Review the enclosed case study “Barbco Engineering” and answer the six questions at the end of the case.
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Barbco Engineering Co.: Strategy-Driven Costing and
HISTORY, CHANGE, AND ENSUING LOSS
Reading the 2008 financial statements, Barb Lutz?s sons knew their company was in trouble. Their family-owned
California manufacturing company had just experienced a reported loss of $350,000?a loss that was approximately
one-third of the company?s equity. The company is small, with $4-6 million in sales. Although it had sought business
with original equipment manufacturers (OEMs), sales are primarily to custom-designed equipment end-users. Sales
are obtained through bids based on the custom design characteristics of the parts Barbco manufactures.
The company is now in its second generation of family management and adheres to the same strategy initiated by Barb
Lutz, the company?s founder?making sales by adding value to customers? equipment. Its foundry-castings business
segment is largely outsourced for manufacturing and is not the focus of this case. Barbco?s other activity, and now its
largest business segment, is the manufacture of uniquely specified steel blades that are bolted to the edges of customers?
heavy equipment, such as road grader original-equipment blades or earth-moving tractor buckets. Barbco?s engineers
work with customers and add their expertise to design the application of tungsten carbide to these add-on blades (called
?bolt-ons?). Their unique tungsten carbide process hardens the edge and saves the equipment from abrasion and wear.
The manufacturing process is called ?tungsten carbide impregnating,? or TCing.
Barbco competes based on custom-design engineering, timely delivery, and its proprietary manufacturing process. It adds
value to customers? equipment, since its relatively inexpensive bolt-ons extend the life of the much more expensive OEM
equipment. For example, a $3,000 Barbco bolt-on protects a $50,000 tractor bucket. Generally, it takes two to three times
longer for a Barbco-TCed blade to wear out compared to competitors? replacement blades. Thus Barbco?s blades lengthen
the in-service time of heavy equipment, and Barbco?s currently fast cycle time helps customers avoid extended downtime
for difficult-to-replace blades.
Barbco has a strategic advantage with the process that melts the bolt-on blades? edges and impregnates them with
tungsten carbide. Its TCing operations are in-house, and it typically processes small orders with lot sizes of 1 to 10
units. Single-unit orders are common. Barbco was profitable from the beginning, and has always focused its efforts on
its competitive advantage in designing custom products. For its TCing business, it historically paid little attention to
critically evaluating and managing materials sourcing, its manufacturing processes, cost control, and job profitability. It
wasn?t until the 2008 financial loss that Barbco?s owners were forced to deal with fundamental business changes in the
nature of their business and the importance of operating issues, job profitability, and information support.
PROBLEMS UNDERLYING THE FINANCIAL LOSS
At the time of the financial loss, Barbco had problems with on-time delivery. This is an important competitive factor for
Barbco since lead-time impacts downtime for customers? key equipment. Unfortunately, Barbco?s lead-times were
irregular and often too long.
The information system for managing inventories worsened the problem. Inventory records were less than 25% accurate.
Additional delays occurred because personnel had to recount inventories and pick and tag them for delivery to specific
customers. For its TCing business, in-house manufacturing time was inconsistent and, consequently, delivery delays were
common. Lead-times from sale to delivery varied from five to eight weeks. Sales would increase until lead-time reached
eight weeks, and then orders dropped off. When lead-time returned to five weeks, sales would again increase.
The manufacture of TCed blades followed the de facto operating rule of ?sell 1 … make 12; somebody will buy the
inventory.? TCing cost control focused on purchasing materials in large quantities at low-bid, maximum-discount prices, and
on reducing manufacturing setup costs by producing larger-than-needed lots. Since half of the finished blades did not turn over
in 12 months, there were large inventories.
