Examine an example thought process to discover the many ways a poorly working process can cost your business.
In the production or sales arenas it’s fairly straightforward to estimate or calculate the cost to a business of a process that results in delay, defects, or excess work. In the office it is not so straightforward. Follow this example as we examine a process for establishing a product specification and some of the many ways it can hurt a business if the process has some problems.
In every business there are processes that work very efficiently and effectively, and those that are imperfect and painful. Imagine a regular sort of business of reasonable size that has a process for specifying the new products to be developed that could use a little work.
First let’s note that the process of writing a specification for a new product to be designed, developed, tested, and launched takes about two months. Of course not all of that time is spent specifically working on the specification. Some of it is gathering information, some of it is writing or developing the specification, but a great deal of that time is spent with the various members of the team working on their other responsibilities.
Let’s say that typically the sales and marketing teams with advice or input from engineering invest about 400 man-hours gathering information to feed the specification. Let’s also say that they typically spend about 200 man-hours writing and editing the product specification before it is released and the team is told to “develop this.” For argument’s sake, that’s a team of five people working about half time for a month to gather information and the same team working about two hours a day, each, to write and edit the product specification. It may be a little rich for some organizations, but it’s not unrealistic.
That describes the typical exercise. The best case may be a total of 200 man-hours for the whole effort and about three weeks to gather information and complete the specification. Alternatively, the worst-case scenario might be six months to gather information and write the specification with closer to 1,200 man-hours invested. Sometimes writing that new specification isn’t as big a priority as other matters, or the teams will debate a great deal, or the information from customers is difficult to acquire.
By the way, the best-case, worst-case, and most likely estimates for your process performance are often relatively easy to establish. A short autopsy of recent efforts, reviewing project schedules or email chains, combined with peoples’ recollection of time and effort will reveal very realistic calculations of time and estimations of man-hours.
For the sake of brevity, let’s consider just the typical case we described. First, let’s discuss the time frame. Assuming that none of the man-hours invested are inefficient (we’ll break this assumption momentarily) a team of five people, locked in a room until the specification is complete, should be able to execute the same effort in 15 8-hour days, or three weeks.
Let’s say that examining the latest product yields a sales and revenue picture from the new product as follows. To keep numbers simple, we’ll say that 1 million are produced and sold annually at a cost of $100 each to produce and sold for $120 to retail stores and select distribution. That’s a total annual profit of $20 million. Nice product. Hardly worth worrying about the specification process over, right? Let’s keep going.
Let’s say that instead of taking two months to produce the specification, we get it out in three weeks. At a profit rate of approximately $385,000 a week, that’s an additional $1.925 million dollars the business could have had. I’d like to add that to my balance sheet.
>Now let’s discuss how many of the man-hours are really necessary. Let’s admit that some of those man-hours are spent reviewing where the team left off since the last time they worked on the specification, or reviewing what a single individual did without the team. Let’s also admit that some of the information gathering was spent searching for information that the team could have had handy if things were better organized. Finally, let’s admit that some of the man-hours were spent debating wording and “wordsmithing” the language because there wasn’t any real guideline or template to follow. Does that sound reasonable?
So, let’s say that instead of requiring 600 man-hours to gather information and write the specification, it might be done in 300 man-hours. That’s still less than the 200-hour estimate given by our best-case scenario. So, let’s accept the team’s estimate.
Now let’s calculate that in terms of cost. If locked in a room, working straight, that team of five could produce the product specification in 7.5 8-hour days. Call it one week. That’s another $770,000 that the business could have had by launching the product another two weeks earlier.
Tally: $1,925,000 + $770,000 = $2,695,000
But, wait, there’s more. Let’s capture those man-hours that could be doing something else instead of unnecessary work on the product specification. We’re talking about five skilled professionals, experienced enough to develop a specification. Let’s say the average burdened rate for those team members is $90 an hour. That means that producing the same quality specification in 200 hours instead of 600 hours saves $180,000 in wasted man-hours.
Now I know that those man-hours are not going to show up on the accountant’s balance sheet at tax time, unless someone is laid off because they aren’t utilized any more. I understand that many dollar counters will not want to add that number to the tally of expenses because of that disconnect, so I’ll do what I don’t like to do and I’ll track it separate from the “hard” dollars that could have shown up.
Opportunity Costs: $180,000
Ok, that might be reason enough to do the specification process differently, but let’s follow the output downstream a little. Let’s say that when the design team presents its first batch of design concepts they missed the mark on some important criteria that weren’t clearly communicated or defined by the specification. It happens often enough.
Suppose that the design team and a couple members of the marketing team spend some time clearing up the understanding and revising the product specification. Call it another five professionals putting in 50-man-hours over two weeks to clear things up. There are also some document control costs that go with processing the document revision, but we’ll call that negligible in the face of hundreds of thousands of dollars.
In addition to the time and man-hours spent clearing up the misunderstanding, the design team must re-design the concepts for approval. Call it another three weeks and 2,250 man-hours (a team of five engineers working 30-hours a week on the design for three weeks). There is also the cost of re-constructing the concept models for hands-on review and comment, say $4,500.
