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Int. J.

Production Economics 135 (2012) 420429

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Int. J. Production Economics


journal homepage: www.elsevier.com/locate/ijpe

The price of responsiveness: Cost analysis of change orders


in make-to-order manufacturing
a b,n
Jukka Uskonen a,1, Antti Tenhial
a
b

Aalto University, Department of Industrial Engineering and Management, Otaniementie 17, 02150 Espoo, Finland
IE Business School, Calle de Mara de Molina 12-5, 28006 Madrid, Spain

a r t i c l e i n f o

a b s t r a c t

Article history:
Received 9 September 2008
Accepted 20 August 2011
Available online 26 August 2011

The ability to produce goods according to customers specications may be an important competitive
advantage, but it exposes manufacturers to the risk of customers requesting changes in their
specications during the fulllment of their orders. Manufacturers often accept these change orders
in the name of customer service despite the fact that they incur additional costs. This study uses
empirical data and activity-based costing to explore the real values and the accrual mechanisms of
change orders costs. The results show that the total costs are considerable, but the analyses also reveal
opportunities for cost savings through the categorization of change orders, time fencing techniques, and
improvements in information processing.
& 2011 Elsevier B.V. All rights reserved.

Keywords:
Customization
Uncertainty
Activity-based costing

1. Introduction
Responsiveness to customers varying requirements has become
a crucial source of competitive advantage for many modern
manufacturing companies (Fisher, 1997; Wong et al., 2006). Due
to increased demand for customized products, manufacturers have
developed tools and practices to accommodate customers unique
requirements into their product offerings (Forza and Salvador,
2002). While this kind of responsiveness enables manufacturers
to charge premium prices, it also exposes them to new kinds of
uncertainties. A particularly difcult challenge is coping with
customers who request changes in specications during the
fulllment of their orders (Partanen and Haapasalo, 2004). Such
requests are understandable because customer requirements may
vary over time, and there is always some lead time in which
changes can occur when products are made or assembled to order.
The question of whether to accept mid-process changes in order
specications poses a dilemma for many make-to-order (MTO)
manufacturers. Most companies consider it to be an important part
of their customer service and a natural extension of their pursuit of
responsiveness (Danese and Romano, 2004). However, change
orders are known to incur costs that are very hard to estimate in
advance, and in most cases, it is difcult to charge the customers
for these costs (Riley et al., 2005). Although this dilemma has been
acknowledged in the literature, to the best of our knowledge, none
n

Corresponding author. Tel.: 34 91 568 9600.


E-mail addresses: jukka.uskonen@aalto. (J. Uskonen),
a).

antti.tenhiala@ie.edu (A. Tenhial


1
Tel.: 358 50 300 5750.
0925-5273/$ - see front matter & 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.ijpe.2011.08.016

of the earlier studies have disclosed what factors determine the


costs of change orders, or how those costs could be best mitigated.
Studies in the construction industry have shown that the overall
costs are often considerable (OBrien, 1997), but detailed analyses
in the manufacturing industries have been lacking.
This article aims to develop an understanding of the behavior of
change orders costs by identifying their constituents and accrual
mechanisms. For that purpose, this study employs the methods of
activity-based costing (ABC) and a multisource dataset from an indepth case study. The case company is a mid-size machinery
manufacturer that produces customized refrigeration cabinets for
grocery retailers. The explorative analyses of this study necessitate
triangulation between different kinds of data (Jick, 1979); qualitative data such as interviews, process mapping, and work observations were necessary in identifying the cost elements. Meanwhile,
objective data from the companys information systems were
necessary to quantify and model the costs of individual changes.
The ndings are discussed in general terms, and the costs are
measured in relative values in order to avoid the context-specicity of the results, which is often a concern in single-case studies
(Yin, 2003). The conclusions of this article are formulated as three
generalized propositions that can be tested in practice as well as in
other studies in different kinds of manufacturing environments.
The paper is structured as follows: rst, we review the existing
literature on the management of change orders. Then we present
research questions that aim to address the gaps identied in the
literature. This is followed by a description of our cost analysis
methodology and research design. Finally, we present the results
of the analyses and conclude with propositions for further
research and practical implementations.

