Increasing Quality and Cutting Costs

Is Quality Job One?

Almost every business in every industry wrestles with this question: How do we improve quality and reduce costs? Should we focus on improving quality, even if it initially increases business costs, and then seek to reduce those expenses later? Is it possible to improve quality and lower costs at the same time?

The answer: It depends.

That’s the conclusion reached by Vanderbilt professors Michael Lapré and Gary Scudder in an award-winning study, Performance Improvement Paths in the Airline Industry. Which path a company should choose depends on its asset frontier—a measure of how closely a business is operating to its maximum ability, or how much “slack” it maintains. As Lapré and Scudder found in their study of airlines over an 11-year period, the closer an airline operates to its asset frontier, the more its ability diminishes to improve quality and reduce costs simultaneously. The more slack an airline has, the greater its potential for improving both quality and cost positions at once, without encountering trade-offs between these two goals.

During the past 20 years, the thinking of operations managers has evolved dramatically. During the late 1980s and early 1980s, the prevailing view held that businesses faced tradeoffs when it came to operations priorities. High quality and low cost, ran this line of thinking, were mutually exclusive goals. In the 1990s, this view was challenged by the “sand cone” model, which suggested a sequence for prioritizing operational objectives: Begin with improving quality, then focus on flexibility and delivery, with cost at the apex of the cone. The advent of mass customization, made possible by advances in operations technologies, further challenged the old concept of tradeoffs by proposing that customers could enjoy flexibility, rapid delivery, good quality and reasonable cost.

Even as management theory began moving toward this newer view, however, other researchers re-examined the topic and found that tradeoffs persist in manufacturing operations that are close to their productivity frontiers. Businesses that remain farther from this frontier can improve performance without having to choose between competing priorities. Meanwhile, as firms improve performance, they can avoid the tradeoff dilemma by investing in new technologies or processes that extend the productivity frontier. Subsequent researchers validated these ideas while introducing the concept of asset frontiers (formed by structural choices reflected in a company’s investment in plant and equipment) and operating frontiers (defined by choices reflected in operating its plant).

But this body of research left one big question unresolved: How should firms make the improvements that will move them closer to their frontier or extend that frontier? How should a firm improve quality and lower costs? Should it seek first to move closer to its existing operating frontier by improving quality, even though it likely will face the tradeoff of higher costs, and then focus on achieving a “better” frontier? Or could it implement an effort that simultaneously extends the frontier while moving the business toward that advancing target?

To analyze these questions, Professors Lapré and Scudder chose to study cost, quality and fleet utilization among U.S. air carriers. The industry provided an alluring research target for one overarching reason: To comply with government regulations, airlines must make available enormous amounts of data on almost all facets of their operations.

Lapré and Scudder examined all 10 major airlines (defined by the U.S. Department of Transportation as earning at least 1% of total domestic passenger revenues) that operated during the entire period of 1988 through 1998. To ensure the most relevant comparisons, they divided the airlines into two groups: (1) those that only fly North American routes (Southwest, America West and Alaska), and (2) those that fly both continental and intercontinental routes (America, Continental, Delta, Northwest, TWA, United and U.S. Airways).

They assessed quality by measuring the number of consumer complaints filed with the U.S. Department of Transportation. (Because the DOT made significant efforts to raise public awareness of its consumer hotline in 1987, and also began requiring major airlines to report statistics on quality indicators, Lapré and Scudder believed that 1988 is when data for their study became most relevant.) In assessing costs, they followed the traditional industry measure of cost-per-available-seat-mile (operating expenses divided by the total number of passenger seats available for purchase). Then, they calculated fleet utilization (the portion of each day an airline uses aircraft for service with passengers on board) to assess how close each airline was to its asset frontier.

Lapré and Scudder tested two hypotheses:

  1. Airlines operating closer to their asset frontiers will face initial tradeoffs such that they will only be able to improve either cost or quality, but not both simultaneously; and
  2. Airlines that end up in a sustainable superior quality-cost position will make large initial improvements on quality compared with cost.

