
80.00
60.00
60.00
40.00
40.00
20.00 20.00
0.00 0.00
Never Infrequently Sometimes Often Always InfrequentABM RegularABM
Figure 7.6 Box plots of reported percent reduction of procured Figure 7.7 Box plots of reported percent reduction of procured
component cost based on frequency of ABM usage. component cost based on infrequent versus regular ABM usage.
Table 7.2 Descriptive Statistics Pertaining to Percentage Reduction of Procured Component Costs at Varying Frequencies
of ABM Application to Procured Component Costs
Uses ABM on Procured Components
Infrequently Sometimes
Percentage Reduction Infrequently Sometimes Often or Less or More (at
of Procured (Less than (Once per (Twice or More Always (Less than Least Once
Component Costs Never Once per Year) Year) per Year) (Systematic) Once per Year) per Year)
Mean 11% 17% 16% 20% 13% 11% 18%

Median 10% 10% 10% 20% 10% 10% 10%
Range 40% 90% 35% 50% 30% 90% 50%
Minimum 0% 0% 5% 0% 0% 0% 0%
Maximum 40% 90% 40% 50% 30% 90% 50%
Interquartile Range 10% 15% 26.25% 15% 25% 20% 10%
Count 36% 15% 8 15% 4% 51% 27%
explanation for this could be that the companies that Always use ABM
on procured component costs have already taken much of the cost out
and were not able to get the same benefit out of this activity that
companies who applied ABM to procured components less frequently
were able to achieve. It is important to note that because the survey
sample responses fall into five categories for this analysis, the number of
observations regarding the percentage reduction in the cost of procured
components in each category form small samples, though they do suggest
an inclination to accept the hypothesis.
H2: Application of ABM to procured services will reduce the

overall cost of procured services and ultimately the total cost
of the product.
Looking at the survey results on cost reductions of procured services

for H2 provides a similar set of results as reducing procured component
costs (H1). Figure 7.8 shows that the largest group of respondents did
not apply ABM to their service providers and that the largest group of
respondents reduced the costs of those services at least once per year
(Sometimes) over the last five years. Figure 7.9 shows the frequencies by
which the company has been able to reduce the cost of procured services
grouped by the frequency of ABM usage to achieve that goal. As in H1,
there seems to be little correlation between the application of ABM to
procured services and the frequency in the reduction of procured service
60 55
50
Company applies ABM
40 33 methods to our service
30 providers
15 18 22
20 18
13 18 13
10
8 Company has reduced
0 the overall cost of
Never
externally contracted
Infrequently
Sometimes
Often
services over the last

Always
five years
who have reduced purchased service costs.
Reduction of Procured Service Costs
Number of Survey Respondents 14

12
12
10 99 Never
Infrequently
8 77
Sometimes
6 5 55
4 44 Often
4 Always
2 2 2 22 2
2 1 1 1 1
0 0 0 0
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Uses ABM on procured services
Figure 7.9 Frequency of procured services cost reductions over the last five years
stratified by the frequency of ABM usage.
costs; Figure 7.9 matches Figure 7.8, placing Sometimes reduction in

procured service costs as the highest result in any frequency of ABM
application to procured services.
Figure 7.10 shows the mean percentage reductions of procured service
costs for each frequency of ABM application to procured services. This
distinctly shows a trend of improved results between the Never and Often
applications of ABM to procured services, going from 6 to 20 percent
reductions in procured service costs, respectively. As in H1, there was a
drop in the Always applies ABM situation, down to 14 percent mean
reduction in procured service costs. Again, this may be because companies
that Always apply ABM have already gotten much of the value out of this
activity; the so-called “low-hanging fruits” are out of the way, and they
do not see the results that a company using ABM less frequently would
see. Figure 7.11 shows the mean percentage reductions of procured service
costs if we broke the results into two categories, Infrequently or less,
which represents the nonregular ABM user, and Sometimes or more, which
represents the regular user. Here, we see a definite 11 percent procured
services cost reduction for those who apply ABM to their procured service
costs over those who do not.
Although the mean results of the percentage reduction in procured
service costs look substantial, they can be biased by a few outlying cases,
so Figure 7.12 and Figure 7.13 show the percentage reduction in procured
Mean % Reduction of Procured Service Costs
25%
20%
20%
15% 14%
13%
9%
10%
6%
5%
0%
Never Infrequently Sometimes Often Always
Uses ABM on Procured Services
Figure 7.10 Mean reported percent reduction of procured service costs based
Mean % Reduction of Procured Service Costs
18%
17%
16%
14%
12%
10%
8% 6%
6%
4%
2%
0%
Infrequently or less Sometimes or more
Figure 7.11 Mean reported percent reduction of procured service costs based
Never Stem-and-Leaf Plot

Often Stem-and-Leaf Plot
2.00 Extremes (=<-100)
13.00 0 . 0000000000114 2.00 0 . 00
5.00 0 . 55555 1.00 0 . 5
7.00 1 . 0000000 3.00 1 . 000
.00 1 . .00 1 .
6.00 2 . 000000 2.00 2 . 00
3.00 2 . 555 .00 2 .
2.00 Extremes (>=60) 1.00 3 . 0
.00 3 .
Stem width: 10.00 1.00 4 . 0
Each leaf: 1 case(s) 1.00 Extremes (>=80)
Stem width: 10.00

Infrequently Stem-and-Leaf Plot

Always Stem-and-Leaf Plot
1.00 0 . 0
.00 0 . 1.00 0 . 0
1.00 0 . 5 .00 0 .
.00 0 . 1.00 1 . 0
.00 0 . 1.00 1 . 5
3.00 1 . 000 .00 2 .
1.00 Extremes (>=20) .00 2 .
1.00 3 . 0
Stem width: 10.00
Each leaf: 1 case(s) Stem width: 10.00
1.00 Extremes (=<-10)

3.00 1 . 000
.00 1 .
1.00 1 . 5
.00 1 .
.00 1 .
2.00 2 . 00
.00 2 .
1.00 2 . 5
Stem width: 10.00

Figure 7.12 Stem-and-leaf plots of reported percent reduction of procured ser-

vice costs based on frequency of ABM usage.
service costs results, grouped by the frequency of ABM application to

procured service costs, with median values as stem-and-leaf diagrams and
box plots, respectively; Figure 7.14 groups the percentage reduction in
procured service cost results into Infrequent or less and Sometimes or
more ABM application category box plots, again representing the nonreg-
ular and regular ABM user. A detailed summarization of the descriptive
statistics for percentage reduction in procured services costs is provided
in Table 7.3. There is still an advantage to those who regularly apply ABM
100.00
100.00
50.00
50.00
0.00 0.00
-50.00 -50.00
-100.00 -100.00
Figure 7.13 Box plots of reported percent reduction of pro- Figure 7.14 Box plots of reported percent reduction of pro-
cured service costs based on frequency of ABM usage. cured service costs based on infrequent versus regular ABM
usage.
Table 7.3 Descriptive Statistics Pertaining to Percentage Reduction of Procured Service Costs at Varying Frequencies of ABM
Application to Procured Service Costs
Infrequently Sometimes or
Percentage Infrequently Sometimes Often or Less More (at Least
Reduction of Procured (Less than (Once per (Twice or More Always (Less than Once per
Service Costs Never Once per Year) Year) per Year) (Systematic) Once per Year) Year)
Mean 6% 9% 13% 20% 14% 6% 17%

Median 5% 10% 12.5% 10% 12.5% 7.5% 10%
Range 170% 20% 35% 80% 30% 170% 90%
Minimum –100% 0% –10% 0% 0% –100% –10%
Maximum 70% 20% 25% 80% 30% 70% 80%
Interquartile Range 20% 8.75% 10% 25% 23.75% 20% 10%
Count 38% 6 8 11% 4 44 23%
to the procured services; the median value of percentage reduction of

procured service costs for regular users is 2.5 percent greater than that of
nonregular users, but this is much less than the 11 percent advantage for
regular ABM users over nonregular users identified by examining the mean
percentage reduction in procured service costs. Again, it is important to
note that because the survey sample responses fall into five categories
for this analysis, the number of observations regarding the percentage
reduction in the cost of procured services in each category form small
samples, though they do suggest an inclination to accept the hypothesis.
H3: Willingness of suppliers and customers to share information

will positively affect the customer’s ability to apply ABM to
The survey instrument provides three ways to examine the effect that
information sharing has on the ability to apply ABM to procured com-
ponents and services. The first method, shown graphically in Figure 7.15
and Figure 7.16, compares the frequency of information sharing with
suppliers to the frequency of ABM application to procured components.
As in H1, Figure 7.15 shows that the largest number of survey respon-
dents reported that their companies Never apply ABM to their procured
components. The vast majority of overall survey r espondents also
reported that they enter into information-sharing agreements with their
suppliers on a Sometimes or better basis. Figure 7.16, which groups
ABC application to procured component responses by the frequency of
entering into information-sharing agreements, does not seem to indicate

50
40 methods to component
40 34 suppliers
29
30 16 23
20 13
15 19
10
0 6
Company is willing to
Never
Infrequently
enter into non-

Sometimes
Often
Always
disclosure agreements
and share sensitive
information with its
suppliers
Figure 7.15 Side-by-side comparison of survey respondents who apply ABM to

procured components and who share information with their suppliers.
Applies ABM to Procured Components
Number of Survey Respondents 18 16

16
14 12 Never
12 1111
Infrequently
10 8
7 Sometimes
8 6
6 Often
4 4 4
4 3 3 33 33 Always
2 2 2
2 1 1 1 1
0 0
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Willing to Share Information with Suppliers
Figure 7.16 Frequency of the application of ABM to procured components strat-

ified by the frequency of willingness to share information with suppliers.
very much in the way of trends based of the frequency of entrances

into information-sharing agreements, though the Often information-shar-
ing-agreement frequency shows a more even distribution of ABM appli-
cation frequencies than the other groups that are dominated by the
Never applies ABM response.
The second method, shown graphically in Figure 7.17 and Figure 7.18,
compares the frequency of information sharing with suppliers to the
frequency of ABM application to procured services. Similar to the first
60 55
Company applies ABM
50
40 methods to our service
40 34 providers
29
30 16
20 18 13
13 18
10
8 Company is willing to
0
enter into non-
Never
Infrequently
Sometimes
disclosure agreements
Often
Always
and share sensitive

information with its
suppliers

procured services and who share information with their suppliers.
Applies ABM to Procured Services
16 15
Number of Survey 14 13 13
Never
Respondents 12
10 Infrequently
8
8 7 Sometimes
66
6 5 5
4 4 Often
4 3 3 33
2 2
2 1 11 1 1 1 1 Always
0
0
er
tly
es
ys
fte
ev
en
im
wa
O
N
et
qu
Al
m
fre
So
In
Willing to Share Information with Suppliers
Figure 7.18 Frequency of the application of ABM to procured services stratified

by the frequency of willingness to share information with suppliers.
method, Figure 7.17 shows that the largest number of survey respondents
reported that their companies Never apply ABM to their procured services.
The vast majority of overall survey respondents also reported that they
enter into information-sharing agreements with their suppliers on a Some-
times or better basis. Figure 7.18, which groups ABM application to
procured services responses by the frequency of entering into information-
sharing agreements, does not appear to show any trends on the basis of
information-sharing-agreement frequency.
The third method, shown graphically in Figure 7.19 and Figure 7.20,
compares the frequency of information sharing with customers to the
50 Customers apply ABM

45
40 37 methods to my products
32 and/or services
30
21 20
20 23
21
14 16
10
10
0
Company is willing to
Never
Infr equent ly
Some time s
Often
enter into non-disclosure

Always
agreements and share

sensitive information with
its customers
Figure 7.19 Side-by-side comparison of survey respondents whose customers

apply ABM to their products and services and respondents who share information
with their customers.
Customer Applies ABM to Procured Components and

Services
14 12 12
Number of Survey
12 Never
Respond en ts
10 8 8 8 Infrequently
8 6 66
5 Sometimes
6 4 4 4 4
4 3 3 Often
22 2 2
2 1 11 1 Always
0 0
0
es
n
er
tly
s
ay
f te
ev
en
im
w
O
N
et
qu
Al
m
fre
So
In
Willing to Share Information with Customers
Figure 7.20 Frequency of the application of ABM to procured products and

services by customers stratified by the frequency of willingness to share informa-
tion with customers.
frequency of ABM application to procured components and services by

the customer. Figure 7.19 shows that the largest number of survey
respondents reported that their customers Never apply ABM to their
procured components and services. A majority of overall survey respon-
dents also reported that their customers enter into information-sharing
agreements with the respondent’s company on a Sometimes or better
basis, but the Never and Infrequently responses were more prevalent
than in the prior two methods. Similar to the first method, Figure 7.20,
which groups customer application of ABM to procured components and
services by the frequency of entering into information-sharing agreements
with customers, does show that the Often information-sharing-agreement
frequency shows a more even distribution of ABM application frequencies
than the other groups that are dominated by the Never applies ABM
response. This may suggest that the ability to apply ABM to procured
components and services may be positively influenced by entering into
agreements to share information.
H4: Frequency of communication with suppliers will positively

nents and services.
As with our examination of H3, the survey instrument provides three

ways to examine the effect that communication frequency has on the
ability to apply ABM to procured components and services. The first
method, shown graphically in Figure 7.21 and Figure 7.22, compares the
60 52 52
50 47
40
27
20 19 methods to component
2 7 15
10 suppliers
0 6 Employees
communicate frequently
Never
Infr equentl y
Somet imes
with each core supplier

Ofte n
Always

procured components and who communicate with their suppliers.

25
20
20 18
Never
15 Infrequently
10 Sometimes
10 9
8 8 Often
6 6 6
5 Always
5 4 4
3
2
1 1 1 1
0000 00 0
0
ly
er
s
es
ay
nt
fte
ev
im
e
w
O
N
qu
et
Al
m
fre
So
In
Frequency of Communication with Suppliers

ified by the frequency of communications with suppliers.
60 55
52
40 methods to our service
27
30 providers
20 18
7 13 18
2
10
8
0
Employees
Never
Infr equently
Sometimes
communicate
Often
Always
frequently with each
core supplier

procured services and who communicate with their suppliers.
frequency of communication with suppliers to the frequency of ABM

application to procured components. Figure 7.21 shows that the largest
number of survey respondents reported that their companies Never apply
ABM to their procured components. The vast majority of overall survey
respondents also reported that they communicated with their suppliers
on an Often or better basis. Figure 7.22, which groups ABM application
to procured component responses by the frequency of communications,
does not seem to indicate any trends on the basis of the frequency of
communication; i.e., the Never applies ABM to procured components
response dominates each category of communication frequency.
compares the frequency of communication with suppliers to the frequency
of ABM application to procured services. Figure 7.23 shows that the largest
number of survey respondents reported that their companies Never apply
ABM to their procured services. The majority of overall survey respondents
also reported that they communicate with their suppliers on an Often or
better basis. Figure 7.24, which groups ABM application to procured
services responses by the frequency of communication, does not appear
to show any trends on the basis of communication frequency.
compares the frequency of communication with customers to the fre-
quency of ABM application to procured components and services by the
customer. Figure 7.25 shows that the largest number of survey respondents
reported that their customers Never apply ABM to their procured compo-
nents and services. A majority of overall survey respondents also reported
that they communicated with their customers on an Often or better basis.
Figure 7.26 groups customer application of ABM to procured components
Applies ABM to Procured Services
Number of Survey Respondents 25

21
19
20 Never
15 Infrequently
Sometimes
9 9 8
10 Often
6 5 65 6
4 4 Always
5 22 1
10000 1001 0
0
tly
er
s
es
ay
fte
en
ev
im
w
O
N
qu
et
Al
m
fre
So
In
Frequency of Communication with Suppliers

by the frequency of communications with suppliers.
70
62
60
Customers apply ABM
50 45
38 methods to my products
40
30 and/or services
17 19
20 21
10 1 14 16
10
0
Never
Infrequently
Sometimes
Often
Employees communicate
Always
frequently with each

customer

apply ABM to products and services and who communicate with their customers.
and services by the frequency of communication with customers, does

not show much of a trend on the basis of frequency of communication;
again Never applies ABM dominates each frequency of communication
category on a relatively even proportional basis.
H5: Presence of long-term supplier relationship will positively

nents and services.
Customer Applies ABM to Procured Components and

Services
19
Number of Survey 20
18
16 Never
Respondents
13
14 11 Infrequently
12
10 8 7 7 Sometimes
8 5 5
6 44 3 4 4 4 Often
4 100 00 1 1 12 1 1 Always
2
0
tly
er
s
es
ay
fte
en
ev
im
w
O
N
qu
et
Al
m
fre
So
In
Frequency of Communication with