TCing was run at full capacity, with 3 shifts and 40 people. The focus was on meeting sales demand, not on fully
integrated process management, job profitability, or cost control. Barbco was making so much money before 2008 that
the owners did not think better management was necessary. Prior to the financial loss, the practice in product pricing was
to set prices at the cost of materials plus overhead and profit. Minimum bid prices for Barbco?s TCing sales were
targeted at 181% of expected materials cost. Thus, a casting with materials that cost $400 was sold for a minimum of
$724. Managers were free to base bids on their judgment of competitive market conditions, but were expected to keep
in mind the minimum-bid targets. Often, market prices greatly exceeded these minimums, and management thought
all of its jobs were making a lot of money.
TC MANUFACTURING PROCESSES BEFORE THE LOSS
Before 2008, the manufacture of TCed blades was a traditional job shop with many functional workstations and multiple
jobs passing through production. See Exhibit 1 for the shop-floor layout. First, suppliers delivered large heavy steel
plates to the cutting station?s incoming inventory rack. ?Hunt-and-peck? was required to sort through the incoming
inventory and find the next job. Then an overhead crane moved the plates to workers, who cut them to rough dimensions
and placed the processed materials on an outgoing rack. Forklift trucks moved the materials from cutting to beveling,
and so on through the production process. Each machine center built-up inventory on incoming and outgoing racks?
as opposed to what would be required for single job flows through the workstations. The average job used 80% of its
labor time in setup. Rework was high with, for example, 50% of bolt holes being drilled out-of- specification. Workers
positioned materials by hand at each station, leading to crushed fingers and very high workers? compensation insurance
In order of importance, Barbco?s key success factors are quality, on-time delivery, and cost. With quality defined
as wear life and custom specifications, Barbco?s products had no problems with quality. Delivery, however, was a
problem. Barbco?s markets are very sensitive to lead-time, and Barbco had long lead-times. With its previous
systems design, Barbco was in a constant cycle of losing and gaining sales as lead- times stretched and shrunk. An
asphalt plant in Southern California, for example, discontinued Barbco?s products because Barbco could not
deliver on time. The failure to deliver one part idled the customer?s entire plant. A part costing $2,000 idled a plant
that cost $20 million! Barbco temporarily reduced lead-time by opening a second plant in Georgia. Yet when this
plant?s pipeline filled, the old cycle resumed. Still, Barbco produced and sold 100% of its capacity. There was no
alarm until the $350,000 loss in 2008; then the cost became a problem also. Hughes would have to address these
failures while maintaining quality.
THE CONTROLLER AS A CHANGE AGENT
Historically, Barbco had no controller charged with ongoing analysis of operations, job profitability, or costs. Following
the 2008 loss, the Lutz brothers created a new position of controller to design and initiate the needed manufacturing,
information, and analysis changes. They hired Vern Hughes, whose background included five years in public
accounting and nine years in manufacturing. Hughes had in-depth knowledge of costing systems and significant largefirm experience.
The new controller developed some key ideas focusing on customer value and process simplification. Hughes would
maintain the quality of custom designs, Barbco?s competitive advantage in TCing, but improve on delivery strategies
related to manufacturing cycle times and costs. Consistent with a belief in simplicity, Hughes thought many of the
firm?s practices only obscured the management process. Consequently, he sought ways to simplify management and
better control costs. He also looked for ways to improve purchasing, increase control of inventory, and reduce cycle time.
NEW PURCHASING AND INVENTORY CONTROL
Hughes proposed mutually helpful linkages with Barbco?s major suppliers of steel (for TCed blades). The plan was
to source materials 100% from suppliers who could meet strict price, material specification and delivery requirements.
Rush orders were ended. All purchases of a given material are now at an annually negotiated price, regardless of the
individual orders? unit volume. As a result, blanket discounts based on annual purchase volumes are given to Barbco,
and average materials prices have dropped 15%, discounted for guaranteed sales. Suppliers delivered steel precut to
job specifications eliminating Barbco?s cutting operation. All steel deliveries were in a three-day window.
