Quality aspects and transfer pricing

7/28/2019 Quality aspects and transfer pricing

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However, many intermediate products do not have readily-available market prices. Examples areshown in the table above: a pharmaceutical company with a drug under patent protection (aneffective monopoly); and an appliance company that makes component parts in the PartsDivision and transfers those parts to its assembly divisions. Obviously, if there is no marketprice, a market-based transfer price cannot be used.

A disadvantage of a market-based transfer price is that the prices for some commodities canfluctuate widely and quickly. Companies sometimes attempt to protect divisional managers fromthese large unpredictable price changes.

Cost-based Transfer Prices:

Cost-based transfer prices can also align managerial incentives with corporate goals, if variousfactors are properly considered, including the outside market opportunities for both divisions,and possible capacity constraints of the upstream division.

First consider the case in which the upstream division sells the intermediate product to externalcustomers as well as to the downstream division. In this situation, capacity constraints arecrucial. If the upstream division has excess capacity, a cost-based transfer price using the

variable cost of production will align incentives, because the upstream division is indifferentabout the transfer, and the downstream division will fully incorporate the companys incrementalcost of making the intermediate product in its production and marketing decisions. However,senior management might want to allow the upstream division to mark up the transfer price alittle above variable cost, to provide that division positive incentives to engage in the transfer.

If the upstream division has a capacity constraint, transfers to the downstream division displaceexternal sales. In this case, in order to align incentives, the opportunity cost of these lost salesmust be passed on to the downstream division, which is accomplished by setting the transfer

price equal to the upstream divisions external market sales price.

Next consider the case in which there is no external market for the upstream division. If theupstream division is to be treated as a profit center, it must be allowed the opportunity to recoverits full cost of production plus a reasonable profit. If the downstream division is charged the full


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cost of production, incentives are aligned because the downstream division will refuse thetransfer under only two circumstances:

- First, if the downstream division can source the intermediate product for a lower costelsewhere;

- Second, if the downstream division cannot generate a reasonable profit on the sale ofthe final product when it pays the upstream divisions full cost of production for theintermediate product.

If the downstream division can source the intermediate product for a lower cost elsewhere, to theextent the upstream divisions full cost of production reflects its future long-run average cost, thecompany should consider eliminating the upstream division. If the downstream division cannotgenerate a reasonable profit on the sale of the final product when it pays the upstream divisionsfull cost of production for the intermediate product, the optimal corporate decision might be toclose the upstream division and stop production and sale of the final product. However, if eitherthe upstream division or the downstream division manufactures and markets multiple products,the analysis becomes more complex. Also, if the downstream division can source theintermediate product from an external supplier for a price greater than the upstream divisionsfull cost, but less than full cost plus a reasonable profit margin for the upstream division,suboptimal decisions could result.

Negotiated Transfer Prices:

Negotiated transfer pricing has the advantage of emulating a free market in which divisionalmanagers buy and sell from each other in a manner that simulates arms-length transactions.However, there is no reason to assume that the outcome of these transfer price negotiations willserve the best interests of the company or shareholders. The transfer price could depend on

which divisional manager is the better poker player, rather than whether the transfer results inprofit-maximizing production and sourcing decisions. Also, if divisional managers fail to reachan agreement on price, even though the transfer is in the best interests of the company, seniormanagement might decide to impose a transfer price. However, senior managements impositionof a transfer price defeats the motivation for using a negotiated transfer price in the first place.


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In the following example, the Clear Mountain Spring Water Company changes from a negotiatedtransfer price of $18 per case (see the above example) to a dual transfer price in which theupstream division receives the local market price of $19 per case, and the downstream division

pays $17 per case.


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Upstream Division:

(1) Intercompany Receivable/Payable $9,500

Revenue from Intercompany Sale $9,500

(2) Cost of Goods Sold Intercompany Sales $8,000

Finished Goods Inventory $8,000

(To record the transfer of 500 cases ofClear Mountain Spring Water, at$19 per case, to the Florida marketing division, and to remove the 500cases from finished goods inventory at the production cost of $16 percase.)

Downstream Division:

(1) Finished Goods Inventory $8,500

Intercompany Receivable/Payable $8,500

(To record the receipt of 500 cases ofClear Mountain Spring Waterat $17per case, from the bottling division in Nebraska)

Corporate Headquarters:

(1) Interco. Receivable/Payable Florida $8,500

Corporate Subsidy for Dual Transfer Price $1,000

Interco. Receivable/Payable Nebraska $9,500


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(To record the transfer of 500 cases ofClear Mountain Spring WaterfromNebraska to Florida, at a dual transfer price of $19/$17 per case.)

Corporate Subsidy for Dual Transfer Price is an expense account at the corporate level. Thisaccount and the revenue account that records the intercompany sale affect the calculation ofdivisional profits for internal reporting and performance evaluation, but these accountsas wellas the intercompany receivable/payable accountsare eliminated upon consolidation forexternal financial reporting. To the extent that the Florida Division has ending inventory, the costof that inventory for external financial reporting will be the companys cost of production of $16per case. In other words, the transfer price has no effect on the cost of finished goods inventory.

Transfer Pricing and Multinational Income Taxes:

When divisions transfer product across tax jurisdictions, transfer prices play a role in thecalculation of the companys income tax liability. In this situation, the companys transferpricing policy can become a tax planning tool. The United States has agreements with most othernations that determine how multinational companies are taxed. These agreements, calledbilateral tax treaties, establish rules for apportioning multinational corporate income among thenations in which the companies conduct business. These rules attempt to tax all multinationalcorporate income once and only once (excluding the double-taxation that occurs at the Federaland state levels). In other words, the tax treaties attempt to avoid the double-taxation that would

occur if two nations taxed the same income. Since transfer prices represent revenue to theupstream division and an expense to the downstream division, the transfer price affects thecalculation of divisional profits that represent taxable income in the nations where the divisionsare based.

For example, if a U.S.-based pharmaceutical company manufactures a drug in a factory that itoperates in Ireland and transfers the drug to the U.S. for sale, a high transfer price increasesdivisional income to the Irish division of the company, and hence, increases the companys taxliability in Ireland. At the same time, the high transfer price increases the cost of product to the

U.S. marketing division, lowers U.S. income, and lowers U.S. taxes. The companys incentiveswith regard to the transfer price depend on whether the marginal tax rate is higher in the U.S. orin Ireland. If the marginal tax rate is higher in the U.S., the company prefers a high transfer price,whereas if the marginal tax rate is higher in Ireland, the company prefers a low transfer price.The situation reverses if the drug is manufactured in the U.S. and sold in Ireland. The generalrule is that the company wants to shift income from the high tax jurisdiction to the low taxjurisdiction.


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There are limits to the extent to which companies can shift income in this manner. When amarket price is available for the goods transferred, the taxing authorities will usually impose themarket-based transfer price. When a market-based transfer price is not feasible, U.S. tax law

specifies detailed and complicated rules that limit the extent to which companies can shiftincome out of the United States.

