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COVER STORY: Why there’s no mistake in quality

Quality is back: just when many companies thought they had the issue sorted – or at least had tried it, not seen much benefit and consigned the thing to the dustbin labelled ‘management consultancy fad’ – the issue has muscled its way back on to the management agenda. And this time around, the FD needs to pay more attention.

So what’s changed in the world of quality that demands this fresh look? Apart from fresh impetus given to the issue by professional bodies and the imminent changes to ISO9000 (see panels, pages 28 and 30), the quality agenda has moved on. We are now entering a new phase in which companies need to review what they’ve achieved and map out further objectives.

There are three specific reasons why FDs ought to become more deeply involved with this activity. The first is that there are many companies which ought to be revisiting the ‘cost of quality’ question if they are to get a true view of the role new quality initiatives can play in sharpening competitive edge. The second is that quality, although still imperative on the shop-floor, is now moving into the back-office. The third is that FDs could play a key linchpin role in facilitating new quality initiatives that tie together disparate parts of a company – perhaps involving both shop-floor and back-office.

Let’s start with cost of quality. When Philip Crosby wrote his seminal book Quality is Free in 1979, he started a process of change which has still not fulfilled its potential. Crosby’s message was simple: ‘Quality is free but no-one is ever going to know it if there isn’t some agreed-on system of management.’

Crosby put the argument so succinctly that it’s worth repeating: ‘All you really need is enough information to show your management that reducing the cost of quality (COQ) is in fact an opportunity to increase profits without raising sales, buying new equipment or hiring new people.

‘The first step is to put together the fully loaded costs of (1) all efforts involved in doing work over, including clerical work; (2) allscrap; (3) warranty (including in-plant handling of returns); (4) after-service warranty; (5) complaint handling; (6) inspection and test; and (7) other costs of error, such as engineering change notices, purchasing change orders, etc.’

Crosby added a rider: ‘It is normal to obtain only one-third of the real cost the first time you try it.’ Any FDs who can put their hands on their hearts and say they know the true figures under all seven categories for all operations in the company can stop here and turn to the leisure magazine of their choice.

The fact is, according to W Jeffery Howard, a member of the APQC Consulting Group, which is a subsidiary of the American Productivity & Quality Centre, the cost of quality in many companies hovers between a staggering 20% and 40% of annual turnover. Howard bases his figure on consulting experience and the (admittedly rare) examples quoted in management literature.

These include Ciba Corning Diagnostics, which estimated that cost of quality amounted to 34% of turnover; and National Westminster Bank, which found that 25% of operating costs were accounted for by the difference between the cost of actually finishing a task and getting it right first time.

Howard, who is also author of The Cost of Quality, argues that the effect of showing cost of quality figures to a board is likely to be so dramatic ‘that a cost of quality audit is often used as the key argument to win top-level commitment to quality improvement’.

The problem with cost of quality is that it is by no means easy to organise on the ground, especially when the finance department is under-resourced or over-worked with other tasks which often impose tight deadlines. As Jeffrey Ridley, visiting professor in auditing at London’s South Bank Business School, notes: ‘You will go a long way to find an organisation that is costing quality.’ But with the first round of quality projects reaching maturity in many companies, FDs need to find a new way to give impetus to a second round. Costing quality could be it.

Which brings us to the second reason why quality is again being talked about in the boardroom. This is that quality is moving off the shop floor and more widely through the company into back-office functions. For example, service industries have discovered quality, sometimes as a result of focusing on customer satisfaction. Their wins from quality management can be even larger than in manufacturing, argues Steve Warwood, a quality specialist who is a senior teaching fellow at the University of Warwick. He estimates that while cost of quality may average out at 20% to 25% in manufacturing, it is as high as 40% to 50% in service companies.

Of course, both kinds of companies have back-office functions, but they tend to eat up a higher proportion of total costs in service firms – which makes back-office quality more of an issue for them. According to Paul Ruggier, head of quality and process at Xchanging – a back-office outsourcing business launched last year with £30m of venture capital – clerical error rates typically run at 7% (or 70,000 per million operations). Using the six sigma methodology (see panel, previous page) Ruggier says it’s possible to reduce errors massively – to just 3.4 per million.

Cutting back errors so dramatically delivers a whole raft of benefits, from reductions in work that has to be done more than once, to an increase in customer satisfaction. But achieving it requires a fundamental shift in back-office culture, plus the addition of simplified processes that are designed to remove opportunities for error.

Xchanging’s chief executive David Andrews – who as head of Andersen Consulting’s international outsourcing business oversaw the successful outsourcing of BP’s accounting function – believes the back-office should become more customer-focused. He says companies should look on back-offices as enterprises in their own right, with their own customers, in order to bring about a fundamental culture change.

Of course, there is special pleading in this argument. Andrews’ point is designed to make the case for outsourcing – and it is certainly one way to create the fast-track culture change which could harvest early quality wins. But that’s not to rule out the possibility of doing it internally, although there are often plenty of barriers to internal change.

One inspiration for any FD embarking on the task is quality guru Masaaki Imai’s book Gemba Kaizen. Imai argues: ‘Today’s managers often try to apply sophisticated tools and technologies to deal with problems that can be solved with a common sense, low-cost approach. They need to unlearn the habit of trying ever-more sophisticated technologies to solve everyday problems.’

So, finally, what is the FD’s role in all of this? Ridley says: ‘I think that the FD not only has a responsibility for the quality and output of the operation he manages, he has an influence on the rest of the organisation and its quality standards.’

Warwood agrees that the FD’s influence over quality standards in the whole company may be larger than he thinks. He points out that a company’s cross-functional processes almost always take in the finance function somewhere along the line. As a result, the FD has links to more different parts of the organisation than almost any other director.