Customers
Figure 7.26 Frequency of customer application of ABM to procured components

and services stratified by the frequency of communications with customers.
As with our examinations of H3 and H4, the survey instrument provides

three ways to examine the effect that the existence of long-term supplier
relationships has on the ability to apply ABM to procured components
and services. The first method, shown graphically in Figure 7.27 and Figure
7.28, compares the frequency of entering into long-term supplier relation-
ships to the frequency of ABM application to procured components. Figure
7.27 shows that the largest number of survey respondents reported that
their companies Never apply ABM to their procured components. The
majority of overall survey respondents also reported that they entered into
70 61
60 52
50 41
40
23
20 7 15 19 methods to component
3
10 suppliers
0 6 Company enters into
Never
Infr equently
long-term relationships
Sometimes
Often
Always
with its suppliers

procured components and who enter into long-term relationships with their suppliers.
25
20
Nu mb er o f Survey
20 Never
Resp ondents
13 Infrequently
15 12 12
11 Sometimes
10 7
5 5 5 Often
5 21 32 3 24 3
10 0 1 Always
00 0 0
0
s
er
es
n
tly
ay
fte
ev
im
en
w
O
N
et
qu
Al
m
fre
So
In
En te rs into Lo ng-Ter m Re lation sh ip s wit h

Su pp lie rs

ified by the frequency of long-term relationships with suppliers.
long-term relationships with their suppliers on an Often or better basis,

with Often getting the largest number of responses. Figure 7.28, which
groups ABM application to procured component responses by the fre-
quency of entering into long-term supplier relationships, does not seem
to indicate any trends on the basis of the frequency of communication;
i.e., the Never applies ABM to procured components response dominates
each category of long-term relationship entering frequency.
compares the frequency of entering into long-term supplier relationships
70 61
60 55
50
40 41 Company app lies ABM
30 25 methods to our ser vice
20 18 pro vider s
3 7 13 18
10
8
0 Company enter s into
Never
Infr equently
Sometimes
long-term relations hips

Often
Always
with its suppliers

procured services and who enter into long-term relationships with their suppliers.
App lies ABM to Procu red Se rvices
Number o f Survey R esp onde nt s 30

26
25
Never
20 Infr equent ly
15 12 Sometimes
10 11
10 7 7 7 Ofte n
5 Always
5 2 32 2 34 43
00 00 1 00 1 0
0
s
es
er
n
tl y
ay
f te
ev
im
en
w
O
N
et
qu
Al
m
fre
So
In
Enters into Long-Term Relationships with

Suppliers

by the frequency of long-term relationships with suppliers.
to the frequency of ABM application to procured services. Figure 7.29

shows that the largest number of survey respondents reported that their
companies Never apply ABM to their procured services. The majority of
overall survey respondents also reported that they enter into long-term
relationships with their suppliers on an Often or better basis. Figure 7.30,
which groups ABM application to procured services responses by the
frequency of entering into long-term supplier relationships, does not
appear to show any trends on the basis of long-term supplier relationship
frequency, except in the Always category, in which the Never applies
ABM responses are not as dominant as the other frequencies of entering
into long-term supplier relationships.
compares the frequency of entering into long-term relationships with
customers to the frequency of ABM application to procured components
and services by the customer. Figure 7.31 shows that the largest number
of survey respondents reported that their customers Never apply ABM to
their procured components and services. A vast majority of overall survey
respondents also reported that they entered into long-term relationships
with customers on an Often or better basis. Figure 7.32 groups customer
application of ABM to procured components and services by the frequency
of entering into long-term relationships with customers, does not show
much of a trend on the basis of frequency of communication; again, Never
applies ABM dominates each frequency of entering into long-term cus-
60
60 53
50 45
40
30 Custom ers apply ABM
20 2113 methods to m y produc ts
14 7 16
1 and/or s ervices
10 10
0
Never
Company enters into long-

Infrequently
Sometimes
Often
term relations hips with its
Always
custom ers

apply ABM to their products and services and who enter into long-term relation-
ships with their customers.
Customer Applies ABM to Procu red Co mponent s

and Se rvices
Nu mb er o f Su rvey Resp ondents
25
20
20 17 Never
15 Infrequently
10 Sometimes
10 7 8 Often
5 6 6 6 6
4 Always
5
100 00 10 10 11 20 2
0
s
er
es
n
tly
ay
fte
ev
im
en
w
O
N
et
qu
Al
m
fre
So
In
Enters int o Long-Term Re lati on sh ip s wit h

Cust omers
Figure 7.32 Frequency of customer application of ABM to procured components

and services stratified by the frequency of long-term relationships with customers.
40
40
30 31 28
26
19 20
20 22
17 Company uses ABM
methods to manage its
11
10 13 internal processes
Company has reduced
0 its number of suppliers
Never
over the last five years

Infr equently
Sometimes
Often
Always
who have reduced their supply base.
tomer relationships, except for the Sometimes frequency category, which

shows a higher number of Sometimes applies ABM to procured compo-
nents and services responses.

a significant reduction in the number of suppliers.
Figure 7.33 shows that the largest number of respondents do not use
ABM to manage the internal processes, such as procurement activities, in
their company. Another significant portion, about 25 percent of those who
answered the question on the survey instrument, report using it to manage
their internal processes at a Sometimes frequency. Among the respondents,
the largest portion of them report that they also reduced their supply base
at a Sometimes frequency over the last five years. In fact, looking at Figure
7.33 reveals that for most of the frequency categories, a roughly equivalent
number of respondents both reduced the size of their supply base and
applied ABM to their internal processes at the same frequency. This suggests
that the two may be very closely related. Table 7.4 shows the relationships
in the survey sample between the frequency of the application of ABM to
internal processes and the frequency with which the company has reduced
its supply base over the last five years. This information is then broken
down graphically in Figure 7.34, in which the frequency with which the
company has reduced its supply base is grouped by the frequency of ABM
application to internal processes.
Table 7.4 Crosstabular Count of Reduced Supplier Base and ABM Application to Internal Processes
Count of Reduced Purchased
Component Costs Reduced Number of Suppliers
ABM Applied to Internal
Processes Never Infrequently Sometimes Often Always Grand Total Percent of Total
Never 9 5 9 7 2 32 33
Infrequently 1 2 2 6 3 14 15
Sometimes 5 4 8 5 2 24 25
Often 4 5 3 4 2 18 19
Always 0 2 3 2 1 8 8
Grand total 19 18 25 24 10 96
Percentage of total 20 19 26 25 10
Reduction of Supply Base

10
Number of Survey Respondents 9 9
9
8
8
7
7 Never
6
6 Infrequently
5 5 5 5
5 Someti mes
4 4 4
4 Often
3 33
3 22 Al ways
2 2 2 2 2
2
1 1
1
0
0
r
tly
s
es
ve
ay
fte
en
im
Ne
w
O
qu
et
Al
m
fre
So
In
Uses ABM internal processes
Figure 7.34 Frequency of supply base reductions over the last five years stratified
by the frequency of ABM usage.
The independence of these two survey responses, ABM application to

internal processes and reduction of the supply base, can be tested using
Pearson’s chi-squared test. This test compares the crosstabular results of
the survey on Table 7.4 with the expected tables of results if ABM
application to internal processes and reduction of the supply base were
truly independent of each other. First, the probability that a tabulated
survey response will fall on each particular row and column in Table 7.4
is determined by dividing the sum of the counts on that row or column
by the total count; this is included in Table 7.4 as “Percent of Total.” A
table of expected results is then generated by multiplying the total sum
of responses by the probability that the survey falls within that column
and by the probability that the survey falls within that row, as per Equation
7.1. This results in Table 7.5.
⎛ counti ⎞ ⎛ count j ⎞
Eij = N ⎜ (Equation 7.1)
⎝ N ⎟⎠ ⎜⎝ N ⎟⎠
Any result in Table 7.4 that matches the result in Table 7.5 suggests
that ABM application to internal processes and the reduction of the supply
base are independent. The difference between the expected result and
the observed result is called a residual. To get an overall rating of
independence, the residuals for each table location are squared and
Table 7.5 Expected Crosstabular Count of Reduced Supply Base and ABM
Application to Internal Processes
Count of
Reduced Purchased
Component Costs Reduced Number of Suppliers
ABM Applied to
Internal Processes Never Infrequently Sometimes Often Always
Never 6.33 4.88 13.54 10.92 3.72

Infrequently 1.88 1.52 4.04 3.28 1.11
Sometimes 2.52 1.98 5.28 4.18 1.45
Often 1.01 0.81 2.05 1.67 0.57
Always 0.15 0.14 0.32 0.24 0.08
summed per Equation 7.2, where E is the expected result, O is the observed
result, i is the row, and j is the column, to get an X2 value.
(Oij − Eij )2
X2 = ∑∑
i j
Eij
(Equation 7.2)
This result is then checked against a chi-squared distribution that is

dependent on the degrees of freedom of the table, where the degrees of
freedom are equal to (r – 1) × (c – 1), where r is the number of rows
and c is the number of columns in the table, to determine a probability
that the two occurrences are independent. In this case there are 16 degrees
of freedom, and the chi-squared probability is 2.19E-19. Generally, if
anything has a chi-squared probability = 0.05, the hypothesis that both
factors are independent of each other is accepted as valid. In this case,
the frequencies of ABM application to internal processes and the reduction
of the supply base are rejected as independent based on a 0.05 probability
test. ABM application to internal processes and the reduction of the supply
base are therefore accepted as interdependent based on the survey results.
Although there is a relationship between the frequency of ABM appli-
cation to internal processes and the reduction of the supply base, the prior
discussion does not establish the degree to which the supply base is
reduced. Figure 7.35 shows the mean percentage reduction of the supply
base for each frequency of ABM application to internal processes. Use of
ABM to manage internal processes at the intermediate Sometimes frequency
produces the largest mean reduction in the supply base at 21 percent.
It may be that those companies that use ABM on a more frequent basis
have already reduced their supply base to the point that they only have
Mean % Reduction of Supply Base
25%
21%
20%
16%
15%
15%
11% 12%
10%
5%
0%
Never Infrequently Somet imes Often A lway s
Uses ABM on Internal Processes
Figure 7.35 Mean reported percent reduction of supply base based on frequency
of ABM usage.
a core set of suppliers and do not need to reduce the size of their supply
base much more. If the pool of respondents is divided into two categories,
Infrequently or less, which represents the nonregular ABM user, and
Sometimes or more, which represents the regular ABM user, it presents a
clearer image of the overall effect of ABM application to internal processes
on the percentage reduction of the supply base. Figure 7.36 shows the
Mean % Reduction of Supply Base
18%
17%
16%
14%
13%
12%
10%
8%
6%
4%
2%
0%
Infrequent ly or less Sometimes or more
Figure 7.36 Mean reported percent reduction of supply base based on frequency
of ABM usage.
mean percentage reduction of the supply base divided into the nonregular
and regular ABM user categories. Those respondents who applied ABM to
their internal processes on a Sometimes or more frequency reduced their
supply base by 4 percent more, on average, than those who did not.
Of course, outliers can bias the mean percentage reduction of supply
base results, so the median results need to be analyzed. Figure 7.37 shows
Frequency Stem & Leaf Often Stem-and-Leaf Plot
1.00 -2 . 0 Frequency Stem & Leaf

.00 -1 .
.00 -0 . 1.00 -2 . 0
9.00 0 . 000000555 1.00 -1 . 0
9.00 1 . 000000055 .00 -0 .
3.00 2 . 055 5.00 0 . 00155
1.00 3 . 0 5.00 1 . 00005
2.00 Extremes (>=40) 3.00 2 . 005
Stem width: 10.00

3.00 0 . 000
3.00 0 . 555 1.00 -1 . 5
3.00 1 . 000 .00 -0 .
.00 1 . 2.00 0 . 01
.00 2 . .00 1 .
.00 2 . 3.00 2 . 005
1.00 3 . 0 1.00 3 . 0
.00 3 . .00 4 .
1.00 4 . 0 1.00 5 . 0
Stem width: 10.00
1.00 Extremes (=<-50)

2.00 0 . 01
.00 0 .
2.00 1 . 00
1.00 1 . 5
5.00 2 . 00000
4.00 2 . 5555
2.00 3 . 00
.00 3 .
2.00 4 . 00
1.00 Extremes (>=100)
Stem width: 10.00

Figure 7.37 Stem-and-leaf plots of reported percent reduction in supply base

based on frequency of ABM usage.
the percentage reduction in supply base results based on the frequency

of ABM application to internal processes as stem-and-leaf diagrams. Figure
7.38 and Figure 7.39 plot out the percentage reduction in supply base
results based on the frequency of ABM application to internal processes
as box plots for all frequencies and for regular (Sometimes or more) and
nonregular (Infrequently or less) use, respectively.
A detailed summarization of the descriptive statistics for percentage
reduction in the supply base is provided in Table 7.6. The difference in
the median percentage reduction in supply base results is even more
pronounced than that of the mean percentage reduction in supply base
results, 10 percent difference in the median results for the percentage
reduction in supply base results for the nonregular and regular ABM user
versus 4 percent difference for the mean percentage reduction in supply
base results between the nonregular and regular ABM user. Because the
survey sample responses fall into five categories for this analysis, the
number of observations regarding the percentage reduction in the supply
base in each category forms small samples, though they can be used in
combination with the frequency of activity observations to suggest an
inclination to accept the hypothesis.
H7: Reduction in the number of suppliers will significantly

reduce the administrative costs of supply-chain management.
Figure 7.40 shows that the largest number of respondents both reduced
their supply base and reduced the administrative costs of supply-chain
management at the Sometimes and Often frequencies. Even more notable
about Figure 7.40 is that, as in Figure 7.33, most of the frequency categories
have a roughly equivalent number of respondents, reducing the size of
their supply base and reducing their supply-chain administrative costs at
the same frequency. This again suggests that the two may be very closely
related. Figure 7.41 groups the frequency with which the company has
reduced its supply-chain administrative costs by the frequency of supply
base reduction. If a Pearson chi-squared test is performed on this infor-
mation as was done for the H6 information, the resulting chi-squared
probability is 9.55E–8. The frequencies of reduction in supply-chain admin-
istrative costs and the reduction of the supply base are rejected as
independent, based on a 0.05 probability test. Reduction in supply-chain
administrative costs and the reduction of the supply base are therefore
accepted as interdependent, based on the survey results.
Figure 7.42 shows the mean percentage reduction in supply-chain
administration costs based on the frequency with which the supply chain
is reduced. The results here are striking with a mean 32 percent reduction
in the supply-chain administrative costs for those who Always (systemat-
100.00
100.00
75.00
75.00
50.00
50.00
25.00
25.00
0.00
0.00
-25.00
-25.00
-50.00
-50.00
Figure 7.38 Box plots of reported percent reduction in supply Figure 7.39 Box plots of reported percent reduction in supply
base based on frequency of ABM usage. base based on frequency of ABM usage.
Table 7.6 Descriptive Statistics for Percentage Reduction in Supply Base at Varying Frequencies of ABM Application to
Procured Service Costs
Percentage Infrequently Sometimes Often Infrequently or Sometimes or
Reduction in supply (Less than (Once per (Twice or Always Less (Less than More (at Least
base Never Once per Year) Year) More per Year) (Systematic) Once per Year) Once per Year)
Mean 11% 15% 21% 12% 16% 13% 17%

Median 10% 7.5% 20% 10% 20% 10% 20%
Range 70% 65% 150% 100% 65% 85% 150%
Minimum –20% 0% –50% –20% –15% –20% –50%
Maximum 50% 65% 100% 90% 50% 65% 100%
Interquartile range 17.5% 23.75% 17.5% 18.5% 28.5% 17.5% 23%
Count 25% 12 20 16 8 37 44%
30
28 26
25 2625
19
20 19 20 19 Company has reduced
its number of suppliers
15 over the last five years
10
119
5
Company has reduced
0
the co st s of
Never
Infr equently
administrating its supply

Sometimes
Often
chain over the last five
Alway s
years
Figure 7.40 Side-by-side comparison of survey respondents who have reduced

their supply base and who have reduced the costs of administering their supply
chain.
Reduced Cost of Administering the Supply Chain

16
15
14
12
Never
10 9
Infrequent ly
8
8 7 Sometimes
6 6 6 6 Often
6 5 5
Always
4 3 33 3
2 2 2
2 1 1 1 11
00 0
0
t ly
r
n
es
ys
ve
fte
en
wa
im
Ne
O
qu
et
Al
m
fre
So
In
Reduces supply base
Figure 7.41 Frequency of reductions in the cost of administering the supply

chain over the last five years stratified by the frequency of supply-chain reductions.
Mean % Reduction of Supply Chain

