Outsourcing
Content
OUTSOURCING
Using FMEA To Assess Outsourcing Risk
by Cliff Welborn
O
utsourcing has become a growing trend among many U.S. companies.1 Two common examples of the practice are outsourcing IT jobs to India and outsourcing product manufacturing to China. Some say the practice is a
In 50 Words Or Less
• Outsourcing has become common for many U.S. businesses, but assessing the risk involved in such arrangements hasn’t. • A modified version of failure mode effects analysis (FMEA) is one way businesses can evaluate the risk of outsourcing options. • Risk priority numbers can be calculated to rate any potential failures.
normal and healthy part of the evolution in the U.S. workforce.2 Lower costs are often the driving factor, and there have been many success stories of companies that enter this global supply chain and realize significant cost savings.3, 4 However, outsourcing does not guarantee business success. There is risk involved and not all sides benefit from such arrangements.5 The advantages of outsourcing should be carefully weighed against risk and must go beyond evaluating just price. So much more goes into judging the business impact of an outsourcing decision. Without a systematic analysis technique to assess risk, much can go wrong: unexpected cost, extended lead times, poor quality or other negative performance variables.
Risk Assessment Basics
Indeed, risk associated with outsourcing can offset the often more publicized benefits.6 Sometimes the risk doesn’t pay off. Some U.S. companies have joined the outsourcing trend only to be disappointed in the overall net effect
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I AUGUST 2007 I 17
OUTSOURCING
on business operations and eventually returned jobs back to the United States.7, 8 Analyzing the risk associated with a supply chain and outsourcing is a relatively new subject, and little research has been done.9 But one thing is certain: Documenting and analyzing risk is an essential element to continued learning and process improvement.10 It is critical to have an easily understood method to identify and manage risk.11 Failure mode effects analysis (FMEA) is tool used to collect information related to risk management decisions.12 There are documented procedures to complete an FMEA and examples of its application in various industries.13 A modified version of the tool can be used to help evaluate the risk of outsourcing options. FMEA is a well documented, proven technique commonly used to evaluate the risk for failures in product and process designs.14 Every potential failure studied is evaluated in terms of likelihood and severity. A higher FMEA score indicates greater risk. Common variables used to quantify risk are frequency of an activity associated with the defect,
FIGURE 1
FMEA Process Steps
Identify risk categories. Identify potential risks. Rate the opportunity, probability, and severity for each risk. Calculate the risk priority number (RPN) for each risk. Analyze risks by RPN using a Pareto distribution. Develop actions to mitigate risks with high RPN. Reassess risks with another cycle of failure mode effect analysis (FMEA).
TABLE 1
Outsourcing Risk Assessment
Opportunity 2 2 4 2 5 4 5 5 5 5 Probability 4 4 4 4 3 2 4 2 2 1
Risk Cost Unforeseen vendor selection cost Unforeseen transition cost Unforeseen management cost Lead Time Delay in production start-up Delay in manufacturing process Delay in transportation of goods Quality Minor cosmetic/finishing defect Major cosmetic/finishing defect Component will not fit with mating parts—requiring rework Structural defect—function failure
quantity of parts associated with the defect, ability to detect the defect, probability of defect and severity of defect. Other industry specific FMEAs use other variables to quantify risk. Rating scales of 1-5 and 1-10 are often used to quantify each variable. The 1-10 scale Risk priority allows more precision in estiSeverity number mates and typically creates more separation in scores 2 16 between risks. However, the 1-5 2 16 scale makes it easier for a team to agree on rating values. 3 48 A risk priority number (RPN) is calculated for each potential 4 32 failure. A common RPN is the 2 30 product of:
2 1 2 4 5 16 20 20 40 25
Probability of failure X detectability of failure X severity of failure. The steps to complete a FMEA process are illustrated in Figure 1.
