Appraisal costs in the order to delivery process

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Appraisal costs in the order to delivery process

A single case study of the car manufacturing plant Pininfarina Sverige A.B.

By

LIESBETH BLOEMENDAL

University of Groningen

Faculty of Economics and Business

Msc International Business & Management – International Financial Management

University of Uppsala

Department of Business Studies

Msc Business and Economics

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Appraisal costs in the order to delivery process

A single case study of the car manufacturing plant Pininfarina Sverige A.B.

Uddevalla, 17 January 2008

Author : Liesbeth Bloemendal

Organization : Pininfarina Sverige A.B. Uddevalla, Sweden

Mentor : B. Fredholm

Supervisors: Mr. dr. J. Lindvall

University of Uppsala, Department of Business Studies

Mr. dr. F. Becker-Ritterspach

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Abstract

The purpose of the research is to give insight in how the appraisal activities in the order to delivery process of Pininfarina Sverige A.B. can be identified and measured. The research was performed by a single case study. The research indicated that the appraisal costs can be identified by the process view of ABC and the appraisal costs can be measured by the Time Driven ABC model.

Keywords : quality cost measurement, appraisal costs, process view of ABC, Time Driven ABC model.

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Abbreviations

FASP Final Assembly shop repair

FC Factory Complete

FROK First Run OK

HR Human Resources

IT Information Technology

NOK Not OK

OK OK

ÖV 4 Övrig 4

P-A-F Prevention Appraisal Failure

PFS Pininfarina Sverige A.B.

TDABC Time Driven Activity Based Costing

TWR Tom Walkinshaw Racing

UC Uddevalla C shop

VCC Volvo Car Corporation

VTJ Vatten Test Justering

VPJ Vägprov Justering

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1. Background Pininfarina Sverige A.B.

1.1 Introduction

This chapter describes the car manufacturing plant Pininfarina Sverige A.B. First, the history of this car manufacturing plant is given. Second, the different shops and the car which is produced at this car manufacturing plant are mentioned. Finally, the essential figures are illustrated.

1.2 History of Pininfarina Sverige A.B.

Volvo founded a car manufacturing plant in 1985. It was considered as a special project where a more humanized approach was implemented. A joint venture named Autonova was formed between Volvo and British TWR in 1995. (Ellegard, 1996)

Before the closure of the Volvo plant the manufacturing plant was characterized with a parallel product flow pattern. When the production restarted in 1995 the assembly line could be described as a semi parallel product flow pattern. The assembly line contained two chronological product flow assembly substructures in two separate workshops. During the production the cars were transported between the workshops with a parallel product flow. A new company was established as a joint venture in 2003 and the car manufacturing plant was named Pininfarina Sverige A.B. (PFS). Pininfarina owns 60 percent and Volvo Car Corporation (VCC) is the minority owner with 40 percent. The car manufacturing plant produces the Volvo C70. The styling is done by Volvo and Pininfarina is occupied with the engineering. Pininfarina contributed to the change of the semi parallel product flow pattern to the assembly line approach. (Pininfarina, 2007) In 2002 the assembly methods were reorganized and a traditional assembly line was introduced. (Johnsson et al., 2004)

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1.3 Body, paint, final assembly and material shop

The car manufacturing plant has a body, paint and final assembly shop. The shops are being supplied with material by the material shop. The body shop is operated with a flow structure and the welding is done manually and mechanically (robots). In the paint shop two of the three paint layers are sprayed manually on the bodies. In 2002 the final assembly shop was installed with a line structure compared to the previous parallel production flow. The final assembly is divided in four areas where around 30 persons per area are working. Pininfarina supported the transformation of a 'satellite' type system to a conventional production line. The material shop deals with the incoming material and delivers the right material at the right place in the manufacturing plant. (VCC Intranet, 2007)

1.4 Volvo C 70

PFS produces the Volvo C 70. The design of this car is defined by Volvo Car Corporation. Pininfarina executed the engineering phases at the car manufacturing plant of Pininfarina in Turin. The product and process engineering was performed during these phases. The manufacturing plant in Uddevalla takes care of the production of the Volvo C 70. The Volvo C 70 is an exclusive car with a three part fully retractable hard top. The car is sold on all markets around the world. However, the USA is responsible for 50 % of the total sales.

1.5 Essential figures

In 2007 PFS has a total of 800 employees, of which 35 % is women.

In the following table can be seen the number of produced Volvo C 70. For the year 2007 the objective is to produce 20.000 cars.

Year Number of cars produced 2004 7.148

2005 1.150 2006 17.000 2007 20.000

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2. Research Framework

2.1 Introduction

This research framework will give an overview of the research performed during the internship at Pininfarina Sverige A.B. (PFS) in Uddevalla, Sweden. This research will be a case study concerning the appraisal costs in the order to delivery process of PFS. The aim of the research is to identify these appraisal activities and to find a way how the costs of these activities can be measured.

2.2 Background

The order to delivery process of the manufacturing plant consists of the order- and production planning, material supply, body shop, paint shop and final assembly shop. This process is perceived as the main process of the plant. Furthermore, there are the management processes and the support processes, such as the departments Engineering, Finance, Quality & Environment, Maintenance, HR and IT. (VCC Intranet, 2007) In the competitive automobile industry it is essential that the manufacturing plant recognizes the importance of quality. Therefore, PFS has for example quality inspections and tests in the main processes. Furthermore, after the production every car is tested and inspected in detail before delivery to the customer. (VCC Intranet, 2007)

According to Schiffauerova and Thomson (2006) various companies regard quality as an important success factor to attain competitiveness. Therefore, different activities need to be performed in the companies to guarantee that a certain quality level is achieved. However, it needs to be taken into account that these activities to guarantee quality can be associated with costs.

2.3 Problem indication

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prevention and on doing any activity properly the first time, it will allow the company to achieve both objectives at the same time. (Groocock, 1974)

PFS has done a pre-study concerning quality costs in the order to delivery process. The cost of quality model of Feigenbaum has been used to identify the different quality costs. The model of Feigenbaum is named P-A-F model, which refers to prevention, appraisal and failure costs. Prevention costs can be seen as expenses necessary in order to avoid defects from taking place. Appraisal costs are evaluations needed for upholding quality levels set by the company. Failure costs are expenses needed due to imperfect products that do not guarantee the quality specifications set by the company. (Feigenbaum, 1956)

The results of the pre study showed that the amount of internal failure costs are high and that the prevention and appraisal costs are low compared to the internal failure costs.

