Business Process Management Overview
Business process management (BPM) is a fundamental concept of six sigma. Efforts to improve individual (local) process components are replaced by systematic methods to understand, control, and improve (even optimize) overall business results. These methods have evolved from the basic tenets of quality and continuous improvement to address specific business objectives.
W. Edwards Deming defined quality in general terms as a product or service that provides value and enjoys a sustainable market. In order to help us understand, control, and improve the business process, he described the familiar supplier —process — customer model, with several key concepts:-
- Process inputs, controls, and outputs are interdependent
- Statistical methods can improve process control and guide improvements
- Process feedback can be used to redesign products and processes, and improve overall business results
BPM is focused on understanding, controlling, and improving business processes to create value for all stakeholders. Six sigma builds on classic concepts to ensure results.
Juran defines three principal dimensions for measuring the quality of this process:
- Effectiveness: how well the output meets customer needs
- Efficiency: the ability to be effective at least cost
- Adaptability: the ability to remain effective and efficient in the face of change
This clearly addresses the need for business processes to provide value to both the customer (effectiveness) and shareholders (efficiency), now and in the future (adaptability). Six sigma initiatives strive to manage the entire business process to maximize these goals for the overall business. Most businesses are structured as functional organizations based on functional groupings such as R&D, product development, engineering, production, distribution, marketing, sales, finance, administration, information technology, etc. Each vertical function also has several vertical levels from the top executive down. Products (goods or services) are produced across many functional boundaries and business levels. Business process management represents a major advance in quality improvement thinking by managing the entire process including those areas between functional responsibilities. Business process management includes steps to plan, organize, control, analyze, and improve the process to maximize overall business results. Traditional management structures are built around functional organizations (vertical silos). The obvious objective is to control and improve each individual function with respect to its own local goals and objectives (e.g. throughput, production costs, quality, and so on). For example, an information technology department should be responsible for managing and improving IT services.
It becomes very difficult to optimize the overall production process when a product path crosses many functional boundaries as shown by the process input/ output path. Here, production starts with the process inputs and flows across many vertical functions and horizontal business levels to produce process outputs (products, goods, or services). Managing across these transitions between functional elements is difﬁcult because, often, no one is in charge. Differences in function, organizational structure, time, vocabulary, and location are sources of confusion and defects. When functional relationships are not clearly understood, business processes can become more expensive or fail. Business process management addresses this problem by taking a matrix organization and project management approach to production. Sometimes this may mean intentional sub-optimization of a local function in order to improve the overall business outcome. For example, an extra setup or changeover in one operation may increase local costs or cycle times, but reduce overall WIP inventory and provide much higher customer value. ” Clearly, the business process management role is critical to overall business success.
Processes are definable portions of a system or subsystem that consist of a number of individual elements, actions, or steps. Omdahl defines a process as a set of interrelated resources and activities which transform inputs into outputs with the objective of adding value. Systems, subsystems, and processes exist for all human activities. They are utilized in both the manufacture of a product or the delivery of a service. All three must be coordinated for maximum benefit.
Process interactions must also be evaluated to ensure that changes that improve one operation do not create more defects in another operation. For example, changing a front end, the burn-in operation may improve front end yields but drive back end yields to zero. On the other hand, an engineering group may take longer to develop a product by fully implementing design for manufacturability standards, but save the company many times the additional amount spent in engineering, through reduced manufacturing costs and reduced rework.
In some operations, the elimination of opportunities for error may be achieved through automation. Automating a poor process, however, is just as likely to result in more stable defect levels rather than a reduced number of defects. Process improvements can be applied to accounting operations and numerous other staff functions by eliminating process steps that do not add value to the organization. All organizational functions can benefit from process optimization.
From an organizational standpoint, a system is defined as a series of actions, activities, elements, components, departments, or processes that work together for a definite purpose. System effectiveness is a measure of the degree to which a system can be expected to achieve a set of specific (mission) requirements, that may be expressed as a function of performance (availability, dependability, and capability). Subsystems are major divisions of a system that are still large enough to consist of more than one process.
Strategic planning, production, delivery, human resources, accounting, maintenance, development, and engineering. All of these functions must work together to achieve customer satisfaction. Management leadership is a measure of how senior executives guide the organization and how the organization addresses its responsibilities to the public and practices good citizenship. Listed below are some key management activities:
- Strategic planning-Examines how the organization sets strategic directions and how it determines key action plans.
- Customer and market focus-Examines how the organization determines requirements and expectations of customers and markets.