Other Regulatory Issues:

Transfer pricing sometimes becomes relevant in the context of other regulatory issues, includinginternational trade disputes. For example, when tariffs are based on the value of goods imported,

the transfer price of goods shipped from a manufacturing division in one country to a marketingdivision in another country can form the basis for the tariff. As another example, in order toincrease investment in their economies, developing nations sometimes restrict the extent towhich multinational companies can repatriate profits. However, when product is transferred frommanufacturing divisions located elsewhere into the developing nation for sale, the localmarketing division can export funds to pay for the merchandise received. As a final example,when nations accuse foreign companies of dumping product onto their markets, transferpricing is often involved. Dumping refers to selling product below cost, and it generally violatesinternational trade laws. Foreign companies frequently transfer product from manufacturingdivisions in their home countries to marketing affiliates elsewhere, so that the determination ofwhether the company has dumped product depends on comparing the transfer price charged to

the marketing affiliate with the upstream divisions cost of production.

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Transfer pricing involves the price that one division (or other responsibility center) of a companycharges for the goods or services that it provides to another division of the same company.

Depending on the production capacity and the market for each divisions goods or services, atransfer price could be based on cost, market prices, or some other amount.

A concern of transfer pricing is whether the amount of the transfer price will cause a divisionalmanager to take action that is not consistent with the action that is best for the company as awhole.

Transfer pricing is aprofit allocation methodused to attribute a corporation's net profit or lossbefore tax to tax jurisdictions. Transfer prices are the charges made between controlled (orrelated) legal entities i.e. within the same group. Legal entities considered under the control of asingle corporation include branches and companies that are wholly or majority owned ultimatelyby the parent corporation. Certain jurisdictions consider entities to be under common control ifthey share family members on their boards of directors.

It refers to the setting, analysis, documentation, and adjustment of charges made between relatedparties for goods, services, or use of property (including intangible property). Transfer pricesamong components of an enterprise may be used to reflect allocation of resources among suchcomponents, or for other purposes. OECDTransfer Pricing Guidelinesstate, Transfer prices aresignificant for both taxpayers and tax administrations because they determine in large part theincome and expenses, and therefore taxable profits, of associated enterprises in different taxjurisdictions.

Over 60 governments have adopted transfer pricing rules.[1] Transfer pricing rules in mostcountries are based on what is referred to as the arms length principle that is to establish

transfer prices based on analysis of pricing in comparable transactions between two or moreunrelated parties dealing at arms length. TheOECDhas published guidelines based on the arm'slength principle, which are followed, in whole or in part, by many of its member countries inadopting rules. The United Statesand Canadian rules are similar in many respects to the OECDguidelines, with certain points of material difference. A few countries, such as Brazil andKazakhstan, follow rules that are materially different overall.

The rules of nearly all countries permit related parties to set prices in any manner, but permit thetax authorities to adjust those prices where the prices charged are outside an arm's length range.Rules are generally provided for determining what constitutes such arm's length prices, and howany analysis should proceed. Prices actually charged are compared to prices or measures of

profitability for unrelated transactions and parties. The rules generally require that market level,functions, risks, and terms of sale of unrelated party transactions or activities be reasonablycomparable to such items with respect to the related party transactions or profitability beingtested.

Most systems allow use of multiple methods, where appropriate and supported by reliable data,to test related party prices. Among the commonly used methods are comparable uncontrolledprices, cost-plus, resale price or markup, and profitability based methods. Many systems
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differentiate methods of testing goods from those for services or use of property due to inherentdifferences in business aspects of such broad types of transactions. Some systems providemechanisms for sharing or allocation of costs of acquiring assets (including intangible assets)among related parties in a manner designed to reduce tax controversy.

Most tax treaties and many tax systems provide mechanisms for resolving disputes amongtaxpayers and governments in a manner designed to reduce the potential for double taxation.Many systems also permit advance agreement between taxpayers and one or more governmentsregarding mechanisms for setting related party prices.

Many systems impose penalties where the tax authority has adjusted related party prices. Sometax systems provide that taxpayers may avoid such penalties by preparing documentation inadvance regarding prices charged between the taxpayer and related parties. Some systemsrequire that such documentation be prepared in advance in all cases.

Quality Management

Why, What, How?

Quality Management vs Quality Audit

In the ePMbook, we will make a distinction between Quality Management and Quality Audit.

By Quality Management, we mean all the activities that are intended to bring

about the desired level of quality. By Quality Audit we mean the procedural controls that ensure participants

are adequately following the required procedures.

These concepts are related, but should not be confused. In particular, Quality Audit relates to theapproach to quality that is laid down in quality standards such as the ISO-900x standards.

The abbreviation "QA" has been generally avoided in the ePMbook as it can mean differentthings - eg "Quality Assurance", "Quality Audit", testing, external reviews, etc.

In this section, we discuss how to achieve quality.

Quality is not an absolute requirement

It is wrong to assume that maximum quality is desirable. Should every car be built to the samequality as a Rolls Royce? Should every computer system be held back until there is not onesingle flaw remaining?
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Required quality should be considered as part of the overall Project Definition work. It willimpact upon such things as the estimatesandbenefit case. Such things are business decisions.They can only be taken by the Project Sponsor and senior management team of the organisation.

Quality decisions are not just a matter of the reliability of the end product - they can also affect

the scope and project approach. This is particularly an issue with e-solutions:

Do you want something magnificent, or do you want something fast beforeyour competitors get ahead?

Do you want a complete solution, or will you settle for a partial solution andcome back to finish it at a later date?

You need to make it clear that these are mutually exclusive alternatives - you cannot domagnificent, complete and fast.

Very often, commercial pressures mean that the best business decision is to achieve an "80%"solution fast. Many early e-commerce business-to-consumer solutions looked great to thecustomer but involved staff re-keying data into the sales order systems or manually processingcredit card transactions.

Case Study

A company decided to achieve a rapid deployment by focusing on

80% solutions and breaking their requirements into five phases of

development and deployment.

A project reviewer asked if they had considered how functional the end resultwould be. Would it be 80% x 80% x 80% x 80% x 80%? That would be 33% -one third what you need.

Aspects of Quality Management

Here is a summary of the various aspects of Quality Management. Different organisations will

use different expressions for these concepts and may package them into other activities. Thisdescription follows the logical requirements.
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Aspect Summary

Quality Plan Define and agree the needs for quality and the

specific approaches to meet them.

Phase Quality

Requirements

For each phase, what specific things will be done

and what specific deliverables will be produced

Apply Quality

Methods

Throughout the work the defined approach to

quality will be followed. Work or deliverables falling

short of the standards will need to be re-worked to

achieve an acceptable standard.

Phase Quality

Review

Before each phase can be closed, a review is

performed to ensure that acceptable quality

standards have been achieved.

Project Quality

Review

Before the project can be completed, the overall

conformance to Quality Methods and requirements

should be assessed and approved.

Responsibilities for quality

The Project Manager will, of course, have overall responsibility for the quality of the project. Itis equally true that all participants have a role to play in delivering good results. Developing aquality culture amongst the team will normally generate greater value and satisfaction.Encourage the belief that the right level of quality is more important than getting things done
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fast. If there is a choice to be made between quality and progress it should be a matter for theSteering Committee to decide

Other managers will also be involved in the Quality Management process. In larger projectsthere may be a Quality Manager and Quality Team. Team Leaders and other senior staff will also

be involved in the processes. In some environments, certain Quality Management functions maybe performed by independent reviewers from outside the Project Team.

Responsibilities for quality should be agreed and communicated to all participants.

