CHAPTER 11

QUALITY COST AND

PRODUCTIVITY : MEASUREMENT,
REPORTING, AND CONTROL
 OBJECTIVE
1. Identify and describe the four types of quality costs.
2. Prepare a quality cost report and explain the
difference between the conventional view of
acceptable quality level and the view espoused by
total quality control.
3. Tell why quality cost information is needed and how
it is used.
4. Explain what productivity is, and calculate the
impact of productive changes on profits.
 QUALITY DEFINED
A quality product or service is one that
meets or exceeds customer expectations.

8 dimensions of quality
1. Performance : How consistently and well
a product functions
2. Aesthetics : The appearance of tangible
products (style, beauty)
3. Serviceability : Measures the ease of
maintaining and/or repairing the product
4. Features : Characteristics of a product that
differentiate functionally similar products
5. Reliability : The probability that the
product or service will perform its intended
function for a specified length of time
6. Durability : The length of time a product
functions
7. Quality of conformance : A measure of how
a product meets its specifications
8. Fitness for use : The suitability of the
product for carrying out its advertised functions
A defective product is one that does
not conform to specifications.
Zero defects means that all
products conform to
specifications.

Cost Of Quality
Control Cost
Failure activities

Four categories of quality costs:

1. Preventive costs : Incurred to prevent poor quality or services
being produced
2. Appraisal costs : Incurred to determine whether products and
services conform to requirements
3. Internal failure costs : Incurred when products and services
do not conform to specifications
4. External failure costs : Incurred when products and services
fail to conform to requirements after being delivered
MEASURING QUALITY COSTS
Observable Quality cost : fees that
can be obtained in the accounting
records
Hidden Quality Costs : opportunity
costs resulting from poor quality.

THE MULTIPLIER METHOD

THE MARKET RESEARCH METHOD
TAGUCHI QUALITY LOSS FUNCTION
 THE MULTIPLIER METHOD
The Multiplier Method Assumes That The Total Failure Cost
Is Simply Some Multiple Of Measured Failure Costs:

Total External Failure Cost = K (measured External

Failure Costs)

Where K Is The Multiplier Effect

If K = 4, And The Measured External Failure Costs Are
$2 Million, Then The Actual External Failure Costs Are
Estimated To Be $8 Million.
THE MARKET RESEARCH METHOD
The market research method uses formal market research
methods to assess the effect of poor quality on sales and market
share.
Customer surveys and interviews with members of a
companys sales force can provide significant insight into
the magnitude of a companys hidden costs.
Market research results can be used to project future
profit losses attributable to poor quality.
THE TAGUCHI QUALITY LOSS FUNCTION
The taguchi loss function assumes any variation
from the target value of a quality characteristic
causes hidden quality costs.
Furthermore, the hidden quality costs
increase quadratically as the actual value
deviates from the target value.
The Taguchi Quality Loss Function
$
Cost

Lower Target Upper

Specification Value Specification
Limit Limit
The Taguchi Quality Loss Function
L(y) = k(y T)
k = A proportionately constant dependent
upon the organizations external failure
cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss
 Quality Cost Report
Unit Actual Diameter (y) y-T (y T) k(y-T)
1 9.9 -0.10 0.010 $ 4.00
2 10.1 0.10 0.010 4.00
3 10.2 0.20 0.040 16.00
4 9.8 -0.20 0.040 16.00
Total 0.100 $40.00
Average 0.025 $10.00
 Image Products
Quality Cost Report
For the Year Ended March 31, 2004
Quality Costs % of Sales
Prevention costs:
Quality training $35,000
Reliability engineering 80,000 $115,000 4.11%
Appraisal costs:
Materials inspection $20,000
Product acceptance 10,000
Process acceptance 38,000 68,000 2.43
Internal failure costs:
Scrap $50,000
Rework 35,000 85,000 3.04
External failure costs:
Customer complaints $25,000
Warranty 25,000
Repair 15,000 65,000 2.32
Total quality costs $333,000 11.90%
RELATIVE DISTRIBUTION OF QUALITY
COSTS External
Failure Prevention
(19.5%) (34.5%)

Internal Appraisal
Failure (20.4%)
(25.6%)
QUALITY COST GRAPH
Total
Cost Quality
Costs Failure Costs

Control Costs
0
AOL 100%

Percent Defects
CONTEMPORARY QUALITY COST GRAPH

Cost Total
Quality
Costs Failure Costs

Control Costs

0 100
%
Percent Defects
TREND ANALYSIS

Quality Costs Actual Sales % of Sales

2000 $440,000 $2,200,000 20.0%
2001 423,000 2,350,000 18.0
2002 412,500 2,750,000 15.0
2003 392,000 2,800,000 14.0
2004 280,000 2,800,000 10.0
MULTIPLE-PERIOD TREND GRAPH:
TOTAL QUALITY COSTS
% of
Sales

20

15

10

0 1 2 3 4 5
Year
MULTIPLE-TREND ANALYSIS FOR
INDIVIDUAL QUALITY COSTS
Internal External
Prevention Appraisal Failure Failure