Administration Costs
35%
32%
30%
25%
19%
20% 17%
15%
10% 8%
4%
5%
0%
Reduces Supply Base over last five years
Figure 7.42 Mean reported percent reduction of supply-chain administration

costs based on frequency of supply-chain reductions.
ically) reduced their supply base versus a mean 4 percent reduction in

mean reduction in the supply-chain administrative costs for those who
Never reduced their supply base. Figure 7.43 shows the mean percentage
reduction in supply-chain administration costs for those who reduced their
supply base Sometimes or more versus those who reduced their supply
Mean % Reduction of Supply Chain

Administration Costs
20.0%
17.3%
18.0%
16.0%
14.0%
12.0%
10.0%
10.0%
8. 0%
6. 0%
4. 0%
2. 0%
0. 0%
Reduces Supply Base over last five years
Figure 7.43 Mean reported percent reduction of supply-chain administration

costs based on frequency of supply-chain reductions.
1.00 -0 . 5
.00 -0 .
5.00 0 . 00000
2.00 0 . 55
1.00 1 . 0
2.00 1 . 55
Stem width: 10.00

Each leaf: 1 case(s) Often Stem-and-Leaf Plot
Infrequently Stem-and-Leaf Plot 6.00 0 . 005555

3.00 1 . 000
Frequency Stem & Leaf 3.00 2 . 005
5.00 3 . 00000
2.00 0 . 00 1.00 4 . 0
1.00 0 . 5 1.00 5 . 0
1.00 1 . 0
.00 1 . Stem width: 10.00
3.00 2 . 000 Each leaf: 1 case(s)
.00 2 .
.00 3 .
.00 3 .
2.00 4 . 00 Always Stem-and-Leaf Plot
Stem width: 10.00 Frequency Stem & Leaf

2.00 0 . 00
1.00 1 . 5
1.00 2 . 7
Sometimes Stem-and-Leaf Plot 1.00 3 . 0
.00 4 .
Frequency Stem & Leaf .00 5 .
.00 6 .
6.00 0 . 000002 1.00 7 . 5
.00 0 . 1.00 8 . 0
6.00 1 . 000000
1.00 1 . 5 Stem width: 10.00
1.00 2 . 0 Each leaf: 1 case(s)
Stem width: 10.00

Figure 7.44 Stem-and-leaf plots of reported percent reduction in supply-chain

administration costs based on frequency of supply base reduction over the last
five years.
base Infrequently or less and presents a mean 7.3 percent supply-chain

administrative cost reduction advantage to those who regularly reduced
their supply base.
The differences in the median percentage reductions in supply-chain
administrative costs, as presented in Figure 7.44, Figure 7.45, Figure 7.46,
and Table 7.7, are also sizeable. Figure 7.44 shows the percentage reduc-
tion of supply-chain administration costs based on the frequency of supply
base reductions as stem-and-leaf diagrams. Figure 7.45 and Figure 7.46
plot out the percentage reduction of supply-chain administration costs
based on the frequency of supply base reductions as box plots for all
80.00 80.00
60.00 60.00
4000. 40.00
20.00 20.00
0.00 0.00
-20.00 -20.00
Never Infrequently Sometimes Often Always Infrequent Reduct Regular Reduct
Figure 7.45 Box plots of reported percent reduction in supply- Figure 7.46 Box plots of reported percent reduction in supply-
chain administration cost based on frequency of supply base chain administration cost based on frequency of supply base
reduction. reduction.
Table 7.7 Descriptive Statistics for Reductions in the Cost of Administrating the Supply Chain at Varying Frequencies of
Supply Base Reduction over the Last Five Years
Percentage Has Reduced the Supply Base over the Last Five Years
Reduction in
Supply-Chain Infrequently Sometimes Often Infrequently or Sometimes or
Administration (Less than (Once per (Twice or More Always Less (Less than More (at Least
Costs Never Once per Year) Year) per Year) (Systematic) Once per Year) Once per Year)
Mean 4% 17% 8% 19% 32% 10.0% 17.3%

Median 0% 20% 10% 20% 27% 5% 10%
Range 20% 40% 30% 50% 80% 45% 80%
Minimum –5% 0% 0% 0% 0% –5% 0%
Maximum 15% 40% 30% 50% 80% 40% 80%
Interquartile range 10% 27.5% 10% 25% 75% 18.75% 26.5%
Count 11% 9 15% 19% 7% 20 41
frequencies and for regular (Sometimes or more) and nonregular (Infre-

quently or less) use, respectively. Table 7.7 summarizes the percentage
reduction of supply-chain administration costs based on the frequency of
supply base reductions results. They show a median 27 percent reduction
in the supply-chain administrative costs for those who Always (systemat-
ically) reduced their supply base versus a median 0 percent reduction in
mean reduction in the supply-chain administrative costs for those who
Never reduced their supply base. The difference between the median
percentage reduction in supply-chain administrative costs for those who
have reduced their supply base Sometimes or more over the last five years
and those who reduced their supply base Infrequently or less over the
last five years is only 5 percent. Because the survey sample responses fall
into five categories for this analysis, the number of observations regarding
the percentage reduction in the supply-chain administrative costs in each
category form small samples, though they can be used in combination
with the frequency of activity observations to suggest an inclination to
accept the hypothesis.

a significant level of procurement involvement in the design
and development process.
Figure 7.47 shows that the largest number of respondents do not use
ABM to manage the internal processes, such as procurement activities, at
their company and that the majority of the respondents reported that
procurement personnel play a significant part in the design and develop-
ment process at their companies at a Sometimes or greater frequency with
almost an equal number reporting procurement involvement at the Some-
times, Often, and Always (systematically) frequency levels.
Figure 7.48 shows the survey results for procurement involvement in
design grouped by the frequency of ABM application to internal pro-
cesses. There is a noticeable trend here; as the frequency of ABM
application to internal processes increases, the number of Always has
procurement involvement increases as a proportion of the responses for
each frequency category.
H9: Application of ABM to procurement activities will limit

common component selection (fewer suppliers and customer
parts) during the design and development process.
Figure 7.49 shows that the largest number of respondents standardized

their component set at an Often frequency over the last five years, and
the largest number of respondents Never apply ABM to their internal
40 40
35
33 33
30 31
23 Company uses ABM
20 22 methods to manage its
17 internal processes
9
10 13
Procurement personnel
0 play a significant part in
Neve r
the design and

Infrequently
Sometimes
Of ten
development process
Always
whose procurement personnel are involved in the design process.
Procurement Involvement in Design
14 13
Numb er o f Survey Respondents
12 11
10 Never
Infrequently
8 77 7 7
6 666 6 6 Sometimes
6 55
4 4 Often
4 3 Always
2 22
2 1 1 11
0
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Uses ABM on internal processes
Figure 7.48 Frequency of procurement involvement in design stratified by the

frequency of ABM usage.
40 40
40
30 31
Company uses ABM
16 18 19 methods to manage its
20 22
17 internal processes
14
10 13
Component set used to
0 design new products
Never
has become more

Infr equently
Sometimes
Often
standardized over the
Always
last five years
who have increased the standardization of their component set.
processes, including their procurement activities. Figure 7.50 groups the

component set standardization frequency results by the frequency of ABM
application to internal processes. As the frequency of ABM application
increases, the frequency of component set standardization becomes greater
because Never, Infrequently, and Sometimes become less prominent as
the ABM application frequency moves from Never to Always.
Figure 7.51 and Figure 7.52 show the mean percentage increase in
component standardization on the basis of the frequency of ABM appli-
cation to internal processes. Figure 7.51 does not display any particular
trend, and Figure 7.52 displays a mere 0.5 percent difference in the mean
percentage increase in component standardization between those who
apply ABM Infrequently or less and those who apply ABM Sometimes or
more. Looking at the stem-and-leaf diagrams and box plots of the per-
centage increase in component standardization based on the frequency
of ABM application to internal processes, shown respectively in Figure
7.53 and Figure 7.54, it becomes clear that the lack of trend in Figure
7.51 and the closeness of the mean percentage increases in component
standardization in Figure 7.52 are most likely the result of an outlier in
the Never applies ABM category. As shown in Figure 7.53 and Figure
7.54, the median values of the percentage increase in component stan-
dardization increase as the frequency of ABM application to internal
processes increases. Figure 7.55 shows the percentage increase in com-
ponent standardization between those who apply ABM Infrequently or
less and those who apply ABM Sometimes or more as box plots. The
Increased Standardized Component Set
12
Numb er o f Su rvey Respondents
10
10 9
8
Never
8 7
Infrequently
6 66 6
6 Sometimes
4 4 4 Often
4 33 3 3 3 3 Always
2 2 2
2 1 1 1
0 0
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Figure 7.50 Frequency of increases in component standardization over the last

five years stratified by the frequency of ABM usage.
Mean % Increase of Standardized Component Set
30%
26%
25%
22% 21%
20%
16%
14%
15%
10%
5%
0%
Figure 7.51 Mean reported percent increase in standardized components based

Mean % Increase of Standardized Component Set
19.9%
19.8%
19.8%
19.7%
19.6%
19.5%
19.4%
19.3%
19.3%
19.2%
19.1%
19.0%
Infrequent ly or less Sometimes or more
Figure 7.52 Mean reported percent increase in standardized components based

descriptive statistics from these charts are summarized in Table 7.8.

Because the survey sample responses fall into five categories for this
analysis, the number of observations regarding the percentage increase
in component standardization in each category form small samples, though
they do suggest an inclination to accept the hypothesis.
H10: Application of ABM to procurement activities will reduce

total quality costs.
Figure 7.56 shows again that the largest number of respondents Never
uses ABM to manage their internal activities, including their procurement
activities, and that the largest numbers of respondents have managed to
reduce their total costs of quality over the last five years on an Often and
Sometimes basis.
The frequency of reduction in total cost of quality responses are also
shown in Figure 7.57, grouped by the frequency of ABM application to
internal processes. No trends are apparent here on the basis of the
frequency of ABM application to internal processes.
Figure 7.58 and Figure 7.59 show the mean percentage reductions in
the total cost of quality based on the frequency of ABM application to
internal processes. There is a noticeable difference between the mean
percentage reductions in the total cost of quality results when ABM is
used Infrequently or less and when ABM is used Sometimes or more; the
Frequency Stem & Leaf Often Stem-and-Leaf Plot
1.00 -2 . 5 Frequency Stem & Leaf

.00 -1 .
.00 -0 . 1.00 -1 . 5
7.00 0 . 0000025 1.00 -1 . 0
6.00 1 . 000005 .00 -0 .
4.00 2 . 0555 .00 -0 .
2.00 3 . 00 2.00 0 . 02
.00 4 . .00 0 .
1.00 5 . 0 2.00 1 . 00
2.00 6 . 02 1.00 1 . 5
1.00 7 . 0 4.00 2 . 0000
1.00 Extremes (>=100) 1.00 2 . 5
Stem width: 10.00

5.00 0 . 00000
1.00 0 . 5 1.00 0 . 0
1.00 1 . 0 2.00 1 . 00
.00 1 . 2.00 2 . 55
2.00 2 . 00 .00 3 .
1.00 2 . 5 .00 4 .
1.00 3 . 0 1.00 5 . 0
1.00 Extremes (>=60) 1.00 6 . 0
Stem width: 10.00 Stem width: 10.00

Each leaf: 1 case(s) Each leaf: 1 case(s)
4.00 0 . 0000
1.00 0 . 5
3.00 1 . 000
3.00 1 . 555
1.00 2 . 0
1.00 2 . 5
.00 3 .
.00 3 .
2.00 4 . 00
Stem width: 10.00

Figure 7.53 Stem-and-leaf plots of reported percent increase in standardized

component set based on frequency of ABM usage.
100.00
100.00
7.005
75.00
50.00
50.00
25.00
25.00
0.00
0.00
-25.00
-25.00
Never Infrequently Sometimes Often Always Infrequent ABM Regular ABM
Figure 7.54 Box plots of reported percent increase in standard- Figure 7.55 Box plots of reported percent increase in standard-
ized component set based on frequency of ABM usage. ized component set based on frequency of ABM usage.
Table 7.8 Descriptive Statistics for Percentage Increase in Standardized Component Set at Varying Frequencies of ABM
Application to Procured Service Costs
Infrequently Sometimes
Percentage Increase Infrequently Sometimes Often or Less (Less or More (at
in Standardized (Less than (Once (Twice or Always than Once Least Once
Component Set Never Once per Year) per Year) More per Year) (Systematic) per Year) per Year)
Mean 22% 14% 21% 16% 26% 19.3% 19.8%

Median 10% 7.5% 20% 17.5% 25% 10% 15%
Range 125% 60% 80% 65% 60% 125% 95%
Minimum –25% 0% 0% –15% 0% –25% –15%
Maximum 100% 60% 80% 50% 60% 100% 80%
Interquartile range 29% 23.75% 30% 19.75% 40% 27.5% 20.75%
Count 25% 12 17% 14 7% 37 38
40
40
33
30 31 28
Company uses ABM
methods to manage its
20 15 22
17 15 17 internal processes
10 13
Company has reduced
0 the total cost of quality
Never
of its products and/or

Infr equently
Sometimes
O ften
services over the last
Always
five years
who have reduced their total cost of quality.
Reduced Total Cost of Quality

12
Numb er of S urvey Respondents
10
10 9
8 Never
8 7 7
Infrequently
6
6 5 5 Sometimes
4 4 4 Often
4 3 3 3 3 3 3
Always
2 2 2 2 22
2
0 0
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Figure 7.57 Frequency of total cost of quality reductions over the last five years
stratified by the frequency of ABM usage.
Mean % Reduction of Total Cost of Quality
25%
20% 19%
20% 18%
15%
12%
9%
10%
5%
0%
Figure 7.58 Mean reported percent reduction in total cost of quality based on
Mean % Reduction of Total Cost of Quality
20. 0% 18. 8%
18. 0%
16. 0%
14. 0%
12. 0% 10. 1%
10. 0%
8. 0%
6. 0%
4. 0%
2. 0%
0. 0%
Figure 7.59 Mean reported percent reduction in total cost of quality based on
more frequent ABM usage presents a mean 8.7 percent reduction in the
total cost of quality advantage.
Figure 7.60 shows the percentage reduction of the total cost of quality
based on the frequency of ABM application to internal processes as stem-
and-leaf diagrams. Figure 7.61 shows the percentage reduction of the total
cost of quality based on the frequency of ABM application to internal
processes as box plots. Figure 7.62 shows the percentage reduction of
the total cost of quality based on the frequency of ABM application to
Never Stem-and-Leaf Plot Often Stem-and-Leaf Plot

6.00 0 . 000225
9.00 0 . 000000000 2.00 1 . 05
2.00 0 . 56 3.00 2 . 000
5.00 1 . 00000 2.00 3 . 05
1.00 1 . 5 .00 4 .
4.00 2 . 0000 1.00 5 . 0
1.00 2 . 5 1.00 Extremes (>=75)
1.00 3 . 0
Stem width: 10.00
Infrequently Stem-and-Leaf Plot Always Stem-and-Leaf Plot
5.00 0 . 00001 .00 0 .