The Quality Plan

The Quality Plan is a broad concept covering many aspects of achieving quality. In manyprojects these might be covered in an array of different deliverables. In particular, procedures

and standards might be documented separately from quality goals and controls.

Many organisations will have pre-existing standards and procedures which should be applied.Check that they are appropriate to the current project - you do not want to develop a web siteusing standards that were written for custom development of mainframe applications.

Here are some types of thing you should consider.

Type of

cont

ent

Description Examples

Objectives What are the objectives

of Quality Management?

To what extent is quality

a requirement in

preference to timescales,

costs, functionality etc?

Acceptable levels offunctionality toachieve

Acceptable levels ofsecurity, bugs etc

Investment in testing

Requireme

nts

What specific

requirements are to be

addressed

Review and sign-off ofspecific deliverablesor work by specifiedpeople

Types and depth oftesting required

Availability ofspecified functions


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Quality

Methods

What approaches and

methods

Iterative developmentin specified stages

Methodology to befollowed

Peer review of alldeliverables

Standards What format and detail

should deliverables be in

web page layout &navigation standards

coding standards

documentationstandards

Procedure

s

Specified procedures for

project tasks

check-in and check-

out of code documentation

control procedure

issues managementprocedure

The Quality Plan is often an evolving document. As the project progresses it will need to adapt tochanges and decisions. For example, detailed website design and navigation is unlikely to bedefined at the start of the project unless you are adding to an existing solution.

Preparing for Quality Management at the start of each

phase

When the detailed plan for each phase is completed it will be possible to identify the specificQuality Methods and controls that should be applied - and what they should be applied to. Onebasic approach is to create two lists:

all the work that should be done (including the methods, techniques andprocedures to be used)

all the deliverables that should be produced (including the formats andstandards that should be applied)

This provides a guide for the people conducting the work and a checklist for the phase-endreview.


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It is good project management practice, as well as a Quality Management process, to identify inadvance all the anticipated deliverables. For each one, you should identify:

nature, description and purpose of the deliverable, quality standard (eg discussion draft, final quality, reviewed or tested for

external publication)

dependencies (what must be completed prior and what further deliverablesdepend upon this one)

date required,

author/creator,

people who have to review it,

people who have to approve it,

people who should receive it for information or use (but who do not get theopportunity to review or approve)

other distribution (eg third parties, auditors, publishing, filing)

security/secrecy requirements - ie who can not see or use it

currency information (eg must be maintained, updateable, one-off,temporary, final project deliverable)

Bringing about quality during the workThe best Quality Methods will depend on the type of project - the team, application, language,technology, participants, environment, etc. They will also be affected by strategic decisionsabout the investment in quality.

Here are some examples:

all requirements should be prototyped iteratively in collaboration with theresponsible user manager

designers are expected to consider any reasonable alternative approachesand discuss them with the responsible user manager before creating adetailed design

any anticipated impact on timescales, resourcing, deliverables, or benefitsshould be communicated to the project manager as soon as possible andbefore any revised action is taken

all documents should include control information such as version numbers,issue dates, status, authors, reviewers etc


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all designs should be reviewed by someone from a different sub-team and bythe overall solution architect

any aspect of a deliverable which could impact upon another deliverableshould be noted in the issues management system

only one person can have update access to a document or systemcomponent at any one time - access will be controlled through theconfiguration management and/or documentation control procedures

all completed work will be signed off by the responsible user manager

once a deliverable is completed, signed off and closed it can only be re-opened by following the change control procedure

developers are not allowed to test their own work

appropriate end users must be involved in all systems tests - each test mustbe signed off by the responsible user manager

where any correction is applied to a deliverable, all other deliverables whichcould be affected must be re-examined and/or re-tested

all components should be sized and tested for absolute peak usage

developers cannot access live components directly - they need to check themout using the configuration management and/or documentation controlprocedures.

There will also be a number of rules, standards and procedures, eg:

format of documents techniques to use (eg estimating technique, modelling technique)

language(s) to use

naming conventions

documentation standards

procedures to follow (eg documentation control, configuration management,issues management, bug reports, testing).

It will be easier to manage quality if the application of Quality Methods and controls is trackedcontinuously through the project, rather than relying solely on reviews at the end of each phase.The status of work and deliverables can be tracked against the lists prepared for the Phase. Thetracking information should show the stage of progress (eg not started, in progress, completed,signed off), and the status of specific controls, reviews, signatures etc. In particular, completionshould be logged and a check made to ensure that the correct methods, controls and approvalswere completed.


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One final thing to note about these Quality Methods: they are all rules for people to follow. Infact, most people do not respond well to being given rules. The most significant thing the ProjectManager and Team Leaders can do to ensure appropriate quality is to take a personal interest inthe quality of work being done, providing coaching and feedback as appropriate.

Reviewing quality at the end of a phase

There should be little to do at the end of the phase - if there are significant problems it is too lateto do anything without an adverse impact on costs and timescales. The Quality Methods youhave applied throughout the phase should have ensured that there is no surprise at the end of thephase.

Before the phase can truly be considered to be complete, you should review that you have:

done everything you said you would do in the way you said you would do it,and

produced everything you said you would produce to an acceptable standard.

There will, of course, be deviations. In each case it should be clear whether:

the change was agreed and its impact has been dealt with the shortcoming was not desirable but is acceptable in terms of delivering the

overall benefit from the project

the failure will be remedied at a later (defined) stage

the fault must be remedied now before the phase can be completed.

The phase-end Quality Review should be agreed and signed off by the Project Sponsor and/orsenior leadership representing the organisation.

Reviewing quality at the end of the project

Similar considerations apply at the end of the project. The senior leadership will consider the

extent to which the project has adequately completed the planned work and deliverables (subjectto agreed changes during its course). As well as the Quality Management aspect of such areview, there will also be many other reasons to examine the success of the project, for example,learning lessons, planning further improvements, improving estimating techniques, payingcontractors and suppliers etc.


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ntroduction to Six Sigma Process

Improvement Tools and Concepts

Program Description

The ability to ask the right questions, gather necessary information and data, make decisions andtake appropriate, corrective action is vital in any organization's efforts to improve its processes,products and services.

This two-day workshop will show you how to choose and apply basic yet powerful Lean and SixSigma tools. It will also introduce important concepts related to theory of variation, includingwhat the termsstable process, capable process andsix sigma capability really mean. Beyondthe techniques, this seminar will also address the critical role of leadership to assure success in aLean Six Sigma initiative.

Through hands-on workshops, demonstrations and lectures, you will learn how you can use thesetools and concepts to dramatically improve processes, quality, productivity and communicationthroughout your organization.

At the end of this program you will have new, powerful techniques to add to your quality toolboxand some challenging theories and insights to guide your future activities and decision making toimprove your company's processes and competitive position.

What You Will Learn

Adopting a "Systems Perspective" Basic Decision Making Techniques:

Flow Charts, Brainstorming, Fishbone Diagrams, Data Collection, ParetoDiagrams, Force Field Analysis, The Deming Cycle, Scatter Diagrams, RunCharts and Histograms

Theory of Variation: stable process; capable process; "Six Sigma capability"

Transformation Model

Basic Procedure for Improving a System: The DMAIC process for Six Sigmaprocess improvement projects

Who Should Attend

Executives, managers, team members, leaders and facilitators and other professionals interestedand involved in process improvements, as well as Lean Six Sigma Black Belt and Green Beltcandidates. This workshop is most beneficial when a team from your organization attendstogether.


