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The Economic Impact of Automation Technology
Aydan Kutay
CMU-RI-TR-89-13
The Robotics Institute Carnegie Mellon University
Pittsburgh, Pennsylvania 15213
July 1989
0 1989 Carnegie Mellon University
i
TABLE OF CONTENTS
1. I~ODUCTION 1
2. THE NEED FOR A NEW CONCEPTUAL FRAMEWORK TO ANALYZE THE ECONOMIC
IMPACT OF AWOMAlION IECHNOLOGY 2
--kchnology 3
bendltsdoutomdkmhchnobgy 5
2.1. The Inad.gwcy d conv.ntloncll oeonanlc theory to 01).il ths bonotlts of
22 Rn badoqwcy d economic mpacr analysis mom& to assess iha
3. THE CONCEPTUAL FRAMEWORK FOR ECONOMlC IMPACT ANALYSIS
3.1. Economks d scope: The economic founddim d the benefits d adomation
7
A. THE ECONOMIC IMPACT ANALYSIS OF AUTOMAnON TECHNOLOGY
A.I. Identlfiylng tho beneftts and costs asockhd with automrrHon
technology
41.2. RducNon In labor costs
A. 1.3. Identltylng corh assoclaled wSth automdlon iuchnobgy
41.1. arutogrc b.nm
A.2. Lhldng tho economk impacf analysis to Dbcounted Cash Flow analysis
4.3. Integration of the varlablltty d market condlionr lo oconomk -act
analysis
5. CONCLUDING COMMENTS
7
10
1 1
1 1
15
16
17
21
23
2 A 6. REFERENCES
iii
ABSTRACT
There k a growing consensus among academlclanr. buslnesr leaders and
government offlclak that the Amerlcan competttlve ptoblem rests centrally on the
riowlng rate of Investment to Integrate new automatlon technology into
InOnUfachrrhg operatbns. Although the source of malor hnovatlons In outomation
technology k horn Unlted States uMrSmer and r-rch cent-, Amsrlcan firms hove
been too slow In odoptlng there technologb. One of the mJor facton underlying thls
pfobktm Ir the kck of an .fonornlc anotpk tsfhnlque spacmcally amed crt estlmatlng
the bsneftts of automatlon technology. Thb paper &en an economlc analyslr
technlque bared upon mS premlse of hcreorsd proboblllty of capturing the market
segmmb ihrou@ economies of scope. T h e paper first demonstrates tho Inadequacy of
current sconomlc anaiy5lr technlquer to asses the bene% of automation technology,
then p r q m e s a new methodology whlch con be Integrated to an expert system to
assess the economk lmpoct of Vorlous types of outomotlon technology.
1
1. INmODUCllON
li k a wdcdocumented fact that me Amerlcon economy hos been lorlng m compewve edge
rdatlve to Its major tmde parinen, Japan In porkular. Between 1970 ond 1987. for example. real
produdon of manufactured products har more than doubied In Japan bbi hos Increased Only by 50
percent In the Unwed State6 Mutoy, 1989).
There h obundont evldencs thot productlvtty grow more rapldly In countrles where
Investment In new plant and aqulpment is hlghest. In foct. i'hefe is a growlng consensus omong
ocodbmkkns. bushess kadem and gowmment oftkkk lhot the Ametican compdtlve problem rests
controlly on the rlowlng rote of Investment to Int%grate new outomoilon technology Into
monufactuflng operdons Wutay. 1989: H q e s et.01.. 1986; Cohen and Zysmon. 1987). Although the
source of major lnnovatlons In automatton technology k US. univenmes and reseorch centers. the
Amerlcan R m hove been too slow h adoptlng Ihere technologies
One of the major foctorr undertying thk problem b the kck of on economlc anolypk technique
rpeclfkol)). ahnod d dmothg the benents of abiotnotlon technology. lhls paper attempts to flll th ls
gop by offerlng an economlc analysis technlque bawd upon ths premke of lncreosed probabllNy of
capluring the morlret aegmertr through economk of scope.
In the subsequent sectlor6 of the paper, It b flnt demonstrated that the conventlonal
economlc theory upon which ihe cunsnt economk -act memods are bored con not awss the
economlc beneftts of automotion tuchndogy. In the moas productlon system. caplial Investments In
new technology cwld uruolly be ) W e d by their potentlo1 to replace human b b o r by rnachlnes to
Improve productlw. In the new system of flexible productlon. however. the economk foundotlons of
the beneflts derhed trcm artomation technokgy are fundamentally dnterent from the beneftts obtolned
from capltol Investments on new technology In the mass productlon system. The use of conventlonal
methods of economlc perfomonce. such as productlvv Improvements. would merely be a
mlrmeosurement of the potentla1 bmefits thrrt could be OMalned from automation technology.
In section two. a ner conceptud tramewotk k developed to evobote the economlc impoct
of automoiion technology. The new conceptual fromework suggests thot the economlc foundatlon of
the benefItr of olrtomotlon technology is the economler of scope bored upon the premh of shorter
kad fmes, Increased llexIbllHy h production. and knprovd product qualm/.
In tsctlon three, It k demonmoted that the economk impact of outomotlon technology.
conrldered 'htonglble' and therefore left UnqWnMed In conventknol OConomkr. can be evaluated
through potentkl gc4i-s in hventoty c&. d e r revenue. and lower opsr&hg and lobor coats due to
Improvements h lead tlmer. fbrdblliiy In productlon. and product quallty. It Is suggested that the entlre
anolysls con be Integroted Into a stondord econmlc justlflcotlon technlque such os Dlscounted Cash
Flow onolysls. to make It undentandoble to company monagers. accountants. and economlsts. An
2
expert system can then be developed to aid the users of outomdon technology to ldentlfy the
beneftk they may obtaln from tk Implementailon.
Once the mode ot economlc hnpoct analysla of automatlon technology developed In this
paper k tested, me ultimate gwl k to develop an expert system to achieve the foilowlng:
1. prior to the Integration of a new technology, the ercpert $#em wlll enable a company to
Mentlfy the areas h the monufacturlng p r o c e ~ In whkh the use of automoWon technology would be
ecmomlcally M e .
