Purpose

Investment in traditional equipment and facilities aims to increase productivity by reducing labor costs and by conserving energy However, automated equipment provides value in many ways other than reducing labor input. These purposes include improving quality, reducing inventories, reducing floor space, and reducing the need to perform dangerous tasks.

Capability

Traditional equipment is comparatively limited in use. Automated equipment has more uses, but requires a much higher level of skill to take full advantage of its capabilities. It also involves a large number of unknowns, and most companies have limited experience in dealing with automated equipment. The success of investing in CIM and creative use of its software depends largely on the ability to gather information needed for effective use of the equipment.

Intangible Benefits

The large number of indirect and intangible benefits associated with automated equipment makes it much more difficult to estimate the impact on profits. While one can readily calculate the results of reducing labor costs, scheduling, set-up time, and reducing work-in-process inventory, the following are very difficult to estimate:

• The benefits derived from improvements in quality; reduction in delivery time, increased flexibility and competitive advantage
• Future operating costs of automated equipment
• The cost of CIM information systems
• The economic life of equipment
• The potential loss in sales from failing to automate

Cooperative Work

Unlike investments in traditional equipment, investments in automated equipment and CIM have strategic implications. Thus, investments in automated equipment and CIM should involve more people throughout the organization than investment in traditional equipment. Consequently, communication among the various fields of operations, manufacturing, engineering, information systems, production management and accounting is essential. Here, then, is one of the strong ties to the seven business innovations and to target costing. The cooperative work approach needed in CIM is supported by the other facets of the business culture.

Mini-Investment

Investment in CIM is an endless project. Instead of scale, economies of scope must be attained in CIM investment. However, the investment is likely to be big because of the cost of using cutting-edge technologies.

Given these differences between the two types of investment, computing the relevant benefits and costs will be extremely difficult. In the next section we will discuss the problems thoroughly.

Reduction in Labor Costs and Energy Conservation

Although direct labor costs decrease with the introduction of FMS equipment, support costs such as maintenance, monitoring, product planning, design, R&D, and software development increase significantly. As a company advances to FA from FMS, the need for design personnel decreases because of the application of CAD. The introduction of CIM links engineering and production with marketing and aims for operations that can quickly adopt environmental changes. Its focus is on reducing indirect labor costs and reducing cycle time. As automation increases, equipment becomes smaller in scale and more efficient. As a result, energy can be conserved.

Reduction in Inventories

It is possible to reduce work-in-process and finished goods inventories significantly with automated equipment. This is accomplished by increasing flexibility in the production schedule, creating an orderly flow of goods, increasing quality and improving schedule management. There is also a tax benefit from reducing inventories.

Quality Improvement

One of the major effects that can be expected, along with a reduction in direct labor costs, is improvement in quality. Robots can perform simple tasks with a great deal of precision and reliability which reduces need for testing facilities and personnel.

Reduction in Floor Space

Compared to traditional equipment and facilities, those that are automated tend to be smaller in size and number because of greater flexibility and sophistication. As a result, floor space and warehouse space can be reduced.

Shorter Lead Time and Throughput

CIM integrates production and engineering with marketing and therefore can drastically cut lead time. For example, Yamazaki Steel shortened the mean processing time for one unit from 35 days to a day and a half. Part of the benefit of reducing the lead time is smaller inventories--which has already been considered above.

Increased Flexibility

Because product specifications can be changed easily, one can change a product to conform with the needs of the customers. This is often practiced in automated automobile factories, where the products coming down the assembly line differ from each other. In short, one of the advantages of using automated equipment and facilities is that simple changes in the flow may be made with ease.

Reduction in Dangerous Operations

The introduction of FA has decreased the number of dangerous and physically taxing operations performed by people, which has cut the occurrence of industrial accidents.

Recruiting the Work Force

Recruiting and retaining the manufacturing work force has become a major problem in Japan. For example, today the best graduates from Tokyo University tend to work for banks or insurance companies rather than for manufacturing companies, which have a dirty image.

The Learning Effect and Competitive Advantage

Investments in new technologies have an important learning effect. Thus, even if the direct cash flows associated with a particular investment are negative, the investment may sometimes be indispensable just to maintain knowledge and hence future competitiveness.

Considering the rapid pace of technological innovation, companies that put off capital investments until new markets develop have no future. Moreover, if a company has not mastered a given level of automation, it cannot go on to the next level and will be left behind by the competition. Companies that did not have any experience with FMS were not able to install FA successfully. Investment in CIM increases the company’s ability to compete on a multidimensional rather than a unidimensional basis. Companies are simultaneously in a position to offer high-quality product at low cost and provide fast and flexible product changes. A number of authors have identified the ability to compete on multiple bases as a key strategic imperative.

The DCF Method and U.S. Companies

DCF methods, and in particular the internal rate of return (IRR), are the most popular methods of evaluating investments in the United States. The net present value (NPV) method is also a very popular method among U.S. accountants for automated equipment as well. The pay-back method was used more frequently when evaluating investments in automated equipment than when evaluating investments in traditional investment. However, the payback method is frequently criticized because “it does not consider all the project’s cash flows or the time value of money, so its use could cause the company to make bad investment decisions” (Band & Hendricks, 1987). It is generally agreed that the IRR and the NPV methods are Superior to the payback method for evaluating investments in CIM equipment (Polakoff 1990).

