Example 1: The Corporate Governance Arrangements for Tesco PLC
Essay Question: Research and evaluate the corporate governance arrangements for Tesco PLC
Tesco Plc, one of the largest food and beverages retailers in the world is a non-cyclical company that has seen enormous investment from around the globe including Warren Buffet’s parent firm Berkshire Hathaway. On grounds of the company’s established strategy and mature business model it is a recommended investment for the client.
- Defines Corporate Governance
- Discusses Tesco’s governance structure
- Value drivers for corporate governance
The fundamental pillar as to how corporations are run day to day and all stakeholder interests (shareholders, management, suppliers etc) are taken into consideration is referred to as “Corporate Governance”. The term encompasses the framework for internal controls that a company has in place to help management and those in charge of running the company to act in the best interests of the shareholders (CFA Institute, 2013).
Principles relevant to Corporate Governance that achieve maximum shareholder wealth are attributed to three fundamentals (CFA Institute, 2013):
- Ability of shareholders to voice their opinions and concerns in regard to running of the company with minimum hassle; and
- The management responsible for running the company acts in an ethical as well as an independent capacity towards all stakeholders of the company so as to ensure the most efficient running of the corporation
- Consistent high quality financial reporting so as to ensure investors are receiving all relevant information in a timely and verifiable manner that eventually results in maximum profitable allocation of resources and capital.
Tesco PLC Structure of Governance
Tesco’s operations around the globe have allowed it to develop a strong and fair framework for running the company across all the markets it operates in. The Board of Directors incorporating the Chairman, the Chief-Executive alongside Non-Executive Directors who provide independent appraisal of the vision of the company whilst adding insight to the strategy lies at the forefront of governance (Tesco, 2014). Furthermore, a senior Independent Director is also present on the Board to ensure all conflicts amongst management and shareholders are resolved in the interests of the shareholders which eventually prevents any “agency problems” or front running by the management in regard to the shareholder investments.
The specialised tasks of running the company have called for segregations of major duties to respective committees in the corporation. At present Tesco Plc supports its vision with the help of five committees (Tesco, 2014).
Tesco PLC Board Committees
The major drivers of each committee alongside its evolvement over the years are summarised below.
The Audit Committee: The committee is tasked to ensure that the risk management principles for the company are effective and are consistently updated to keep risk management of Tesco in line with its strategy (Tesco, 2014). Furthermore, interim audits and financial disclosures are verifiable and accurately presented to any person who demands knowledge of them.
The Audit committee is also responsible for recommending the appointment of an independent external auditor for the yearly audit and conducting inquiries into management in regard to any investigative matter it deems fit (Tesco, 2014). Over the years the committee has hired external legal counsel to advice on matters that have raised concern.
“Corporate Governance” Critique for Tesco
- Presence of knowledgeable financial experts to help the operating environment of the company
- External auditors appointed through shareholder participation and not by management decision
- Adherence report in regard to compliance with the UK Governance Code
- Continuous training of personnel on the committee to remain updated on matters of accountancy and finance
The Remuneration Committee: The Remunerations committee is primarily responsible for determining the compensation agreements of senior management as well as analyse structure of compensations that needs to be extended out to Executive members so as to retain the most competent and diligent executive management for overseeing the company (Tesco, 2014).
The committee sets out the incentive fee specifications for senior management as well as deliberates on the aptness of expenses that can be claimed by management so as to focus on long term profitability and not short term goals (Tesco, 2014).
“Corporate Governance” Critique for Tesco
- Disclosures regarding share scheme payments to management are discussed in the Annual Reports or any other public document
- “Clawback” provisions are present to discourage management from participating in short term profitability at the expense of long term ones
- Use of external counsels and consultants to ensure no conflict arises in regard to compensation between management and the committee
- Outlining philosophy for compensation to management and shareholders so as to assess compensation in “Best case” and “Worst case” situations
The Corporate Responsibility Committee: The committee was established in 2012 and incorporates the principles of the Companies Act 2006 to help govern its scope of operation (Tesco, 2014). The committee ensures Tesco acts in a sustainable manner to benefit the communities and environment. Moreover, it considers impact of corporate actions by Tesco or any of its subsidiaries on the ethical culture present across all its markets of operation.
