Six Sigma measures the number of defects per million opportunities for error within a business process. While that might sound Greek to some, corporate finance executives at leading companies are becoming fluent in this quality initiative because of its significant cost-management capabilities.
When the term Six Sigma comes to mind, many financial managers think of a process quality goal, and for good reason. It is, by definition, a statistical term that measures how much a business process varies from perfection and is based on the number of defects per million opportunities for error. The idea is to scrutinize all processes, pinpoint where errors occur, analyze and correct them, and then put measures in place to control the process. Proponents of Six Sigma, whose roots trace back to earlier quality initiatives such as total quality management and reengineering, say it’s a faster way to achieve process improvement than its predecessors.
There is, however, more to Six Sigma than its goal of delivering a higher percentage of defect-free products. These days, Six Sigma is being credited with maximizing equipment usage, optimizing cycle time and even improving response time to customer inquiries. In the cost-management arena, it’s reducing high costs of inspection, maintenance, inventory carrying, frequent expediting and high scrap and rework, among other expenses.
"Excess costs related to poor quality include excess manufacturing steps, excess people to do the job, overtime and excess equipment," says Joseph A. DeFeo, executive VP and COO of the Juran Institute Inc., a management consulting and training firm in Wilton, Conn., which helped develop the Six Sigma concept. "By using Six Sigma to reduce those areas of waste, you can often reduce your total costs by 15 percent to 20 percent annually."
Historically, operations managers have been the Six Sigma champions. However, the cost-management benefits inherent in the concept have spurred more and more financial managers to pick up the Six Sigma banner and run with it.
"Today, there’s a strong trend toward senior financial managers championing Six Sigma," DeFeo says. "There’s a much stronger tie with the financial people to Six Sigma than there has been with earlier quality initiatives like total quality management. More and more of them are becoming black belts" (a designation given to those who complete a certain level of training for Six Sigma). He adds that having the financial manager lead Six Sigma gives credibility to the project and validates the results.
Validation of Six Sigma savings is one duty of financial managers at AlliedSignal, a Fortune 500 aerospace, automotive and chemical company based in New Jersey. "The financial manager has to audit and validate that the product savings credited to Six Sigma actually do positively affect our bottom line," says Steve Peterson, worldwide director of quality and Six Sigma for Turbocharging Systems of AlliedSignal Inc. in Torrance, Calif.
AlliedSignal, along with General Electric Co. (GE) and Motorola Inc. — which pioneered Six Sigma over 10 years ago — are among the most notable companies to ingrain the concept into their core operations and reap significant cost savings as a result. According to GE’s annual letter to shareholders, employees and customers, Six Sigma techniques applied at GE resulted in bottom-line benefits of more than $750 million in 1998. At Motorola, the estimated savings attributed to Six Sigma since the company started using it in the late 1980s are about $2.2 billion. And at AlliedSignal, cost savings credited to Six Sigma totaled over $500 million in 1998. "The payoff that Six Sigma delivers is usually two to three times the amount of money and time that must be put into it," DeFeo says.
These companies have made no secret of the fact that they’re saving money with this initiative, something which has earned the attention of major investors. "Wall Street analysts have definitely taken notice — to the point where more of them are saying, ‘Show me what you’ve done with Six Sigma’ and including that information in their evaluations," says DeFeo.
Six Sigma is not an activity any company can just start, without the right kind of preparation, working environment, training and people. "I think Six Sigma should be the icing on the cake," says L.H. Garlinghouse quality engineer at Waterloo Industries in Pocahontas, Ark., who’s seen quality initiatives come and go during his 35 years in manufacturing. "In other words, you need a world-class corporate culture that’s already using things like the Balanced Scorecard, activity-based costing/management (ABC/M) and total quality management before you can start using Six Sigma. Without those things in place, you’ll likely go nowhere with it."
Employees who don’t understand the purpose of Six Sigma may not embrace it, says Garlinghouse. "If your company has a policy of laying people off as your level of efficiency goes up, your people may wonder what the value is in doing Six Sigma if all they’ll get out of it is a lost job," he says.
