Economics of Quality: A Strategy for Growth

ISE Magazine March 2019 Volume: 51 Number: 3

By Kaiwen Cheng

No business can survive long term without quality. Most business leaders are aware of this fact, but some still view quality only as a necessary evil. Some may view quality as nothing but paper-work. We want to move away from this negative approach to quality and instead fit quality into the economic model of the business.

Quality of products and services is a fundamental requirement to sustain a business. But just blindly using all known quality tools won’t guarantee a successful outcome. A smart deployment of quality tools brings amazing benefits to a business. The recommended approach starts with defining the strategic position by choosing the level of quality that drives the proper set of tools. Then follow up with the positive key performance indicators (KPIs) to build the cadence of improvement.

Four levels of quality

The behavior of a business can be categorized into one of four quality levels. This should be done with a self-reflection exercise to determine the appropriate level that represents one’s own brand and value. The result from this self-reflection would be the key strategic component to drive the business’s quality approach.

There is no right or wrong level. A business may also move between levels based on circumstances, and different parts of a business may operate at different levels. For example, when trying to move from level 1 to level 2, a solid inspection plan is more appropriate than conducting design of experiments. Typically, a higher quality level would require using more proactive and predictive quality tools. It would also increase the focus on customer services and require different sets of creative talents.

As an example, it is clear Walmart is at level 3. It is a huge, successful enterprise and clearly demonstrates that a higher quality level is not necessary. Reviewing the company’s three-year strategic plan in 2018 (see image to the right), it is clear becoming a premium brand is not its target. Instead, there is an obvious focus on processes to de-liver value and a seamless experience with customers.

It is also well-known that Walmart uses a low-margin strategy to drive up volume. That is the core approach started by founder Sam Walton from the beginning. A low margin model is not an issue if you can drive efficiency, as Walmart emphasizes in its strategy.

Porsche is another good example at a premium quality level. Porsche is driving to target 15 percent as its threshold on margin while other automakers are working hard for sub 10 percent; this is included in Porsche’s “Strategy 2025.” The company is de-signed for “inspiring customers with a unique product and brand experience” as stated on its website. The low-volume production – Porsche’s 55,000 vs General Motors’ 10 million car sales per year – would require a different set of quality plans where more specific testing becomes feasible.

Other premium brands in each sec-tor are typically at the highest quality level. For example, Tiffany, Nike and Lexus are companies where having prestige pricing drives higher margins. The premium-brand paradigm is one example of how quality level is a critical factor of the economic model for your business and will continue to be relevant in the following discussion.

Positive key performance indicators

Key performance indicators need to be selected once the strategic direction is set. It is used to describe whether the areas or processes are moving at a rate that meets the need. There are cases where multiple KPIs can be selected to measure the same thing, and it is critical to select KPIs that encourage positive thinking. A positive metric will drive positive behavior.

For example, businesses want to keep inventory lower to avoid tying up working capital. However, operations can also lose flexibility with restricted inventory. Instead of measuring inventory level directly, it can be measured with inventory turns to be more positive. In this case, the size of inventory doesn’t matter. Such a metric would drive more attention toward managing high value or critical items to flow faster and drive up inventory turn. Such a positive metric would prioritize resource management naturally.

We suggest businesses start with re-turn on asset (ROA) as the foundation for the positive KPI approach. Instead of seeing ROA as a simple “return/as-set,” we turn it into a positive metric by driving up the margin and/or driving up turns to improve ROA, as seen in Figure 2

Margin and asset turns are strongly correlated with quality level and operational efficiency, respectively. Businesses can drive up margin by driving up the quality level. Such a focus translates into an overall positive attitude for the workforce versus mere cost reduction. However, margin is also strongly controlled by the market and often limited within the industry.

An efficient operation always has a good asset turn. It is as powerful, and often easier, to drive up ROA than margin. To achieve a higher asset turn, a business needs to become more predictable, which means less down-time, scrap and other wastes. That also means a high-quality process is also a predictable process.

Figures 3 and 4 demonstrate the combined effect on margin and turn. The curve in Figure 3 indicates the high rate of asset turn decreasing for a constant 12 percent return. As we dis-cussed earlier, the external factor from the market, driven by customers, has a strong control on margin. But even if the margin is as low as 6 percent, as in Figure 4, the compounding 10 percent improvement on asset has a significant improvement on return.

ROA is an outcome (lagging) metric and it is a powerful indicator by it-self. An even more efficient approach is to combine it with input (leading) metrics. In short, one highly recommended measure is the overall equipment effectiveness (OEE) metric with its sub-metrics: availability, productivity and yield. This is also a common metric used in lean manufacturing. Businesses can utilize these measurements to properly prioritize and achieve the maximum potential of its workforce.

Reaping the benefits of increased quality

The concepts of four levels of quality and positive KPI are the foundation of the economics of quality. By applying a plan-do-check-act cycle approach, the quality level is developed during “plan” phase. The KPI would be a perfect device integrated into the do-check-act phase to monitor the progress of improvement.

Even without full deployment of the margin/turn process, the concept can easily turn the conversations into a positive direction. To harvest even more benefits from this concept, businesses need to drill further down with the OEE dashboard or other quantifiable measurements to drive project selections and implementations. This drilldown would involve more complex conversations.

In a nutshell, quality shall generate tangible business benefits beyond just “it is the right thing to do.” We realize the journey can be challenging and confusing. This two-phase approach can turn the challenging journey into an enjoyable one.