Management by knowing - counting the cost, part III.

On a recent flight out of New York, I pondered the fact that the reason I don't like flying is because someone else is in control of my destiny. In those few seconds during landing, right before the wheels touch the ground and everything is flashing by, that's when I really feel flying is "seat-of-the-pants" stuff.

Do the pilots know where they are going? Surprisingly they seem to. The question is, do we know? "I often wonder if any of us knows where we are going," mumbled my flying companion, just as we were thundering into the sky. "Certainly the government doesn't. How in Hades can we possibly survive another profligate Congress which spends more than it makes?"

I couldn't have agreed more. For example, New York City is still the wealthiest-looking city in the world until you get down there and witness its ailments. Living in our debt-ridden and extremely wasteful society makes no sense, yet we live with debt and waste every day.

"I am reading a report from one of my managers, and he is telling me that the firm's unquality costs, the cost to the company caused by non-conformance such as customer complaints, producer liability lawsuits, redoing defective work, products scrapped, etc., is at least 25% of sales, maybe as high as 35%. We are no better than the government."

He looked at me for the first time and must have seen a kindly face. "Right now we are doing so well, it takes up all of my time to keep up with the increase in business. I don't have the time to solve all those internal mistakes; that's his job." Then he returned the report to his briefcase.

My view, though I didn't reveal it, was that he didn't believe his manager. If he had, my new friend would see it as a fantastic opportunity. Without increasing his sales, this vastly improved return on sales would not only push his bonuses through the roof, he would soon be CEO. His manager had the answer to survival but my friend didn't see it. As Deming and Juran have preached for years, we must find a new way to manage. If we are throwing away 25% of sales dollars on wasteful practices, we don't deserve sympathy.

I switched on my Laptop and began to investigate some data I had accumulated at my last port of call. It was information on reasons for unquality events (UEs) in a $25 million wholesale distributor. The CFO had worked out the unquality cost of each reorder, partial shipment, back order, etc. He had found, for example, that an inventory adjustment cost $29, a shipping error $51, a credit memo $48. Multiplying each unquality event by its appropriate average cost presents a picture of the cost of "not doing things right the first time." For this month, it was $264,771. His sales were approximately $1.5 million for the same month. So these unquality costs represent nearly 18% of his business, a huge chunk of possibility if his monthly margin was only a positive 2%.

It is difficult to argue that his $264,771 July unquality costs are true accountable dollar savings. But any CFO worth his salt knows that any reduction in these costs in August must indicate a positive variance to the bottom line. He may not know the exact amount, but can assess the effect. Comparisons from some benchmark month will tell the value of Managing by Knowing on profits as the months go by.

Unquality costing has three vital values:

1. It demonstrates the cost magnitude of accepting faulty processing as a matter of current business practice. An 18% positive adjustment to margins must be an incentive to at least try to improve processing.

2. It pinpoints areas, functions, operations, etc., of greatest potential gain. If 25% of all UE's were related to inventory adjustment and only 16% to shipping, yet shipping UEs were 14% more costly, reducing shipping UEs will have a bigger bang for the buck.

3. It monitors the progress and achievements of your quality improvement efforts. If shipping UEs were reduced 50% in August, a $25,000 savings is feasible. And that ignores the intangibles of improved customer service. Who's to know that your best customer noticed a marked improvement in your shipping service in August and decided to give you more business in September. These are the facts of business life. If you give value, you will receive value.

Phil Crosby argued 15 years ago that service firms spend as much as 40% of sales on unquality. This seemed highly disproportionate at the time. But he was right. If you accept failure as normal, unquality costing is a waste of time. We budget for it. But getting rid of unquality is not only your survival mechanism, it is, at the same time, the best way of getting out of debt.

I showed my new friend the results. He knew nothing about wholesale distribution, but he saw my point. He said nothing for a moment. Then he put his glasses back on, reached into his briefcase and pulled out his manager's report. He opened it again, but this time he clearly read it with care.

"You know," he said, after a few moments hesitation, "perhaps there's something in this. After all, if you eliminate only a small percentage of waste, it immediately affects the bottom line. And if you get into the habit of improving as a way of business life, you cannot help but win."

Now that was profound. With luck, he had experienced a mind-set change. If only I could get him to take me on as a consultant, what a rewarding flight this would be. But my luck was running out. Suddenly I realized we were landing.

Too soon we were parked at the gate. I hadn't had the chance to get my sales pitch in. There I was with a possible client and he was heading off the plane. Oh well, at least we had landed safely.