Cost of Quality

Quality costs are real and estimated at:

25% of costs in manufacturing and 35% of costs in service industry

Quality costs are defined as costs associated with non-achievement of

product/service quality. In simple terms, quality cost is the cost of poor
products/services.

The cost of poor quality can add to other costs such as design,
production, maintenance, inspection, sales, etc. Quality costs cross
department boundaries by involving all activities of the organization –
marketing, purchasing, design, manufacturing, service, etc.

The price of nonconformance (Philip Crosby) or the cost of poor quality

(Joseph Juran), the term 'Cost of Quality', refers to the costs associated
with providing poor quality product or service.

Cost of quality is only the measure of operational

performance
1
Classifications of Costs of Quality

Costs of
Visibility

Visible Hidden
cost cost
 How to classify Quality Costs
Is this cost related to the YES
prevention of poor quality
PREVENTION
NO
Is this cost related to the YES APPRAISAL
Evaluating non-conformity
NO
Is this cost related to the YES
non-conforming Found before
INTERNAL
dispatch
NO
The product is not Found after
EXTERNAL
qualitative dispatch
 – Internal Failure Costs (Defective)
• Costs incurred to fix problems that are detected before the
product/service is delivered to the customer.
– External Failure Costs (Defective)
• All costs incurred to fix problems that are detected after the
product/service is delivered to the customer.
• Appraisal Costs
– Product and/or service inspection costs.
– EX: Time and effort spent for course evaluations
• Prevention Costs
– Quality training, planning, customer assessment, process control, and
quality improvement costs to prevent defects from occurring
– EX: Instructor training for better course presentation

Scrap, Rework, Warranty

High inventory, Re-inspection cost, customer service, excessive

use of material, loss of good will
Activities associated with preventive costs

Examples of
prevention Cost
– Job descriptions
– Market analysis
– Application screening – Pilot projects
– Capability studies – Procedure writing
– Controlled storage – Prototype testing
– Design review – Procedure reviews
– Equipment maintenance & – Quality incentives
repair – Safety reviews
– Field testing – Time and motion studies
– Fixture design and – Survey
fabrication – Quality training
– Forecasting – salesperson evaluation and
selection
– Housekeeping
– Personnel reviews
Activities associated with Appraisal Costs
• Inspection and testing
– costs of testing and inspecting materials, parts, and product at various
stages and at the end of a process
• Test equipment costs
– costs of maintaining equipment used in testing quality characteristics of
products
• Operator costs
– costs of time spent by operators to gather data for testing product quality,
to make equipment adjustments to maintain quality, and to stop work to
assess quality
Examples of Appraisal cost
• Audit
• Document checking
• Diagram checking
• Equipment calibration
• Final inspection
• In-process inspection
• Laboratory test
• Personnel testing
• Procedure testing
• Prototype inspection
• Receiving inspection
• Shipping inspection

Activities associated with Internal Failure Costs

• Scrap costs
– costs of poor-quality products that
must be discarded, including labor,
material, and indirect costs
• Rework costs
– costs of fixing defective products to
conform to quality specifications
• Process failure costs
– costs of determining why production
process is producing poor-quality
products
• Process downtime costs
– costs of shutting down
productive process to fix
problem
• Price-downgrading costs
– costs of discounting poor-
quality products—that is,
selling products as “seconds”
External Failure Costs
• Customer complaint costs
– costs of investigating and
satisfactorily responding to a
customer complaint resulting
from a poor-quality product
• Product return costs
– costs of handling and
replacing poor-quality
products returned by
customer
• Warranty claims costs
– costs of complying with
product warranties
• Product liability costs
– litigation costs
resulting from product
liability and customer
injury
• Lost sales costs
– costs incurred because
customers are
dissatisfied with poor
quality products and
do not make additional
purchases
 The Consequences of Poor Quality
• Loss of business: Customer quietly stops buying.
Customer complaints rarely reach to the upper
management.

• Liability: Due to damages or injuries resulting from

poor quality (design, conformance, ease of use,
service)

• Low productivity: Rework or scrap. More input but

does not increase the output.

• High costs
 Why should we calculate Quality Cost

Management will give special attention when quality is

measured in monetary terms because cost of quality failure is
calculated as a percentage of profit or annual turnover

needed or had been made

To monitor the effectiveness of quality improvement
initiatives

To be used in a generic term by senior management,

shareholders and financial institutions, so that they can readily
understand implication of quality in the term of money
Benefits of using quality costing
Greater accuracy in the evaluation and forecasting of resource use•
Identification and prioritization of activities, processes and departments in
terms of corrective action, investment, or quality improvement
Justification for investment in the prevention and appraisal of failures
initiatives
Greater accuracy in the evaluation and forecasting of resource use
Justification for investment in the prevention and appraisal of failures
Ability to cost and compare performance across all departments
functions and activities
• Ability to set cost-reduction targets and then to measure and report progress
• Ability to produce “local” data which improves understanding of resource
utilization objectives and targets at all levels throughout the company
• Provision of data to support formal quality management system (including,
especially; those based upon the ISO9000)
• Enable decisions about quality to be made in an objective and systematic
manner
• Promoting TQM and a company-wide quality improvement culture
 Relation of TQM and cost of quality
Customers will seek out the highest One time improved quality that exceeds
quality product. customer expectations will generate more
revenue

Therefore, quality is “not free”.

Applying TQM for improving quality that

Customers will seek out the highest
exceeds customer expectations will generate
quality product.
more revenues that exceed the cost of
quality.

Therefore, quality is “free”.

 W. Edwards Deming proposed Quality can be and
that improving quality reduces should be improved
cost and improves profitability. continuously.
Total Revenues & Costs

Revenues

Max Profit

Total Cost

Max Quality

Quality

But how much maximum quality should be

given to achieve high quality returns ?
 Return on Quality (ROQ)
Profit is maximized at the The optimum quality level is always achieved before
optimum quality level. maximum attainable profit is reached.

Cost
Total Revenues & Costs

Revenues
Max
Profit

Optimum Quality

Quality
Preventing Poor Quality (Comparison)

Prevention Costs

Benefit
Appraisal Costs

Rs. Repair Costs Prevention Costs

Failure Costs Appraisal Costs

• Internal Repair Costs
• External
Failure Costs

Before After Quality

Quality Cost Cost
Alignment Alignment
 1:10:100 Rule
1
Prevention

10
$ $
Correction
$ $
100

Failure $
$
$
$
$
$

One dollar spent on prevention will save $10 on appraisal and $100 on failure
costs.

This rule helps one to prioritize expenditure on prevention, which is sure to bring in
greater returns.
Difficulties in using Quality costing

Management have not believed in the possibilities of improvement

Quality costing is demanding

◦ It requires a lot of data of each activity related to quality

Other limitations
◦ Does not resolve quality problems
◦ Does not provide specific actions
◦ vulnerable to short-term mismanagement
◦ difficult to match effort and accomplishment
◦ subject to measurement errors
◦ may neglect important or include inappropriate costs
Steps in implementing quality cost
1. Involve accountants right from the start
2. Decide purpose and objectives
3. Decide how to deal with overheads
4. Distinguish between basic work and quality related
activities
5. Collection data which offers the prospect of real gains
6. Start by examining failure costs
7. Evaluate the costs of inspection
8. Analyze and use the data
9. Collecting and reporting quality cost data