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Outsourcing options can be FIGURE 2 Example of Pareto Distribution of Risks in Outsourcing evaluated in much the same manner as product and pro50 cess defects. Risks are evaluated in terms of opportunity, 40 probability and severity, and can be grouped into intuitive 30 categories. The opportunity score for a 20 risk is the frequency at which that activity happens. Using the 1-5 scale, an activity that is 10 a one-time event or seldom takes place has an opportunity 0 score of 1. If the activity is a common occurrence, the opportunity score is 5. The probability score is the expected likelihood that the risk will actually happen. The severity score indicates the level of impact if the risk Risk materializes. A risk with a low severity score causes a minimal impact on operations when it happens, while a risk instance, when RadioShack builds a new store or with a high severity score creates a significant remodels an existing one, RSSF consolidates the impact to operations. The impact might be in terms required construction materials from various venof cost, lead time, loss of intellectual property, dors into one shipment. This procurement configuquality to the customer or other relevant cateration reduces complexity and shipping costs for gories. RadioShack. The RPN for a risk is calculated as the product of: The supply of major store display fixtures is typically awarded on a yearly contract basis. Through Opportunity score X probability score a request for proposal (RFP) process, vendors subX severity score. mit bids to supply a fixture for a calendar year. Once the RPN is calculated for each risk, the Historically, RSSF used domestic manufacturers to risks are analyzed using a Pareto distribution. supply all major furniture and fixtures, including Actions are then taken to mitigate risks, and the items such as wall systems, gondolas and shelves process can be performed again to evaluate residto display products. ual risk. Recently, RadioShack changed its fixture design direction from primarily wood based products to RadioShack Example metal based fixtures. When this design change was implemented, potential vendors in Asia were conRadioShack Store Fixtures (RSSF), a division of sidered in the RFP process. Initial estimates indiRadioShack Corp., procures and distributes furnicated that Asian vendors offered a significant cost ture and fixtures to RadioShack retail store locasavings compared with domestic vendors, espetions. RSSF serves as a consolidation warehouse for cially those vendors that provided metal fixtures. items purchased from many different vendors. For
Risk priority number
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QUALITY PROGRESS
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OUTSOURCING
RadioShack decided to award the business to an Asian manufacturer. Although the quoted purchase price from the selected vendor was significantly lower than other domestic or offshore vendors, there was a concern about the risk of entering into a long-term relation-
Ratings and Scores
In the third step, the team evaluated each risk using the 1-5 rating system and the variables of opportunity, probability and severity. The 1-5 rating was determined by consensus following group discussion. Although this rating technique might not represent the utmost in analytical accuracy, it is a quick, easy and commonly used technique that provides a quantitative measurement to a qualitative concept. For example, the risk of a delay in the manufacturing process was given an opportunity score of 5. Since manufacturing is a recurring activity, the chance of a delay at this stage is recurring. The opportunity score of 5 indicates that there were many instances when this risk could materialize. The probability score for a delay in manufacturing process risk is 3. This is the team’s evaluation of the chance that there would actually be a delay in manufacturing. This evaluation was also based on the team’s understanding of the vendor’s manufacturing capabilities and performance history. The final variable scored was severity. A delay in manufacturing was evaluated to have a severity score of 2. The score indicates the overall impact to RadioShack if the delay materializes. The score also suggests that the impact would not be greatly significant to the overall performance of the company. As described in Figure 1, the fourth step in the FMEA development was to calculate the RPN value for each risk. This was a simple multiplication of: Opportunity score X probability score X severity score. In the fifth step of the FMEA development, the risks were sorted in descending order based on their RPN score and graphed as a Pareto distribution, as shown in Figure 2 (p. 19). This representation of the risks was used to prioritize risk mitigation efforts. In this example, the risk with the highest RPN score was “unforeseen management costs.” It had a RPN of 48. “Unforeseen management costs” represented the risk associated with incurring additional cost to conduct business with a vendor from another country. The management team was concerned about the communication barrier and its ability to efficiently convey business transactions.
Outsourcing options can be evaluated in much the same manner as product and process defects. Risks are evaluated in terms of opportunity, probability and severity, and can be grouped into intuitive categories.
ship with a relatively unknown vendor not based in the United States. The outsourcing risk assessment procedure illustrated in Table 1 was used to evaluate the risks of this relationship. A cross functional team consisting of representatives from design, global sourcing, operations and quality assurance was established to perform the FMEA. The outsourcing risk assessment chart in Table 1 was used to collect the relevant FMEA data. The first step of the FMEA development process was to identify risk categories. Through group discussion, the general categories were established as cost, lead time and quality. In the second step of the FMEA development, the team brainstormed and generated a detailed list of potential risks. The detailed risks were grouped under the risk categories established in step one.