2000 2.0%1 2.0% 6.0% 10.0 %

2001 3.0 2.4 4.0 8.6
2002 3.0 3.0 3.0 6.0
2003 4.0 3.0 2,5 4.5
2004 4.1 2.4 2.0 1.5
1Expressed as a % of sales
 Multiple-Period Trend Graphic:
Individual Quality Cost Categories
Percentage 10
of Sales
9
8
7
6
5
4 Prevention
3
2 Appraisal
Internal failure
1 External failure
0
0 1 2 3 4 Year
PRODUCTIVITY:
MEASUREMENT AND CONTROL

Productivity is concerned with producing

output efficiently, and is it specifically
addresses the relationship of output and the
inputs used to produce the outputs.
Productivity: Measurement
and Control
Total productive efficiency is the point at
which two conditions are satisfied:
1. for any mix of inputs that will produce
a given output, no more of any one
input is used than necessary to produce
the output
2. given the mixes that satisfy the first
condition, the least costly mix is
chosen.
 TECHNICAL EFFICIENCY
Technical efficiency is the condition where no more of any one
input is used than necessary to produce a given output.
Technical efficiency improvement is when less inputs are used
to produce the same output or more output are produced using
the same input.
Current productivity
Inputs Outputs:
:Labor
Capital
4 6
Same Output, Fewer Inputs
Inputs: Outputs:
Labor

Capital
3 6
More Output, Same Inputs
Outputs:
Inputs
:Labor
Capital
4 8
More Output, Fewer Inputs
Inputs: Outputs:
Labor
3 8
Capital

Technically Efficient Combination I:

Inputs: Outputs:
Labor 3
Capital
$20,000,000
8
Technically Efficient Combination II:

Inputs: Outputs:

Labor
2 8
Capital
$25,000,000

Of the two combinations that produce the same output,

the least costly combination would be chosen.
 Partial Productivity Measurement

Partial productivity measurement: measuring productivity

for one input at a time.
Partial measure = output/input
Operational productivity measure: partial measure where
both input and output are expressed in physical terms.
Financial productivity measure: partial measure where both
input and output are expressed in dollars.
Profile measurement provides
a series or a vector of separate
and distinct partial operational
measures.
 PROFILE PRODUCTIVITY MEASURES
Example 1
The productivity of both labor labor and materials moves in the same
direction:

2003 2004
Number of motors produced 120,000 150,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,428,571
Partial Productivity Ratios
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.105
 Profile Productivity Measures
Example 2:
Assume the same data as Example 1 except the material
used is 1,700,000 pounds.
2003 2004
Number of motors produced 120,000 150,000
Labor hours used 40,000 37,500
Materials used (lbs.) 1,200,000 1,700,000
Partial Productivity Ratios
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.088
 PROFIT-LINKED PRODUCTIVITY
MEASUREMENT
Profit-linkage rule: for the current period, calculate the cost of the inputs that
would have been used in the absence of any productivity change, and compare
this cost with the cost of the inputs actually used. The difference in costs is the
amount by which profits changed because of productivity changes.

To compute the inputs that would have been used

(PQ), use the following formula:
PQ = Current Output/Base-Period Productivity Ratio
 PROFIT-LINKED
PRODUCTIVITY
MEASUREMENT

2003 2004
NUMBER OF MOTORS PRODUCED 120,000 150,000
LABOR HOURS USED 40,000 37,500
MATERIALS USED (LBS.) 1,200,000 1,700,000
UNIT SELLING PRICE (MOTORS) $50 $48
WAGES PER LABOR HOUR $11 $12
COST PER POUND OF MATERIAL $2 $3
 Profit-Linked Productivity
Measurement
PQ (labor) = 150,000/3 = 50,000 hrs.
PQ (materials) = 150,000/0.100 = 1,500,000 lbs.
Cost of labor: (50,000 x $12) $ 600,000
Cost of materials: (1,500,000 x $3) 4,500,000
Total PQ cost $5,100,000
The actual cost of inputs:

Cost of labor: (37,500 x $12) $ 450,000

Cost of materials: (1,700,000 x $3) 5,100,000
Total current cost $5,550,000
 Profit-Linked Productivity
Measurement
Profit-linked effect = Total PQ cost - Total current cost
= $5,100,000 $5,550,000
= $450,000 decrease in profits

The net effect of the process change was

unfavorable. Profits declined $450,000
because of productivity changes.
 PRICE-RECOVERY COMPONENT
THE DIFFERENCE BETWEEN THE TOTAL PROFIT CHANGE AND THE PROFIT-LINKED
PRODUCTIVITY CHANGE IS CALLED THE PRICE-RECOVERY COMPONENT.

2004 2003 Difference

Revenues $7,200,000 $6,000,000 $ 1,200,000
Cost of inputs 5,550,000 2,840,000 2,710,000
Profit $1,650,000 $3,160,000 $-1,510,000

Price recovery = Profit change Profit-linked productivity change

= $1,510,000 $450,000
= $1,060,000