Q 746. Break-Even Analysis provides the minimum sales volume needed to cover the costs. How can this analysis be used in a Lean Six Sigma project which is being done on a support process (i.e. there is no sales to show)? Provide an example showing the detailed analysis to support your answer.

 

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Break-even analysis is commonly used to determine the minimum sales required to cover costs. One thing break-even analysis is not limited to revenue-generate activities; it can be applied in all cases. An example of this is when Lean Six Sigma approach is applied in support functions where nothing comes in terms of revenue but nevertheless, break-even analysis can be conducted to measure cost savings related to process improvements.

 

Below is a practical example of how break-even analysis can be used in a call center automation project.

Break-Even Calculation Table

Category	Value
Total Employees (Before RPA)	150 employees
Total Employees (After RPA)	100 employees
Initial Cost of RPA Implementation	₹4,50,000
Annual Maintenance Cost	₹25,000 per year
Total RPA Cost (Over 3 Years)	₹5,25,000
Average Salary Per Employee (Annually)	₹2,00,000
Reduction in Headcount	50 employees
Total Annual Cost Savings	₹1,00,00,000
Break-Even Point Calculation	₹5,25,000 ÷ ₹1,00,00,000
Time to Break Even	6.3 months

 

 

Break-even analysis can be leveraged in financial improvement Six Sigma projects in following ways:

1. To ascertain if the project is financially viable by comparing costs and savings
2. To define clear financial targets to achieve project success.
3. To allocate resources more efficiently through a cost structure drill down
4. To build trust among stakeholders though financial accountability.
5. To assess financial risks and associated impact on the project's viability
6. To measure progress and performance against financial targets.
7. To take informed data driven decisions based on cost-benefit trade-off.
8. To provide financial justification for the project to stakeholders.
9. To prioritize projects based on their financial value.
10. To analyze different scenarios and permutations to understand potential outcomes.
11. To track financial progress and adjust/adapt the strategies as required.
12. To perform a nut & bolt level cost-benefit analysis to understand the project's impact.
13. To compare the project's financial performance against benchmarks in the industry.
14. To control costs by identifying expenses (fixed + variable)
15. To assess the return on investment by understanding the break-even point.
16. To Identify areas for improving process efficiency.
17. To create accurate budgets/baselines based on the break-even analysis.
18. To forecast financial outcomes and plan for future improvements.
19. To Identify areas for cost control/ reduction and efficiency gains.
20. To Increase transparency and trust in financial planning and reporting.

 

Other example where break even analysis could be leveraged in lean six sigma project is Energy Efficiency project where company aims to implement energy saving measures. If we consider the fixed cost as USD 500K, Variable cost of USD 50 per unit and cost savings of USD 150 per unit through reduced energy consumption. The breakeven point will be calculated as Fixed cost/ (Savings per unit – Variable cost per unit) = 500000/ (150-50) = 5000 units

The energy efficiency measures need to save energy of at least 5000 units to break even.

 

 

 

 

Break Even Analysis (BEA) is a financial measure that calculates the minimum return or sales volumes required to cover the product or service costs. A Lean Six Sigma project that focuses on a support process will not have direct sales or revenue generation. In such cases, BEA can be applied using alternative metrics that reflect the service value or process output.

 

Here is an example of how to apply BEA in a Lean Six Sigma project for a support process:

 

Break-Even Analysis for a QA Support Process in the Medical Coding Industry.

 

The break-even analysis for a medical coding QA process helps to find the point at which the support activities bring in the same amount of money as they cost. This means that the company doesn't have to pay the client a penalty for a claim error.

Key Components of Break-Even Analysis:

 

Fixed Costs: Annual Salary of QA Staff ($50000)

 

Variable Costs: Software Licenses, Membership Renewals, and Other Expenses ($1/chart audited)

 

Revenue: Savings from error reduction or avoiding paying a penalty for poor quality from client audits ($3/client error findings)

 

Output Metric: Avoid paying a penalty for claim errors from the client audits.

 

Break Even Formula: Fixed Costs/Revenue per Unit - Variable Cost per Unit
 

50000/(3-1) = 50000/2 = 25000

 

Conclusion:

 

The company needs to avoid paying penalties to clients for at least 25,000 claims per year to cover QA support process costs.

Let us understand couple of concepts before we delve further into this scenario:

Break-Even Point(BEP): The point at which a business’s revenues equals its costs, which implies there is no profit or loss.