Although no longer a dominant source of business, foundry casting?s activity also benefited from these changes. The
same materials sourcing methods used in TCing are now used for wholesaled parts, and Barbco receives four-week
delivery for foundry castings. Also regarding foundry castings, Hughes introduced cycle counting where 100 items
making up 80% of sales volume are counted every four weeks. Inventory not turning over in 12 months is deeply
discounted to sell, or scrapped. Wall-to-wall inventory counts are made every 90 days. Additionally, Barbco reduced
5,000 castings part numbers to 1,200 stockable items, with all other items purchased only when sold. Inventory count
accuracy improved rapidly, costs were reduced, and the changes successfully rid the company of many of its management
NEW TCING CELL
Operating system simplicity, timeliness, and continuous improvement were key elements for Hughes? new system.
In TCing, Hughes moved to principles of just-in-time inventory management (JIT) to improve the supply-todelivery cycle time. Goals were to improve finished-product delivery times and simplify management of the TCing
process. Barbco changed from a traditional functional layout to what Hughes calls an ?in-line? (straight-line, singleunit flow) system?an approach that is similar to lean manufacturing.
By having vendors supply steel precut to specifications, which was a major dangerous activity for Barbco, the cutting operation
was eliminated. Hughes regrouped the remaining production activities into two activity centers?tungsten crushing and
conversion processing. Tungsten is crushed from scrap parts, and tungsten chips are merged with steel blades in a conversion
processing cell. A single building houses conversion processing as one JIT manufacturing cell. See Exhibit 2 for the
conversion-processing layout after the change.
The conversion-processing cell combines five of the previous manufacturing activities: (1) beveling, (2) bolt- hole
cutting, (3) tungsten impregnating, (4) steel blade straightening, and (5) drilling. Process management focuses on keeping
the tungsten-impregnating machine running at average available capacity, defined as maximum capacity net of average
downtime for repairs and maintenance. Average available capacity works out to be 80% of maximum capacity.
Thus, actual runtime below 80% signals that profits are below what is possible.
The processing flow uses conveyors for a single-unit production line through the five activities. New materials- flow
equipment allows each process operator to receive and mechanically position each job. Forklifts bring steel to the
beginning of the line, and remove finished product at the end. The elimination of manual positioning lessens setup time
and reduces in-process inventory.
Following Theory of Constraints (TOC) principles, tungsten impregnating is deliberately designed to be the bottleneck, or
capacity-limiting process. The other four activities in processing have excess capacity so that they do not limit throughput.
Consequently, these design features create an unbalanced cell. Tungsten impregnating is the only constraining process, and
the JIT cell serves this process.
LEAN JIT CELLS
This design approach is in contrast to most lean cells that can reduce costs by striving for a balanced workflow to
minimize unit costs. Instead, Hughes used an insight from the Theory of Constraints to build a cell focusing on the
value of the core competency?TC. The strategy was to focus on the core value of ?wear capabilities.? TOC claims
perfect balance is impossible and there is always a bottleneck, or constraint, that forms the focus for value creation and
the center of management attention. Hughes applied the same concept of managing the constraint by deliberately
designing the strategic core competency?TC as the constraint.
Barbco?s cell was designed to have excess capacity in the non-TC activities to assure TC could be run at full capacity.
Thus, the TC machine is the focus for all management activity, since it sets the capacity for the entire cell. In Hughes?
system, changes at non-constraints were evaluation by their impact on the TC activities. Overall, the operating system?s
simplicity facilitates effective process management and continuous improvement. This simplicity is a key factor
underlying increased profits. Specific savings were dramatic.
After changes in inventory sourcing and operations, average inventory levels dropped from $80,000 to $6,000.
2. After process redesign, worker injuries were dramatically reduced, and workers? compensation insurance costs
fell by more than 60%. This paid for the additional new production equipment.
3. Manufacturing labor fell 40%?from three shifts to one, and from 40 to 20 people.
4. Lead order time dropped from maximums of eight weeks to a maximum of eight days.
5. Manufacturing defects fell from 25% to one per week.
However, these were only the short-term results. Over the long term, continuous incremental improvements led to
sustainable competitive advantage.
Market Prices -> Job Profitability -> Product/Process/Cost Improvement
For the TCing business, Hughes installed an information, analysis, and control system to maintain and continuously
improve key areas of competitive focus and advantage. While Barbco?s key success factors are product quality, on-time
delivery, and cost, its continuous improvement (CI) system may be the company?s ultimate competitive advantage.
