Jumpstarting Process Improvement in Your Organization: The Top 10 Essentials (Part 3 of 10)

This post is third in a series by Jason Kilgore about how to implement a formal process improvement effort in your organization.  

Essential #3:  Clearly defined rules and metrics for success.  Tying back into an earlier thought, the rules and metrics must align with the philosophy and objectives of the overall process improvement mission.  For example, if the goal of the process improvement effort is to improve quality, each defect or complaint or customer return must carry with it an associated dollar-value cost – either by empirical data or by convention.  Therefore, if the number of defects or complaints or returns is reduced, the dollar-value of the project is entirely quantifiable.  How the company chooses to value such lapses in quality is secondary to the fact that the valuations (or rules) are established in advance. 

Similarly, cost savings must be defined.  Typically, there are three types of cost savings in the process improvement arena.  They are as follows:

  1. Hard cost savings – savings calculated from those costs that were incurred in the baseline year and were not incurred in Year 1.  For example, “In 2010, our cost per student was $8,657. After significant process improvement efforts, our cost dropped to $7,943.  Reductions were as follows…”  Hard savings are sometimes called green dollars – meaning tangible, bottom-line, in-the-bank savings. 
  2. Soft cost savings – savings estimated from costs associated with extraneous human effort, inefficient process, cycle times, or wasted movement.  Typically, when improvements are made to reduce soft costs, time is taken out of the process, but no workers have been displaced.  Once the time savings have been documented, it’s fairly straightforward to put a dollar value on the project.  However, since no workers have been cut, the dollar savings are theoretical.  Important? Yes.  The right thing to do? Yes.  Critical to the success of the business? Yes.  Dollars added to the bank account? Not so much. (Soft savings become hard savings when the number of workers performing the tasks is reduced.)
  3. Cost avoidance – savings calculated from money slated to be spent but was not actually spent due to a non-routine intervention.  This type of savings has several aspects.  Suppose that a company was in a position to invest one million dollars in capital to support a new product or service.  Bids were placed and a budget formulated.  If the business continued in steady state, the one million dollars would have to be spent.  However, if under the leadership of a process improvement specialist, changes were made to facilitate the new product or service in a way that required only a $200,000 investment, the cost avoidance would be $800,000.  In this case, there is not hard cost savings – the company spent $200,000 more than it did the previous year.  However, it was able to accomplish the same goal for $800,000 less than anticipated through targeted process optimization. 

Defining the “rules” – how cost savings are accumulated – is both tricky and necessary.  All are important, but cost avoidance and soft savings rarely, if ever, justify the cost employing full-time specialists.  As a general rule, I’d recommend a balanced approach to setting savings targets:  A minimum of 60% of total savings to be hard savings and a maximum of 40% of total savings to be any combination of soft savings and cost avoidance. 

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