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A New Paradigm for Engineering Economy*
Economie and Financial Justification of Advanced Manufacturing Technologies H.R. Parsaei et al. (Editors) 1992 Elsevier Science Publishers B.V.
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A New Paradigm for Engineering Economy* William G. Sullivan Department of Industrial a n d S y s t e m s Engineering, Virginia Polytechnic Institute a n d State University, Blacksburg, Virginia 2 4 0 6 1 - 0 1 1 8 , U S A
Abstract T h i s paper d i s c u s s e s a fundamental c h a n g e that a p p e a r s to be occurring in the practical a n d theoretical aspects of engineering e c o n o m y . Recent e m p h a s i s on the engineer's role in strategic a n d design-related decision p r o c e s s e s h a s created a very real n e e d for c h a n g e in focus in engineering e c o n o m y t e c h n i q u e a n d m e t h o d o l ogy. Several areas of research opportunity that arise b e c a u s e of t h e p a r a d i g m shift are also identified herein.
1. INTRODUCTION T o d i s c u s s s o m e of the c h a n g e s taking place in t h e field of engineering e c o n o m y (which, by the w a y , is taught a n d practiced b y all engineering disciplines), w e first consider several definitions: E n g i n e e r i n g : A profession in w h i c h k n o w l e d g e of t h e mathematical a n d natural s c i e n c e s g a i n e d by study, experience a n d practice is applied with j u d g m e n t to d e v e l o p n e w w a y s to utilize, economically, t h e materials a n d forces of nature for the benefit of m a n k i n d [1]. Engineering E c o n o m y : A subset of engineering that requires t h e application of technical a n d e c o n o m i c analysis, with a goal of deciding w h i c h c o u r s e of action best meets technical performance criteria a n d uses scarce capital in a prudent m a n n e r [8]. This field deals with t h e c o n c e p t s a n d t e c h n i q u e s of analysis useful in evaluating the worth of s y s t e m s , products, a n d services in relation to their cost [31]. P a r a d i g m : A pattern or a m o d e l ; a set of rules a n d regulations w h i c h establish b o u n d a r i e s a n d define s u c c e s s or failure within t h e s e boundaries. P a r a d i g m Shift: T h e structure, o r framework, of a n existing p a r a d i g m under-
* A d a p t e d f r o m T h e Engineering Economist, V o l . 3 6 , No. 3, p g s . 187-200. Copyright 1 9 9 1 , Institute of Industrial Engineers, 2 5 T e c h n o l o g y Park/Atlanta,- Norcross, Georgia 30092.
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g o e s f u n d a m e n t a l c h a n g e s w h e n it fails to provide effective solutions to real p r o b l e m s . T h e s e c h a n g e s lead to a paradigm shift. Engineering Design*: T h e process of devising a s y s t e m , c o m p o n e n t , or process to meet d e s i r e d needs a d e c i s i o n - m a k i n g p r o c e s s (often iterative) basic sciences are applied to convert resources optimally to meet a stated objective . . . . Fundamental elements are the establishment of objectives a n d criteria, synthesis, analysis, construction, testing a n d evaluation [1]. B a s e d o n this definition, the design process is s u m m a r i z e d below. Recognition of Need
!
Definition of the Problem
r
Note: Feedback Loops Not Shown
Synthesis
r Analysis and Optimization
—t
Evaluation
t
Presentation
Analysis/Optimization/Evaluation: A n integral c o m p o n e n t of the design process that d r a w s heavily o n mathematical modeling skills taught primarily in the engineering science portion of the undergraduate c u r r i c u l u m . This paper b a s e s its c o n c l u s i o n s o n fundamental a n d far-reaching c h a n g e s taking place in U.S./international manufacturing a n d service industries [11]. T h e s e transformations represent a p a r a d i g m shift in the w a y w e will plan a n d operate our businesses in the 21st century. This paradigm shift will impact every engineering discipline a n d create needs that alter the w a y w e look at our profession. Engineering e c o n o m y is no exception; in fact, m a n y significant c h a n g e s are already underw a y . The objective of this paper is simply to provide s o m e insight into the paradigm shift that a p p e a r s to be occurring in the field of engineering e c o n o m y . S o m e ideas regarding a r e a s of research opportunity will also be presented. "Design" is derived f r o m the Latin w o r d designare
w h i c h m e a n s "to point the way."
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2.
REVEILLE!
O v e r t h e past 3 0 y e a r s there h a v e b e e n m a n y critics of engineering e c o n o m y . A p r e d o m i n a n t complaint s e e m s t o be that w e "think small" a n d deal with relatively unimportant t y p e s of p r o b l e m s [4,13,22]. In 1976 Ira Horowitz (an "outsider") o b s e r v e d that "engineering e c o n o m y gives t h e narrowest possible interpretation t o its d o m a i n . . . . [14] Horowitz's w o r d s c u t to t h e bone w h e n he a s k e d "Should engineering e c o n o m y exist?" He w e n t o n to s a y : "Engineering e c o n o m y has, t o all intents a n d p u r p o s e s , b e e n at a virtual standstill for t h e past quarter of a century - at precisely t h e s a m e t i m e that t h e horizons a n d m e t h o d s of e c o n o m i c s h a v e b e e n e x t e n d e d by leaps a n d bounds." [14, p. 436] Since Horowitz's "warning" in 1976, engineering e c o n o m y h a s c o n t i n u e d to focus o n capital investment d e c i s i o n - m a k i n g . O n e might argue that nothing really new a n d exciting h a s b e e n d o n e in the past 15 years. After all, s o m e t h i n g a s "simple" a s dealing with n o n capital-related investments (e.g., operating-budget b a s e d process i m p r o v e m e n t s ) h a s apparently e s c a p e d out attention. Others of us w o u l d take exception t o s u c h a naive generalization. Perhaps it is t i m e to c o m m u n i c a t e more effectively regarding h o w engineering e c o n o m y adds value t o t h e engineering profession a n d p r o p o s e s t o respond to survival-threatening challenges being f a c e d b y 21st century c o m p a n i e s . While w e have p r o g r e s s e d nicely during the last d e c a d e , n o b o d y will disagree that m u c h more remains t o b e d o n e in t h e next 10-15 years. N o w is t h e t i m e t o take a hard look at s o m e of t h e elements of c h a n g e facing u s . A s y o u shall s e e , reveille h a s been sounded.
3. Y E S T E R D A Y ' S T O M O R R O W IS N O W A review of t h e literature reveals that manufacturing c o m p a n i e s are moving t o w a r d b e c o m i n g "service businesses" in that t h e y are information intensive, highly flexible a n d immediately responsive t o c u s t o m e r expectations. Yesterday's traditional p a r a d i g m in manufacturing w a s t o derive competitive a d v a n t a g e f r o m e c o n o m i e s of scale, standardization a n d repetition. During m u c h of t h e 20th c e n tury, o u r manufacturing superiority w a s b a s e d on high v o l u m e d o m e s t i c markets a n d relatively low product differentiation. If t o m o r r o w ' s factories are to flourish, low cost g o o d s a n d services must be p r o d u c e d to meet c u s t o m e r requirements regarding product quality a n d functionality. Manufacturing a n d service industries will operate w i t h similar expectations b e c a u s e both are b e c o m i n g integrated systems of h u m a n a n d physical resources that process capital, information, energy, a n d time. This p a r a d i g m shift in manufacturing n o w p r o d u c e s n e w rules a n d strategies for generating sufficient future wealth to perpetuate t h e firm. Several salient differences b e t w e e n traditional manufacturing a n d the n e w manufacturing p a r a d i g m are s u m m a r i z e d in Figure 1 .
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Yesterday
Today's New Paradigm
High volume, long production runs, long product life cycles
Low volume, short production runs, short product life cycles
Maximize profits through return on assets
Minimize waste; maximize value added
Small number of product variations in a domestic market
Large number of product variations in an international market
Large direct labor component; high cost of processing information
Relatively high technology costs; relatively low information processing costs
Small indirect/overhead costs in relation to direct labor
Large indirect/overhead costs in relation to direct labor
Many unconnected (stand-alone) islands of technology representing intradepartmental improvement programs.
Integrated technologies connected by computer networks and dedicated to continuous plantwide improvement
Adapted from W. G. Sullivan and R. Sawhney [26] Figure 1. Fundamental Changes Taking Place in Modern Manufacturing Firms. T h e paradigm shift indicated in Figure 1 creates m a n y perplexing challenges for o u r discipline. Consider, for example, these "unconventional" strategies resulting f r o m t h e n e w paradigm outlined o n t h e right-hand side:
Strategy 1 .
