POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

Taguig Branch
General Santos Ave., Lower Bicutan, Taguig City

QUALITY COSTS
Written Report

In partial fulfilment of the Requirements for the Degree of Business Administration Major in
Marketing Management

Presented to the faculty of

College of Business

Presented by:
Javellana, Mary Anne
Napa, Mary Glein
Roquero, John Vincent
Tubio, Michaella Danica
BSBA-MM-2-1

Submitted to:
Dr. Danilo A. Valenzuela
Subject Professor
 Cost of Quality
Costs of quality or quality costs does not mean the use of expensive or very highly quality
materials to manufacture a product. The term refers to the costs that are incurred to prevent,
detect and remove defects from products. Quality costs are categorized into four main types.
These are:

1. Prevention costs

2. Appraisal costs

3. Internal failure costs and

4. External failure costs.

These four types of quality costs are briefly explained below:

Prevention costs:

It is much better to prevent defects rather than finding and removing them from products. The
costs incurred to avoid or minimize the number of defects at first place are known as
prevention costs. Some examples of prevention costs are improvement of manufacturing
processes, workers training, quality engineering, statistical process control etc.

Appraisal costs:

Appraisal costs (also known as inspection costs) are those cost that are incurred to identify
defective products before they are shipped to customers. All costs associated with the activities
that are performed during manufacturing processes to ensure required quality standards are
also included in this category. Identification of defective products involve the maintaining a
team of inspectors. It may be very costly for some organizations.
Internal failure costs:

Internal failure costs are those costs that are incurred to remove defects from the products
before shipping them to customers. Examples of internal failure costs include cost of rework,
rejected products, scrap etc.

External failure costs:

If defective products have been shipped to customers, external failure costs arise. External
failure costs include warranties, replacements, lost sales because of bad reputation, payment
for damages arising from the use of defective products etc. The shipment of defective products
can dissatisfy customers, damage goodwill and reduce sales and profits.

More examples of quality costs

Examples of prevention cost:

 System development

 Quality engineering

 Quality training

 Quality circles

 Statistical process control

 Supervision of prevention

 Quality improvement projects

 Technical support to suppliers

 Quality data gathering, analysis and reporting

 Audit of the quality system

Examples of appraisal cost

 Test and inspection of incoming materials

 Final product testing and inspection

 Supplies used in testing and inspection

  Supervision of testing and inspecting activities

 Depreciation of test equipment

 Maintenance of test equipment

 Plant utilities in inspection area

 Field testing and appraisal at customer site

Examples of internal failure cost

 Net cost of scrap

 Net cost of spoilage

 Rework labor and overhead

 Re-inspection of reworked products

 Disposal of defective products

 Down time caused by quality problems

 Analysis of the cause of defects in the production

 Retesting of reworked products

 Re-entering data because of keying

 Debugging software errors

Examples of external failure cost

 Cost of field servicing and handling complaints

 Warranty repairs and replacement costs

 Liability arising from defective products

 Lost sales arising from a reputation of poor quality

 Returns and allowances arising from quality problems

 Product recalls

 Repairs and replacements beyond the warranty period

Failure Costs

Failure costs are those incurred by a manufacturer when it produces defective goods.

Failure costs can be either internal or external. Internal failure costs and external failure costs

that impair the goodwill of the company occur due to a poor quality so these costs are also

known as costs of poor quality by some people.

Classification of Failure Costs:

1. Internal Failure Costs

Internal failure costs are costs that are caused by products or services do not meet the

requirements of customer or user needs and are found before delivery of products and services

to external customers. They would have otherwise led to the customer not being satisfied.

Deficiencies are caused both by errors in products and inefficiencies in processes. They could

include:

 Waste: Performance of unnecessary work or holding of stock as a result of errors, poor

organization, or communication.

 Scrap: Defective product or material that cannot be repaired, used, or sold.

 Rework or rectification: Correction of defective material or errors.

 Failure analysis: Activity required to establish the causes of internal product or service

failure.
  The more effective a company’s appraisal activities the greater the chance of catching

defects internally and the greater the level of internal failure costs. This is the price that

is paid to avoid incurring external failure costs, which can be devastating.

2. External Failure Costs

External failure costs are costs that are caused by deficiencies found after delivery of

products and services to external customers, which lead to customer dissatisfaction. Examples

include the costs for:

 Repairs and servicing: Of both returned products and those in the field.

 Warranty claims: Failed products that are replaced or services that are re-performed

under a guarantee.

 Complaints: All work and costs associated with handling and servicing customers’

complaints.

 Returns: Handling and investigation of rejected or recalled products, including transport

costs.

