Dec 24, 2013 2765 Words 12 Pages
Rev. April 28, 1993
Seligram, Inc.: Electronic Testing Operations
tC
We put in a piece of automated equipment a year ago that only fits the requirements
of one customer. This equipment reduced the direct labor required to test his components and,
because of our labor-based burden allocation system, substantially reduced his costs. But
putting a $40,000 machine into the general burden pool raised the costs to our other
customers. It just doesn’t make sense shooting yourself in the foot at the same time you are
lowering the company’s cost of operations.
Paul Carte, Manager
Introduction
No
Electronic Testing Operations (ETO), a division of Seligram, Inc., provided centralized testing
for electronic components such as integrated circuits. ETO was created as a result of a decision in 1979
to consolidate electronic testing from 11 different divisions of Seligram. ETO commenced services to
these divisions in 1983. It was estimated that centralization would save Seligram in excess of $20 million
in testing equipment investment over the next five years.
ETO operated as a cost center and transferred products to other divisions at full cost (direct
costs plus allocated burden). Although ETO was a captive division, other divisions within Seligram
were allowed to use outside testing services if ETO could not meet their cost or service requirements.
ETO was permitted to devote up to 10% of its testing capacity to outside customers but chose to work
mainly with other Seligram divisions due to limited marketing resources.
ETO employed approximately 60 hourly personnel and 40 administrative and technical staff
members. Budgeted expenses were $7.9 million in 1988 (see Exhibit 1).
Testing Procedures
Do
ETO expected to test between 35 and 40 million components in 1988. These components
included integrated circuits (I.C.s), diodes, transistors, capacitors, resistors, transformers, relays, and
crystals. Component testing was required for two reasons. First, if defective components were not
This case was prepared by Professor Peter B. B. Turney, Portland State University and Christopher Ittner, Doctoral Student,
under the supervision of Professor Robin Cooper as the basis for class discussion rather than to illustrate either effective or
ineffective handling of an administrative situation.
Copyright © 1988 by the President and Fellows of Harvard College. To order copies or request permission to
reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No
part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in
any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the
permission of Harvard Business School.
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189-084
Seligram, Inc.: Electronic Testing Operations
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caught early in the manufacturing cycle, the cost of repair could exceed the manufacturing cost of the
product itself. Studies indicated that a defective resistor caught before use in the manufacturing process
cost two cents. If the resistor was not caught until the end product was in the field, however, the cost of
repair could run into the thousands of dollars. Second, a large proportion of Seligram’s work was
defense related. Military specifications frequently required extensive testing of components utilized in
aerospace and naval products. By 1988, ETO had the ability to test 6,500 different components.
Typically, however, the division would test about 500 different components each month and between
3,000 and 3,500 per year. Components were received from customers in lots; in 1988, ETO would receive
approximately 12,000 lots of components.
ETO performed both electrical and mechanical testing (see Exhibit 2). Electrical testing
involved measuring the electrical characteristics of the components and comparing these measurements
with the components’ specifications. For example, the specifications for an amplifier may have called for
a 1-volt input to be amplified into a 10-volt output. ETO would deliver a 1-volt input to the component.
By measuring the amplifier’s output, ETO gauged its conformance with specifications.
tC
Mechanical testing included solderability, component burn-in, thermal shock, lead
straightening, and leak detection. Solderability involved the inspection of components to see if they held
solder. Burn-in was the extended powering of components at high temperature. Thermal shock
involved the cycling of components between high and low temperatures. Lead straightening was the
detection and correction of bent leads on components such as axial components. Leak detection
examined hermetically sealed I.C.s for leaks.
No
Components varied significantly in the number and type of electrical and mechanical testing
procedures they required. This variation resulted in about 200 different standard process flows for the
division. Process flows were determined by the different combinations of tests and specifications
requested by the customer. Based on these combinations, ETO planners determined the routing of
components between testing equipment and the type of tests to be performed at each station. I.C.s, for
example, could follow six different flows through the facility. While some I.C.s only required electrical
testing at room temperature (solderability and leak detection, for instance), others also required thermal
shock and burn-in.