“Corporate Governance” Critique for Tesco
- Consistent and timely updates on ethical stances of Tesco throughout its financial year and implications of such actions on the communities
- Updating investor and consumer beliefs in regard to sustainable business model and sourcing of operations for Tesco Plc
- Develop strong communication channels to ensure investors are aware of business model and the company is living up to its reputation
The Nominations Committee: The Nominations committee lies at the heart of the company. It is tasked primarily with all matters relevant to management. Acting in accordance with the Companies Act 2006, the committee ensures that executives on the board possess relevant skill to discharge duties, project a vision for the achievement of goals and the balance required between executive and the non-executive directors so as to maintain independence within the organisation (Tesco, 2014). Furthermore, the committee deals with regular appraisal of management so as to make sure the leadership quality of the board is not compromised.
Since its development the committee has also taken up the responsibility to ensure that equitable nomination procedures are drawn and implemented on a firm wide basis as well as a smooth transition mechanism is prevalent for passing over of responsibility when managerial personnel change.
“Corporate Governance” Critique for Tesco
- Presence of independent members ensure shareholder interests are at the forefront of discussion
- Linking management performance to compensation by means of regular appraisals helps Tesco ensure that it is extending out the most cost-effective expertise at every level
The Disclosures Committee: The committee not only makes sure that consistency prevails in financial statements making them easily verifiable but also scrutinizes the annual reports to ensure that accounting estimates or policies are not inappropriate for treatment of various matters (including financial and operating leases) (Tesco, 2014). The committee also deals with incorporating a framework within the firm to handle “material nonpublic information” and how it is to be disclosed.
“Corporate Governance” Critique for Tesco
- Helps ensure effective risk management with regard to insider information and assessing best course of action to dealing with speculations in the market
- Enhancing investor confidence by making sure that notes to the financial statements are comparable over periods of time
The Corporate Governance framework at the Executive Management level is limited to the Board, the Board’s composition and the committees formed to review their respective matters. To deal with corporate governance on a business strategy level Tesco ensures that each division possesses its own strategic plan to enhance performance and help achieve the company’s vision. The committees can be thought of as being responsible for a distinct business segment of the company and at the moment are made up of the following (Tesco, 2014):
- Compliance Committee
- Multichannel Committee
- People Matters Group
- Property Strategy Committee
- Social Responsibility Committee
- Technology Committee
- Commercial Committee
Given the nature of the work of such committees the overall oversight responsibility lies with the Chief Executive of the company. These add value by ensuring the laying down of a strategy for fulfillment of objectives.
A brief critical outline for other minor stakeholders is also provided below. However, corporate governance should be more closely linked with management, the Board and shareholders. (CFA Institute, 2013).
Tesco’s “Clubcard” rewards programmes and the “Finest Product” range helps the mature company retain its trusted image. Customers see such aspects as the most value efficient means for satisfying their needs. A store format from hypermarkets to corner stores ensures that each store type caters to the unique needs of the community it is housed in. Tesco’s ability to house a multichannel leadership under one roof helps keep barriers to new entrants high and protect market share in the UK.
Tesco places immense importance on the skill and betterment of its employees. The company trained more than 250,000 employees last year in light of turning around the company. The employees are not only encouraged to suggest improvements in stores or company policies through Tesco’s feedback approach but are also made to feel as an intangible asset of the company by continuous investment in their betterment.
Legislation has a huge impact on how Tesco conducts its businesses around the globe. The impact is further magnified when the company’s policies are in the spotlight. Anti-competitive and employment legislation have affected Tesco the most over the years, whether in developing or developed markets (Tesco, 2014). For a better public image and to comply with local legislation Tesco actively hires from the local community where new stores are opened. Furthermore, Tesco actively participates in sustainability projects where its huge hypermarket stores open up so as to benefit the community.