- Information and analysis-Examines the management, effective use, and analysis of data and information to support key organizational processes and the organization’s performance management system.
- Human resource focus-Examines how the organization enables its workforce to develop its full potential and how the workforce is aligned with the organization’s objectives.
- Process management-Examines aspects of how key production/delivery and support processes are designed, managed, and improved.
The SIPOC process map is designed to be a high-level process view with 4 – 7 displayed steps. This is a flow chart viewed at the 50,000-foot level. The map enables all team members to view the process in the same light. The diagram should not be made too detailed and thereby lose the ability to focus on an improvement project that has a significant reward.
The SIPOC diagram is a foundation technique for six sigma management and improvement.
SIPOC is an acronym for the ﬁve major elements in the diagram:
- Supplier(S): The organization providing resources to the process of concern
- Input(I): The information, materials, or service provided
- Process(P): The set of action steps that transforms the inputs into outputs
- Output(O): The final product or service resulting from the process
- Customer(C): The person, process, or organization that receives the output
Input and Output Variables
Measurements of process inputs and outputs can be used to optimize the process being measured. Process inputs may be raw materials, human resources, or services. All inputs have some quantifiable measurement, including human effort and skill level. Process input requirements should be stated so that key measures of input quality can be controlled. Measurements within the process can also be used as effective controls. Once process capabilities are known, output measures can be used to monitor if the process has remained in control. Feedback from downstream process measurements can be used to improve an upstream process. For example, electrical testing for solder shorts can be used to as optimize a circuit board soldering operation even if it is several processes upstream from the testing operation.
When considering the entire organizational feedback system, complex interrelationships are likely to exist. This is where planned experimentation and designing for six sigma comes into play. Planned experimentation deals with isolating the effects of several different, independent variables on a process.
The advantages of using a SIPOC model include:
- A display of cross functional activities in a single, simple diagram
- A “big picture” perspective to which additional detail can be added
- A framework applicable to both large and small organizations
Creating SIPOC diagram
The ultimate goal is to identify essential workflows and sources of variation in work overtime. The diagram can also be adapted to a number of essential support processes. SIPOC captures the key components of success from suppliers through internal processes and on to key customers. Other tools such as process mapping, flowcharting, and affinity diagrams can be used to further identify the major steps in a process or system.
The following steps may be used for developing a SIPOC diagram:
- Start by identifying the starting and ending points of the process you are studying
- State the purpose of the process. Ask:
- Why does this process exist?
- What is the purpose of this process?
- What is the outcome?
- Fill in the main process steps between the starting and ending points so you have a total of five to seven steps.WhendoingaSIPOC analysis, be sure to keep the process to between five and seven steps. You want to portray an overall picture of the major actions that occur in the process, not delve into details.Think of your diagram as a top-level flowchart, where the focus is on main steps, not details. Here you are not concerned with loops or errors. To identify the main steps in the process, ask the following questions:
- What happens to each input?
- What conversion activities take place?
- Identify outputs from the process. Outputs can include physical products, documents, information, services, and decisions. To identify outputs, ask the following questions:
- What product does this process make?
- At what point does this process end?
- What information does this process produce?
- Identify the customers for each output by asking:
- Who uses the products/information supplied from this process?
- Who are the customers of this process?
- Identify the key process inputs. Here it helps to try to think of what actually flows through your process and what is being transformed. Is it a physical part or raw materials? A form? Documentation? A sample? Most process inputs are primarily in the form of materials and information, but they can also include ideas, labor, and environment. To identify inputs, ask:
- What flows into the process?
- What triggers the process to start?
- Identify the key suppliers for each input by asking:
- Where does the information or material we work on come from? Who are our suppliers?
- What do they supply?
- Where do they affect the process flow?
- What effect do they have on the process and on the outcome?
Some suppliers might provide more than one input, and a process often has more than one output.
- Have the team create the process map.
- The process may have 4 or 5 key steps. How is the raw material transformed?
- List the outputs of the process. What is the end product or service?
- List the customers of the output of the process. Who is the end user?
- List the inputs of the process. Where do the materials come from?
- List the suppliers of the process. Who are the key suppliers?
- As an optional step, identify some preliminary requirements of the customers.
- Involve the team leader, champion, and other stakeholders for verification.
A close investigation of the SIPOC model shows how six sigma is based on the powerful concept of closed-loop business system models:
- Any change in the process output (0) will be related to one or more changes in supplier, inputs, or process actions (SlPs).
