Turning Latent Defects into a Profit Center

The recent news that car reliability has regressed for the first time in years really brings into focus the problems having no real sense of value adding versus non-value adding (waste) creates. The rate and magnitude of silly, often destructive decisions that flow from not knowing the difference is turbo-charged when compounded by the absurd reliance on standard costs.

Consider the standard cost breakdown on this product. Management has a big problem because they sell is for $12.00 but the accountants say it costs $12.29 to make it. In fact it only costs $5.00 – or $6.30 if you think people a throw-away items – and the rest is the cost of something else, but not this item. The accountants need to put every nickel somewhere, however, so they do their allocation mojo and even convince themselves that they are losing money on this item.Standard Cost problem

How to fix it? By reducing the cost of materials is the first choice; cutting labor costs is the next alternative. Not much point in going after any of the overheads, however. Even if all of the quality costs, for instance, could be eliminated they only amount to 26¢; besides, they have no idea how to make stuff without quality inspectors. So the focus is on the big numbers – where the greatest opportunities lie. The problem is fixed by (1) bludgeoning suppliers into price reductions, (2) switching suppliers with the ones in jerk-water third world countries being the ‘best’ solutions – which drives up the overheads to handle massive quantities and dubious quality but those costs aren’t directly tied to this product and are sort of fixed so who cares?; (3) having the thing made in China; or (4) simply downgrading the material. Who is to notice or care if we use a slightly lower grade of steel or resin?

The lean company, of course, goes after the costs behind the $3.76 in non-value adding overheads. They don’t think they have a problem with this or any other particular product. They think they have a problem as result of creating processes that drive too much non-value adding waste so they attack quality costs and the like, and don’t too much care if or where accounting might want to allocate those or any other costs.

… but back to our traditional company.

The upshot of all of this is the solutions are all aimed at reducing the value adding costs – the part of things that customers are willing to pay for; and it ignores all of the non-value adding waste. The other big implication is an inevitable reduction in reliability. The common thread among the attacks on the value adding activities is not so much in quality, but in an increase in early life failure … the Chinese processes are a little less under control and more is produced at the extremes of the tolerance limits, the lesser material fails after 1500 strokes rather than the 10,000 the old stuff could withstand – nor problem for most customers but a problem for the heavier users, suppliers cut corners to achieve the lower cost mandates.

Everything meets the immediate quality standard, but having so much at the margins stacks up and things just fail sooner – don’t hold up quite as well as the old versions. But all of this is pretty hard to see – nigh unto impossible if you believe in standard costs and think the reports from final quality inspectors really tell an accurate tale about value.

The incredible aspect of all of this – where such little sense of how value is created passes from the ridiculous to the sublime – is the next not-so-brilliant financial thought: ‘We should charge folks for an extended warranty’. I mean, are they really that ignorant? Did they really sit back and say to themselves, “Hmmm … all of these customer complaints could be an opportunity!”

When the checkout person at Walmart asks me if I want to spe...nd another $15 for a warranty on the item I am paying $100 for I have to wonder – are they simply trying to steal $15 from me, or are they trying to tell me I shouldn’t send the $100 because this thing probably won’t last as long as I have every reasonable right to expect?

No, I don’t want the warranty. I expect the product to hald up for a reasonable period of time with reasonable use and if it doesn’t:

Vehicle dependability is a strong predictor of customer loyalty, J.D. Power said. Auto owners who experience no problems with their vehicles buy another from the same brand 56% of the time. Loyalty tumbles with even a slight increase in problems. Just 43% of owners who experience three or more problems return to the brand.”

That’s right. If it doesn’t I just won’t buy your product again … and you will probably never know why.

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