Their analysis of 11 years of data confirmed both hypotheses. Validating the sand cone model, they found that “lasting quality improvements clearly precede lasting cost improvements.” In fact, noted Lapré and Scudder, all of the airlines that improved their quality-cost positions between 1988 and 1998 improved more on quality first.

Second, Professors Lapré and Scudder concluded that airlines operating close to their asset frontiers encountered tradeoffs, improving quality only by also incurring higher costs; later, as they had hypothesized, these carriers were able to reach superior quality-cost positions. Among the geographic specialists, for example, Southwest had the highest fleet utilization in 1988. As the airline initially increased flying operations expenses, quality (as measured by a decrease in customer complaints) also rose. Later, Southwest was able to reduce flying operations expenses somewhat.

Likewise, Delta, American and United—the carriers among the larger, “geographic generalists” that operated closest to their asset frontiers—all improved quality only by accepting higher costs until reaching better quality-cost positions. Delta reduced customer complaints while increasing expenses for flying operations, promotions and sales, and general and administrative costs. Within two years, however, the airline was able to scale back these costs without adversely affecting customer satisfaction. While American did not encounter these tradeoffs in 1989, it could not maintain this cost position in 1990 and 1991, supporting the Lapré-Scudder hypothesis.

In contrast, Alaska began with the lowest fleet utilization among the geographic specialists in 1988. Just as Lapré and Scudder predicted, the data showed that Alaska was able to improve both quality and cost simultaneously, with the greatest improvements focused on quality. Alaska, for example, was the first airline to use a “heads-up guidance system” during flights to reduce disruptions caused by fog. Investments in quality were offset by savings in other areas where the airline maintained slack. On a typical flight, Alaska reduced the number of flight attendants from five to three and eliminated meal service on flights shorter than 100 minutes. The airline also replaced its Boeing 727s with Boeing 737-400s, which were 40% more fuel efficient and required one fewer pilot. It added seats without compromising legroom by adjusting closets and galleys. And it cut turnaround times in half, from one hour to just 30 minutes.

Among the geographic generalists, Northwest, with the lowest fleet utilization, was farthest from its asset frontier in 1988. Like Alaska, it improved its quality and cost positions simultaneously by focusing heavily on quality. In 1989, to address negative perceptions by customers, a new management team made friendliness a major emphasis. Working to overcome the airline’s “Northworst” image, management also empowered local employees to resolve customer problems on the spot, adopted automated baggage tags to reduce the chance of misrouted luggage, and increased the number of spare airplanes at its hubs. While these and other improvements raised flying operations expenses at first, management was able to reduce other costs. As one example, it retrofitted aging planes with “hushkits” to improve efficiency and bring them in compliance with FAA standards for noise control. As a result, Northwest extended the useful lives of these planes by as much as 15 years.

In one other notable finding, Lapré and Scudder illuminated the close relationship between quality and business viability among air carriers. Eastern and Pan Am, the two major airlines with the highest complaint rates in 1988, ceased operations within two years. The three with the next highest complaint rates—TWA, America West and Continental—all operated under Chapter 11 bankruptcy protection in 1991. Of these, only America West improved its cost position between 1988 and 1998. The airline with the next highest complaint rate, U.S. Airways, did not improve its position during the decade under study. Meanwhile, the six airlines with the lowest complaint rates in 1989 all achieved better quality-cost positions.

Although the researchers acknowledge that much more operational performance data from other, less regulated industries need to be gathered, Lapré and Scudder believe that their findings are applicable beyond the airlines—and most directly to other service industries that are low on labor intensity, customization and customer interaction. In addition, their study supports the sand cone model and the theories of previous researchers regarding asset frontiers and tradeoffs—all of which should broadly translate across business categories. For businesses seeking answers to an age-old business question—how to improve quality while lowering costs—the airline study illuminates a promising path forward.

Published Sep 3, 2007 in Vanderbilt Business Intelligence
Copyright 2007 Vanderbilt Owen Graduate School of Management