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Quality and Profits

An Ounce of Prevention

Gaining Significant Cost Reductions from Process Improvement

By Jeff Pallister, CMC, CEP


Process improvement is a powerfully effective solution to the challenge of “more for less” demanded by internal and external customers.  Unlike ‘cutbacks’, process improvement can reduce costs significantly and increase productive capacity, and improve product and service quality.  Process improvement works by taking preventive actions (an ounce of prevention) to reduce the much larger amount of costs associated with rework, fixing problems, errors, waste and non-value added activities (the pound of cure).

The Challenge

The pressure by internal and external customers to provide “more for less” include demands for better quality products and services, faster delivery and lower prices.  To meet all three at the same time appears to be a daunting challenge, especially if your firm has a high and inflexible cost structure.

Fortunately, process improvement can achieve the three goals.  In this article, the focus is on cost reduction.  Work processes account for a significant cost of operations and are usually an opportunity ready for considerable cost reduction.  These excess costs are what Juran calls “the gold in the mine”.

The Cost of Quality is 20-30% of Sales

The “cost of quality” consists of failure, appraisal and preventive costs.  These are the costs incurred by a company to ensure products meet customer requirements.   “Failure” costs are the most expensive costs and include rework, scrap, waste, errors and the failure to meet customer requirements.  “Appraisal” costs are incurred to ensure that products meet requirements and include activities such as inspections.  Preventive costs include training, planning, simplifying and streamlining processes, standardizing work, etc.

These three costs typically account for some 20% to 30% of company's sales.  In other words, for every $1 million in sales a company makes, it spends $200,000 to $300,000 on the cost of quality.  With an effective and efficient process, both failure and appraisal costs would approach 0%, and preventive costs can be less than 5%.  This is a significant opportunity for cost reduction.

Another perspective on excess costs is to consider work that does not add value to the customer.  An “ABC Approach” identifies three types of work:

A.     work that Adds value (such as assembly, or providing service to a customer)

B.     Burden or overhead, or necessary work, that adds value internally, but not directly to the customer (e.g. preparing payroll)

C.     Costs that does not add value to either the customer or the supplier (e.g. rework)

From this perspective, some been estimate that only between 10 and 20 percent of a worker's time is spent on activities that add value to the customer.

“One day, after attentively observing operators working …, Taiichi Ohno said to the workers, “May I ask you to do at least one hour’s worth of work every day?” Believing themselves to have been working hard all day long, the workers resented this remark.  What Ohno actually meant, however, was, “Will you do your value-adding work for at least one hour a day?” (Imai, p. 75)

Back to the customer’s challenge. Suppose the customer is aware of these costs in your operation and decides that starting now, it will only pay for value-added work plus a modest amount for overhead.  The customer then expects you (and your competitors) to provide prices accordingly.  How would you meet this challenge?

Another scenario is that a newcomer to the industry (or an established competitor) embarks on a low cost structure business strategy and undercuts the prices of existing competitors, while at the same time improves delivery time, product and service quality, and is able to earn a high profit to reinvest in the growth of the business.

The best scenario is if that company is yours.

Why is Waste So Prevalent?

Non-value-added activities are prevalent since they are hidden, they are accepted, and processes are not fully developed.

The costs are hidden.  The “tip of the iceberg” of waste is scrap, rework and warranty work.  They are obvious.  Most of a company’s waste, however, is hidden or buried in processes and are not identified until one deliberately searches for it.

Costs are accepted.  People tend to live with non-value added work as the normal situation.  They may not be aware of the magnitude of the problem, or know that these costs can be reduced.

Processes are not developed.  Processes evolve through several stages or levels of maturity:

0.       Incomplete – the process is either not performed or is partially performed; process goals are not achieved.

1.       Performed – process is performed and meets its output goals.

2.       Managed – process is performed, follows policies and meets other goals such as cost, delivery and quality, is conducted by trained persons with adequate resources, and is monitored, reviewed and controlled.

3.       Defined – the process is managed and standard processes are tailored to requirements.

4.       Quantitatively managed – the process is defined and is controlled and managed using quantitative methods and meets measurable process and product objectives.

