About this lesson
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.
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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