2. If the company k Interested In dedoplng a new technology, the oxpert system wlll gulde
company managers to m a k e a m e r allocatbn of the rsroarch and development funds Into areas
whkh ghe the best return on Investrmnt.
3. me expert system wAl enable companles to mdte a better rpeclflcotlon of the general
range of conditbonr where new technologles can generate occeptable returns to Jurtlfy thelr
Investment.
The arguments ruppomng the llne of r-nlng ret fmth In thb paper need to be emplrlcalty
verified by further research. Thk effort. nevertheless, la meant to provlde a new methodology upon
whlch Mure economk Impact stwiles of new automatron technobgy rmy be bated.
I
2. THE NEED FOR A NEW CONCEPTUAL R A W W O R K TO ANALYZE THE ECONOMIC IMPACT
OF AUlOMAnON TECHNOLOGY
In recent years. a growing b d y of lheroture has developed on tho fundamental chonges In
the productlon process tacllltated by the new automatlon technokgy. The research In thls area,
however. tends to ernphasbe efther dlrect labor displacement effects wllhout conrlderlng me changer
In the nature of work (for example Ayrer m d Mlller. 1963). or tends to be advocacy type of efforts
whkh assert the exlstence of certaln beneflts from automatlon technology *out explalnlng the
precbe source of there benefits (Hayes et.01.. 1988; Cohen and Zyunan, 1987; Jellnek and Goldhar.
1984).
The flrst economk or Mcktal Impact studlet of automation technology overwhelmlngly
empharlzed labor displacement Issues whlch unfortunately encouraged the formation of a hostlle
aiiltude toward automation technology paltlcularly on the l abor Me. Whlk tl k true that outomdon
technology replaces humon lobor dlrecth/ Involved In the production ot m r on the factory noor, It
creates more Job0 h processes Involved h producllon of goods. Autornotbn technology transforms
the nature of work trm dlr- conmbutlng to me produclion of nnkhed goods to conmbuting to
prductlon Indirectly by generatlng lnformatlon to reduce uncertalnty In decblons related to the
productlon, exchange, clrculdon, dlstributlon and consumptlon of g o d s (Cohen and Zysman, 1987).
Consequently, more jobr are created In settlng up the production systems. In deslgnlng the products, In
R&D efforts, and h flnonce, markethg. and dlshlbutlon stages of produdon. Dlrect human labor In
3
productlon has neverthelsar been reduced for repemlve and hazardous tasks where dlsplocement b
more advontapous for labor In the long term.
One of the key arguments of thb paper Is that the lock of on economlc onalysls technlque
speckally almed at cluestlng the bene* of otjiomatlon technow k the major cause d the confurlon
observed In the prlor rtudles of outomdon. In the next sectlon we dlred the attentlon to the
Inadequacy of conventlonol economic theory to assess the bendis of outordon technology.
21. Ih. hadoquocy 04 com.ntlond ecanomlc to QWOT tho bo- of artomatlon
tochndogy
T h e foundations of tradltlonol economlc theory were developed durlng the tbne of the
industrial revoktHon when moss productlon and cwuumption prevolled In the world economy. In
me system of muss productlon. the rnaJor prcductlon strategy to expand proffts wos to Increase the slze
of the toid target market. The major dllemma a flrm faced to meet compsrmon wos therefore to lower
untt costs to expand the size of the morket for tts product(s). The unlt costs were lowered through
economler of scale 0,s.. produclng an hcreorlng quantliy of the same product) and b y bwerlng labor
and row moterial c& through capltol Investments. The economic performance of a firm. on hdustfy. or
the larger macro economy was therefore evaluoied by 'productMty' whkh measured the Increase In
output relothre to o untt lncreare In copttol, lobor and raw materials.
The flnt recognked methods to Increase produdvlty were:
I) To Increase the divlslon of lobor. ond
ID To delegate repetmve task to machlnery.
These methods became economlcol 6 hlgher outputr tourclng In scale economles. Adam
Smlth's fomws dM&n of lobar and 8s heightened productivity from petformlng o dngle repembe task
could only be achleved by lncreoslng the dlvlrlon of labor and speclalblng Jobs Into repetttlve tasks
whlch could then be replaced by mochlnes. Copltol Investments In new tech- could therefore be
juWled by thek potentlo1 to reploce human lobor WtM machlnes to hc- productfvtty.
RnaUy. productlvb lmprovefnents through the hcracsd me of machlnery wos only pordble
through furlher rtandor&atlon of products whlch led to a rtbstontlal decline In untt productlon costs.
Gken the emphads of lowerlng the untt costs of rtondordbed products to expand lhe total target
market size, producnvw was pecr&ny rdevont to measure econorntc petformonce In the system of mass production.
Once the world markets began to saturate durlng the 1060s and the 1970s. n become
lncreodngly cleor thot man productlon of standardbed products was no longer prontoble slnce the she
of the total torget market could not be expanded. At the soma lime. wlth an Increase In lntematlonol
ccinpetlkn. the number of manufacturers altacklng a market mrltlplled. rewmng In a large number of
dlfferentiuted product venlons on the morket. The anphasls to galn the markets hlfted trom econom~e~
4
of scob to economies of scope. That k. manutaduren produced a variety of products to satisfy a far
greater rang% of market needs by Increaslng the copaclty to manufacture goods cheoply In small
batches. Even If the *e of the total target market could not be hc-d (or even If the she of the ple
could not be expan-. economler of scope arcettdned that the proboMw of actuulb capturlng the
targeted total market could be Increased through product dlfferentlatlon. New trends toward
htsmatkndlzaiion of the world economy dso Increased compermDn whkh, In turn propelled the need
to shorten the perkd of tlme necessary to introduce a varlety of products to the market In smoll
batches. As orto can m, these trenb In fkxibb production were In contrast to the way flrms
competed In the system of mass produdlon by producing kxge quantmes of shUar products. The new
automatlon technology consquentry became crvclal In productlon rlnce It Improved product leod-
tlme. product qualliy, ond the capablllly to Increase product dhrarslty.
Once the I U ~ S of the economic system stalted to change, one expected to o see a change
In the performance -ures of the economlc system. WhYe the measure of econornlc performonce
through labor, raw material, and mtdtlfactor productlvlty were perfectly relevant In the system of mass
productlon. these technlques were Inadequate to measure econornlc performance In flexlble
productlon.
