Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

The Cost of Poor Quality

It has been emphasized in several instances that a benefit of any Six Sigma initiative is the ability to tie process variation to the cost associated with that variance. Once this figure is calculated, sigma teams have a tangible dollar figure that connects the esoteric jargon of statistics to the easily understood language of yen, won and rupees. Prior to arriving at that calculation, however, it is important to categorize the types of costs associated with poor quality:

Internal defects: Costs that can be traced to defects that are discovered before the customer receives the merchandise. As a customer can be either internal or external to an organization, examples of internal costs include rework, scrap, down lines and multiple inspections.

External defects: Costs associated with errors that are uncovered after the customer receives the product or service. These costs include return freight charges, refusal to pay, invoice allowances, product replacement and loss of customer goodwill.

Appraisal costs: Expenses associated with monitoring the quality of a product or service, including inspections, audits and quality control.

Prevention costs: Costs associated with taking a more proactive approach to quality that includes supplier integration efforts, quality at the source, employee training and equipment maintenance.

Pinpointing the expense associated with defects can be a cumbersome task. This point becomes even more relevant when one recognizes that the supplier and customer incur the same costs. Whether considering the time associated with fixing mistakes, the expense of phone calls and faxes exchanged during resolution or the lost productivity associated with the entire exercise, it is clear that both supplier and customer share in the pain. As such, any calculation that estimates cost of poor quality (COPQ) must be increased by an order of two to account for the losses incurred by buyer and seller.

To wrap up the accounts payable example, it was determined that two full-time employees in the eight-person accounts payable department were dedicated exclusively to auditing and fixing bad invoices from suppliers. Although their presence does bring benefit by reducing the impact of paying incorrect invoices, it can be argued that the cost of their very presence is a COPQ. Taking into consideration two fully loaded salaries, communications expenses, office space, system bandwidth and general administrative expenses, the cost of employing two such people could easily exceed $90,000 per year. Also, if each of the suppliers employs people dedicated to correct and reissue invoices, the COPQ across the entire supply chain increases proportionately.

Apart from the total expense of having employees dedicated to auditing invoices, calculations can be performed that bring a per-hour cost to the exercise as well. Aided by the DPMO and sigma level, any company can do simple calculations for the cost per man-hour of auditing supplier invoices. A rudimentary calculation may consist of the following:

Cost per man-hour Average hours needed to fix one invoice

Number of invoices

Based on internal calculations, let's say that a company can determine that its cost per man-hour in accounts payable is $30. This includes not only the fully loaded hourly wage of one person but also the direct expenses allocatable to the entire audit/correction process. It has also been determined that the average time needed to identify, audit and resolve invoice-related problems is 2.5 hours per invoice. Finally, the total number of invoices that must be audited and corrected is 40 per month. With these figures, the company can determine its own COPQ as:

$30 2.5 hours 40 invoices = $3,000 per month or $36,000 per year

Needless to say, it is much easier for a Six Sigma team to approach management with these figure than with a DPMO of 22,700 or a sigma level of 3.5. When a sigma team can express a problem in a financial format, the likelihood of obtaining top management's support in eradicating process variation will be much higher. It is this unique feature of the methodology that makes Six Sigma so appealing and COPQ calculations a requirement for any project.