The ability to produce goods according to customers' specifications may be an important competitive advantage, but it exposes manufacturers to the risk of customers requesting changes in their specifications during the fulfillment 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.
Responsiveness to customers' varying requirements has become a crucial source of competitive advantage for many modern manufacturing companies (Fisher, 1997 and 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 difficult challenge is coping with customers who request changes in specifications during the fulfillment 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 specifications 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 difficult 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 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 (O'Brien, 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 in-depth 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 company's information systems were necessary to quantify and model the costs of individual changes. The findings are discussed in general terms, and the costs are measured in relative values in order to avoid the context-specificity 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: first, we review the existing literature on the management of change orders. Then we present research questions that aim to address the gaps identified 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.
Many make-to-order manufacturers strive to be responsive to customers' changing requirements even when the requirements are modified after the initial placement of the order. This study demonstrated that the practice of accepting change orders may incur significant 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 first 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 identified, 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 modifications and imposing additional charges for the most costly changes.
Finally, the simulations with the costing model demonstrated that swift information flows play a crucial role in the efficient 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 flows 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.