 

 (image source: Wikipedia)

 

Break-Even analysis:  A financial calculation used to determine the BEP
Some of the typical Constituents of Break-Even Analysis are Fixed Cost, Variable cost, Revenue, Break-Even Point, Contribution Margin

[Note: Am not going to the nitty-gritties of each of these constituents, as it can be talked in depth. For a quick look, a good and useful link is there, IMHO . You can  refer https://www.investopedia.com/terms/b/breakevenanalysis.asp]

Example:

Let us see a hypothetic example in a LSS project on a support process in an IT industry. 
An IT organization wanted to focus on cost reduction for its support process for all the applications that were in maintenance.  Therefore, it was looking for ways to achieve that. The leadership team felt the pinch and all wanted to ensure that this problem was quickly resolved

The maintenance projects were being run in managed services mode where the IT organization was entirely responsible for the work being done and as per the contract with its customer, the organization has a designated recurring monthly amount (for a stipulated contract period) which it got from its customer.   It had approximately 400 staffs
A cross-functional team from the IT organization decided to address the cost reduction challenge and it wanted to complete this LSS project in 4 months’ time .  

 

The scope of the LSS project was limited to the areas in which the IT organization was involved directly (as in the master contract).                                            

Out of scope: Applications which other vendors were involved and where the organization was not involved.

The goal statement was to reduce the overall cost atleast by 10% (from the current cost) in 4 months’ time. 

While deciding the CTQ, the team contemplated on various aspects before finalizing Overall Cost Reduction on Fixed and Variable costs by 10% on the existing ecosystem

 

Because as per the contract, it was mentioned that the key factors involving the contractual amount for the applications are the support scope (of services/components), System complexity, the geographical location, different levels of Business (eg. Small-sized, mid-sized , large-sized), Skills/expertise needed, hence the team realized that the CTQ (defined above) would meet its needs.  The team also felt that these factors can give lot of insights to address its goal.  So, the team decided to collect the data (in terms of cost associated) for these factors

 

Once the team collected the data (the variable costs, the fixed costs incurred due to each of these factors), the team analyzed the factors contributing what could be the vital few to work upon. It threw some pointers 

The parameters(factors) Geographical location, Skilled staffs stood out  
a.    ‘Geographical location’:  It had an impact for variable cost reduction, as labour rates differed (across countries) for people of same experience and same expertise on the same skill set 
b.    Skilled staffs: It had an impact for variable cost reduction. It helped in showcasing the experienced and lesser experienced or new joinees, in each of the teams which are part of this support process.  

 

The team came up with the solution in the improve phase. Therefore, as a solution, 

1.    it ensured that there were distributed team members as well across different countries (where already there were some existing office infrastructure).   The distribution (of staffs) happened at countries where labour rates were low when compared with the existing setup. This induced a reduction in variable cost
2.    The team, with the help of the leadership team identified areas(applications) where there was potential scope of less-experienced staffs (who has lesser labour rate but who can produce the same quality of work), who can replace outgoing (movement to other areas, resignations) staffs. This induced a reduction in fixed cost especially for small and mid-sized applications. 
3.    The team felt for big-sized applications, it was a challenge to find less-experienced staffs as the applications experienced professionals. Therefore, the team came up with an approach of Blended rate where they will have a common labour rate for experienced and lesser experienced staffs. This was accepted by the leadership team and when the contract was due for renewal, the amendment ensured that this was considered for big-sized applications

 

By having these solutions, the team was able to achieve its goal of overall cost reduced by 10%, in 4 months’ time

 

The team ensured that it monitored the overall cost in every month, for a minimum of 2 quarters and confirmed that this process was stable and efficient. It setup a continuous monitoring process which ensured that the overall cost was well within the target

Conclusion:

As we can see with the above example, Break-Even Analysis (BEA) can help us in decision-making through various means:

 

1.    Finding the Vital Few parameters:

•  In the above example, it helped the team to identify the vital parameters. This helped the team to arrive at a viable solution.

2.    Pricing strategy 

• It can make an organization competitive. 
• For instance, by having a blended rate, in the above example, the IT organization gained advantage over its competitor vendors while going for the amendment as its scope of support coverage got increased, because the customer felt, blended rate ensured that labour rate got evened out for experienced and lesser experienced and more work could be taken by the IT organization as well, all of these happened within the stipulated overall contract amount. 
• A win-win situation for both the parties, thus was arrived because of taking the decision of using blended rate

3.    Arriving at the right Staffs

• For instance, in the example above, it helped to identify the need for lesser-experienced staffs wherever applicable 
• It also identified the need for distributed team members

4.    Customer Contract Management:  

• As we see in the example, it helps in suitable pricing resulting in profitability for the parties concerned  

 

Thus, we can see how Break-Even Analysis (BEA) can be leveraged in a LSS project for a support process.

Break-even analysis can be a useful tool in the Lean Six Sigma projects related to support processes since it helps organizations to understand the relationship between

• costs,
• volume of work,
• the necessary efficiency improvements to cover costs.

In support processes, the "sales" can equal to service delivered, efficiency gains, or customer satisfaction.

