Six Sigma is a disciplined, structured and data-driven methodology focusing on customer requirements. It refers both to the methodology of business process improvement and the quality goal of 3.4 defects per million opportunities. It includes productivity and other process improvements, along with the goal of greatly reducing the number of errors made in business processes. While Six Sigma is a powerful tool for improving the operational capability of any department or set of processes, tracing the results of Six Sigma improvement projects to the bottom line can be difficult.

What is Six Sigma?

Six Sigma was first developed at Motorola in the 1980s and is a registered trademark of Motorola. Some of the early adopters of Six Sigma include General Electric (GE), Honeywell International (formerly Allied Signal) and Raytheon. Jack Welch introduced Six Sigma at GE in 1996, and operating margins improved from 14.8 percent to 18.9 percent by the year 2000.(1) After the well-publicized success at GE, many other organizations also adopted Six Sigma practices.

Under the overall umbrella of Six Sigma are two sub-methodologies: DMAIC and DFSS. DMAIC is an acronym for Define-Measure-Analyze-Improve-Control. It focuses on reducing process variation and is used in existing processes that are not performing as planned. Central to DMAIC are the requirements for collecting data to establish a baseline for the existing process, statistical analysis to determine causality of errors, use of tools such as Design of Experiments to improve the process, and monitoring after-the-fact to ensure the process remains in control.

DFSS, which stands for Design for Six Sigma, is sometimes referred to by its process acronym, DMADV, Define-Measure-Analyze-Design-Verify. DFSS is the sub-methodology used for development of a new product, service or process with high quality and a focus on customer expectations.

Six Sigma is usually implemented with the support of management, by a team of well-trained employees. Those trained in the various tools of Six Sigma carry one of three main designations borrowed from the martial arts. Green Belts practice Six Sigma while continuing in their existing positions. Black Belts are full-time positions that lead Six Sigma project teams. Master Black Belts teach Six Sigma and mentor Black Belts.

There is an investment in training necessary to develop a cadre of Six Sigma experts in an organization. Many firms are ready to help with training and consulting support. Costs can range anywhere from $1,300 per employee for simple training to as much as $20,000 or $30,000 per employee for training, project coaching and organization-wide implementation support.(2) However, the savings can be enormous.

Six Sigma and the bottom line

Black Belts save an organization an average of $230,000 per project, according to the Six Sigma Academy.(3) GE has estimated the benefits attributed to Six Sigma at $10 billion during the first five years after implementation.(4) Six Sigma has had a dramatic financial impact in mid-sized companies as well. An Aberdeen Group study states that mid-sized adopters of Six Sigma have realized a 15 percent improvement in EBITA (earnings before interest, taxes, and amortization) and an 18 percent increase in revenues.(5)

While many organizations have experienced great financial benefits, not every Six Sigma implementation has been entirely successful. The selection of Six Sigma improvement projects can be one problem. It is important to select projects that are driven by the organization’s strategic initiatives. Utilizing the large investment in Six Sigma training and consulting to focus initially on a process that is not strategically important to the organization’s success is counterintuitive

The Theory of Constraints (TOC) provides a good example. TOC says it is not urgent to use Six Sigma to increase capacity in an area that is not considered a bottleneck. Why increase the speed of an assembly line from nine to 10 units per minute when you can only paint the product at a rate of eight per minute? While the capacity increase has a future benefit, TOC would say that the paint operation is a better candidate for limited Six Sigma resources.

The principles of lean also provide good examples. Why produce an accounting report one day earlier if it is not serving any useful purpose? The waste elimination idea behind lean suggests that the organization not prepare a useless report. Careful selection of Six Sigma projects can ensure the organization invests in projects that are important to the customer, whether internal or external, and provide financial benefits to the owners. These projects are ones that provide critical support to the organization in achieving its strategic objectives.

Accounting and Six Sigma

The adoption of Six Sigma within an organization impacts the accounting organization. First, the initial consulting and training costs need to be budgeted. Generally accepted accounting principles require accountants to expense these costs.

It is important, however, that accountants keep management aware that Six Sigma costs are an investment that will yield future benefits. Investments in Six Sigma are similar to investments in advertising or research and development (R&D). These items are expensed, but it is generally recognized that advertising and R&D have future benefits. Six Sigma has a large initial cash outlay for training and consulting but it should lead to future cost savings.

We suggest accountants segregate Six Sigma costs within the organization. Costs include salaries of those selected to work full-time on projects plus all necessary support costs, including fringe benefits, travel, training, office supplies, etc. Accountants might even include the incremental costs of implementing a Six Sigma solution as well; although these costs might also be charged to the department receiving the benefit.

Once Six Sigma costs are segregated, it becomes easier to compare the cost to the benefits obtained. Unfortunately, the initial investments are not capitalized like investments in property, plant and equipment. Management and the accountants must focus on a long-term view of financial performance because, in the short-term, profitability is likely to suffer as the initial implementation costs are expensed.

