Turning Loss into Cost

Paul Hardiman, TPM consultant manager at Industry Forum explores how organisations can control their losses and even turn them into profits by learning how to use value analysis/value engineering (VA/VE) and industrial symbiosis.

Whether an organisation uses lean principles or other tools like Total Productive Maintenance (TPM) to drive improvement, it is important for an organisation to fully understand all losses and their associated costs to enable focused improvement activities. Costdown pressures will only intensify as global competition progresses and emerging economies continue to improve.

For TPM, the Japan Institute of Plant Maintenance (JIPM) encourage organisations to group losses into three main categories comprising of 16 losses.

 

The first task for an organisation is to ask whether they have a true picture of all losses. Many organisations think they do, but a more detailed analysis often identifies many gaps.

Next is to look at the way the losses are accounted for. Many are reported as measures such as overall equipment effectiveness (OEE), parts per million defect (PPM) or percent scrap or rework. But what are these losses really costing?

Finance will often make assumptions based on the data, which often are not visualised or understood throughout the organisation.

“The first task for an organisation is to ask the question whether they have a true picture of all losses”

A tool extensively used in TPM is a loss cost matrix. The following guidelines can be used to assist in drawing up your own loss/cost matrix and in calculating the cost of the losses. You will need at least one person in the team with detailed financial knowledge. They will need to know how the costing system works in your own organisation.

To create the matrix list the 16 losses down the left hand side of a grid. You may need to split some of the losses into more than one line e.g., rework and scrap, as they have slightly different cost components.

Along the top of the grid create columns for the total manufacturing costs, split into categories that reflect typical line items in the Profit and Loss account.

The matrix is then populated to show which losses inflate which costs. The solid and outlined circles show the direct and indirect impact, respectively, of the losses on the various costs.

“Finance will often make assumptions based on the data, but often these results are not visualised or understood throughout the organisation” 

Again detailed knowledge of how costs are made up in your organisation will help in populating the matrix.

Now calculate the cost of the losses in the right hand column. The following formulae are guidelines as to how some of these may be done. The finance team will need to provide a lot of the information to make the conversion.

 

 

In this matrix we are showing the costs for the whole organisation and so the losses at level 4 of the loss tree will have to be totalled across the whole tree.

Now think about other costs that can be included in the loss totals. Some examples are shown below:

• Penalties for missed or late deliveries. Premium freight costs.
• Costs associated with outsourcing manufacture to catch back on lost production.
• Any significant supplier rebate costs – i.e. paying a higher price per unit for supplied items as the predicted volume (which would have been supplied at a cheaper unit price) was not bought in.
• Impact from cash flow disruption; not being paid in the expected time slot as delivery late, so needing to borrow money. This will incur the costs associated with borrowing.
• Scrapping material as a result of a breakdown e.g., if other earlier parts of the process can’t be shutdown.
• Costs of catalyst loss. If a catalyst is used in the process and it has a known shelf-life then loss can be incurred  when it is not used to process materials during extended breakdowns.
• The cost of utilities e.g. heat/light/ water/waste costs can’t be recovered at any point.

It is very important to capture how you calculate each of the loss costs so it can be repeated later. You should write down the sources of information used, the conversion factors (correct at that date), any assumptions made and the actual formulae used in your organisation.

Once the matrix is created this can now be used by the improvement teams to attack and reduce the biggest losses. It is easy at the end of the improvement activity to see the true financial benefit to the organisation.

This matrix exercise may well identify an area which requires sustained attention. A proven and effective method for progressing such areas is value analysis/ value engineering (VA/VE) which was developed in the United States during World War II. It spread to Europe and the UK during the 60s and 70s but in recent decades has become unjustly neglected.

A VA/VE project should be carried out by a cross- functional team and needs effective leadership. It is easy to find how to guides for VA/ VE on the net and it is worth using one which goes into some detail and following each step through.