In the past, some managers have taken the attitude, “Let’s go ahead and ship everything to

customers, and we’ll take care of any problems under the warranty.” This attitude generally

results in high external failure costs, customer ill will, and declining market share and profits.

External failure costs usually give rise to another intangible cost. These intangible costs are

hidden costs that involve the company’s image. They can be three or four times greater than

tangible costs. Missing a deadline or other quality problems can be intangible costs of quality.
 Juran’s Model of Optimum Quality Cost

Joseph M. Juran

The traditional economic model of quality of conformance graph, proposed by J. M. Juran in

1962, demonstrates how the cost of producing your product drops when a quality assurance

program begins, only to swing back up as the cost of the quality assurance program increases. A

dotted vertical line at the point where the cost of quality assurance intersects with the cost of

noncompliance represents the optimum level of quality. This line continues straight up passing

through the total cost curve, where it marks the optimal cost of producing your product. At this

intersection, you have invested just enough in quality assurance, but not so much to increase

the total cost.

Total Cost Curve

Starting at the top of the traditional economic model of quality of conformance, we find the

total cost curve. It represents the cost of producing your product. This curve, much like a

smiley-face, dips as you institute and experience the new costs of a quality assurance program

and then swings back up as the costs of quality assurance continue a climb higher than would

be considered optimal.

Costs Due to Nonconformance Curve

The cost of nonconformance curve represents the costs or inherent losses associated with

not having a quality assurance program. These costs are highest at first, demonstrating the high

cost of not conforming to a quality assurance program. Then, as you move to the right, the

curve drops steadily, representing the costs dropping as you institute a quality assurance

program in the production process. The curve showing the drop in quality assurance, therefore,

swings from high (no quality assurance program = costs to the business) to low (fewer to no

costs with a quality assurance program).

Cost of Quality Assurance Curve

The cost of quality assurance curve, also on the traditional economic model of quality of

conformance, swings from low to high. It represents the cost increases you incur as spending on

quality assurance increases. It starts with low or no costs with no quality assurance program
and rises to reflect the increasing costs of the quality control program. Because it is the

opposite trajectory of the costs due to nonconformance curve, these two curves intersect

forming an important juncture.

Optimum Level of Quality Line

The optimum level of quality for a business falls precisely at the point where the two curves,

cost of quality assurance and the cost of nonconformance, intersect. Draw a vertical line on the

traditional economic model of quality of conformance graph that passes through the

intersection of the two curves -- cost of quality assurance and the cost of nonconformance.

Note that the optimum level of quality line intersects the total cost curve at its lowest possible

point.

The goal of any quality cost system is to reduce quality costs to the lowest practical

level. Juran and Gryna (1988) present these costs graphically as shown in Fig. 8.3. In the figure it

can be seen that the cost of failure declines as conformance quality levels improve toward

perfection, while the cost of appraisal plus prevention increases. There is some “optimum”

target quality level where the sum of prevention, appraisal, and failure costs is at a minimum.

Efforts to improve quality to better than the optimum level will result in increasing the total

quality costs.

The quality cost conformance model provides an example of a constrained optimization

approach. In this model the economic conformance level (ECL) is obtained where prevention
and appraisal costs are equal to external and internal failure costs. Prevention and appraisal

costs increase as the level of conformance quality increases. Conformance quality refers to

conformance to specifications as opposed to design quality, i.e., service functions or features.

Failure costs are expected to decrease as the level of conformance quality increases. Therefore,

the total costs associated with conformance quality will be U-shaped as indicated in the exhibit

below. Prevention costs include quality engineering, training and related supervision costs.

Appraisal costs include inspection, testing and supervision related to these activities. Internal

failure costs include spoilage, scrap, rework and the associated downtime costs, while external

failure costs include warranty costs and the costs of lost customers.

Reduce Costs

Costs Reduction is the process used by companies to reduce their costs and increase

their profits. Depending on a company’s services or product, the strategies can vary. Every

decision in the product development process affects cost. Companies typically launch a new

product without focusing too much on cost. Cost becomes more important when competition

increases and price becomes a differentiator in the market.