Tesco’s significant market share allows it to obtain favorable terms from its suppliers from a monetary point of view whereas special teams such as the agricultural team within the corporation help make sure that the company obtains products of utmost quality from its suppliers (Tesco, 2014). Moreover, the “protector line” initiative by Tesco under which any wrongdoing on part of the supplier can be raised by the suppliers’ employees on behalf of Tesco would enable Tesco to improve its operations (Tesco, 2014).
Having analysed the broad corporate governance framework prevalent at Tesco, improvements that can be instituted to reflect better corporate publicity and reputation are related to three main aspects of the company. The table below illustrates methods for strengthening the prevalent model.
- Election policy of the Board members should be with staggered whilst keeping a majority of independent members at all times thus making sure that shareholders’ interests are paramount
- Related party transactions or any conflict of interest arising from people serving on the Board should be disclosed in all interim reports and annual reports
- The board should meet without the presence of the management so as to prevent any over riddance of independence
- Little or no barriers to communication with investors or shareholders should be prevalent
- Establish a Code of Ethics to dictate corporate culture of the firm
- Increased transparency of options, their exercise period and fees paid out to management for their services rendered (currently amounts disclosed in Financial Statements)
- Choosing the optimal “peer group” to benchmark performance so as to allow for the most meaningful comparison
- The use of company assets and property should be limited to circumstances as determined by shareholders and the usage as such should be disclosed at the Annual General Meeting
- Use of different share classes with different voting powers are fully known to the shareholder
- Whether the company allows for shareholders to cast their vote in absence (proxy voting)
- Procedure for raising concerns at the Annual General Meeting
- Procedures that need approval from the shareholders prior to implementation by the management ( such as defenses in takeovers)
The complex and ever-changing nature of Corporate Governance does not allow for a limited set of principles that govern the matters. The interpretation of the framework for the corporate governance lies with the collaborate interaction of the shareholders and the management.
Given Tesco’s strong framework to delegate matters of public interest and scrutiny to committees independent of the Board and delegating internal strategy vision to segments within the corporation, Tesco successfully ensures that all stakeholder interests are looked after at all times.
The continuous updating of the foundations that form the Corporate Governance framework allows the company to retain its strong customer base and investor confidence. The internal review and revamping of the company’s strategic committees after the “Horse-meat scandal” ensure that the company strives to deliver the very best of responsibility at all levels. Given the responsibilities of various committees of the Board and a “Corporate Code of Ethics” within the firm it is safe to conclude that the company has established an effective corporate governance framework.
CFA Institute (2013). Corporate Finance & Portfolio Management. USA: Wiley.
Tesco PLC  Annual Report [Online] Available from www.Tescoplc.com/files/pdf/reports/ar14/download_annual_report.pdf
Gray, I. & Manson, S. (2011). The Audit Process. 5th ed. USA: South Western — Cengage Learning.
Hillier, D., Ross, S. & Westerfield, R. (2010). Corporate Finance. 1st European Edition UK: McGraw-Hill Higher Education
Robinson, T., Greuning,H., Henry,E. & Broihahn, M. (2009). International Financial Statement Analysis. USA: John Wiley & Sons Inc
Seal, W., Garrison, R. & Noreen, E. (2009). Management Accounting. UK: McGraw Hill Higher Education
Example 2: Target Costing & Life Cycle Costing Systems
Letscommunicate Ltd produces mobile phones for sale in supermarkets. In today’s competitive market of mobile phones with short product life cycles, it is important for mobile phone producers to develop and market products that not only meets the customers demand for features at a certain price level but also generate the desired profits. This essay analyses the benefits and limitations of using target costing and life-cycle costing systems over the existing costing and performance measures used by the company. The current techniques used by the company are useful for keeping costs under control but they do not provide an indication of either the maximum costs allowable for defined product features or profits over the total life of a product.
