Application of Six Sigma to Corporate Finance Roger Hoerl GE Global Research

Outline Why worry about finance? What does corporate finance actually do? Important differences between finance and manufacturing, relative to Six Sigma Sample applications in finance What weve learned about succeeding in finance

Why Worry About Finance? The vast majority of Six Sigma applications have been in manufacturing/engineering For example, according to Dusharme* (2003), the top three application areas for Six Sigma have been: –Manufacturing –Plant Operations –Engineering Research as far back as the 70s & 80s has shown that rework and waste costs are higher in service than in manufacturing Finance is literally where the money is There is a long history of successful application of statistics to finance, often referred to as quantitative finance –E.g., optimization of investment portfolios, stock option valuation *Quality Digest, February 2003

What Does Corporate Finance Actually Do?* Corporate finance addresses two fundamental questions: –Q1: What investments should the organization make? –Q2: How should it pay for those investments? Investments are not limited to financial holdings (stocks, bonds, etc.), but include tangible things like plant and equipment, acquisitions, and so on The second question considers various ways of raising money, such as issuing stock, issuing bonds, collateralized loans, etc. The Controller/Comptroller typically manages budgeting, accounting, and auditing, ensuring that money is properly used (Q1) The Treasurer typically manages the organizations cash accounts, and maintains relationships with banks and other financial institutions (Q2) In large corporations, a Chief Financial Officer oversees both activities, becoming a critical and influential policymaker on the CEOs staff *Admittedly oversimplified

Some Unique Aspects of Finance Conceptual Differences Lack of tangible output or product Lack of a process view of work Lack of an improvement mindset Technical Differences Lack of measurement systems for data* Lack of standardized work processes Lack of engineers Note: Many of these differences also apply to other non-manufacturing areas. *Data for improvement purposes

Similarities That Enable Six Sigma Applications Work occurs through processes (SIPOC model applies) These processes have errors and inefficiencies (rework), which provide opportunities for improvement These processes can produce information to study and improve the process These processes involve combinations of people, equipment (e.g., computers), materials (e.g., information), and methods or procedures, i.e., the same categories as in manufacturing Excessive variation is a often a root cause of problems

Results of a Collections Project in GE Project focus – Skip Tracing in consumer credit – finding people for whom we had invalid contact information Estimated savings across the business - $2MM annually About half in increased cash, half in reduced write-offs Senior management did not believe the estimated savings, asked for a 6 month trial After 6 months, about $1.45MM in actual savings had been documented - $2.9MM annually Secondary benefit: analysis determined optimal number of collectors – resulted in additional hires

Other Actual Financial Application Areas Accounts receivable Accounts payable Factoring inventories Closing the books Financial auditing Manual account reconciliation Acquisitions Realizing revenue Hedging foreign currencies Cash flow Credit scoring Journal entry accuracy Forecast accuracy Financial reporting Filing taxes Managing pension funds Payroll accuracy

What Weve Learned About Succeeding in Finance The perception is the problem –Theres no money outside manufacturing –The statistical tools dont apply –The people cant understand Six Sigma –You cant get data –Its too hard (outside our comfort zone) Biggest barrier – lack of process viewpoint With a process viewpoint, financial applications have more similarities than differences with manufacturing There is a tremendous amount of opportunity in finance