Question

John Lane is the new appointed financial controller of Sonic Manufacturing Ltd (Sonic). The company specializes in the manufacture of audio and video devices. John met with Tony Chan, Sonic’s plant manager, on the first day of work at his new job. Tony expressed his big concern to John about the current huge cash flow tied up in the inventory stored in the warehouse. He has been considering the implementation of a JIT production project in the plant. However, he is unsure about the benefits, given the risks involved for not keeping adequate inventory for production. John was asked to evaluate the proposal and give him the recommendation. The following information are obtained from Tony:

1. Annual cost for JIT production implementation would be $1,000,000.
2. Average inventory would decline by 80% from the current level of $6,000,000
3. The expected savings from insurance, space, warehousing costs would be 80% of the current level of $800,000.
4. Rework costs would be reduced by 50% due to quality improvement achieved from the JIT production system. The company currently incurs $200,000 in annual rework costs.
5. The existing annual sales of Sonic’s products are 100,000 units at selling price $500 each in average. Improved product quality under JIT production would enable the company to have higher value added to products and therefore can charge a higher price of $502 per unit. However, the company also expects an incremental cost of $200,000 in overtime premiums each year to avoid any loss of sales due to stockouts. Sonic’s required rate of return on inventory investment is 15% per year.

Required:
a) From a financial perspective, should Tony implement the JIT production project? Explain.
b) Identify five nonfinancial and qualitative factors Tony should consider when making the decision to adopt JIT production.
c) Assume that Tony has implemented JIT production. Give six examples of the performance measures (financial and non-financial) that Tony could use to evaluate and control JIT production.

Answer 1

A) Tony should definitely implement the JIT production system because -

1. It will reduce the inventory stock and thus warehouse cost. This is 80% of the present expense.

2. Rework costs would be reduced by 50% due to quality improvement achieved from the JIT production system.

3. The organization can charge $2 more for every product. This will directly increase the revenue.

4. Customers will get the exact same product as per their choice. This will increase sales by a big margin.

5. The 80% money that will be saved on inventory can be used to improve the manufacturing techniques. Also it can be used on personnel training.

B) Factors that Tony should consider before implementation of JIT production system -

1. Vendors

If you want to implement JIT you should have trusted vendors who can provide you stock as per customer demand. You can not rely on multiple vendors as that doesn't create the trust you want to have in them.

2. Lead Times

You need to shorten up the lead times if you want successful JIT implementation. If the time required in delivery is more than you will not be able to cope up with such low inventor stock.

3. Equipment Maintenance

You need to keep the machine breakdown to a minimum limit. Thus need to have constant and frequent checks.

4. Lot Sizes

The lot size should be as small as possible. A minimum replenishment is desired for both manufactured and purchased parts.

5. Queues

Eliminate the queues.If the queues are small, it surfaces the need to identify and fix the cause.

C)

1. Whether the waste has been reduced to the required level.

2. Check the quality control. How much improvement is there in the produced parts.

3. Check the reduction in the set up time.

4. Whether unnecessary movement of workers is reduced or not.

5. How much reduction is there in lead time.

6.Whether the suppliers are providing you inventory at the required time.