2.00 0 . 23 1.00 0 . 5
.00 0 . 2.00 1 . 00
.00 0 . 1.00 1 . 5
.00 0 . 2.00 2 . 00
1.00 1 . 0 .00 2 .
.00 1 . 2.00 3 . 00
1.00 1 . 5
2.00 Extremes (>=35) Stem width: 10.00
Stem width: 10.00
3.00 0 . 003
.00 0 .
2.00 1 . 00
2.00 1 . 55
1.00 2 . 0
4.00 2 . 5555
Stem width: 10.00

Figure 7.60 Stem-and-leaf plots of reported percent reduction in total cost of

quality based on frequency of ABM usage.
80.00 80.00
60.00 60.00
40.00 40.00
20.00 20.00
0.00 0.00
Never Infrequently Sometimes Often Always Infrequent ABM Regular ABM
Figure 7.61 Box plots of reported percent reduction of total Figure 7.62 Box plots of reported percent reduction of total
cost of quality based on frequency of ABM usage. cost of quality based on frequency of ABM usage.
internal processes grouped into those who apply ABM to internal pro-
cesses Infrequently or less and those who apply ABM to internal processes
Sometimes or more as box plots. The descriptive statistics from these
charts are summarized in Table 7.9. From them, it can be seen that the
median values of the percentage reduction of the total cost of quality
increase as the frequency of ABM application to internal processes
increases, a 9.5 percent difference between those who use ABC Infre-
quently or less and those who use ABM Sometimes or more. Because the
survey sample responses fall into five categories for this analysis, the
number of observations regarding the percentage reduction in the total
cost of quality in each category form small samples, though they do
suggest an inclination to acceptance the hypothesis.
H11: Cost evaluation and management of the total life-cycle

cost of the product or service will strengthen the competitive
Figure 7.63 shows that a large majority of the survey respondents

felt that their company was Always positioned competitively in their
primary markets and that the distribution of those who use TLCC to
manage the cost of their services and pr oducts was relatively even
between all of the frequency categories. The competitive positioning
results are shown grouped by frequency of TLCC usage in Figure 7.64.
The large response of Always positioned competitively from the survey
makes it hard to pick out any trends on the basis of frequency of TLCC
usage. This may be a perception issue; when asked about their com-
pany’s competitive position, many respondents may have felt compelled
to rate their company, which they identify themselves with, very highly.
It is notable, however, that the three respondents who rated their
company as Never or Infrequently positioned competitively in their
primary markets also reported that their company never used TLCC to
manage its costs.
Results
Table 7.10 summarizes the results of the previous hypothesis-testing
discussions, including the verdicts of each test. H1, H2, H3, H5, H6, H7,
H8, H9, and H10 are inclined to be accepted, and H4 and H11 ar e
inclined to be rejected on the basis of the survey results. Figure 7.65
redisplays the TCO study hypothetical model with the rejected hypoth-
eses removed.
Table 7.9 Descriptive Statistics for Percentage Reduction of Total Cost of Quality at Varying Frequencies of ABM Application
to Internal Processes
Percentage Infrequently Sometimes Often Infrequently or Sometimes or
Reduction of Total (Less than (Once per (Twice or Always Less (Less than More (at Least
Cost of Quality Never Once per Year) Year) More per Year) (Systematic) Once per Year) Once per Year)
Mean 9% 12% 20% 19% 18% 10.1% 18.8%

Median 10% 2% 17.5% 15% 17.5% 5.5% 15%

Range 30% 65% 50% 75% 25% 65% 75%
Minimum 0% 0% 0% 0% 5% 0% 0%
Maximum 30% 65% 50% 75% 30% 65% 75%
Interquartile range 20% 15% 16.75% 28% 17.5% 16.25% 20%
Count 23% 11% 14 15% 8 34 37
100
86
80
Company examines and
60 manages the total life
37 cycle costs of its
40 29 products and/or
23 29
20 2 2 20 12 26 services.
Company is positioned
0
competitively in its
Neve r
Infrequently
primary market(s).
Sometimes
Of ten
Always
Figure 7.63 Side-by-side comparison of survey respondents who use TLCC and
who are competitive in their primary markets.
Company Is Positioned Competitively

25
22
20 18
Never
15 13 Infrequently
12 12
Someti mes
9
10 Often
7 7
6
5 Always
4
5 3
2 2 2
1
00 0 00 00 00
0
er
tly
es
s
ay
fte
ev
en
im
w
O
N
qu
et
Al
m
fre
So
In
Uses Total Life Cycle Costing
Figure 7.64 Frequency of competitive market positioning stratified by the fre-

quency of TLCC usage.
Table 7.10 Summary of Hypothesis-Testing Results
Hypothesis Observed Results Verdict
H1: Application of ABM to procured Frequency: No observable correlation. Inclined to accept on basis of percentage
components will reduce the overall cost Percentage reduction: Observable reduction of procured component cost
of procured components and ultimately benefit when looking at mean results.
the total cost of the product. percentage reduction of procured
component costs, particularly at Often
application of ABM. Median results
favorable only when looking at the
Often application of ABM.
H2: Application of ABM to procured Frequency: No observable correlation. Inclined to accept on basis of percentage
services will reduce the overall cost of Percentage reduction: Observable reduction of procured service cost
procured services and ultimately the benefit when looking at mean results.
total cost of the product. percentage reduction of procured
service costs, particularly at Often
application of ABM. Median results also
favor ABM.
H3: Willingness of suppliers and Frequency: Companies that Often enter Inclined to accept on basis of frequency
customers to share information will into information-sharing agreements observations.
positively affect the customer’s ability to displayed slightly higher frequencies of
apply ABM to procured components ABM application.
and services.
H4: Frequency of communication with Frequency: No observable trends. Inclined to reject on basis of frequency
suppliers will positively affect the observations.
customer’s ability to apply ABM to
Table 7.10 Summary of Hypothesis-Testing Results (Continued)
Hypothesis Observed Results Verdict
H5: Presence of long-term supplier Frequency: Companies that enter into Inclined to accept on basis of frequency
relationships will positively affect the long-term relationships Always observations.
customer’s ability to apply ABM to (systematically) with service providers
procured components and services. show slightly higher frequencies of
ABM application. Customers that enter
into long-term relationships Sometimes
with survey respondents show slightly
higher frequencies of ABM application.

H6: Application of ABM to procurement Frequency: Chi-squared test indicates Inclined to accept on basis of chi-
activities will lead to a significant interdependence. squared test and percentage reduction
reduction in the number of suppliers. Percentage reduction: Mean and median of supply base results.
percentage reduction of supply base
indicate higher reduction of supply
base with increased frequency of ABM
application.
H7: Reduction in the number of suppliers Frequency: Chi-squared test indicates Inclined to accept on basis of chi-
will significantly reduce the interdependence. squared test and percentage reduction
administrative costs of supply-chain Percentage Reduction: Mean and median of supply-chain administration costs.
management. percentage reduction of supply-chain
administration costs indicate higher
reduction of supply-chain
administration costs with increased
reduction of supply base.

H8: Application of ABM to procurement Frequencies: Always (systematically) Inclined to accept on basis of frequency
activities will lead to a significant level involvement of procurement personnel observations.
of procurement involvement in the in design and development process
design and development process. increases with frequency of ABM
application to internal processes.
H9: Application of ABM to procurement Frequency: Standardization of Inclined to accept on the basis of
activities will limit common component component set increases as frequency frequency observations and median
selection (fewer suppliers and customer of ABM application to internal percentage increase in component set
parts) during the design and processes increases. standardization observations.
development process. Percentage increase: Mean percentage
increases in component set
standardization do not appear to be
significant. Median percentage
increases in component set
standardization increase with increases

in the frequency of ABM application to
internal processes.
H10: Application of ABM to procurement Frequency: No observable correlation. Inclined to accept on basis of percentage
activities will reduce total quality costs. Percentage reduction: Mean and median reduction of total cost of quality results.
percentage reduction of total cost of
quality indicate higher reduction of
total cost of quality with increased the
frequency of ABM application to
internal processes.
H11: Cost evaluation and management of Frequency: No observable trends. Inclined to reject on basis of frequency
the total life-cycle cost of the product or observations.
service will strengthen the competitive
Enabling Results for

Total Life Cycle Costing and BSC System
Factors
Management using TCO and ABC/M
Suppliers and
Customers
Sharing Sensitive
Information
Total Overall Product Cost
H3
+
Cost of Procured Cost of Procured
H3 Components Services
+
H1
–
ABM Applied to Procured Components
H2
–
Administrative
Total Cost of Cost of Supply
Quality Chain
H7 Management
H5 +
+
ABM Applied to Procured Services
H5
+ Number of
Suppliers
H10
–
Existence of Long-
Term Supplier
Relationships H6
– Procurement
Involvement in
ABM Applied to Procurement Activities H8 Design and
+ Development
H9
+
Common
Component
Selection
Figure 7.65 Hypothetical model for TCO study after hypothesis testing.
Game Theory Analysis

When looking at the strategic importance of adopting cost evaluation and
management methods based on TCO and TLCC, it becomes necessary to
examine how interaction with competitive players in the marketplace will
affect the adoption of these business methods. Game theory can provide
us with tools to examine these interactions. In a saturated and competitive
worldwide market, market share can be modeled as a zero-sum game,
i.e., where a gain in market share for one company represents an equal
loss for its competitors.
Table 7.11 is a zero-sum game matrix that represents potential strategies
that two competing companies could employ. One of these companies,
Company A, wants to use an activity-based approach to evaluating and
managing its TCO. The other company, Company B, is employing either
no method of evaluating and managing its TCO, or it is employing a non-
activity-based method such as traditional costing or GT-based costing. Each
number in the matrix indicates a percentage cost advantage that Company
Table 7.11 Game Theory Matrix — Procured Component Cost Advantage

Based on Survey Results
Company B Potential Strategies
B2. Systematically
Competitive Cost Advantage for B1. Makes no active employs some
Company A Based on Cost of effort to understand method to analyze
Procured Components or manage costs TCO other than ABC
Company A A1. Systematically 0% 1%

potential employs ABC to
strategies analyze TCO
A2. Systematically 2% 3%
employs ABM to
analyze and
manage TCO
analyzes and
manages TLCC
(including TCO)
A will get if Company A and Company B pick the corresponding strategies;

Company B loses an amount of cost advantage equal to Company A’s gain.
The values in the matrix were derived from the survey results. Each one
represents the difference between the mean percentage reduction in the
cost of procured components of those survey respondents who used the
corresponding strategy regularly (Sometimes or more, i.e., at least once
per year) and the mean percentage reduction in the cost of procured
components of those survey respondents who used the opposing strategy.
According to game theory, each competing company will decide what
to do based on their own self interest. Both will pick a strategy that
maximizes their potential cost advantage while simultaneously minimizing
the potential cost advantage of the competitor. Company A will determine
the minimum value in each row of the matrix, which represents the
minimal result for each of its strategies based on Company B’s potential
strategies, and then choose the strategy that corresponds to the largest of
those minimum values. In this way, Company A is picking the best of its
worst-case scenarios. In Table 7.11, based on the survey results, Company
A would pick strategy A2.
Company B, on the other hand, will choose the strategy that potentially
produces the most minimal result if Company A realizes the maximum
result of that strategy. Company B will determine the maximum value in
each column of the matrix, which represents the maximal result for each
of its strategies based on Company A’s potential strategies, and then

choose the strategy that corresponds to the smallest of those maximum
values. In Table 7.11, based on the survey results, Company B will choose
strategy B1.
This game theory payoff matrix results in a “saddle point,” a single
strategy for each company that will produce a single value for the matrix,
in this case 2 percent. If the individual resultant values for Company A’s
and Company B’s strategies had been different from one another, i.e., if
the maximum value of all of the minimum row values (the maximin) or
the minimum value of all of the column maximum values (the minimax),
it would indicate that there is a range of values in the system. In such a
case, either competitor might be able to optimize the value of its outcome
by proportioning out its efforts between two or more strategies.
The survey instrument gives us three additional cost parameters that
can be examined in this way: percentage reduction in procured service
costs, percentage reduction in supply-chain administration cost, and per-
centage reduction in total cost of quality. Table 7.12, Table 7.13, and Table
7.14 show the game theory matrices for these cost reduction parameters
based on the survey results. Table 7.15 summarizes the Company A results
of these game theory matrices. All of them settle on saddle points. In
three of the four cost reduction parameters, the strategy of choice for
Table 7.12 Game Theory Matrix — Procured Services Cost Advantage Based
on Survey Results
B1. Makes no active B2. Systematically
Competitive Cost Advantage for effort to employs some
Company A Based on Cost of understand or method to analyze
Procured Services manage costs TCO other than ABC

employs ABM to
analyze and
manage TCO
analyzes and
manages TLCC
(including TCO)
Table 7.13 Game Theory Matrix — Supply-Chain Administration Cost

Advantage Based on Survey Results
B2. Systematically
Competitive Cost Advantage for B1. Makes no active employs some
Company A Based on Cost of effort to understand method to analyze
Supply-Chain Administration or manage costs TCO other than ABC

employs ABM to
analyze and
manage TCO
analyzes and
manages TLCC
(including TCO)
Table 7.14 Game Theory Matrix — Total Cost of Quality Advantage Based
on TCO Strategies in Competitive Environment
B2. Systematically
B1. Makes no active employs some
Competitive Cost Advantage for effort to method to analyze
Company A Based on Total Cost understand or TCO other than
of Quality manage costs ABC

employs ABM to
analyze and
manage TCO
analyzes and
manages TLCC
(including TCO)
Table 7.15 Results of Game Theory Matrices Cost Advantage Analysis

Cost Advantage Strategy Solution
Company A
Procured components cost A2
Procured services cost A2
Supply-chain administration cost A1 or A2, either strategy equally
advantageous
Total cost of quality A2
Company A is the application of ABM to control costs, based on the

survey results.
The game theory matrix can be adjusted to test a great variety of
potential situations and strategies, given a reasonable set of data such as
the survey results. For example, a large Company A and a small Company
C are competing in similar markets with similar products at similar costs.
Both companies want to use TCO methods to reduce the cost of admin-
istering their supply chains. Because of the relative sizes of their infra-
structures, however, they will not be able to get the same results from
the same strategy. Table 7.16 is a game theory matrix for such a scenario
using the results of the survey, in which any company of over 1000
employees is regarded as large and any company of less than 1000
employees is considered small. In this scenario, the solution is for the
large Company A to apply ABM to its supply-chain administration costs
and for the small Company C to only use ABC to study its supply-chain
administration costs. This suggests that smaller companies cannot capitalize
on ABM or overall TLCC to reduce supply-chain administration costs as
easily as a larger company, which may have either more resources to
send at the problem or more nonvalue activities to trim from their
procurement operations.
Again, this data can be reconfigured and weighted in different ways,
depending on the competitive situation, e.g., different competitors could
be differentiated by revenues, size, geographies, industries, etc., and
different strategies. However, as the examples from Table 7.11, Table 7.12,
Table 7.13, Table 7.14 and Table 7.16 show, ABM is an effective tool
when compared to other TCO methods for achieving cost reductions.
Table 7.16 Game Theory Matrix — Supply-Chain Administration Cost Advantage Based on TCO Strategies; Large versus
Small Company Example
Small Company C Potential Strategies
C2. Systematically
employs some C4. Systematically C5. Systematically
method to analyze C3. Systematically employs ABM to analyzes and
Competitive Cost Advantage for Company A TCO other than employs ABC to analyze and manages TLCC
Based on Supply-Chain Administration Costs ABC analyze TCO manage TCO (including TCO)
Large Company A A1. Systematically 8% –1% 6% 6%

potential employs some
strategies method to
analyze TCO
other than ABC
A3. Systematically 5% –4% 3% 3%
employs ABC to
analyze TCO
A4. Systematically 9% 0% 7% 7%
employs ABM to
analyze and
manage TCO
A5. Systematically 9% –2% 5% 5%
analyzes and
manages TLCC
(including TCO)
Chapter 8
Conclusions and
Recommendations
Ultimately, the goal of each company is to remain competitive and stay

in business. As cost management through outsourcing and supply-chain
management becomes a more prevalent strategy, strategic management
methods such as BSC require more accurate TCO data and better ways
of managing their TCO. This study has proposed the use of ABC and
ABM to accomplish this and meet the strategic needs and objectives of
the company.
The results of this study show that the ability to apply ABM to suppliers
is affected by the existence of long-term relationships and willingness to
share sensitive information, both signs of partnership-type relationships,
but that it is not affected by the frequency of communication with the
supplier. This leads to a number of conclusions. As companies look to
employ more accurate systems of managing their supplier costs, it will be
necessary for them to develop these partnerships. Coming fr om the
opposite direction, as companies develop partnerships with their suppliers
to manage issues such as delivery and access to special technologies and
skills, they will have a greater opportunity to try employing ABM to their
supply chain and reduce their costs and their suppliers’ costs as well.
Frequency of communication may have been too broad an indicator of
partnerships when compared to sensitive information sharing and long-
term relationships; it is just an important general requirement for business,
partnership or not.
153
In this study, application of ABM to procured components and services