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The risk with the next highest RPN was “component will not fit with mating parts—requiring rework.” Its RPN was 40. The new vendor would be producing many different fixture components that would have to connect to components made by other vendors. There was a concern that components from two different vendors would have dimensional discrepancies resulting in a poor fit. With this quantified risk assessment, RSSF’s management team implemented mitigation efforts. A small product/process development team was established to ensure smooth operations with the new vendor. This three-person team made several trips to the vendor’s location in Asia. Focus was on the development of a system to manage business transactions, such as communication of orders, schedules, payments, returns and repairs. Additionally, the representatives from RSSF and the new vendor met to establish clear product specifications. Samples from RadioShack’s existing product stock were sent to the new vendor to verify fit conformity. In some cases, the mating parts that were not to be produced by the vendor were sent to ensure proper fit. Prototypes were produced and sent to RSSF’s warehouse for thorough evaluation before the vendor was allowed to begin production. These proactive risk mitigation efforts resulted in a smooth supply chain relationship. Without the FMEA based outsourcing risk assessment tool, unforeseen problems might have impacted the overall success of the global outsourcing efforts.
REFERENCES
Future of the Analysis Tool
Decision makers considering outsourcing options should use the FMEA based outsourcing risk assessment technique. The technique is easily implemented and understood. Further research should be undertaken to verify the risk assessment results with actual shortcomings and failures of various outsourcing options. This can be done through a comprehensive study of companies undertaking outsourcing programs.
1. J.K. Liker and T.Y. Choi, “Building Deep Supplier Relationships,” Harvard Business Review, Vol. 82, No. 12, pp. 104-113. 2. T.J. Rodgers, “The Truth About Outsourcing,” IEEE Design and Test of Computers, Vol. 22, No. 1, pp. 12-13. 3. H.L. Lee, “The Triple A Supply Chain,” Harvard Business Review, Vol. 82, No. 10, pp. 102-112. 4. R.E. Slone, “Leading a Supply Chain Turnaround,” Harvard Business Review, Vol. 82, No. 10, pp. 114-121. 5. P.J. Singh, A. Smith and A.S. Sohal, “Strategic Supply Chain Management Issues in the Automotive Industry: An Australian Perspective,” International Journal of Production Research, Vol. 43, No. 16, pp. 3,375-3,399. 6. Mohammed H.A. Tafti, “Risk Factors Associated with Offshore IT Outsourcing,” Industrial Management & Data Systems, Vol. 105, No. 5, 2005, pp. 549-560. 7. Lee, “The Triple A Supply Chain,” Harvard Business Review, see reference 3. 8. Brad Stone, “Should I Stay or Should I Go?” Newsweek, April 19, 2004, pp. 52-53. 9. Roshan R. Pai, Venkata R. Kallepalli, Reggie J. Caudill and MengChu Zhou, “Methods Toward Supply Chain Risk Analysis,” Proceedings of the IEEE International Conference on Systems, Man and Cybernetics, Vol. 5, 2003, pp. 4,560-4,565. 10. John A. Walewski, Edward G. Gibson and Vines F. Ellworth, “Improving International Capital Project Risk Analysis and Management,” Proceedings of Project Management Institute Research Conference, July 2002. 11. Thomas A. Carbone and Donald D. Tippett, “Project Risk Management Using the Project Risk FMEA,” Engineering Management Journal, Vol. 16, No. 4, pp. 28-35. 12. Anand Pillay and Jin Wang, “Modified Failure Mode and Effects Analysis Using Approximate Reasoning,” Reliability Engineering & System Safety, Vol. 79, No. 1, pp. 69-85. 13. D.H. Stamatis, Failure Mode Effect Analysis—FMEA From Theory to Execution, ASQ Quality Press, 1995. 14. G.Q. Huang, J. Shi and K.L. Mak, “Failure Mode Effect Analysis Over the WWW,” International Journal of Advanced Manufacturing Technology, Vol. 16, 2000, pp. 603-608.
CLIFF WELBORN is an assistant
professor at Middle Tennessee State University in Murfreesboro. He earned a doctorate in industrial engineering from the University of Texas at Arlington.