The key polnt Is that, the aconomlc foundations of the benetlh d e w from new automotlon
technow are fundamentally dltferent from the benefh obtalned from capbl Investments In the mas
productlon system. The use of conventlonal methods of economic performance, such as productlvlty.
would merely mlrmeasure the potential beneflh that could be obtalned from automatlon technology.
The maln beneflfr of automotlon technology. such as reduced bod tlmes. faster response to market
rhlfts. and Increased fbxlblllty In product dtflerentlatlon. do not enter into the calculus of the
conventlonal mearures of economk perfomunce. It Ir no wonder mot productivity rtudles of lnformatlon
technoloW conclude that user flrms have not experlenced productlvlty galns from automatlon
technology and that the lnvwtment In other tachnologler would be more beneflclal (Loveman. 1988).
Flmrr whlch were the early UWHI of auiomotlon technology do expmbnce Increases In employment. The
conventlord measure6 of econmlc performance whkh regard redudlon h labor costs due to capkal
Investments os a podtlve change. ociy mislead us. The recent producwvtty mea- developed by the
Bureau of Labor statlrtcs (Dean and Kunze. 1988). on the other hand. conrlder technologlcal change
or mumfoctor producthlty 01 the unexpldned rorldual h Ovtput mowth wlthout prwldlng any -ure
of how rruch of the Increase In nwtitfoctor produCmmy could be aMbuted to automatlon technology.
Let us revlew the bodc COlCUlatlOnS of productMty to support thb argument, The most
common measures of productlvtly CalCUlote th% growth h output due to growth In capRal and lobor
Inputs. The rate of growth In output p e r hour of all p e w m employed In a firm DT Industry b recognhed as ' labor productlvtty'. and the rote of growth In output per Unit of CapltOl services Ir recognked OS 'copItol
productlvlty'. In recent yeors. the Bureau of Labor Statlstlcs 0 has staiied to measure muItlfoctor
5
produdvity by calculating the pMtlon of growth rate In output that cannot be accounted for b y the
groWm rate of comblned Inputs of labor and capltol and k therefore attributed to techno~lcal change.
me term nomad as mullifactor productlvilv (or what BLS recognizes os the beneflt derfved from
technological change) Lr actually the unexplained rerldual In the calculblon. BLS does not e v e n
prwkk o msthod to ambutlng c h o w In the gmwih rate of -ut due to ~pecfflc tschnologler such
as wtumalion. These fmuktlonr have been dmlved from the production fu&n Q = A Wls. where
A reprewrnh ths state of the technology and 0, K, and L denote output, labor
rerpectivetyv. Nowhere In thk cakulotlon w n the potentlol bsneffh of automailon technologl such as product quaNty. the hgth of lead h. product d l ? f e r e n ~ , and flexblah, bs evaluated.
capital and
The convantlonal methods of msasurlng sconomk performonce served us well when the basic
d l l a m faced In the produdlon process was to reduce the unit cwtr through economles of scale to
w o n d demand for a standardbed product. InfiedMe manufacturlng bmed upon the aconmI65 of very
large scale productlon of standardized products, however. severely Umtts the number of product
venlonr. Retwllng of a @ant or a productbn Hne to meet the customer demand whkh a competttor Is
challenglng. utuohy m e a n s the sacrtflce of anolher market segment unless new plonh are added to the
manufacturlng copaclty wlth substantlal costs. The long lead times from the conceptlon of a new
product to production reduce the ablUIy of the flrm to meet cwrpsrmOn on a timely bask. Automatlon
of manufaciurlng operatlorn Is. therefore. oaolutely n-ory to compste successtulty In th% system ct
flerdble production.
What La needed mort Is the development of new meawes of economlc performance whkh
can evaluate the economlc ImpDctr of automotkn technology h the system of fiedble productlon. In
the nexf rectlon. we revlew the current methods used to assess the ecommlc benefits of outmatlon
technology In U.S. flm and suggest that these technlques are hetfectlve In evoluotlng the economlc
beneffts that can be obtalned from automulion technology.
22. Rn Inadoqwy d .conomlc mpoa malpb mothod# to .wM. M. b.mllh ol
automdkn hthdogy
The Oconomlc Impact analysls ah-& at Megratlng new technology or equlpmsnt Into the
manufacturing operailom of US. thmr Is h the form of a cap4tal Investment procedure whlch typkally
allocates currant rerowces In the prospect of Mure returns. The prlnclpler of thew, technlques were
lald down In 1934 when labor wos the chlef varlable cost ond when mas productlon propelled U.S.
Industry to world domlnarce. These techniques simply rhapscl and generated declrlons h such a way
that a requlred level of flnanclal macttveness was achieved by sh@y focusing on short term flnanclal
goals and respondlng to the lmplled needs of a forecasted future by reduclng lobor costs.
Over the last 20 p a r s . however. dlract labor Corn have been reduced to about 10 to 12% of
the total prcductlon costa (Kutay. 1989). The malor attributes of many of the new technologies are, tor
6
example. long term strategic gwls such 02 the product qual%, dellvery speed and reiiablllty. and the
rapldtly wlth whlch new produds can be Introduced to the make?. Yet the p o l of b b o r from whlch the
rmlngs would come to justify the investment on new technology has dwlndled. Glven the focus on
reducing labor costs. strateglc factors cannot be quonrmbd wtthln a trodltional economlc a n a W
Therefore, capltal hvsotment on tuldamentally Merent tachnobgler Ir much more dMcult to JurW In
econornlcal tern. Retahlng the edrtlng manufocturhg equipment conrequentky peIfoorms as a better
altemdve than Investing In new technology.
The reluctance of many U.S. conpank to adopt new tebchndogles, therefore, portly reflects
the habllfh/ of tradmOnal a c o m k analysis procedures to evaluate Me term strateglc beneftts of
automation technology. Firms whlch could achkve subtantlol beneth from new technologler moy fall
to ULB them A m p l y because Mere k no acceptable methodology to quantify the return on investment.