Strategy 2. Strategy 3Strategy 4.
Invest in flexibility (not only in machinery but also in d e s i g n , organization structure, marketing, etc.). T h e n design s y s t e m s to produce at low cost a n d high quality to take a d v a n t a g e of technological superiority a n d integrated information s y s t e m s . Deliberately truncate the product life cycle to frustrate competitors' actions t o mimic niche products a n d undercut established "bread a n d butter" products. Proliferate in product diversity s o c u s t o m e r s have no reason t o s h o p elsewhere. I m b e d product uniqueness into your o w n , possibly specialized, manufacturing processes. T h i s m a y establish a d d e d value t h r o u g h innovation.
T h e a b o v e strategies give rise to t h e interesting collection of capital a n d non-capital investment issues e n u m e r a t e d in A p p e n d i x I. It is b e c o m i n g more apparent that engineering e c o n o m y will need to move into t h e "strategy arena" to
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m a k e meaningful contributions to problems of investment. W e n o w e x a m i n e w h a t appear to be key e l e m e n t s of a p a r a d i g m shift taking place in engineering e c o n o m y . T h i s shift most likely has b e e n motivated by c h a n g e s occurring in multinational manufacturing a n d service industries.
4. ENGINEERING E C O N O M Y P A R A D I G M SHIFT?
Totals
Retirement/ Disposal
Operational/ Support
Production/ Construction
Detail Design/ Development
METHODOLOGIES. TECHNIQUES
Concept Formuh Preliminary Desi
^VjJFE-CYCLE
Need Determination
A n N S F - s p o n s o r e d grant, c o m p l e t e d in 1985, provided a f r a m e w o r k for analyzing project activity in our field [30]. In 1989 questionnaires w e r e sent to a nationwide g r o u p of active practitioners, educators a n d researchers revealing the breakout of engineering e c o n o m y projects according to this f r a m e w o r k . T h e 108 projects w e r e classified according to stage of the product life cycle v e r s u s primary type of methodology/technique utilized a n d displayed in Figure 2. Figure 2 indicates M ,, that a majority of these projects fell into "Analysis/Evaluation" and R e c o m m e n d a t i o n / D e c i s i o n [29].
A=7
A.
Definition of Alternatives
3
3
1
B.
Forecasting/ Estimating
3
3
5
6
5
Β = 22
C.
Cash Flow Development
3
3
5
5
5
C = 21
D.
Analysis/ Evaluation
4
1
18
4
1
D = 28
E.
Recommendation/ Decision
3
3
18
4
1
Ε = 29
F
Implementation/ Control
1
F=1
Figure 2. Snapshot of Engineering E c o n o m y Project Activity in Methodologies/Techniques (Circa 1989) S u p p o s e our present engineering e c o n o m y p a r a d i g m c a n be pictured in t e r m s of the p y r a m i d s h o w n in Figure 3.
If projects identified in Figure 2 are ar-
ranged according to the four layers of the pyramid in Figure 3, o u r strong orientation
8 to Correct Process is clearly revealed. (The right-hand row totals f r o m Figure 2 for each layer of the pyramid.)
side of Figure 3 s h o w s the
Row Totals (from Figure 2)
Survival (MaWiize
Level 1 (Lowest Priority)
Futpre Wealth) Goodiiptions/AltemaHves (Tactical, Cost-Only in Nature)
Level II
A=7
^tecurate Data/Useful Information (Cost-Volume-Profit)
Level III
B=22 C=21
Level IV (Highest Priority
D=28 E=29 F=1
/ / / /
|^
\
Correct Process (Analysis Optimization and Follow-Up)
Relative Emphasis
\ \ \ \
^|
Figure 3. Engineering E c o n o m y A s Typically S e e n By Educators a n d Practitioners (the Old Paradigm) T h e most important concern in industry is, of course, Survival. This appears at the top of the pyramid in Figure 3, but historically engineering e c o n o m y has not d e v o t e d m u c h energy to the subject of Strategies for Survival. Deployment of strategy has b e e n left to our colleagues in professional business s c h o o l s [21,24] and is generally v i e w e d by engineers a s being "somebody else's problem." T h e next most important concern in Figure 3, which directly impacts the engineering profession, is development of g o o d ideas a n d options. Creative problem solving, concurrent d e s i g n , a n d design to target cost are topics that beg for the attention of engineering economists [10]. Speaking of the critical role of design in manufacturing competitiveness, Dixon a n d Duffey observe that "further cost reductions, as well as quality a n d time-to-market i m p r o v e m e n t s , will be driven not by d o w n s t r e a m manufacturing, inspection, a n d quality control, but by the strength of engineering design practices" [9, p. 12]. In truth m a n y of our colleagues are conducting research in t e c h n i q u e s for cost-effective design [28], but educators a n d practitioners have b e e n slow to react to the reality that o v e r 8 0 % of a product's life cycle costs are c o m m i t t e d during c o n c e p tual a n d preliminary d e s i g n . Fortunately, learning h o w better to incorporate economic a n d other "soft" d a t a into the design of life-cycle engineered products is being actively r e s e a r c h e d at the present time. For e x a m p l e , cost analysis models sensitive to engineering design activity a n d its impact on d o w n s t r e a m life cycle issues are presently being s o u g h t by most manufacturing c o m p a n i e s [9].
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Next in t h e p y r a m i d of Figure 3 is o u r requirement for accurate, relevant a n d timely d a t a w h i c h m a y b e financial in nature or non-financial. For years n o w leading m a n a g e m e n t a c c o u n t a n t s have b e e n acutely a w a r e of product cost distortions c a u s e d b y (1) indirect a n d o v e r h e a d c o s t s allocated by using v o l u m e - b a s e d m e a s u r e s , a n d (2) t e c h n o l o g y costs that a r e period b a s e d rather t h a n activity b a s e d [7,16,17]. O u r ingrained tradition, dating b a c k t o Frederick T a y l o r a n d H e n r y Ford, is that product value derives mainly f r o m labor a n d material. In fact, it is b e c o m i n g quite apparent that superior design must also b e factored into t h e equation for d e t e r m i n i n g overall product value. T o d a y ' s cost accounting s y s t e m s a r e driven b y the financial accounting d a t a base a n d d o not adequately portray t h e effect of design on a product's cost over its life cycle. This a n d other requirements for better m a n a g e m e n t accounting (i.e. decision making) information has given birth to a concept t e r m e d "activity- b a s e d costing" [5]. T h e o u t g r o w t h of "the n e w accounting" paradigm u p o n t h e field of engineering e c o n o m y is worth a s e c o n d look. Hopefully o u r territorial instincts will not c a u s e too m u c h adrenaline t o flow - but d i d y o u k n o w that activity-based decision support s y s t e m s a r e being d e v e l o p e d for (1) product c o s t i n g , (2) cost estimating, (3) purc h a s e v e r s u s manufacture, (4) investment analysis, (5) design t o cost a n d (6) a b a n d o n m e n t analysis? Most of these topics are listed under "areas of interest" to readers of the T h e Engineering Economist, but a s indicated in Figure 3 w e have placed a modest a m o u n t of e m p h a s i s o n the general a r e a of "getting g o o d data." With great options (alternatives) a n d g o o d data, t h e huge e m p h a s i s on Correct Process in Figure 3 is probably w a r r a n t e d . In fact, o u r traditional engineering e c o n o m y p a r a d i g m h a s led u s to devote a n inordinate a m o u n t of energy o n what m a y be t h e least important aspect of capital investment problems. After all, survival is t h e n a m e of t h e g a m e , a n d "correct process" m a y not contribute a s m u c h to wise capital investment practice a s g o o d ideas a n d information d o . T h i s brings u s b a c k t o t h e observation that U.S. c o m p a n i e s are c h a n g i n g the w a y t h e y d o business. N e w mindsets are being d e v e l o p e d a s t h e result of a f u n d a mental p a r a d i g m shift. A s a c o n s e q u e n c e , a "cultural re-focus" in engineering e c o n o m y is taking place a n d is being most influenced by professionals w h o m a y not consider t h e m s e l v e s t o be engineering economists. K u h n points o u t that paradigm shifts are led by individuals at t h e fringes of a particular field ( e . g . engineering e c o n o m y ) b e c a u s e they have little v e s t e d interest a n d are not intimidated by "mainstream" thinking [18]. In a nutshell, t h e engineering e c o n o m y p a r a d i g m shift is perceived as s h o w n in Figure 4. C o m p a r e d with Figure 3, this figure features a n inverted p y r a m i d t o indicate that priorities on w h a t is important are being altered. A s noted, more e m p h a s i s is being placed o n o u r role in strategic p r o b l e m solving a n d product/ process option d e v e l o p m e n t . Figure 4 also s h o w s increasing e m p h a s i s o n producing accurate a n d timely information, for decision m a k i n g , that is d i v o r c e d f r o m a firm's financial accounting (external reporting) requirements.
