Lead Time Performance Measurement

This paper discusses the design of a performance evaluation system in a decentralized firm when subunits are organized as cost centers and lead time has an important effect on demand or cost. The model incorporates agency costs associated with managers' efforts and overhead absorption and control costs due to inaccurate marginal cost estimates. The results include that if production and lead time decisions are delegated to cost centers, performance measurement systems exist that lead to a profit maximum. Very often firms use average cost to estimate marginal cost. Another important conclusion is that more accurate marginal cost estimates (and better production decisions) occur when non-value-added time is removed from the production process. Thus, two benefits of just-in-time and business process reengineering are accurate estimates of marginal cost and superior general manager decisions about prices and profit maximizing production rates.