The relationship between appraisal and failure costs has been described by Porter and Rayner (1992). It is suggested that increasing the appraisal costs will have a decreasing effect on the failure costs. An optimum quality costs level can be seen where beyond this point further investment in appraisal costs will not have this decreasing effect.

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2.4 Research objective and question

According to De Leeuw (1996) the problem indication can be supported by reporting the research objective, the main question and the delimitations. In this section the research objective and question are given.

Research objective

A car manufacturer has to perform certain activities in order to guarantee the quality requirements which are set by the company and expected by the customer. For a car manufacturer, it is therefore important that the various activities with the aim of assuring this quality are identified. This will increase the possibility to implement quality improvement strategies which might lead to lower total quality costs.

The objective of this research is to indicate how appraisal costs in the order to delivery process of PFS can be identified and measured, which allow PFS to create quality improvement strategies.

Main research question

This research extends previous research on quality costing in a manufacturing plant. This research presents an initial possibility to examine the appraisal activities in the order to delivery process of PFS. Given the importance of quality costs in the order to delivery process of PFS, the following research question has been developed: How can the appraisal activities in the order to delivery process of PFS be identified and the costs of these activities be measured?

Research delimitations

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2.5 Sub questions

In order to obtain an answer on the main research question several sub questions have to be formulated. The sub questions will structure the research and create different phases in the research. By answering the sub questions the main research question will be answered as well.

1. Which cost of quality models can be found in literature?

The different cost of quality models can give insight in how appraisal costs can be identified. In the literature different researchers described several cost of quality models. The different models might give insight in the different quality costs and their definitions. The definitions used in the literature can give insight in the different quality costs in the order to delivery process of PFS.

2. Which activities in the order to delivery process of PFS can be identified as appraisal activity and why are these activities being performed?

The definitions of quality costs will be combined with the different appraisal activities which are performed in the order to delivery process of PFS. This will help in categorizing the different activities.

3. Which resources do the appraisal activities in the after process of PFS utilize?

The appraisal activities use different resources. These resources are e.g. people, machines and equipment. The resources have to be classified, before they can be allocated.

4. How can PFS quantify these resources in order to allocate them to costs?

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2.6 Label, theoretical idea, conceptual models

Label: Quality costs

Key words theoretical idea: cost of quality, prevention costs, appraisal costs, failure costs, order to delivery process and quality cost measurement

Conceptual models:

A division can be made between a research model and a conceptual model. A research model gives an overview of the process of the complete research. The conceptual model provides an indication in which way the different concepts used are linked together and presents a comprehensive understanding of the contents of the research.

In the conceptual model the P-A-F model of Feigenbaum is presented. The reason for including the model in the conceptual model is because PFS has used the P-A-F model in order to categorize the quality costs in the order to delivery process. This research is focused on the appraisal costs in the order to delivery process; therefore prevention and failure are indicated differently. However, the categories are mentioned with the purpose of having a complete overview.

Research model

Figure 2.1: Research model (Source: Bloemendal, 2007)

Identify appraisal activities

Material shop Body shop Paint shop Final

assembly shop

Appoint resources

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Conceptual model

Figure 2.2: Conceptual model (Source: Bloemendal, 2007)

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2.7 Preview of the organization of the paper

This report starts with the background of the company used in the single case study. Second, the research framework which provides an overview of the study performed is described. In the third chapter the methodology of this research is mentioned. The fourth chapter provides a theoretical background, where the different quality cost models are described. Moreover; this chapter illustrates the process view of ABC and the Time Driven ABC model which are used in chapter five and six respectively.

Chapter five deals with the appraisal activities in the order to delivery process and the costs of the appraisal activities in the after process are calculated in chapter six. The final chapter provides the conclusion of this research. Furthermore, a discussion of the research and suggestions for further research are presented.

Figure 2.3: Preview of the organization of the paper (Source: Bloemendal, 2007)

How can the appraisal activities in the Order to Delivery process of PFS be identified and the costs of these activities be measured?

Evaluation of Cost of Quality models Chapter 4

Appraisal activities in the Order to Delivery process Chapter 5

Appraisal activities in the after process Chapter 6

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3. Research Methodology

3.1 Introduction

This chapter describes the methodology used in this research. First, the research strategy in general is described. Second, the operationalization of the research questions is explained. Furthermore, the practical methods used in this research are given. Finally, the validity and reliability issues are described.

3.2 Research strategy

A single case study

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Therefore, examining the appraisal costs of this specific order to delivery process can be seen as a single case study. Furthermore, this research can be classified as an illustration in which a theoretical view is used as a basis for real examples.

Research case selection

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Theory building or testing approach

The following two types of research approaches are described in this section theory building and theory testing research. Eisenhardt and Graebner (2007) argue that when the research strategy is used that theory is built from cases, it should be justified why this approach is used to answer the research question. (Eisenhardt & Graebner, 2007) This research uses a theory building research approach due to the following reasons. First, the definitions used for the different categories of quality costs might be suggested by literature. However, Sörqvist (1998) argues that every company deals differently with the definitions and should not be compared with each other. Second, this research tries to understand the appraisal activities of this particular order to delivery process of PFS. The appraisal activities in this process have not been identified. Therefore, the answers cannot be found in theory. Furthermore, this research examines why and how the appraisal activities take place. Although, suggestions concerning this topic are being made in other studies, these might not be applicable in this particular situation. (Sörqvist, 1998) The literature suggests several quality cost models, which are being presented in the theoretical framework. In this research the TDABC model is being applied on the appraisal activities in the production process. This study provides insight in the activities on a detailed level and investigates the reasons why the appraisal activities occur in a car manufacturing plant. This research suggests potential shortcomings of the model used in this specific context.