Each type of component required separate software development, and custom tools and fixtures
were often required. Software, tools, and fixtures were developed by the engineering group, which was
made up of specialists in software development, equipment maintenance, calibration and repair, tooling
and fixturing, and testing equipment operation. Software engineers developed programs for specific
applications. The programs were then retained in a software library for future use. ETO had 6,500
different software programs on file, of which 1,300 were programs developed in the past year. ETO also
had an inventory of 1,500 tools and fixtures, of which 300 had been developed in the past year. The
large number of tools and fixtures allowed the testing of components with a wide variety of leads, pin
combinations, and mating configurations.
Do
The testing facility was divided into two rooms. The main testing room contained the
equipment used for electrical testing. The mechanical room contained the equipment used for
mechanical testing, plus incoming receiving and the stockroom. A total of 20 people worked in the two
rooms on each of two main shifts, and 10 people worked on the night shift.
Cost Accounting System
The cost accounting system measured two components of cost: direct labor and burden. Burden
was grouped into a single cost pool that included burden costs associated with each of the testing rooms
as well as the engineering burden costs relating to software and tooling development and the
administrative costs of the division. Total burden costs were divided by the sum of testing and
engineering labor dollars to arrive at a burden rate per direct labor dollar. The division costed each lot
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Seligram, Inc.: Electronic Testing Operations
189-084
Signs of Obsolescence
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of components. Burden was calculated for each lot by multiplying the actual direct labor dollars
associated with the lot by the 145% of burden rate. The resulting burden was then added to the actual
direct labor costs to determine the lot’s total cost. In 1988, the facilitywide burden rate was 145% of each
direct labor dollar, of which more than 40% was attributable to equipment depreciation (see Exhibit 3).
tC
Several trends pointed to the obsolescence of the labor-based burden allocation process. Since
the founding of the division in 1983, direct labor hours per lot tested had been steadily declining (see
Exhibit 4). This trend was aggravated by an increased dependence on vendor certification. Vendor
certification was a key component of Just-in-Time (JIT) delivery. With vendor certification, Seligram’s
suppliers did the primary testing of components. ETO then utilized statistical sampling to verify that the
supplier’s production process was still in control. Thus, whereas JIT led to an increased number of
smaller lots being received by ETO, vendor certification reduced the number of tests performed. Early
indications were that JIT deliveries would account for 30% of Seligram’s shipments within the next five
years.
No
In addition to declining direct labor content and fewer test lots, the obsolescence of the laborbased allocation system was intensified by a shift from simple inspection services to broader-based test
technology. On complex parts requiring screening, environmental conditioning, and testing, the
division was consistently cheaper than outside services. Where only elementary testing was required,
however, low-technology outside laboratories were often cheaper, especially on large lots. The
advantage that the division brought customers over the outside labs was that the latter provided
essentially no engineering support, whereas ETO with its resident engineering resources was able to
support such service on a rapid and cost-effective basis. The shift to more technically sophisticated
services prompted a shift in the labor mix from direct to indirect personnel. The division expected to see
a crossover between engineering head count and hourly head count early in the 1990s.
Finally, the introduction of high-technology components created the need for more automatic
testing, longer test cycles, and more data per part. Digital components, for example, were currently
tested for up to 100 conditions (combinations of electrical input and output states). The new generation
of digital components, on the other hand, would be much more complex and require verification of up
to 10,000 conditions. These components would require very expensive highly automated equipment.
This increase in automation would, in turn, lead to a smaller base of direct labor to absorb the
depreciation costs of this new equipment.
There were fears that the resulting increase in burden rates would drive some customers away.
ETO had already noticed an increase in the number and frequency of complaints from customers
regarding the rates they were charged for testing.