He recalls: ‘When I was running quality workshops with boardroom teams, I used to persuade one of them to take on the responsibility of quality director for a year. I always used to try to get the FD to do it first because of the number of links that he has with other aspects of the business. Getting the FD involved also had the added benefit that he could do a cost of quality analysis right up front in any total quality management project the company planned to launch.’

Warwood says one of the problems with quality is that it’s not always easy to find the financial payoff. So it’s important to put a marker in the sand before a quality project starts, so that the board can see the payoff after it has been running for some time.

E-business introduces some new twists in the quality tale, one of which is the need to ensure that processes are hacker-proof – which will make quality and security a pair of odd bedfellows. Again, the FD will be in a good position to drive action.

Above all, the emergence of the ‘zero tolerant’ customer increasingly puts a premium on quality in all aspects of business. So, the next time quality strategy is on the board agenda – and it ought to be soon – there will be plenty to talk about.

Quality is Free, by Philip Crosby, is published by McGraw-Hill. The Cost of Quality, by W Jeffrey Howard, is published by Cambridge Strategy Publications. Gemba Kaizen, by Masaaki Imai, is published by McGraw-Hill.

Let’s talk quality

The quality business has spawned a whole vocabulary of its own, and many of the words and phrases originate in Japan. A small selection include:

Ask why five times. The idea that you shouldn’t be satisfied with the first answer you get. Questioning the answer from the previous question gets you to the root cause after five ‘whys’.

Gemba. Means ‘real place’ in Japanese. By inference, the workplace. The idea is that when a problem occurs the first thing a manager should do is visit the gemba to see what’s happening on the spot.

Just-in-time (JIT). Narrowly thought of as a way of organising deliveries, but, more broadly, quality management that helps eliminate waste – in time, materials and money.

Kaizen. Japanese again. This means ‘continuous improvement’

and is the basis

of a management philosophy which aims at the same.

Kanban. ‘Delivery system’ in Japanese. Essentially a communication system for use in JIT. A kanban notice instructs delivery of a number of parts. When they’re all used the kanban returns to its starting point and triggers another delivery.

Muda. More Japanese: ‘waste’. Not just scrap on the floor. Anything that doesn’t add value to a process – in manufacturing or back-office.

Six Sigma. A statistical tool designed to reduce the number of errors in business processes to fewer than four per million.

Total quality management (TQM). A crusade involving all employees – often organised in quality circles – in an effort to boost quality. 80% of TQM initiatives in the UK are said to have failed.

Value analysis. Technique designed to reduce costs of components upstream by using reviews and cross-team collaboration during design, manufacturing and quality assurance.

Quality in the finance function

Because the quality debate has usually focused on manufacturing, it has not often seemed particularly relevant in the finance function. But times are changing. Tougher competition means managers are increasingly expecting the back-office to make its contribution to competitiveness.

In fact, talk about finance function quality has been around for at least a quarter of a century. It first surfaced in the Sandiland committee’s report – concerning improvements to the standard of financial reporting – which appeared in 1975.

Jeffrey Ridley, visiting professor in auditing at London’s South Bank Business School, has followed the emerging finance function quality debate closer than most.

As chief accountant at Kodak UK, he was a pioneer in introducing ISO9000 – BS5750 as it then was – into the company’s finance function. He also had an opportunity to view the broader quality debate from a finance perspective when he served on Kodak’s quality council in the mid-1980s.

Ridley believes that good quality ought to be closely linked to good governance, a topic which has received high-profile attention in many corporates’ finance functions. Systematic attention to quality is a visible sign that the quality of financial reporting is taken seriously.

‘Not many organisations try to relate these issues, but I think the finance function has a strong reason to create an environment not just of financial but of operational control, too,’ Ridley argues.

He points to the Accounting Standards Board’s Statement of Principles on Financial Reporting, published last December, as an indication that the subject of finance quality is beginning to move centre stage. The Auditing Practices Board is establishing quality standards for audit work and the Chartered Institute of Public Finance and Accountancy (CIPFA) has set up a quality forum.

But, although there is plenty of detailed work on how finance functions can apply quality effectively, at the root of the debate is a basic principle. Says Ridley: ‘The finance director is responsible for the quality of financial reporting in his organisation. To meet that objective, the FD must have quality systems.’

ISO9000 up for revamp

Companies that have thought about implementing the ISO9000 quality standard in the past – and rejected it because of cost or time restraints – might want to think again. ISO9000 is about to undergo its biggest transformation since it appeared as part of the quality landscape.

According to the enthusiasts, ISO9000 has always been able to deliver plenty of benefits for those who put their heart and soul into implementing it. The problem has been that some companies have looked at what’s involved and pushed it to one side because of the time and expense in gaining certification.

Others have implemented it reluctantly, in order to satisfy the requirements of an important customer which insists suppliers are quality certified. Still others have implemented it in order to get an impressive plaque in reception.

The big shift for ISO9000 is that it will start to focus more on what is done rather than how it is done. John Hele, business manager for quality systems at the British Standards Institution, says: ‘The old ISO9000 was procedure-based and tended to be centred around quality assurance and quality control. What we are looking for in the new standard is a heavy commitment from top management to understand customer expectations and then set policies and objectives that can meet them.’

Put simply, there will be less emphasis on defining detailed procedures within the organisation and much more focus on what it delivers to customers – including internal ‘customers’.

The new standard will increase the emphasis on staff competencies and on the provision of the resources and environments needed for staff to perform their roles. As a result, Hele hopes the new standard will be less bureaucratic than the old.

However, it’s not yet certain that the Swiss-based International Standards Organisation, which defines ISO9000 around the world, will agree to the changes. A July meeting is scheduled to take final decisions. So, even if all goes well, the new standard is unlikely to be launched much before the end of the year. Return to the Financial Director website

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