Eisenhardt & Graebner (2007) argue that when the objective of the research is to develop theory, theoretical sampling can be applied. Theoretical sampling refers to cases being selected because they are appropriate for expanding associations and sense among constructs. According to Eisenhardt & Graebner (2007) theoretical sampling of single cases is straightforward. Frequently they are selected because they are unusual, rare examples or there are opportunities for unusual research access. The latter holds for this research, since there is given the opportunity to study the appraisal activities of the order to delivery process at PFS. Data collection methods: ethnography

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(2002) indicates that there are four field roles in ethnography. The field roles are complete participant, complete observer, observer-as-participant and participant-as-observer. These can be found in the figure.

Figure 3.1: field roles in ethnography (Source: Gill and Johnson, 2002)

A division can be made between participant observation and non participant observation. In participant observation the researcher takes part of the activities of the subjects and shares experiences by not only observations, however also obtaining the feeling. Furthermore, this approach allows insight into what the persons actually do (informal organization) in stead of what is told they should do (formal organization). Participant observation might be the necessary method in order to understand what is really taking place. (Gill and Johnson, 2002) A risk of participant observation is that the researcher become part of the setting and can no longer hold an objective view.

Non participant observation has the disadvantage that the researcher is not interacting and does not take part of the activities. Therefore, the researcher might not understand why certain activities take place. A benefit of the non participant observation is that the presence of the researcher does not lead to disturbances of the daily activities and might not change the normal behaviour.

Overt observation points to the subjects being aware of the presence of the observer and knowing why the researcher is present. It is disputed that persons being observed might react differently compared to how they perform the activities in a natural situation. It is therefore argued that the ecological validity is decreased if overt observation is being used. Covert observation means that the operators are unaware of the presence of the researcher. The

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advantage of this approach is that the operators perform the activities as in a natural situation. This will increase the ecological validity. However, the disadvantage might be that the researcher does not understand what the reasons are behind certain activities.

The importance in this research is to understand what activities the workers perform and why they are doing these activities. Furthermore, it is important to see how much time is necessary for the activities. This research had an overt approach, which indicates that the workers were aware that they were being observed. The reason for this approach was because they had to answer questions during the observations. Furthermore, the role as spectator was used. The observations took place by following the workers during their work activities. During the observations the time in minutes was calculated by the researcher. A risk of the observation approach used is that the operators might show a different behaviour compared to their daily work activities. It might be that they work faster or more accurate. The solution for this situation is to observe different operators doing the same work activity and obtain a more precise estimation of the time in minutes of the activities. The work activities performed by the operators are more or less standardized and it is assumed that the operators execute the activities using the same method.

Qualitative data

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3.3 Operationalization of the subquestions

The table gives an overview of the different data collection methods.

Sub questions Data sources

1. Which cost of quality models are discussed in literature? Literature study 2. Which activities in the O-to-D process of PFS can be identified as appraisal

activity and why are these activities being performed? Observations Interviews Intranet VCC 3. Which resources do the appraisal activities in the after process of PFS utilize? Observations

Interviews Intranet VCC 4. How can PFS quantify these resources in order to allocate them to costs? Literature study

Table 3.1: sub questions and data sources (Source: Bloemendal, 2007)

The research comprises two parts. The first part is based on a secondary data and the second part is primarily based on primary data. The main research question is answered by four sub questions. The first question deals with different quality cost models which can be found in literature. Although, the P-A-F model is used universally and in PFS, there are other quality cost models described in the literature. All these models provide different definitions to the cost of quality. It is necessary that these models are reviewed in order to comprehend the differences between these quality cost models. Based on the literature study it is needed that different categorizations are defined which can be used in PFS. A definition which can be understood by all employees will simplify the identification and categorization of the different activities. Questions two and three are answered by primary data.

Furthermore, secondary data are used by the intranet of Volvo Car Corporation and literature in order to support the primary data. The following persons within PFS were interviewed. Koen Dubois, who is responsible for the manufacturing was interviewed during a visit in the manufacturing plant. He was asked to give insight in the different activities taken place within the order to delivery process. Since Koen Dubois is the responsible for the overall manufacturing process, it is suggested that interviews with the managers of the different parts of the plants were performed as well. They have more detailed information in which activities are done and the reason why these activities take place. Furthermore, these managers can give insight in the resources which these activities require. The last question deals with the allocation of the resources into costs. In order to answer this question, a literature review was performed. The end result gives PFS an indication how they can measure the costs and provides an overview of the different appraisal costs in the order to delivery process.

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First, the process flow has been followed together with the person responsible for manufacturing with the intention to acquire a clear overview. Furthermore, two days visits took place in the body, paint and final assembly shop. During these visits the quality workers, area managers and operators have been observed in their daily working activities. Furthermore, these employees were asked to give explanations considering the appraisal activities they performed.

3.4 Practical methodology

The quality costs study performed by an employee of PFS investigated the quality costs at PFS on a top level. This means that first the different quality cost categories (prevention, appraisal and failure) were identified and the different activities such as maintenance, rework, internal audit, water test were pointed to a specific cost category. The number of man hours on a yearly basis was estimated and the costs were calculated by number of man hours multiplied by the average salary for every activity.

This research uses a different approach and stresses the importance of obtaining insight in how much an activity costs if one car is undertaking an appraisal activity. If it is known what the activity unit rate is of an appraisal activity, it might support decisions on a more detailed level. For example, when it is questioned if a certain appraisal activity is really necessary for all cars, then the costs can be calculated if the activity is performed on all the cars. Moreover, it gives insight in the costs which can be saved if the number of cars being tested is decreased.

Practical problems

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Another problem refers to the absence of a clear management information system with accurate or specific data, which was needed as input for this research. For this reason, the area managers were asked for the volume drivers of the different appraisal activities. Due to the fact that data is difficult to obtain, it is needed that the area managers are interviewed often and this can be seen as a time consuming activity. Moreover, interviewing area managers by different interviewers with the intention to gather the same data might lead to different conclusions and it might provide management reports which contradict each other. In this research the problem has been considered by stating clearly the question and data needed.

Cost model

This section describes the measurements used in the TDABC model in major conditions. The cost model measures the activity unit rates, which refers to the costs of one car undertaking the activity.