Do
The division’s accounting manager proposed a new cost accounting system to alleviate the
problem. Under this new system, burden would be directly traced to two cost pools. The first pool
would contain burden related to the administrative and technical functions (division management,
engineering, planning, and administrative personnel). This pool would be charged on a rate per direct
labor dollar. The second pool would include all other burden costs and would be charged based on
machine hours. Exhibit 5 provides the proposed burden rates.
Shortly after the accounting manager submitted his proposal, a consultant hired by Seligram’s
corporate management prepared an assessment of ETO’s cost system. He recommended the
implementation of a three-burden-pool system utilizing separate burden centers for each test room and a
common technical and administrative pool. Burden would be directly traced to each of the three burden
pools. Like the accounting manager’s system, burden costs in the test rooms would then be allocated on
a machine-hour basis. Technical and administrative costs would continue to be charged on a rate per
direct labor dollar.
3
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Seligram, Inc.: Electronic Testing Operations
Technological Future
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To examine the impact of the two alternative systems, ETO management asked that a study be
conducted on a representative sample of parts. Exhibit 6 provides a breakout of actual direct labor and
machine-hour requirements per lot for the five components selected for the study.
tC
In 1988, the division faced major changes in the technology of testing that required important
equipment acquisition decisions. The existing testing equipment was getting old and would not be able
to keep pace with developments in component technology. Existing components, for example, had
between 16 and 40 input/output terminations (e.g., pins or other mating configurations), and ETO’s
equipment could handle up to 120 terminations. Although the 120-termination limit had only been
reached a couple of times in the past few years, a new generation of components with up to 256
terminations was already being developed. Similarly, the upper limit of frequency on existing
components was 20 MHz (million cycles per second), whereas the frequency on the next generation of
components was expected to be 50 MHz.
The equipment required to test the next generation of components would be expensive. Each
machine cost approximately $2 million. Testing on this equipment would be more automated than
existing equipment, with longer test cycles and the generation of more test data per part. It was also
likely that lot sizes would be larger. The new equipment would not replace the existing equipment but
would merely add capabilities ETO did not currently possess. Additionally, the new equipment would
only be needed to service the requirements of one or two customers in the foreseeable future. Exhibit 7
provides a summary of the new equipment’s economics and operating characteristics.
No
The impact of this new equipment would be an acceleration in the decline in direct labor hours
per lot of components. At the same time, burden would increase with the additional depreciation and
engineering costs associated with the new equipment. This would result in a large increase in the
burden rate per direct labor dollar. As Paul Carte, manager of ETO, saw it, the acquisition of the new
equipment could have a disastrous effect on the division’s pricing structure if the labor-based allocation
system remained in use:
Do
We plan on investing $2 million on a large electronic testing machine to test the chips of one
or two customers. This machine will be very fast and will require little direct labor. Its
acquisition will have a significant effect on our per direct labor dollar burden rate, which will
result in an increase in charges to our other customers. It is clear that a number of customers
will walk away if we try to pass this increase on. I am afraid that we will lose 25% of our
customer base if we don’t change our cost system.
4
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Seligram, Inc.: Electronic Testing Operations
Seligram Inc.: Electronic Testing Operations
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Exhibit 1
189-084
1988 BUDGETED EXPENSES
Direct Labor
Overhead
Indirect Labor
Salary Expense
Supplies & Expenses
Services1
Personnel Allocations2
Service Allocations3
859,242
394,211
538,029
245,226
229,140
2,448,134
$4,713,982
tC
Total Overhead
$3,260,015
$7,973,997
Do
No
Total Budgeted Expenses
1Includes tool repair, computer expenses, maintenance stores, and service cost transfers from other divisions.
2Includes indirect and salaried employee fringe benefits, personnel department, security, stores/warehousing,
and holidays/vacations.
3Includes building occupancy, telephones, depreciation, information systems, and data control.
