COST OF QUALITY

Muhammad Fahmy
Quality Manager
1
 C ONT ENT S

1. Definition- Cost of Quality! 10. Benefits of minimizing COQ.

2. History 11. Guidelines
3. What is COST OF QUALITY? 12. Steps in implementing Quality Costs
4. Categories of Quality Costs 13. Gaining Approval
5. Cost of Poor Quality(COPQ) 14. Case Study : H&S Motors
6. Impact of TQM on COQ 15. Relationship
7. Effects of identifying COQ. 16. Investing in Prevention costs.
8. Goal of COQ system 17. Concluson
9. Why measure COQ? 18. Bibliography
 DEFIN ITION

• The term “QUALITY COSTS” has different meanings to differen

people.

• Some equate “QUALITY COSTS” with the costs of poor quality (mainly the costs of
finding and correcting defective work).
• Others equate the term with the costs to attain quality.
• Still others use the term to mean the costs of running the Quality department.
HISTOR Y

• It was Joseph Juran who first discussed the cost of quality analysis in
1951 in the first edition of “Quality Control Handbook”

• And it was Armand Feigenbaum who identified

four quality cost categories in 1956 in “Total
Quality Control” in the Harvard Business Review,
Vol. 34
• The Quality Cost Committee was established by the then ASQC in
1961.
 WHAT IS COST OF QUALITY?

• It is the term that is widely used and widely misunderstood.

• The "cost of quality" is not the price of creating a quality product or
service.

• It's the cost of NOT creating a quality product or service.

 WHAT IS COST OF QUALITY?

Every time work is redone, the cost of quality increases.

Examples include:
• The reworking of a manufactured item.
• The retesting of an assembly.
• The rebuilding of a tool.
• The correction of a bank statement.
• The reworking of a service, such as the reprocessing of a loan operation or the replacement of
a food order in a restaurant
 WHAT IS COST OF QUALITY?

Cost of quality = Cost of conformance + Cost of non-conformance

• Cost of conformance is the cost incurred in ensuring that things are done right
the first time.
• It is the cost of providing products or services as per the required standards.
• This can be termed as good amount spent. (Prevention & Appraisal costs)

• Cost of non-conformance is cost incurred as a result of not doing things right

the first time.
• It is the failure cost associated with a process not being operated to the
requirements.
• This can be termed as unnecessary amount spent.( Internal & External failure
costs)
 C A T E G O R I E S O F QUALITY C O S T S

Quality Costs

COST OF COST OF NON-

CONFORMANCE CONFORMANCE

PREVENTIO APPRAISAL INTERNAL EXTERNAL

N COSTS COSTS FAILURE FAILURE
COSTS COSTS
 PREVENTION C O S T S
• Prevention costs are associated with design, implementation , maintenance, and planning prior to
actual operation, in order to avoid defects from happening.

• The emphasis is on the prevention of defects in order to reduce the probability of producing
defective products.

• Prevention activities lead to reduction of appraisal costs and both type of failures ( internal and
external ).

• The motto is “Prevention rather than appraisal” .

 In the ideal situation, Prevention costs will be the

largest portion of the Total Cost of Quality

 Typically, prevention is less than 10% of Total COQ

where it should be about 70%
 ACTIVITIES AS S O CIATED WITH PREVENTION C O S T S

• Market Research
• Quality planning : It includes the cost associated with creating the entire quality plan , communication of quality
plans to all the employees.

• New product review :Cost of reliability and other quality related activities associated to launching new designs.

• Tolerance analysis before design release.

THESE ARE ALLPLANNED
• Field Trials PROACTIVE ACTIVITIES.
• Cost of research and development activities , analysis and correction of causes and defects.

• Cost of training : It consists of either training the workers , supervisors and managers .Cost involved in
arranging training programs, attending technical exhibitions , seminars and conferences etc.
• Quality audits : Cost involved in evaluating the execution of activities in overall quality plans involved in the
organization.

• Cost involved in prevention of defects ,it may be technical or non-technical.

“Intellectuals solve problems.
Geniuses prevent them. ”
-- Albert Einstein
 APPRAISAL C O S T S

• Appraisal costs are spent to detect defects to assure conformance to quality standards.
• It is the cost expenditure on inspection and testing.
• Appraisal cost activities sums up to the “cost of checking if things are correct”.
• The appraisal costs are focused on the discovery of defects rather than prevention of defects

Appraisal Costs should be the second

largest category, but should not exceed
prevention costs
ACTIVITIES ASSOC IAT E D WITH APPRAISAL
COSTS

• Inspection/test of purchased material

• In-process and final inspection/test
THESE AREALL
• Product, process or service audits
PLANNED ACTIVITIES
• Calibration of measuring and test equipment
• Maintaining accuracy of testing equipment, performed in
terms of periodic calibration.
• Cost of non-destructive testing such as electric probes, X
rays, radiography etc.
 INTERNAL FAILUR E C O S T S

• These are the failure costs occurring prior to delivery or shipment of the product, or the
furnishing of a service, to the customer.