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-Relative E m p h a s i s S u r v i v a l (Formulation a n d Execution of Strategy; Development of Critical S u c c e s s Factors; Monitoring Performance Against Targets) tvelopment of Ideas and Optior (Cost Effective Design, Concurrent Engineering, luality Function D e p l o y m e n t
Level I (Highest Priority)
L e v e l II
st M a n a g e m e n t S y s t e ( \ c t i v i t y - B a s e d Costir V a l u e - A d d e d Analyses)
L e v e l III
Correct Process (Analysis, Optimisation a n d FteedbaoK in a Desigrj Cgritext)
L e v e l IV (Lowest Priority)
Figure 4. T h e Essence of the Paradigm Shift in Engineering E c o n o m y ?
5. R E C E N T D E V E L O P M E N T S Considerable evidence supports the contention that the paradigm shift of Figure 4 is gaining m o m e n t u m . A n early call for attention to Levels II a n d III of Figure 4 w a s m a d e partly in response to Horowitz's challenge [30]. M a n y engineering research projects a n d publications since 1975 have been directed to the economics of design a n d k n o w l e d g e - s y s t e m b a s e d cost estimation. Furthermore, significant contributions to levels I, II, a n d III have b e e n m a d e by researchers w o r k ing in non-engineering fields. A n attempt to identify several notable d e v e l o p m e n t s which support Figure 4 is presented in Table 1 . O n e e x a m p l e of "recent developments" is the w o r k being d o n e by C A M - i in their Cost M a n a g e m e n t S y s t e m (CMS) p r o g r a m . Because of its potential importance to the field of engineering e c o n o m y , CAM-i's investment m a n a g e m e n t methodology is briefly d i s c u s s e d below [6].
11 Table 1. Influential Players in the Engineering E c o n o m y P a r a d i g m Shift A u t h o r [Reference] Level I (Strategy)
Dixon a n d Duffey [9] Porter [21] Skinner [24] Wacker[32]
Level II (Development of Ideas a n d Options)
C A M - i , Inc. [6] Fleischer a n d K h o s h n e v i s [12] Noble a n d T a n c h o c o [20] Suri a n d Shimizu [28]
Level III (Cost M a n a g e m e n t Systems)
Brimson [5] C o o p e r s a n d Kaplan [7] Huthwaite a n d S p e n c e [15] J o h n s o n [16] S h a n k [23]
Level IV (Correct Process)
A z z o n e a n d Bertele [2] B a r o n , Burstein a n d G r a h a m [3] Mantel [19] Son a n d Park [25] Suresh [27]
Step 1 : Identify Goals and Objectives During t h e strategic planning process, g o a l s a n d objectives are evaluated, a g r e e d u p o n , prioritized a n d c o m m u n i c a t e d from senior m a n a g e m e n t to the entire firm or enterprise. Step 1 is the process of translating corporate strategies into divisional, product a n d operational goals a n d objectives. G o a l s m a y be d e f i n e d as: Corporate Level: Return on Equity, Market Share Product Level: Profit, Sales Revenue, Operating Margin, T i m e to Market Operation Level: Total Delivered Cost, C u s t o m e r Satisfaction, Zero Defects S t e p 2: E s t a b l i s h P e r f o r m a n c e M e a s u r e s a n d T a r g e t s Establish performance measure targets consistent with goals a n d objectives. T h e r e are three t y p e s of performance m e a s u r e m e n t : financial, e.g., Net Present W o r t h ( N P W ) a n d Return o n Investment (ROI); nonfinancial quantitative, e.g., process yield a n d s c h e d u l e attainment; a n d qualitative, e.g., product a n d process o b s o l e s c e n c e . T h e s e criteria c o m m u n i c a t e a s h a r e d objective despite differing Figure 5 provides a n e x a m p l e of m e a s u r e m e n t s at various levels of the firm.
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performance m e a s u r e s a n d targets. T h e ultimate target is perfection: 1 0 0 - % process yield, 1 0 0 % schedule attainment, no w a s t e a n d no inventory. Target
Performance M e a s u r e I.
II.
Financial A.
Present W o r t h
$6M@10%
B.
Operating Margin
12%
C.
Level of Investment
$15M
Nonfinancial A.
T h r o u g h p u t Time
2 Weeks
B.
Process Yield
98%
C.
Schedule Attainment
99%
D.
Lead Time
10 W e e k s
E.
Product Life Cycle
2 Years
F.
Manufacturing Process
Required for N e w Product
G.
Basic R & D / T e c h n o l o g y
Innovative Breakthrough
H.
C u s t o m e r Expectations
C u s t o m i z e d Products
Figure 5. Example of Performance T a r g e t s S t e p 3: I d e n t i f y C o s t s a n d C o s t D r i v e r s M a n y investments are m a d e to reduce or minimize cost. Use of investment m a n a g e m e n t c o n c e p t s a n d tools s u c h as activity a c c o u n t i n g , value a d d e d analysis a n d target costing bring a new d i m e n s i o n to cost m a n a g e m e n t efforts. Activity accounting a n d related cost driver analyses identify investment opportunities. Investments that f o c u s o n eliminating the c a u s e of cost (i.e., cost drivers) a n d n o n value a d d e d c o s t s c a n be incorporated a n d prioritized to meet the firm's objectives. Investment opportunities m a y also be identified during the target costing process. Certain projects m a y be required to get cost or performance results in line with m a n a g e m e n t defined targets.
13 S t e p 4: I d e n t i f y A l t e r n a t i v e A p p r o a c h e s After investment opportunities are identified, alternatives s h o u l d be generated f r o m either the operational or manufacturing area. Projects with different levels of t e c h n o l o g y m a y be p r o p o s e d as alternatives. S t e p 5: A s s e s s a n d A n a l y z e R i s k s Risk m a y include e c o n o m i c , c o m m e r c i a l , technological a n d implementation uncertainties. Reduction of risk c a n be a p p r o a c h e d t h r o u g h d e v e l o p m e n t of mitigation plans. A b r e a k d o w n in the investment process h a p p e n s w h e n mitigation plans are not b a s e d o n clearly d e f i n e d targeted levels of m e a s u r a b l e p e r f o r m a n c e w h i c h will be t r a c k e d during the project life. Use of performance f e e d b a c k for action ("trigger points") is an important element of investment m a n a g e m e n t implementation strategy. S t e p 6: E v a l u a t e I n v e s t m e n t s Evaluation of alternative investments usually involves qualitative a n d n o n financial quantitative criteria. Scoring models, portfolio analysis m o d e l s a n d decision support s y s t e m s m a y be used to help evaluate a n d decide w h i c h investment alternatives maximize goal attainment. T h e s e m o d e l s c a n be u p d a t e d a n d used throughout the life cycle of the investment. S t e p 7: S e l e c t a n I n v e s t m e n t P o r t f o l i o A "go/no go" decision is required w h e n evaluating a n y investment. New evaluation technologies (discussed in Step 6) provide m u c h better information on w h i c h to base this selection than single project tools of the past. Ultimately, expert s y s t e m s will be d e v e l o p e d to advise the decision m a k e r a n d risk m a n a g e r . S t e p 8: Integrate I n v e s t m e n t M a n a g e m e n t i n t o t h e C o s t M a n a g e m e n t S y s t e m Investment m a n a g e m e n t must be integrated into the firm's cost m a n a g e m e n t s y s t e m to fully achieve potential benefits. S t e p 9: E s t a b l i s h P e r f o r m a n c e T r a c k i n g S y s t e m T h e investment performance tracking s y s t e m is an o n g o i n g process a n d not merely a post audit event. T h r e e features distinguish p e r f o r m a n c e tracking f r o m conventional a p p r o a c h e s : A c t i v i t y A c c o u n t i n g relates actual results to plan or g o a l . Activities to track are t h o s e that affect criteria u p o n w h i c h t h e investment decision w a s m a d e . T e c h n o l o g y A c c o u n t i n g facilitates o n g o i n g evaluation of the asset in a "cause a n d effect" relationship. T a r g e t C o s t i n g allows c o m p a r i s o n of actual cost against b e n c h m a r k perf o r m a n c e of an investment over its life cycle.