Edstlng Meroture, when dercrlblng the advantages of new automation technology. suggests
that a large nurrixr of 'htanglbkr' benefltr extd whlch, by impllcotlon. are unquanthlable and thus are
precluded from any rigorour economic evaluallon (Cohen and Zpnan. 1987: Meredith. 1986). Recent
reporta on the progress of automallon h Amerkan manufacturing <Buslnsar Week, 1987. 1988) rugged
that top rmnagement often accept the abtormtlon technology as bdng a 'justifloble act of faRh on a
strateglc technology' and Implement them without the necessary understandlng of the lmpllcatlons
crltlcat to their successful operatlon. Thls approach stti1 p o s e s rerlous problems. Flrst. olthwgh R k less
lkely that such strateglc Investments WUI be turned down by standard procedures becaw they do not
meet tradttlonal financlal cMer!a. lt tends to be hlghty dependent on a ldectlon process that separates
'strateglc' from 'nonstrateglc' Investments. Unfortunately, most US. companies treat the choke of
manufacturlng technology as a 'nonstrateglc' krue (Hayes et;al., 1988). Most proposals of the
Investment on new equipment, therefore, end up getting evaluated wlthln the standard budgeting
process.
Second. the process of outomatlon through the use of automatlon technology represents a
long term commhent, with lmplementotlon extendlng over mvoral y w n . The lock of quantlflable
obJectlve$ prevents progress from belng rnonltcfed in financkl terms whlch are understandable to
management. WWhout defhed finonclol obJSalves. any dkruptkn can be used to abondon the new
technology whore economic b e n e f i t s are reallrable In the long term. Koplan (1986) suggests that
problems arlre because the beneTlts of new technology are not deflned in flnonclal terms that top
management can understand. American machhe tool wppllen. for example, are not fully commHted to
the produciion of new robot systems befause they perceive that If thdr potential customers cannot
clearty identlly deflned economk JuMfkatlons then they wll not purchase such systems (Amerlcon
MachlnM. 1988). T h e r e difficulties can be overcome If a new conceptual framework whlch can quantlfy
the 'intanglble-strategic' beneflts of automatlon technology Is developed and is integrated In a
7
standard economlc analysls procedure acceptable to company manogerr, economlsts. and
accountants.
S. WE CONCEPNAl FRAMEWORK FOR ECONOMIC IMPACT A N M Y S l S
As polnted out In the prdolrr b n . the bsnents dertved from new automotlon technology
are fundamantdly difIffent from the bmeflts obtalmd from capltal InMBtments In the m a s prodUCtlOn
system. Uslng the conventlonal methods of econorrdc performance would only mlrmeasure the
potentlal benentr thaf could be obtalned from new automation technology. The maln beneflts of
automcrtlon technology such of reduced bad tl-, taster response to market r h h . and Increased
fkdblllty In product dmerentlatlon 01 well 01 Its sl!Jnl&antly enhanced capabllttles to produce complex
products of hlgher quallty and relloblllty levels. do not enter the calculatlons of the conventional
measures of econmlc performance. In lhlr sectlon, a new conceptuol framework whtch can reodlly
htegrote the benetlh of autMnawon technology Into the calculotlons of the Improvements In economlc
pdmance . k developed.
3. I . Eeonomkr o( =ope: Rn econank founddm d M. brndlh d d o m a i l o n technology
The economlc foundation of the automotlon technology k the economles of scope as
o p p d to economler of scale whkh nsceasbtes a paradlgm shWt In the wny we measure bCOnOmlC
performance, Economles of scope are sold to exist if a single plant can produce a varlety of products at lower unft cost than a combhatlon of reporate plank each produdng a rhgle product at the given
level of output. More fomwrlly. W e are hcrwslng returns to rope to a plant producing X and Y
cgc.v) < Crn.0) + C(0.Y)
where X and Y are the glven lev& of output of each product and C(.) are thelr respective
cost functbns.
Automation technology hos the potentlal to make tt Just as cheap to produce say fitly
dlfferent verslons of a product 01 It Lr to produce Rfty ldentlcal pieces of a @ken product. The
fundamental production problem faced by flm today Is to capture different ragments of a broadly
defined market WtM different tortes. It, for example. refrlpraton corwtlhh 0 brocdly deflned motbi, a glven flrm may produce a number of different medals soch of whlch Is abed at capturing a rubdection of
that broadly defined market for the firm. lhk can be made pomlbk, by producing a certain model 4th
the athibutes whkh no other flrm corrpetlng for M e -me market can prodEe. In thk new system of
l lsxbb production, Imnr no longer confront a rltucRlon of rlngle unlforrn demond for a commodity called
refrlgerator (as It was under the mass productlon system). but face dtstributed demands for dlfferent
++pes of refrigerators: some with Ice makers, mne with double d m . some powerl.ul, some small and w
on. Offering a Standard model which only comes In whlte Is not likely to rutRce In capturlng the entire
maNet for refri,praton. In the flexible productlon system. as the consumer tostet become dlverslfied
8
and more complex, rmnufocturen mist Mentlfy the qments of coruumer demond wlthln whlch taster
and purchasing power are rebtiwsty unlform. They must then offer thosa segments the products that
closely match each ~ m e n t ' s expectanom.
The markets me no longer as predictable as they wad to be under the mass production
m. They have become more um!toln and complex. In order to quanlfy the benefb derived from
autwnotlon tech- h thh new system of prductlon. we have to m e away from the tradfflonal
concept of 'ProdUCY In conventlonal economlc meow. Productr should not be defined os physical
COmmodmeS but should be conceptwlbed os a bundle ot chorocterlrtlcr sought after by consumers.
Gohg back to M e Wrkprator exomple. mere chamcteerhtlcs may be $be, color. lnterlor room. exterlor
Image. rellobllw. and energy consumptlon. We, therefore, can conceptualbe a product as an n-
element vector:
X - [xl, G!, x3, ....., xn)
where 'fl k the product choracterlrtla
In the same ndlmenslonol space, a Qben consumer can be conceptualbed tn the form of a characterlstlca vector:
C - (cl, c2. c3. .......,, cnl
where 'cII b the chorac tMa the consumer seeks In a product
ll Y-c In the case of a given consumer. the probobllw for thk consumer to buy the product
should be I . n x 1 ~ . the probabllt+f ot o sole to that consumer k k thon one.