Future benefits of Six Sigma implementation can be broken down into multiple categories -- from hard savings that flow directly to the income statement to the softest of soft savings.(6) For example, let us consider a situation where a Six Sigma project leads to improved quality. Better quality will reduce warranty costs and increase customer satisfaction. Reduced warranty costs are easy for the accountant to quantify and the effects are readily apparent on the income statement. Improvements in customer satisfaction should lead to savings as well, but they take a bit longer to be realized and are softer savings. Customer satisfaction increases as quality improves. Increasing customer satisfaction inevitably leads to increased sales. However, the calculations are more difficult. The accountant must calculate how much of a revenue increase is due to improved quality versus general market conditions.

In another example, consider the situation where a Six Sigma project leads to reductions in inventory. Inventory reductions lead to savings in inventory carrying costs. Some of these benefits are reflected directly on the income statement through reduced interest and warehousing costs. Indirectly, we know that other benefits are not so easy to quantify, but are no less real, like reduced risk of obsolescence. Inventory and other working capital reductions have an additional side benefit that is also difficult to quantify: financial capital is liberated to finance other investments.

Cost avoidances are also examples of soft savings. A process with less rework and fewer errors will have additional capacity. Some of the savings associated with reduced rework and errors are hard savings, but the capacity increase is a benefit as well, even if the process is not a bottleneck. In the future as sales volume increases, the organization will not have to invest future capital in this process to increase its capacity.

Another option is to take resources, often people, and reassign them from the excess capacity process to a process that needs additional help. Please notice that we suggest reassigning resources and not reducing headcount. If employees are terminated because of Six Sigma, employee support for Six Sigma will evaporate quickly.

The techniques for tracking Six Sigma benefits are not unlike those employed by accountants to track the benefits of a capital investment. Accountants are frequently called on to estimate the savings associated with a new warehouse, piece of equipment or new Enterprise Resource Planning (ERP) system. If we can forecast these savings and then audit them after the capital project, we should be able to do the same for Six Sigma.

The Balanced Scorecard and Six Sigma

The Balanced Scorecard (BSC) is a useful tool in Six Sigma implementation. The BSC is a strategic management system that aligns the organization’s resources behind its strategies for success. Performance measures, some financial but more nonfinancial, are developed that will measure the organization’s success on achieving those strategic objectives.

Use of a BSC technique called strategy mapping will illustrate how a project will eventually lead to improved financial performance. Strategy maps demonstrate a key to the successful use of the BSC, the linking of measures in a cause-and-effect chain. Driver measures are linked to outcome measures. For example, productivity is linked to on-time delivery, which is connected to customer satisfaction. The final links in the chain are the financial measures like revenues, profit and return-on-investment.

For more information on BSC, check out an archived Disclosures article on the VSCPA Web site: http://www.vscpa.com/Press_Room/News_Releases/press06240501.aspx.

Be patient for results

There is usually a time lag between adoption of a strategy and its effect on financial results. We admit that there can be a great amount of discomfort for management immediately after adopting any costly strategic initiative. Often, these initiatives do not show immediate financial gains, and it is during these trying times that many potentially successful initiatives are abandoned. It is, therefore, important for the organization to change its culture to focus more on long-term financial performance and less on short-term results.

Six Sigma and the BSC are wonderful tools for implementing long-term strategies, but the unfortunate truth is, "culture eats strategy for breakfast." Without a culture that is focused on long-term financial success through meeting customer requirements, it will be impossible to sustain any improvement project that requires an initial investment before savings can be recognized.

(1) Betsy Morris, "New Rule: Look Out, Not In. Old Rule: Be Lean and Mean," Fortune, July 11, (2006).
(2) Mark Friedman and Howard Gitlow, "Six Sigma Primer for CPAs," The CPA Journal, November, (2002): 56-59.
(3) Six Sigma — What is Six Sigma? i Six Sigma, http://www.isixsigma.com/sixsigma/six_sigma.asp.
(4) Ibid.
(5) Kathy Williams, "Is Six Sigma Beneficial for Midsize Companies?" Strategic Finance, November, (2006): 23.
(6) Mary Ruff, "Hard and Soft Savings: What Counts Can Be Counted," i Six Sigma, http://www.isixsigma.com/library/content/c030315a.asp.

GERALD K. DeBUSK, CPA, CMA, Ph.D., is an assistant professor of accounting and Dixon Hughes Research Fellow at Appalachian State University. His 17 years of public accounting and industry experience included roles as a cost accounting manager, plant controller and corporate controller/treasurer. Gerald also serves on the VSCPA Editorial Task Force. Contact him at debuskgk@appstate.edu.

CHUCK DeBUSK is a GE-certified Six Sigma Master Black Belt and senior manager in GE Healthcare’s Performance Solutions division. He is a registered professional engineer with more than 25 years of experience in process improvement. He holds an MS in industrial engineering from the University of Tennessee and a BS in industrial engineering and operations research from Virginia Tech. Contact him at charles.debusk@med.ge.com.