- If all SlPs are stable, the output (0) will be stable.
- A change in 0 means one or more of the SlPs must have changed.
- Apparent violations of this rule indicate that the process model is incomplete.
- If one or more of the SlPs change significantly, the Os may or may not change.
- If they do, SIP changes may be used to predict and control changes in O.
- If not, the changed SlPs are robust and may provide process savings.
- Closed-loop relationships between SlPs and 05 provide a method to define process correlations and possible cause-effect relationships.
Six Sigma relies on the SIPOC model to create, monitor, and improve closed-loop business systems for process management, process improvement, and process design/redesign. SIPOC can help everyone “see” the business from an overall process perspective by:
- Displaying cross functional activities in simple diagrams (process flow charts)
- Providing a framework applicable to process of all sizes
- Helping maintain the big picture business perspective
- Providing methods for adding additional detail as needed
When process flow charts are used with the SIPOC model, business process monitoring, control, understanding, and improvement are greatly enhanced. To complete the picture, however, it is helpful to consider one additional factor: the levels of the business process. Processes can be viewed as being both comprised of smaller micro-processes or sub-processes and constituents of larger macro-processes. Process problems are hierarchical and interconnected to operational issues, which in turn, are tied to support systems ultimately linked to business issues such as customer satisfaction, profitability, and shareholder value. The three main levels may be described as a business, operations, and process.
The Business level.
High-level problems often relate to the enterprise information and financial systems used to “steer” the business. These represent strategic sigma projects. Some examples include systems that measure customer feedback and supplier quality systems. Harry’s six sigma breakthrough strategy at the business level is:
- Recognize the true states of your business
- Deﬁne what plans must be in place to realize improvement of each state
- Measure the business systems that support the plans
- Analyze the gaps in system performance benchmarks
- Improve system elements to achieve performance goals
- Control system-level characteristics that are critical to value
- Standardize the systems that prove to be best in class
- Integrate best-in—class systems into the strategic planning framework
The operations level.
The issues of managing operations and making products or producing services are the focus at this level. It is important to recognize operational issues that link to key business systems. Issues of the product cost, quality, inventory, throughput, and availability are often important at this level. Six sigma projects at this level may take a year or more to complete because of the complex combination of factors involved. Required improvements at this level may be derived from the business level needs. Harry’s six sigma breakthrough strategy, at the operations level, is:
- Recognize operational issues that link to key business systems
- Define six sigma projects to resolve operational issues
- Measure performance of the six sigma projects
- Analyze project performance in relation to operational goals
- Improve six sigma project management system
- Control inputs to project management system
- Standardize best-in-class management system practices
- Integrate standardized six sigma practices into policies and procedures
The process level.
The process level deals with process elements that may be contributing locally to the cost of poor quality (COPQ). The objective is to recognize process problems that link to important operational issues. Harry’s six sigma breakthrough strategy, at the process level, is:
- Recognize functional problems that link to operational issues
- Define the processes that contribute to the functional problems
- Measure the capability of each process that offers operational leverage
- Analyze the data to assess prevalent patterns and trends
- improve the key product/service characteristics created by key processes
- Control the process variables that exert important influence
- Standardize the methods and processes producing best-in-class performance
- Integrate standard methods and processes into the design cycle
The six sigma business improvement process moves up and down the vertical levels of the organization as well as across the functional elements. Using the SIPOC process model, and understanding the differences in process levels, will make it easier to manage the process of business improvement.
Value of Six Sigma
Six Sigma is a highly disciplined process that focuses on developing and delivering near-perfect products and services consistently. It is also a management strategy to use statistical tools and project work to achieve breakthrough profitability and quantum gains in quality. It has been stated that product characteristics with six sigma process capabilities (Cpk > 1.5) are of world-class performance. Snee describes six sigma as, “A business improvement approach that seeks to find and eliminate causes of mistakes or defects in business processes by focusing on outputs that are of critical importance to customers.” Motorola, under the direction of Chairman Bob Galvin, used statistical tools to identify and eliminate variation. From Bill Smith’s yield theory in 1984, Motorola developed six sigma as a key business initiative in 1987. Dr. Mikel Harry, who had led the corporate effort, subsequently left Motorola and later founded the Six Sigma Academy to accelerate the efforts of corporations to achieve world-class standards.