J. Uskonen, A. Tenhi
al
a / Int. J. Production Economics 135 (2012) 420429

2. Literature review
2.1. Responsiveness as an ability to adopt change orders
The concept of responsiveness has a number of different meanings in the literature of manufacturing management. In addition
to the capability of satisfying varying customer requirements
(Fisher, 1997; Wong et al., 2006), the concept has also been
dened as the speed of fullling customized orders (McCutcheon
et al., 1994; Salvador and Forza, 2004). It has also been viewed in
more general terms as the overall capability to seize business
opportunities (Kritchanchai and MacCarthy, 1999) and has been
discussed in more specic terms as the ability to swiftly conrm
the specications and delivery dates of customers orders
(Pibernik, 2005). Yet another stream of research has focused on
dening the different constituents of responsiveness (Holweg,
2005; Reichhart and Holweg, 2007). While all of the varying
perspectives have their merits, in this study, responsiveness will
be considered as the capability to satisfy wide-ranging and
frequently changing customer requirements. The acid test of that
kind of responsiveness is the ability to adopt customers change
requests that occur after the initial entry of their orders.
2.2. Importance of adopting change orders
Most MTO manufacturers consider change orders to be an
inherent part of their business. Manufacturers typically sympathize with the fact that the conditions in customers own
environments may change during the time that is needed to
fulll the orders (Danese and Romano, 2004). This is especially
the case in the manufacturing of capital goods. For example, in
the production of construction materials, the turbulent conditions
of construction sites translate to frequent changes in customers
plans and schedules (OBrien, 1997). Such changes often necessitate modications to the technical specications and the delivery
dates of the manufacturers products (Vrijhoef and Koskela, 2000).
The difculty in preventing change orders from occurring
arises from the fact that it is often hard to determine whether
the changes result from customers behavior or from the manufacturer itself. Manufacturers usually acknowledge the difculty
of eliciting customers real needs at the time of the initial order
entry (Huffman and Kahn, 1998). Miscommunications or mistakes
occurring at that point may result in a need for modication at
some later phase in the order fulllment process (Hegde et al.,
2005). It is normally preferable to execute such modications
than to deliver products that are not suitable for the customers
intended use. Furthermore, many of the customer-originated
changes are quite similar to the ordinary engineering change
orders, which the manufacturers face anyway (Tavcar and
Duhovnik, 2005).
One particularly good motivation to accept change orders is
given in a study by Hendricks and Singhal (2003). Its results show
that if disagreements about the contents of customers orders hit
the news, then the market values of publicly traded manufacturing companies will immediately drop by about 13%. Moreover,
this plunge in the share value is accompanied with a considerable
reduction of sales (Hendricks and Singhal, 2005). Hence, it is often
the safest choice to try to accommodate customers change
requests as soon as they are received.
2.3. Costs of adopting change orders
While the importance of adopting change orders appears to be
widely acknowledged, the costs of the modications have seldom
been studied in detail. In the classic model of the hidden factory,
the change transactions are counted as non-value-adding

421

activities, and they are estimated to contribute up to 40% of


manufacturers overhead costs (Miller and Vollmann, 1985). More
recent gures can be found from studies in construction industry,
in which cost and time overruns are relatively common, and one of
their main causes are mid-process changes in the project plans
(Williams et al., 2003). The primary drivers of these unexpected
costs are the additional activities and the overtime work that are
necessary to execute the changes (Hanna et al., 2004). The total
costs of the change orders vary from 5% to 15%, depending on the
size and the type of the project (Riley et al., 2005). The overall
annual costs of change orders in the U.S. construction industry
have been estimated as 1326 billion dollars (Gunduz and Hanna,
2005).
Despite the fact that only rough gures about the costs of
change orders have been offered in the literature, many companies have made signicant investments to reduce the amount of
changes. The most intuitive response for that purpose is to reduce
the lead time of order fulllment so that changes have less time to
occur (Partanen and Haapasalo, 2004). Effective solutions include
at least the following: the use of standardized components,
modular products, and product platforms (Salvador and Forza,
2004; Hoover et al., 2001). In customized production, these
solutions enable the postponement of product differentiation,
which reduces order fulllment lead times (Krajewski et al.,
2005), and also gives customers more time to nalize their
specications, thus reducing the need for subsequent change
orders (Forza et al., 2008). In order to evaluate the protability
of investments in these solutions, it would be valuable to have a
clear understanding about the real nature of change orders costs.

3. Research questions
Due to the paucity of research on the costs of change orders,
we designed an empirical inquiry to shed light on how the costs
of change orders are composed and how they behave over time.
This objective is served by seeking answers to the following
research questions:
RQ1: What are the critical factors that determine the costs of
change orders?
RQ2: How does each critical factor inuence the costs of
change orders?
RQ3: What are the annual total costs of being responsive to
customers change orders?
RQ4: How the costs of change orders could be reduced without
deteriorating the responsiveness perceived by the customers?

4. Activity-based costing of change orders


4.1. Consumption of resources by activities
In this study, the method of analyzing the costs of change
orders follows the principles of activity-based costing (ABC). The
ABC methodology was originally developed to replace traditional
costing systems, whose ability to deal with indirect costs were
claimed to be inadequate (Cooper, 1987, 1988). As the name
implies, the logic of ABC is focused on activities instead of the cost
centers, which are the main components in the traditional costing
systems. When building an ABC model, the rst step is to identify
the activities that consume the resources of the organization
(Kaplan and Cooper, 1998). The most typical activities in manufacturing organizations are the operations of the production,
sales, and procurement processes. The most typical resources
include materials, labor, support functions, and all necessary
overhead, such as the heating and lighting of facilities.