QUALITY PROGRESS
I AUGUST 2007 I 21
Using FMEA To Assess Outsourcing Risk
by Cliff Welborn
O
utsourcing has become a growing trend among many U.S. companies.1 Two common examples of the practice are outsourcing IT jobs to India and outsourcing product manufacturing to China. Some say the practice is a
In 50 Words Or Less
• Outsourcing has become common for many U.S. businesses, but assessing the risk involved in such arrangements hasn’t. • A modified version of failure mode effects analysis (FMEA) is one way businesses can evaluate the risk of outsourcing options. • Risk priority numbers can be calculated to rate any potential failures.
normal and healthy part of the evolution in the U.S. workforce.2 Lower costs are often the driving factor, and there have been many success stories of companies that enter this global supply chain and realize significant cost savings.3, 4 However, outsourcing does not guarantee business success. There is risk involved and not all sides benefit from such arrangements.5 The advantages of outsourcing should be carefully weighed against risk and must go beyond evaluating just price. So much more goes into judging the business impact of an outsourcing decision. Without a systematic analysis technique to assess risk, much can go wrong: unexpected cost, extended lead times, poor quality or other negative performance variables.
Risk Assessment Basics
Indeed, risk associated with outsourcing can offset the often more publicized benefits.6 Sometimes the risk doesn’t pay off. Some U.S. companies have joined the outsourcing trend only to be disappointed in the overall net effect
QUALITY PROGRESS
I AUGUST 2007 I 17
OUTSOURCING
on business operations and eventually returned jobs back to the United States.7, 8 Analyzing the risk associated with a supply chain and outsourcing is a relatively new subject, and little research has been done.9 But one thing is certain: Documenting and analyzing risk is an essential element to continued learning and process improvement.10 It is critical to have an easily understood method to identify and manage risk.11 Failure mode effects analysis (FMEA) is tool used to collect information related to risk management decisions.12 There are documented procedures to complete an FMEA and examples of its application in various industries.13 A modified version of the tool can be used to help evaluate the risk of outsourcing options. FMEA is a well documented, proven technique commonly used to evaluate the risk for failures in product and process designs.14 Every potential failure studied is evaluated in terms of likelihood and severity. A higher FMEA score indicates greater risk. Common variables used to quantify risk are frequency of an activity associated with the defect,
FIGURE 1
FMEA Process Steps
Identify risk categories. Identify potential risks. Rate the opportunity, probability, and severity for each risk. Calculate the risk priority number (RPN) for each risk. Analyze risks by RPN using a Pareto distribution. Develop actions to mitigate risks with high RPN. Reassess risks with another cycle of failure mode effect analysis (FMEA).
TABLE 1
Outsourcing Risk Assessment
Opportunity 2 2 4 2 5 4 5 5 5 5 Probability 4 4 4 4 3 2 4 2 2 1
Risk Cost Unforeseen vendor selection cost Unforeseen transition cost Unforeseen management cost Lead Time Delay in production start-up Delay in manufacturing process Delay in transportation of goods Quality Minor cosmetic/finishing defect Major cosmetic/finishing defect Component will not fit with mating parts—requiring rework Structural defect—function failure
quantity of parts associated with the defect, ability to detect the defect, probability of defect and severity of defect. Other industry specific FMEAs use other variables to quantify risk. Rating scales of 1-5 and 1-10 are often used to quantify each variable. The 1-10 scale Risk priority allows more precision in estiSeverity number mates and typically creates more separation in scores 2 16 between risks. However, the 1-5 2 16 scale makes it easier for a team to agree on rating values. 3 48 A risk priority number (RPN) is calculated for each potential 4 32 failure. A common RPN is the 2 30 product of:
2 1 2 4 5 16 20 20 40 25
Probability of failure X detectability of failure X severity of failure. The steps to complete a FMEA process are illustrated in Figure 1.