Target costing is a method to determine the cost at which a product with specified parameters must be produced to generate the required rate of return. It involves cost analysis during the developmental phase as well to keep the overall costs below the threshold. The cost control techniques currently used by the company are useful in managing costs during production stage. However, moving cost management efforts from the production stage to the product development stage translates into higher profits because of lower costs . This is particularly useful for companies producing mobile phones for supermarkets because supermarkets drive tougher bargains.
The benefits of target costing are higher if specific targets for costs and product features are established earlier in the product development cycle . Cost analysis in earlier stages of the product development may indicate whether it is feasible to produce a mobile phone that not only meet customers’ expectations of price and quality but also generates the desired returns for Letscommunicate Ltd. Also, modifications to the product in the initial development stages cost less and will increase the company’s profit and ability to compete better.
However, the target costing concept will take lower priority if Letscommunicate were to focus on meeting fast time-to-market demands because of shorter time to launch a mobile phone . It is also difficult to forecast price in the future due to rapid technology developments in mobile phones and changes in customer preferences .
Life-cycle costing systems
The competitive nature of the mobile sector means that mobile producers have to not only manage with lower profit margins and shorter product life but also spend a significant amount on developing new products and features. This means that costing methods like absorption costing systems that only look at production costs are less useful because they neglect research and development costs in evaluating profitability of a product. Life-cycle costing systems overcome this drawback as they evaluate costing from the research and development phase through to the eventual conclusion of a product’s life. This approach is useful in determining the overall profits from a product like a mobile phone that has high development costs and a short product life due to new products being launched constantly by competitors.
The major challenge of using the life-cycle costing system is that it would be difficult for Letscommunicate to estimate full life-cycles of a mobile phone in a rapidly changing environment and increasing competition.
Target costing overcomes some of the drawbacks of the current costing and performance techniques used by Letscommunicate as it focuses on maximum allowable costs during the development phase so that the company can generate the required returns. Life-cycle costing is useful as it will incorporate high development costs and short product life in determining the feasibility of a product.
Example 3: Management Accounting Systems Essay
The company’s profits are falling and there is a build-up of inventory within the production process. This report considers three management systems which could rectify the situation. Considering theory of constraints, just in time and programme evaluation and review technique, the report recommends that more information regarding the cause of the problems is undertaken, and a suitable programme of revaluation of the business processes is undertaken.
The role of management accounting in the organisation has become so much more that the reporting of the score to managers (Hansen, Mouritsen 2006). In the wake of the decline of Western Manufacturing and the relevance crisis of management accounting to modern business as outlined by Kaplan and Johnson in ‘Relevance Lost’, the traditional cost accounting approach has been largely replaced by alternative methodologies (Kee, Schmidt 2000). The role of the management accounting in the modern firm is not only to report the score, but to seek to influence the score by using techniques and theoretical approaches to improve the business processes. As such it is important for managers to understand the use and usefulness of a variety of alternatives to traditional accounting approaches, especially traditional cost accounting and look to introduce other techniques which may have practical advantages for the firm (Dugdale, Jones 1998). There is no one size fits all approach which will work in any case and the application of cost accounting can and will always provide key information about how the business is doing in terms of its goals. Indeed many of the newer techniques focus on particular applications within industry and each of them has something to offer the firm in terms of improving the business processes (Plenert 1993). This report considers three approaches in the context of practical application to a range of common problems, problems which may be responsible for the inventory build-up of the firm in question and its declining profits. The approaches are the Theory of Constraints (TOC) and the attendant logic of Throughput Accounting (TA), Just in Tim Inventory Management (JIT) and wider implications to ‘Lean’ manufacturing methodologies and the Program Evaluation and Review Technique framework (PERT). The report outlines the main features of these methodologies and the advantages and limitations of them with specific reference to their usefulness in a variety of practical situations. The report concludes that each of the methodologies has something to offer and that any management decision must be based on the goals and objectives of the company and its strategic direction.