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When the ABC methods are applied to the costs of change


orders, the activities refer to the work that is needed to execute
the requested changes in the original specications. Such activities may include revising production plans, rearranging work
orders, reworking on some components, reassembling products,
and reordering or expediting some externally procured raw
materials. The resources that are consumed by the changes
include materials and the labor hours of production planners,
buyers, and shop-oor personnel.
4.2. Utilization of activities by cost objects
In the logic of the ABC methodology, activities consume
resources. Similarly, the goods and services that are being produced
utilize the activities. They are the nal receivers of all costs and
thus they are called the cost objects. The allocation of costs to the
cost objects is done in two steps: rst, resource drivers quantify
how much each activity consumes resources; then, activity drivers
dene how much each cost object utilizes different activities.
In normal ABC systems, the cost objects are the products,
services, or customers of an organization. In this study, the
concept is extended to cover change orders. The ABC methodology is particularly suitable for the costing of change orders
because the methodology was originally developed to improve
the understanding of indirect costs (Cooper, 1987, 1988). As
discussed in the literature review, the earlier research considered
change orders as a source of indirect costs and thus as a part of
the hidden factory whose costs are difcult to analyze and
manage (Miller and Vollmann, 1985). Once the hidden costs are
revealed, it is possible to start managing and reducing them in a
systematic manner (Kaplan and Cooper, 1998; Turney, 1996).

5. Data and methods


5.1. Research design
This research was conducted as an in-depth case study.
Although single-case studies are sometimes considered problematic in terms of generalizability, the research design has some
clear advantages. For the purposes of this investigation, the
single-case approach was particularly suitable because the cost
analyses necessitate detailed corporate data that would be difcult to acquire in a multiple-case design. The downsides of the
method are not that pressing because the topic is of exploratory
nature (Glaser and Strauss, 1967). Thus, it is not necessary to
provide exact generalizations, but rather to identify the most
important factors and describe how they are related to one
another (Handeld and Melnyk, 1998). Such tentative results
can be elaborated in further studies. Following the inductive logic
of the relationship-mapping research, we will try to facilitate the
further studies by formulating our main ndings as generalizable
propositions (Eisenhardt, 1989).
The possibility of triangulating between different sources of
data is an important advantage of case studies. In this investigation, process mapping, interviews, work observations, and process
data were used to identify the main elements of the ABC model.
Later, we conducted additional interviews and arranged crossfunctional workshops to validate the ABC model and the results
that it yielded.
5.2. Case description
The case company is a typical MTO manufacturer in the
machinery manufacturing industry. It produces refrigeration
machinery and remotely refrigerated display cabinets for grocery

retailers. Customization is needed because grocery stores and


supermarkets vary greatly in their dimensions, layouts, and
interior design. The products must also be painted and accessorized according to the specications of the retail chains. Moreover,
different materials and refrigerants must be used in different
countries based on the local regulations.
5.3. Development of the ABC model
The rst step of the analysis was to map the change order
management process and develop an ABC model of executing a
generic change order. The process was as follows: rst, a sales
person receives a change request from a customer. If the requested
change relates to customized features or technical specications of
the product, the sales person rst consults a product designer
about the feasibility of the request. Once the feasibility is ensured,
the subsequent treatment depends on the amount of time remaining to the nal assembly of the product. This is because the
company tried to enforce a frozen period of four weeks in their
master schedules. The period was based on the normal lead times
of order-specic raw material purchases (one to three weeks) and
the throughput time of the internal production activities (one week
on average). Thus, the changes that occurred within this time
frame possibly necessitated changes in the procurement and
production plans. Such requests were formally documented as
change orders and passed on to the production planners. If the
changed customer order was already very close to its completion,
the sales person would need a permission of the plant manager to
issue a change order. On the other hand, if the request is related to
a customer order outside the frozen period, the sales person would
simply change the contents of the order and no change order
would be needed to call the attention of the production planners.
When the production planners get the change order, they must
nd out the status of the changed customer order and assess the
implications of revising the production schedules accordingly.
When doing this, they need to consult the supervisors of different
parts of the production process. At minimum, they must inform
everyone to halt the progress of the changed order until they have
gured out how to execute the change. Typically the planners
need to consult the warehouse personnel about the availability of
basic raw materials and the buyers about the status of possible
order-specic raw materials. On the basis of these inquiries, the
production planners decide on what would be the least disruptive
way of executing the change. After reaching a decision, they
distribute the revised plans to the relevant personnel in the
production, warehousing, and purchasing functions.
Finally, the personnel of the shop oor, warehouse, and purchasing must react to the revised production plans. The activities of the
shop-oor personnel depend on where they work in the production
process. The relevant work centers in this process are painting,
evaporator assembly, polyurethane casting, automatics assembly,
nal assembly, and accessorizing. Painting must be completed
before casting, whereas casting needs to be nished together with
the evaporator and the automatics, before the nal assembly and
the subsequent accessorizing may begin. The warehouse activities
relate to moving and storing goods, while the buyers activities
consist of revising procurement plans and purchase orders as well as
negotiating expedited deliveries from the suppliers.
After mapping the change order management process, we
identied the labor, material, and inventory resources that were
consumed by the activities. Next, we determined how each
activity consumed the resources (i.e., the resource drivers). Lastly,
we determined how different kinds of change orders triggered
different activities (i.e., the activity drivers). This necessitated
identifying the critical factors that differentiated change orders in
terms of their costs and thus provided the answer to Research