Sigma is a statistical term that refers to the standard deviation of a process about its mean. In a normally distributed process, 99.73% of measurements will fall within ± 3.0 sigma and 99.99966% will fall within ± 4.5 sigmas. In a stable attribute distributed process, 99.73% of values will fall within the probability of 0.00135 and 0.99865. Motorola noted that many operations, such as complex assemblies, tended to shift 1.5 sigmas over time. So a process, with a normal distribution and normal variation of the mean, would need to have speciﬁcation limits of 1 6 sigmas in order to produce less than 3.4 defects per million opportunities. This failure rate can be referred to as defects per opportunity (DPO), or defects per million opportunities (DPMO).
It should be noted that the term “six sigma” has been applied to many operations including those with non-normal distributions, for which a calculation of sigma would be inappropriate. The principle remains the same, deliver near-perfect products and services by improving the process and eliminating defects. The end objective is to delight customers.
The six sigma steps for many organizations are described as DMAIC:
- Deﬁne: Select the appropriate responses (the “Ys”) to be improved.
- Measure: Data must be gathered to measure the response variable.
- Analyze: Identify the root causes of defects, defectives, or significant measurement deviations whether in or out of specifications. (The “Xs”, independent variables).
- Improve: Reduce variability or eliminate the cause.
- Control: With the desired improvements in place, monitor the process to sustain the improvements.
Harry proposes that the entire six sigma breakthrough strategy should consist of the following eight elements:
- R Recognize the true states of your business.
- D Define what plans must be in place to realize improvement of each state.
- M Measure the business systems that support the plans.
- A Analyze the gaps in system performance benchmarks.
- I Improve system elements to achieve performance goals.
- C Control system-level characteristics that are critical to value.
- S Standardize the systems that prove to be best-in-class.
- I Integrate best-in-class systems into the strategic planning framework.
The business successes that result from a six sigma initiative include o Cost reductions, Productivity improvements, Market – share growth, Customer relations improvements, Defect reductions, Product and service improvements, Culture changes, Cycle – time reductions
Motorola credits the six sigma initiative for savings of $940 million over three years. AlliedSignal now Honeywell reported an estimated $1.5 billion in savings in 1997. GE has invested a billion dollars with a return of $1.75 billion in 1998 and an accumulated savings of $2.5 billion for 1999. Harry reports that the average black belt project will save about $175,000. There should be about 5 to 6 projects per year, per black belt. The ratio of one black belt per 100 employees can provide a 6% cost reduction per year. For larger companies, there is usually one master black belt for every 100 black belts. Organizations that follow a six sigma improvement process for several years find that some operations achieve greater than six sigma quality. When operations reach six sigma quality, defects become so rare that when they do occur, they receive the full attention necessary to determine and correct the root cause. As a result, key operations frequently end up realizing better than six sigma quality. Snee provides some reasons why six sigma works:
- Bottom line results
- Senior management is involved
- A disciplined approach is used (DMAIC)
- Short project completion times (3 to 6 months)
- Clearly defined measures of success
- Infrastructure of trained individuals (black belts, green belts)
- Customers and processes are the focus
- A sound statistical approach is used
Companies that have embraced six sigma include Motorola, AlliedSignal, General Electric, Black &Decker, Dupont, Dow Chemical, Polaroid, Federal Express, Kodak, Boeing, Sony, Johnson & Johnson, Toshiba, Navistar.
The lean enterprise encompasses the entire production system, beginning with the customer. It includes the sales outlet, the final assembler, product or process design, and all tiers of the supply chain( including raw materials). Any truly lean system is highly dependent on the demands of its customers and the reliability of its suppliers. No implementation of lean manufacturing can reach its full potential without including the entire enterprise in its planning. Lean techniques are, in their most basic form, the systematic identification and elimination of waste, the implementation of the concepts of continuous ﬂow, and customer pull. The touted benefits of lean production systems include lower production costs, fewer persons, quicker product development, higher quality, higher proﬁtability, and greater system flexibility. By continually focusing on waste reduction, there is truly no end to the benefits that can be achieved.
Generally, five areas that drive the lean producer are cost, quality, delivery, safety, and morale. Just as mass production is recognized as the production system of the 20th century, lean production is viewed as the production system of the 21st century. Typically, Japanese terms are used in defining lean principles in order to convey broad concepts with iconic (representative) terminology. Once properly explained, the term “Kanban” can be more descriptive than “those little cards which help control product moves.” One should choose carefully the training methods (and terms) for conveying lean tools and methods. Are lean techniques applicable in a service-oriented industry or office environment? Every system contains waste. Whether one is producing a product, processing material, or providing a service, there are elements that are considered waste. The techniques for analyzing systems, identifying and reducing waste, and focusing on the customer are applicable in any system, and in any industry. Any implementation of lean techniques will be different, depending on various factors such as industry, internal culture, and internal business considerations. The tools used to implement lean operations, and the order in which one combines them, is highly dependent on whether a company is a discrete manufacturer, continuous producer, or provider of a service.