14 6. C O N C L U S I O N If engineering e c o n o m y is to remain a relevant a n d vital specialty within the engineering profession, w e must be prepared to d e v e l o p a n d transfer knowledge suitable for the business p a r a d i g m of the next twenty-five years. Here is a sampling of the issues of potential interest to engineering e c o n o m i s t s : (1)
(2)
(3)
(4)
W h a t financial a n d nonfinancial performance measures are actually n e e d e d to j u d g e investments in light of a firm's strategy for remaining competitive and ensuring its survival? H o w might the principles a n d t e c h n i q u e s of engineering e c o n o m y be utilized to assist in the creation of more life-cycle complete but less costly solutions to engineering p r o b l e m s ? C a n activity-based cost m a n a g e m e n t s y s t e m s (CMS) accurately measure costs associated with scale, s c o p e , experience, t e c h n o l o g y a n d complexity; a n d c a n C M S actually lower product c o s t s t h r o u g h i m p r o v e d allocation of resources during conceptual/preliminary design activity? H o w can investment decision making be redesigned to allow the d y n a m i c s of a volatile marketplace to be interpreted across interrelated portfolios of present a n d planned resource c o m m i t m e n t s ?
It's time to e x a m i n e our traditional p a r a d i g m that quite possibly has blinded us to the challenges facing our discipline. After all, if w e don't c h a n g e o u r direction, w e may e n d up w h e r e we're headed.
7. A P P E N D I X I: A C O L L E C T I O N O F R E L E V A N T I N V E S T M E N T I S S U E S FACING 21st CENTURY MANUFACTURERS T h e r e are several recurring issues concerning the difficulty of evaluating investments in A d v a n c e d Manufacturing T e c h n o l o g y (AMT). E a c h is briefly described below. A . I n v e s t m e n t s m u s t b e t i e d t o c o r p o r a t e s t r a t e g y . Corporate strategy s h o u l d drive the investment justification process so that piecemeal purchases are not m a d e solely for the s a k e of having the latest technology. T h e resources (e.g., manufacturing s y s t e m s ) n e e d e d t o support long-term strategy must be classified into activities (e.g., machining operations). T y p e s of activities w h i c h are anticipated t h e n give rise to investment opportunities (e.g., a flexible a s s e m b l y cell). Projects that a d d r e s s t h e s e opportunities s h o u l d be evaluated in t e r m s of how well the long-term objectives are fulfilled to provide the firm with a competitive edge. This a s s u m e s that objectives c a n be translated into plant-level goals and performance m e a s u r e s s u c h as s c r a p rate, percent schedule attainment, v a l u e a d d i n g up-time, a n d so forth.
15 Β. O r g a n i z a t i o n I m p e d i m e n t s m u s t b e a d d r e s s e d . Most A M T s have an impact a c r o s s n u m e r o u s traditional organizational units. A s a result, m a n y jurisdictional issues arise that involve the m a n a g e m e n t , labor unions a n d staff functions. Mutli- disciplinary t e a m s , consisting of m a n a g e r s , t e c h n o l o g y experts, union representatives a n d others (e.g., industrial engineers), are n o w required to ensure a fair a n d c o m p l e t e evaluation of i m p r o v e m e n t opportunities. Their efforts m u s t c o m e to grips with o u t d a t e d cost accounting practices, appropriation request ceilings that promote suboptimal incremental investments, turf battles o v e r c h a n g e s in existing organizational p o w e r b a s e s , a n d so o n . C. P r o c e d u r e s f o r q u a n t i f y i n g a n d t r a c k i n g n o n - f i n a n c i a l b e n e f i t s m u s t b e developed. Methodologies are n e e d e d for cost-effectively evaluating A M T benefits that are non-financial in nature. B e c a u s e m a n y of these benefits are plantwide, responsibility for quantifying t h e m as part of the investment process is hard to place. Typical non-financial benefits of A M T are: i m p r o v e d quality and flexibility, higher machine utilization, reduced throughput t i m e s , better ability to meet s c h e d u l e s a n d i m p r o v e d learning opportunities regarding n e w technology. M a n a g e r s n e e d to be e d u c a t e d in h o w to establish the validity of a p p r o a c h e s for quantifying non-financial benefits a n d in h o w to c o m b i n e their results with financial m e a s u r e s for i m p r o v e d d e c i s i o n - m a k i n g . D. P r o c e d u r e s f o r e v a l u a t i n g p o r t f o l i o s o f i n v e s t m e n t s m u s t b e d e s i g n e d . Benefits a n d costs of A M T are often synergistic a c r o s s functional activities and o v e r t i m e . A M T synergies must be u n d e r s t o o d , m e a s u r e d a n d included in investment evaluation exercises. Otherwise, long-term benefits associated with s h a r e d d a t a b a s e s , for e x a m p l e , will be under estimated. Ignoring portfolios of interrelated projects for continuous improvement creates a s e q u e n c e of s t a n d alone, d i s c o n n e c t e d investments that may or m a y not improve the firm's c o m p e t i tiveness. Possible explanations for disregarding portfolios of interrelated projects are that technological opportunities are not well u n d e r s t o o d and/or that proced u r e s a n d d a t a to support such analyses are not available. E. M o r e a c c u r a t e c o s t i n f o r m a t i o n a n d f i n a n c i a l m e a s u r e m e n t s a r e r e q u i r e d f r o m c o s t m a n a g e m e n t s y s t e m s . S o m e of the difficulties noted a b o v e are attributable to o u t d a t e d a n d inadequate cost accounting s y s t e m s . M o d e r n cost m a n a g e m e n t s y s t e m s w h i c h f o c u s o n activity-based c o s t i n g , improved traceability of c o s t s to products, t e c h n o l o g y accounting a n d life cycle cost m a n a g e m e n t are being d e v e l o p e d . To gain better control o v e r t e c h n o l o g y costs, activity-based a p p r o a c h e s for attaching t h e m to specific products are making variable costs out of previously fixed costs (e.g., depreciation). Conversely, s o m e historically variable costs (e.g., t o u c h labor) are being v i e w e d as fixed. Financial m e a s u r e s that will be more accurately portrayed include g r o s s margin a n d various t y p e s of cost savings s u c h a s reduced labor c o s t s , less scrap and rework, r e d u c e d floor space requirements a n d lower information tracking costs.
16
F. I n c o m e t a x c o n s e q u e n c e s o f A M T m u s t b e b e t t e r u n d e r s t o o d . In m a n y p r o p o s e d applications of a d v a n c e d manufacturing s y s t e m s , cost of software creation, installation a n d support c o m p r i s e s 5 0 % of total life cycle cost. If software d e v e l o p m e n t costs are e x p e n s e d , their impact on period technology c o s t s (e.g., depreciation) is minimized but traceability to the operational phase of the product life cycle is m a d e difficult. O n the other h a n d , if s u c h costs are capitalized their full after-tax advantage is not realized. Improved income tax policies a n d guidelines are needed for investments in software, e m p l o y e e training, research a n d development, etc. to provide incentives for their pursuit. G- P o l i c i e s t o w a r d r i s k i d e n t i f i c a t i o n a n d m a n a g e m e n t m u s t b e m o r e r e l e v a n t t o d e c i s i o n m a k i n g . M a n y firms attempt to deal with risk a n d uncertainty of p r o p o s e d A M T by using artificially high discount rates a n d / o r by reducing the useful life of the technology. Both imperil recognition of "downstream" benefits of A M T a n d fail to deal realistically with the true risks of using t e c h n o l o g y to bring about i m p r o v e d competitiveness. Better measures of risk are n e e d e d as well as more relevant procedures for quantifying riskiness in investment portfolios. H. M a n a g e m e n t u n d e r s t a n d i n g a n d s u p p o r t i s i m p e r a t i v e . T h e implementation of A M T requires vision, t e a m building a n d a "champion of the c a u s e with clout." Without m a n a g e m e n t understanding and support of the new technology, regardless of w h e t h e r it is piecemeal or integrated, an A M T project is likely to be futile. G r o u p decision t e c h n i q u e s that include t o p m a n a g e m e n t have proven effective at building participation and confidence in the investment evaluation process.
8. 1.
2.
3.
4.
5. 6.