led to reductions in their costs. As established in Chapter 1, these costs
represent over half of the cost of the manufactured product. As indicated
by the survey results, many of the respondents did not report using ABM
on their procured components or services, but those that do have seen
substantial reductions in the costs of those procured components or
services, lowering their bottom lines and increasing their profits and ability
to invest. Similarly, the total cost of quality, the reduction of which this
study strongly correlates with increased ABM application to procurement
activities, also affects the bottom line.
ABM application to procurement activities led to increases in procure-
ment involvement in design and development activities and increases in
the amount of component standardization. The effects of ABM can be
seen here in an area other than manufacturing or procurement, acknowl-
edging the effect that other areas of the business have on the overall cost
of the product. This, of course, is one of the central points of ABC and
ABM, determining how the traditional overhead activities affect cost and
effectively using that knowledge to control costs. It also suggests an
organizational model made popular by concurrent engineering circles, in
which the compartmentalized “over-the-wall” mentality is replaced by a
more holistic whole business point of view.
In this study, ABM application to procurement activities led to reduc-
tions in the number of suppliers, and reductions in the supply base
corresponded with reductions in the cost of administering the supply base.
This shows the value of ABM to achieve cost reductions, but it is also
interesting because reductions in the size of supply base increase depen-
dency on the suppliers who are selected for continued business. This in
turn creates the need for partnership arrangements with these suppliers
to ensure the dependability of delivery and price from the customer’s
point of view and dependability of sales from the supplier’s point of view.
It is just this sort of relationship that supports and allows the application
of detailed TCO costing and management methods such as ABC and ABM
to supplier operations.
As a whole, competitiveness was not shown to be affected by the
overall use of TLCC. As mentioned earlier, the survey response regarding
the company’s competitiveness within its primary markets seems to be
affected by a great deal of personal bias, with the vast majority of the
respondents reporting that their company was positioned positively. It is
also possible that TLCC, despite the relatively large number of respondents
who reported some usage of TLCC, is just not perceived as a factor in
companies’ competitive positioning when compared to other possible
factors such as product and service offerings, flexibility, stock performance,
quality, and dependability.
Conclusions and Recommendations 155
Some flaws in the survey instrument and procedure came to light

during the study that future studies should take into account. Many of
the respondents to this study’s survey felt that they did not have exact
answers to the questions as they were unfamiliar with their company’s
accounting and cost management structures. Hence, future studies could
be focused on specific employees who have direct knowledge about a
company’s accounting methodology and cost management strategies, such
as accounting and procurement managers. The survey only received
minimal testing (3 individuals) prior to wide distribution; future surveys
should receive a more thorough predistribution screening. The
Never–Infrequently–Sometimes–Often–Always scheme for reporting the
frequency of various activities was useful and easy for survey respondents
to understand, but it did not always apply equally to all activities. As the
data was all self-reported, some bias undoubtedly crept in, particularly
when asked about their company’s competitive posture; future studies
should implement a method of independently verifying questions that
might involve a high degree of bias.
Future studies in the area of TCO and supply-chain integration might
be taken in several directions. All of the participants in this study are from
within the United States, but the future surveys could be expanded to
compare results in other geographical locations such as Asia-Pacific and
Europe. A topical area of inquiry might be into whether TCO is being
utilized in international outsourcing arrangements and, if not, whether
TCO analysis would still recommend this activity. The TCO activities of
surveyed companies in future studies could be compared with the process
model presented in this study to determine whether they are using a
similar model and using the model outputs to generate key indicators for
BSC systems. Future studies should examine the role of TCO data in
strategic decision making and goal setting. With the continued trends
toward globalization, productivity-measurement tools such as learning
curve, outsourcing, and competitive supply chains, the management of
cost in this environment is only going to become a more important facet
of competitive strategy in the years to come.
Appendix A
Survey Instrument
ABC/M in Outsourced Supply-Chain Survey
Name:
Date:
Company and business unit (if applicable):
Company Web site:
Annual revenue: $0–$5 million $100–$500 million
(Place an X next to the $5–$10 million $500 million–$1 billion
most appropriate $10–$25 million $1–$5 billion
selection.) $25–$50 million > $5 billion
$50–$100 million
Number of 0–50 1,000–5,000
employees: 50–200 5,000–10,000
(Place an X next to the 200–500 >10,000
most appropriate 500–1,000
selection.)
Industry: Construction Manufacturing
(Place an X next to the
most appropriate Education and Natural resources and
sector.) health services mining
Financial Other services
activities
Government Professional and
business services
Continued.
157
Information Transportation and

utilities
Leisure and Wholesale and retail
hospitality trade
Main product lines or 1.
service offerings: 2.
3.
4.
Job title:
E-mail address:
Work phone:
Note: All answers will be treated as confidential and are for academic purposes
only. All survey participants will be sent a copy of the results.
Background definitions (to be read prior to filling out the survey):
Activity-based costing (ABC): A cost estimation methodology that

attempts to directly determine the cost contribution of all activities
related to a product or service. It stands in contrast to traditional
costing methods in which the costs of overhead and administration
activities are allocated on the basis of another, more easily mea-
sured activity such as direct labor time or machine operation time.
Activity-based management (ABM): Management of activities for the
purpose of reducing overall costs using ABC information. Typical
ABM actions include eliminating redundant activities and determin-
ing unprofitable product offerings.
Original equipment manufacturer (OEM): A company that produces
complex equipment (as a computer system) from components
usually sourced from other manufacturers.
Total cost of ownership (TCO): All costs associated with the acqui-
sition, use, and maintenance of a product or service. It includes
costs incurred at the supplier but not costs incurred at a customer
or end user if those costs are not charged back to the producer.
Total cost of quality: All costs associated with product quality. It
traditionally includes costs for proactive prevention and inspection
activities and reactive internal and external failure mitigation activ-
ities; can be included in the TCO.
Total life-cycle cost: All costs attributed to a pr oduct or service
throughout its entire life cycle. It encompasses the entire supply
chain, from raw material supplier to end user, including field use
and end-of-life costs; includes the TCO.
Survey Instrument 159
I regard my company or business unit as (check all applicable):
___ An original equipment manufacturer (OEM)

___ Contracted supplier of components/materials/subassemblies to
OEMs
___ Contracted service provider to OEMs
Amount of your company’s (or business unit’s) overall products or

services outsourced to suppliers or subsuppliers: ____ percent.
Instructions: Place an X in the correct space next to each question. Skip

any questions that are not applicable, but please try to answer as many
as you can. Only mark one response per question. If you are part of a
large multiunit company, please respond for just your business unit. Terms
such as activity-based costing and total cost of ownership are defined on
the first page of the survey.
Infrequently Sometimes Often
(Less than (Once per (Twice or More Always
Never Once per Year) Year) per Year) (Systematically)
1. My company (or business unit)
uses an activity-based costing
(ABC) system to determine the
cost of its internal processes.
uses an ABC system to
determine the costs of
externally supplied
components.

uses an ABC system to
determine the costs of
externally supplied services.
4. My customers use an ABC
system to determine the cost of
the product or services that we
provide them.
uses a cost estimating method
other than ABC to determine
the total cost of ownership
(TCO) of the products or
services that we purchase.
Continued.
6. My customers use a cost
estimating method other than
ABC to determine the TCO of
the products or services that
they purchase.
uses ABM methods to manage
its internal processes.
applies ABM methods to our
component suppliers.
applies ABM methods to our

service providers.
10. My customers apply ABM
methods to my products or
services.
examines and manages the total
life-cycle costs of its products or
services.
12. My customers examine and
manage the total life-cycle costs
of their products or services.
13. My suppliers examine and
manage the total life-cycle costs
of their products or services.
Continued.
(Less than (Once per (Twice or More Always
Never Once per Year) Year) per Year) (Systematically)
is positioned competitively in
its primary markets.
is willing to enter into
nondisclosure agreements and
share sensitive information with
its suppliers. Examples of
sensitive information could
include intellectual property,
product roadmaps, and

production and sales figures.
is willing to enter into
nondisclosure agreements and
share sensitive information with
its customers.
17. Employees in my company (or
business unit) communicate
frequently with each of our core
suppliers.
18. Employees in my company (or
business unit) communicate
frequently with each of our
customers.
Continued.
enters into long-term
relationships with its suppliers.
enters into long-term
relationships with its
customers.
21. Procurement personnel
(supply/materials management,
procurement engineering
buyers, etc.) play a significant
part in the design and
development process in my
company (or business unit).

For the following questions, place an X in the correct space next to each question, and also give an approximate percentage
reduction if applicable. Estimate to the best of your knowledge.
Percentage (Less than (Once per (Twice or More Always
Reduction Never Once per Year) Year) per Year) (Systematically)
22. Over the last five years, my
company (or business unit) has
reduced its number of
suppliers.
reduced the overall cost of
purchased components.
Continued.
Percentage (Less than (Once per (Twice or More Always
Reduction Never Once per Year) Year) per Year) (Systematically)
reduced the overall cost of
externally contracted services.

reduced the costs of
administrating its supply chain.
reduced the total cost of quality
of its products or services.
reduced the costs of managing
its customer relationships.
Continued.
For the following questions, place an X in the correct space next to each question and also give an approximate percentage
increase, if applicable. Estimate to the best of your knowledge.
Infrequently Sometimes Often (Twice
Percentage (Less than (Once per or More per Always
Increase Never Once per Year) Year) Year) (Systematically)
increased the number of long-
term relationships with its
suppliers.
increased the number of long-

term relationships with its
customers.
company’s (or business unit’s)
products or service offerings
have become more
standardized.
31. Over the last five years, the
component set used to design
new products has become
more standardized.
Appendix B
Survey Data
167
Survey Annual Percentage Percentage
Response Industry Revenue of Employees OEM? CM? CSP? Outsourced
1 Manufacturing $25–50M 50–200 x x 0

2 Manufacturing $10–25M 50–200 x 0
3 x 30
4 Education and health 1,000–5,000 x
5 Manufacturing $50–100M 200–500 5
6 Manufacturing $50–100M 500–1,000 x 5
7 Manufacturing $25–50M 50–200 x
8 Manufacturing $1–5B >10,000 x
10 Manufacturing $100–500M 1,000–5,000 x

12 Manufacturing $100–500M 1,000–5000 x 50
13 Manufacturing $100–500M 500–1,000 x
14 Financial services >$5B >10,000
16 Manufacturing >$5B >10,000 x 1
17 Manufacturing >$5B >10,000 x
21 Manufacturing >$5B >10,000 10

27 Manufacturing $25–50M 50–200 0
29 Manufacturing $1–5B 1,000–5,000 x
31 Manufacturing $1–5B 5,000–10,000 x 0
34 Manufacturing $1–5B 5,000–10,000 10

38 Manufacturing $1–5B 5,000–10,000
39 Manufacturing $1–5B 500–1,000 x
40 Manufacturing $1–5B >10,000 x 20
42 Transportation and utilities >$5B >10,000 x 10
44 Manufacturing $50–100M 1,000–5,000 x 50
46 Transportation and utilities $10–25M 50–200 18
47 Manufacturing 500–1,000 x 75
49 Manufacturing $5–10M 0–50 x 0.5
Survey Data 169

52 Financial services 50–200 5
59 Other services $1–5B >10,000 x
60 Manufacturing 200–500 x
61 Manufacturing $100–500M 1,000–5,000 x x x 5
62 Other services $25–50M 50–200 100
63 $50–100M 50–200 x x 30
65 Other services $1–5B 1,000–5,000 x 10
70 Manufacturing $100–500M 1,000–5,000 x x x 50
71 Other services $100–500M 1,000–5,000 x 30
73 Manufacturing $100–500M 200–500 x x
74 Manufacturing $500M–$1B 1,000–5,000 x 5

77 Manufacturing $10–25M 500–1,000 70
86 Manufacturing $100–500M 500–1,000 x x 10

89 Manufacturing $500M–$1B 5,000–10,000 0
90 Professional and business services $100–500M 1,000–5,000 50
91 Wholesale and retail trade $100–500M 1,000–5,000 90
92 Manufacturing >$5B >10,000 30
96 Government $500M–$1B 1,000–5,000 x 30
97 Professional and business services $500M–$1B 1,000–5,000 x 30
98 Manufacturing $25–50M 200–500 x x 5
99 Manufacturing $1–5B >10,000
100 Manufacturing $1–5B >10,000 x
Survey Data 171


108 x
111 Government $100–500M 1,000–5,000 x 50
114 Other services $1–5B 5,000–10,000 99
116 Manufacturing 5,000–10,000 x
117 Information >$5B >10,000 x
120 Professional and business services $50–100M 500–1,000 5

122 Manufacturing $100–500M 1,000–5,000 20
126 Education and health 50–200 x
128 Other Services $1–5B 1,000–5,000 x 20
129 Manufacturing $50–100M 500–1,000 x
132 Professional and business services x x 30
133 Government 1,000–5,000 x 75

134 Government $500M–$1B 1,000–5,000 x 10
135
136 Financial services 5,000–10,000 0
137 Government $0–5M 5,000–10,000 x x
138 Government $0–5M 5,000–10,000 x 10
140 Manufacturing >$5B >10,000 x x x 30
141 Other services $100–500M 1,000–5,000 x 3
Survey Data 173
6. Customer
5. Use of TCO Applies TCO
2. ABC Applied 3. ABC Applied on Procured on Procured
Survey 1. Internal Use to Procured to Procured 4. Customer Components/ Components/
Response of ABC Components Services Applies ABC Services Services
1
2 Sometimes Never Never Never Never Never
3 Sometimes Sometimes Infrequently Infrequently Sometimes Sometimes
4
5 Often Often Often Sometimes Infrequently Sometimes
6 Never Never Never Always
7 Never Never Never Never Never Never
8 Often Always Often Often Sometimes Sometimes

9
10 Always Sometimes Sometimes Often Never Never
11 Always Often Sometimes Infrequently Never Sometimes
12 Often Sometimes Sometimes Often Often Sometimes
13 Sometimes Sometimes Sometimes Often Sometimes Sometimes
14 Never Never Never
15 Always Sometimes Sometimes Often Sometimes Often
16 Always Always Often Sometimes Infrequently Often
17 Never
18 Sometimes Often Often Often
19 Infrequently Infrequently Infrequently Never Never Never
20 Infrequently Infrequently Infrequently Sometimes Always Always
21 Sometimes Infrequently Never Sometimes Never

22 Often Infrequently Infrequently Infrequently Sometimes Sometimes
23 Infrequently Infrequently Infrequently Infrequently Always Always
24 Often Infrequently Infrequently Infrequently Always Always
25 Sometimes Often
26 Sometimes Often Often Sometimes
28 Never Never Never Infrequently Never Infrequently
30 Never Never Never Never Always Never
31 Infrequently Never Never Sometimes Sometimes
32 Sometimes Infrequently Infrequently Infrequently Often Often
33 Infrequently Never Never Never Often Sometimes

35 Never Never Never Never
36 Sometimes Sometimes Sometimes Sometimes Sometimes Always
37 Infrequently Never Infrequently Sometimes Often Often
38
39 Sometimes Often Often
40 Often Often Sometimes Never Often Often
41 Sometimes Often Sometimes Often Sometimes Often
42 Often Never Never Sometimes Never Never
44 Never Never Never Infrequently Often Often
45 Infrequently Infrequently Never Never
46 Never Always Never
47 Infrequently Infrequently Infrequently Infrequently Sometimes Sometimes
Survey Data 175
6. Customer
48 Often Never Sometimes Infrequently Infrequently Often

50 Never Never Never Never Sometimes Often
51 Infrequently Infrequently Never Infrequently Often Often
52 Infrequently Never Never Never Sometimes Never
53 Infrequently Sometimes Infrequently Never Always Often
54 Often Sometimes Infrequently Infrequently Sometimes Never
55 Often
56 Sometimes Never Never Often Sometimes Sometimes
57 Never Never Never Never Always Always
58 Sometimes Infrequently Never Infrequently Sometimes Infrequently
59
60 Never Never Never Never Sometimes Sometimes
61 Never Never Never Never Infrequently
62 Never Never Never Often Always Always
63 Infrequently Never Sometimes Sometimes Often Sometimes
65 Infrequently Infrequently Infrequently Sometimes Sometimes Sometimes
66 Often Infrequently Often
67 Always Often Often Often Always Never
68 Infrequently Always Often Often Always Sometimes

69
70 Always Always Always Always Always
71 Infrequently Infrequently Infrequently Often
72 Never Never Never Sometimes Always Sometimes
73 Never Infrequently Sometimes Infrequently Often Often
74 Often Infrequently Infrequently Never Always
76 Always Always Always Always Never Never
77 Often Often Sometimes Infrequently Always Infrequently
78 Always Always Always Always Always Never
79
80 Often Often Often Always Never Never
81 Sometimes Never Never Never Never Sometimes

82 Often Sometimes Sometimes Infrequently Sometimes Often
83 Always Often Often Often Sometimes
84 Often Often Sometimes Sometimes Infrequently Never
86 Always Always Often Sometimes Sometimes
87 Infrequently Never Never Never Always Always
90 Never Never Never Sometimes Sometimes
92 Sometimes Often Often Sometimes Infrequently Infrequently
93 Never Never Often Often Always Sometimes
94 Never Never Never Often Often
Survey Data 177
6. Customer
95 Often Often Often Often Sometimes Sometimes

96 Always Always Always Always Infrequently Never
97 Often Always Often Always Sometimes Sometimes
98 Infrequently Never Never
100 Never Never Never Never Never
101 Infrequently Infrequently Infrequently Often Often
102 Often Often Sometimes Often Often Often