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Workshop List

Developing the Team Process for ContinuousImprovement

Failure Mode and Effects Analysis for the Systems

Engineering Environment

Introduction to Advanced Design of Experiments

Introduction to Design of Experiments

Introduction to Design of Experiments for theSystems Engineering Environment

Introduction to Six Sigma Process ImprovementTools and Concepts

Science of Leadership

Six Sigma Executive Overview

Statistical Process Control

Value Stream Process Mapping

Process Improvement Inquiry Form

Project Management

Systems Engineering Technical Programs

Request Information

o Individual Enrollment

o Programs by Subject Area

Online Graduate Programs

Contact

Corporate & Professional Education100 Institute RoadWorcester, MA 01609-2280Phone: +1-508-831-5517Fax: [email protected]

Six Sigma is a set of tools and strategies for process improvement originally developed byMotorola in 1985.[1][2]Six Sigma became well known afterJack Welch made it a central focus of
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his business strategy at General Electric in 1995,[3] and today it is used in different sectors ofindustry.[4]

Six Sigma seeks to improve the quality of process outputs by identifying and removing thecauses of defects (errors) and minimizing variabilityinmanufacturing andbusiness processes.[5]

It uses a set ofquality managementmethods, including statistical methods, and creates a specialinfrastructure of people within the organization ("Champions", "Black Belts", "Green Belts","Orange Belts", etc.) who are experts in these very complex methods. [5] Each Six Sigma projectcarried out within an organization follows a defined sequence of steps and has quantifiedfinancial targets (cost reduction and/or profit increase).[5]

The term Six Sigma originated from terminology associated with manufacturing, specificallyterms associated with statistical modeling of manufacturingprocesses. The maturity of amanufacturing process can be described by asigma rating indicating its yield or the percentageof defect-free products it creates. A six sigma process is one in which 99.99966% of the productsmanufactured are statistically expected to be free of defects (3.4 defects per million), although,

as discussed below, this defect level corresponds to only a 4.5 sigma level. Motorola set a goal of"six sigma" for all of its manufacturing operations, and this goal became a byword for themanagement and engineering practices used to achieve it.

six sigma

six sigma training, history, definitions - six sigma and quality management

glossary

Six Sigma is now according to many business development and quality improvement experts, the

most popular management methodology in history. Six Sigma is certainly a very big industry inits own right, and Six Sigma is now an enormous 'brand' in the world of corporate development.Six Sigma began in 1986 as a statistically-based method to reduce variation in electronicmanufacturing processes in Motorola Inc in the USA. Today, twenty-something years on, SixSigma is used as an all-encompassing business performance methodology, all over the world, inorganizations as diverse as local government departments, prisons, hospitals, the armed forces,banks, and multi-nationals corporations. While Six Sigma implementation continues apace inmany of the world's largest corporations, many organizations and suppliers in the consulting andtraining communities have also seized on the Six Sigma concept, to package and provide all sortsof Six Sigma 'branded' training products and consultancy and services. Six Sigma has alsospawned manay and various business books on the subject. Six Sigma, it might seem, is taking

over the world.

Interestingly while Six Sigma has become a very widely used 'generic' term, the name Six Sigmais actually a registered trademark of Motorola Inc., in the USA, who first pioneered Six Sigmamethods in the 1980's. The original and technically correct spelling seems to be Six Sigma,rather than 6 Sigma, although in recent years Motorola and GE have each since developed their

own sexy Six Sigma logos using the number six and the Greek sigma characters.
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Six Sigma is now a global brand and something of a revolution. But what is Six Sigma?...

six sigma definitions

The answer is that Six Sigma is lots of things.

First, Six Sigma is arguably a very clever way of branding and packaging many aspects of TotalQuality Management that exist in their own right, regardless of the development of Six Sigma.Read the section about Total Quality Management and 'Excellence'and you will understand this.

Six Sigma is lots of different things because it had different meanings over time, and alsobecause it is now interpreted in increasingly different ways. And Six Sigma is still evolving.

The UK Department for Trade and Industry says Six Sigma is:

"A data-driven method for achieving near perfect quality. Six Sigma analysis can focus on anyelement of production or service, and has a strong emphasis on statistical analysis in design,manufacturing and customer-oriented activities." June 2005.

Here's the DTI fact-sheet on Six Sigma - please note this is Crown copyright.

Motorola Inc., who first developed the methodology in the mid-late1980's and who provideextensive Six Sigma training and consultancy services, provide the following definitions:

six sigma according to motorola

"...Six Sigma has evolved over the last two decades and so has its definition. Six Sigma hasliteral, conceptual, and practical definitions. At Motorola University (Motorola's Six Sigmatraining and consultancy division), we think about Six Sigma at three different levels:

As a metric As a methodology

As a management system

Essentially, Six Sigma is all three at the same time."

"...Six Sigma as a Metric: The term "Sigma" is often used as a scale for levels of 'goodness' orquality. Using this scale, 'Six Sigma' equates to 3.4 defects per one million opportunities(DPMO). Therefore, Six Sigma started as a defect reduction effort in manufacturing and wasthen applied to other business processes for the same purpose.."
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"...Six Sigma as a Methodology: As Six Sigma has evolved, there has been less emphasis on theliteral definition of 3.4 DPMO, or counting defects in products and processes. Six Sigma is abusiness improvement methodology that focuses an organization on:

Understanding and managing customer requirements

Aligning key business processes to achieve those requirements Utilizing rigorous data analysis to minimize variation in those processes

Driving rapid and sustainable improvement to business processes.."

"..At the heart of the methodology is the DMAIC model for process improvement. DMAIC iscommonly used by Six Sigma project teams and is an acronym for:

Define opportunity Measure performance

Analyze opportunity

Improve performance

Control performance.."

"...Six Sigma Management System: Through experience, Motorola has learned that disciplineduse of metrics and application of the methodology is still not enough to drive desiredbreakthrough improvements and results that are sustainable over time. For greatest impact,Motorola ensures that process metrics and structured methodology are applied to improvementopportunities that are directly linked to the organizational strategy. When practiced as amanagement system, Six Sigma is a high performance system for executing business strategy.

Six Sigma is a top-down solution to help organizations:

Align their business strategy to critical improvement efforts Mobilize teams to attack high impact projects

Accelerate improved business results

Govern efforts to ensure improvements are sustained.."

"..The Six Sigma Management System drives clarity around the business strategy and the metricsthat most reflect success with that strategy. It provides the framework to prioritize resources forprojects that will improve the metrics, and it leverages leaders who will manage the efforts for

rapid, sustainable, and improved business results.."

Copyright 1994-2005 Motorola, Inc.


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General Electric (GE), the first large-scale adopters and advocates of Six Sigma after Motorola,and considered by most experts to have been responsible for Six Sigma's rapidly achieved highprofile, provide the following definitions of Six Sigma:

six sigma according to general electric

"...Six Sigma is a highly disciplined process that helps us focus on developing and deliveringnear-perfect products and services. Why 'Sigma'? The word is a statistical term that measureshow far a given process deviates from perfection. The central idea behind Six Sigma is that ifyou can measure how many 'defects' you have in a process, you can systematically figure outhow to eliminate them and get as close to 'zero defects' as possible. To achieve Six SigmaQuality, a process must produce no more than 3.4 defects per million opportunities. An'opportunity' is defined as a chance for nonconformance, or not meeting the requiredspecifications. This means we need to be nearly flawless in executing our key processes."