REFERENCES Accreditation Board for Engineering a n d Technology, "Criteria for Accrediting P r o g r a m s in Engineering in the United States," 345 East 47th Street, New York, NY 10017-2397, 1990. A z z o n e , G. a n d U. Bertele, "Measuring the Economic Effectiveness of Flexible A u t o m a t i o n : A N e w A p p r o a c h , " International Journal of Production Research, Vol. 27, No. 5, 1989, pp. 735-746. B a r o n , J . , M. C. Burstein and P. G r a h a m , "Planning a n d Analysis of Manufacturing Investments," Tool a n d Manufacturing Engineers Handbook, Fourth Edition, Vol. 5, C h . 3, Society of Manufacturing Engineers, Dearborn, Ml, 1988. Blank, L. T., "The C h a n g i n g Scene of Economic Analysis for the Evaluating of Manufacturing S y s t e m Design a n d Operation," The Engineering Economist, Vol. 30, No. 3, 1985, pp. 227-244. Brimson, J a m e s Α., Activity A c c o u n t i n g : A n Activity-Based Costing A p p r o a c h , J o h n Wiley & S o n , N e w York, 1 9 9 1 . C A M - i , "Cost M a n a g e m e n t System Investment M a n a g e m e n t Guide," u n published manuscript, Arlington, TX, 1 9 9 1 .
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3
A New Paradigm for Engineering Economy* William G. Sullivan Department of Industrial a n d S y s t e m s Engineering, Virginia Polytechnic Institute a n d State University, Blacksburg, Virginia 2 4 0 6 1 - 0 1 1 8 , U S A
Abstract T h i s paper d i s c u s s e s a fundamental c h a n g e that a p p e a r s to be occurring in the practical a n d theoretical aspects of engineering e c o n o m y . Recent e m p h a s i s on the engineer's role in strategic a n d design-related decision p r o c e s s e s h a s created a very real n e e d for c h a n g e in focus in engineering e c o n o m y t e c h n i q u e a n d m e t h o d o l ogy. Several areas of research opportunity that arise b e c a u s e of t h e p a r a d i g m shift are also identified herein.
1. INTRODUCTION T o d i s c u s s s o m e of the c h a n g e s taking place in t h e field of engineering e c o n o m y (which, by the w a y , is taught a n d practiced b y all engineering disciplines), w e first consider several definitions: E n g i n e e r i n g : A profession in w h i c h k n o w l e d g e of t h e mathematical a n d natural s c i e n c e s g a i n e d by study, experience a n d practice is applied with j u d g m e n t to d e v e l o p n e w w a y s to utilize, economically, t h e materials a n d forces of nature for the benefit of m a n k i n d [1]. Engineering E c o n o m y : A subset of engineering that requires t h e application of technical a n d e c o n o m i c analysis, with a goal of deciding w h i c h c o u r s e of action best meets technical performance criteria a n d uses scarce capital in a prudent m a n n e r [8]. This field deals with t h e c o n c e p t s a n d t e c h n i q u e s of analysis useful in evaluating the worth of s y s t e m s , products, a n d services in relation to their cost [31]. P a r a d i g m : A pattern or a m o d e l ; a set of rules a n d regulations w h i c h establish b o u n d a r i e s a n d define s u c c e s s or failure within t h e s e boundaries. P a r a d i g m Shift: T h e structure, o r framework, of a n existing p a r a d i g m under-
* A d a p t e d f r o m T h e Engineering Economist, V o l . 3 6 , No. 3, p g s . 187-200. Copyright 1 9 9 1 , Institute of Industrial Engineers, 2 5 T e c h n o l o g y Park/Atlanta,- Norcross, Georgia 30092.
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g o e s f u n d a m e n t a l c h a n g e s w h e n it fails to provide effective solutions to real p r o b l e m s . T h e s e c h a n g e s lead to a paradigm shift. Engineering Design*: T h e process of devising a s y s t e m , c o m p o n e n t , or process to meet d e s i r e d needs a d e c i s i o n - m a k i n g p r o c e s s (often iterative) basic sciences are applied to convert resources optimally to meet a stated objective . . . . Fundamental elements are the establishment of objectives a n d criteria, synthesis, analysis, construction, testing a n d evaluation [1]. B a s e d o n this definition, the design process is s u m m a r i z e d below. Recognition of Need
!
Definition of the Problem
r
Note: Feedback Loops Not Shown
Synthesis
r Analysis and Optimization
—t
Evaluation
t
Presentation
Analysis/Optimization/Evaluation: A n integral c o m p o n e n t of the design process that d r a w s heavily o n mathematical modeling skills taught primarily in the engineering science portion of the undergraduate c u r r i c u l u m . This paper b a s e s its c o n c l u s i o n s o n fundamental a n d far-reaching c h a n g e s taking place in U.S./international manufacturing a n d service industries [11]. T h e s e transformations represent a p a r a d i g m shift in the w a y w e will plan a n d operate our businesses in the 21st century. This paradigm shift will impact every engineering discipline a n d create needs that alter the w a y w e look at our profession. Engineering e c o n o m y is no exception; in fact, m a n y significant c h a n g e s are already underw a y . The objective of this paper is simply to provide s o m e insight into the paradigm shift that a p p e a r s to be occurring in the field of engineering e c o n o m y . S o m e ideas regarding a r e a s of research opportunity will also be presented. "Design" is derived f r o m the Latin w o r d designare
w h i c h m e a n s "to point the way."
5
2.
REVEILLE!
O v e r t h e past 3 0 y e a r s there h a v e b e e n m a n y critics of engineering e c o n o m y . A p r e d o m i n a n t complaint s e e m s t o be that w e "think small" a n d deal with relatively unimportant t y p e s of p r o b l e m s [4,13,22]. In 1976 Ira Horowitz (an "outsider") o b s e r v e d that "engineering e c o n o m y gives t h e narrowest possible interpretation t o its d o m a i n . . . . [14] Horowitz's w o r d s c u t to t h e bone w h e n he a s k e d "Should engineering e c o n o m y exist?" He w e n t o n to s a y : "Engineering e c o n o m y has, t o all intents a n d p u r p o s e s , b e e n at a virtual standstill for t h e past quarter of a century - at precisely t h e s a m e t i m e that t h e horizons a n d m e t h o d s of e c o n o m i c s h a v e b e e n e x t e n d e d by leaps a n d bounds." [14, p. 436] Since Horowitz's "warning" in 1976, engineering e c o n o m y h a s c o n t i n u e d to focus o n capital investment d e c i s i o n - m a k i n g . O n e might argue that nothing really new a n d exciting h a s b e e n d o n e in the past 15 years. After all, s o m e t h i n g a s "simple" a s dealing with n o n capital-related investments (e.g., operating-budget b a s e d process i m p r o v e m e n t s ) h a s apparently e s c a p e d out attention. Others of us w o u l d take exception t o s u c h a naive generalization. Perhaps it is t i m e to c o m m u n i c a t e more effectively regarding h o w engineering e c o n o m y adds value t o t h e engineering profession a n d p r o p o s e s t o respond to survival-threatening challenges being f a c e d b y 21st century c o m p a n i e s . While w e have p r o g r e s s e d nicely during the last d e c a d e , n o b o d y will disagree that m u c h more remains t o b e d o n e in t h e next 10-15 years. N o w is t h e t i m e t o take a hard look at s o m e of t h e elements of c h a n g e facing u s . A s y o u shall s e e , reveille h a s been sounded.
3. Y E S T E R D A Y ' S T O M O R R O W IS N O W A review of t h e literature reveals that manufacturing c o m p a n i e s are moving t o w a r d b e c o m i n g "service businesses" in that t h e y are information intensive, highly flexible a n d immediately responsive t o c u s t o m e r expectations. Yesterday's traditional p a r a d i g m in manufacturing w a s t o derive competitive a d v a n t a g e f r o m e c o n o m i e s of scale, standardization a n d repetition. During m u c h of t h e 20th c e n tury, o u r manufacturing superiority w a s b a s e d on high v o l u m e d o m e s t i c markets a n d relatively low product differentiation. If t o m o r r o w ' s factories are to flourish, low cost g o o d s a n d services must be p r o d u c e d to meet c u s t o m e r requirements regarding product quality a n d functionality. Manufacturing a n d service industries will operate w i t h similar expectations b e c a u s e both are b e c o m i n g integrated systems of h u m a n a n d physical resources that process capital, information, energy, a n d time. This p a r a d i g m shift in manufacturing n o w p r o d u c e s n e w rules a n d strategies for generating sufficient future wealth to perpetuate t h e firm. Several salient differences b e t w e e n traditional manufacturing a n d the n e w manufacturing p a r a d i g m are s u m m a r i z e d in Figure 1 .
6
Yesterday
Today's New Paradigm
High volume, long production runs, long product life cycles
Low volume, short production runs, short product life cycles
Maximize profits through return on assets
Minimize waste; maximize value added
Small number of product variations in a domestic market
Large number of product variations in an international market
Large direct labor component; high cost of processing information
Relatively high technology costs; relatively low information processing costs
Small indirect/overhead costs in relation to direct labor
Large indirect/overhead costs in relation to direct labor
Many unconnected (stand-alone) islands of technology representing intradepartmental improvement programs.