Integration of Lean and Six Sigma
There is an ongoing debate in some organizations regarding the difference between lean and six sigma, and whether they are mutually exclusive. Toyota in particular is credited with making lean a well-known approach as embodied in the Toyota Production System (TPS). Lean is about eliminating wastes, taking time out of processes, and creating better flow. Asked about the essence of Lean (TPS), Taiichi Ohno summarized it as, “All we’re trying to do is shorten the timeline from order receipt to collecting the cash for the goods or services provided.” Six Sigma has been defined in a variety of ways. One definition states, “Six Sigma is a business strategy and philosophy built around the concept that companies can gain a competitive edge by reducing defects in their industrial and commercial processes.” A few key characteristics of lean and six sigma are discussed and compared below.
Both six sigma and lean focus heavily on satisfying customers. Six Sigma makes customers the primary driver for action in a “war on variation” and identiﬁes opportunities that promise a large, fairly immediate, financial reward. Lean considers customer inputs and conducts a “war on waste.” One of the selling points that some six sigma gurus tout is that six sigma zeroes in better on “big bang” improvements. Black belts are expected to target and achieve large bottom-line savings in projects every year.
Both six sigma and lean empower people to create process stability and a culture of continuous improvement. The cornerstone of the lean strategy are tools such as Value Stream Mapping(VSM), 5s, Total Productive Maintenance (TPM), Kanban, Kaizen, Setup Reduction, Teamwork, Error Proofing, Problem-solving, cellular manufacturing, and one-piece flow. Many problem identification and problem-solving techniques are commonly used with both lean and six sigma methodologies. These include brainstorming, cause-and-effect diagrams, 5 “whys”, Pareto analysis, 8-Ds, FMEAs, and others. Both six sigma and lean methodologies have a heavy emphasis on careful problem deﬁnition. Six sigma better promotes a rigorous, systematic process to ﬁnd the true root cause(s) of the problem. Value stream mapping (VSM) is the principal lean diagnostic tool. It is credited to Toyota, who called it material and information flow mapping.. VSM creates a visual representation of what is happening in a process to improve system performance. Process mapping is a tool favored by the six sigma community and is best used to identify the inputs, outputs, and other factors that can affect a process.
Should six sigma and lean coexist in any organization? Yes. Lean approaches should precede and coexist with the application of six sigma methods. Why? Put simply, lean provides stability and repeatability in many basic processes. Once stability has taken hold, much of the variation due to human processes go away. The data collected to support six sigma activities thereby become much more reliable and accurate.
When to use Lean tools?
If major business problems fall into the following categories:
- There seems to be a lot of waste
- There is a need to minimize inventories and redundancies
- There is a need to improve work ﬂows
- There is a need to speed up processes
- There are human mistakes
If so, then lean tools should be utilized to Eliminate wastes, Simplify processes, Increase speeds, Improve flows, Minimize inventories, Mistake proof processes
When to use Six Sigma tools?
However, if organizational challenges exhibit the following attributes:
- There are quality issues
- There is excessive variation
- There are complex problems
- There are challenging root cause identifications
- There are numerous technical considerations
In these cases, six sigma tools should be utilized to Minimize variation, Apply scientific problem solving, Utilize robust project chartering, Focus on quality issues, Employ technical methodologies.
Lean and Six Sigma tools
Most executives recognize that they have a combination of both sets of issues. Placing lean six sigma in the middle of this continuum reﬂects a more holistic and synergistic approach. If a specific problem requires only lean or six sigma tools, then that is perfectly ok. Lean six sigma is a relatively new paradigm providing a broader selection of approaches. If the only tool in a company’s bag is a hammer, then all problems start to look like a nail. It is best to have a tool kit with a broader set of tools, principles, and ways of thinking. What has been occurring for some time (at least the past several years) is a marriage of lean and six sigma initiatives into a unified approach called lean six sigma or some variant of this nomenclature. If lean-specific projects represent a 6% corporate improvement overtime, and six sigma initiatives represent another 6% improvement, then a combination could potentially represent an improvement of 12% or more. An increasing number of organizations (manufacturing, service, hospitals, municipalities, military, insurance, etc.) have been unifying their efforts into a lean six sigma approach. The mechanisms of these combinations vary widely. The most effective approaches include management direction and involvement, a cadre of trained specialists, the use of teamwork, the use of project management, team member training, the humane treatment of people, and understandable problem-solving methodology, and some mechanism to apply the appropriate tool(s). Refer to the table below for some applications of the various lean and six sigma tools at various problem-solving stages.
