Locked lesson.
About this lesson
The cost-benefit analysis quantifies the financial impact of the Lean Six Sigma project. It includes the project costs and the operational impacts which could include cost savings, new cost of new operations, and the gross margin impact of additional sales.
Exercise files
Download this lesson’s related exercise files.
Cost Benefit Analysis Exercise.docx60.6 KB Cost Benefit Analysis Solution.docx
61.3 KB
Quick reference
Cost-Benefit Analysis
The cost-benefit analysis quantifies the financial impact of the Lean Six Sigma project. It includes the project costs and the operational impacts which could include cost savings, new cost of new operations, and the gross margin impact of additional sales.
When to use
The cost-benefit analysis is often done in the Define phase using estimated values for costs and benefits and then refined in the Control phase with the actual values for project costs and an improved estimate of the ongoing cost and benefits in operations.
Instructions
Costs benefit analysis are normally done at the beginning of a project as part of project approval. However, an accurate cost-benefit analysis requires a clear understanding of the work to be done on the project. Lean Six Sigma projects normally do not have a clear understanding of the work required at the beginning of the project. While the complaint or quality defect may be known, the root cause(s) are not known and therefore the solution is not known. For this reason, it is virtually impossible to have an accurate cost-benefit analysis in the Define phase. Therefore, Lean Six Sigma teams are often asked to create the analysis in the Control phase.
When that happens, the analysis is not used to approve the project, rather it is used to communicate to the stakeholders the ongoing costs and benefits that they should budget for based upon the problem solution.
The benefits are usually associated with cost savings in the process or support functions. However, if the project was to resolve an external customer complaint, the benefits may also include increased sales or customer retention. The benefits are normally expressed as a monetary benefit per time period (such as a month or week).
The costs are of two types. There are often some increased costs in selected operational or support categories due to the addition or change of process and equipment. These are also expressed as a cost per time period. There are also the one-time costs associated with doing the Lean Six Sigma analysis and implementing the solution. These do not have a time component with them. If you have costs associated with the purchase or modification of capital equipment, be sure to involve finance so they can handle the tax and reporting requirements
Hints & tips
- The advantage of doing the analysis at the end of the project is that cast and benefit factors are known with a high degree of accuracy. If doing the analysis at the beginning of the project, just estimate to two significant figures.
- Make sure you translate all benefits into monetary terms. Consider how the operators or customers will change behavior and monetize the change. For instance, higher customer satisfaction should lead to more sales. Improved employee satisfaction should lead to less absenteeism.
- The costs or benefits for operational impacts are often expressed as a savings per month or per unit rather than a fixed amount.
- If the project costs include the purchase of capital equipment, find out if Finance wants to show the total cost in the time period it was acquired or if they want to show the depreciated cost spread over the time period of depreciation. Either approach could be used, but Finance will need you to use the approach that is consistent with how they have treated other capital assets due to tax implications.
- 00:05 Hi, I'm Ray Sheen.
- 00:07 Well, we're getting near the end of the project and
- 00:09 one of the things stakeholders often ask for is a cost-benefit analysis.
- 00:15 >> So what is a cost-benefit analysis?
- 00:17 Traditionally, this analysis is done at the beginning of a project and
- 00:21 is used by the stakeholders to determine whether or not to do the project.
- 00:25 It answers the question of how much benefit am I going to receive if I spend
- 00:28 all this money?
- 00:30 But it's very difficult to do that analysis on a Lean Six Sigma project.
- 00:34 During the Define Stage we don't yet know what the real problem is.
- 00:38 We don't know what the root cause of the problem is, and
- 00:41 we have no idea what the solution should look like.
- 00:44 That's why many times with a Lean Six Sigma project,
- 00:47 we don't do this analysis until the end of the project.
- 00:50 So then it's not an analysis used for approval.
- 00:53 Rather, it's an analysis used by operations for
- 00:56 planning going forward now that they know the impact, fortunately for this module,
- 01:00 it doesn't matter when the analysis is done, we still do it the same way.
- 01:05 The only difference is that we have a lot more confidence in the numbers,
- 01:08 if we do it at the end of the project instead of the beginning.
- 01:12 So let's focus first on the operational impacts since that's where most of
- 01:15 the cost and benefits are likely to occur.
- 01:18 These costs are often repeated costs, so many times they're stated with
- 01:23 a time component such as so many dollars per week or per month.
- 01:28 First, we'll look at the benefits.
- 01:30 These include things like fewer returns and complaints that need to be processed,
- 01:35 less scrap and rework, less inventory holding costs, because the process is so
- 01:39 much faster.
- 01:40 And a more efficient process with less movement or non value added effort.
- 01:45 But sometimes there are also some increased costs based on our solution that
- 01:50 will offset these benefits.
- 01:52 Things like additional inspection or test costs, new equipment or
- 01:55 tooling to maintain and calibrate.
- 01:58 Training and certification for operators or
- 02:00 possibly even increased oversight at a supplier.
- 02:04 One other key point to watch is that the costs and
- 02:07 benefits may not be confined to just the process.
- 02:11 There may be other departments in the organization that are impacted.
- 02:14 If there are fewer returns, there may be savings in shipping,
- 02:18 failure analysis, sales,administration, and finance.
- 02:23 Of course, there are also the costs of the Lean Six Sigma project.
- 02:27 These costs are not ongoing costs, but
- 02:29 rather they are a one time cost associated with doing this project.
- 02:34 With most Lean Six Sigma projects,
- 02:36 the primary cost is the cost of the people on the project team.
- 02:40 There may also be costs for material use and testing or
- 02:42 the cost of prototypes if your solution use that.
- 02:46 And of course, there's the cost of administrating the Lean Six Sigma program.
- 02:50 Occasionally the team will need to purchase or modify capital equipment.
- 02:55 When that's necessary, get your finance people involved.
- 02:58 Capital equipment has some very precise and sometimes some rather strange rules
- 03:02 with it that affect the financial reports and taxes.
- 03:06 In today's environment of financial scrutiny,
- 03:08 you want to make sure you're doing everything correctly.
- 03:11 The cost of conducting the project are normally absorbed by the department that
- 03:15 will be sponsoring the project since they will likely get most of the benefit.
- 03:19 However, some organizations separate out all the Lean Six Sigma projects and
- 03:23 charge them to a separate business improvement account.
- 03:25 So that the managers don't feel that they can't afford an improvement project.
- 03:30 >> The universal language of business is money.
- 03:34 By converting your work and the impact into monetary terms, it will be easier for
- 03:38 our business leaders to understand.
Lesson notes are only available for subscribers.
PMI, PMP, CAPM and PMBOK are registered marks of the Project Management Institute, Inc.