J. Uskonen, A. Tenhi
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423

Fig. 1. ABC model of executing change orders in the case company.

Question 1. Together, the elements constituted the ABC model, as


summarized in Fig. 1.
The identication of the activities, resources, activity drivers,
and the cost determinants was based on 30 days of work
observation, 16 interviews, and a number of informal discussions
with people from different business functions. The resource
drivers were dened by analyzing data from the enterprise
resource planning (ERP) system of the case company. The data
records of interest included standard costs of materials, bills of
materials (BOMs), and routings. The unit costs of standard and
overtime labor as well as the inventory holding costs were
acquired from the nance department.
5.4. Implementation and validation of the ABC model
In order to use the ABC model for cost calculations, we created
a large spreadsheet database for the data on the resources,
activities, and resource drivers. One of the spreadsheets served
as an interface in which the user could input values for the cost
determinants identied in the rst step of the analysis. The rules
on how different combinations of determinants triggered different activities (i.e., the activity drivers) were stored as formulae
and macros. This tool enabled us to calculate the cost of any given
change order and thus gave the answer to Research Question 2.
During this phase of the study, we also carried out 12 additional
interviews to ensure the completeness and validity of the model.

for how much the costs could approximately be. On the basis of
their experience, the workshop participants conrmed that the
results were realistic. In the third workshop, we presented the
ndings to the executives of the company. This workshop focused
on the policy changes based on the results.

5.6. Simulations with the ABC model


Similarly as the ABC model enabled calculating the costs of
changes that had already occurred, it enabled calculating costs of
imaginary change orders. One could, for example, take the information on any change request received from a customer and enter it to
the user interface of the spreadsheet database. The model would
then calculate the costs of accepting that change. This way the
model could be put into everyday use at the company. However, it
also served our research interest because we were able to use the
model to simulate how the total costs derived in the previous step of
the analysis would have changed if the changes of the year 2006 had
been a little different. We focused the simulations on the effects of
when the change orders were received by the production planners.
Using the spreadsheet database, we could easily calculate how the
total costs would have changed, had the change orders arrived
earlier than what they did in reality. We rerun the total cost
analyses with datasets that were otherwise the same as in the
previous step but the date of receipt was one to ve days earlier.
These simulations gave the answer to Research Question 4.

5.5. Using the ABC model with real data


To test the ABC model, we entered a large amount of real
change order data into the user interface of the spreadsheet
database. We used the ERP system of the case company to collect
the information about all changes to customer orders that had
occurred during the year 2006. The sum of these calculations gave
the answer to Research Question 3. The overall sum and the
results on the costs of individual changes were discussed in three
workshops with the personnel of the case company. In the rst
two workshops, we presented the results to altogether 12 middle
managers, sales persons, and production planners who all had
experience in processing change orders and thus had good sense

6. Results
6.1. RQ1: determinants of change orders costs
The determinants of the change orders costs were identied in
the rst step of the analysis. All detailed results and absolute costs
are omitted from this article due to their condentiality. However, the most important ndings can be discussed in general
terms and elaborated with values that are relative to the standard
costs of the products. As for the drivers of the change orders

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costs, three main factors kept arising in the interviews:


The type of the change.
The product that is subject to the change.
The time when production planners receive the change order.
The type of the change refers to the nature of the modication
that the customer has requested. Although the possibilities for
different modications appeared to be almost innite at rst, it
was eventually possible to categorize them in ten generic types.
The categories are listed in Table 1. Some of the changes affect
how the product is built and thus necessitate changes in both the
work content (W) and the production schedules (S). Meanwhile,
some of the changes are related only to the delivery dates and
item quantities and thus only affect the production schedules (S).
The second determinant of the costs is the type of the product
that is being changed. In the studied case, there were seven clearly
distinguishable product groups with different cost implications.
The differences were negatively related to the average standard
costs of the product groups. This was because many of the change
activities consumed a lot of labor resources, which had fairly
constant costs. Consequently, the relative cost effects tended to
be higher for the less expensive products. The products in the
lower end of the companys portfolio were called multi-shelve
refrigerators (Multi-Shelve 1, Multi-Shelve 2, and Multi-Shelve 3).
They were basic coolers with congurable shelves. The higher end
of the portfolio consisted of serve-over cabinets (Serve-Over),
freezer cases (Case), glass door cabinets (Glass-Door), and combination cabinets (Combi). Those product groups included more
customizable options than the lower-end products. Thus, they
were more prone to mid-process modications but the relative
costs of the changes were generally lesser. This was because
Table 1
Different types of changes in the manufacturing of refrigeration cabinets.
Type of change