5
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Seligram, Inc.: Electronic Testing Operations
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Exhibit 2
Seligram, Inc.: Electronic Testing Operations
Do
No
tC
TESTING CAPABILITIES
6
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Seligram, Inc.: Electronic Testing Operations
Seligram, Inc.: Electronic Testing Operations
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Exhibit 3
189-084
CALCULATION OF BURDEN RATE
Based on 1988 Plan
=
144.6%
=
145%
Do
No
tC
$4,713,982
$3,260,015
=
EFFECTIVE RATE
TOTAL BURDEN $4
DIRECT LABOR $
=
BURDEN RATE
4Cost Breakdown:
Total Burden
Variable
$1,426,317
-------------Fixed----------Depreciation
Other
$1,288,000
$1,999,665
Total
$4,713,982
7
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Seligram, Inc.: Electronic Testing Operations
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Exhibit 4
Seligram, Inc.: Electronic Testing Operations
Do
No
tC
D.L. HRS. PER LOT CHART
8
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Seligram, Inc.: Electronic Testing Operations
Seligram, Inc.: Electronic Testing Operations
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Exhibit 5
189-084
PROPOSED BURDEN RATES
Based on 1988 Plan
Machine-Hour Rate
MACHINE HRS.
Main Test Room
Mechanical Test Room
Total
BURDEN $5
33,201
17,103
50,304
$2,103,116
1,926,263
$4,029,379
Test Room
Burden $ =
Machine Hrs.
$4,029,379
50,304
=
$80.10
tC
Machine-Hour Rate
Effective Machine-Hour Rate = $80.00
Direct Labor Hour Rate
Total Engineering & Administrative Burden $ = $684,603
Total Direct Labor Dollars = $3,260,0156
Burden Rate =
Engr. &
Admin. Burden $
Direct Lbr $
=
=
$684,603
$3,260,015
21%
Do
No
Effective Burden Rate Per Direct Labor $ = 20%
5Cost Breakdown
Main Test Room
Mechanical Test Room
Test Room Burden
Engineering & Admn.
Total Burden
VARIABLE
$ 887,379
443,833
$1,331,212
$ 95,105
$1,426,317
-------------------FIXED---------------OTHER
DEPRECIATION
$ 88,779
$1,126,958
674,327
808,103
$ 896,882
$1,801,285
$ 198,380
$ 391,118
$1,288,000
$1,999,665
TOTAL
$2,103,116
1,926,263
$4,029,379
$ 684,603
$4,713,982
6Includes all direct labor costs, including direct labor costs incurred in both test rooms as well as in engineering.
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Seligram, Inc.: Electronic Testing Operations
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Exhibit 6
Seligram, Inc.: Electronic Testing Operations
Direct Labor and Machine-Hour Requirements
Actuals For One Lot
-----------------MACHINE HOURS-----------------
PRODUCT
DIRECT LABOR $
$ 917
ICB
2051
CAPACITOR
1094
AMPLIFIER
525
DIODE
519
MECH.ROOM
TOTAL
8.5
10.0
18.5
14.0
26.0
40.0
3.0
4.5
7.5
4.0
1.0
5.0
7.0
5.0
12.0
Do
No
tC
ICA
MAIN ROOM
10
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Seligram, Inc.: Electronic Testing Operations
Seligram, Inc.: Electronic Testing Operations
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Exhibit 7
189-084
New Testing Equipment Economics and
Operating Characteristics
$2 Million
Useful Life:
8 Years
Depreciation
Method:
Double Declining Balance
(First Year Depreciation Costs of $500,000)
Location:
Main Test Room
Utilization:
10% first year, rising to 60% by third year and in all subsequent years,
based on 4,000 hours per year availability (2 shifts x 2,000-hour year)
Direct Labor
Requirements:
Approximately five minutes per hour of operation; average labor rate of $30
per hour
Engineering
Requirements:
$75,000 in installation and programming costs in first year
tC
Cost:
$250,000
($100,000 variable, $150,000 fixed)
Do
No
Estimated overhead
(nonengineering
depreciation)
11
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