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An Ounce of Prevention
Gaining Significant Cost Reductions from Process Improvement
By Jeff Pallister, CMC, CEP
Abstract
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.
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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