Description

Impactn

Colorexterior
Colorinterior
Itemadded
Itemremoved
Delivery
dateearlier
Delivery datelater
Dimensionsheight
Dimensionslength
Refrigerant
Controls

The exterior color is changed


The interior color is changed
A product is added to the order
A product is removed from the order
The delivery date is brought earlier

W&S
W&S
S
S
S

The delivery date is postponed


The height is changed (higher or lower)
The length is changed (longer or shorter)
The cooling uids are changed
The design of the automatic controller is
altered

S
W&S
W&S
W&S
W&S

n
W: work content (materials, technical specications, and work instructions);
S: production schedules.

the labor intensity of their production made their standard costs


higher. Also, the customizable options contained materials and
parts that were relatively expensive but often packaged in modular
components and thus quicker to change.
The third determinant of the costs represents the time dimension of the changes. It is calculated as the number of days
remaining until the planned completion of the customer order
at the time when the change order is received by the production
planners. This is, of course, relevant because the necessary
activities depend on how far the procurement and production
processes have reached at the time of receiving the change order.
6.2. RQ2: dynamics of the change orders costs
In the second step of the analysis, we used the ABC model to
calculate the costs of different kinds of change orders. The results
demonstrated how the three different cost determinants inuenced the costs of any change order. We observed considerable
differences between the different types of changes. The costs ranged
from nearly nothing to over 110% of the products standard costs.
Fig. 2 shows a common pattern in making different types of
changes to a given customer order at a given point of time.
The costs differ between the types of changes because the
scope of the additional activities varies considerably. For example,
changes in the controlling logic or in the refrigerant affect only
the installation of the controllers and the evaporators. Meanwhile,
changes in the colors or the dimensions of the product may cause
additional work in a number of different work centers. They also
involve relatively expensive resources of the painting, polyurethane casting, and nal assembly work centers. Another expensive type of change, the addition of a completely new item,
necessitates additional work in all work centers.
Fig. 3 shows the cost differences in the types of changes for all
of the product groups. The relative differences between the
different types of products are quite small. The only major
difference is trivial: the changes in the interior colors are not
possible for the products that have standardized interiors. Otherwise the differences result from standard costs, as the relative
costs are higher for the cheaper products, as well as from product
modularity; the costs are higher for the less modular products.
In Figs. 2 and 3, the time factor of the costs has been xed. If
the timing of the change orders is allowed to vary in the costing
model, then the result is rather intuitive: the costs are normally
higher the later the modications are made. Fig. 4 illustrates the
time-based behavior of costs in the case of an example product.
There are thresholds in the accumulation of the costs because the
modications get more expensive as more work centers have begun
their operations. Another reason for the increasing time-based
costs is the suppliers surcharges for expedited deliveries. They
naturally increase as the requested lead times get shorter.

Fig. 2. Average costs of different change types.

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425

Fig. 3. Costs of different changes in different products.

Fig. 4. Example on the behavior of costs over time.

In certain situations, however, the costs of the changes may decrease


when the original delivery date draws closer. The costs of postponing an order decrease when all of the production phases have been
nished. This is because the production planners and the shop-oor
personnel do not have to take any action at that point, and thus
there is no additional consumption of labor resources. The additional
expenses are only manifested as inventory costs. In these cases, it is
better not to react to the changes at all. Thus, it is critical that the
relevant decision makers are aware of this phenomenon and refrain
from passing the information about the changes to the shop oor. If
the shop-oor personnel see from their information systems that an
item is postponed or deleted, they will instinctively adapt to the
change, and higher coordination costs will ensue.
6.3. RQ3: total costs of change orders
The total costs of the change orders were calculated on the basis of
the records from the ERP system. The data consisted of 1696 change
orders that were received and executed during the year 2006.

The records contained information about the type of the change,


the product that was subject to the change, and the relative time of
receiving the change order (i.e., the amount of days before the due
date of the order). This information made it possible to enter each
change order into the user interface of the ABC model. The model
then calculated the costs, which we summed up to get the total
annual cost. Table 2 presents the result and its distribution among the
different types of changes. Although the total cost represents less than
one percent of the case companys revenues, the managers who
participated in our workshops thought that it was quite signicant
considering the relatively low margins of the majority of their
customer orders.
The costs are graphed cumulatively in Fig. 5. It shows that the
costs of change orders follow a Pareto distribution: 7% of the
change orders caused half of the total costs in 2006. These
changes were mainly modications to product dimensions, added
items, and advancements of delivery dates. Meanwhile, postponements of delivery dates were the most frequent modications
(68%), but they only caused 35% of the costs.