Theory of Constraints and Throughput Accounting
Developed by E.M. Goldratt as a response to the criticisms of traditional cost accounting, the TOC states that the traditional variable costs of Cost Accounting do not apply, or rather, they apply with less rigour in a modern management situation (Bragg 2007). In the past Labour was seen as a totally variable cost, workers would work to the management’s discretion and short time and layoffs were dictated by the level of production need. Goldratt argued that this was no longer the case as changes to society and legislation had meant that the workforce was more of a fixed cost for the organisation (Wei, Liu et al. 2002). The TOC states that even though modern managers are still evaluated by labour use, such efficiencies can lead to decisions which harm the organisation rather than help optimise production. This criticism led Goldratt to develop the TOC as an alternative system, identifying ‘constraint’ as a decision relevant concept in the service or production process (Watson, Blackstone et al. 2007).
The central idea to TOC and TA is that each organisation has a specific goal (or a set of specific goals) which can be effected by decision making, better decision making leads to better completion of the goals (Linhares 2009). If one takes the normative assumption of a profit orientated organisation as the maximisation of the owner’s wealth, then the ‘goal unit’ will be the ‘throughput contribution’ (TC) which is similar to the ‘total contribution’ marginal costing (Hansen, Mouritsen 2006). The difference in TA is that ‘throughput contribution’ is defined in the TOC as Sales (S), less total variable cost (TVC) which is he cost of raw materials (not labour). This is placed in the context of two further conceptual mechanisms, Investment (I), which refers to money tied up in the system in terms of inventory and work in progress, as well as with machinery and buildings and the like, the second is Operating Expense (OE) which is the money spent by the system on generating goal units, but not the cost of raw materials, so items such as utilities and wages (Davies, Mabin et al. 2005).
This delineation of the costs of production and services allows the processes to be viewed in terms of a number of optimization questions. Typically firms need to ask themselves how throughput (TC) can be increased, how Investment (I) can be reduced and how Operating Expense (OE) can be reduced. These questions in turn will affect the Net Profit, Return on Investment, Productivity and Investment.
Therefore it can be argued that the maximisation of throughput contribution is key to the maximisation of all of the above key performance indicators. The firm can seek to maximise TC by optimising a number of aspects of the production processes. There are five common steps associated with this process;
- Identify the system constraints
- Exploit the system constraints
- Subordinate everything else to the decisions made
- Elevate the system’s constraints
- Restart the process if a constraint has been broken
The following example illustrates the process.
Company A has two workers and produces two products (Workers, A,B, Products X & Y). Product Y Requires ten minutes of Worker A’s time, and product X requires fifteen minutes. Potential demand for X is 100 units, for Y is 50 units. If the total time available to worker A is 2000 minutes per week Worker A is not a constraint as the total time to manufacture both products is equal to the total available time (15 minutes x 100, 10 minutes x 50 = 2000 minutes). Worker B also works on the two products but takes 15 minutes on both products (15 minutes x 100, 15 minutes x 50 = 2250), assuming that Worker B has the same maximum time available (2000 minutes) there is a constraint around Worker B. Thus the constraint has been identified.
Step two seeks to exploit the constraint. Concentrating on Worker B as this is where the constraint occur, the exploitation of the constraint means the company (according to its goal of maximising wealth) needs to make a decision based on how to allocate production. To do this the managers need to know what the Throughput Contribution is for each unit. Assume that TC for product X is £75 per unit and for product Y it is £120 per unit. The constraint here is time, measured in units of a minute, therefore the TC per unit of constraint is found by dividing the TC by the time taken with each worker, at the point of constraint this is as follows (X, 75/15 = £5, Y, 120/15 = £8.33), as there are only 2000 minutes available the TOC suggests that all 50 units of product Y should be produced with a total time taken of (50 x 15 = 750, TC = £8.33 x 750 = £6247.5) leaving 1250 minutes to produce product X (TC 1250 x £5 = £6250). Net profit will therefore be (6247.5 + 6250 = £12497.5). In this example this is how the TOC makes all other considerations subordinate to this decision.