• These are the costs that would disappear if no defect is found in the product beforedispatching.
 ACTIVITIES ASSOC IAT E D WITH INTERNAL
FAILURE C O S T S

• Cost of rework , scrap , defectives , waste etc.

• Cost of re-inspection , re-tests to verify the performance analysis.
• Cost of 100% inspection.
• Changing processes: Modifying manufacturing or service processes to correct deficiencies
• Lost production due to supplier materials and own material.
 E X T E R N A L FAILU R E C O S T S

• These are the costs incurred after the product is dispatched to the consumer.
• It may include the cost to the business of providing a bad service or product and this may also result
into cancellation of order.

• These costs also would disappear if there were no deficiencies.

 ACTIVITIES A S S O C IATED WITH EXTERNAL
FAILURE C O S T S

• Warranty charges
• Complaint adjustment : Costs of investigation and adjustment of
justified complaints attributed to defective product or installation.
• Returned material : Costs associated with receipt and replacement of
defective product received from the field.

• Recalling of the product,due some reasons such as safety,health

,accidents etc.
• Allowances : The costs of concessions made to customers due to
substandard products accepted by the customer as is or to conforming
product that does not meet customer needs.
 Quality costs

COST OF COST OF NON-

CONFORMANCE CONFORMANCE

PREVENTIO APPRAISAL INTERNAL EXTERNAL

N COSTS COSTS FAILURE FAILURE
COSTS COSTS
 C O S T O F POOR QUALITY (COPQ)

 “How much is it costing our organization by

not doing a good job on quality?” Thus we
will use the term “cost of poor quality.”

 The obvious and visible costs are a small

portion of the overall COPQ. The bottom
of the iceberg represents the majority of
the COPQ and are not easily identified
and quantified.

By revealing new hidden costs of poor quality,

a company can prevent the production of a
nonconforming product.
 IMPACT O F TQM ON C O S T S

• TQM is primarily aimed to improve the quality of the product , higher customer satisfaction and
better working environment for the employees. The most dramatic impact of TQM is on
reduction of quality costs which directly effect the profitability .

• This is demonstrated by the results of TQM program in Xerox Corp . The change in various
elements of quality cost before and after launching TQM by Xerox Corp is shown on the next
slide.
 IMPACT O F TQM ON C O S T S .

35 An example from Xerox Corp.

30

25 Internal
% of sales

Failure
20

15 Internal
Failure
Appraisal
10
Appraisal
5
Prevention
prevention
0
Before Quality After Quality
E F F E C T S O F IDENTIFYING C O Q
 GOAL O F C O Q S YST E M

The goal of using COQ is to increase prevention activities in order to eliminate internal and external
failures and to reduce appraisal activities.
 WHY M E A S U R E C O Q ?

“When you measure what you are speaking about and express it
in numbers, you know something about it”

You cannot manage what you cannot measure

 WHY M E AS U R E C O Q ?

• Measure COQ - Why?

 COQ can be used to identify quality improvement candidates

 COQ provides one measure of comparing the success of projects
 COQ can provide cost data for motivational purpose

 Money is the language of management, you need to show them the numbers
- Crosby
 B ENEFIT S O F MINIMIZING C O Q …

Decreases Increases
• Defects • Sales
• Overall Costs • Profit
• Returned Goods • Capacity
• Customer Complaints • Customer Satisfaction
• Owner & Mgmt. Stress • Market Share
• Decrease Legal Costs • Competitive Edge
• Employee Satisfaction
 M E ASURING C O S T O F QUALITY…

COQ data can be measured and presented in many different ways.

• % age of sales
• % age of profits
• % age of manufacturing cost
• Rs per direct labor hr
• Rs per unit of product
 STEPS IN IMPLEMENTING QUALITY
COSTS
The following sequence applies to most organizations -

• 1. Review the literature on quality costs or consult others in similar industries who are using the
same tool.
• 2. Select one organizational unit of the company to serve as a pilot site. This unit may be one plant,
one large department, one product line, etc.
• 3. Discuss the objectives of the study with the key people in the organization.