Another drawback is that companies often can’t identify a clear purpose or determine where to use Six Sigma. "Sometimes companies that are doing only Six Sigma have trouble targeting what part of the business they want to use it for first," says Brian Kanter, partner with Deloitte Consulting in Boston. "Another potentially weak area of Six Sigma is determining whether Six Sigma efforts achieved the results the company wanted to achieve. You don’t get a feeling of having a closed loop on a project."
Finance managers who are involved with Six Sigma can direct it toward the parts of the business most in need of cost improvement. That task is easier for businesses that already use ABC/M. Letting ABC/M results guide the direction of a Six Sigma initiative makes sense, according to Peterson.
"ABC/M helps us set our Six Sigma priorities," Peterson says. "Six Sigma can become esoteric and narrow, so you need to set the priorities for the business before Six Sigma comes into play."
Six Sigma, which was originally called "operational excellence" at AlliedSignal when the company began using it in 1995, serves as a sort of universal language for the company’s cost-management efforts. "With Six Sigma, everyone in the company, including employees at our locations in Asia and Europe, can all speak the same language. They all have the same targets, and they all use the same tools. That commonality has helped with the total business," says Peterson.
Six Sigma can fix the areas of waste that lean manufacturing identifies. According to Kanter, lean manufacturing focuses on seven areas of waste: overproduction (often due to poor scheduling), transportation (excessive moving of parts from one area to another), inventory, processing, wasted motion (among employees), the number of defects in a process, and waiting (idle employees and unused equipment).
AlliedSignal used the two terms interchangeably. Isola Laminate Systems in LaCrosse, Wisc., — formerly AlliedSignal Electronic Materials’ Laminate plant of Hoosick Falls, N.Y., which was divested in September — is applying Six Sigma to identify specific bottleneck areas. In 1998, those efforts produced a 40 percent reduction in setup times, an 11 percent reduction of inventory costs, a 25 percent reduction in cycle time and an 18 percent increase in productivity.
Has AlliedSignal achieved Six Sigma, that is, 3.4 errors per million opportunities? No. Few, if any, companies have accomplished that feat. The company is hovering at an overall level of about 4.5 Sigma. To put that figure in perspective, Four Sigma is 6,210 errors per million, and Five Sigma is 230 errors per million. So going from Four Sigma to Five Sigma requires about a 30-fold improvement in the error rate. (See Six Sigma Defined [1].)
Companies that achieve a certain level of process improvement with Six Sigma may seek recognition from outside sources such as ISO 9000, an international standardization organization that provides certification to companies that attain a high degree of process control and assurance. It requires that organizations meet 23 different process and quality criteria, and companies that make the grade can parlay their certification into more business.
"For suppliers, having the ISO 9000 can help them reduce the number of audits they receive from companies like GM that say, ‘You must do X, Y and Z if you expect to do business with us,’ " says DeFeo. "A supplier can say they’ve already met all these ISO 9000 standards, which can improve their ability to attract business from companies like GM. ISO 9000 companies can also improve their marketing by advertising that they have the certification."
DeFeo adds that an updated version of ISO 9000, called ISO 9000:2000, will soon be in place and will include more emphasis on process improvement and planning than its earlier version. "Industry-specific quality standards are in the works, too. For instance, TC 9000 will become a standardized level of quality for the telecommunications industry beginning in 2000," he says.
Achieving Six Sigma may be like trying to reach the unreachable star. But having that goal out there for a company always gives it something to keep shooting for. The trouble is, the closer one gets to actually reaching it, the amount of time and effort devoted to it multiplies exponentially.
"A friend of mine has an antique car, and he spent X amount of money to reach a rating of 98 out of 100 at an antique car show," says Kanter. "In order for my friend to reach the 100 level, he would have had to double X. The question is, is it worth doubling the amount of money he needs to spend to gain those extra two points?"
Companies such as Motorola that make microchips for space exploration applications, will want to make a lot of extra effort to gain just a small reduction in defects. A shirt manufacturer that would have to spend twice as much money annually to reduce its error rate by 2 percent or 3 percent probably can’t justify the cost.
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[1] http://businessfinancemag.com/magazine/archives/figure.html?fig=2000/January/010074/010074.gif