Equation one: Activity unit rate

AUR = ((Ft x CT) x CTU

) + IC + SC

Ft

AUR Activity unit rate

Ft Frequency during a specific time period (volume driver)

CT Cycle time in minutes per activity performed by operator

CTU Cost of time used in minutes (cost per time unit of available capacity)

IC Indirect costs

SC Supervisor costs

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Equation two: Cost of time used

CTU = (ASBC x P) / (80 % x TCt)

ASBC Average monthly salary of a BC worker in the final assembly shop

P Number of persons working at the work station

TCt Theoretical capacity at a particular station during a specific time period

Equation three: Theoretical capacity

TCt = (WH x 60 x WDt) x P

WH Working hours per day

WDt Working days during a specific time period

Equation four: Indirect costs

IC = (ASBC x P) x 5.6 %(*)

IC Indirect costs

ASBC Average monthly salary of a BC worker in the final assembly shop

(*) The 5.6 % is a percentage used by PFS to budget the indirect costs as a percentage of the average salary costs.

Equation five: Supervisor costs

SC = PT x ASWC

SC Supervisor costs

PT Percentage time spent by supervisor on the work station

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In the TDABC the capacity used during the activities is measured as well. The calculations are illustrated in equation six and seven.

Equation six: Excess capacity

EC = (80 % x TCt) – (Ft x CT)

EC Excess capacity in minutes

Ft Frequency during a specific time period (volume driver)

CT Cycle time in minutes per activity performed by operator

Equation seven: Cost of excess capacity

CEC = EC x CTU

CEC Cost of excess capacity

EC Excess capacity in minutes

3.5 Validity and reliability

A case study needs to maximize four conditions which are associated to design quality. These are construct validity, internal validity, external validity and reliability. In order to have a clear view of the validity and reliability of this research proposal the conditions are described. Construct validity

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Internal validity

This concerns setting up a causal relationship, whereby a particular situation results in another situation. Internal validity has to be described when an explanatory or causal study is performed. (Yin, 2003) The internal validity is not relevant for this research, since neither causalities nor relationships are examined.

External validity

External validity stresses the way in which the results of a research can be generalized. Yin (2003) describes two different manners of generalization; “analytic generalization” and “statistical generalization”. Statistical generalization refers to a conclusion concerning a population which is drawn from empirical data gathered about a sample. This single case study can be seen as analytic generalization, in which a prior developed theory is applied as a model. This model can be used to evaluate and compare the empirical results of the case study. (Yin, 2003) The generalization of this research is supported by using theory in this single case study. The theory used can be found in the theoretical background.

Reliability

Reliability concerns the ability to repeat the research with for example the same data collection methods and obtain the same results. (Yin, 2003)

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4. Theoretical background

4.1 Introduction

This chapter explains the different concepts used in this research. The theoretical background should support the research by providing an abstractive structure in which the research questions can be answered. This theoretical background should provide an understanding of previous literature which might be helpful in this research.

First, the definitions of cost of quality are given. Then, this chapter gives an overview of the different cost of quality models. These costs of quality models will be compared and then the cost of quality model used in this research will be described. Furthermore a method is presented how the appraisal activities can be identified and measured.

4.2 Definition of quality costs

This section will give an overview of the different quality costs definitions used by researchers.

According to Sörqvist (1998: 30) the definition of poor quality costs can be defined as 'the

total losses caused by the products and processes of a company not being perfect.' Losses are

referred to the impact quality insufficiencies have on the income of the company. Furthermore, he mentioned examples of poor quality costs, such as poor efficiency, rejects and complaints. Another definition of poor quality costs are 'those costs associated with the

non achievement of product or service quality as defined by the requirement established by the company and its contracts with customer and society'. (Chiadamrong, 2003: 1000) This

definition also includes the effect poor quality might have on society.

Several researchers refer to quality costs in stead of poor quality costs. Several definitions of quality costs will be described as well, in order to give a complete overview. Quality costs can be defined as 'costs incurred because poor quality can exist or because poor quality does

exist'. Quality is seen as the conformance to certain creation specifications. According to this

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of a quality management system, the cost of resources committed to continuous improvement, the costs of system, product and service faults and all other necessary costs and non value added activities required to achieve a quality product or service'.

The definition of Albright and Roth (1992) include the significance of the existence of poor quality or the belief that poor quality exists. Every company might have a different view on quality, which has an effect on the quality requirements set by that specific company. It depends on the goal setting of the company. If a company considers quality as very important, it might have a zero defects policy. And this might lead to more appraisal activities in the production process in order to guarantee the quality requirements.

4.3 Cost of quality models

4.3.1 P-A-F model

Feigenbaum (1956) was the founder of the Prevention-Appraisal-Failure model. He categorized the quality cost in three groups. These are prevention, appraisal and failure costs. This model has been adopted by many researchers and is used in various companies. According to Feigenbaum (1956) prevention costs have the objective of preventing imperfections from happening at all. These costs can be seen as the costs due to design, implementation and maintenance of total quality management. The prevention costs are calculated and taken into account before the actual situation. The resources which can be included into this category can be seen as the 'costs of doing it right the first time'. (Oakland, 1993: 187)

Appraisal costs can be seen as the costs related to evaluating the product quality in order to investigate if the products meet the quality standards. These costs can be related to inspection activities and tests during the production process. (Feigenbaum, 1956) The appraisal costs are 'costs of checking it is right'. (Oakland, 1993: 188)

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delivered to the customer, for example warranty costs. The failure costs are the 'costs of getting it wrong'. (Campanella, 1999:190)

The P-A-F model suggests that increasing prevention and appraisal costs will lead to a decrease in failure costs. Furthermore, Schiffauerova and Thomson (2006) mention that additional prevention costs might decrease appraisal costs. The aim of this model is to discover the quality level that reduces the total cost of quality. (Schiffauerova and Thomson, 2006)

According to Groocock (1974) the major costs in the prevention and appraisal categories are the costs of human resources: inspectors, testers, quality engineers, test – equipment development engineers, etc. These costs are difficult to measure since these costs are overhead and not easily visible. Campanella (1999) recognizes this situation and indicates that there are frequently calculated failure costs and unseen failure costs. The frequently calculated failure costs are scrap, rework and warranty. The unseen failure costs are not easily notable and described by Campanella (1999) as the time spent by the engineering department and management, workshop downtime, enlarged inventory, reduced capacity, delivery problems and lost orders.