Integrated technologies connected by computer networks and dedicated to continuous plantwide improvement
Adapted from W. G. Sullivan and R. Sawhney [26] Figure 1. Fundamental Changes Taking Place in Modern Manufacturing Firms. T h e paradigm shift indicated in Figure 1 creates m a n y perplexing challenges for o u r discipline. Consider, for example, these "unconventional" strategies resulting f r o m t h e n e w paradigm outlined o n t h e right-hand side:
Strategy 1 .
Strategy 2. Strategy 3Strategy 4.
Invest in flexibility (not only in machinery but also in d e s i g n , organization structure, marketing, etc.). T h e n design s y s t e m s to produce at low cost a n d high quality to take a d v a n t a g e of technological superiority a n d integrated information s y s t e m s . Deliberately truncate the product life cycle to frustrate competitors' actions t o mimic niche products a n d undercut established "bread a n d butter" products. Proliferate in product diversity s o c u s t o m e r s have no reason t o s h o p elsewhere. I m b e d product uniqueness into your o w n , possibly specialized, manufacturing processes. T h i s m a y establish a d d e d value t h r o u g h innovation.
T h e a b o v e strategies give rise to t h e interesting collection of capital a n d non-capital investment issues e n u m e r a t e d in A p p e n d i x I. It is b e c o m i n g more apparent that engineering e c o n o m y will need to move into t h e "strategy arena" to
7
m a k e meaningful contributions to problems of investment. W e n o w e x a m i n e w h a t appear to be key e l e m e n t s of a p a r a d i g m shift taking place in engineering e c o n o m y . T h i s shift most likely has b e e n motivated by c h a n g e s occurring in multinational manufacturing a n d service industries.
4. ENGINEERING E C O N O M Y P A R A D I G M SHIFT?
Totals
Retirement/ Disposal
Operational/ Support
Production/ Construction
Detail Design/ Development
METHODOLOGIES. TECHNIQUES
Concept Formuh Preliminary Desi
^VjJFE-CYCLE
Need Determination
A n N S F - s p o n s o r e d grant, c o m p l e t e d in 1985, provided a f r a m e w o r k for analyzing project activity in our field [30]. In 1989 questionnaires w e r e sent to a nationwide g r o u p of active practitioners, educators a n d researchers revealing the breakout of engineering e c o n o m y projects according to this f r a m e w o r k . T h e 108 projects w e r e classified according to stage of the product life cycle v e r s u s primary type of methodology/technique utilized a n d displayed in Figure 2. Figure 2 indicates M ,, that a majority of these projects fell into "Analysis/Evaluation" and R e c o m m e n d a t i o n / D e c i s i o n [29].
A=7
A.
Definition of Alternatives
3
3
1
B.
Forecasting/ Estimating
3
3
5
6
5
Β = 22
C.
Cash Flow Development
3
3
5
5
5
C = 21
D.
Analysis/ Evaluation
4
1
18
4
1
D = 28
E.
Recommendation/ Decision
3
3
18
4
1
Ε = 29
F
Implementation/ Control
1
F=1
Figure 2. Snapshot of Engineering E c o n o m y Project Activity in Methodologies/Techniques (Circa 1989) S u p p o s e our present engineering e c o n o m y p a r a d i g m c a n be pictured in t e r m s of the p y r a m i d s h o w n in Figure 3.
If projects identified in Figure 2 are ar-
ranged according to the four layers of the pyramid in Figure 3, o u r strong orientation
8 to Correct Process is clearly revealed. (The right-hand row totals f r o m Figure 2 for each layer of the pyramid.)
side of Figure 3 s h o w s the
Row Totals (from Figure 2)
Survival (MaWiize
Level 1 (Lowest Priority)
Futpre Wealth) Goodiiptions/AltemaHves (Tactical, Cost-Only in Nature)
Level II
A=7
^tecurate Data/Useful Information (Cost-Volume-Profit)
Level III
B=22 C=21
Level IV (Highest Priority
D=28 E=29 F=1
/ / / /
|^
\
Correct Process (Analysis Optimization and Follow-Up)
Relative Emphasis
\ \ \ \
^|
Figure 3. Engineering E c o n o m y A s Typically S e e n By Educators a n d Practitioners (the Old Paradigm) T h e most important concern in industry is, of course, Survival. This appears at the top of the pyramid in Figure 3, but historically engineering e c o n o m y has not d e v o t e d m u c h energy to the subject of Strategies for Survival. Deployment of strategy has b e e n left to our colleagues in professional business s c h o o l s [21,24] and is generally v i e w e d by engineers a s being "somebody else's problem." T h e next most important concern in Figure 3, which directly impacts the engineering profession, is development of g o o d ideas a n d options. Creative problem solving, concurrent d e s i g n , a n d design to target cost are topics that beg for the attention of engineering economists [10]. Speaking of the critical role of design in manufacturing competitiveness, Dixon a n d Duffey observe that "further cost reductions, as well as quality a n d time-to-market i m p r o v e m e n t s , will be driven not by d o w n s t r e a m manufacturing, inspection, a n d quality control, but by the strength of engineering design practices" [9, p. 12]. In truth m a n y of our colleagues are conducting research in t e c h n i q u e s for cost-effective design [28], but educators a n d practitioners have b e e n slow to react to the reality that o v e r 8 0 % of a product's life cycle costs are c o m m i t t e d during c o n c e p tual a n d preliminary d e s i g n . Fortunately, learning h o w better to incorporate economic a n d other "soft" d a t a into the design of life-cycle engineered products is being actively r e s e a r c h e d at the present time. For e x a m p l e , cost analysis models sensitive to engineering design activity a n d its impact on d o w n s t r e a m life cycle issues are presently being s o u g h t by most manufacturing c o m p a n i e s [9].
9
Next in t h e p y r a m i d of Figure 3 is o u r requirement for accurate, relevant a n d timely d a t a w h i c h m a y b e financial in nature or non-financial. For years n o w leading m a n a g e m e n t a c c o u n t a n t s have b e e n acutely a w a r e of product cost distortions c a u s e d b y (1) indirect a n d o v e r h e a d c o s t s allocated by using v o l u m e - b a s e d m e a s u r e s , a n d (2) t e c h n o l o g y costs that a r e period b a s e d rather t h a n activity b a s e d [7,16,17]. O u r ingrained tradition, dating b a c k t o Frederick T a y l o r a n d H e n r y Ford, is that product value derives mainly f r o m labor a n d material. In fact, it is b e c o m i n g quite apparent that superior design must also b e factored into t h e equation for d e t e r m i n i n g overall product value. T o d a y ' s cost accounting s y s t e m s a r e driven b y the financial accounting d a t a base a n d d o not adequately portray t h e effect of design on a product's cost over its life cycle. This a n d other requirements for better m a n a g e m e n t accounting (i.e. decision making) information has given birth to a concept t e r m e d "activity- b a s e d costing" [5]. T h e o u t g r o w t h of "the n e w accounting" paradigm u p o n t h e field of engineering e c o n o m y is worth a s e c o n d look. Hopefully o u r territorial instincts will not c a u s e too m u c h adrenaline t o flow - but d i d y o u k n o w that activity-based decision support s y s t e m s a r e being d e v e l o p e d for (1) product c o s t i n g , (2) cost estimating, (3) purc h a s e v e r s u s manufacture, (4) investment analysis, (5) design t o cost a n d (6) a b a n d o n m e n t analysis? Most of these topics are listed under "areas of interest" to readers of the T h e Engineering Economist, but a s indicated in Figure 3 w e have placed a modest a m o u n t of e m p h a s i s o n the general a r e a of "getting g o o d data." With great options (alternatives) a n d g o o d data, t h e huge e m p h a s i s on Correct Process in Figure 3 is probably w a r r a n t e d . In fact, o u r traditional engineering e c o n o m y p a r a d i g m h a s led u s to devote a n inordinate a m o u n t of energy o n what m a y be t h e least important aspect of capital investment problems. After all, survival is t h e n a m e of t h e g a m e , a n d "correct process" m a y not contribute a s m u c h to wise capital investment practice a s g o o d ideas a n d information d o . T h i s brings u s b a c k t o t h e observation that U.S. c o m p a n i e s are c h a n g i n g the w a y t h e y d o business. N e w mindsets are being d e v e l o p e d a s t h e result of a f u n d a mental p a r a d i g m shift. A s a c o n s e q u e n c e , a "cultural re-focus" in engineering e c o n o m y is taking place a n d is being most influenced by professionals w h o m a y not consider t h e m s e l v e s t o be engineering economists. K u h n points o u t that paradigm shifts are led by individuals at t h e fringes of a particular field ( e . g . engineering e c o n o m y ) b e c a u s e they have little v e s t e d interest a n d are not intimidated by "mainstream" thinking [18]. In a nutshell, t h e engineering e c o n o m y p a r a d i g m shift is perceived as s h o w n in Figure 4. C o m p a r e d with Figure 3, this figure features a n inverted p y r a m i d t o indicate that priorities on w h a t is important are being altered. A s noted, more e m p h a s i s is being placed o n o u r role in strategic p r o b l e m solving a n d product/ process option d e v e l o p m e n t . Figure 4 also s h o w s increasing e m p h a s i s o n producing accurate a n d timely information, for decision m a k i n g , that is d i v o r c e d f r o m a firm's financial accounting (external reporting) requirements.