18
I AUGUST 2007 I www.asq.org
Outsourcing options can be FIGURE 2 Example of Pareto Distribution of Risks in Outsourcing evaluated in much the same manner as product and pro50 cess defects. Risks are evaluated in terms of opportunity, 40 probability and severity, and can be grouped into intuitive 30 categories. The opportunity score for a 20 risk is the frequency at which that activity happens. Using the 1-5 scale, an activity that is 10 a one-time event or seldom takes place has an opportunity 0 score of 1. If the activity is a common occurrence, the opportunity score is 5. The probability score is the expected likelihood that the risk will actually happen. The severity score indicates the level of impact if the risk Risk materializes. A risk with a low severity score causes a minimal impact on operations when it happens, while a risk instance, when RadioShack builds a new store or with a high severity score creates a significant remodels an existing one, RSSF consolidates the impact to operations. The impact might be in terms required construction materials from various venof cost, lead time, loss of intellectual property, dors into one shipment. This procurement configuquality to the customer or other relevant cateration reduces complexity and shipping costs for gories. RadioShack. The RPN for a risk is calculated as the product of: The supply of major store display fixtures is typically awarded on a yearly contract basis. Through Opportunity score X probability score a request for proposal (RFP) process, vendors subX severity score. mit bids to supply a fixture for a calendar year. Once the RPN is calculated for each risk, the Historically, RSSF used domestic manufacturers to risks are analyzed using a Pareto distribution. supply all major furniture and fixtures, including Actions are then taken to mitigate risks, and the items such as wall systems, gondolas and shelves process can be performed again to evaluate residto display products. ual risk. Recently, RadioShack changed its fixture design direction from primarily wood based products to RadioShack Example metal based fixtures. When this design change was implemented, potential vendors in Asia were conRadioShack Store Fixtures (RSSF), a division of sidered in the RFP process. Initial estimates indiRadioShack Corp., procures and distributes furnicated that Asian vendors offered a significant cost ture and fixtures to RadioShack retail store locasavings compared with domestic vendors, espetions. RSSF serves as a consolidation warehouse for cially those vendors that provided metal fixtures. items purchased from many different vendors. For
Risk priority number
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QUALITY PROGRESS
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OUTSOURCING
RadioShack decided to award the business to an Asian manufacturer. Although the quoted purchase price from the selected vendor was significantly lower than other domestic or offshore vendors, there was a concern about the risk of entering into a long-term relation-
Ratings and Scores
In the third step, the team evaluated each risk using the 1-5 rating system and the variables of opportunity, probability and severity. The 1-5 rating was determined by consensus following group discussion. Although this rating technique might not represent the utmost in analytical accuracy, it is a quick, easy and commonly used technique that provides a quantitative measurement to a qualitative concept. For example, the risk of a delay in the manufacturing process was given an opportunity score of 5. Since manufacturing is a recurring activity, the chance of a delay at this stage is recurring. The opportunity score of 5 indicates that there were many instances when this risk could materialize. The probability score for a delay in manufacturing process risk is 3. This is the team’s evaluation of the chance that there would actually be a delay in manufacturing. This evaluation was also based on the team’s understanding of the vendor’s manufacturing capabilities and performance history. The final variable scored was severity. A delay in manufacturing was evaluated to have a severity score of 2. The score indicates the overall impact to RadioShack if the delay materializes. The score also suggests that the impact would not be greatly significant to the overall performance of the company. As described in Figure 1, the fourth step in the FMEA development was to calculate the RPN value for each risk. This was a simple multiplication of: Opportunity score X probability score X severity score. In the fifth step of the FMEA development, the risks were sorted in descending order based on their RPN score and graphed as a Pareto distribution, as shown in Figure 2 (p. 19). This representation of the risks was used to prioritize risk mitigation efforts. In this example, the risk with the highest RPN score was “unforeseen management costs.” It had a RPN of 48. “Unforeseen management costs” represented the risk associated with incurring additional cost to conduct business with a vendor from another country. The management team was concerned about the communication barrier and its ability to efficiently convey business transactions.
Outsourcing options can be evaluated in much the same manner as product and process defects. Risks are evaluated in terms of opportunity, probability and severity, and can be grouped into intuitive categories.
ship with a relatively unknown vendor not based in the United States. The outsourcing risk assessment procedure illustrated in Table 1 was used to evaluate the risks of this relationship. A cross functional team consisting of representatives from design, global sourcing, operations and quality assurance was established to perform the FMEA. The outsourcing risk assessment chart in Table 1 was used to collect the relevant FMEA data. The first step of the FMEA development process was to identify risk categories. Through group discussion, the general categories were established as cost, lead time and quality. In the second step of the FMEA development, the team brainstormed and generated a detailed list of potential risks. The detailed risks were grouped under the risk categories established in step one.