"...At its core, Six Sigma revolves around a few key concepts.

Critical to Quality: Attributes most important to the customer Defect: Failing to deliver what the customer wants

Process Capability: What your process can deliver

Variation: What the customer sees and feels

Stable Operations: Ensuring consistent, predictable processes to improvewhat the customer sees and feels

Design for Six Sigma: Designing to meet customer needs and processcapability..."

Copyright General Electric Company 1997-2005

six sigma according to isixsigma

The Isixsigma organisation, which seems to be the biggest online 'community' of Six Sigmapractitioners, was founded in 2000, and is owned and run by a number of 'quality professionals'.Isixsigma provides the following main definition of Six Sigma (which actually serves as anintroduction to several other very detailed Six Sigma definitions contained in the Isixsigma

resources):

"...Six Sigma is a rigorous and disciplined methodology that uses data and statistical analysis tomeasure and improve a company's operational performance by identifying and eliminating'defects' in manufacturing and service-related processes. Commonly defined as 3.4 defects permillion opportunities, Six Sigma can be defined and understood at three distinct levels: metric,methodology and philosophy..." July 2005.


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six sigma history

Here's a brief history of Six Sigma, and the Six Sigma name. Additionally, comments I've

received about Six Sigma contain aspects of Six Sigma history.

Since the 1920's the word 'sigma' has been used by mathematicians and engineers as a symbolfor a unit of measurement in product quality variation. (Note it's sigma with a small 's'because in this context sigma is a generic unit of measurement.)

In the mid-1980's engineers in Motorola Inc in the USA used 'Six Sigma' an an informal namefor an in-house initiative for reducing defects in production processes, because it representeda suitably high level of quality. (Note here it's Sigma with a big 'S' because in this context SixSigma is a 'branded' name for Motorola's initiative.)

(Certain engineers - there are varying opinions as to whether the very first was Bill Smith orMikal Harry - felt that measuring defects in terms of thousands was an insufficiently rigorousstandard. Hence they increased the measurement scale to parts per million, described as 'defectsper million', which prompted the use the the 'six sigma' terminology and adoption of thecapitalised 'Six Sigma' branded name, given that six sigma was deemed to equate to 3.4 parts - ordefects - per million.)

In the late-1980's following the success of the above initiative, Motorola extended the SixSigma methods to its critical business processes, and significantly Six Sigma became aformalised in-house 'branded' name for a performance improvement methodology, ie., beyondpurely 'defect reduction', in Motorola Inc.

In 1991 Motorola certified its first 'Black Belt' Six Sigma experts, which indicates thebeginnings of the formalisation of the accredited training of Six Sigma methods .

In 1991 also, Allied Signal, (a large avionics company which merged with Honeywell in 1999),adopted the Six Sigma methods, and claimed significant improvements and cost savings withinsix months. It seems that Allied Signal's new CEO Lawrence Bossidy learned of Motorola's workwith Six Sigma and so approached Motorola's CEO Bob Galvin to learn how it could be used inAllied Signal.

In 1995, General Electric's CEO Jack Welch (Welch knew Bossidy since Bossidy once

worked for Welch at GE, and Welch was impressed by Bossidy's achievements using Six Sigma)decided to implement Six Sigma in GE, and by 1998 GE claimed that Six Sigma hadgenerated over three-quarters of a billion dollars of cost savings . (Source: George Eckes'book, The Six Sigma Revolution.)

By the mid-1990's Six Sigma had developed into a transferable 'branded' corporatemanagement initiative and methodology, notably in General Electric and other largemanufacturing corporations, but also in organizations outside the manufacturing sector.
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By the year2000, Six Sigma was effectively established as an industry in its own right,involving the training, consultancy and implementation of Six Sigma methodology in allsorts of organisations around the world.

That is to say, in a little over ten years, Six Sigma quickly became not only a hugely popular

methodology used by many corporations for quality and process improvement, Six Sigmaalso became the subject of many and various training and consultancy products and servicesaround which developed very many Six Sigma support organizations.

six sigma central concepts

You will gather from the definitions and history of Six Sigma that many people consider themodel to be capable of leveraging huge performance improvements and cost savings.

None of this of course happens on its own. Teams and team leaders are an essential part of theSix Sigma methodology.

Six Sigma is therefore a methodology which requires and encourages team leaders and teamsto take responsibility for implementing the Six Sigma processes. Significantly these people needto be trained in Six Sigma's methods - especially the use of the measurement andimprovement tools, and in communications and relationship skills, necessary to involve andserve the needs of the internal and external customers and suppliers that form the criticalprocesses of the organization'sdelivery chains.

Training is therefore also an essential element of the Six Sigma methodology, and lots of it.

Consistent with the sexy pseudo-Japanese 'Six Sigma' name (Sigma is in fact Greek, for the letter's', and a long-standing symbol for a unit of statistical variation measurement), Six Sigmaterminology employs sexy names for other elements within the model, for example 'Black Belts'and 'Green Belts', which denote people with different levels of expertise (and to an extentqualifications), and different responsibilities, forimplementing Six Sigma methods.

Six Sigma teams and notably Six Sigma team leaders ('Black Belts') use a vast array of tools ateach stage of Six Sigma implementation to define, measure, analyse and control variation inprocess quality, and to manage people, teams and communications.

When an organization decides to implement Six Sigma, first the executive team has to decidethe strategy - which might typically be termed an improvement initiative, and this basestrategy should focus on the essential processes necessary to meet customer expectations.

This could amount to twenty or thirty business process. At the top level these are the mainprocesses that enable the organization to add value to goods and services and supply them tocustomers. Implicit within this is an understanding of what the customers - internal and external -actually want and need.


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A team of managers ('Black Belts' normally) who 'own' these processes is responsible for:

identifying and understanding these processes in detail, and also understanding the levels of quality (especially tolerance of variation) that

customers (internal and external) expect, and then

measuring the effectiveness and efficiency of each process performance -notably the 'sigma' performance - ie., is the number of defects per millionoperations (pro-rate if appropriate of course).

The theory is entirely logical: understanding and then improving the most important 'delivery-chain' processes will naturally increase efficiency, customer satisfaction, competitive advantage,and profitability.

Easily said - tricky to achieve - which is what the Six Sigma methodology is for.

Most practitioners and users of Six Sigma refer to Motorola's early DMAIC acronym (extended

since to DMAICT) as a way of reinforcing and reminding participants what needs to be done:

six sigma DMAIC and DMAICT process elements

D - Define opportunity M - Measure performance

A - Analyse opportunity

I - Improve performance

C - Control performance, and optionally:

T - Transfer best practice (to spread the learning to other areas of theorganization)

Motorola emphasises that in order for Six Sigma to achieve 'breakthrough improvements' that aresustainable over time, Six Sigma's 'process metrics' and 'structured methodology' must beextended and applied to 'improvement opportunities' that are directly linked to 'organizationalstrategy'. It is difficult to argue with the logic. There is little point in measuring and improvingthings that have no significant impact on the strategically important organizational processes.

