Issue link: https://industrialmanagement.epubxp.com/i/656209
14 Industrial Management tions can be identified that link the qualitative benefit to a financial impact, then it should be made into a quanti- tative benefit. If benefits cannot be quantified, they are difficult to quantify or the correlation between the quali- tative benefit and the financial benefit is not likely to be credible, then the benefits should be considered quali- tative. Improved employee morale and enhanced customer goodwill are just two examples of qualitative benefits. Decision traps Above all, ignore sunk costs. As APICS maintains, sunk costs already have been paid and are not relevant to the future. Including sunk costs can lead to distorted and flawed decision-making. When identifying the costs, Reginald Tomas Lee's "How We Overstate ROI on Improvement Projects" in Cost Management calls for differentiating between cash costs and noncash costs to avoid overstating the benefits of business cases. To illustrate, a person earns $40,000 a year to conduct complex financial analysis. A spread- sheet salesperson's business case suggests that her product could cut costs by 90 percent via the following analysis: The employee works 2,000 hours per year ($20 per hour); shifting to a spreadsheet will require only 200 hours per year, a 90 percent reduction. As 90 percent of $40,000 equals $36,000, that's your ROI. But if the employee still earns $40,000 per year, there are no real savings, although the employee could be reallocated to more value-added tasks. Allocation-based costing systems also can distort decision-making, so understanding how costs are allocated is important. For example, a machine setup cost is $100. Each unit the machine produces costs $1. If the machine produces 100 units, the cost to operate the machine would be $200. An allocation-based costing system might present the unit cost as $2 per unit. If, upon analysis, a team decides that it can save 20 percent by buying lower- cost raw material, team members might The business case needs to tie directly to the bottom line. think the future state would be a unit cost of $1.60. However, the 20 percent savings only applies to material. The changeover cost is intact, so the unit cost would be $1.80. Allocation-based costing systems, if not understood, can lead to distorted math and poor decision-making. The business case needs to tie directly to the bottom line and may require more action than indicated in the business case. For example, an improved IT system won't save millions of dollars unless the executives are able to use the newly available information to make better decisions. Productivity gains are popular in business cases. But they must be tied to the bottom line. If demand is 200 units per day of product X and the manufacturing plant has four lines producing 50 units each, a business case that proposes improving line capacity by 50 percent would result in each line producing 75 units, or 300 per day total. After the improvements, the manufacturer has several options to improve profitability: Idle one line to reduce the variable cost while meeting market demand, or maintain the lines and sell more. In this example, increasing produc- tivity is the first step that enables options. The second step is to reduce expenses or sell more products. The business case should indicate the actions required to realize the potential benefits. Behavioral economics offers some insights into how individuals, including analysts and managers, are subject to biases. Those writing the business case and those making the decisions should guard against these common biases, distortions and deceptions: • Anchoring: The tendency to be affected by numbers, even when they aren't valid. They "anchor" us, and we adjust away from them less than we should. They affect us even when we should ignore them. Our questions prime our attention for certain infor- mation, ignoring or omitting contra- dictory data. • Framing: How a situation is presented affects the decision. Generally, our pain of losing is more powerful than our pleasure of winning, hence we are risk averse, or less likely to assume risk, to gains and risk seeking, or more likely to assume risk, to avoid future loss. • Availability heuristic: Events that are vivid, easily imagined or consistent with memory structures are judged to be more likely than equally probable events. Recent events get weighted disproportion- ately higher than past events.