Given the conceptual framework above. we can measure the performance of a flrm not by
growth rote of output rebtlve to a change In labor and capitol (os k the cose In measures of
productlvlty). but rather we measure ¶he p&onnance of a flrm through the degree of product
dlfferentlatlon. Nr In turn detemJner the probobllHy of copturlng the tsgmentt of the market for whlch
the flrm b competing.
We can express thk dOnonshlp more f m l k Wm a rtochortlc functlon R?4) dedgnatlng the
probability of capiudng a market segment
where a = XI - cI c 0 for every Rh characteristic In the n-space. SI k vl - CI < 0 for every I lnthe
n-space, where yl Is on element of the product choracterlstlc quantlty vector y of the next most
9
cornpetitbe product to Me product question. The partial derhdlves of F(M) are negative wlth rerpect
to a but p M v e WtM respect to 8 and R and e k the mor term. Thk formula wggssta that the firm can capture the entlre market by reduclng 3 to zero or by
produclng as many custombed vuletbs of the products oa there are potentlal customers through
outomotlon tehnology. The degree of the mlrrlrnkcrtlon of a. or the probablltfy of wpturlng o market
mgment ts detmhed by the degree of flexiMHy In product varlatlon whkh b In turn dependent upon
the use of automation technology. If Z Is the number of models or vorldes of a g b n p r o d u d that are
poduced by the firm, me yno l le r the Z the larger me &e of the consumer p o p u m n the flrm k trylng
to appeol to. the larger me varhblltty of tartas In this particular consum poptiidon, and therefore
the undler the prdMMnty of copturlng lb c o m u m e m h mot porkular popuhtbn.
Thls conceptuol tomework atcertolns that Increoslng product dWferentlatlon Increases the
probablllty of capturlw the market segments whlch In tum lmpmves the economlc performance of the
flrm. Thk new evoluatlon Mnlque based on the dsgree of product differentlation Is a more etfectlve
way of measuring economlc performonce than measuring p&ormance through productlvlty by
empharlzlng the obllliy to lower the unlt cost of a slngle product. The new conceptual framework
ascertalns that the probablllty of capturlng the targeted total market Increases wlth product
dlfferentlatlon and breaks the role of product dlfbrentlatlon out of the bounds of being rtrlctly on attempt to Increase mles. T h e ablltty to Increase the number of product venlonr. on the other hond, Is
constrained by the degree of lntegrat!on of automation techndogy to the production process. T h e less
the f lm uses automatlon technology. the fewer the number of product verslons It can offer to
consumers, therefore the less the probablllty of copturlng the market segments and ts economic
p e r f m c e Wlll be lower.
By 6hMng the emphasb from economies of swle to sconomles of scope, the new conceptual
framewok suggests mat the economlc hneflts of autormtlon technology are:
- to Increase product dlfferentlatlon
- to shorten product Iwd limes. and
- t o Improve prodUa qwllty.
Wlthln the wisdom of conventlonal economlcr. however. M e mOln beneflt of new technology
ts almost always recognhed as the abnlty to lower unlts costs to Improve producthmy. The bene% thd
can be dedved from automatlon technology are therefore ovekeked os 'lntonglbles' ond are not
hcorporoted Into an sconomlc mpact onolysk.
10
4. THE ECONOMIC IMPACT ANALYSIS W AUTOMATION ECHNOLOGY
We suggest Mot the economic beneffts derived from automation technology considered to be
'htanglbles' and are overlooked h convBntlomI economics, can be quontlfied and Incorporated into a
standard method of economlc evaiudon.
me beneRh of artomotlon technology k i u d e brcreosed lledblilty, faster response to
shifts. improved poduct quoltiy, and reduced bod times. There benefits represent a comparative
adVOntage whkh may increase the compdWenss of M e firm h the markets. Maklng tha correct link
beiwssn the benefkfs of automatlon technology a d the trodmonai categodes 01 accountlng con
remedy the problem of quanmkdon.
One way of quaniltying strategic benetltr k to consider the vaddons in inventory which can
be highly Influenced by, tor example. reduced lead times. Another way of quantitying beneftts may be
through soles expandon and revenue enhancement. Some of the bensflts obtolned from reduced bod
time. for exompie, can be incorporated into on ertlmate of rovlngr from inventory reductions. The
procesr flexibiilty, better product flow, hlgher quatlty, and better cchedunng, cut both Work in Process
(WIP) and finished goods lnvsntory levels. The reductlon in avsroge inventory levels provldes a large
cash innow which con be captured In o Discounted Cash Factor (DCQ anotpls. Better quality products
can be quantlMd through reductlons In the defect rote, waste. tcrop. rework, lnspectlon stations and
Inspectors. and reductlons in worranfy eqmrrre. Reductions In 'Accoonts Recetvabie' can also be ured
to quantity the benefits from better quoitiy products rlnce the lncldence of customers who defer
payment until quo1H-y problem are resolved can be eliminated by producing better quailty products.
Since the new technobgles also hove me potential to lncreose saies, increased cash fiow from me inventory reductions villi continue In ail tuture yeon b y nduclng the cost of soles. The moJor impact.
however. will be on morketing odvontoge and on the obiilly to meet customer demand wMh shorter
bad times and to respond quickly to changes In demand whkh can be estimated from post marketing
and rates dato. The generation of extra sales due to stmtegic bemefits. such a$ reduced bod limes,
taster response to market rhitts. and Increased tlsxblltty wlii resutt in an increased contribution to
revenues.
T h impact of reduced product forts On p D d U C t prices ond market mOre con be estlmoted
from past soles and marketing p d o m ~ n c e of m% product. Declhing cosh mw, market share. and prom
mrgins may also be possible tf the firm decides not to hvest In automawOn technology dnce there b
always the ilkellhood mot some cornpefflon may start using the new technology giving them the
competitive advantogo
Savings In the cost of spoce. etther through square-foot rental value or the annuaihed cost of
new constn~ctlon. is another benew Item which w n be computed in terms of the opportunity cost of
the spuce.