Totaling the above, we get an additional $4,500 and $1.155-million in hard costs and lost revenue from delayed launch. We also estimate another $207,000 in wasted man-hours.
Tally: $2,695,000 + $4,500 + $1,155,000 = $3,854,500
Opportunity Costs: $180,000 + $207,000 = $387,000
Now let’s go sown stream a little further. Let’s look at the testing phase. Suppose that some of the specifications turn out to be very difficult to prove. Let’s be merciful and say that the engineering team identifies the problem before the development is ready for testing and corrects the issue without requiring any redesign or development re-do.
The correction does however, take some time and some more work. Suppose that it pushes testing back another two weeks. That’s more delay to the launch and also we’ll say that it caused the project to lose its spot in the testing queue and the project paid a penalty fee with the test lab. We’ll say the lost slot in the queue results in an additional week of delay and a $10,000 fee. We’ll say that it took another three people a total of 25 man-hours to fix the specification and the test plans.
Now, we were merciful. How much time and expense might have been lost if the problem resulted in re-design and development of the prototype, a new batch of prototypes for testing, and a second round of testing? It could have caused several weeks of delay and thousands of man-hours and tens of thousands of dollars re-testing.
Taking our merciful scenario, we calculate $10,000 in fees and another $1,155,000 in lost profits from delayed launch. We also get another $2,250 in wasted man-hours, not counting what might have been wasted while the team waited for testing to finally take place. The latter is “chump change” at this point, but it’s there.
Tally: $3,854,500 + $10,000 + $1,155,000 = $5,019,500
Opportunity Costs: $387,000 + $2,250 = $389,250
Now, we have one more thing to look at before we are done with our estimating and then we can grind our teeth and pull our hair. Suppose that the product defined by the specification failed to truly distinguish itself from a competitor product launched at roughly the same time. For simplicity’s sake, we’ll say that a survey of retail stores that carry both products reveals that they share the retail market equally, each taking half.
Imagine if an improved user interface, or a viable feature could have significantly distinguished our example’s product from the competitor product. To find out, we do a survey of some customers with whom we have contact and discover that about half of them would have definitely bought the example’s product over the competitor product if the interface and feature were included at a price that maintained the same $10 per unit profit. We’re trying to keep our example simple.
That means that instead of selling 1 million units a year, we could have been selling 1.5 million units a year. That means that a missed opportunity in the product definition left behind another $5,000,000. Adding that to the total, we get the final amount for our discussion.
Tally: $5,019,500 + $5,000,000 = $10,019,500
Opportunity Costs: $389250
Now, before we lay the example to rest, let’s address some arguments. The first argument that I get when setting out this kind of estimating is that just because we move up the launch date, we don’t necessarily get direct profit from the product. I disagree.
The product’s termination or discontinuation date will not change with the launch date. If the product launches several weeks earlier, you will absolutely capture several more weeks of revenue and profit. We may as well calculate that opportunity using the first year’s average profits since that is when the additional weeks will manifest.
The second argument usually surrounds the “opportunity costs.” Because our accountants can’t directly point at a dollar on the balance sheet as belonging to a particular man-hour that was not wasted, accountants and business managers alike often choose not to include those savings in their estimates of cost or improvement.
I offer the following counter. Man hours spent doing work that did not produce product or enhance the outcome, or spent doing unnecessary work, or doing re-work, cannot be recovered. They were wasted, and your business paid those employees for it. Those dollars are lost forever, even if you cannot point to them on the balance sheet. They are very real. They are not imaginary.
The real cost of our example in-need-of-improvement specification process is the full $10,408,750 for the latest product launch. It is actually much more than that, because many of the costs are systemic, not acute, and affect every product launch to some degree.
Would you have guessed, in your wildest dreams, that a specification process that is not necessarily a-typical for many product development businesses would cost more than $10 million dollars annually to a moderately sized product development business? It could be a great deal more. We only examined one product launch to get that number, and we only examined the typical case. What would the damage be if a worst-case scenario happened to an important product development effort?
If you aren’t too frightened by this example, use the same thought process on your own business and see what kind of number you get. Do an autopsy of a recent product launch and ask the project manager and engineers what problems occurred as a result of the specification or changes to it. Examine the project’s final schedule for lost launch time, and the project budget for expedite fees, costs of re-dos and other unnecessary expenses. Get your team to estimate the man-hours spent correcting issues.
If you are concerned that such estimating will carry a certain amount of error with it, consider this. So what? If your estimate is that you only lost a few thousand dollars, you might have bigger problems to go solve. If your estimate is $10,000,000 you would probably still go and fix that process even if the real number is half of your estimate. The purpose is to decide if it’s big enough to fix, not how much it’s worth at auction.
The example in this post uses numbers that were very simple to add and multiply. It is contrived, but it is also very much based on real phenomena, common phenomena, and the numbers are very realistic in terms of their basic magnitude. Yes, a frustrating process can actually cost a business that much money.
Print this example out. Use it like a guide or roadmap to go seek the lost profits, revenues, or man-hour costs that your less-than perfect processes cost your business. Then get the agreement to go forth and fix those processes. They are worth a great deal of money.
Stay wise, friends.
If you like what you just read, find more of Alan’s thoughts at www.bizwizwithin.com.