103 Always Always Always Always Often Often
104 Sometimes
105 Never Never Never Never Often Often
106
107 Infrequently Never Never Infrequently Never Never
108
109 Infrequently Infrequently Infrequently Always
110 Never Never Never Infrequently Sometimes Often
111 Often Sometimes Sometimes Sometimes
112 Infrequently Never Never Infrequently Infrequently Infrequently
114 Often Never Infrequently Always Never Never
115 Never Never Never Sometimes

116 Infrequently Often Infrequently Often
117 Infrequently Often Often
118 Sometimes Sometimes Sometimes Often Often
119 Often Sometimes Sometimes Never Always Always
121 Often Always Always Often Sometimes Sometimes
122 Always Never Never Always Never Never
123 Never Never Never Never Always
124 Infrequently Infrequently Infrequently Often
126 Always Always Always
127 Often
128 Sometimes Never Never Never Sometimes Infrequently

129 Sometimes Sometimes Sometimes Sometimes Often Often
130 Infrequently Never Never Sometimes Often Sometimes
131 Always Never Always Never Always
132 Always Always Always Sometimes Sometimes
133 Always Always Sometimes Always Sometimes
134 Always Always Always Always Never Never
135 Always Always Always Always Sometimes Sometimes
136
137 Always Always Always Sometimes Infrequently
138 Often Sometimes Often Often Always Sometimes
139 Sometimes Sometimes Infrequently Often Infrequently Infrequently
140 Sometimes Never Never Never Always Often
141 Sometimes Always Sometimes Often Infrequently Always
Survey Data 179
8. ABM Applied to
Survey 7. Internal Use of Procured 9. ABM Applied to 10. Customer Applies
Response ABM Components Procured Services ABM 11. Use of TLCC
1
3 Often Sometimes Sometimes Sometimes Often
4
5 Infrequently Infrequently Infrequently Infrequently Infrequently
6 Never Never Never Never Sometimes
8 Sometimes Sometimes Sometimes Sometimes Always
9
10 Sometimes Often Often Always
11 Sometimes Sometimes Sometimes Infrequently Often
12 Often Sometimes Sometimes Sometimes Sometimes
13 Sometimes Sometimes Sometimes Sometimes Infrequently
14 Never Never
15 Infrequently Infrequently Sometimes
16 Always Sometimes Sometimes Infrequently Sometimes
17 Never Never
18 Often Sometimes Always Infrequently
19 Infrequently Infrequently Infrequently Never Sometimes
20 Always Never Never Never Sometimes
21 Sometimes Infrequently Never Never Often
22 Often Often Often Often Often
23 Never Never Never Never Often

24 Often Infrequently Infrequently Infrequently Infrequently
25 Sometimes Infrequently Sometimes Always
26 Often Often Sometimes
28 Never Never Never Infrequently Never
31 Infrequently Infrequently Infrequently Infrequently Never
32 Sometimes Sometimes Sometimes Sometimes
35 Never
36 Sometimes Never Never Never Infrequently

37 Sometimes Sometimes Infrequently Sometimes Often
38
39 Always Often Often
40 Often Often Often Never Often
41 Often Sometimes Infrequently Sometimes Often
42 Often Never Never Never Often
43 Sometimes Never Never Sometimes Never
44 Sometimes
45 Infrequently Infrequently
46 Sometimes Infrequently Infrequently Infrequently Sometimes
47 Infrequently Infrequently Infrequently Infrequently Infrequently
48 Sometimes Infrequently Sometimes Often Infrequently
Survey Data 181
8. ABM Applied to

52 Always Always Always Never Infrequently
53 Infrequently Never Never Never Often
54 Sometimes Sometimes Sometimes Sometimes
55 Sometimes Infrequently
56 Sometimes Infrequently Infrequently Sometimes Never
58 Sometimes
59 Often
60 Sometimes Never Never Sometimes Never
62 Never Infrequently Never Never Often
63 Never Never Infrequently Sometimes Sometimes
65 Infrequently Infrequently Never Never Sometimes
66 Often Sometimes
67 Often Often Often Often Always
68 Always Often Often Infrequently Always
69 Always
70 Always Always Always Always
71 Sometimes Infrequently Infrequently Sometimes Often
72 Infrequently Never Never Never Often

73 Sometimes Never Never Sometimes Sometimes
74 Sometimes Never Never Infrequently Infrequently
75 Always
76 Always Always Always Often Always
78 Often Always Always Always Always
79
81 Sometimes Never Never Never Never
82 Often Often Often Often Infrequently
84 Always Often Often Always Often

86 Sometimes Often Often Always
87 Infrequently Never Never Never Never
90 Never Never Sometimes Sometimes Infrequently
92 Infrequently Often Often Infrequently Infrequently
95 Often Sometimes Infrequently Often
96 Always Often Often Always Always
98 Sometimes Infrequently Never Sometimes Never
Survey Data 183
8. ABM Applied to

101 Infrequently Infrequently Never Sometimes
104 Sometimes Always

106
107 Infrequently Never Never Never Never
108
109 Infrequently Never Infrequently Often
111 Often Infrequently Often
112 Sometimes Infrequently Never Never Infrequently
113 Never Never Never Sometimes Never
114 Often Never Sometimes Always Sometimes
115 Infrequently Never Never Infrequently
116 Often Often Often Infrequently Often
117 Sometimes Infrequently Never Infrequently Sometimes
118 Often
119 Sometimes Sometimes Sometimes Never Never
121 Often Often Sometimes Often Infrequently
124 Sometimes Sometimes Often
125 Sometimes Never Never
126
127 Always
130 Never Never Never Sometimes Often
131 Infrequently Sometimes Infrequently Always Never

132 Often Often Often Sometimes Always
133 Sometimes Infrequently Infrequently Sometimes Always
136
137 Never Infrequently Infrequently Infrequently Always
138 Often Sometimes Often Often Infrequently
139 Sometimes Infrequently Infrequently Often Infrequently
141 Infrequently Infrequently Infrequently Often Often
Survey Data 185
15. Sensitive 16. Sensitive
14. Competitive Information Information
Survey 12. Customer 13. Supplier Use Positioning in Sharing with Sharing with 17. Communication
Response Use of TLCC of TLCC Primary Market Suppliers Customers with Suppliers
1 Always Sometimes Infrequently Always

2 Never Never Often Infrequently Infrequently Infrequently
3 Often Infrequently Always Sometimes Sometimes Often
4 Always Sometimes Sometimes Often
5 Infrequently Infrequently Often Sometimes Infrequently Always
6 Often Often Always Never Never Sometimes
8 Sometimes Often Often Often Often Often
9 Often Infrequently Often Often

10 Always Often Sometimes Never Never Often
11 Infrequently Infrequently Always Always Always Always
12 Sometimes Sometimes Often Always Often Sometimes
13 Infrequently Sometimes Sometimes Often Often Often
14 Always Never
15 Often Sometimes Often Sometimes Often Sometimes
16 Sometimes Infrequently Always Often Often Always
17 Always Infrequently Sometimes Sometimes
18 Infrequently Always Often Often Always
19 Sometimes Sometimes Never Never Often
20 Sometimes Infrequently Always Always Sometimes Often
21 Sometimes Infrequently Often Often Sometimes Often
22 Often Infrequently Sometimes Infrequently Infrequently Always

23 Infrequently Infrequently Always Sometimes Sometimes Always
24 Infrequently Infrequently Always Always Sometimes Sometimes
25 Always Always Often Often Sometimes
26 Often Often Sometimes Sometimes
27 Never Never Always Often Often Often
28 Infrequently Infrequently Often Sometimes Infrequently Often
29 Never Sometimes Always Sometimes Never Often
30 Infrequently Infrequently Often Always Never Infrequently
31 Never Infrequently Often Never Never Always
32 Always Often Often Always
33 Sometimes Sometimes Always Often Sometimes Often
34 Sometimes Infrequently Always Always Always Always
35 Often Often Often Often

36 Never Infrequently Always Always Never Sometimes
37 Infrequently Sometimes Always Sometimes Sometimes Often
38 Always Always
39 Often Often Sometimes Sometimes Often
40 Infrequently Sometimes Always Always Infrequently Always
41 Often Infrequently Always Always Sometimes Often
42 Never Sometimes Always Sometimes Always Always
43 Never Never Always Sometimes Sometimes Often
44 Often Sometimes Infrequently Sometimes
45 Never Infrequently
46 Infrequently Infrequently Always Sometimes Sometimes Infrequently
47 Sometimes Sometimes Often Sometimes Infrequently Often
48 Sometimes Infrequently Sometimes Often Often Sometimes
Survey Data 187
49 Never Often Sometimes Infrequently Often

50 Often Infrequently Sometimes Sometimes Sometimes Often
51 Sometimes Infrequently Sometimes Sometimes Sometimes Often
52 Never Never Always Sometimes Never Infrequently
53 Often Sometimes Always Often Often Always
54 Sometimes Infrequently Always Sometimes Sometimes Often
55 Always Never Infrequently Often
56 Sometimes Infrequently Often Often Often Always
57 Sometimes Often Always Often Sometimes Often

58 Sometimes Often Always Infrequently Infrequently Sometimes
59 Never Always Always Often Sometimes
60 Never Never Infrequently Infrequently Often Often
61 Often Often Often Often
62 Always Often Often Often Often Often
63 Sometimes Often Often Always Never Often
64 Sometimes Often Always Never Never Sometimes
65 Sometimes Sometimes Often Often Often Sometimes
66 Sometimes Infrequently Always Always Always Often
67 Always Sometimes Always Sometimes Infrequently Sometimes
68 Often Often Always Often Infrequently Often
69 Always Always Often Always Always Always
70 Always Always Always Always Always Always

71 Often Never Often Often Often
72 Infrequently Infrequently Always Always Always Always
73 Sometimes Infrequently Often Often Always Sometimes
74 Never Never Often Often Often Always
75 Always Always Always Always Often Always
76 Always Always Always Never Never Always
77 Always Always Always Infrequently Infrequently Sometimes
78 Always Always Often Often Often Sometimes
79 Always Never Never
81 Never Never Often Always Always Always
82 Infrequently Infrequently Always Often Often Always
83 Often Always Always Always Always Always

84 Infrequently Sometimes Always Often Often Often
85 Never Never Always Always Always Always
86 Always Always Often Never Always Often
87 Sometimes Sometimes Always Always Always Always
88 Sometimes Often Often Sometimes Infrequently
89 Never Infrequently Always Often Sometimes Sometimes
90 Sometimes Often Often Always Sometimes Always
91 Often Infrequently Always Always Sometimes Always
92 Sometimes Sometimes Often Often Often Sometimes
93 Often Infrequently Always Never Often Always
95 Always Infrequently Always Always Always Always
96 Always Often Always Often Sometimes Often
Survey Data 189
97 Always Often Always Always Often Always

98 Sometimes Often Infrequently Infrequently Often
99 Never Always Infrequently
100 Never Never Always Infrequently Often
101 Always Often Sometimes Sometimes
102 Often Often Always Always Often Sometimes
103 Sometimes Sometimes Always Always Infrequently Often
104 Always
105 Often Sometimes Always Sometimes Sometimes Always

106 Always Sometimes Sometimes Often
107 Never Never Always Always Always Often
108 Infrequently Often
109 Infrequently Always Always Always Often
110 Often Infrequently Often Infrequently Never Often
112 Infrequently Never Always Infrequently Infrequently Often
113 Never Never Sometimes Sometimes Sometimes Sometimes
114 Always Infrequently Always
115 Always Never Never Infrequently
117 Often Infrequently Always Never Never Sometimes
118 Often Often Sometimes Sometimes

119 Never Never Always Never Never Always
120 Infrequently Infrequently Always Sometimes Often Always
121 Infrequently Sometimes Always Often Often Often
122 Always Never Always Always Never Always
123 Sometimes Sometimes Sometimes Often
124 Often Often Often Never Never Often
125 Sometimes Sometimes Sometimes Often
126 Sometimes Sometimes Sometimes
127 Always Often Always Always Always Always
128 Sometimes Sometimes Always Often Often Always
129 Often Often Always Sometimes Sometimes Sometimes
130 Sometimes Sometimes Always Always Always Always
131 Infrequently Never Sometimes Often Often Always

132 Always Sometimes Always Infrequently Infrequently Often
133 Always Always Often Often Always Sometimes
134 Always Always Sometimes Infrequently Often Always
135 Always Often Always Always Always Always
136 Always
137 Always Always Always Often Often Always
138 Always Always Always Often Always Always
139 Sometimes Sometimes Often Often Often Often
140 Sometimes Infrequently Always Often Never Always
141 Always Often Always Often Often Often
Survey Data 191
19. Long–Term 20. Long–Term 21. Procurement 22. Percentage
Survey 18. Communication Relationships Relationships Involved in 22. Reduced Reduction of
Response with Customers with Suppliers with Customers Development Supplier Base Supplier Base
1 Always Always Always Never Infrequently

2 Infrequently Often Always Sometimes 5
3 Always Often Often Sometimes 20
4 Always Sometimes Often
5 Always Always Always Often
6 Always Sometimes Often Sometimes
7 Never Never Never Never Often 10
8 Often Often Often Always 50
9 Always Often Always Often Sometimes

10 Infrequently Often Often Sometimes Sometimes 25
11 Always Always Always Always Never
12 Infrequently Infrequently Often Sometimes Sometimes 20
13 Always Often Often Sometimes Sometimes
14 Always
15 Always Never Often Sometimes 0
16 Always Always Always Always 20
19 Often Often Often Sometimes Never
20 Always Always Always Sometimes Sometimes –15
21 Often Often Often Infrequently Sometimes
22 Always Often Always Often Infrequently 1
23 Often Always Often Sometimes Often 30

24 Often Often Often Infrequently Often 10
25 Always Often Always Always Infrequently
26 Sometimes Often Often Often Often
27 Often Often Often Infrequently Often
28 Infrequently Sometimes Sometimes Often Sometimes 20
29 Often Often Often Often Infrequently 5
30 Always Sometimes Always Sometimes Sometimes 15
31 Always Always Always Always Sometimes 10
32 Always Sometimes Sometimes Often Never 20
33 Always Often Often Sometimes 50
34 Sometimes Often Infrequently Always Sometimes 5
35 Always Often Often Often
36 Sometimes Often Often Often Often 20

37 Often Always Often Infrequently Often 30
38 Often Always Always Infrequently
39 Always Always Always Sometimes
40 Always Often Often Often Always 90
41 Sometimes Always Often Often Sometimes 5
42 Often Often Always Always Infrequently 10
43 Often Often Always Infrequently Infrequently 1
44 Often Often Often Infrequently 20
45 Often Infrequently Sometimes Infrequently Infrequently 5
46 Infrequently Infrequently Always Infrequently Sometimes
47 Often Often Often Often Infrequently
48 Infrequently Sometimes Infrequently Often Often 100
49 Infrequently Often Infrequently Sometimes Infrequently
Survey Data 193
50 Often Infrequently Often Infrequently Sometimes 25

51 Sometimes Often Often Infrequently Never 0
52 Always Sometimes Often Never Infrequently 0
54 Always Often Always Always Always 40
55 Sometimes Always Always Sometimes
56 Always Often Often Often Infrequently 10
57 Often Always Always Often Often 25
58 Always Often Always Sometimes Sometimes

59 Always Often Often Never
60 Always Never Often Sometimes Infrequently
61 Sometimes Often Infrequently Infrequently
62 Often Often Often Sometimes Never 0
64 Often Often Often Always
65 Infrequently Infrequently Infrequently Infrequently Often 65
66 Sometimes Often Often Often Often
67 Sometimes Often Sometimes Infrequently
68 Infrequently Often Infrequently Always Often 20
69 Often Often Often Always 20
70 Always Always Often Always Sometimes
71 Always Often Often Infrequently Sometimes 25
72 Always Always Always Infrequently Sometimes 5

73 Always Sometimes Often Infrequently Sometimes 20
74 Infrequently Often Often Always Always 40
75 Sometimes Always Often Often Always 25
76 Always Always Always Always Infrequently 1
77 Often Often Often Always Never 0
78 Infrequently Always Always Always Infrequently 5
79
80 Always Often Never Never
81 Often Always Always Often Sometimes 10
82 Often Often Often Sometimes Never –10
83 Always Always Always Always Often 30
84 Always Sometimes Always Often 25
85 Often Often Often Sometimes Sometimes 10