Six Sigma team leaders (Black Belts) work with their teams (team members will normally bepeople trained up to 'Green Belt' accreditation) to analyse and measure the performance of the

identified critical processes. Measurement is typically focused on highly technical interpretationsof percentage defects (by a which a 'sigma' measurement is arrived at - see theone-to-six sigmaconversion scale below), and a deep detailed analysis of processes, involving organizationalstructures and flow-charts. Many other tools for performance measurement and analysis are used,for example the 'balanced scorecard'method, and 'process mapping', etc., depending on theprocesses and systems favoured by the team leaders and project statisticians, and what needs tobe measured and analysed. Six Sigma does not stipulate specifically what analytical methodsmust be used - the organization and particularly the team leaders decide these things, which is
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why implementation and usage of Six Sigma varies so widely, and why Six Sigma will continueto evolve. Any analytical tool can be included within Six Sigma implementation.

Six Sigma experts and commentators commonly refer to typical failure rates of organizationsthat have not put particular pressure on their quality performance levels. Aside from anything

else this at least helps to put the 'Sigma' terminology into a simpler mathematical context:

It is said that many ordinary businesses actually operate at between three and two and sigmaperformance. This equates to between approximately 66,800 and 308,500 defects per millionoperations, (which incidentally is also generally considered to be an unsustainable level ofcustomer satisfaction - ie., the business is likely to be in decline, or about to head that way). Bearin mind that an 'operation' is not limited to the manufacturing processes - an 'operation' can beany process critical to customer satisfaction, for example, the operation of correctlyunderstanding a customer request, or the operation of handling a customer complaint. Six Sigmais not restricted to engineering and production - Six Sigma potentially covers all sorts of service-related activities. What matters is that the operation is identified as being strategically critical

and relevant to strategy and customer satisfaction.

A measurement of four sigma equates to approximately 6,200 DPMO, or around 99.4%perfection. This would arguably be an acceptable level of quality in certain types of business, forinstance a roadside cafe, but a 99.4% success rate is obviously an unacceptable level of quality inother types of business, for example, passenger aircraft maintenance.

A measurement of five sigma equates to just 233 defects per million opportunities, equivalent toa 99.98% perfection rate, and arguably acceptable to many businesses, although absolutely stillnot good enough for the aircraft industry.

Here's a simplified one-to-six sigma conversion scale:

one to six sigma conversion table

'Long

Term

Yield'

(basically

thepercentag

e of

successful

outputs or

operation

s)

Defects

Per Million

Opportunit

ies (DPMO)

'Process

s Sigma'


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%

99.99966 3.4 6

99.98 233 5

99.4 6,210 4

93.3 66,807 3

69.1 308,538 2

30.9 691,462 1

You can see from the conversions above that the sigma scale is exponential. The differencebetween the DPMO equating to each whole number more than doubles as you move up throughthe scale. By my rough calculation, 'seven sigma' would equate to about 2 defects per 100million opportunities (correct me if I'm wrong), which is perhaps a little over-demanding evenfor the aircraft industry, and that's perhaps why nobody bothers much with anything over sixsigma.

Motorola and many other devotees of Six Sigma are increasingly at pains to point out that SixSigma is nowadays far less concerned with the mathematical theory of the Sigma calculations,and a lot more concerned with the model's broader performance improvement methods,nevertheless, Six Sigma's complexity and variable interpretations are not helped by the difficultyin penetrating the original mathematical reasoning behind the essential Six Sigma metric: justexactly why does Six Sigma equate to 3.4 defects per million? What are the calculations whichtake us from 3.4 PPM (parts per million), ie., 0.0000034%, to 'Six Sigma'? Mathematicalinterpretations vary apparently. (If you can explain this in simple language, and less than acouple of hundred words,please do, and I'll gladly add the explanation to this page).

There is also difficulty in phrasing a single simple definition of Six Sigma. For example, the task

of creating a Six Sigma 'elevator speech' (in other words - explain Six Sigma inside 30 seconds)continues to challenge many of the Six Sigma enthusiasts who frequent the growing Six Sigmaweb forums. If you have a good Six Sigma 'elevator speech'please send it, and I'll gladly add itto this page.
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six sigma elevator speech

Here is a suggested Six Sigma elevator speech (thanks Steven, Jun 2010): "Sigma is the symbolof standard deviation, a measurement of deviation of a sample from the population average. Eachsigma you depart from the average, the event, in this case failure, becomes more an more

improbable. At 6 sigma, the probability is about 3.5/million. But this is just the statistical side ofSix Sigma. The bulk of the work in a Six Sigma project would be in defining failures, measuringdeviations, and other activities which ultimately lead to product quality. In fact, Six Sigma isused as a term for a management style, with the ultimate goal of high levels of customersatisfaction."

Can you offer a better Six Sigma elevator speech than this? If soplease send it.

See also the Six Sigma elevator speech funny storybelow.

Aside from its definitions, the Six Sigma concept now has a life of its own, open to a range ofinterpretations, beyond the control and reach of the early Six Sigma originators.

I heard someone say once that Six Sigma is a bit like Naomi Campbell - an attractive, seductive,yet highly complex model. (Also, sexy, expensive, and has been known to fall over...)

Advocates of Six Sigma, which include many highly respected people such as Jack Welch, are inno doubt that Six Sigma can produce immense results, and quickly too. You will see claims thatMotorola saved in excess of $16bn resulting from implementing Six Sigma.

The Six Sigma model may or may not be the most popular ever, but ultimately - as with anybusiness methodology - it relies not on how it is defined, it relies instead on how well people useit.

six sigma - other points of note

First and simply, Six Sigma is a quality improvement methodology.

Six Sigma has also become a generic 'brand' for a set of concepts that many organizations have

used, and continue to use, to improve quality, and to provide quality and performanceimprovement services and training.

In this respect Six Sigma has captured corporate imagination. Six Sigma is an immenselypopular vehicle for initiating and supporting the process of organizational change. Six Sigma hasbecome an industry in its own right. See the names of some of themajor US organizations thathave adopted Six Sigma in recent times.
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Six Sigma is a very flexible concept: to an statistical engineer Six Sigma might be a productionquality metric; to a customer service employee, or a CEO, Six Sigma can represent a corporateculture.

The expression Six Sigma was first used in the context of quality improvement by American

Motorola engineers in the mid 1980's.

Initially within Motorola Six Sigma was purely a quality metric that was used to reduce defectsin the production of electronic components.

Six Sigma was then simply a statistical term that specifically referred to a performance target of3.4 defects per million operations or 'opportunities' (DPMO).

The target of 3.4 defects per million operations which was set by Motorola engineers was to anextent arbitrary and subjective. Even the calculations which arrive at 3.4 defects per million andwhich correlate to precisely six sigma, are open to debate and different interpretation. At this

level, Six Sigma is a highly complex science, so it is not surprising that the meaning of SixSigma had to change in order for it to become something that managers and employees couldrelate to.

Sigma is Greek for the letter 'S', and the term 'sigma' has been used for many years bystatisticians, mathematicians and engineers, as a measurement unit of statistical variation.

During the mid to late 1980's Motorola developed its Six Sigma ideas, which extended to andembraced many existing quality improvement methods and tools.

Motorola quickly realised that they could extend Six Sigma principles beyond manufacturing - to

reduce variation and defects in all aspects of organizational performance.

