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The proof that the Lean Six Sigma team’s solution will be found in the measured change in the process performance. The benefit analysis quantifies this change and translates it into business terms if necessary.

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Quick reference

Cost - Benefit Analysis

The proof of the benefit of that the Lean Six Sigma team’s solution will be found in the measured change in the process performance. The benefit analysis quantifies this change and translates it into business terms if necessary.

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 value. The analysis can then be used by operational managers to budget and plan future costs and benefits.

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 required work 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. Although, 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.

The cost benefit analysis is the combination of all costs and all benefits. The time dependent costs and benefits should use the time period specified by the stakeholders. If they did not specify one, I use one year for the time period. A variation of this analysis is called the payback period where all of the costs and benefits are included in an equation with the time dependency. The equation is then solved for the time when enough benefits have accumulated to pay all the accumulated costs. See below:

Proj Cost + Implementation Cost + (New Operations Cost * t) =

(Reduced CoQ + Gross Profit from new sales + Reduced Operations Costs) * t

Then solve for time (t).

Hints & tips

  • If doing a payback calculation, make sure you use the same time units in all factors.
  • 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 process change behavior and monetize the change.
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  • 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.
  • 00:14 So what is a cost-benefit analysis?
  • 00:17 Traditionally, this analysis is done at the beginning of a project and
  • 00:20 is used by the stakeholders to determine whether or not to do the project.
  • 00:24 It answers the questions of how much benefit am I going to receive if
  • 00:27 I spend all this money?
  • 00:29 But it is very difficult to do this analysis on a Lean Six Sigma project
  • 00:34 during the Define phase, because we don't yet
  • 00:36 the real problem, we don't know the root cause of the problem and
  • 00:39 we definitely don't have any idea what the solution should look like.
  • 00:43 That's why many times with Lean Six Sigma projects,
  • 00:46 we don't do this analysis until the end of the project.
  • 00:49 So then it is not an analysis used for approval, rather it's analysis used by
  • 00:54 the operations for planning going forward, now that they know the impact.
  • 00:59 Fortunately for this module, it doesn't matter when the analysis is done,
  • 01:03 we still do it the same way.
  • 01:04 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.
  • 01:11 So let's focus on the operational impact, since that is where most of the costs and
  • 01:16 benefits are likely to occur.
  • 01:18 These costs are often repeated costs, so many times they are stated
  • 01:22 with a time component, such as how many dollars per week or per month.
  • 01:26 First, we'll look at the benefits.
  • 01:28 These include things like fewer returns and complaints to process, less scrap and
  • 01:33 rework, less inventory holding costs because the process is much faster and
  • 01:38 a more efficient process with less movement or non-value added effort.
  • 01:42 But sometimes, there are also increased costs based upon our solution
  • 01:46 that will offset these benefits.
  • 01:47 Things like additional inspection of test steps.
  • 01:50 New equipment or tools to maintain and calibrate.
  • 01:53 Training and certification for an operator, or
  • 01:55 possibly even increased oversight at a supplier.
  • 01:58 Another key point to watch, is that these costs and
  • 02:01 benefits may not be confined to just the process.
  • 02:04 There may be other departments in the organization that are impacted.
  • 02:08 If there are fewer returns, there maybe savings and
  • 02:10 shipping, failure analysis, sales administration and in finance.
  • 02:16 Of course, there are also the costs of the Lean Six Sigma project.
  • 02:20 These costs are not ongoing costs, but
  • 02:22 rather they are one time costs associated with doing the project.
  • 02:26 With most Lean Six Sigma projects,
  • 02:28 the primary cost is the cost of the people involved in the project.
  • 02:32 There may also be cost for materials used in testing,
  • 02:35 with the cost of creating prototypes if the solution requires that and of course,
  • 02:39 there's the cost of administering the Lean Six Sigma program.
  • 02:42 Occasionally, the team will need to purchase or modify capital equipment.
  • 02:46 When that is necessary, get your finance people involved.
  • 02:50 Capital equipment has very precise and sometimes
  • 02:52 strange rules associated with it, that affect financial reports and taxes.
  • 02:57 In today's business environments of financial scrutiny,
  • 03:00 you want to be certain that you're doing things correctly.
  • 03:04 The cost of conducting the project are normally absorbed by the department that
  • 03:08 is sponsoring the project, since they will usually get most of the benefit.
  • 03:12 However, some organizations separate out all the Lean Six Sigma projects and
  • 03:16 charge them to a separate business improvement account, so
  • 03:19 that managers don't feel that they can't afford to do an improvement project.
  • 03:24 So now it's time for the math.
  • 03:27 Once you've determined all the costs and
  • 03:28 benefits, you just total them up to determine the net effect.
  • 03:32 Be careful to keep the one time cost in a separate column
  • 03:35 from the on going costs and benefits.
  • 03:38 To get the total impact for those costs and
  • 03:40 benefits that are ongoing, you will need to multiply them by some time period.
  • 03:45 Normally that time period will be set by the stakeholders or finance.
  • 03:49 If they don't give you one, then use one year for your first round of calculations.
  • 03:53 There are several methods for doing the calculation that can be used and
  • 03:57 if you have a finance background, you probably know them all.
  • 04:00 Some of them are very powerful, but also complex.
  • 04:04 Since our projects are normally small, fast and
  • 04:06 focused, we'll just concentrate on the simple ones.
  • 04:09 The easiest is just to subtract the costs from the benefits to get a net amount.
  • 04:14 A variation of this, called payback, is to add up all the costs and then determine
  • 04:18 how many days, weeks, or months of benefit are needed to offset the costs.
  • 04:23 Again, this is an easy calculation.
  • 04:25 If you do have a large project with major capital expenses, talk to finance,
  • 04:30 they will probably have you do a net present value or IRR calculation.
  • 04:34 Since the payback calculation method is frequently used and
  • 04:38 seems to be the one preferred by IASSC, I thought I would spend a few minutes on it.
  • 04:43 This is the method where you sign a cost or benefit per unit of time for
  • 04:47 all of the impacts that are not a one-time event.
  • 04:50 One caution, use the same time unit for all the costs and benefits and
  • 04:54 I normally do everything in months.
  • 04:57 Then on the cost side, there's the one-time cost of the project,
  • 05:00 the one-time cost of implementing the solution and
  • 05:03 any ongoing monthly costs to sustain the new process.
  • 05:08 On the benefit side, there is the monthly savings and quality costs.
  • 05:12 The monthly impact from sales, normally we use the gross profit number,
  • 05:16 not the actual sales value.
  • 05:17 And the monthly savings from all the non-value added work that is eliminated.
  • 05:22 Put all those into the equation as shown and then solve for
  • 05:26 the variable t, as in months of time.
  • 05:29 This is called the pay back period for the project.
  • 05:31 It is a number of months the new process must be in place, to pay for
  • 05:35 the analysis and change over.
  • 05:39 The universal language of business is money.
  • 05:42 By converting your work and the impact into monetary terms,
  • 05:46 it will be easier for our business leaders to understand.

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