4.3.2 Opportunity cost model

This model focuses on the intangible and opportunity costs. Intangible costs are the costs which are difficult to assess for example the loss of customers. Moen (1998) argues that the intangible costs contain the costs of customer dissatisfaction and the loss of reputation costs. These costs can be loss of sales due to poor experience with the product; lost revenues from potential buyers of the product due to poor quality and the estimation of the lost sales due to the loss of an existing buyer. (Moen, 1998) Opportunity costs consist of the following elements: under exploitation of capacity, poor material handling and insufficient delivery of service. In this model the quality costs are categorized as the cost of conformance, the cost of non conformance and the cost of lost opportunity. (Schiffauerova and Thomson, 2006)

4.3.3 Process cost model

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non conformance. The cost of conformance is the cost of offering products with certain standards by a particular process in a completely effective way. These costs are needed to realize a product without failures which suits the needs of the customer. (Campanella, 1999) The cost of nonconformance is described as the cost of wasted time, equipment and capacity related with the process in the reception, manufacturing, shipment and improvement of inadequate products. These are the costs due to a failure in the current process. The cost of non conformance can be seen as scrap and rework.

In order to use the process cost approach it is necessary to understand the whole process. Hwang & Aspinwall (1996) argue that this approach can be used in manufacturing industries and be applied to improve a process characterized with high non conformance costs by enlarging prevention costs or with extreme conformance costs. (Hwang & Aspinwall, 1996) The process cost approach includes the cost of conformance; prevention, appraisal and the common manufacturing costs of the production process. This is in contrary to the quality costing approach (e.g. P-A-F model) which only examines the costs of guaranteeing quality (the prevention and appraisal costs). (Campanella, 1999)

4.3.4 ABC model

Tsai (1998) mentioned that it is difficult to do quality measurements with the help of traditional accounting systems. The reason for this is because traditional accounting systems are based on expenses rather than activities. There is no method which indicates how overhead costs can be allocated to costs of quality components. Furthermore, there is no right method to outline quality cost to their sources. The ABC model is not a cost of quality model; however it is a method for managers to manage the cost of quality. An ABC model has the objective to abolish the non value added activities and to improve processes and quality so that fewer defects are manufactured. (Tsai, 1998)

4.3.5 Choice of cost of quality model for this research

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should be noted that the content and significance of conformance and non conformance costs of the P-A-F model might differ from the process cost approach. The ABC model sees the prevention costs in the P-A-F model and some of the conformance costs in the process cost approach as value added.

According to Tsai (1998) the cost of non conformance seen through the P-A-F model or the process cost model will decrease by increasing the expenditures on prevention activities. In the process cost model this would mean redesigning the process. (Tsai, 1998)

The different models described above give insight in the costs of activities and processes; however the ABC model provides more information concerning why inspection activities are used and which resources are allocated to these activities.

Tsai (1998) suggest that the P-A-F model or the process cost model should be integrated in the building blocks of the ABC model. The cost of quality models give no specific method how to allocate overheads neither indicate how quality costs can be outlined to their causes. According to Tsai (1998) this issue can be solved by combining the P-A-F model or the process cost model with the ABC model.

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4.4 Process view of ABC

In this section will be explained the method used in order to answer the question why inspection activities are being performed in the production process of PFS. The method used to answer the question is the process view of ABC. The process view of ABC is used because it might give insight in the root causes of activities and possible opportunities of improvement.

ABC model: two views

The ABC model is a method which is developed based on the shortcomings of traditional cost accounting. Tsai (1998) mentioned that in the current manufacturing environment the overhead costs have increased due to automation and computerization. The overhead costs might vary between different products manufactured. Therefore traditional cost accounting might lead to over costing of high volume products and under costing of low volume products. To overcome this problem the ABC model is introduced and two views can be seen: cost assignment view and process view. (Tsai, 1998) The cost assignment view presumes that cost objects (e.g. products, markets) generate the need for activities. The activities generate the need for resources. This view utilizes a two stage procedure to point resource costs to cost objects. First, resource costs are allocated to diverse activities by resource drivers. Every resource type specified to an activity turns into a cost component of an activity cost pool. These are the total costs which are related to an activity. An activity center consists of connected activities, which are grouped by process or function. In the second phase, every activity cost pool is allocated to cost objects by utilizing an adequate activity driver which has the function to measure the spending of activities by cost objects. For example if the cost object is a product, then the total cost of that particular product can be estimated by summing up the costs of several activities allocated to that particular product. The unit cost of the product is achieved by dividing the entire costs by the amount of the product. (Tsai, 1998)

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variables which can be used to explain the behavior of activity costs. Tsai (1998) argues that one activity might have several cost drivers. Performance measures specify the work effort of the activity executed and the results which are accomplished in the activity. They indicate how well the activity meets the requirements of the internal customers. There are five components of the performance of an activity. These are the quality of the work performed, the productivity of the activity, the cycle time necessary to perform the activity, the allocated costs and the customer fulfillment. (Tsai, 1998) The process view of ABC focuses on processes. A process can be defined as a number of activities that are related to achieve a particular aim. Due to the interrelation between the activities in a process, the work performed at one activity might have effect on the performance of another activity in the process. It can be that performance measurements from one activity might become cost drivers for another activity. For example defected material due to poor quality of the supplier might have an impact on the inspection activities by the operator on the production line. The operators might identify that the material is defect and cannot be assembled on the car. The operator needs to report this defect in the computer, so the defects will be repaired at the repair area. The defected material leads to increased work at the repair areas.

The ABC model divides the activities in value added or non value added activities. Value added activities can be defined as an activity which adds to the customer value or if it suits an organizational need. If this is not the case the activity can be seen as non value added and should be seen as an improvement opportunity. (Tsai, 1998) The value added activities need to be developed even further. Liker (2004) mentions the methods used by the Toyota Company to describe the value of the activities. In his view the activities can be divided into the following three categories: value added, which refers to the concrete transformation process necessary to produce a product or service; non value added, which indicates the real waste such as rework and non value added, but required, which denotes the activities which are necessary in the current situation, however which do not add value for the clients. These activities are for example inspections and tests. (Liker, 2004)

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Gathering information

In order to obtain an insight in the process view of the ABC model, the following steps should be performed to gather information. (Tesselhof, 2003)

1. Identify the appraisal activities in the order to delivery process

The identification of the appraisal activities is realized by the process flow maps of PFS and interviewing the managers of the different shops.