Lean Six Sigma Tools in a DMAIC Matrix.
There are a multitude of effective tools in addition to those listed above.
Six sigma projects can be directed at any number of CTX (critical to X) requirements. An incomplete set of examples is listed below:
Critical to quality improvement projects may include:
- Simplifying product designs
- Aligning product designs with customer requirements
- Meeting current marketplace quality levels
- Exceeding current marketplace quality levels
- Exceeding reliability and maintainability requirements
- Exceeding product appearance expectations
- Meeting technical requirements
- Providing products that are more durable
Cost of quality improvement projects may include:
- Reducing internal rejections
- Reducing external rejections
- Minimizing salvage and sorting operations
- Reducing warranty claims
- Reducing product variation
- Reducing process variation
- Reducing various forms of waste
- Eliminating unnecessary inspections
Critical to delivery improvement projects may include:
- Providing exact amounts of product
- Providing service within a specific time interval
- Ensuring immediate responses to customer questions
- Providing a product or service on the proper day and time
- Providing more rapid field service
- Providing cost-effective delivery methods
- Meeting customer packaging requirements
- Minimizing shipping damage
Critical to process improvement projects may include:
- Designing products that are easier to assemble
- Minimizing changeover times
- Reducing in-process inventories
- Minimizing product touch times
- Optimizing work cell design
- Streamlining internal work flows
- Reducing process flow variation
- Enhancing process velocity
- Eliminating redundant operations
- Maximizing product yields
- Speeding up operations
- Reducing cycle times
- Minimizing equipment downtime
- Maximizing preventative maintenance
- Performing value stream mapping
Critical to safety improvements may include:
- Simplifying tasks
- Mistake proofing operations
- Providing operator visual prompts
- Providing safety cut-off devices
- Using warning alarms
- Providing adequate employee training
- Providing clear written instructions
- Protecting both operators and equipment from damage
- Making products that are user-friendly
- Providing constraints to prevent incorrect product use
- Providing back-up redundancies for critical processes
- Conducting safety reviews
- Expanding prototype testing
- Providing protective devices when applicable
- Eliminating failure-prone elements
- Meeting product disposal requirements
Effective business process management (BPM) requires an integrated system of metrics in order to achieve the desired six sigma business improvements. It describes how this system of metrics might link all three levels of the enterprise, with the KPOVs (key process output variables) of each level of the process becoming the KPIVs (key process input variables) of the next:
This system should provide monitoring and control of each metric at each level of the business, as well as identify the linkages needed to discover the key relationships of KPIVs to KPOVs across the entire system. It should facilitate the collection of data and building of summary information from detailed parameters (temperatures, voltages, or dimensions) at the process level to customer and manager parameters (DPMOs, yields, and throughputs) at the operations level to market and financial indicators (profit, growth, market share) at the business level. A closer look at each level reveals the kind of measures and sampling strategies required for an effective six sigma process.
Business Level Metrics
Business level metrics are typically financial (external) and operational (internal) summaries for shareholders and management. Business level management metrics can be the following areas:
- Customer perception
- Internal business processes (Operations)
- Company learning and growth
- Employee satisfaction (sometimes added as a fifth category)
Operations Level Metrics
Operational efficiency measures relate to the cost and time required to produce the products. They provide key linkages between detailed process measures and summary business results, and help identify important relationships and root causes. Senge found that employees and teams who can see the impact of their efforts on the overall business outcome learn and make improvements more effectively and efficiently.
Detailed process-level metrics include the data from production people and machinery. This is the information that operators and supervisors need to run normal operations. This information is also the subject of much of the measure, analyze, improve, and control phases (MAIC) of six sigma, once the improvement project has been selected and defined.
Measurement System Considerations
Some helpful recommendations for effective process performance metrics for the modern enterprise.
- The vital few versus the trivial many: Large organizations may have hundreds or even thousands of metrics, but no individual should have to focus on more than a few. Overall business level metrics should be less than 20.
- Metrics should focus on the past, present, and future. Past history provides context for decisions and builds organizational wisdom. The present data provides real-time process control. Future predictions provide the basis for estimates, improvement plans, and strategies.