• 4. Collect whatever cost data are conveniently available from the accounting system and use this
information to gain management support to make a full cost study.

• 5. Make a proposal to management for a full study. The proposal should provide for a task force of
all concerned parties to identify the work activities that contribute to the cost of poor quality.
Work records, job descriptions, flowcharts, interviews, and brainstorming can be used to identify
the activities.
 STEPS IN IMPLEMENTING QUALITY
COSTS (CONTD.)
• 6. Publish a draft of the categories defining the cost of poor quality.
• 7. Finalize the definitions and secure management approval.
• 8. Secure agreement on responsibility for data collection and report preparation.
• 9. Collect and summarize the data. Ideally, this should be done byAccounting.
• 10. Present the cost results to management along with the results of a demonstration quality
improvement project (if available). Request authorization to proceed with a broader companywide
program of measuring the costs and pursuing projects.

Clearly, the sequence must be tailored for each organization.

 GAINING APPROVAL…

• Establish that the costs are large enough to justify action.

- Use the grand total to demonstrate the need for quality improvement. This is the most
significant figure in a quality cost study.

- Relate the grand total to business measures.

• Estimate the savings and other benefits.

- If the company has never before undertaken an organized program to reduce quality-
related costs, then a reasonable goal is to cut these costs in two, within a space of 5
years.
- Don’t imply that the quality costs can be reduced to zero.
 GAINING APPROVAL( CONTD. )

• Calculate the return on investment resulting from improvement in quality.

• Use a successful case history (a “bellwether” project) of quality improvement in the company to
justify a broader program.

• Identify the initial specific improvement projects.

• Propose the structure of the improvement program including organization,problem

selection,training, review of progress, and schedule
 CASE STUDY: H&S MOTORS
• The H&S motor company produces small motors for use in lawnmowers and garden equipment.
The company instituted a quality improvement program in 1999 and has recorded the following
quality cost data and accounting measures for 4 years.

The company wants to assess its quality assurance program and develop quality index using sales
basis for the 4 year period.
 KEY POINTS OF STUDY:
• Approximately 75% of the H&S’s total quality costs are a result of internal and external failures.
• In 2000 company spent more money on product monitoring and inspection that resulted into high
appraisal cost.
• With this strategy, H&S was able to identify more defective items, resulting in an apparent
increase in internal failure cost and lower external failure cost.
• In year 2001 & 2002 company spent more money on prevention activities i.e. training of
employees, redesigning the production process and planning how to build in product quality etc.
• Prevention costs increased by more than 300 % during the 4 year period resulted into decrease
in overall quality costs.
The H&S company also desired to develop index numbers using quality costs as a proportion of
sales.

Quality index no. for 1999 sales is:

= (810,400/4,360,000)*100 = 18.58 and similarly for other years:

These index no's alone provide little insight into the effectiveness of the quality management
program; however as a standard to make comparisons over time they can be useful.
RELATIONSHIP BETWEEN
PREVENTION+APPRAISAL
AND FAILURE C O S T S
 INVESTING IN P R EVENTION C O S T S . .

• Richard W. Anderson, former general manager of the computers systems division of Hewlett-
Packard, expresses this point in his widely cited quote explaining the damage caused by a two-
cent resistor:
• If you catch the resistor before it is used and throw it away, you lose two cents. If you don’t
catch it until it has to be soldered into a computer component, it may cost $100 to repair the part.
If you don’t catch the component until it is in a computer user’s hands, the repair cost will
amount to hundreds of dollars and may exceed the manufacturing costs.

By eliminating a defective product in the early stages of production, a company can greatly
reduce its cost of poor quality. Investing in prevention costs, therefore, is extremely important.
 C O N C LU SI O N …

Is Cost related to Prevention YES

of Non- Conformance? PREVENTION

NO
Is Cost related to
Evaluating the YES APPRAISAL
Conformance ?

NO INTERNAL FAILURE
Is Non-Conformance
Is Cost related to
YES found prior to
Non-conformance?
Shipment ?
YES
NO
NO
Not a QualityCost

EXTERNAL FAILURE
 C ONC LUSION

• The cost of poor quality can be reported in an endless number of ways.

• It can take a variety of different forms.
• It can represent 10% of a company’s annual sales, or it can represent 40%,
depending on how far they “peel the onion”.
 C ONC LUSION

• However, once quality costs are presented in the language of money,

misunderstandings evaporate and executives immediately realize the true significance
of the cost of poor quality.

• “Quality costs are dynamic and constantly changing over time.”

COST OF QUALITY