1 1
ldentlflcatlon of benefits wfthln the standard occountlng categodes of sales. Inventon/.
operdng costs. and labof Corn enobior t h d r quantlflcdbn since data on these categolles should b%
normally omliable In the occounthg r d of a flnn
The conceptual framework, whlch we wlil develop In m e detail in the rest of thls paper.
hmly d M from the conrentkmal methods of .conomk hrpoct anolysk used In the current Judlfkatlon
of new techndoglss. Current methodr only condder pmslble reductions In cash already Incurred Ulng
the extrtlng technologlea. Our proposad framework condders revenue enhancements due to strategic
benefits Iuch as reduced bad tlm and hcrwred WMW as well as cost redudlonr.
Wng convenI4ord methods, hvdment on new technology k typkally evaluated agahst a
statusquo altemcMve that assumes a contlnwtbn of cunent m d e t share. dllng pke. and costs A
correct alternative to Investment on new technology should abo conslder focton such as decllnlng
carh flows, market share, and prom mrglns. Once a new technology becomes cornmerclally
appAcaMe. even ll one company decldet not to Invert in It. the Ukeilhood k that some competbors wIII.
We Integrate the posdble lmpocts of chonglng market wndmons and competitor behavbr into the
economlc Impact anolysis via a computer progrom that rlmuloter the proboblllstlc occurrences of
atterncrttve lutures. Thb progrorn readlly interacts wfth the sconomk analysis program and provldes 0
magnitude of bene* under Merent abmatlves.
We rugeest the framework depicted In Flgure 1. Depending on the lype of robot or
outornatbn system. certaln cost or beneftt categories Identllled In the framework con be ornltted or
expanded upon.
4.1. Idontifylng thm bomlltr ond catr ms0date.d with actwndion hchnology
Thb stags includes 0 detdled ttomhotbn of all the bmad scale ben%fftr ond costs ldentlfled In
the first stage wlthln standard accountlng categories and thetr quanWlcatlon urlng the sxlstlng
occountlng records of a fkm or rnanufacturlng plant. identlficatbn of costs and b e n e f i t s wlthin the
standard accounting cat- enables thdr precke quantiflcatkn dnce data on thwe Item should
normally be available in the accounting records. - A, Reductlon In inventq costs:
Redudon In Inventory cOm h a benefit item whkh h usually overlooked In most economlc
Impact studlet. T h e new d o m a t h technology. on the other hand. offen the posrlblllty of reduclng
stock levels In work-In-process (WlP), flnlrhed goods and raw moterlol Inventory due to greater
predldoblltty of the production prweo. faster thrOUghod times and due to the reductlon of scrap and
rework. Colcuidng the flnanclal d n g s retuitlng from a ghren inventory reductlon Is more complex
than normally assumed. Tne only benefft item that has been Included h prbr dudlea has been the dlrect
12
SIMULATION OF ALTERNATIVE KXPXZT COND IT I ONS
* v
I
,
Inventory Sales reduct ion enhancemen
I I
Flgure 1 - me conceptual hamcmork
13
cash ravlngr (See for example Kaplan (1986) and Meredtth (1985)). Wlthln our conceptual
framework. we suggest me lnduslon of the benems below:
a. Direct cash savlngs: Any rovlngs In Inventory corn due to the introduction of a new
tschndogy should be valued on the basis of old technology rlnce the exlstlng kvek of stock are
produced by extrtlng manufodurlng pioc-. Savings In the raw nwterlal stock should be considered
not anly in row materlat Inventory but also In WIP and nnkhed goods Inventory. Rsductlon In those
hventory Iterr6 rhwld atso be r e M e d to the direct labor content of WIP and tlnkhed goods. an Item
whlch b dkrwpded In prror skulk. shcs meW, nductlonf oppear In the balance sheets as an Increase
In cash rcrther mon an h- h profMs. no addltonal tax eqaense should be Incurred.
b. Orsrheod savfngr: Slnce the reduction In lnventoiy lsveL wln #or the book value due to a
redudon In flrred and varbble oVemwds, a decrease In prom will be Incurred. Slnce the decrease In
profits k purely a reduction on paper, the tax IlabtlRy wnl also fall whlch should be Included 01 a beneftt
In the btonomlc Impact analysts.
The reduction In average Inventory lev& represents a large cash Inflow ot the tlme the
automdlon technology becomes operational. Automotlon technology, on the other hand, reduces
%rap and rework, Increases the predlctablllty of the produdon process. and shortens lead tlmes. These
Im~ovemants permlt a major reduction h average Inventory kvek. The following La a lkt of b e n e f l t s that
rhould be Included In the economlc impact analysk:
BENEFITS MERlOD OF WANTIFCATION
Shorter lead time
Reduced delays
Shorter lead time
Shorter lead time and improved orderlng pollcy
Improved qualiiy
Reduction In WIP due to shorter
leod timer
Reduction In m b i y WIP
due to the mldance
of unplanned shortages
Redudon In raw rnatetialr
Inventory
Reducnon In nnlrhed goods
Inventory
Reduction In unwanted stock
due to the avoldance of
14
Improved quality Redudon In obsolete stock
ldentmed for dlrposal
Improved quality Reductlon h rporsr stock
Improved quallty Reduction In r r a p moterlol
Lower tax HabllHv
Rsductbn In flnbhed poduct
stock.
ovemeod d n g s due to me reductlon of Inventory.
B. Sales enhancement:
A major advantage of Mltwnatlon technology Ls the generaWon Of extra sales because Of
strategic benefits. such as reduced lead l imes , faster response to moket shlfk. ond Increased flexlblllh/
reruttlng In on Increased conhlbulion to revenues whlch ccm be ldsnrmsd through sales enhancement.
The method of colculotlng the addfflonal contrlbutlon ph’narlly relate.$ to me question. ‘What ‘x’
percent of Increased sales con be ex- from o percent reductlon In say leod tIme7’ Mhough t i
Ls dtfncun to determine me oppmprlute value of Y to Insert In the obwe quertlon. tl ls olso trus mot an
estlmoie should stlll be made of the potential hweare In 6 d e s Thk &matron can be made by uslng be
exlstant lnformatlon on soles lost due to reJection. late delkery. or not belng able to meet customer
needs In produd rpecmccrtlon. Another woy to & M e soles enhancsmt h to forecost me growth In
mafket share due to lower prlces becam of a reductlon In product c&.