 

This analysis can be used in LSS projects for service industry in following manner -

Optimize the process cost -

• It can be utilized to find out the fixed costs (remains constant) and variable cost (changes depending on the output) for a process.

Give a strong definition to what “output” is -

• It can be used to define what "output" means in the context of the support process which can be shown using the number of support tickets resolved, the number of customers served, or any other relevant metric.

Calculating the BEP for the process -

• By using the defined output we can calculate the break-even point which will give us an idea how many units of output are needed to cover costs. The formula used is Fixed Costs/(Fixed Cost per unit - Variable cost per unit).

Assist in creating well-defined targets -

• It can be used to set targets for improvement initiatives, which will in turn help the organizations in improving the efficiency and customer satisfaction by reducing costs or increasing output

 

 

Example -

As an example, we can take a BPO team -

Fixed Costs (FC) of the process is $20,000
Variable Costs (VC) for the process is $10 per ticket

Let’s define output as the number of support tickets resolved in a month.

To find the break-even point (BEP), use the formula:
BEP = Fixed Costs/{Price per unit} - {Variable Costs per unit}
In a support process, consider the "price" as the saved cost or value delivered by resolving tickets. Assume that each resolved ticket saves the company $20 in productivity or avoids additional costs.
BEP = {20,000}/{20 - 10} = {20,000}/{10} = 2,000 tickets

The BPO team needs to resolve at least 2,000 tickets per month to cover their costs.
If they resolve fewer than 2,000 tickets, they’ll incur a loss. If they resolve more, they generate a surplus that can be reinvested into process improvements or additional resources.

If the team identifies a process improvement initiative that can reduce the average handling time of support tickets by 20%, they may increase the number of tickets resolved without increasing costs.
By employing break-even analysis, the BPO team can strategize on cost management, target improvement initiatives, and ultimately enhance overall operational efficiency in alignment with Lean Six Sigma principles.

For the survival of a business, it is necessary that the businesses generate the profit as early as possible, whether it is a manufacturing or service industry. This implies that what should be the minimum sales volume to cover the costs and start generating profits. Break-Even Analysis helps to understand the minimum sales-volume needed to cover the costs and give the idea when a business will start generating profits. 

 

So here, first we will understand the Break-Even Analysis concept and then we understand how it can be used in Lean Six Sigma Projects.

 

Break Even Analysis has five components:

1. Fixed Cost: This cost is not varied with the production. For example, Rent, Taxes and Wages
2. Variable Cost: This cost varies with the production such as raw materials, production supplies, utilities, packaging etc.
3. Sales: Sell of the product generate the revenue for the business.
4. Contribution Margin: It is the difference between the selling price per unit and the variable cost per unit.
   • Mathematically: (Selling Price per unit - Variable Cost per Unit)
5. Break-Even Point: It is the point, where the sales revenue equal to the total costs or we can say that the company will start generating profits after this point.
   • Mathematically: Break-Even Point is the ratio of Fixed Cost to the Contribution Margin.
   • BEP = Fixed Cost / (Selling Price per Unit - Variable Cost per Unit)

Let's take an example to better understand the concept of Break-Even Analysis.

 

Rajan starts a business of manufacturing Helmet. He invests Rs.10,00,000/- as fixed cost. He calculates that cost of producing a Helmet is Rs.300/-. He then sets the selling price of the Helmet Rs.500/- that includes the profit of Rs.200/- per Helmet.

 

Now the number of units needed to sell to cover the total costs can be calculated as 

• Break Even Quantity = 10,00,000/ (500-300) = 5000

 

It implies that Rajan has to sell 5000 Helmets to cover the total costs and after that he starts generating profits. 

 

Now Lean Six Sigma focuses on the waste reduction and variation in the process to improve the process continuously and so reduce the cost of production or deliver the service.

 

Rajan initiates the Lean Six Sigma Project, and he successfully reduces the per unit cost of production of the Helmet from Rs.300/- to Rs.250/- then let see what the impact will be on the Break-Even Quantity.

• Break-Even Quantity = 10,00,000/ (500-250) = 4000

We can clearly see the difference that now Rajan has to produce only 4000 Helmets after reducing per unit cost of Helmet using Lean Six Sigma project to cover the total cost and now, he earns the profit by selling next 1000 Helmets.

 

Conclusion:

Break-Even Analysis helps in understanding how much unit of volume a business has to produce to cover the total costs and gives and opportunity for a businessman to make informed decisions. It identifies the areas where cost can be reduced and increase profitability. And, Finally, Break-Even Analysis serves as a financial metric helps to understand the businessman where his business stands in achieving the business goals.

Some interesting examples of how Break Even Analysis can be applied to processes where we do not have direct sales.

 

The best answer to this question is from Rahul Das. Well done!