Following Motorola's success in defining and applying the Six Sigma methodology, Six Sigmabecame a transferable model. The early adopters of Six Sigma aside from Motorola were AlliedSignal (a large avionics company which merged with Honeywell in 1999), and then moresignificantly the massive GE (General Electric) corporation; (according to most commentatorsthe Six Sigma model was transferred between the Chief Executives of the respectiveorganizations).

GE particularly trumpeted its successes and multi-billion dollars of bottom-line improvementsderived from Six Sigma, and by the end of the millennium Six Sigma was established as a

mainstream management methodology, and had been adopted by very many of the world'slargest corporations.

Strictly speaking the Six Sigma brand is trade-marked in the USA and belongs to Motorola Inc..Motorola has since developed its own accredited, certified services and training for Six Sigma,within what is called the 'Motorola University'.


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Many other organizations and consultancies of all sizes also develop and deliver Six Sigmatraining, and this activity seems not to be subject to particular mandatory control or accreditation(although Motorola certainly do have established structures and competencies). Seeminglyanyone can start up as a Six Sigma consultant, just like anyone can start up as a qualitymanagement consultant, or a performance management consultant.

Six Sigma grew quickly from a statistical process for reducing defects in production, to become a'branded' and yet generic management methodology, whose elements extend far beyond themeaning of the original Six Sigma expression.

So, Six Sigma is very flexible, and it continues to evolve, and it's difficult to describe.

Perhaps the most objective way of looking at Six Sigma is to recognise that the Six Sigmamethodology essentially provides a framework, and importantly a strongly branded corporateinitiative, for an organization to:

train its people to focus on key performance areas understand where the organization wants to go (its strategy, related to

its market-place)

understand the services that the organization's customers need most

understand and better organize main business processes that deliverthese customer requirements

measure (in considerable detail) and improve the effectiveness of theseprocesses.

Motorola, and as a rule other advocates of Six Sigma, say that as a management system, Six

Sigma is a top-down method (ie., instigated at CEO-level) for executing business strategy byusing and optimising these process elements:

Aligning critical improvement efforts to business strategy. Mobilizing teams to attack high-impact projects.

Accelerating the improvement of business results.

Governing efforts (of teams and people) to achieve and sustainimprovements.

Central also to Six Sigma purpose and method is increasing the clarity of business strategyand the metrics that most reflect success within it. Other more recognizable terms for thesemight be KRA's (Key Results Areas) and KPI's (Key Performance Indicators).

While Six Sigma's attention to process quality variation is arguably greater than most otherperformance improvement methodologies, the basic principles of establishing and measuringcritical processes are not earth-shatteringly new. What is new is arguably Six Sigma's focus(some would say obsessive focus) on detailed analysis.


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the statistical, engineering and mathematical aspects of Six Sigma. The more complexmathematical terms and acronyms are included in this glossary not to provide detailedexplanations, but instead to enable initial recognition and a basis for further investigation, if youare so inclined. This small glossary is not exhaustive because it would take about ten years tocompile an exhaustive Six Sigma and Quality Management glossary. This is just a few

highlights, some points of clarification, words of warning, items of mild amusement, and termsof special note. The really obvious STBO terms have not been included. If you need a moredetailed listing try the one on the isixsigma website which could keep you occupied for days. Ifyou wish to nominate an item of Six Sigma or Quality Management terminology for inclusionhere - especially an amusing or intriguing example - pleasesend to me. Despite being completelyfascinating of course, Six Sigma is possibly is one of the driest subjects I've ever encounteredand so will benefit from as much light relief as you can suggest.

acceptance, and acceptable quality level (ACL) - Acceptance has at least two differentmeanings in Six Sigma terminology, so be careful to understand which one is being referred to.Firstly, acceptance relating to quality is the quality expectation of the customer, internal or

external. Acceptable Quality Level (ACL) means the same basically, in more formal Six Sigma-speak, and which will frequently be expressed in terms of percentage defects. Secondlyacceptance refers to the buy-in or agreement of people affected by proposed actions and changes,notably stakeholders. While not strictly part of the Six Sigma battery of supporting tools, I canstrongly recommend Sharon Drew Morgen's facilitative communications concepts for anyonestruggling with stakeholder acceptance (and wholesale organisational change as well for thatmatter.)

activity report - A simple tool which enables teams and team leaders to manage projectmanagement tasks, responsibilities and timescales.

affinity diagram - A diagrammatic method of capturing, analysing and organising lots of ideas,elements, activities, etc., that together represent or influence an overall category, such as aprocess or issue. Thebrainstorming method is central to structuring an affinity diagram, and'post-it' or sticky notes are commonly used as a way of generating and organising data.Commonly used in brainstorming solutions during the Improve stage of DMAIC.

analysis - Analysis of all sorts of data is a critical component within the Six Sigma model, whichinvolves using various analytical methods to identify and quantify the causes of quality variationand failure in specific processes. Various analysis perspectives are adopted, for example:

discrete - looking at a particular failure or problem - eg., using Pareto('80:20') or pie-charts to show causes by percentage

continuous - mapping performance variation and types, etc., over time, usingdistribution graphs

process - creating detailed flow-diagrams to understand what's really goingon in the process or sub-process

ANOVA, ANCOVA, MANOVA, MANCOVA - Despite first impressions these are nothing todo with Russion gymnastics or ice-skating moves. ANOVA is an acronym for analysis of
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variance, a specialised variation calculation method concerned with comparing means and testinghypotheses, best left to engineers and mathematicians. So are the related methods, ANCOVA(analysis of covariance), MANOVA (multiple analysis of variance), and MANCOVA (multipleanalysis of covariance). Unless you are an engineer or a mathematician you will almost certainlyhave better things to do than get to grips with this level of statistical capability. Terms such as

these illustrate why we need to work in multi-disciplined teams.

balanced scorecard - A sophisticated strategic analysis and improvement methodologydeveloped by Kaplan and Norton which in its own right can sit outside Six Sigma, but which canbe included within Six Sigma methods, and in any event might be used or referenced in thecontext of quality and performance improvement. The 'balanced scorecard' identifies, correlates,'balances', measures and drives improvement across a wide variety of factors that are deemedresponsible for overall organisational effectiveness, and for meeting customer expectations. Thetool essentially translates strategy into operational metrics, and according to Motorola (ie., in aSix Sigma context) typically features the perspectives of, vision, current initiatives, businessprocesses, and business results. 'Balanced Scorecard' became a generic 'brand' for business

improvement in the 1990's, rather like Six Sigma, although arguably not on such a grand scale.

black belt - A specific Six Sigma term to describe a team leader and one who has achievedaccredited 'Black Belt' qualification via an appropriate training course.

black noise/white noise - Technical terms relating to respectively non-random and randomcauses of variation.

business improvement campaign - A Motorola Six Sigma buzz-phrase, which represents aleadership initiative to improve the business's 'big Y's'.

business process management - A common generic expression in its own right, but also a SixSigma term for the initial strategic element of Six Sigma. Six Sigma's strategic first phase isdesigned to develop management's commitment to Six Sigma, and also management's activeparticipation in the Six Sigma process (which suggests why a powerful brand name for theinitiative, ie., Six Sigma, is helpful..). This amounts to identifying the key processes within theorganisation that determine effectively meeting customer expectations; then measuring theeffectiveness and efficiency of the processes (notably measuring variation in quality andanalysing the causes), and then initiating improvements in the weakest processes, which shouldlogically yield the greatest results and return on effort.

cause-effect diagram - Also known as the fishbone diagram, this is a generally used tool for

mapping and analysing causal factors towards an end output, so that contributing factors (andweaknesses can be more easily identified). Used especially in Six Sigma as a team brainstorminganalysis tool. Called a fishbone diagram because the diagram plots contributing factors alongparallel diagonal lines which each join a central horizontal time-line (like the back-bone) whichculminates at one end with the main issue or question.
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CTQ - Critical To Quality - An element within a process that has a major influence on theprocess quality, and typically the quality of a critical process, or it would be unlikely to bereceiving Six Sigma attention.

defect - A vital and generic Six Sigma term for any failure in meeting customer expectation

(internal and external customers) - any failure within the delivery process.