- Metrics should be linked in a systematic way to meet the needs of shareholders, customers, and employees.
- The key to an effective system is to have multiple metrics, not just one important one. Success is about balance, not a mindless focus on quality, shareholder value, profit, or any other individual measure.
- Metrics should be linked to shareholder needs at the business level.
- Metrics should be linked to the customer needs on the operations level.
- Metrics should be linked to the employee needs on the process level.
- Metrics should be consistent for all levels of the organization.
- Multiple measures can be combined (aggregated) into overall indices of performance for higher levels.
- Metrics should evolve as strategy and situations evolve.
- Metrics must have targets or goals based on research. Six sigma improvement methods help establish improved goals.
Harry states simply that six sigma is about making money. It is about profitability, although improved quality and efﬁciency are immediate byproducts. The financial beneﬁts of six sigma projects are the measurements that create a link between philosophy and action. Financial benefits and associated risks are the factors used to evaluate, prioritize, select, and track all six sigma projects. This section describes the common financial measures, methods for risk analysis, and the features of quality cost systems used for this purpose. Project cost-benefit analysis is a comparison to determine if a project will be worthwhile. The analysis is normally performed prior to the implementation of project plans and is based on time-weighted estimates of costs and the predicted value of benefits. The cost-benefit analysis is used as a management tool to determine if approval should be given for the project go-ahead. The actual data is analyzed from an accounting perspective after the project is completed to quantify the financial impact of the project.
- The sequence for performing a cost-benefit analysis is:
- Identify the project benefits.
- Express the benefits in dollar amounts, timing, and duration.
- Identify the project cost factors including materials, labor, and resources.
- Estimate the cost factors in terms of dollar amounts and expenditure period
- Calculate the net project gain (loss).
- Decide if the project should be implemented (prior to starting), or if the project was beneficial (after completion).
- If the project is not beneficial using this analysis, but it is management’s desire to implement the project, what changes in beneﬁts and costs are possible to improve the cost-benefit calculation?
Return on Assets (ROA)
Johnson gives an equation for return on assets (ROA) as:
Where the net income for a project is the expected earnings and total assets is the value of the assets applied to the project. Additionally, a calculation of the return on investment is widely used:
Where net income for a project is the expected earnings and investment is the value of the investment in the project.
There are several methods used for evaluating a project based on the dollar or cash amounts and time periods. Three common methods are the net present value (NPV), the internal rate of return (IRR), and the payback period methods. Project risk or the likelihood of success can be incorporated into the various cost-beneﬁt analyses as
Net Present Value (NPV) Method:
The equation for net present value (NPV) as:
Where n is the number of periods, t is the time period, r is the per-period cost of capital for the organization (also denoted as I if the annual interest rate is used) and CFt is the cash flow in time period t. Note that CFO cash flow in period zero is also denoted as the initial investment. The cash flow for a given period, CFt is calculated as:
CFt = CFB,t – CFC,t
Where CFB,t, is the cash flow from project benefits in time period t and CFC,t, are the project costs in the same time period. The standard convention for cash flow is positive (+) for inflows and negative (—) for outflows.
The conversion from an annual percentage rate (APR) equal to I, to a rate r for a shorter time period, with m periods per year is:
If the project NPV is positive, for a given cost of capital, (r), the project is normally approved.
Internal Rate of Return (IRR) Method
The internal rate of return (IRR) is interest or discount rate, I or r, that results in a zero net present value, NPV = 0, for the project. This is equivalent to stating that time weighted inflows equal the time weighted outflows. The equation for IRR is
The IRR is that value of r which results in NPV is equal to 0 and is calculated by an iterative process. Once calculated for a project, the IRR is then compared with other projects and investment opportunities for the organization. The projects with the highest IRR are approved until the available investment capital is allocated. Most real projects would have an IRR in the range of 5% to 25% per year. Managers, given the opportunity to accept a project which has calculated values for IRR higher than the company’s return on investment (ROI), will normally approve them, assuming the capital is available.
The above equations for net present value and internal rate of return have ignored the effects of taxes. Some organizations make investment decisions without including taxes, while others look at the after tax results. The equations for NPV and IRR can be used with taxes, if the cash ﬂow effect of taxes is known.
