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How Lean Six Sigma reduces the “Cost of Poor Quality”

in Organisations

Alex Colman Lean Six Sigma MBB - BEng Mech. Eng. – MCIPS - PGCE

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Philip B Crosby – (1926-2001)

"Quality is conformance to requirements;

non-quality is non-conformance."

CROSBY'S 4 ABSOLUTES

1. Quality means conformance to requirements, not goodness.

2. The system for causing quality is prevention, not appraisal.

3. The performance standard must be zero defects, not "that's close enough."

4. The measurement of quality is the price of non-conformance, not indexes.

Total Cost of Quality

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Total Cost of Quality

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Traditional Costs of Quality

Cost of Achieving Good Quality Prevention costs

costs incurred during product design Appraisal costs

costs of measuring, testing, and analyzing Cost of Poor Quality

Internal failure costs include scrap, rework, process failure, downtime, and

price reductions External failure costs

include complaints, returns, warranty claims, liability, and lost sales

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Prevention Costs

Quality planning costs costs of developing and implementing quality management program

Product-design costs costs of designing products with quality characteristics

Process costs costs expended to make sure productive process conforms to quality

specifications Training costs

costs of developing and putting on quality training programs for employees and management

Information costs

costs of acquiring and maintaining data related to quality, and development of reports on quality performance

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Appraisal Costs

Inspection and testing costs of testing and inspecting materials, parts, and product at

various stages and at the end of a process

Test equipment costs costs of maintaining equipment used in testing quality

characteristics of products

Operator costs costs of time spent by operators to gar data for testing product

quality, to make equipment adjustments to maintain quality, and to stop work to assess quality

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Internal Failure Costs

Scrap costs costs of poor-quality products that must be discarded, including

labor, material, and indirect costs Rework costs

costs of fixing defective products to conform to quality specifications

Process failure costs costs of determining why production process is producing poor-

quality products

Process downtime costs costs of shutting down productive process to fix problem

Price-downgrading costs costs of discounting poor-quality products—that is, selling

products as “seconds”

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External Failure Costs

Customer complaint costs costs of investigating and satisfactorily responding to a customer

complaint resulting from a poor-quality product Product return costs

costs of handling and replacing poor-quality products returned by customer

Warranty claims costs costs of complying with product warranties

Product liability costs

litigation costs resulting from product liability and customer injury Lost sales costs

costs incurred because customers are dissatisfied with poor quality products and do not make additional purchases

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Measuring and Reporting Quality Costs

Index numbers ratios that measure quality costs against a base value

labour index

ratio of quality cost to labour hours

cost index ratio of quality cost to manufacturing cost

sales index

ratio of quality cost to sales

production index ratio of quality cost to units of final product

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Quality–Cost Relationship

Cost of quality Difference between price of nonconformance and

conformance

Cost of doing things wrong 20 to 35% of revenues

Cost of doing things right

3 to 4% of revenues

Profitability In the long run, quality is free

DMAIC sequence

Define

Measure Analyse Improve Control

Selection

Tollgate Review

(assessment)

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G G G

Post Project Reviews

Trigger

G

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Theory of Constraints !! Bottleneck !!

Customer Value Added

Business Value Added

Waste

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Activity Based Costing and Lean

Accounting

•What is Activity Based Costing?

•Cost Accounting Systems

•Traditional Cost Systems

•Activity Based Costing

•Implementing ABC

•Benefits & Limitations of ABC

•Lean Accounting

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Traditional, Volume-Based Product-Costing System

M ode I M ode I I M ode I I IDir ect mater ials 50.00$ 90.00$ 20.00$ Dir ect labor 60.00 80.00 40.00 M anufactur ing over head 99.00 132.00 66.00 Total 209.00$ 302.00$ 126.00$

M ode I M ode I I M ode I I ICost per unit 209.00$ 302.00$ 126.00$ Tar get selling pr ice 261.25 377.50 157.50

209.00 x 1.25

With these product costs, Aerotech established target selling prices (Cost × 125%).

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Activity-Based Costing

Two pieces of information are

required to compute the cost-driver rate:

•Activity Cost •Activity Volume

Activity Cost ÷ Activity

Volume = Cost-Driver Rate

EXAMPLE #1 The proper activity in this case is the # of units produced. The cost-driver rate would be: $360,000 ÷500,000 units = $.72 per unit

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Benefits of Activity-Based Costing

• ABC leads to more activity cost pools with more relevant cost drivers

• ABC leads to enhanced control of overhead costs since overhead costs can be more often traced directly to activities

• ABC leads to better management decisions by providing more accurate product costs, which contributes to setting selling prices that will achieve desired product profitability levels

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Resources

Activities

Products & Customers

Driver Analysis

Performance Analysis

Activity-Based Management Model Cost View

Operational View

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Lean Accounting

Lean accounting is the general term used for the changes required to a company's accounting, control, measurement, and management processes to support lean manufacturing and lean thinking.

Most companies embarking on lean manufacturing soon find that their accounting processes and management methods are at odds with the lean changes they are making. The reason for this is that traditional accounting and management methods were designed to support traditional manufacturing; they are based upon mass production thinking. Lean manufacturing breaks the rules of mass production, and so the traditional accounting and management methods are unsuitable and usually actively hostile to the lean changes the company is making.

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Lean Accounting

•A valid assessment of the financial impact of lean manufacturing improvement.

•Many companies are looking for short-term cost cutting to come from their lean efforts.

•They are usually disappointed. Lean manufacturing does not cut costs; it turns waste into available capacity.

•The financial impact comes as you make decisions on how to use this capacity (and the cash flow from reduced inventory).

•These are strategic decisions. Lean Accounting uses a specific tool for understanding the impact of lean changes on the company financially.

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