Incentives for overhead cost reduction: Setup time and lot size considerations

Abstract

This paper addresses incentive issues arising in the integration of production control and process improvement on the shop floor. High overhead rate estimates identified by an activity based costing (ABC) system can result in a decision to increase lot sizes, thereby reducing setup related overhead costs. We integrate ABC and EOQ analyses to establish the circumstances under which increasing the lot size becomes a viable alternative. However, while increasing the lot size may be important for short-term competitiveness, long-term control of setup related overhead costs can be achieved only by decreasing setup time. We address the role of incentive systems in simultaneously implementing both short-term and long-term strategies. In particular, we focus on how the choice of performance measures can result in conflicts between production personnel who may be concerned with short-term cost reduction and engineering personnel who are responsible for reducing setup time. Finally, we discuss the value of group incentive systems in mitigating such conflicts.