10
-Relative E m p h a s i s S u r v i v a l (Formulation a n d Execution of Strategy; Development of Critical S u c c e s s Factors; Monitoring Performance Against Targets) tvelopment of Ideas and Optior (Cost Effective Design, Concurrent Engineering, luality Function D e p l o y m e n t
Level I (Highest Priority)
L e v e l II
st M a n a g e m e n t S y s t e ( \ c t i v i t y - B a s e d Costir V a l u e - A d d e d Analyses)
L e v e l III
Correct Process (Analysis, Optimisation a n d FteedbaoK in a Desigrj Cgritext)
L e v e l IV (Lowest Priority)
Figure 4. T h e Essence of the Paradigm Shift in Engineering E c o n o m y ?
5. R E C E N T D E V E L O P M E N T S Considerable evidence supports the contention that the paradigm shift of Figure 4 is gaining m o m e n t u m . A n early call for attention to Levels II a n d III of Figure 4 w a s m a d e partly in response to Horowitz's challenge [30]. M a n y engineering research projects a n d publications since 1975 have been directed to the economics of design a n d k n o w l e d g e - s y s t e m b a s e d cost estimation. Furthermore, significant contributions to levels I, II, a n d III have b e e n m a d e by researchers w o r k ing in non-engineering fields. A n attempt to identify several notable d e v e l o p m e n t s which support Figure 4 is presented in Table 1 . O n e e x a m p l e of "recent developments" is the w o r k being d o n e by C A M - i in their Cost M a n a g e m e n t S y s t e m (CMS) p r o g r a m . Because of its potential importance to the field of engineering e c o n o m y , CAM-i's investment m a n a g e m e n t methodology is briefly d i s c u s s e d below [6].
11 Table 1. Influential Players in the Engineering E c o n o m y P a r a d i g m Shift A u t h o r [Reference] Level I (Strategy)
Dixon a n d Duffey [9] Porter [21] Skinner [24] Wacker[32]
Level II (Development of Ideas a n d Options)
C A M - i , Inc. [6] Fleischer a n d K h o s h n e v i s [12] Noble a n d T a n c h o c o [20] Suri a n d Shimizu [28]
Level III (Cost M a n a g e m e n t Systems)
Brimson [5] C o o p e r s a n d Kaplan [7] Huthwaite a n d S p e n c e [15] J o h n s o n [16] S h a n k [23]
Level IV (Correct Process)
A z z o n e a n d Bertele [2] B a r o n , Burstein a n d G r a h a m [3] Mantel [19] Son a n d Park [25] Suresh [27]
Step 1 : Identify Goals and Objectives During t h e strategic planning process, g o a l s a n d objectives are evaluated, a g r e e d u p o n , prioritized a n d c o m m u n i c a t e d from senior m a n a g e m e n t to the entire firm or enterprise. Step 1 is the process of translating corporate strategies into divisional, product a n d operational goals a n d objectives. G o a l s m a y be d e f i n e d as: Corporate Level: Return on Equity, Market Share Product Level: Profit, Sales Revenue, Operating Margin, T i m e to Market Operation Level: Total Delivered Cost, C u s t o m e r Satisfaction, Zero Defects S t e p 2: E s t a b l i s h P e r f o r m a n c e M e a s u r e s a n d T a r g e t s Establish performance measure targets consistent with goals a n d objectives. T h e r e are three t y p e s of performance m e a s u r e m e n t : financial, e.g., Net Present W o r t h ( N P W ) a n d Return o n Investment (ROI); nonfinancial quantitative, e.g., process yield a n d s c h e d u l e attainment; a n d qualitative, e.g., product a n d process o b s o l e s c e n c e . T h e s e criteria c o m m u n i c a t e a s h a r e d objective despite differing Figure 5 provides a n e x a m p l e of m e a s u r e m e n t s at various levels of the firm.
12
performance m e a s u r e s a n d targets. T h e ultimate target is perfection: 1 0 0 - % process yield, 1 0 0 % schedule attainment, no w a s t e a n d no inventory. Target
Performance M e a s u r e I.
II.
Financial A.
Present W o r t h
$6M@10%
B.
Operating Margin
12%
C.
Level of Investment
$15M
Nonfinancial A.
T h r o u g h p u t Time
2 Weeks
B.
Process Yield
98%
C.
Schedule Attainment
99%
D.
Lead Time
10 W e e k s
E.
Product Life Cycle
2 Years
F.
Manufacturing Process
Required for N e w Product
G.
Basic R & D / T e c h n o l o g y
Innovative Breakthrough
H.
C u s t o m e r Expectations
C u s t o m i z e d Products
Figure 5. Example of Performance T a r g e t s S t e p 3: I d e n t i f y C o s t s a n d C o s t D r i v e r s M a n y investments are m a d e to reduce or minimize cost. Use of investment m a n a g e m e n t c o n c e p t s a n d tools s u c h as activity a c c o u n t i n g , value a d d e d analysis a n d target costing bring a new d i m e n s i o n to cost m a n a g e m e n t efforts. Activity accounting a n d related cost driver analyses identify investment opportunities. Investments that f o c u s o n eliminating the c a u s e of cost (i.e., cost drivers) a n d n o n value a d d e d c o s t s c a n be incorporated a n d prioritized to meet the firm's objectives. Investment opportunities m a y also be identified during the target costing process. Certain projects m a y be required to get cost or performance results in line with m a n a g e m e n t defined targets.
13 S t e p 4: I d e n t i f y A l t e r n a t i v e A p p r o a c h e s After investment opportunities are identified, alternatives s h o u l d be generated f r o m either the operational or manufacturing area. Projects with different levels of t e c h n o l o g y m a y be p r o p o s e d as alternatives. S t e p 5: A s s e s s a n d A n a l y z e R i s k s Risk m a y include e c o n o m i c , c o m m e r c i a l , technological a n d implementation uncertainties. Reduction of risk c a n be a p p r o a c h e d t h r o u g h d e v e l o p m e n t of mitigation plans. A b r e a k d o w n in the investment process h a p p e n s w h e n mitigation plans are not b a s e d o n clearly d e f i n e d targeted levels of m e a s u r a b l e p e r f o r m a n c e w h i c h will be t r a c k e d during the project life. Use of performance f e e d b a c k for action ("trigger points") is an important element of investment m a n a g e m e n t implementation strategy. S t e p 6: E v a l u a t e I n v e s t m e n t s Evaluation of alternative investments usually involves qualitative a n d n o n financial quantitative criteria. Scoring models, portfolio analysis m o d e l s a n d decision support s y s t e m s m a y be used to help evaluate a n d decide w h i c h investment alternatives maximize goal attainment. T h e s e m o d e l s c a n be u p d a t e d a n d used throughout the life cycle of the investment. S t e p 7: S e l e c t a n I n v e s t m e n t P o r t f o l i o A "go/no go" decision is required w h e n evaluating a n y investment. New evaluation technologies (discussed in Step 6) provide m u c h better information on w h i c h to base this selection than single project tools of the past. Ultimately, expert s y s t e m s will be d e v e l o p e d to advise the decision m a k e r a n d risk m a n a g e r . S t e p 8: Integrate I n v e s t m e n t M a n a g e m e n t i n t o t h e C o s t M a n a g e m e n t S y s t e m Investment m a n a g e m e n t must be integrated into the firm's cost m a n a g e m e n t s y s t e m to fully achieve potential benefits. S t e p 9: E s t a b l i s h P e r f o r m a n c e T r a c k i n g S y s t e m T h e investment performance tracking s y s t e m is an o n g o i n g process a n d not merely a post audit event. T h r e e features distinguish p e r f o r m a n c e tracking f r o m conventional a p p r o a c h e s : A c t i v i t y A c c o u n t i n g relates actual results to plan or g o a l . Activities to track are t h o s e that affect criteria u p o n w h i c h t h e investment decision w a s m a d e . T e c h n o l o g y A c c o u n t i n g facilitates o n g o i n g evaluation of the asset in a "cause a n d effect" relationship. T a r g e t C o s t i n g allows c o m p a r i s o n of actual cost against b e n c h m a r k perf o r m a n c e of an investment over its life cycle.