“The key idea in industrial symbiosis is process waste only exists in relation to a specific process. The process waste from a given firm is just stuff the firm doesn’t know how to transform into something customers want”

One of the powerful aspects of VA/VE is the effort that goes into identifying, analysing and refining the problem. A common feature of failed costdown projects is they assumed too rapidly the real cause of the problem had been identified and ended up only tackling symptoms rather than the real issues.

VA/VE also goes through a well-structured method of brainstorming solutions and then carefully selecting and refining possible solutions. Often three options are taken forward some way and the final option is only selected on a careful cost-benefit analysis.

A good VA/VE project guide will also include suggestions on how to play the inevitable organisational politics that surface in a project of this kind. For example, it is important at an early stage to identify the main stakeholders involved in the solutions that are being investigated and to keep them informed of how the project is developing. A sudden surprise at senior level when the project is well developed can easily provoke hostility, resistance or even rejection. A senior project sponsor is also an invaluable asset. This method of developing innovation is currently emerging globally in the public sector under the new name of i-team.

It is important to recognise that this disciplined approach to sustaining or enhancing product performance, while making major reductions in cost, has been used by Chinese manufacturers to progress from significant regional players to dominant global firms in specific markets. This development has been analysed in the book The Dragon at Your Door: How Chinese Cost Innovation is Disrupting Global Competition by Ming Zeng and Peter J Williamson. The project leader for VA/VE exercise can make good use of the examples in this book, to help persuade doubters of the importance of boosting value while reducing cost.

“VA/VE is becoming a must- have capability for manufacturers in advanced countries. In particular, where a firm detects that its market is under threat from Asian companies using a cost innovation approach, the determined use of VA/VE is a good way to kickstart a response”

It is true that currently the low cost competitive platform of Chinese manufacturing is facing various challenges which are beyond their control. This means they will almost certainly develop the strategies which they can control like
cost innovation. Effectively this means that VA/VE is becoming a must-have capability for manufacturers in advanced countries.
In particular, where a firm detects that its market is under threat from Asian companies using a cost innovation approach, the determined use of VA/VE is a good way to kickstart a response.

Many experienced observers of the global manufacturing scene think the strongest cards advanced country manufacturers possess lie in the power and potentiality of the networks they can develop and leverage. An important example of this approach goes under the name industrial symbiosis (IS).

IS started as an academic idea but it was first shown to be practically effective in the West Midlands. The key idea in IS is that process waste only exists in relation to a specific process. The process waste from a given firm is just stuff the firm doesn’t know how to transform into something customers want. Whether the waste is in fact useful to someone else is unknown until a deliberate search is made.

IS uses the power of networks to find customers for the material that other network members can’t use. It is important to recognise the immense power of this approach. The firm generating the waste finds that something that it had to pay someone to dispose of becomes a revenue item – cost has literally been changed into value. Similarly the firm that takes the waste as input finds it benefits from a costdown on its purchasing bill.

This approach relies on the network being large and varied so there is a good chance a reasonable proportion of the identified wastes can find new users. It is also helped by a well-designed matching system.

IS now has an important profile in Europe. In its 2020 flagship initiative, Roadmap to a Resource Efficient Europe the European Commission highlighted the role industrial symbiosis schemes can play. The European Resource Efficiency Platform (EREP) has acknowledged the role of “facilitated industrial symbiosis” schemes in “diverting waste from landfill, contributing to the preservation of resources and moving waste up the value chain”. It has called
for the wide-scale implementation of IS networks across Europe. It also credited industrial symbiosis projects for accelerating innovation and creating green jobs. There is now an important desire to implement a Pan-European network of industrial symbiosis programmes.

Europe’s leading experts in the implementation and development of facilitated industrial symbiosis projects and networks have joined forces to create the European Industrial Symbiosis Association (EUR-ISA). EUR-ISA initially brings together the organisations responsible for up to 10 established industrial symbiosis programmes (collectively engaged with more than 20,000 companies across Europe) and provides the European Commission with a focal point to accelerate industrial symbiosis in Europe in order to generate substantial economic, environmental and social benefits.

This article was first published in The Lean Management Journal, September 2014 Edition

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