5.       Optimized – the process is quantitatively managed and is changed and adapted to meet relevant current and projected business objectives. It focuses on continually improving process performance. (stages and definitions are based on Carnegie Mellon)

As an example, a company with less mature Level 1 stage process concentrates on performance, rather than optimization, which means it:

·         is focused on “getting the product out the door”

·         “doesn’t have time” to do it right the first time (but has time to do it the second and third time)

·         has an emphasis on repairing things that go wrong rather than prevention.

It eventually meets the product requirements, but at what cost?

As processes mature towards Level 5 and become optimized, a company has mastered performance, has established a low-cost structure, undercuts its competitors, gains market share, expands, earns high profit margins, and reinvests to further strengthen its position.

Cost Reductions from Process Improvement

As processes are improved and mature, failures (such as rework and scrap) decrease.  As the processes mature further, there is less need for inspection to make sure customer requirements are met.

Resources that were allocated to rework (a non-value-added activity) can now be redeployed to productive work, increasing the production capacity without additional cost.

As an example, a small manufacturer had some 160 people working on the production line.  Fifteen workers (almost 10%) were assigned to the “Rework” station.  They were needed because the others “did not have time do it right the first time”.  The approach taken was to move 12 persons from rework to the line so the work was performed properly, and the remaining 3 people remained at the end of the line to conduct final inspection.  As a result of this simple change, rework costs were reduced significantly, without incurring additional costs or taking more time.

Get Started with a Gap Analysis

An excellent starting point to Process Improvement is to conduct a Gap Analysis.  The Gap Analysis will:

·         identify the gap between the present and desired state

·         identify what the excess costs are (cost of quality and non-value added activities) that are not visible

·         how prevalent the costs are

·         define specific areas for improvement (identify the "gold in the mine"), and

·         determine the return on investment for improvement.

Once the costs of quality are uncovered, management will decide that certain of these costs are not acceptable and will proceed with a process improvement initiative.

In a Nutshell

Internal and external customers demand “more for less” – better product quality, faster delivery and less cost.  Process improvement is a powerfully effective method to reduce costs and provide better quality with faster turnaround.  Why? Because it provides real productivity improvements by reducing waste and making processes and people more capable.  It adds some less expensive preventive costs (an ounce of prevention) to reduce the more expensive failure costs (a pound of cure).

The first step to realize improvements from process management is to conduct a Gap Analysis that identifies the extent and magnitude of the cost of quality.  Once these are revealed, it will be clear what action needs to be taken to address these problems.

References and Further Reading

Carnegie Mellon Software Engineering Institute. (2002)  Capability Maturity Model Integration, continuous representation.

Crosby, Philip B. (1996) Quality is Still Free: making quality certain in uncertain times, New York: McGraw-Hill.

Harrington, H. James (1987) Poor-Quality Cost, ASQC Quality Press.

Imai, Masaki. (1997)  Gemba Kaizen, a commonsense, low-cost approach to management, McGraw-Hill.

National Quality Institute, Cost of Quality, Survey of Canadian Small and Medium Firms.

About the Author

Jeff Pallister, CMC, BA, BSc
Jeff Pallister, President is a Certified Management Consultant with considerable experience gained from working on numerous consulting assignments since 1974.

Jeff specializes in the strategic and operational management of manufacturing firms and technology companies. This involves addressing the drivers of performance: leadership, planning, customers, people, processes and supplier management.

His focus is in achieving high impact performance improvement. His expertise includes preparation and implementation of strategic and operational plans, market assessments for new products, improvement of business operations, and the application of ISO 9000 and Excellence quality systems.

Jeff Pallister received his education from the Columbia University Graduate School of Business, New York; University of Calgary; Simon Fraser University; and the Banff School of Advanced Management.

He is a Certified Excellence Professional, a designation granted by the National Quality Institute.

Jeff is trained in the Power Idea Session and the Profit Improvement Process and currently is using these powerful tools and systems in concert with his quality expertise in Canada.  His website.

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