Benchmark Six Sigma Expert View by Venugopal R Lean Six Sigma and Business Excellence professionals often come across improvement projects that are important but sometimes difficult to justify the gains to get a CFO approval. A “Cost avoidance” related projects is perhaps one such situation. I recall a situation where the customer has a penalty clause if the Quality level of our output falls below 98%. For many years, we have been managing very well, barring some occasional blips and maintained Quality levels high enough to avoid the penalties. One fine day, the customer revises the SLA and raises the Quality requirement to 99.5% and gives us 3 month’s time to attain the same. This forces us to frantically work on an improvement project, which if successfully done on time, will help us to ‘avoid the cost’ of penalty. However, the finance staff will not see it reflected as a cost saving on their books.
Now, imagine another situation where we are already incurring losses, as a result of being penalized for not meeting the Quality score. If a project is taken to address this issue and we succeed in getting rid of the penalty, this will obviously be seen as a saving on the Finance books and would probably get appreciated better than the previous case.
“Cost reduction” refers to the reduction of a cost that is already being incurred. It is like getting relieved from a pain that we are already suffering. “Cost avoidance” refers to efforts that will avoid a potential cost, which would be incurred, if the action is not taken. It is like preventing us from a pain that we are likely to suffer if we do not act on time.
DFMEA and PFMEA are tools that help us to prevent potential failures and thus help in “cost avoidance”. Fault tree analysis and corrective action are efforts that help us to solve an existing problem and hence result in “cost reduction”.
However, once we implement a “cost reduction” activity, it has to be regularized and implemented as a "cost avoidance"on a similar new process or product design. Then on, it becomes an established practice and may no longer be perceived as a “cost avoidance” action when repeated.
A project that addresses and removes non-value adding steps in a process drives “cost reduction”, where as a process or layout that is designed right in the beginning keeping away all those NVAs, will be considered as “cost avoidance” action.
If a machine is producing more rejects and costs money, getting it repaired could result in “cost reduction” by eliminating the reject generation. However, a good Preventive Maintenance program would have been a “cost avoidance” initiative, as it would have prevented the reject generation in the first place.
A greater awareness and appreciation of “cost avoidance” initiatives in an organization will encourage superior thinking and preventive oriented actions. On the other hand, poor organizationalawareness of “cost avoidance” will discourage preventive oriented initiatives. In this context let me mention aboutthe Cost of Quality (COQ), whichhas 3 broad components viz. Prevention costs, Appraisal Costs and Failure Costs. The Appraisal and Failure costs are often referred to as ‘Cost of Poor Quality’. (COPQ). The prevention costs should ideally be considered as ‘Investments’ that help in avoiding the COPQ. However, usually, the information on COPQ is more easily available in an organization than the ‘Prevention Costs’.
