To Improve Financial Performance and Profitability - Six Sigma

Bob Galvin (then Motorola president) was reputed to be the man who began the Six Sigma revolution by issuing a ‘Six Sigma Challenge’ in 1987 for a ten - fold improvement in performance in every 2 year period (Goetsch and Davis, 2010). Over the 10 years following the call, Motorola claims to have saved $414 billion, increased sales by a factor of 5 and increased profits by 20% each year (Pande et al, 2000). GE declared that for 3 years (1996 - 1998) Six Sigma related savings were about $2bn; Honeywell stated that its annual Six Sigma savings as around $600-700 million; and Dow Chemicals claimed $2.2bn of Six Sigma financial benefits (Lee, 2002).

It is often stated that a ‘typical’ company operates around the 3 sigma level (Murphy, 1998) and there have been a number of attempts to quantify the financial effects of varying sigma levels. Klefsjo et al (2001) suggest that for Six Sigma performance levels the cost of poor quality would be less than 1percent of sales, while for 5 Sigma that would rise to 5 - 15 per cent, at 4 Sigma the cost would be 15 - 15 per cent and at 3 Sigma levels it would equate to around 25 - 40 per cent of sales.

Cost of Poor Quality

Perhaps the most obvious tangible benefit of quality improvement is the reduction of costs associated with non - quality. If we have to throw a product away because we have made an error in its manufacture, it is clear that there is an immediate financial impact as all the costs sunk into the product are lost. Similarly, doing an incorrect operation over again absorbs cost (operator time, power, additional materials, etc.).

Although anyone who works in an organization will be familiar with many examples of both of these issues, business accounting systems are not set up to capture these costs. Traditional accounting approaches are designed to track the inflow and outflow of money in an organization (and, by extension, to product lines or departments). there is little emphasis on whether the money in the department is spent effectively. For example, budget reporting will recognise that overtime cost £100,000 this month, but will not differentiate between time used to respond to short lead - time customer demand and time spent correcting errors.

Even when it does highlight a cost of poor quality, perhaps in an over - budget condition in material spend, it will give no clear indication of where exactly the over - spend occurred. Table shows Fiegenbaum’s Prevention - Appraisal - Failure ( P - A - F ) model of costs of poor quality, although there are others.

TableCost of Quality types and examples (adapted from Feigenbaum, 1961)

The lack of clarity of the cost of poor quality in organizations led to a lack of focus on improvement for many years. It was only with the advent of the “Cost of Quality” approach in the 1950’s (Defoe and Juran, 2010) that organizations had a financial tool to assess the costs associated with quality failures and thus focus on the most important areas for improvement. Six Sigma directly assesses costs of poor quality on a project by project basis, providing clear motivation for improvement and an indication of expected gains.

The basic logic is that a relatively small increase in spending on prevention activities will deliver a more than compensating reduction in appraisal and failure costs (see figure )

Quality costs during improvement (adapted from Businessballs.com,2011)

Waste

Cost of Quality models are certainly helpful in generating momentum in the quality improvement movement, however, they are, at best, a partial view of the economic benefits. the focus on failure neglects aspects of waste which relate to low and deficiency as opposed to accuracy. For example, an operator having to wait for products from a previous process would not register on the P - A - F model, but would clearly have an impact on the costs of the organization.

The concept of waste is fairly generic in nature and has been around for a long time. Many organisations refer to ‘non - value added activities’ and ‘process waste’. However, these are rather broad terms and, whilst it is easy to agree that waste is bad and should be eradicated (or at least reduced) it does not much help in the process of improvement. the Seven Wastes were identified by Ohno as part of the Toyota Production System (Ohno, 1988) and have since been widely applied to process improvement, becoming particularly associated with the principles of lean manufacturing.

It can readily be seen that some of the costs associated with these activities would it neatly into the Cost Of quality models discussed in the previous section, but that some would be transparent to that system. Table indicates the kind of financial impacts that might be caused by the types of waste. hose which would not be picked up by a Cost of Quality measurement system are in bold italics.

TableTypes of waste and associated costs

This type of approach allows for a clear identification of potential cost savings, whilst also allowing for the improvement and ‘what to do differently’ elements of the waste based approach.

The impressive financial gains associated with Six Sigma certainly account for much of its popularity, but on the downside may also be responsible for the ‘quick ix’ mentality which has characterised at least some of the applications.


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