TOC does have its problems, it makes many of the normative assumptions about the behaviour of costs that traditional cost accounting does, and largely ignores costs of changing the activities of many of the business processes to suit a particular set of circumstances (Rand 2000). Yet it is a powerful decision making tool and one which, if used properly can alter the success of a manufacturing process in terms of the goal of maximising the wealth of the company .
Just In Time (JIT)
JIT Inventory Management is one of a set of ‘Lean’ manufacturing methodologies which has grown out of the Japanese Approach to management accounting (Abdul-Nour, Lambert et al. 1998). In particular much of modern JIT management is based on the Kanban system of Inventory management which is a part of the Toyota Production System (TPS) which is famous the world over for its efficiency and speed to market with new products (Houghton, Portougal 1997). JIT as a part of a Lean system relies upon the pull of the market rather than the push of production targets and generally states that investment in inventory, both in terms of raw materials and work in progress, also finished goods, represents a waste to the company (White, Prybutok 2001). JIT requires the accurate organisation of the production process in terms of both processes and components of production and finds a minimum level of stock holding at every level of the process. The original Kanban system was based around a set of two cards which accompanied an individual component through the production process. At each point where a component was removed from stock to be used in a process of manufacturing one of the cards would be returned to the previous process to alert that process that another was required. This meant that without the aid of sophisticated computers the TPS managed to cut its value of stock in the factory to a fraction of what it had been, requiring less investment of working capital, lower overheads in terms of storage and warehousing, and less risk of over production of any components or of finished goods (Abdul-Nour, Lambert et al. 1998).
JIT is a system which has largely been adopted in many of the larger production facilities which have adopted ‘Lean’ technology. These range from most car manufacturers to manufacturers of high technology. But there is growing evidence that it may be very useful in terms of the smaller manufacturer, and even the service industry, especially as the cost of raw materials is rising in the face of increased demand for core materials (Abdul-Nour, Lambert et al. 1998, Khan, Sarker 2002).
JIT is difficult to implement and requires considerable investment in the production processes (Hansen, Mouritsen 2006, Houghton, Portougal 1997). It is impossible to implement JIT unless there has been a programme of business process redesign to allow such minimum stock levels to be held, and this can present a large investment cost in the firm which may or may not ultimately benefit from such an inventory management programme. JIT requires the firm to invest heavily in partnerships with suppliers as well and to evaluate the supply chain from almost every angle to prevent a total collapse of the production system (David, Eben-Chaime 2003). This is because there is little room for error in the process, if demand is poorly predicted and is higher than expected then the firm will run out of the raw materials of production and may lose custom (Kelle, Al-khateeb et al. 2003). If lower than predicted the firm will not have the capacity to store inventory (die to process redesign). Further if suppliers fail to deliver for any reason the process will come to an abrupt halt. JIT therefore requires a significant amount of managerial information from both the external market and the internal processes to get right and there have been many cases of difficult implementation, especially in smaller companies (Abdul-Nour, Lambert et al. 1998).
Notwithstanding this there is a lot of evidence that with more and sophisticated modelling techniques from increasingly advanced technology, JIT systems are getting easier to implement (White, Prybutok 2001, Yasin, Small et al. 1997). Therefore as long as the systems are set up correctly there are major advantages in reducing the waste of inventory throughout the process of manufacturing. Because of its requirements, and making everything subordinate to the level of inventory, it is not applicable for JIT systems to be used in conjunction with the Theory of Constraints, as managers are unable to subordinate all decisions within the production process to a ‘bottleneck’. Therefore some would argue that JIT systems are less flexible, or certainly allow less flexibility that TOC does (Yasin, Small et al. 1997).