20
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The risk with the next highest RPN was “component will not fit with mating parts—requiring rework.” Its RPN was 40. The new vendor would be producing many different fixture components that would have to connect to components made by other vendors. There was a concern that components from two different vendors would have dimensional discrepancies resulting in a poor fit. With this quantified risk assessment, RSSF’s management team implemented mitigation efforts. A small product/process development team was established to ensure smooth operations with the new vendor. This three-person team made several trips to the vendor’s location in Asia. Focus was on the development of a system to manage business transactions, such as communication of orders, schedules, payments, returns and repairs. Additionally, the representatives from RSSF and the new vendor met to establish clear product specifications. Samples from RadioShack’s existing product stock were sent to the new vendor to verify fit conformity. In some cases, the mating parts that were not to be produced by the vendor were sent to ensure proper fit. Prototypes were produced and sent to RSSF’s warehouse for thorough evaluation before the vendor was allowed to begin production. These proactive risk mitigation efforts resulted in a smooth supply chain relationship. Without the FMEA based outsourcing risk assessment tool, unforeseen problems might have impacted the overall success of the global outsourcing efforts.
REFERENCES
Future of the Analysis Tool
Decision makers considering outsourcing options should use the FMEA based outsourcing risk assessment technique. The technique is easily implemented and understood. Further research should be undertaken to verify the risk assessment results with actual shortcomings and failures of various outsourcing options. This can be done through a comprehensive study of companies undertaking outsourcing programs.
1. J.K. Liker and T.Y. Choi, “Building Deep Supplier Relationships,” Harvard Business Review, Vol. 82, No. 12, pp. 104-113. 2. T.J. Rodgers, “The Truth About Outsourcing,” IEEE Design and Test of Computers, Vol. 22, No. 1, pp. 12-13. 3. H.L. Lee, “The Triple A Supply Chain,” Harvard Business Review, Vol. 82, No. 10, pp. 102-112. 4. R.E. Slone, “Leading a Supply Chain Turnaround,” Harvard Business Review, Vol. 82, No. 10, pp. 114-121. 5. P.J. Singh, A. Smith and A.S. Sohal, “Strategic Supply Chain Management Issues in the Automotive Industry: An Australian Perspective,” International Journal of Production Research, Vol. 43, No. 16, pp. 3,375-3,399. 6. Mohammed H.A. Tafti, “Risk Factors Associated with Offshore IT Outsourcing,” Industrial Management & Data Systems, Vol. 105, No. 5, 2005, pp. 549-560. 7. Lee, “The Triple A Supply Chain,” Harvard Business Review, see reference 3. 8. Brad Stone, “Should I Stay or Should I Go?” Newsweek, April 19, 2004, pp. 52-53. 9. Roshan R. Pai, Venkata R. Kallepalli, Reggie J. Caudill and MengChu Zhou, “Methods Toward Supply Chain Risk Analysis,” Proceedings of the IEEE International Conference on Systems, Man and Cybernetics, Vol. 5, 2003, pp. 4,560-4,565. 10. John A. Walewski, Edward G. Gibson and Vines F. Ellworth, “Improving International Capital Project Risk Analysis and Management,” Proceedings of Project Management Institute Research Conference, July 2002. 11. Thomas A. Carbone and Donald D. Tippett, “Project Risk Management Using the Project Risk FMEA,” Engineering Management Journal, Vol. 16, No. 4, pp. 28-35. 12. Anand Pillay and Jin Wang, “Modified Failure Mode and Effects Analysis Using Approximate Reasoning,” Reliability Engineering & System Safety, Vol. 79, No. 1, pp. 69-85. 13. D.H. Stamatis, Failure Mode Effect Analysis—FMEA From Theory to Execution, ASQ Quality Press, 1995. 14. G.Q. Huang, J. Shi and K.L. Mak, “Failure Mode Effect Analysis Over the WWW,” International Journal of Advanced Manufacturing Technology, Vol. 16, 2000, pp. 603-608.
CLIFF WELBORN is an assistant
professor at Middle Tennessee State University in Murfreesboro. He earned a doctorate in industrial engineering from the University of Texas at Arlington.
QUALITY PROGRESS
I AUGUST 2007 I 21