Automotlon technology reduces dellvq tlrnes and hcr- the Wablllty of a firm wMch moy
Improve the sales record and prevent potentlol sales from M n g lost. Soles lost due to dellvery tlme.
Wectbn of products. lower quallty can be obtcllned from the marltetlng data. Morketlng can also be
used to provide an ertlmote of the percentage Incr- In sales due to reduced dellvery t h . The
ha- h des can be sadly converted to a rductbn In ovefheod c0m.
Automdon technology ako enobk the h e r bunch of new products to the market and
therefore Increase sales due to mafket penetratkn. Whlle occurate ddhr ertlmates of such a sales
Improvement Is more dlfflcult to obtaln. ertlmater can be obtalned by anolyzlng the marketing data. T h e
following Is a Itrt of beneRh due to rdes enhancement thoi should be Included In me economlc Impact
analysls.
1 5
BENEFITS MNOD OF WANnFICATION
shorter iead time
Shorter dellvery time
Improved quailly
Improved quanty
lncrwsed flexblllty
In product
Increased market share
Increased rder due to capoctly
Incnoss and shorter d - u p
n m
Sales lost due to n j a d l o n s
Soh M due to Incorrect
Parts
Sdes M due to the
dlrrcrthfactlon d customer needs
Potential hcreose In sales due to
more predre products based on
customer d
Potentla1 Increase In saks due to
Increased market penetration
and more varlabls product mb:
Potent!ul Increase In sak6 due to
lower prices.
P Automotlon technology reduces labor costs In ihe design. production ond malntenance
stages as well as In the supenrlslon ond lnspectlon of the manufactured cornponenis or products.
Abough lobor costs currently constltute 8 to 12% of total production costr. the magnitude In wlngr
should still be Included In the econwnlc Impact anaW..
1 6
Automotion technology oms the potentlal to reduce labor costs In the design. producMn
and rnalntenonce stages 06 well as in supervklon and inspection of the components. Slnce the
technology offers lhe potenilal to produce compenents in precise accwcy. rupervlrlon and lnrpedion
corn should be rlgnlglcantiy reduced. The bene* due to lower labor costs have been Identified as
redudon In:
- dlrect productbn labor costs d w to M e r &-ups.
- support lobor coltt due to supervision and impectkn.
- labor corn dua to wemnm paymmls.
- labor Corn due to n c r u h n t and trahlng.
- Inventory control labor cwtt due to lowsr WlP and flnkhed good inventory.
- labor casts due to todlng.
- labor costs h mandffitudng deslgn.
- labor costs due to molntenance.
- operathg c0m due to englneerhg and design
- l a b cwtt due to the reductlon of flttlng and a s e r k i y requlrementr.
- labor coda In prototype production.
- l a b o r cwts In fruterialr hundllng.
- labor costs in fhrlng.
- production control cwts.
It k Important that the potential UDer of a new technology b aware of all the coats osxrclded
wkh the new technology, M that they can be odequateiy allowed for. Costs rhould be dlsilngulshed
based on whether the costs Incurred are 'oneoff type or 'ongoing' costs to be able to Identify the
tlming and mognltude of cash flows. For example. the hMal cost of custmhing softwore should b%
wporoted from that of the software proaramrrsn required to keep the system operollonai.
The most immediate cost rsductlon In the Introduction of new technology k the ravings in
labor costs. However. tt b equaiiy Important to identlfy depamnents where extra stcn'f rmy be needed to
operote the rysfem. Mwf automation technology. for sxampls. involves the development of CAD
software with the need for computer suppart sta~Y to be considered.
lnrtaliatlon and start up Corn hould Include:
- Cornp~f f Hardware
- Corrputer lnstallatlon costs
- Sofiware costs
- Cost of wMlng software In-house
- External costs for customklng purchased m a r e
17
- internal Corn for customking purchased toftware
- Consumng costs
- Company-wkle education of personnel who need to understand itie system
- Mucatbn ond tralnlng cost of people who wlli drectty OpMate the +m
- Cost ol tempMary stoff to install ond fun the ryrtem
- cost of disrupted productron dufing implement- - Cost ol rubcontract work to ovoid bst production duting tnplsmsntcrHon
- Redundancy costs
The Runnlng Costs rhwld Include:
- Hire or lease of hardwore and toftware
- Maintenonce controd for hardware ond sotiware
- insurance
- Operating costs
- ConWmoMes.
- Cost of Softwore updates.
- The management costs of the W e m . - Progra-r costs.
- Ongolng educatron and trolning.
- Staff upgrading costs.
4.2 UnWng Iha oconomlc impad anolyrls to Dkcounhd colk F k m (DCF) onalysb
Once costs ond benefits are quontlfled. h Mrcornted Cash Flow (DCO onalysk Lr almed ai
meoruting the economlc returns on inve6hnent of new technology over tlme.
DCF analysis is based on the concept of Wme vdue of money' opprooch. T h e basic Idea
underlyhg thls approach b to translate the returns mot can be obtained from a certain investment over
a certain perlod of tlme into a n omount equivalent to a wlue today. All cash inflows (benefits) and
outflows (costs) associated wfth an investrnfsnt are dkcounted to a certain voiuo todoy so that the
magnitude of inwstment is not larwr thon the Pmemt v o b of future d n g a . The discounting functlon
serves to make cosh llows recdved in the future equlmient to corh flows recetvd at the present.
There are other capital investment evoluotlon methods such as the payback, payback
reciprocal, and accounting rote of retum which are rlmpler to we than the D C F method but Ignore the
tlme value of carh flows. T h w methods s h W Y detcwmlne the perlod of time It tokes for a project to
return the original amount of money invested in It. This II ~4%=ulorly &tubing if w e consider the iong
term commitment me ImplementoHon of outomotlon iechnologv requires. Slnce the potenHal bene% of
18
the technology can be rwlhed ontj h the long term, any short run dlsruptlon can be used io abonden
the new technology. By provldlng quanttflable ob)edlver. the DCF method enables progress to be
monitored In finandal terms undemtandable to ronapmnent.
A cmrCal factor In DCF analysh ls ths tlrnlng of cash fbws associated wtth the hvertment.
