Six Sigma and the Cost of Quality

In the first chapter of their book Six Sigma:  The Breakthrough Management Strategy Revolutionizing the World’s Top Corporations, by Ikel Harry, Ph.D., and Richard Schroeder, the authors relate the sigma level of a company’s processes to what the costs are of achieving that level of quality.

First of all, what are the costs of quality?   In a way, this is a misleading term.    As the American Society for Quality (ASQ) website points out, it’s not how much it costs to create a quality product, but how much it costs NOT to produce a quality product.   In other words, it’s the costs of lack of quality, also known as the costs of nonconformance.

Nonconformance vs. Defect

Before going into the cost of quality or the cost of nonconformance, I wanted to take a little detour to discuss the word “nonconformance.”   Although the word “defect” and “nonconformance” are sometimes used interchangeably, there’s an important difference between the two in terms of semantics.    Companies tend to use the word “nonconformance” rather than the word “defect” because the word “nonconformance” means that the product or result of a process has strayed outside of the specification limits set by the company.

The part itself may still be usable, and may not end up failing when it gets to the customer, so it may not be “defective” in the common, every-day usage of the word as “unable to be used.”   In producing an automobile, chipped paint on a door and a missing engine may both be considered “defects” because they are not supposed to occur during the manufacturing process.  However, one defect is truly catastrophic in that it prevents the car from even being used, i.e., the missing engine.   A paint chip is a cosmetic blemish that does not effect the performance of the car, but it does effect the customer’s emotional reaction to the car.

Having worked for a car company managing product liability litigation, I can tell you that plaintiff attorneys LOVE the word “defect” because it implies something is seriously wrong with a product from a safety standpoint.   So if documents say the word “defect”, you know that attorney will want to make sure that the jury sees that document, even if they don’t understand the context.    Now the engineers may be using the term in its more benign meaning of “lies outside of specification limits”, but not in the sense of “unusable by the customer” or worse, “dangerous to the consumer.”   To avoid this linguistic bait-and-switch by attorneys who may want to cloud juries’ minds with the wide range of meanings behind the word “defect”, many companies use the more linguistically neutral term “nonconformance.”   It’s less likely to be used out of context than the word “defect.”

Okay, with that out of the way, let’s go back to the discussion of the cost of nonconformance.

Cost of quality

There are three categories in the cost of quality:

1)  Prevention Costs–costs of all activities specifically designed to prevent poor quality in products and services

The first cost is that of trying to prevent a defect.   This can be done in the design phase by creating a design that is easier to manufacture without defects, or by educating the manufacturing line workers in the importance of quality to try to prevent defects that are used by human error.   Of course, a Six Sigma project, which is designed to reduce defects by eliminating their root cause, would be another important category of prevention costs.

2)  Appraisal Costs–costs associated with measuring, evaluating or auditing products or services to assure conformance with quality standards and performance standards.

After prevention, you must work on detection of defects, which means inspection of a product or auditing of processes in order to find out whether defects are occurring, and if so, what their root cause is of those defects that are detected.

3)  Failure Costs (Internal and External)

Let’s say that a defect does occur.   This is a quality failure.  What do you do now?  You must of course try to repair or rework those products which are found to have defects before sending them out to the consumer.  The cost of this repair or rework is an internal failure cost, meaning a cost of correcting a quality failure that is detected while the product is internal to the company.

There is the off chance that your detection methods may miss a product with defects, and those defects may be found out by the customer.   In those cases, the costs are handled through a warranty program.   However, if the defective product, such as an automobile, causes property damage to another vehicle or causes injury to another driver, it can become a product liability issue.    Both of these costs are examples of an external failure cost, meaning a cost of correcting a quality failure that is detected while the product is external to the company, i.e., in the customer’s possession.

All three of these cost categories, prevention, appraisal, and failure costs, are what make the sum total of cost of quality.

Here’s a chart taken from the first chapter of their book which shows the relationship between the Sigma level of a company’s processes, what this translates into in terms of number of defects, and what the cost of quality is to create that sigma level expressed in terms of the percentage of sales revenue.

Sigma Level Defects per million opportunities Cost of Quality (% of sales)
2 (noncompetitive) 308,537 N.A.
3 66,807 25-40%
4 (industry average) 6,210 15-25%
5 233 5-15%
6 (world class) 3.4 < 1%

Note that, for each increase in sigma level, the cost to a company of nonconformance, what we have been calling, the “cost of quality”, gets reduced by about 10%, meaning that the net income of a company increases about 10% for each Sigma level.

So if you ask why so many companies put effort into raising their sigma level, the above chart tells the story:   because it is one of the most readily available ways for any company to increase its income.   So rather than asking a company why it is incorporating Six Sigma methods in its manufacturing and/or commercial processes, the better question is, why isn’t a company doing it?    Now just because it is readily available, doesn’t mean that is it easy.   Jack Welch, the CEO of GE for 20 years from 1981-2001, said that incorporating Six Sigma into GE’s processes was one of the most difficult “stretch goals” the company had ever undertaken.   But it definitely ended up being one of the most rewarding.

The next post starts the material in the second chapter, where we open up the mysterious black box of the “Six Sigma process” and look at what lies inside.


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