DFSS - Commonly used abbreviation in Six Sigma activities and communications, it meansDesign For Six Sigma, and describes the method of using tools, training, measurements, andverification so that products and processes are designed at the outset to meet Six Sigmarequirements. A more specific version is DMADV: Define, Measure, Analyze, Design, andVerify. Both DFSS and DMAVD are concerned with, and emphasise the importance of, usingSix Sigma principles in product/process design, not just for remedial improvements - ratheradvocating that prevention is better than cure. Thus, if Six Sigma capability is built into neworganizational systems and products when they are designed, so performance will be better, andthe need for Six Sigma remedial effort will be reduced.

DMAIC/DMAICT - Central Six Sigma process and acronym to ensure you remember it:Define, Measure, Analyse Improve, Control, more recently extended to DMAICT by others inthe Six Sigma consulting and training communities, to Transfer (transfer best practice andthereby share learning).

DMADV - An alternative/substitute abbreviation to DFSS (Design For Six Sigma), and likeDFSS DMADV is central to Six Sigma initiatives. DMADV more specifically describes amethod comprising linked steps; Define, Measure, Analyze, Design, Verify, for ensuring thatproducts and processes are designed at the outset to meet Six Sigma requirements.

frequency distribution/frequency distribution analysis or checksheet - Frequencydistribution and the checksheets and other frequency distribution measurement tools form anessential aspect of Six Sigma data analysis. Identifying frequency of variation in processes iscentral to Six Sigma, since customers are particularly sensitive to variation, arguably even morethan isolated failures. Therefore the sampling and collection of data over many operations andextended time periods, and the use of this data to indicate the frequency (number of times) thata variation occurs rather than the size of isolated failures, is an essential perspective for trulyunderstanding what's happening, and the causes, within any critical delivery process. Frequencydistribution analysis is an excellent antidote for any temptation to respond to an isolated failurewith a knee-jerk quick fix, such as shooting the messenger or bollocking the workers whensomething deeper in the process is awry.

green belt - A Six Sigma team member who has received Green Belt training and who workspart-time on Six Sigma projects under the guidance of a Black belt team leader.

just in time (JIT) - Just In Time, commonly abbreviated to JIT, describes operational orproduction methods based on minimising stock levels, the aim of which is to reduce capitalemployed in stock, which also has knock-on benefits to reducing storage space, decreasingdependence on logistics, easier supply chain management, and better overall quality. Just In


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Time is actually a capability arising from improvements within a business operation, rather thana cause of improvement itself. Introducing Just In Time methods without improving efficiencyand reliability necessary to support it is not viable. Since Just In Time methods entail reducingstock levels to absolute minimum or even zero, JIT allows no room for error. Timing andpredictibility are cruicial. JIT requires total commitment to quality and efficiency or the supply

chain and related operations break down, the costs and implications of which can easily exceedany savings from JIT stock reductions. The term and methodology were developed by theJapanese during their post-war industrial revival (second half of the 1900s) as a logicalprogression from 'materials requirements planning' (MRP). The Japanese original terminology is'kanban', and is important within 'lean production' methodology. The aim of kanban is actuallyzero inventory. JIT features in highly efficient manufacturing corporations, and has morerecently been significantly enabled by computerization, especially to analyse and managetimings rather than stock levels. Noted authors to have covered the subject include EdwardsDeming, Taiichi Ohno, and Yasuhiro Monden. The acronyms page contains a moreamusingdefinition of JIT.

master black belt - A highly qualified Six Sigma practitioner, typically concerned withoverseeing Six Sigma activities from an organizational perspective.

materials requirements planning (MRP) - production quality management methodologyfocusing on planning stock (materials and components of all sorts) levels and availabilityaccording to production schedules.

pareto principle, pareto diagram, pareto analysis - The Pareto Principle is otherwise andmore commonly known as the 80:20 rule. The Pareto Principle was named after its originatorVilfredo Pareto, (1848-1923) an Italian economist and professor of political economics atLausanne University, who first discovered the 80:20 'rule' of 'predictable imbalance', that (as far

as Six Sigma is concerned) provides a basis for focusing on the 20% of activities that generate80% of results, or the 20% of failures that are responsible for 80% of the waste, etc. Pareto firstmade his discovery while analysing wealth distribution among the British, in 1897. The ParetoPrinciple is also known as The Parato Law, The Principle Of Least Effort, and The Principle OfImbalance, which in themselves provide an example of the Pareto Principle in action becausedespite all the options, hardly anyone ever uses any other name than 'The 80:20 Rule'. MorePareto explanation and examples in use.

process - The word process is worth mentioning because it is a fundamental cause of confusion(and not just in Six Sigma, but that's another story). The word process is used heavily indescribing how Six Sigma works, and it's also used heavily in referring to the service orproduction activities (processes) on which the Six Sigma methods (or processes) are directed.You see what I mean... It is both the subject and the object. People easily get confused byterminology at the best of times, so it's worth taking extra care when using words like processwhich have at least two distinctly different meanings. For example avoid phrases such as "SixSigma is a process that uses processes to improve processes." It's true, but its a load of bollocks.So, when using the word process, check that people know what process you are actually referringto, and then you will have a fighting chance of not disappearing up your own backside.
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process mapping - diagrammatical representation of how processes work, as could be used anddeveloped in team meetings on a flip-chart, or other media, to enable teams to understandprocesses, participants, and where and how improvements might be made.

production planning - generic term describing the over-arching methodology used in managing

the supply process from receipt (or forecast) of customer requirements through to delivery notesand invoicing. Production planning therefore includes:

interpretation of customer orders/requirements works orders

schedules and computer programs/ implications

parts, stocks and materials

machinery, plant, equipment availability and allocation

people and teams

quality and other targets - setting and monitoring

stock and purchasing monitoring and records

order processing, administration and accounting

necessary inter-departmental liaison (e.g., sales, export, etc)

Production planning is typically highly modularized and computerized since process reliability iscrucial and is systematically repeated, although production planning must also allow forvariation in response to sales or other changing demands and product specifications. Production

planning is generally a weekly and monthly requirement, as well as incorporating longer-termcommitments and considerations. The particular sales environment and predictability of themarket and business have major impacts on production planning. Volatile markets andunpredictable sales obviously make production planning more difficult. Costs and budgets,health and safety, environmental, and other indirect considerations or compliances are of courserele

Quality aspects and transfer pricing

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