Success in competitive markets increasingly demands shorter new-product development time and more rapid response to customers. Rapid response to customers can occur when work processes meet both quality and response goals. Response time improvement should be a major focus in quality improvement because it often drives simultaneous improvements in quality and productivity. Considering response time, quality, and customer satisfaction objectives together will provide benefits greater than the sum of the benefits from considering them separately.
Think of customer response time in two categories: (1) new-product development time and (2) operational measures of time.
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IMENew-product development timerefers to the period between a firm’s first consideration of a product and its delivery to the customer. Firms that respond quickly to customer needs for new products may develop an advantage over competitors. For example, when Honda identified U.S. consumers’ need for fuel-efficient cars, the firm’s fast development capabilities gave it a competitive advantage for several years.
Not only does management want to shorten new-product development time, it also wants to understand how quickly the company can recover its investment in a new product. Break-even time (BET)refers to time required before the firm recovers its investment in new-product development.
Analyzing break-even time requires identifying the differential cash flows related to the product—that is, the future cash inflows and outflows that result from introducing the new product. Overhead costs are irrelevant if adding a new product changes only the way the firm allocates overhead without changing the total cash outflow for overhead costs. Break-even time analysis should also include both positive and negative cash-flow effects that the new product may have on sales of existing products.
Break-even time works as follows:
1. Break-even time begins when management approves a project, rather than when cash outflows first occur.
2. Break-even time considers the time value of money by discounting all cash flows.3
3You do not need to know discounting techniques for this chapter. We discuss discounted cash flow techniques in
Chapter 8.
Dallas Oil Company’s research and development department presents a proposal for new product research that will require research, development, and design investments of $300 million (discounted cash flow). Sales will begin after three years and will generate an annual discounted net cash flow of $125 million starting in year four. Analysts compute the break-even time as follows:
Break-Even Time¼ Investment
Annual Discounted Cash Flowþ
Time Period from Approval of Project until Sales Begin
¼$300 million
$125 millionþ 3 years ¼ 2:4 years þ 3 years ¼ 5:4 years
Although Hewlett-Packard and other successful companies use break-even time in assessing new-product development, this approach has several limitations:
1. Break-even time ignores all cash flows after the moment of breakeven. Thus, managers using a decision criterion based on break-even time may reject projects with high profit potential in later years in favor of less-profitable projects with higher cash inflows in the early years. As a result, managers could pursue short-term projects with lower profits rather than long-term innovative projects that might contribute more to the long-run profitability of the company. 2. Break-even time does not consider strategic and nonfinancial reasons for product develop-
ment. It focuses strictly on cash flows.
3. Break-even time varies greatly from one business to the next, depending on product life cycles and investment requirements. For example, an acceptable break-even time for the automobile industry may be five years, while the computer industry might demand a break-even time of two years or less.
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E ASURES OFT
IMEOperational measures of timeindicate the speed and reliability with which organizations supply products and services to customers. Companies generally use two operational measures of time: customer response time and on-time performance.
Customer response time(also called delivery cycle time) is the period that elapses from the moment a customer places an order for a product or requests service to the moment the firm delivers the product or service to the customer. That is, it is the time the firm takes to respond to the customer; it has nothing to do with any response by the customer. The quicker the response time, the more competitive the company. Several components of customer response time appear in Exhibit 4.8. Depending on the nature of the company, it may improve in any of the
EXHIBIT 4.8 Customer Response Time
Customer Places Order Order Ready for Setup Order Is Set Up Product Is Completed Customer Receives Product Order Receipt Time Order Waiting Time Order Manufacturing Time Order Delivery Time
four areas—order receipt time, order waiting time, order manufacturing time, and order delivery time.
For example, Steve’s order receipt time is minimal—an employee answers the phone and takes the order. The time elapsed between the order being taken at the phone and being passed to the preparation area varies—during rush times the order-taker cannot always transfer the order immediately as other calls are coming in. The firm could decrease this time by relocating the phone closer to the preparation area. It might decrease order preparation time by arranging the ingredients in a more efficient pattern. Order delivery time depends on distance to the customer, which Steve’s cannot decrease, and efficient routing, which it can control.
On-time performancerefers to situations in which the firm delivers the product or service at the time scheduled for delivery. For example, Steve’s Sushi keeps records of the times at which it takes orders, promises delivery, and actually delivers the orders, and then measures performance as the ratio of on-time deliveries to total deliveries.