Payback Period Method:
The payback period is the length of time necessary for the net cash beneﬁts or inflows to equal the net costs or outflows. The payback method generally ignores the time value of money, although the calculations can be done taking this into account. The main advantage of the payback method is the simplicity of calculation. It is also useful for comparing projects on the basis of a quick return on investment. A disadvantage is that cash beneﬁts and costs beyond the payback period are not included in the calculations.
Organizations using the payback period method will set a cut-off criteria, such as 1, 1-1/2, or 2 years maximum for approval of projects. Uncertainty in future status and effects of projects, or rapidly changing markets and technology tend to reduce the maximum payback period accepted for project approval. If the calculated payback period is less than the organization’s maximum payback period, then the project will be approved. For projects with an initial investment and ﬁxed annual cash inﬂow, the payback period is calculated as follows :
Cost of Poor Quality (COPQ)
The costs of poor quality (COPQ) are those costs associated with providing poor quality products or services. There are four categories of costs: internal failure costs (costs associated with defects found before the customer receives the product or service), external failure costs (costs associated with defects found after the customer receives the product or service), appraisal costs (costs incurred to determine the degree of conformance to quality requirements) and prevention costs (costs incurred to keep failure and appraisal costs to a minimum). The following quality cost deﬁnitions are:
- Prevention costs: The costs of activities specifically designed to prevent poor quality in products or services.
- Appraisal costs: The costs associated with measuring, evaluating, or auditing products or services to ensure conformance to quality standards and performance requirements.
- Failure costs: The costs resulting from products or services not conforming to requirements or customer/user needs-that is, the costs resulting from poor quality.
Failure costs are divided into internal and external failure cost categories:
- Internal failure costs: Failure costs which occur prior to delivery or shipment of the product, or the furnishing of a service, to the customer.
- External failure costs: Failure costs which occur after shipment of the product, or during or after furnishing a service, to the customer.
The Three Levels of Product Costs
The following elements may be included in the Preventive cost categories.
Applicant screening, Personnel reviews, Capability studies , Pilot projects, Controlled storage, Planning, Design reviews, Procedure reviews, Education (Quality or SPC), Procedure writing, Equipment maintenance, Prototype testing, Equipment repair, Quality design, Field testing, Safety reviews, Fixture design and fabrication, Surveys, Forecasting, Time and motion studies, Housekeeping, Training, Job descriptions, Vendor evaluation, Market analysis and Vendor surveys
The following elements may be included in the Appraisal cost categories.
Audits, Laboratory testing, Document checking, Other expense reviews, Drawing checking, Personnel testing, Equipment calibration, Procedure checking, Final inspection, Prototype inspection, In-process inspection, Receiving inspection, Inspection and test, Shipping inspection, Inspection and test reporting, Test equipment and Maintenance
Internal Failure Costs
The following elements may be included in the Appraisal cost categories.
Accidents Cost, Late time cards, Accounting error corrections, Obsolescence, Design changes, Overpayments, Employee turnover, Premium freight, Engineering changes, Redesign, Equipment downtime, Reinspection, Excess interest expense, Repair and retesting, Excess inventory, Retyping letters, Excess material handling, Rework, Excess travel expense, Scrap, Failure reviews, and Sorting
External Failure Costs
The following elements may be included in the Appraisal cost categories. Note that many of the costs related to internal failure also appear on this list.
Bad debts, Overpayments, Customer complaint visits, Penalties, Customer dissatisfaction, Premium freight, Engineering change notices, Price concessions, Equipment downtime, Pricing errors, Excess installation costs, Recalls, Excess interest expense, Redesign, Excess inventory, Reinspection, Excess material handling, Repair costs, Excess travel expense, Restocking costs, Failure reviews, Retesting, Field service training costs, Returns, Liability suits, Rework, Liability, Scrap, Loss of market share, Sorting, Obsolescence, design changes, Warranty expenses
Optimum Quality Costs
Usually considered indirect costs Six sigma is all about ﬁnancial benefits. A good quality cost system is an important part of the six sigma infrastructure and critical to good process management. Some authorities contend that every dollar spent on prevention will save approximately seven dollars in failure costs. Whether this figure can be defended or not, most companies initially find that they spend an inadequate amount on prevention activities. Initially, managers discover that prevention costs are too low and both internal and external failure costs are too high. Often, failure costs will exceed the appraisal costs as well. Even the relationship between internal and external failure costs may point to needed changes in planning or product design.
If you need assistance or have any doubt and need to ask any question contact us at firstname.lastname@example.org. You can also contribute to this discussion and we shall be very happy to publish them in this blog. Your comment and suggestion are also welcome.