Question

Companies are continuously seeking ways to improve the quality of production and reduce costs. One of the areas is to work with suppliers to improve the quality and reliability of parts and products shipped. In an article entitled "In Defense of Activity-Based Cost Management," Robert S. Kaplan says:
An ABC model can play a major role in improving supplier relationships as well. These relationships must be a vital part of any quality and cycle-time improvement program. A key insight is to use ABC to distinguish between low-price and low-cost suppliers. Traditional cost accounting, with its emphasis on purchase price variances, encourages purchasing people to continually scan the population of potential suppliers to obtain low price quotations. Most companies have learned, the hard way, that many of their low-price suppliers are actually extremely high-cost suppliers. (Source: Management Accounting: November 1992)

Required:

(a) Explain what Kaplan means by "many of their low-price suppliers are actually extremely high-cost suppliers."
(b) What general prevention and appraisal activities can be used to improve the quality and reliability of parts and products shipped from suppliers?

Answer 1

(a) A low price supplier can be a high cost supplier  

offer low prices only when they can deliver large volumes of materials. This requires the purchasing company to incur costs of storage for materials.

The company must check items in through a receiving dock and incur excessive paperwork costs.

The quality of the product shipped is poor, resulting in production defects and excessive quality control activities related to materials.

Costs of inspection increase as defective items shipped must be inspected.

Poor quality materials lead to product breakdowns, leading to external failure costs such as warranty replacements and product repairs.

Delivery time may be unpredictable, leading to costs of expediting, rescheduling, unexpected plant downtime and great increases in confusion.

Costs of scrap, rework and obsolescence increase due to defective items.

Downtime increases due to poor quality materials

(b) Prevention activities can include certifying suppliers or by using only suppliers of materials that can guarantee high quality. Appraisal activities can include inspecting materials upon delivery and providing regular evaluation of suppliers so that they will know how well they are meeting a company's quality needs