2. Identify the performance measures in the order to delivery process

The performance measures in the process are identified by interviewing the managers of the different shops.

3. Identify the cost drivers that determine the work load

The cost drivers that determine the work load are recognized by interviewing the managers of the different shops.

4.5 Time Driven Activity Based Costing

This section will describe the method used in order to answer the question how appraisal activities can be measured in the production process of PFS. The methodology used to answer the question is Time Driven Activity Based Costing.

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by permitting unit times to be calculated for difficult transactions. (Kaplan & Anderson, 2004) The steps which need to be performed in TDABC approach are described underneath. Step 1: Estimating the cost per time unit of capacity

The first step consists of calculating the practical capacity of the available resources. It is proposed that the available practical capacity is 80 – 85 % of the theoretical capacity. The practical capacity for workers is 20 % lower than the theoretical capacity where the time spent on pauses, arrival and departure, communication and education is taken into account. If the capacity is calculated for machines then the theoretical and practical capacity might differ 15 %. This difference can be explained by maintenance, line stops and repairs.

Another approach to measure practical capacity is to examine the month with the highest number of a certain activity with the lowest hold-ups, bad quality or overtime. It needs to be stressed that the practical capacity is an approximation and the progression of operating the TDABC system will reveal the errors sooner or later. (Kaplan & Anderson, 2004)

An example of estimating the cost per time unit of capacity is given underneath.

At a certain department are working 4 employees, 20 days a month and 7 hours a day. The department deals with 5,000 applications and 1,000 late payments per month. The practical capacity is 90 % in this example. The time available in minutes can be calculated by (4 x 20 x 7 x 60) x 90 % = 30,240. The direct costs are $16,800 per month. The cost per time unit of capacity is $16,800 / 30,240 = $0.555. (Barrett, 2007)

Step 2: Estimating the unit times of activities

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Process Applications Chase Late Payments Total

Volume driver 5,000 1,000

Cycle time (min) 4,00 10,00

Total time used (4 x 5,000)

20,000 (10 x 1,000) 10,000 30,000 Cost of time used (20,000 x $0.555)

$11,100 (10,000 x $0.555) $5,550 $16,650 Supervisor costs ($5,600 x 60% x 60%)

$2,016 ($5,600 x 60% x 40%) $1,344 $3,360 Indirect costs ($4,200 x 30%)

$1,260 ($4,200 x 70%) $2,940 $4,200 Total activity cost ($11,100+$2,016+$1,260)

$14,376 ($5,500+$1,344+$2,940) $9,834 $24,210 Activity unit rate ($14,376/5,000)

$2.88 ($9,834/1,000) $9.83

Excess capacity (min) (30,240 – 30,000)

240

Costs of excess capacity (240 x $0.555)

$133

Table 4.1: calculations TDABC approach (Source: Barrett, 2007)

Step 3: Assigning indirect and supervisor costs

The supervisor uses 60 % of her time on managing the department. The costs of the supervisor are $5,600. The time spent of the supervisor on process applications is 60 % and the other activity late payments take 40 % of her time. Furthermore, $4,200 indirect costs, such as services and IT, are allocated to this department. The indirect costs are allocated to the activities derived from the resources they use. In this example, late payments are allocated 70% of the costs and 30% on the activity process application.

Step 4: Deriving cost driver rates

The cost driver rates (activity unit rate) can be calculated by dividing the total activity cost by the volume driver. In the example the cost driver rates are $2.88 and $9.83. It is suggested that these cost driver rates can be helpful in assigning costs to transactions.

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Step 5: Analyzing and reporting costs

TDABC facilitates to state the costs in a manner that shows the costs of the activities and the time spent on the activities. The figure illustrates as well that the excess capacity has been calculated and the costs of this excess capacity. Therefore the TDABC also gives insight in the efficiency of the process.

Strengths and Weaknesses of the TDABC approach

The strength of this approach is that it makes visible the dissimilarities between the total amount of time needed to perform activities in a cost center and the actual amount of time accessible given present resources.

The TDABC approach also has some weaknesses. First, the time spent on an activity has to be accurate. For example if a phone call takes 4 minutes in stead of 4 minutes and 10 seconds, it might lead to a large difference when a volume is calculated of 100,000 calls. The second weakness is that there might be variances in duration drivers (the measurements of the time necessary to complete the activity). For example, a more complex call might need eight instead of four minutes. This call has to be charged differently. When duration drivers are obtainable for single transactions, the TDABC approach can be applied to determine a distinctive cost for each particular situation.

Aggregation, task coherence and time notification

This section stresses the measurement errors in time driven costing design and how these errors have been taken into account in this research. Cardinaels and Labro (2006) mentioned that the new method time driven ABC model is affected by errors which occur when workers have to estimate the time spend on activities. (Cardinaels and Labro, 2006)

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A coherent task means that the activities are being performed in a structured order. For example, an operator on the assembly line executes the job the same way in a predetermined cycle time. An incoherent task refers to activities which are presented in a spontaneous manner. For example, the repairs which have to be done at the repair areas might differ for every car. A repair area might have more than hundred different kinds of repairs. These repairs differ in time necessary to perform the repair. Other factors which influence the time necessary are the waiting time for material orders delivered by the logistic department. (Cardinaels and Labro, 2006) This research deals with the appraisal activities. These activities are being executed in a structured order and therefore are less affected by measurement error. The reason for this is because they are more accurately estimated by the operators and easier to observe.

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5. Appraisal activities in the order to delivery process

5.1 Introduction

This chapter gives an overview of the appraisal activities in the main process of PFS. The appraisal activities which are presented in this chapter can be seen as the costs of checking it is right. This means that the activities are being performed to see if the delivered products are according to the quality requirements. In order to obtain an understanding of the reason why appraisal activities are performed in the main process the process view of ABC is applied. A clear view of the situation has been acquired by observations on the shop floor and interviewing shop managers and several persons responsible for quality. This chapter should give the reader an introduction on the following chapter were the process from when the car comes off line until it is recognized as factory complete is described more thoroughly. This chapter introduces the appraisal activities in the process before the car comes off line. The flow charts of the order to delivery process can be found in the appendices.