Programme Evaluation and Review Technique (PERT)
Put simply a PERT map is a model of complex processes which occur to facilitate an outcome (Castro, Gómez et al. 2008). The PERT framework is very similar and often used in conjunction with a critical pathway diagram which shows the key processes involved in such an outcome (Mummolo 1997). PERT modelling makes a number of assumptions and has many conventions. In drafting a PERT chart the processes will be numbered in tens, to allow for further additions as the model grows. Further the model assumes that there is a linear relationship between the processes and therefore a number of key relationships (critical pathways) are determined (Cox 1995). These are often termed predecessor events and successor events. The PERT model deals with time in a number of ways giving an optimistic time and a pessimistic time for the completion of a process. It allows managers to view a project, task or process in a way which will help to maximise the efficiency of such a task in terms of a number of variables (Shipley, de Korvin et al. 1997).
Implementation of PERT requires a significant investment of time and expertise and so can have an impact on the costs of an activity, which must be weighed with the advantages or benefits such analysis brings to the process redesign (Azaron, Katagiri et al. 2006). Often PERT is a useful way to implement ‘Lean’ techniques of production as it allows the mapping of existing processes to look for ‘slack’ in the system. But its complexity can also be a disadvantage in terms of the time it takes to complete and the risk of errors in the model having unintended consequences to any new or redesigned process (Azaron, Katagiri et al. 2006).
PERT is most useful at outlining the dependencies of a process and the identification of the critical pathways which affect the outcomes of a process. Further the methodology allows for the identification of the benefits of early, late and slack starts or a process (Cox 1995). It is also a way of organising a large and complex amount of information I a way which is relatively easy to understand by non-specialist managers, and as such allows the input of many areas of speciality in the redesign process, some of which may not be heard in terms of purely operations or accounting systems such as JIT and TOC.
Yet PERT can have a number of significant disadvantages when used. First and foremost is the possibility of thousands of critical and interrelated aspect of a singly process (Mummolo 1997). The time taken to map out all of them can be considerable and even if they are all mapped out the subtle interrelationships are often difficult to place into such a restrictive framework. It is a given that in real life the process will not always work in the way in which it is modelled, and small changes across a few key aspects can vastly change the outcomes and behaviours of many of the assumptions behind PERT analysis. PERT is very useful in terms of initial investigation of a process or event, but it takes both art and science to appreciate how something will work in the real world situations of manufacturing or service industries. In this respect PERT should be seen only as an aid to understanding and not a ‘right’ answer (Castro, Gómez et al. 2008).
The three managerial tools which have been outlined in this report are all powerful providers of decision relevant information. Further all three allow the management to view not only the outcomes at the current time, but also to make significant changes to the processes of production or provision of services which can dramatically improve performance. The case given points to both poor profits and returns on investment and poor inventory management as problems for the company, as such it is important before any decisions are made about the implementation of new management practices, as to why these are occurring. If the drop in profits are due to a slackening of demand, a change to JIT and the attendant redesign of the business along ‘Lean’ philosophy may be significantly advantageous, as it will allow tight control over inventory and allow the company to respond to the needs of the market more effectively. By removing overproduction and inventory as wastes to the business, profits would be expected to recover, as long as the business is still a going concern (Hansen, Mouritsen 2006).
If, however, the company still has similar levels of demand for its products then the company will need to investigate where the problems in the existing processes are. TOC would be one way of looking at this problem, so too would JIT. It is felt if the levels of demand are broadly similar it may well be worth the management of the company undertaking some analysis of the business processes with a view to coming to a decision about the suitability of either TOC or JIT, but it must be appreciated that each of these approaches carry some significant costs and risk if the analysis is not well thought out. PERT analysis will map out the internal process and identify the various problems with slack and time, but it does not look in much detail at costs. Other methodologies the company may like to consider as a part of any process redesign are the Activity Based approaches to costing, management and budgeting, these fit well with JIT management, but not so well with TOC. TOC has significant limitations because it subordinates everything to the constraint, and as new constraints appear the process has to be restarted from scratch. This criticism also gives it the flexibility that the other systems mentioned herein do not possess. This report recommends that managers identify the reason for the falling profits, and look to find out why inventory is building up (are these a symptom of slack demand, or of inefficiencies within the business). Based on these findings a decision as to what further systems are needed can be made.
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