Key Strategies to Reduce the Cost of Poor Quality

Emphasizing that quality is neither intangible nor unmeasurable, Philip Crosby, in his

book “Quality is Free”, maintained that quality is a strategic imperative that can be quantified

and used to improve the bottom line. For most organizations quality has always been difficult

to measure, primarily because there are several factors contributing to poor quality that may or

may not be related to each other. Difficulty in value control also contributes to the loss of
millions of money each year. However, this Cost of Poor Quality (CoPQ) is not unbeatable. An

organization’s CoPQ can be reduced by identifying the different areas in which there are

potential wastes, failures, and additional costs. CoPQ typically falls into four categories: internal

failure costs, external failure costs, appraisal costs, and prevention costs. Measuring quality is

measuring the requirements to get the job done right the first time out. It requires the

management to have an agenda, communicating it clearly with defined goals and

measurements. There are strategies that can help reduce the cost of poor quality:

1. Clear Product and Process Traceability

One way to cut down your costs of poor quality is to improve the visibility into your product

quality, as well as the processes involved in manufacturing and distributing your product.

Without good traceability in products and processes, organizations are more susceptible to

product delays, defects, and recalls, and process breaches. Additionally, ensuring clear product

and process traceability helps you shorten the time to track down root causes and identify the

stage at which the defect was caused. Organizations have implemented automated tools for

gaining insight in the different stages of their internal and distributor processes, as well as

mapping all their processes from manufacturing to distribution to different stages of a product

life cycle. Company can view and access specifics of manufacturing site, production time,

inventory, labeling and packaging, and information related to shipment with readily available

reports for better insight.

 2. Periodic Internal Quality Audit

Internal quality audit is essential for organizations in goods or processes to keep a tab on

un-conformities, if any. It helps to note any gaps in or deviations from quality requirements that

can be mitigated as soon as possible from origin. If quality issues go unnoticed, the CoPQ of the

company may increase, and it may snowball into a tragedy in the long run, impacting the

bottom line. The best way to address this is to implement a quality audit solution that facilitates

a federated approach to managing various types of internal quality audits such as factory

audits, process audits, facility audits, and health & safety audits, which helps boost operational

excellence and ensure compliance with industry quality standards. It would also enable quality

audit processes from audit planning and scheduling to audit execution and issue management

to be fully managed.

3. Aggregated Customer Complaints and Timely Return Management

When it comes to customers, their satisfaction of product is what will keep organization

growing. Ensuring that they are happy is often a tricky business. To stay on top of things, it is

essential to keep track of all customer complaints, analyze them, and provide prompt remedial

responses. There is a lot of learning an organization can take away from assessing the nature

and frequency of the complaints they receive, and make decisions based on the actions taken

for similar complaints in the past. An efficient complaints management tool should be able to

help analyze the complaint, mapping it to corresponding risks, policies, and even compliance

activities. It will also provide with the analytics and business intelligence you need to carry
further investigations, notify relevant personal, and track remedial actions. Capturing and

managing all the complaints from various sources will help organizations be aware of arising

issues and implement corrective and preventive measures.

4. Effective Training for Employees and Suppliers

Maintaining and nurturing the knowledge-base of employees and suppliers is one of the

crucial elements of taking a step toward reducing CoPQ. All personnel need to be up to speed

with policies, SOPs, regulations, and other relevant quality metrics, so that violations are kept

at bay. By providing periodic training sessions, tests, and awareness programs for the

employees and suppliers, you can ensure all of the components of the business ecosystem are

on the same page, moving toward achieving a unified objective. With an introduction of any

new policy or guideline, a training management program can trigger notifications to

appropriate stakeholders to complete relevant training courses and also provide a training

guide. A streamlined training process helps reduce risks and non-compliance gaps. Company

can also test the effectiveness of the training program through tests and questionnaires, and

any gaps can be bridged with additional training courses.

5. Electronic Records and Documentation Management

In order make sure that that employees and suppliers are up-to-date with relevant policies,

contracts, SOWs, SOPs, guidelines, regulations, and other such documents, company needs to

be able to store them in a centralized location with applicable access rights. This helps

employees and suppliers follow set processes and policies, reducing the likelihood of

nonconformity, product defects, and rework costs. A system that can scale with the
organization will allow to support policy management at a local, regional, and organizational

level. To reduce the CoPQ, company need to look at it from an overall organization perspective.

Addressing quality issues in a holistic and proactive way helps you identify the areas of concern

which may accrue to a high CoPQ. This approach not just aggregates all possible issues across

the length and breadth of the processes, but it also helps define preventive measures and maps

it to the end result. This enables to quickly assess what is going right or wrong and what

company can do about it, before it is too late.

Using of Cost of Quality for Improvement

A Quality Cost initiative reflects the ongoing quality development program of an

enterprise. A COQ plan converts the effects of quality issues into financial terms, recognizes

areas that need improvement, highlights the importance of mitigation measures and

monitoring tasks in the battle against possible deficiencies, and offers a way of tracking

progress.