5.2 Material shop

The logistic process consists of three parts. First, PFS calls to the supplier and orders material. The supplier controls the material, gives a pre advice with the part number, quantity and dispatch note number and sends the goods to PFS. The second part begins when the material arrives at PFS and the advice of the supplier is examined (part number, quantity and dispatch note number). At that time the material is received at goods receiving and the material is in stock at PFS. The third part of the logistic process can be seen as the internal logistics. This part includes organization of material in buffers (next to the lines), picking of material, sequence material, pre assembly and the delivery of material or feeding the line with material. (Interview H. Eriksson, 2007)

Cost drivers Activities Performance measures

Incorrect parts and dispatch note

Quality process supplier Identify incoming material per collie Number of corresponding invoices related to dispatch note Up to date stock level

Quality process supplier Quality process PFS Customer demand

Control inventory Deviations (+/- zero) Number of missing parts

Number of cable harnesses Scanning cable harnesses Number of right cables

Number of labels Scanning labels (100 % in process) Number of wrongly picked parts

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Identification incoming material

Every collie is being inspected, because it needs to be verified that the number of parts and the dispatch note are correct. This activity should give insight if the dispatch note corresponds to the incoming material and if there is a deviation it should be recognized. During this activity the incoming material is given an address which points out if the parts need to go to the buffers next to the assembly line or if it should go in stock. The cost driver of this inspection activity is the number of incorrect parts compared to the dispatch notes, which refers to the quality of the internal production process of the supplier. The performance measure is the number of correct parts compared to the dispatch notes. (Interview H. Eriksson, 2007)

Control inventory

An inventory check occurs if it has been seen that the incoming material is different compared to the order or if it is not according to the requirements three times by the same supplier. Then there is a control on the quantity of the incoming material which is performed by the inventory controllers. This is a control which is performed if it is suspected that there is not always a correct quality of the supplier. The deviations in the stock are the trigger to perform these inspection activities. The control is done to be sure that the suppliers are not held responsible for something which has not been their fault. (Interview H. Eriksson, 2007) The deviations are investigated to see what has happened. A deviation example can be that some wind screens are missing. For example the workers have changed the wind screen of several cars and it had not been registered in the system. Then there is a deviation in the stock. Ford Motor Company and Volvo Car Corporation demand that the inventory is controlled and it should not be done by the same person (counting and administration). Furthermore, the inventory is controlled to avoid line stop. This might happen if there are parts which should be in the inventory but are in fact absent. The cost driver is the quality of the internal process of the supplier and the internal process of PFS. The latter refers to the material being used, however not being reported in the inventory system. The performance measure is the number of parts missing. (Interview H. Eriksson, 2007)

Scanning cable harnesses

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specific equipment is used to make sure that the right material is being assembled on the right car. The cable harnesses with material are in sequence and related to specific cars. The scanning of the cable harnesses can be seen as an inspection activity in order to secure a faultless internal process. The cost driver is the number of cable harnesses and the performance measure is the number of faults identified. (Interview H. Eriksson, 2007)

Scanning labels

Picking is an activity where specific parts and material are being put on a car or in a box. These material and parts are picked for a specific car. The scanning activity of the labels is a 100 % in process check and is being performed to guarantee a perfect internal process. The scanning activity is a 100 % inspection activity. The cost driver is the number of labels and the performance measure is the number of wrongly picked parts. (Interview H. Eriksson, 2007)

Conclusion material shop

The appraisal activities of the material shop concern the quality of the internal process of the supplier and the internal process of PFS. The standard inspections are performed on the quantity of the material. The quality of the incoming material is not inspected since PFS assumes that the material quality of the supplier is according to the requirements. The activities scanning cable harnesses and scanning labels are related to the non standardized cars being assembled at PFS. This refers to the fact that every car is being built according to the end customer demands.

5.3 Body shop

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Table 5.2: overview cost drivers and performance measures body shop (Source: Interview J. Skoogh, 2007)

Geometric measurement

At this inspection point the geometric measurements are being performed on about twelve bodies a week. These bodies are taken out of the process after the 10, 20, 40 and 50 lines. When the body is taken out later in the process, more time is needed to complete the geometric measurements. A geometric measurement means that the distance between different parts and for example the holes are being measured. If the inspector sees that the distance is not according to the requirements, than a technical analyzer is asked to examine the results of the geometric measurement. When an operator sees that a body might have a problem due to a fault on the line, the body can have an extra inspection by the geometric measurement. The geometric measurement investigates the quality of the internal process of the body shop. The cost driver is the number of bodies being inspected and the performance measurement is the number of faults being identified. (Interview J. Skoogh, 2007)

Check after line 20, 30-40

After line 20 the quality worker is performing a check and sees if the robots and operators have done their job correctly. If a fault is seen the quality worker gives feedback to the operator or checks the robot. Furthermore, it is examined if other bodies have the same fault. During the check a chisel test is performed. This means that it is checked manually with a hammer if the strength of the welding is according to the requirements. The chisel test is a customer demand of Volvo Car Corporation. After line 30-40 the quality worker inspects if the glue and several welding spots are according to the standards. If the operators made a mistake or forgot something, it is being reported to the quality worker or the area manager. In this case the body will be repaired off line or at the end of line 50, which is the end of the internal process of the body shop. The cost drivers of the inspection activities are the quality

Cost drivers Activities Performance measures

Number of inspected bodies Geometric measurement Number of faults identified Number of inspections

Quality internal process Check after line 20, 30-40 Number of faults identified Quality internal process

Customer demand Tear down testing Quality of welding Quality internal process

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of the internal process and the number of bodies checked. The performance measure is the number of defects identified. (Interview J. Skoogh, 2007)

Internal audit

Three bodies a day are being inspected by the internal auditors. This inspection is done on a body which has gone through the whole process of the body shop. The inspection activity focuses on faults and defects caused by robots or operators. The internal audit is necessary due to the internal process of the body shop not being perfect. The results of the internal audit are being discussed by the workers which are responsible for quality and the area managers. If a defect is being identified, the other bodies on the line are inspected as well to see if the same defect occurred on these bodies. The cost driver is the quality of the internal process and the number of bodies being inspected. The performance measure is the number of defects and mistakes identified. (Interview J. Skoogh, 2007)

