4 Essential Steps to Make Failure Costs Transparent - Food Strategy Institute

conqDo you find it difficult to get good insight in the failure costs in your organization?

Do you often get tough questions on your financial performance or budget?

Do you struggle to show how exactly you and your team add value to the organization?

And, as a result, do you feel stressed, undervalued and often not being heard by others in the organization?

Well, this is the daily life of key figures in food companies, such as managers of Finance, Operations, Production, Supply Chain, or Quality. One of the main reasons is that they’re not capable (yet) of properly making hidden failure costs visible.

Senior managers and company owners use money as a measuring unit to base most (if not all) of their decisions. In order to get their attention it’s therefore necessary to translate everything happening in the organization into money.

But how to do this? One way is to have an activity-based costing structure, whereby failure costs can simply be calculated using the ERP system. However, not a lot of companies are able to do this at the level of attention to detail required to get proper insight. In this article we will explain the four basic steps to take to create a much leaner monitoring program for logistics failure costs in your organization.

 

Step 1. Engage with the right people

Very often we encounter managers who try to solve all their problems in splendid isolation. But when it comes to failure costs that is exactly what NOT to do. All of the key managers we mentioned above – Finance, Operations, Production, Supply Chain, and Quality – are responsible for most factors contributing to failure costs, so they should work together to create a better monitoring approach.

The system we’re going to outline won’t be accurate to the last penny, so collaborating from the start will avoid endless debates about whether or not costs were calculated in the right way. Whoever is taking the initiative should therefore make the other three people/managers co-owners of this new approach, by reaching out to them and explaining their intent.

 

Step 2. Create a structure

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Once you have the buy-in from the other key managers, you can start defining the structure of your monitoring system.

The best way to do this is to organize a brainstorm session in a small group that includes the four managers and a maximum of four more people. During this session you’ll want to list as many examples as possible of failure costs. To make sure that everybody is heard, write down each building block on a separate post-it and arrange them on a flipchart. Everybody who has a similar post-it can then put it on top of the earlier one. This way you can be sure all the building blocks are discussed and everybody owns the outcome.

During the brainstorm session, people should feel free to discuss and write additional building blocks. This will give you a stronger tool in the end.

Once you have a complete list of building blocks, you’ll want to organise them in clusters, either by department where the costs are generated, or by their severity level (e.g. not-right-first-time production, complaints, severe issues, product recalls, etc.). The most important thing here is that everybody agrees on the clusters.

 

Step 3. Calculate the typical costs

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Now that you have defined all of the building blocks, you will need to establish how exactly costs can be calculated.

At this stage it’s very easy to end up creating elaborate costing models that would be too expensive and time consuming. To keep things simple, define a “standard” cost associated with each of your building blocks.

For example, if one of them includes non-urgent product complaints, you could look at last year and make the best estimate possible of all the costs under that category. These could be, but are not limited to, return shipment costs, customer re-imbursement costs, investigation costs, travel costs made in relation to complaints, costs of rework and downgrading or scrapping of returned product. With that, you can then calculate a standard cost per occurrence. If, following our example, you find out that the average cost of a non-urgent product complaint amounts to $15,000, you can simply multiply the number of non-urgent product complaints in a given period by that average amount to obtain a fairly accurate indication of the cost associated with this building block.

Again, it is not necessary to be 100% picture perfect, but you will know whether the costs of a failure are in the range of hundreds or in the range of tens of thousands of dollars per year.

 

Step 4. Monitoring

monitoring

The final step is to define a clear monitoring structure for each of the building blocks in each cluster. There are three things you need to establish in order to do that.

a) Identify who is responsible for delivering the information on the number of occurrences for each of the identified building blocks. Very often the best people for this task will be staff members in production, operations, or supply chain, who have access to that information.

b) Make these people responsible for reporting this on a regular basis. Also, make managers of their respective departments accountable for getting the right information on time.

c) Define an easy to use reporting structure where people only need to fill in the number of occurrences and all the necessary calculations are performed automatically. Some of the calculations you need to perform to get to the exact costs of a building block might be quite complex. By automating them in an Excel spreadsheet, the system will be simple to use and have fewer errors in it.

If you would like to see a PDF of a typical overview, including all the building blocks and the responsible staff members for collecting the base data on a monthly basis, have a look at our template for product-related failure costs.

 

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