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6.4. RQ4: potential savings in change order costs


The ABC model and the data from the ERP system made it
possible to simulate how the costs would behave if the cost
determinants were altered from what they actually were in the
year 2006. This makes sense because not all of the determinants
are necessarily xed in reality. Although the type of the change
and the product that is subject to the change are typically given
by the customer, the manufacturer may well inuence the timing
of the change orders. That is because the time when the production planners receive the change order depends greatly on how
early customers changed needs are recognized in the companys
front end and how swiftly they are processed thereafter. Consequently, we focused the analysis of the potential savings on the
timing of when the production planners receive the change
orders. We did this by recalculating the total annual costs with
datasets that were otherwise the same as the data of year 2006

Table 2
Total costs of change orders in 2006.
Type of changea

Number of
changes

Share of all
changes (%)

Total
Share of all
cost (eur) costs (%)

Colorexterior
33
Colorinterior
71
Item(s)added
106
Item(s)removed
177
Delivery
48
dateearlier
Delivery Datelater 1160
Dimensionsheight
8
Dimensionslength
35
Refrigerant
58

2
4
6
10
3

5893
13004
38913
1806
25138

3
6
17
o1
11

68
o1
2
3

80442
11531
53949
600

35
5
23
o1

Total

100

231276

100

1696

a
Data were not available about the change orders for the automatic controllers.

but where each change order was manipulated to have arrived


one to ve days earlier. Fig. 6 shows the results.
The results show that a reduction of only one day in the
processing of the change orders would have decreased the total
costs by 10%. This reduction was considered realistic and achievable by the personnel of the case company because they knew
that the processing of the change requests often took several days
in the front end of the company. In fact, the personnel thought
that it would be possible to reduce at least a couple of days from
the administrative process.

6.5. Summary of results and implications for the case company


In summary, the analyses disclosed (1) the main factors that
inuence the costs of change orders, (2) the ways in which those
factors drive the costs, (3) the total costs that can be attributed to
the change orders, and (4) the importance of fast processing of
change orders if the total costs are to be reduced. Apart from
answering to our research questions, the ndings triggered
several policy changes at the case company.
First, improving the management of change orders was made a
priority in the overhaul of the companys ERP system, which was
scheduled to take place in the following two years. In the revised
ERP system conguration, the change order management process
was to be formalized and streamlined in order to reap the cost
savings of the reduced processing times. Also, the vendor of the
ERP system was inspired to develop automated procedures for
change order management. Second, the ndings were used to
motivate changes in the product portfolio. All existing initiatives
to increase product modularity, which were initially considered
very expensive, got support from the estimated savings in the
change order costs of modular products. Consequently, many
changes were implemented to minimize the proportion of nonmodular products in the companys portfolio. Third, the cost
analysis also gave additional input to the cost-benet analyses

Fig. 5. Cumulative costs of all change orders in 2006.

Fig. 6. Simulated savings from swifter handling of change orders.

J. Uskonen, A. Tenhi
al
a / Int. J. Production Economics 135 (2012) 420429

of several suggested process reengineering projects that were


aimed to reduce the throughput time of the manufacturing
operations. Also these initiatives were generally very expensive
and thus deemed very risky in the absence of reliable estimates
about their benets. Not only did the cost analysis provide such
estimates, but the information on how the costs depend on the
timing, the product type, and the type of the change helped to
prioritize between different initiatives.

7. Discussion
This article reports a preliminary exploration to the costs of
change orders. The results are not suggested to apply as such to
other organizations. Instead, they serve as an example of how the
relative costs of change orders are composed and how they behave
in one mid-size machinery manufacturing company. The results
also demonstrate that the ABC methodology can be successfully
used to decompose the costs of change orders so that their
practical implications can be better understood and managed. In
the following sections, we will summarize the most important
ndings as propositions that can be tested in further studies.
7.1. Determinants of change order costs
First of all, the ndings indicate that the costs of change orders
can be large enough to deserve managerial attention. By identifying the most critical determinants of change orders costs,
companies can improve their nancial performance. The assessment of the determinants can be done on the basis of the three
factors that were identied in this study: the time of the change,
the type of the change, and the product that is being changed. In
the following, we formulate propositions to summarize the effect
of each of them.
Proposition 1a. The costs of change orders are nonlinearly
associated with the timing of when the production planners
receive them: the costs are generally the higher the later the
change orders are received, but due to the reduced need for
coordination activities, the costs begin to reduce for postponements when the delivery date draws closer.
This proposition emphasizes the importance of discretion by
the sales personnel and production planners who are the rst
people to deal with the change orders received from the customers. When a change order is received very late, the coordination
costs of executing it may exceed the costs of nishing a product
that is not needed as early as originally expected. Of course, one
must have conducted the kind of analysis presented in this paper
in order to make the right decisions on when to execute and when
not to execute the change.
Proposition 1b. The costs of change orders are related to the type
of the change so that the costs are generally the higher the more
resources are involved in the execution of the change.
This proposition relates the ndings to the literature on
process modularity. In essence, one corollary of the proposition
is that the more modular the production processes are the less
costly it is to execute changes to the technical specications and
features of the products. That is because in a modular process,
individual featureswhich are potential subjects for change
ordersare added to products in their entirety in specic parts
of the process (e.g., Pine, 1993; Baldwin and Clark, 2000; Tu et al.,
2004). This effectively reduces the amount of resources that are
inuenced by the change orders in comparison to non-modular
processes where individual features may be worked on in many
different parts of the process.

