Academic journal article Management Accounting Quarterly

Using pEOQ to Help Save American Automakers

Academic journal article Management Accounting Quarterly

Using pEOQ to Help Save American Automakers

Article excerpt

During the last quarter of 2008, the original "Big Three" automotive companies appeared to be doomed. Then Chrysler and General Motors became recipients of billions of taxpayer-loaned funds to remain viable, while Ford declined help. Now Ford posted a surprise profit of nearly $1 billion in November 2009, and Chrysler said it broke even in September. Although things seem to be getting better, given the previous highly negative cash flow for all of the "Detroit Three," as they are now known, it seems timely to share a method that could drastically reduce the large number of multimillion-dollar prototypes that are needed to develop new vehicles. During the tenure of one of the authors at a Detroit Three automaker, the company spent more than $300 million on prototype builds each year.

The prototype Economic Order Quantity (pEOQ) model proposed here can reduce this spending by as much as 40%, according to simulations we ran. In addition to the dramatic savings, the method can significantly reduce product development time because testing is timelier and because the right prototypes are more likely to be available when they are needed. Managers would not have to wait for the late delivery of prototypes, which can hold up the entire product development process.

What is pivotal is cutting costs without destroying the company. During a typical belt-tightening, many a manager may have thought, "We are tightening our belts all right, but it's not around the waist, it's really around the neck!" To avoid comments like these, any reductions in something as pivotal to the safety and function of a new automobile or truck as prototypes should be approached gingerly. The builds should be sufficient to do all tests needed for a robust product.

Author Savya Rafai, previously an engineer at Chrysler and creator of the Strategic Budgeting method, developed the pEOQ model. (1) The motivation for creating the model was the high cost of prototype builds and the large number of wasted prototypes that were built but never used or that were built and used only to justify their high cost since they did not help in developing the new product. One way the existence of unused prototypes was determined was the "dust test." Prototypes parked at the plant were checked for dust. Those with dust were assumed to have never been used for testing. Other unused prototypes were "lent" to engineers and upper-level managers as perks.

The pEOQ method identifies overlaps in testing that, when eliminated, can dramatically decrease prototype builds. Yet without changes in evaluation and reward systems, long-term buy-in and use of the pEOQ method in the planning of most programs is doubtful. In addition to presenting the pEOQ method, we will address a new technique for changing the metrics and rewards.


There are a number of considerations that should be taken into account with regard to the use of prototypes in the development and testing of new vehicles:

1. Prototypes are crucial for verifying and validating program objectives. Verification of the product design is critically important and occurs during roughly the first two-thirds of the prototype testing process. Validation of the production process occurs mostly through the remainder of the prototype process.

2. If too few prototypes are ordered, then any unforeseen circumstances could cause long delays while more prototypes are built so that the required tests can be run. In addition to dramatically raising costs, this could hamper or delay delivery of the new vehicle.

3. The number of prototypes to be built has a dramatic effect on the Engineering Research and Development (ER&D) budget.

4. Prototype quantity estimation is like Zero-Based Budgeting. The number of estimated builds is ranked based on the critical nature of the tests performed on specific kinds of prototypes. …

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