Tradttional capital Investment evaluations generally osurne that the total expendlture on a new
technologv taker place at a sin* poht In tlme. WtM full cash flow savings rhnllarly belng achleved.
With mare c o n p l e x technologler, however, the cost of commMonlng and the ksr of revenue durlng a
period of runup rmy mlously attect Itr llnoncbl vlabMty Cautlous optrmsm k necessary In regard to the
stort-up perlod and me tlmhg of expenditure. There may be an extmrlvs period of provlng robot
fMures. and control CAD software and hardware. The level of rnannlng ab0 may not reflect the tlme-
scale of productlon bulld-up. Mor research on ikdble manufacturlng systems (Darnell and Dale. 1982
Kutay. 19880) polnt out that a period d up to three to fba yean may be rsqulred beiween the flrd
malor expendtiwe on a Wern and the commencement of produdon. Thls delay may even be followed
by addmonal yean before fu0 bsneRts are ochleved.
Conventlonal technlques also assume mat when a new technologlcal Innovation Is
comrnlssloned. the correspondhg outmoded faclltly Is terrnlnated. Theretore, Incremental cash flows of
born cash and tavhgs. occupy the same Rme scale. Thls assumption k certalnly lnvalld In the case of
automatlon technology whose cornplexliy may compllcate Its realbotlon and Increase the tlrne at
whlch it can be consldered to be fully fonmtssloned.
Thls problem wlll be resolved by developing a computer prcgram to regulate the tlrnlng of cash
flows wlth due provlslon belng mode for lower Mvlngs durlng the .rtart-up period. Flgure 2 deplcts
slmpl lstk asurnptlons Incorporated wtthin a trodltlonal evaludon. whereas Flgure 3 represents the
more complex way In which cash fbws change with tlme In a more complex automation technology.
The computer program wlll determine the net cash flow by evaluating the lndlvidual cash flows
wparately bated on three DCF methodt:
I) fnfernd R d e of Return O: The IRR ts the Interest rote that dlscwnts an Inveement's
future cash (lows to the present so that the present value d the cash fkws exactly equals the cost of
Investment. The IRR is, In fact, ths Interest rate that Is s a d on the lnvesiment. Once the IRR ts found.
It wll be compared wllh the rnlnlmurn rate of return whkh ts Me firm's cost of capttal.
2, Net Present Vdue (NPV): Nw of evaluating an Investment Involves dlscountlng all the
project's cash flows to thelr present vdue uslng a torget rute of lntsrest. whlch la the flrm's cost of
copltal. The computotlon of the NW WM rest on the assumption mot all lnflowr from the Investment are
reinvested at the flrm'r target rate of return.
Y) Pfo#ab / /~ /&ex (PD: PI wll be Cornwed to convert the NFV to comparable flgures wtth
other Investments the flrm may be conslderlng to undertake. PI ls the ratio of the present value of cash
Inflows to the present value d ths coh d o w s .
21
The DCF analysis d60 requlres the computotion of the coot of capital so that the return on
Investment on a new technology can be comporobe to a target value. Theoretlcalty. M e Cost Of
capltal con be computed as the welghted average of the rate$ pdd to varlous Investors. For many flm.
however. the cost of capkal may be dm[cutt to compvte because the cost of bonowlng cf the cost of
q t l y funds may change wfth change6 In WIO economy, @nwmment actions and changer In the rlsk of
varloua types of hvsstments. The DCF approach. on me other hand, malty goes wrong when flms ret
arbmadly hlgh target rates or 'hurdls raks ' for waluallng the returns on Investment.
The corrputerpro@mm wll conpote the cost of ca@tal bcped on Mree methods:
1. The opportunity cast of wpltal, whlch k Me return avallaMe In the capltal markets for
lnvesiments of the same risk.
2. Cost of Comon Stock. which Is the ratb of dMderd per share to market per share.
3. Cast of Preferred Stock. whlch la the r o b of prefened dividend per share to market prlce of
preferred share.
4. Cost of LongTom Debt.
5. Welghted Average Cost of Capnol whlch Is the wdghted mroges of Long-Term Debt, Cost
of Preferred Stock and Cast of Common Stock based on the w o n of the capltalkation of the debt
ofanrrn.
4.3. Intogratbn ol th. varlabllty d mafk.1 condmOn to oconomlc bnpact analysb
Urlng conventional methods. Investment on new techndogy k typically evaluated agalnst a
statusquo atternatlve that usually assumes a contlnuatlon of current market share, selllng prlce, and
costs. Correct alternattve to Investment on new technology should also condder a dtuatlon of decllnlng
cash flows, market share. and proflt marglns. Once a new technology becomes commerclally
applicable. even If one company decides not to Invert In it, M e sltetlhod h that some competitors wlll.
In thls study, the porrlble chonges h market shore, selling prlce, and costs wlll be slmulated by
a computer progrom basad on decklon system anulyrk. The computer program wlll be based on the
probobllltlc occurrences of porrlbk, aitemathw whlch r e s u ~ If a firm declder to authorbe or MI1 the
Investment on a new technology. Thk program wlll readlly interact wfth the economlc evaluatlon
program as deplcted In Figure 4.
23
6. CONQUDINQ COMMENTS
One of key arguments of thk paper Is thot the lack of an econornlc anaiysls technlque
speclticalty amed at DPeulng the beneftta of automation techndogy Is the malor cause of the slow rate
of Investment on new technologbs In the Unlted States. T h e paper oddreued thls problem b y
dsvebplng a new conceptual h m m bored upon the premke of hcreared probability of capturlng
me market qments through economk of scope. me paper ako d m s t r a t e d that the proposed
hansworlc k v l y hnpbrrmtakk In practice and can be hiegrated Into a standard method of
economlc evaluatlon understandable to company executkes, accountants and econornlsts. The
arguments wppomng the llne of rwronlng set forM In thls paper need to be mplrlcally vertfled by
further research. Thk effort, neverthelars. Is meant to provlde a new methodology upon whlch future
economlc tmpoct studies of new automailon technology may be based.
24
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Sodsly of Mechanical Engheerr, Synpaslvm on W d e f In TloMmon: Techndoglwl Change'. Aprll.
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