427

Proposition 1c. The costs of change orders are related to the


product that is subject to the change so that the costs are the
lower the more modular the product is.
This proposition emphasizes the importance of product modularity. This is not necessarily surprising but adds to the current
body of knowledge in at least two ways. First, there has been
some disagreement whether product modularity decreases or
increases costs in manufacturing (Agrawal et al., 2001; Zipkin,
2001). Our ndings support the former view. Second, the earlier
researchers, who have found support for the cost advantages,
have identied certain mechanisms through which the savings
can occur (Jacobs et al., 2007), but they have not identied the
reduced change order costs as one of these mechanisms.
7.2. Cost categories of change orders
The second observation of general nature is that the types of
change orders can be grouped on the basis of their cost effects.
According to the total cost analysis, 7% of the changes made up
about 50% of the costs in the case company. Analyzing the costs of
the different types of changes can help in categorizing between
costly and inexpensive change orders. Such a division may enable
the creation of specic time fences for the different types of
change orders. Such a practice would enable more efcient but
still mainly responsive operations. Therefore, we formulate the
following proposition:
Proposition 2. Enforcing a common frozen period for all change
orders reduces equally the total costs of change orders and the
companys perceived responsiveness to change orders, but using
different frozen periods for different types of change orders
enables proportionally larger reductions in the total costs than
in the perceived responsiveness.
This proposition contributes to the body of knowledge on time
fencing practices. In the traditional practice, only one frozen
period is applied to each end product regardless of what kind of
changes are made to the production plans (e.g., Vollmann et al.,
2005; Proud, 2007). Our result suggests that it could be benecial
to have multiple different frozen periods for each product. In such
approach, the changes that incur costs earlier would have the
longest frozen periods, whereas the changes that start incurring
costs only later in the fulllment process could have much shorter
frozen periods. In the case company, all changes to the dimensions of the product belong to the former group while the changes
in the colors or in the refrigerant belong to the latter (see Fig. 4).
The idea of using multiple frozen periods for individual end
products is not entirely new. For example, Yeung et al. (2003)
have proposed that setting up different frozen periods for different BOM levels would help coping with demand variations.
Similarly, Trentin et al. (2011) have proposed that using multiple
frozen periods would facilitate the postponement of product
differentiation without costly reengineering interventions to
production processes. Our proposition adds to these ndings by
describing yet another way of using multiple frozen periods and
by suggesting that it could help coping with change orders in a
manner that is simultaneously responsive and cost efcient.
Furthermore, our proposition applies to MTO manufacturing
whereas the earlier contributions have been made in the context
of make-to-stock manufacturing.
7.3. Value of time in the processing of change orders
The third main nding is related to the importance of time. It
is a crucial part of the equation because it is not necessarily as
rigidly xed as the type of the change and the changed product.