The Overall Evaluation and Pay back in Japanese Companies

Japanese companies do not normally justify investment solely on the basis of economic factors and take other quantitative and nonquantitative factors into account. Since many factors in investing in CIM cannot be quantified, an overall evaluation that incorporates strategic considerations is superior to an analysis based solely on quantifiable economic factors. With CIM, such intangible benefits as flexibility, improvement in quality, competitive advantage and the learning effect can be of overriding importance

When Japanese companies use a quantifiable method, they most often use the payback method Mr. Koike, the statutory auditor of NEC commented that a two year payback period is appropriate for his company. With NEC, the payback method is used not because it is simple but because the goal is a quick recovery of capital. This raises an interesting question. Japanese managers are believed to have a long term perspective Kagono et al., 1985), but they use the payback method, which seems to be based on short term considerations There are three important issues that influence this:

The life cycle of products has been shortening. The average life of a product in Japan is now two to three years. Thus, capital investment must be recovered quickly.

The life cycle of equipment has also been getting shorter

Sales of high technology products cannot be accurately predicted. Semiconductors are a typical product of this type. Thus, early recovery of invested capital is essential.

The Process of Decision-Making in Investment Justification

Decisions for investing in CIM equipment involve four stages. First, proposals are generated by relevant departments in the middle-range business planning stage. Next, the framework for investment in plant and equipment is formulated in the policymaking process for budgeting. In the third stage, coordination between executive board and production planning group are made through the budgeting process. Finally, decisions are made about the investments.

Middle-range business plans extend over a two- or three-year period and are rolled forward each year. Within this plan, policies for expansion of operations, proposals for improvement and other important JSSUCS are examined every year

In the first stage, a basic policy is determined, and studies concerning specific numbers are given second consideration. What is essential is to determine what action is to be taken. Policymaking is more important than concrete numbers.

In the second stage, an investment proposal is initiated and studied from a company perspective.

In the third stage, a budget proposal is presented the framework of profit Planning. The need for and adequacy of the proposal in CIM equipment is reviewed in relation to the overall investment plan in the production department. Here, a method of economic justification such as payback ROI or IRR is applied

In the final stage, after the budget has been determined, a Ringisyo (formal proposal for top management approval) is submitted and final approval of top management is obtained.

What receives approval in addition to the budget proposal are the research report on the investment proposal and the proposal for investment criteria The research report on the investment proposal Indicates:

• The specification
• An outline (product quantity to be produced, process, operating time and period of use)
• The reason for purchase (expansion, conservation of energy rationalization of operations, reduction in manpower, improvement in quality, reduction in environmental pollution, improvement in operations, renovation and others)
• The conditions for purchase (from another vendor, import, specially ordered, valuation of similar item and others)
• The conditions for purchasing a substitute item
• The evaluation process concerning why a specific vendor was selected
• The results
• The cost-effectiveness
• The future prospects

CIM Investment Criteria

Company X uses a two-stage process to screen projects. In the first stage, investments are evaluated based on their projected payback and profitability. In the second stage, intangible benefits are considered. The primary criteria are shown in Figure 16. The number in the lower line in each block is the weight given to that item.

The secondary criteria are shown in Figure 17. These criteria include effects of the investment on quality flexibility and competitiveness.

The mian criteria for investment justification in CIM
Description	Scores (number of companies)
Profitability Weight	20-30% (30)	15-20% (25)	10-15% (20)	5-10% (10)	0-5% (5)	Negative (0)
Payback (years) Weight	1-2 (30)		2-4 (20)		4-5 (5)	Over 7 (0)
Adapted from: Sakurai, Michiharu, and Paul Scarbrough, Integrated Cost Management, Productivity Press 1995. Used with permission.

Secondary criteria in CIM
Description	Scores
Future Outlook	Development 30	Growth 25	Mature 15	Saturation 10	Downward 5
Quality		Greatly 25	High 15	Moderately 10
Urgency		Essential 25		Important 10	Convenient 5
Flexibility		High 20	Middle 15	Low 10	A Little 5
Delivery			Very Good 15	Good 10	Fair 5
Competitiveness			Very High 15	Strong 10	Fair 5
Adapted from: Sakurai, Michiharu, and Paul Scarbrough, Integrated Cost Management, Productivity Press 1995. Used with permission.

In the overall determination, investment proposals that exceed a score of 30 in the primary criteria and 75 in the secondary criteria tend to be selected. Nonetheless, these are not automatically selected, and ultimately the person making the decision, the company president, the executive in charge, or the department head will decide on the basis of corporate strategy.

Company X has factories in areas A, B and C. In area A, they produce semiconductors, so that the role of strategic factors is considerable in investment decision Technological innovation occurs rapidly, product life-cycle is very short, and long term predictions are difficult. Therefore, in the primary criteria much greater weight is given to payback because early recovery of investment is indispensable for this industry. However because of the size and strategic nature of this investment the intangible benefits and the judgment of the company president are likely to prove critical.

On the other hand, area B makes products in which there is hardly any room for technological innovation. Therefore, much greater weight is given to profitability evaluations and the intangible benefits are far fewer.

In area C, the life-cycle of products is short. Consequently in area C the payback period is set to two years and investments with a payback in excess of two years will be turned down even though the ROI may be satisfactory.