With its continuous improvement system, product design and production process improvements are driven by the value
of Barbco?s products to its customers. This is achieved by using profitability and not just costs to evaluate jobs. At
weekly production meetings, all jobs for the week are ranked by profitability, and the least profitable jobs are candidates
for detailed analysis. This approach uniquely merges market value and costs to identify activities to be investigated for
This information supports a continuous improvement culture by identifying preferred activities for investigation that
should have a greater chance of improving strategic value since they are the least profitable jobs. Areas for change
may include product-design and manufacturing processes, pricing, and whether the product should even be
continued. This information connects technological adaptations directly to market value for the products.
Conversion processing costs are allocated by time on the TCing machine. Thus, TCing time becomes the focus for
cost improvement, and product redesign. By reducing a product?s use of TCing machine time, it is allocated less
cost and its profitability is increased. A secondary benefit of reducing a product?s use of TCing machine time is that
bottleneck TCing capacity is freed for other profitable sales/ production opportunities.
SETTING SALES PRICES
In determining bid prices, Barbco uses prices on competing products as a guide, but negotiates a price the market will
bear?a price that the customer accepts as fair. To achieve this, Dave Lutz, the president, designed a sales bidding
sheet (Exhibit 3) that isolates factors expected to create market value for the product as well as providing key
engineering specifications. It shows the various factors affecting production: tungsten crushing, setup, number of edges,
bolt-hole cutting, etc.
Sales staff first estimate, through experience and benchmarking, the market values of activities required by a job. The
values are then listed on the bidding sheet to explain pricing. The bidding sheet gives a market value rather than a
cost-plus price justification. It signals unusual job specifications requiring price negotiation and communicates to
customers the basis for pricing. Consequently, customers see prices as market-driven, rational, and fair. As a result of
this negotiation, changes to the value of Barbco?s products are readily apparent. In application, Hughes uses these
negotiated prices and the actual product cost, from his costing system, to compute the gross profit for each job to initiate
continuous improvement management in weekly meetings. This system and not individual insight drives CI. For
example, one product initially required a series of tungsten strips. Impregnating these strips as specified onto the steel
blade used several passes on the TCing machine. With costs assigned using time on the TC machine, this created a
reported loss on this job. Looking to future contracts for this product, Barbco worked with the customer to redesign the
product. In the future, it would use fewer tungsten strips that were more critically placed. The product then became
profitable, and the price remained competitive.
Bidding Sheet ? Front End Loader Edges (FEL) A-36
THE COSTING SYSTEM
The ?four-wall? costing system designed by Hughes allocates all JIT cell costs based on products? consumption of TCing
machine time. The allocation rate equals total costs in the JIT conversion cell divided by average available capacity. This
cost assignment reflects ?cause and effect? at a strategic level. While cell costs are operationally largely fixed they are not fixed
strategically. These costs are determined by the strategic choices about how to provide TCing capacity and service levels to
customers. There are several advantages of this costing system.
It keeps the primary cost-control focus on Barbco?s strategically determined value-adding capacity, which is the use
of its proprietary TCing machine.
It is consistent with the production system?s design that emphasizes a ?value stream? approach to managing cell
throughput with a single capacity constraint. This design is different from a traditional functional layout where individual
processes within a production line are managed for efficiency, or targeted cost control. That is, the emphasis shifts to
optimizing a value stream and not individual components within the system.
It is simple and easily understood, thus facilitating the timely weekly production and analysis of cost reports and job
Barbco?s measurement of job profit equals negotiated market price minus materials cost and allocated cell costs. This
profit measure has several information features.
It captures the net benefit Barbco receives from using its key competitive TCing capacity on a particular job,
aligning strategy with operations.
It captures the value set by the market for Barbco?s premium product.
Jobs with the lowest profit margins are the starting point for weekly continuous improvement activities.
Finally, if continuous improvement efforts fail through product …
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