14 6. C O N C L U S I O N If engineering e c o n o m y is to remain a relevant a n d vital specialty within the engineering profession, w e must be prepared to d e v e l o p a n d transfer knowledge suitable for the business p a r a d i g m of the next twenty-five years. Here is a sampling of the issues of potential interest to engineering e c o n o m i s t s : (1)
(2)
(3)
(4)
W h a t financial a n d nonfinancial performance measures are actually n e e d e d to j u d g e investments in light of a firm's strategy for remaining competitive and ensuring its survival? H o w might the principles a n d t e c h n i q u e s of engineering e c o n o m y be utilized to assist in the creation of more life-cycle complete but less costly solutions to engineering p r o b l e m s ? C a n activity-based cost m a n a g e m e n t s y s t e m s (CMS) accurately measure costs associated with scale, s c o p e , experience, t e c h n o l o g y a n d complexity; a n d c a n C M S actually lower product c o s t s t h r o u g h i m p r o v e d allocation of resources during conceptual/preliminary design activity? H o w can investment decision making be redesigned to allow the d y n a m i c s of a volatile marketplace to be interpreted across interrelated portfolios of present a n d planned resource c o m m i t m e n t s ?
It's time to e x a m i n e our traditional p a r a d i g m that quite possibly has blinded us to the challenges facing our discipline. After all, if w e don't c h a n g e o u r direction, w e may e n d up w h e r e we're headed.
7. A P P E N D I X I: A C O L L E C T I O N O F R E L E V A N T I N V E S T M E N T I S S U E S FACING 21st CENTURY MANUFACTURERS T h e r e are several recurring issues concerning the difficulty of evaluating investments in A d v a n c e d Manufacturing T e c h n o l o g y (AMT). E a c h is briefly described below. A . I n v e s t m e n t s m u s t b e t i e d t o c o r p o r a t e s t r a t e g y . Corporate strategy s h o u l d drive the investment justification process so that piecemeal purchases are not m a d e solely for the s a k e of having the latest technology. T h e resources (e.g., manufacturing s y s t e m s ) n e e d e d t o support long-term strategy must be classified into activities (e.g., machining operations). T y p e s of activities w h i c h are anticipated t h e n give rise to investment opportunities (e.g., a flexible a s s e m b l y cell). Projects that a d d r e s s t h e s e opportunities s h o u l d be evaluated in t e r m s of how well the long-term objectives are fulfilled to provide the firm with a competitive edge. This a s s u m e s that objectives c a n be translated into plant-level goals and performance m e a s u r e s s u c h as s c r a p rate, percent schedule attainment, v a l u e a d d i n g up-time, a n d so forth.
15 Β. O r g a n i z a t i o n I m p e d i m e n t s m u s t b e a d d r e s s e d . Most A M T s have an impact a c r o s s n u m e r o u s traditional organizational units. A s a result, m a n y jurisdictional issues arise that involve the m a n a g e m e n t , labor unions a n d staff functions. Mutli- disciplinary t e a m s , consisting of m a n a g e r s , t e c h n o l o g y experts, union representatives a n d others (e.g., industrial engineers), are n o w required to ensure a fair a n d c o m p l e t e evaluation of i m p r o v e m e n t opportunities. Their efforts m u s t c o m e to grips with o u t d a t e d cost accounting practices, appropriation request ceilings that promote suboptimal incremental investments, turf battles o v e r c h a n g e s in existing organizational p o w e r b a s e s , a n d so o n . C. P r o c e d u r e s f o r q u a n t i f y i n g a n d t r a c k i n g n o n - f i n a n c i a l b e n e f i t s m u s t b e developed. Methodologies are n e e d e d for cost-effectively evaluating A M T benefits that are non-financial in nature. B e c a u s e m a n y of these benefits are plantwide, responsibility for quantifying t h e m as part of the investment process is hard to place. Typical non-financial benefits of A M T are: i m p r o v e d quality and flexibility, higher machine utilization, reduced throughput t i m e s , better ability to meet s c h e d u l e s a n d i m p r o v e d learning opportunities regarding n e w technology. M a n a g e r s n e e d to be e d u c a t e d in h o w to establish the validity of a p p r o a c h e s for quantifying non-financial benefits a n d in h o w to c o m b i n e their results with financial m e a s u r e s for i m p r o v e d d e c i s i o n - m a k i n g . D. P r o c e d u r e s f o r e v a l u a t i n g p o r t f o l i o s o f i n v e s t m e n t s m u s t b e d e s i g n e d . Benefits a n d costs of A M T are often synergistic a c r o s s functional activities and o v e r t i m e . A M T synergies must be u n d e r s t o o d , m e a s u r e d a n d included in investment evaluation exercises. Otherwise, long-term benefits associated with s h a r e d d a t a b a s e s , for e x a m p l e , will be under estimated. Ignoring portfolios of interrelated projects for continuous improvement creates a s e q u e n c e of s t a n d alone, d i s c o n n e c t e d investments that may or m a y not improve the firm's c o m p e t i tiveness. Possible explanations for disregarding portfolios of interrelated projects are that technological opportunities are not well u n d e r s t o o d and/or that proced u r e s a n d d a t a to support such analyses are not available. E. M o r e a c c u r a t e c o s t i n f o r m a t i o n a n d f i n a n c i a l m e a s u r e m e n t s a r e r e q u i r e d f r o m c o s t m a n a g e m e n t s y s t e m s . S o m e of the difficulties noted a b o v e are attributable to o u t d a t e d a n d inadequate cost accounting s y s t e m s . M o d e r n cost m a n a g e m e n t s y s t e m s w h i c h f o c u s o n activity-based c o s t i n g , improved traceability of c o s t s to products, t e c h n o l o g y accounting a n d life cycle cost m a n a g e m e n t are being d e v e l o p e d . To gain better control o v e r t e c h n o l o g y costs, activity-based a p p r o a c h e s for attaching t h e m to specific products are making variable costs out of previously fixed costs (e.g., depreciation). Conversely, s o m e historically variable costs (e.g., t o u c h labor) are being v i e w e d as fixed. Financial m e a s u r e s that will be more accurately portrayed include g r o s s margin a n d various t y p e s of cost savings s u c h a s reduced labor c o s t s , less scrap and rework, r e d u c e d floor space requirements a n d lower information tracking costs.
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F. I n c o m e t a x c o n s e q u e n c e s o f A M T m u s t b e b e t t e r u n d e r s t o o d . In m a n y p r o p o s e d applications of a d v a n c e d manufacturing s y s t e m s , cost of software creation, installation a n d support c o m p r i s e s 5 0 % of total life cycle cost. If software d e v e l o p m e n t costs are e x p e n s e d , their impact on period technology c o s t s (e.g., depreciation) is minimized but traceability to the operational phase of the product life cycle is m a d e difficult. O n the other h a n d , if s u c h costs are capitalized their full after-tax advantage is not realized. Improved income tax policies a n d guidelines are needed for investments in software, e m p l o y e e training, research a n d development, etc. to provide incentives for their pursuit. G- P o l i c i e s t o w a r d r i s k i d e n t i f i c a t i o n a n d m a n a g e m e n t m u s t b e m o r e r e l e v a n t t o d e c i s i o n m a k i n g . M a n y firms attempt to deal with risk a n d uncertainty of p r o p o s e d A M T by using artificially high discount rates a n d / o r by reducing the useful life of the technology. Both imperil recognition of "downstream" benefits of A M T a n d fail to deal realistically with the true risks of using t e c h n o l o g y to bring about i m p r o v e d competitiveness. Better measures of risk are n e e d e d as well as more relevant procedures for quantifying riskiness in investment portfolios. H. M a n a g e m e n t u n d e r s t a n d i n g a n d s u p p o r t i s i m p e r a t i v e . T h e implementation of A M T requires vision, t e a m building a n d a "champion of the c a u s e with clout." Without m a n a g e m e n t understanding and support of the new technology, regardless of w h e t h e r it is piecemeal or integrated, an A M T project is likely to be futile. G r o u p decision t e c h n i q u e s that include t o p m a n a g e m e n t have proven effective at building participation and confidence in the investment evaluation process.
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