86 Infrequently Always Always Sometimes Often 20
87 Always Always Always Always Always 40
88 Often Sometimes Often Sometimes Sometimes 10
89 Always Often Always Sometimes Always
90 Often Always Sometimes Infrequently Never 0
91 Sometimes Often Infrequently Never Infrequently 0
92 Often Often Often Sometimes Often 10
93 Always Often Always Often Often 10
94 Always Often Always Often Never 0
95 Always Sometimes Always Sometimes
96 Sometimes Sometimes Always Always Sometimes
97 Always Always Always Always Always 50
98 Always Often Always Always 25
Survey Data 195

100 Sometimes Often Never
101 Infrequently Often Sometimes Often Often
102 Often Often Often Often Often 10
103 Infrequently Sometimes Often Often Often
104 Often Always
105 Always Always Always Always Sometimes

107 Always Sometimes Always Always 0
108 Often Often Often Sometimes
109 Always Infrequently Always Sometimes Often 10
110 Always Often Always Sometimes Sometimes 10
111 Sometimes Never Never 0
112 Sometimes Always Sometimes Infrequently Sometimes 25
113 Sometimes Sometimes Sometimes Sometimes 10
114 Often Sometimes Often Often Never –20
115 Infrequently Sometimes Sometimes Often Always 30
116 Always Often Often Sometimes Often 25
117 Sometimes Often Often Never
118 Often Sometimes Always Often Sometimes 15

119 Always Always Always Often Never
120 Always Always Always Infrequently
121 Sometimes Often Always 15
122 Always Always Always Sometimes Often 10
123 Infrequently Infrequently Infrequently Never Never 0
124 Often Often Sometimes Infrequently Never
125 Often Often Sometimes Infrequently Never 0
126 Often Sometimes Sometimes Sometimes
127 Always Always Often Always
128 Sometimes Sometimes Always Always Never
129 Sometimes Sometimes Sometimes Sometimes Infrequently
130 Always Always Always Often Never 20
131 Always Often Always Often Often 0

132 Often Always Always Always
133 Often Sometimes Always Infrequently 15
134 Always Always Always Often
135 Always Always Always Infrequently
136 Infrequently Sometimes Often
137 Often Always Always Always Sometimes 15
138 Always Always Always Sometimes Infrequently 10
139 Always Always Always Sometimes Often 30
140 Always Sometimes Always Infrequently Often 40
141 Often Often Often Always Often 5
Survey Data 197
25. Percentage
23. Reduced 23. Percentage 24. Percent 25. Reduced Reduction of
Purchased Reduction of 24. Reduced Reduction of Supply-Chain Supply-Chain
Survey Component Purchased Purchased Purchased Management Management
Response Costs Component Cost Service Costs Service Cost Costs Costs

2 0 0 0
3 10 10 5
4
5 30
6
7 Always 10 Often 5 Sometimes 5
8 Often 40 Never Sometimes 5

10 Sometimes 25 Never 0
12 Infrequently Sometimes Infrequently
13 Often Sometimes Infrequently
14
15 30 0 0
16 10 10 20
18 Always Always Sometimes
19 Never Infrequently 20 Infrequently 15
20 Sometimes 5 Sometimes 0 Sometimes 0
21 Often Sometimes Often

22 Often 50 Often 30 Often 40
23 Often 40 Always 70 Often 50
24 Often 5 Sometimes 5 Often 5
25 Infrequently
26 Often Often Often
28 Always 40 Sometimes 20 Never 10
29 Often 5 Often 10 Often –5
30 Sometimes 5 Never 0 Never 0
31 Always 10 Infrequently
32 Always Often 10 Never 5
33 20 20 20
34 Always 15 Never 0 Often 20

35 Often Often 90
36 Often 10 Often 20 Always 20
37 Often 20 Sometimes Often 30
38 Sometimes Sometimes
39 Sometimes 20
40 Often 20 Sometimes 20 Always 75
41 Sometimes 5 Infrequently 10 Often 30
42 Infrequently 10 Sometimes 25 Never 0
43 Infrequently 3 Infrequently 4 Never 0
44 0 30
45 Infrequently 5
46 Often Often Infrequently
Survey Data 199
25. Percentage
48 Often 30 Sometimes 20 Infrequently 30

49 Infrequently Infrequently Infrequently
50 Infrequently 0 Infrequently 0 Sometimes 10
54 Always 35 Often 25 Often 27
55
57 Sometimes 15 Sometimes 10 Infrequently 5
59
60 Infrequently Infrequently Infrequently
61 Never
62 Never 0 Never 0 Infrequently 10
63
64
65 Often 90 Often 60 Sometimes 30
67 Sometimes 10 Infrequently
68 Always 40 Always 40 Often 30

69
70 Often Always Always
71 Sometimes 10 Sometimes 10
73 Infrequently 5 Sometimes 25 Infrequently 10
74 Always 10 Always 20 Never 0
75 Always 4 Always 4 Infrequently 0
77 Sometimes 10 Infrequently 5 Infrequently 5
79

82 Often 5 Sometimes 10 Sometimes 5
83 Often 15 Often 15 Often
84 10 0 30
85 Infrequently 5 Infrequently 5 Never 0
87 Always 15 Infrequently –100 Always 80
90 Often 15 Often 20 Never 0
94 Never 0 Infrequently 5 Never 0
Survey Data 201
25. Percentage
95 Infrequently Sometimes Sometimes

97 Always 30 Always 30 Always 30
98 6 1 0
99
100 Never

104
106
107 10 0 10
109 Often 5 Never 0 Sometimes 0
110 Sometimes 5 Infrequently 5 Infrequently
111 Never 20 Never
112 Never 0 Sometimes 25 Never 0
113 10 10 5
114 Infrequently 0 Often 15 Sometimes
115 Always 25 Infrequently 0 Infrequently 15

116 Often 25 Often 25
117
118 Sometimes 5 Sometimes 5 Often 15
120
121 10 –10 8
123 Never 0 Never 0 Never 0
124 Often 5 Sometimes 10 Infrequently
126
127
128 Sometimes Never Never

129 Always 20 Infrequently Infrequently
130 Always 15 Never 100 Never 0
131 Always 5 Often 40
132
133 15
134
135 Sometimes
136
137 Infrequently 5 Sometimes 10 Sometimes 10
138 Infrequently 5 Sometimes 20 Sometimes 20
139 Often 5 Often Often
Survey Data 203
27. Percentage
26. Percentage 27. Reduced Reduction in 28. Increased 28. Percentage
26. Reduced Total Reduction in Customer Customer Long-Term Increase of Long-
Survey Cost of Quality Total Cost of Management Management Supplier Term Supplier
Response Costs Quality Costs Costs Costs Relationships Relationships
1 Never Never Often

2
3 15 10 10
4 Sometimes
5
6 Often 20
7 Often 10 Sometimes 5 Infrequently 5
8 Sometimes Sometimes 50 Sometimes 5

9
12 Sometimes Infrequently Never
14
15 0 20 0
16 10 20 20
18 Often Always
19 Never Never Always 25
20 Often 20 Sometimes –5 Sometimes –5

22 Infrequently 5 Never 0 Infrequently 5
24 Sometimes 2 Infrequently 2 Sometimes 5
25
28 Infrequently 20 Infrequently 10 Infrequently 0
29 Always 6 Always 1 Often 15
30 5 2 0
31 Always 1 0 Always 5
32 Infrequently 0 Never –5 Sometimes
33 Often 30 Sometimes 50 Sometimes
34 Never 0 Never 0 Often 10

35 Often
36 Often 25 Often 15 Infrequently 5
37 Always Often Often 30
38 Sometimes Always
39 Infrequently 30 Infrequently 20
40 Often 30 Infrequently 10 Infrequently 0
41 Always 35 Sometimes 15 Often 15
42 Always 75 Never 0 Sometimes 25
45 Never 0 Infrequently 5
46 Infrequently Infrequently Sometimes
Survey Data 205
27. Percentage

49 Infrequently Sometimes Never
51 Sometimes 20 Never 0 Infrequently 5
52 Infrequently 10 Never 0 Sometimes 5
53 Often Often Always
55 Always
56 Often 20 Never 0 Sometimes 20
57 Never 0 Infrequently 10 Often 40
59
61 Sometimes Never
63 30
64
66 Sometimes Often Sometimes
67 Often 20
68 Always 20 Never –10 Often 20

69 Often Often 20
70 Always Always Often
71
74 Often 15 Never 0 Never 0
76 Often Never Always
78 Sometimes 20 Never –25 Sometimes 20
79
80 Never Never Sometimes 10

82 Never 0 Sometimes 0 Sometimes 10
84 5 0 10
86 Sometimes Often Often 25
87 Always 65 Never –20 Never 50
89 Often Infrequently Often 25
90 Often 20 Infrequently 10 Sometimes 30
93 Always 15 Never 0 Often 5
Survey Data 207
27. Percentage
95 Infrequently Infrequently Always

98 0 0 10
99
100 Sometimes Sometimes Never
102 Always 50 Always 20 Often

103 Often Often Infrequently
104
105 Always Always Sometimes
106
107 0 0 0
109 Often 15 Sometimes 0 Never 0
110 Infrequently Infrequently Infrequently 5
111 Never 0 Often 50
113 10 5 10
114 Never 0 Never –10 Never 0

118 Sometimes 15 Never 0 Sometimes 15
119 Often Often Always
120
121 2 5 4
124 Infrequently Never Often 10
125 Never Infrequently 5
126
127 Always

129 Sometimes Infrequently Often 20
130 Never 0 Never –10 Never 5
132 Sometimes
133 25 15 15
134 Sometimes Often
136
139 Often Sometimes Sometimes 5
140 Sometimes 0 Sometimes 0 Often 20
141 Often 3 Infrequently Often 10
Survey Data 209
29. Increased 29. Percentage 30. Percentage 31. Percentage
Long-Term Increase of Long- 30. Increased Increase in 31. Increased Increase in
Survey Customer Term Customer Standardization Standardization Standardization of Standardization of
Response Relationships Relationships of Offerings of Offerings Component Set Component Set
1 Always Often Never

2
3 10 0 15
5
8 Often 300 Always Always
9
12 Infrequently Infrequently Often
13 Often Sometimes Sometimes
14
15 15 0 60
16 10 20 0

23 Infrequently 20 Often 25 Always 70
25
27 Always Infrequently Infrequently
30 100 25
31 Always –10 Never 0 Always 5
32 Infrequently Never Sometimes
35 Often Often
36 Often 5 Never 25 Often 15
37 Often Sometimes 10 Often 10
38 Always Often
39 Infrequently 30
41 Often 5 Infrequently 3 Often 20
43 Infrequently 3 Never 0 Sometimes 10
44
45 Infrequently 5 Sometimes 20
46 Sometimes Infrequently Sometimes
47 Infrequently Sometimes Infrequently
48 Never 0 Infrequently 0 Never 0
Survey Data 211
49 Never Often Often

51 Infrequently 10 Never 0 Never 0
52 Often 25 Often 25 Always 50
53 Always Often Always
54 Often 25 Always 30 Often 25
55 Always Often
56 Sometimes 20 Never 0 Often 40

59
60
61 Never Infrequently Infrequently
63 30 0
64
66 Sometimes Often Often
67 Sometimes 50 Often 50
68 Sometimes 5 Infrequently Always 60
69 50 Often Often

71 Sometimes 10 Sometimes 10
73 Sometimes 15 Never Sometimes 15
74 Often 20 Never 0 Infrequently 0
75 Never 0 Infrequently 20
76 Often Always Infrequently
78 Sometimes 20
79
80 Sometimes 10
81 Never 0 Often 20 Always 40
82 Sometimes 15 Never –15 Never –15

84 15 40 10
88 Never 0 Infrequently 0 Sometimes 5
89 Always 50 Often 25 Sometimes 25
90 Sometimes 10 Often 30 Often 62
91 Never 0 Never 0 Always 100
93 Often 5 Always 10 Sometimes 2
95 Always Never Sometimes
Survey Data 213
97 Sometimes 0 Often 25 Often 25

98 10 5 5
99 Often Often
100 Sometimes Sometimes Never
102 Always Often 50 Often 20

104
105 Sometimes Sometimes Infrequently
106 Often Always
107 10 20 0
110 Sometimes 10 Sometimes 5 Infrequently
112 Sometimes 15 Often 10 Infrequently 0
113 5 10 10
114 Always 25 Never –10 Never –10
115 Infrequently 0 Infrequently 0 Infrequently 0

120 Always 2
121 8 20 2
123 Never 0 Never 0 30
124 Sometimes 15 Often 5 Infrequently
125 Infrequently 5 Infrequently 5 Often 15
126
128 Sometimes Often Always
129 Often 20 Infrequently Infrequently

130 Often 20 Never –25 Never –25
131 Often Never Never
133 50 0 20
136
138 Infrequently 5 Always 50 Often 50
139 Often Often 15 Infrequently
141 Often 30 Often 30 Infrequently 10
Survey Data 215
Index
A and procurement involvement in design

process, 129
Acceleration principle, ix, 14–15 and reduced supplier base, 114–120
Accountability, 6 reducing TCO and procured
Activity-based costing (ABC), vii, ix, 1, 59, components through, 89–97
60 and TCO, ix, 1
complaints about, 66–67 and total quality costs, 132–138
expense of implementing, 2 vs. traditional cost accounting, viii
long-term focus of, 63 Activity frequency, measurement of, 82
model of, 2 Activity identification process, 61
Activity resources, 61
relative accuracy of, 61
Administrative costs, 148
steps in, 61
frequency of cost reductions, 123
U.S. Marines use of, 71
game theory matrix of cost advantage,
Activity-based management (ABM), vii, 3,
149, 151
64
mean reported percent reduction based
application and cost reductions, 69, 154 on frequency of supply base
and component set standardization, reductions, 124
129–132 reduction with reduced supply base,
and frequency of communication with 120–128
suppliers, 106–109, 110 of supply-chain management, 72
game theory and, 74–75 Advanced manufacturing systems (AMS), 63
hypothetical model, 70–74 Aerospace industry, survey of, 79
importance of partnerships to, x Aggregate decreased production cost, due
integration with TCO, ix to learning curve impact, 23
limiting common component selection Analysis methodology, 79
through, 73, 128–132 hypothesis testing, 89–140
literature review, 56–67 Automatic decisions, avoiding, 64
and long-term supplier relationships, Automation, in business processes, 40
109–114 Automotive industry, 6
process model with integrated TCO, 55, survey of, 79
67–70 Avoidable cost components, 56
217
B Case studies, offshoring knowledge work,

48–52
Baby boomers, and upcoming labor Channel efficiency, 7
shortages, 38 Chi-squared probability, 117
Back office jobs, offshoring opportunities, China, computer science and college
37 graduates in, 42
Balanced scorecard (BSC), ix, 1, 2, 4, 65 College graduates, international
categories of, 5 comparisons, 42
feeding ABM data and results into, 69 Commitment, and successful partnership
requirement for more accurate TCO alliances, 19
data, 153 Common component selection, limiting
Batch activities, 63 through ABM, 73, 128–132
Beer Game, 14 Communication, and successful partnership
Benchmarking, 2, 3 alliances, 19
Benefits, savings through offshoring, 43 Communication frequency, 71, 153
Best Buy with suppliers, 106–109
DuPont financial analysis, 50–52 Communications responsiveness, 58
offshoring practices, 36 Company age, and benefits from learning
Best practices, 3 curves, 26
Bias, in survey results, 155 Company size, and supply-chain
Bottlenecks, 62 administration cost advantage,
inevitability of, 32 151
Box plots Competition, engendering through
outsourcing, 45
component set standardization and ABM
usage, 134 Competitive advantage
as corporate goal, 153
percent reduction in administrative costs
based on frequency of supply with cost analysis and management, 1
base reduction, 126 factors ensuring, 55
percent reduction in supply base based no effect by use of TLCC, 154
on ABM usage, 121 strategies for enhancing, 7
percent reduction of procured strengthening through TCO evaluation,
component cost based on ABM 74
usage, 95 and total life-cycle cost, 140, 142
percent reduction of procured services Component set standardization, 130–132
cost based on ABM usage, 101 based on frequency of ABM usage, 134
total quality costs reductions based on frequency of increases and ABM usage,
frequency of ABM usage, 139 131
Brain drain, 37 percent increase based on frequency of
Buffer stocks, 27 ABM usage, 131
Bureau of Labor Statistics, employment Computer science graduates, international
projections, 41 comparisons, 42
Business environment, as evaluation metric Continuous improvement, 3, 4
for offshoring, 47 Contract manufacturers, as survey
Business process outsourcing (BPO), 37 respondents, 80
Buyer passivity/proactivity, 18 Corporate models, changes in, 41
Cost accounting, traditional vs. ABM, viii
Cost-based supplier performance
evaluation system, 56, 58
C Cost control, through outsourcing, 42
Cost driver rates, reducing, 59
Capacity variables, 30 Cost drivers, 61, 62
Index 219
Cost focus, six stages of, 7 percent reduction of procured