When the Cost of Quality % starts dropping, improved financial performance and customer

satisfaction follow.

Reducing Cost of Quality % requires:

 Tracking performance,

 Using data to identify and prioritize improvement targets and,

 Tackling the source of problems.

Track performance
When tracking progress, the key if to look for trends. The overall trend of the Cost of Quality %

is important, not the absolute value.

 If the trend shows a steady reduction in Cost of Quality %, the absolute value will eventually

be acceptable.

 Early on, increases in Prevention activities and probably Appraisal tasks should lead to

corresponding reductions in both External Failures and Internal Failures.

 There is no standardized specific expected or acceptable rate of improvement. If the Cost of

Quality % trends down, the effort is likely on track. However, if the trend reverses and the

Cost of Quality % increases, something is amiss. Investigate and find out why.

 The Cost of Quality % will never reach zero. Even if a zero failure rate is achieved, Cost of

Quality includes appraisal and prevention activities. While zero is a realistic goal for both

Internal and External Failures, costs associated with some Appraisal tasks and, to a greater

degree, Prevention activities will continue.

Use data to identify and prioritize improvement targets

 Once a COQ effort is underway, numerous improvement opportunities will quickly become

apparent.

 A Pareto Chart can prioritize targets by identifying which ones have the greatest potential

payback.

Tackling the source of problems

When tackling a problem, it is crucial to get to the source; the root cause is the source. A

problem can be solved “for good” only when the root cause has been addressed.

 Mistake-proofing addresses the root cause.

 Strong mistake-proofing solutions (e.g. Forced Control Prevention solutions) prevent

problem recurrence.

 Even relatively “weak” mistake-proofing solutions (e.g. Sensory Alert Detection solutions)

will provide a proactive alert that the problem has resurfaced.

 Any mistake-proofing solution will lead to lasting reductions in COQ.

BUILD ON WHAT IS WORKING.

 When there is an opportunity to leverage a solution or breakthrough, it is like getting

unexpected compound interest on an earlier investment.

 If successes are publicized and celebrated, the exposure increases the probability that

someone else will find an application for its use.

REVISIT WHAT IS NOT WORKING.

 Perhaps more important than identifying successes that can be leveraged is finding process

steps, techniques or practices that are holding the organization back or in conflict with the

program.

 When a practice negates or cancels out part of the COQ effort, waste is generated that

actually adds to the Cost of Quality.

The COQ analysis gives the following benefits to the organization.

1. Brings out the magnitude of the quality problem in the organization. It further leads to

establishing goals for the organization to improve quality.

2. Enables cost reduction owing to steps taken for improvement based on analysis.

3. Enables taking steps to improve customer satisfaction.

4. Displaying the results motivates employees to improve further.

References:

No author. (n.d.) “Analysis of External Failure Cost”. Course Hero. Retrieved from

https://www.coursehero.com. Retrieved on November 21, 2019.

No Author. (n.d.) “Cost of Quality (COQ).” ASQ. Retrieved at https://asq.org. Retrieved on

November 21, 2019.

No Author. (n.d.) “Key Strategies to Minimize The Cost of Poor Quality.” Insights. Retrieved

from

https://www.metricstream.com. Retrieved on November 21, 2019.

No Author. (n.d.) “Quality Costs – Types, Analysis and Prevention.” Learn Financial and

Managerial Accounting for Free. Retrieved from https://www.accountingdetails.com.

Retrieved on November 21, 2019.

No author. (n.d.) “Using Cost of Quality to make Improvement and Reduce Costs.” Quality

Training Portal. Retrieved from https://qualitytrainingportal.com. Retrieved on

 November 21, 2019.

J.R. Martin, Ph.D. (n.d.) “The Quality Cost Conformance Model” Retrieved from

https://maaw.info/QualityCostConformanceModel.htm Retrieved on November 22,

2019

M. Zellman (n.d.) “Traditional Economic Model of Quality of Conformance” Retrieved from

https://smallbusiness.chron.com/traditional-economic-model-quality-conformance-

13016.html Retrieved on November 22, 2019

References:

Failure Costs:

https://asq.org/quality-resources/cost-of-quality

https://www.accountingdetails.com/quality_costs.htm

Juran’s Model of Optimum Quality Cost Model:

https://smallbusiness.chron.com/traditional-economic-model-quality-conformance-13016.html

https://qualityamerica.com/LSS-Knowledge-

Center/qualitymanagement/goal_of_quality_cost_system.php

https://maaw.info/QualityCostConformanceModel.htm

Reducing costs:

https://www.metricstream.com/insights/costofPoorQuality_home.htm