Some years ago, I was visiting a manufacturer of railroad car couplers, the big connectors that hold the cars together. Their biggest material expense was the coupler itself. They purchased forged pieces and then performed secondary machining operations to get a finished product. While visiting, I was told that they purchased the forged parts from either China or India. I said something like “Wow. It sounds like you must pay a lot for shipping.” They said “Yeah. But it is still cheaper than buying them here.” I was then introduced to their QC process during incoming inspection. They were doing 100% inspection and taking numerous measurements on each coupler piece. This entailed moving the skid with the parts to the QC area, taking the measurements, and then moving them back to an inventory location if inspection passed or to a hold area if it failed. I asked what the failure rate was, and they told me it was 50%! I was sure I misheard, so I asked again. Same answer. I think they knew what I was going to ask next, so they said, “Even with 50% rejects, the price we get abroad is so cheap, we are coming out ahead.” But are they?
The problem is that they are only accounting for the material purchase and (maybe) shipping costs. There were numerous negative effects that they didn’t recognize. The first thing that came to mind is the QC lab effort. Since the inspection failure rate and risks posed with potential field failures were so high, their QC process was very cumbersome. For you Lean thinkers, consider the movement waste! And since the failure rate was 50%, this means that they had to inspect double the amount of product! To me, this implies the QC department is twice the size it should be. What does that cost? And that is just inspection. All the failed parts still need to be dealt with in some manner. Due to shipping costs, they weren’t returned. They sat around and took up a lot of space. This cluttered the warehouse. What does this cost in terms of extra effort to stock/pick in the warehouse? Does this affect their ability to meet shipping due dates? Then I considered the effect on cash flow. Since half of the parts fail, does this mean that they are ordering twice what they need? How quickly do they get reimbursed for the rejects? But the biggest risk I saw was the impact on meeting customer due dates. If the customer orders 100 and they can only deliver 50 this creates a few problems. First, they only get paid for 50. Again, this has a negative impact on cash flow. Secondly, and more importantly, what damage does this do to the relationship with their customer? What cost do you assign to this? One more thing that wasn’t considered is that some bad parts may escape. The old rule of thumb is that 100% inspection is only 80% effective. This guarantees that some bad parts will escape. What will it cost them if their part fails in the field, and they are held responsible? There have been several train derailments in the news lately and it makes me wonder about the couplers in use.
Focusing on cost can lead to a number of bad outcomes and blind you to the risks that you are accepting. Focusing on value is always a better strategy. It isn’t that hard to calculate the additional costs you might be incurring and ask a few “what if” questions. The problem is usually the company policy driving the buyers to make purchasing decisions in a vacuum based solely on material cost. I encourage you to take another look at your purchasing policy and see if you are making similar mistakes.
Don’t focus on cost,