428

J. Uskonen, A. Tenhi
al
a / Int. J. Production Economics 135 (2012) 420429

Often only the time of receiving the initial change request from
the customer is xed, and it is up to the manufacturers own
processes how much time is spent before a change order is issued
to the production planners. The process of administering change
orders can be sped up by recognizing potential modications
early and by facilitating a awless and fast information channel to
ensure swift and reliable messaging between the front-end
personnel who receive the change orders and the production
planners who execute them. This leads to the following
proposition:
Proposition 3. The faster is the processing of change orders the
lower are the total costs of change orders.
This proposition complements the work of Trentin and Forza
(2010), who have discussed a similar effect on delivery performance. Moreover, our results quantify the value of swift information processing. Specically, our simulations with the ABC model
showed that, on average, one wasted day in the administration of
a change order increases its costs by approximately 10%. Therefore, the cost of slowness can be calculated for information
ows just as it can be calculated for slow-moving materials.
Earlier studies have demonstrated that this analogy between
slow-moving information and slow-moving goods holds in mathematical models and laboratory settings (e.g., Chen, 1999; Croson
and Donohue, 2006). Our results demonstrate the phenomenon in
the real world. The ABC model of this paper serves as an example
of how the costs of slow information can be calculated in practice.
7.4. Boundaries of generalizability
One way to assess the extent and the limits of the external
validity of results from a single-case study is to identify the
critical factors that made the results possible (Dubin, 1978). As a
part of the process of theoretical generalization (Yin, 2003), these
boundary conditions specify the domain within which the propositions are supposed to hold. We propose that in this study, the
boundary conditions are dened by the existence of the following
four factors: order-specic customer requirements, uncertainty
regarding the customer requirements, non-zero order fulllment
lead time, and the specialization of resources.
Without order-specic customer requirements there would
obviously be no change orders from customers. Although there
could be other kinds of modications, such as engineering change
orders, the propositions would not hold as such. For example,
when it comes to the engineering change orders, the speed of
processing is much less relevant than, for example, the timing of
the changes. However, it should be noted that this boundary
condition does not necessitate the products to be customized.
Instead, changes to the order-specic customer requirements can
be manifested merely as changes to the requested delivery dates.
Such changes can occur in a wide variety of business environments, and we suggest that our propositions will hold in those
environments. For example, it could be benecial for a company
to establish different frozen periods for postponements and
advancements of delivery dates. Alternatively, different frozen
periods could be applied to the changes in the day of the delivery
and the hour of the delivery.
Another boundary condition is that there should be some
uncertainty regarding the order-specic customer requirements.
This is not always the case. If a company makes tailor-made
shoes, for instance, the likelihood of the preferred size to change
during the order fulllment process is very low. This may also
apply to the color, style, and the delivery date of the product.
Meanwhile, in the operating environment of the studied company, both the specications and the delivery dates are highly

sensitive to the vast uncertainties of the construction sites to


which the products are typically ordered.
The third boundary condition is that there should be some lead
time between the specication of the customer requirements and
the delivery. This is not always the case either. For example, when
product differentiation takes place very late in the fulllment
process, the customer-specic requirements can be satised
simply by adding accessories or by conguring the software of
the product. Sometimes such customizations can be done at the
point of sales, and thus the time for the customers to change their
minds is effectively eliminated.
Lastly, the resources used in the production must be specialized to some extent. The more a company utilizes common
components, general-purpose machinery, and multi-skilled workforce, the less there is need to coordinate responses to change
orders. The reduced need for replanning production schedules
and expediting the purchases of order-specic raw materials
reduces the costs of the change orders and thus makes the
propositions less relevant.
We propose that the applicability of the results in other
environments than the studied company depends on how well
the other environments t within the boundary conditions. It is
noteworthy that all of the conditions are critical. For example, if
in some environment, the other three conditions existed but there
was no order fulllment lead time, then the propositions would
not be relevant. Also, it should be noticed that the tness to the
boundary conditions is a continuousnot a binaryattribute. In
other words, the question is not whether or not a given company
ts within the conditions but to what extent the company ts
within them. For example, the longer the lead times are the more
relevant the propositions should be. Although the boundary
conditions are relatively tight and many contemporary business
trends, such as form postponement, component commonality,
and time-based competition, reduce the relevance of the propositions, there are still many relevant industries where the conditions hold very well. They include at least all capital goods
manufacturing, the construction industry in its entirety, and the
production of luxury craft products.

8. Conclusions
Many make-to-order manufacturers strive to be responsive to
customers changing requirements even when the requirements
are modied after the initial placement of the order. This study
demonstrated that the practice of accepting change orders may
incur signicant costs to manufacturing companies. However, the
results also showed that different kinds of changes may have very
different cost implications, and only a relatively small portion of
changes can make up the majority of change orders total costs.
Therefore, attention should be paid to the management of change
orders, and in order to do so, one should rst get an understanding of how the costs of change orders behave. The ABC
methodology described in this article provides a tool for carrying
out the necessary analyses.
The results from using the ABC model in the case company
showed that change orders can be categorized according to their
cost implications. Making such categorization may open opportunities for cost savings without jeopardizing the overall responsiveness of the company. Once the most costly changes have been
identied, management efforts can be focused on reducing them
or gaining control over them. The ways to mitigate the costs of
change orders include establishing separate frozen periods for
different kinds of modications and imposing additional charges
for the most costly changes.

J. Uskonen, A. Tenhi
al
a / Int. J. Production Economics 135 (2012) 420429

Finally, the simulations with the costing model demonstrated


that swift information ows play a crucial role in the efcient
processing of change orders. Wasting a single day in the administration of customers change requests appears to increase the costs
by approximately 10%. The costs of slow information ows should
be understood in companies that strive for responsiveness. If the
policy of a company is to accept customers change orders, then all
change requests should always be processed as quickly as possible.

Acknowledgements
We thank the anonymous reviewers whose comments and
suggestions were very helpful and constructive. We are also
grateful to Eero Eloranta and Kari Tanskanen for their feedback
on the earlier drafts of the manuscript. We further gratefully
acknowledge the nancial support from Tekesthe Finnish Funding Agency for Technology and Innovation. Finally, we thank Arto
Koskelainen and the other employees of the case company who
made this research possible in the rst place.

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