Cost functions estimation, 59 component costs by ABM
Cost measurement systems, 66 application, 96
Cost objectives, 2 percent reduction of procured services
Cost of ownership, 56, 57. See also Total costs by ABM application, 102
cost of ownership (TCO) total quality cost reductions and ABM
Cost pools, 61, 62 usage, 141
Costing methods, 59 Design and development, 68
Costly activities application of IBM and procurement
involvement in, 73
eliminating, 59
as prime target for ABM, 72
redesigning, 64
procurement role in, 85, 128, 129
Creative swiping, 3
Direct labor, as share of product cost, 60
Critical materials/resources, worldwide
Direct savings, ix
allocation of, 18
through offshoring, 35
Customer contact jobs
Distorted demand data, 14
benefits of offshoring, 43
Dominant game strategies, 74–75
offshoring opportunities, 37
DuPont financial analysis model, ix
Customer dissatisfaction ratings, 73
Best Buy, 50–52
Customer relationships, reducing costs of
return on net work (RONW), 36
managing, 86, 87
Staples case study, 48–50
Customer responsiveness, 7
Customer satisfaction, 4
measures of, 65
Cycle times, 30, 63 E
balancing in production lines, 27–28
Economic unrest, 46
Economies of scale, vs. learning, 26
Electronics industry, 6
D survey of, 80
Elemental capacity, and learning curves, 32
Data analysis, 83–88 Elemental task learning curves, ix
Data center services, offshoring of, 37 and line balance, 28–32
Data sharing, willingness, 58 in production line, 23
Davenport, Thomas, 4 Employed populations, by country, 39
Dedicated suppliers, 16 Employee numbers, of survey respondents,
Degrees of freedom, 117 80
Delayed information, 14 Employment projections, 41
Delivery failure costs, 57 English-language skills, and offshoring
Dependability, as competitive advantage, opportunities, 38
55 Enterprise value-added costs of sales, 7
Descriptive statistics Equilibrium point, 28
administrative costs reductions at Errors, cost of, 66
varying frequencies of supply European labor costs, 42
base reduction, 127 Experience, role in lower cost and
component set standardization and production speed, 24
frequency of ABM application, External cost analysis activities, 67, 68–69,
135 84, 86
percent reduction in supply base by Externally contracted services, cost
ABM application, 122 reductions for, 87
F I
Facility-sustaining activities, 63 IBM, xiii
Fiber-optic cables, role in offshoring trend, India
38 computer science and college graduates
Field failures, 73 in, 42
Financial-based decisions, 64 offshoring of knowledge work to, 35
Financial performance measures, 65 Indirect savings, ix
Financial structure, as evaluation metric for through offshoring, 35
offshoring, 47
Industrial surveys, 79–80
First-stage allocation, 62
Industry profile, of survey respondents,
Flexibility, 63 81–82
as competitive advantage, 55
Information flows, 14
Forester’s Effect, 14
Information gathering, 67–68
Frequency data, survey results, 84–86
Information sharing. See also Data sharing
Frequency of communication, 71
ABM application by frequency of
affect on customer ability to apply ABM,
willingness, 104
72
and customer ability to apply ABM to
Functional cost minimization, 7
procured components and
services, 103–106
with customers, 105
G effect of willingness on customer ability
to apply ABM, 72
GAAP accounting measures, 67 frequency of, 103
Game theory analysis, vii, viii, x, 74–75, willingness, 71
145–151 Infrastructure, as factor in offshoring
matrix cost advantage analysis, 150 decisions, 46
GDP per capita, by country, 39 Innovation
Global Crossing, 38 as competitive advantage, 55
Group technology (GT)-based cost measures of, 65
estimation, 59
Intangibles, ABC measures of, 63
Interenterprise value-added cost, 7
Internal cost analysis activities, 67
H Internal processes, 4
costing with ABC systems, 84
Hammer, Michael, 4 crosstabular count of reduced supplier
Heavy machinery industry, survey of, 80 base and ABM application to,
Holding costs, 57 115
Home construction and furnishings, survey measures of, 65
of, 80 Internet use, by country, 39
Hypothesis testing Inventory reduction syndrome, 14–15
procured components cost reduction
with ABM usage, 89–97
procured services cost reduction with
ABM use, 97–103 J
results summary, 143–145
Hypothetical models, TCO with ABM, Just-in-time systems, learning curve theory
70–74 and, 24
Index 221
K M
Knowledge work, 37 Maintenance and repair operations (MRO),
benefits of offshoring, 42–44 68
drawbacks and risks of offshoring, Management accounting, decline in, 60
45–46 Manufacturers, as service providers, 6
drivers for offshoring, 37–42 Manufacturing environment, influencing,
economic implications of offshoring, 14–15
44–45 Manufacturing expense, purchasing as
increasing shareholder value by percentage of, 8
offshoring, 35–36 Manufacturing sector, job loss in, 36
offshore locations for, 46–48 Margin potential, 13
offshoring case study, 48–52 Market maturity, 16
offshoring of, ix, viii, 35–36 Material flows, 14
opportunities for offshoring, 37 Measurement, cost of, 66
Kumar, Sameer, xiii Medical device industry, survey of, 79
Methodology for analysis, 79
Military, survey of, 80
Mobile telephone use, by country, 39
L Morgenstern, Oskar, 74
Labor costs, international comparisons, 44

Labor shortages, as driver of offshoring, 38
Lead time syndrome, 14–15, 15 N
Learning and growth activities, 4
Learning curves, ix, 23, 24–27. See also Net new job growth, 44, 45
Elemental task learning curves Neumann, John Von, 74
as capacity variable, 30 Neural network cost estimation, 59
and elemental capacity, 32 Non-value-added activities, 3
elemental task, ix eliminating, 64
multiple elemental tasks with, 29 Nondisclosure agreements, 85
rate of learning, 25
recommendations, 33–34
vs. economies of scale, 26
Life-cycle costing (LCC), 57
O
Line balance, 23 Occurrence rates, reducing, 59
and elemental task learning curves, OEM manufacturers, as survey respondents,
28–32 80
objectives gained from, 27 Offfshore locations, 46–48
Line design, 31, 32 top 20 countries for, 47
Literacy rates, 38 Offfshoring opportunities, by job type, 37
Logistics, 68 Offshore Location Attractiveness Index,
Long-term supplier relationships, 71 46–47
and customer’s ability to apply ABM, Offshoring. See also Outsourcing
109–114 business benefits of, 42–44
frequency of entering into, 111–112 drivers for knowledge work, 37–42
increased, 86, 88 economic implications, 44–45
Lowest delivered cost, 7 evaluation metrics for, 47
Lowest end-user delivered supply-chain of knowledge work, viii
cost, 7 number of U.S. jobs affected by, 36
Lowest-price pressure, 16 rationales for, 42, 43
Operational indicators, in balanced Procured services

scorecard measures, 65 and component set standardization, 135
Organizational learning, 24, 32–33 cost advantage in game theory matrix,
Outsourcing 148
defined, 6 cost reduction with ABM usage, 97–103
of knowledge work, 35–36 and frequency of communications with
as predominant practice, vii suppliers, 108–109
rationales for, 42–43 frequency of cost reductions by
reasons for, 6 frequency of ABM usage, 98
Overheads, as share of product costs, 60 percent cost reduction based on
frequency of ABM usage, 99
and willingness to share information
with suppliers, 105
P Procurement
involvement in design and
Part defect counts, 73
development, 73, 85, 128
Partnerships, 153
results of ABM application to, 154
dependence of world-class supply
chains on development of, 71 Procurement organizations, critical role of,
elements of successful, 19 8
importance in applying ABM principles, Product diversity, 66
x Product life-cycle costs (PLCC), 56, 57
Payoff matrix, game theory, 75 Product offerings, standardization of, 88
People skills, as evaluation metric for Product-sustaining activities, 63
offshoring, 47 Production costs
Performance measures, traditional and impact of experience on, 24
SCM, 21 reductions with line balance, 27
Plan, Do, Check, Act, 4 Production line
Pool rates, 61 balancing cycle times in, 27–28
Population growth, by country, 39 elemental task learning curves in, 23
Predistribution screening, 155 learning curves in, 25
Process improvement, 2, 3 Profit margin, Best Buy vs. Staples, 52
Process mapping, 61 Public accounting, legally mandated, 67
by U.S. Marines, 71 Purchased components
Process models, TCO with ABM, 67–70 crosstabular count of reduced costs and
Process-oriented philosophies, 65 ABM application, 91
Process performance, 5 reduced overall costs of, 85, 87
Process reengineering, 2, 3–4 side-by-side survey respondents
Procured components comparison, 90
contribution to overall cost, 56 Purchasing, 68
cost reduction through ABM, 89–97 critical role in supply chain, 8
and frequency of communications with Purchasing costs, 57
suppliers, 107 Purchasing excellence, vs. supply-chain
frequency of cost reductions, 92 management, 17
game theory matrix and cost advantage,
147
and long-term relationships with
suppliers, 112–114 Q
mean reported percent reduction based
on ABM usage, 92, 93 Quality
percentage cost reductions, 93 as competitive advantage, 55
Index 223
costs of poor, 57 Small companies, product performance

reducing total cost of, 87 advantages and, 16
Quality/engineering, 68 Software developers, offshoring of, 37
Software engineers, offshoring of, 37
Staff departments, destruction of, 66
Staples
R DuPont financial analysis, 48–50
offshoring practices, 36
Rate of learning, 25 Statistical analysis, 4
Redundant activities, 64 Statistical process control (SPC), 64
eliminating through ABM, 72 determining normal variance with, 65
Repetitive tasks, and production speed, 24 Stem-and-leaf plots
Research and development, offshoring component standardization and
opportunities for, 37 frequency of ABM usage, 133
Residuals, 116–117 percent reduction in supply base based
Resources on ABM usage, 119
assigning to cost objectives, 2 percent reduction in supply base based
as focus in second-wave ABC, 63 on frequency of supply base
Responsiveness, 58 reduction, 125
Return on Assets, Best Buy vs. Staples, 52 percent reduction in total quality costs
Return on Net Worth (RONW), 36 based on ABM usage, 138
Staples vs. Best Buy, 48, 52 percent reduction of procured
Revenue, of survey respondents, 80 component cost based on ABM
Reverse marketing, 18 usage, 94
Risks, of offshoring knowledge work, 45–46 percent reduction of procured services
Rock-Paper-Scissors Game, 75 cost based on ABM usage, 100
Stop ships, 73
Supplier-customer relationships, increasing
complexity of, 17
S Supplier dependencies, 154
Supplier management
Saddle points, 148 reducing administrative costs of, 72
Safety stock syndrome, 15 as target of outsourcing, 6
Scrap costs, 73 Supplier numbers, reduction by ABM
Second-stage allocation, 62 application, 72, 87
Second-wave ABC, 63 Supplier-owned technology, access to, 6
Security breaches, 45 Suppliers, dedicated, 16
through offshoring of knowledge work, Supply base
37 frequency of reduction by frequency of
Sensitive information ABM usage, 116
frequency data, 85 percent reduction of, 118, 121
willingness to share, 71 and reduction in administrative costs,
Service offerings, standardization of, 88 120–128
Service sector, job losses in, 36 and use of ABM, 114–120
Shareholder value Supply-chain cost evaluation, vii
increasing by offshoring knowledge Supply-chain innovations
work, 35–36 history of, 12
and offshoring knowledge work, ix, viii trends in, ix, 11–13
Short, J.E., 4 Supply-chain management
Simplified breakdown cost estimation, 59 performance measures, 21
Six Sigma, 2, 5 vs. purchasing excellence, 17
Supply-chain structure, 15–22 percent reduction based on frequency

Supply chains, 7 of ABM usage, 137
extending TCO into, viii reducing by ABM application, 74
world-class, 71 Total Quality Management (TQM), 2, 4, 65
Survey bias, 155 Traditional cost estimation, 59
Survey construct, 79–83 distortion by, 60
flaws in, 155 ineffectual nature of, 60
Survey respondents Trust, and successful partnership alliances,
company profile of, 80 19
industry profile of, 81–82
Survey results
frequency data, 84–86
U
percentage data, 86–87
Unavoidable cost components, 56
Unemployment rate, by country, 39
University of St. Thomas, xiii
T U.S. Department of Defense (DOD), use of
Technical skills, need for workers with, 40 TCO by, 56
Telephone use, by country, 39
Theory of constraints, 32, 62
Theory of Games and Economic Behavior, V
74
Throughput time, 27 Value, defined, 19–20
Time-to-market goals, 18 Value-added activities, 3
benefits of offshoring, 43–44 Value web management (VWM), 16
Total cost of ownership (TCO), vii, viii, 7 Value webs, 16
and ABM, ix, 1 Virtual supply chains, 15–16
disappointing implementation, 58 vs. rigid supply chains, 16–17
extending to supply chain, viii
game theory and, 74–75
hypothetical model, 70–74, 146
integrated with ABM process model, ix, W
55
Warranty costs, 73
literature analysis, 56–67
Win-win scenarios, supplier-customer, 20
process models, 67–70
Working age population, U.S. decline in, 40
purchase price share of, 56
Workstation numbers, 27–28
reducing through ABM, 89–97
World-class customers, 21
Total life-cycle cost, 85
World labor force, 42
and competitive advantage, 140, 142
strengthening competitive advantage
through management of, 74
Total quality costs Z
and ABM application, 132–140
and advantage with game theory matrix, Zander, Matthew, xii
149 Zero base pricing (ZBP), 56
frequency of reductions, 136 Zero-sum game matrix, 146

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Supply Chain

Supply Chain Cost Control Using Activity-Based Management

Boca Raton New York

Auerbach Publications is an imprint of the

No claim to original U.S. Government works

International Standard Book Number-10: 0-8493-8215-7 (Hardcover)

Library of Congress Cataloging-in-Publication Data

Visit the Taylor & Francis Web site at

T&F_LOC_A_Master.indd 1 6/1/06 10:33:40 AM

To our families and friends

Outsourcing has become a predominant practice, and the cost of procured

viii Supply Chain Cost Control Using Activity-Based Management

Contribution of the Book

Organization of the Book

x Supply Chain Cost Control Using Activity-Based Management

Chapter 6 Methodology for Analysis

The authors are especially grateful to the participants of industry

About the Authors

Sameer Kumar is a professor and Qwest Endowed Chair in global

Matthew Zander is a procurement quality engineer at IBM where he

1 Activity-Based Management and Total Cost of

2 Major Trends in Supply-Chain Innovations ............................11

3 Elemental Task Learning Curves in a Production Line ..........23

4 Offshoring Knowledge Work to Increase Shareholder

xvi Supply Chain Cost Control Using Activity-Based Management

Drawbacks and Risks ..................................................................................... 45

5 Integrated Total Cost of Ownership and Activity-Based

6 Methodology for Analysis..........................................................79

7 Analysis and Findings................................................................89

8 Conclusions and Recommendations ......................................153

2 Supply Chain Cost Control Using Activity-Based Management

Figure 1.1 Activity-based costing model.

benchmarking, process improvement, process reengineering, Total Quality

1. Activities performed to fill customer needs consume resources that

ABC is a relatively new approach to cost assignment. However, because

Activity-Based Management and Total Cost of Ownership 3

ABC data enables managers to engage in ABM. ABM consists of

4 Supply Chain Cost Control Using Activity-Based Management

of business processes to achieve rapid and dramatic improvements in

Activity-Based Management and Total Cost of Ownership 5

Customer Perspective Internal Business Process Perspective

Learning and Growth Perspective

Figure 1.2 Categories of a balanced scorecard.

(Kidwell et al., 2002). Proponents of the scorecard claim that it clarifies

6 Supply Chain Cost Control Using Activity-Based Management

Some believe these management tools and techniques are helpful in

Activity-Based Management and Total Cost of Ownership 7

products allows for easy outsourcing of manufacturing (Tully, 1994),

Stage 1: Functional cost minimization — functional areas look to

The supply-chain cost perspective is migrating toward a total view of

8 Supply Chain Cost Control Using Activity-Based Management

In this environment, purchasing takes on a critical role. In most supply-

Activity-Based Management and Total Cost of Ownership 9

Gourdie, S. (November 2001), Tools of the Trade, Financial Management (CIMA),

The front end of the supply chain is becoming as important as the

12 Supply Chain Cost Control Using Activity-Based Management

Table 2.1 A Decade of Supply-Chain Initiatives

1992 Lean manufacturing/just-in-time

understanding and responding to customer needs — is becoming