Tear down testing

This inspection activity occurs five times a year and is done by the maintenance department. The body is pulled apart and it is being inspected if the welding is strong enough. The quality of the internal process, which refers to the welding process, is being inspected. The tear down testing is a customer demand of Volvo Car Corporation. Therefore the cost driver is the customer demand and the number of bodies being pulled apart. The performance measure is the quality of the welding process. (Interview J. Skoogh, 2007)

Inspection first station line 50

The first station on line 50 inspects if the robots have missed any welding spots. Furthermore, the manually welding of line 40 is examined to see if any defects occurred. The robot always places the welding spots on the same spot, however it might be that the parts are different and this leads to defects. The manually welding is examined because operators might make mistakes. The cost driver of this inspection is the quality of the internal process and the performance measure is the number of defects identified. (Interview J. Skoogh, 2007)

In process inspection

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time of four minutes, it is repaired on the line. If the repair takes longer than four minutes, the body is taken out of the assembly process and is repaired at the rework station of the body shop. The cost driver is the number of bodies being inspected. The performance measure is the number of bodies being reworked or repaired due to damages or defects. (Interview J. Skoogh, 2007)

Conclusion body shop

The inspection activities in the body shop are focused on the internal process of the body shop. The defects and mistakes might occur due to the welding equipment, the operators and the quality of the material. The internal audits provide feedback in order to find solutions or prevent the same mistake from happening again. If faults or defects are being identified during the process, they are being reworked at the repair area in the body shop.

5.4 Paint shop

The paint shop is responsible for painting the body. Every body is already sold and therefore has a particular colour. This might lead to one body being black and the next body being painted red or blue. The suppliers of the paint shop are the material shop, the body shop and the Torslanda plant for the electro coat and the customers are the final assembly shop and Volvo Car Corporation. The internal process starts when the body enters the paint shop after the electro coat dipping being done at the Volvo plant in Torslanda.

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Cost driver Activity Performance measurement Quality electro coating process Measuring electro coating layer Number of deviations coating layer Transport Torslanda – Uddevalla

Quality delivered by body shop Inspecting bodies Number of bodies with dirt or deviations Quality work inspecting at receiving of

operators

Number of bodies inspected

Internal audit inspection bodies at

receiving from Torslanda Number of faults/defects Quality work sealing operators

Number of bodies inspected Internal audit sealing process Number of faults/defects Quality work filler operators

Number of bodies inspected Measuring layer thickness Wrong quantity compared to requirements Quality filler process

Number of bodies inspected Inspecting bodies for dirt Number of bodies with dust or dirt Quality work operators

Number of bodies inspected Internal audit inspection bodies Number of faults/defects Quality filler process

Number of bodies inspected Control (100%) Number of defected bodies Number of bodies inspected 2K robot check Number of faults identified Number of bodies Official inspection Number of defects found Quality work official inspection

operators Internal audit official inspection Number of faults/defects Number of repairs

Table 5.3: overview cost drivers and performance measures paint shop (Source: Interview H. Strömberg, 2007)

Measuring electro coating layer

After the body has been welded at the body shop, it is transported to the Volvo plant in Torslanda. At this plant the body is given an electro coating layer, before it returns at PFS and enters the paint shop. The layer of the electro coating protects the car against rust and should be according to the quality requirements. Four times a day the quality responsible is measuring the electro coating layer of the bodies entering the paint shop. The inspection activity takes place to investigate if the Volvo plant in Torslanda has delivered a product according to the requirements. The cost driver is the number of inspections by the person responsible for quality. The performance measure is the number of deviations of the coating layer compared to the quality requirements. (Interview H. Strömberg, 2007)

Inspecting bodies

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difficult problem and special tools are required to fix the problem. The cost drivers are the quality of the work done by the body shop and the transportation of the bodies between Uddevalla and Torslanda. The performance measure is the number of bodies with dirt or deviations. (Interview H. Strömberg, 2007)

Measuring layer thickness

Filler is the first layer on the body in the paint shop. The filler is sprayed on the car in the filler box, before it is going into the filler oven. After the oven the bodies are waiting in a buffer for the next step in the process. At this step in the process the layer thickness is measured by the quality inspector of the paint shop. It measures the layer thickness at different points of the body. This activity can be seen as a check if the operators have sprayed the right quantity according to the requirements on the body. If the quantity of the layer thickness is not correct, this is noted in a system and the operators are informed of their mistakes by the quality inspector. Measuring the layer thickness is done two times a shift and there are two shifts a day. The cost drivers are the number of bodies inspected and the quality of the filler process. The performance measurement is the thickness of the filler layer. The thickness should be according to the requirements. (Interview H. Strömberg, 2007)

Internal audit

Appraisal costs in the order to delivery process

Appraisal costs in the order to delivery process

A single case study of the car manufacturing plant Pininfarina Sverige A.B.

By

LIESBETH BLOEMENDAL

University of Groningen

Faculty of Economics and Business

University of Uppsala

Department of Business Studies

Appraisal costs in the order to delivery process

A single case study of the car manufacturing plant Pininfarina Sverige A.B.

Uddevalla, 17 January 2008

Abstract

Table of Contents

Abbreviations

1. Background Pininfarina Sverige A.B.

1.1 Introduction

1.2 History of Pininfarina Sverige A.B.

1.3 Body, paint, final assembly and material shop

1.4 Volvo C 70

1.5 Essential figures

2. Research Framework

2.1 Introduction

2.2 Background

2.3 Problem indication

2.4 Research objective and question

2.5 Sub questions

2.6 Label, theoretical idea, conceptual models

2.7 Preview of the organization of the paper

3. Research Methodology

3.1 Introduction

3.2 Research strategy

3.3 Operationalization of the subquestions

3.4 Practical methodology

) + IC + SC

3.5 Validity and reliability

4. Theoretical background

4.1 Introduction

4.2 Definition of quality costs

4.3 Cost of quality models

4.3.1 P-A-F model

4.3.2 Opportunity cost model

4.3.3 Process cost model

4.3.4 ABC model

4.3.5 Choice of cost of quality model for this research

4.4 Process view of ABC

4.5 Time Driven Activity Based Costing

5. Appraisal activities in the order to delivery process

5.1 Introduction

5.2 Material shop

5.3 Body shop

5.4 Paint shop