Trend Analysis

Quality cost reports reveal the magnitude of quality costs and their distribution among the four categories, thus revealing opportunities for improvement. Once quality improvement measures are undertaken, it is important to determine whether quality costs are being reduced as planned.. Quality costs reports will not reveal whether or not improvement has occurred. It would be useful to have a picture of how the quality-improvement program has been doing since its inception.

By plotting quality costs a percentage of sales against time, the overall trend in the quality program can be assessed. The first year plotted is the year prior to the implementation of the quality-improvement program. Assume that a company has experienced the following:
Year Quality Costs 2002 2003 $ 440,000 $ 423.000 Actual Sales $ 2.200.000 $ 2.350.000 Costs as a Percentage (%) of Sales 20.0% 18.0%

2004
2005 2006

$ 412.500
$ 392.000 $ 280.000

$ 2.750.000
$ 2.800.000 $ 2.800.000

15.0%
14.0% 10.0%

From the data, there has been a steady downward trend in quality costs expressed as a percentage of sales and also reveals that there is still ample room for improvement toward the long-run target percentage. Additional insight can be provided by plotting the trend for each individual quality category. Assume that each category is expressed as a percentage of sales for the same period of time.
Cont

From the data, it shows the trend for each category. We can see 2002 2.0% 2.0% 6.0% 10.0% that company has had dramatic success in reducing external and 2003 3.0% 2.4% 4.0% 8.6% internal failures. More money being spent on prevention. Appraisal 2004 3.0% 3.0% 3.0% 6.0% costs have increased and then decreased. Note also that the 2005 4.0% 3.0% 2.5% 4.5% relative distribution of costs has changed. In 2006 4.1% 2.4% 2.0% 1.5% 2002, failure costs were 80% of the total quality costs (0.16/0.20). In 2006, they are 35% of the total (0.035/0.10) The potential to reduce quality costs also affects the way decisions are made. The usefulness of quality information for decision making and planning should not be underestimated.

Year

Prevention

Appraisal

Internal Failure

External Failure

Using quality cost information for quality program implementation decisions and for evaluating the effectiveness of these programs, once implemented, is just one potential use of a quality cost system. Other important uses can also be identified. The following scenarios illustrate the utility of quality cost information for a strategic pricing decision and profitability analysis of a new product design. The principle objective of reporting quality costs is to improve and facilitate managerial planning, control, and decision making. Example: In deciding to implement a supplier selection program to improve the quality of material inputs, a manager will need an assessment of current quality costs by item and by category, an assessment of the additional costs associated with the program, and an assessment of the projected savings by item and by category.

Scenario A: Strategic Pricing Leola Wise as the marketing manager, Earl Simpson as the controller.
Example of the report for the lower-level instruments follows:
MEMO

To: Leola Wise From: Earl Simpson Subject: Quality Costs

Leola, I have assembled some data that may be useful to you. As requested, I have provided you some estimates of the quality costs associated with this line. I have not included any costs of lost sales due to nonconforming products, as you are probably in a better position to assess this affect. Quality Costs (estimated): Inspection of raw materials Scrap Rejects Rework Product Inspection Warranty Work Total Estimate

$ 200.000 $ 800.000 $ 500.000 $ 400.000 $ 300.000 $ 1.000.000 $ 3.200.000

(+) Cont

Cont.. Scenario A illustrates that both quality cost information and the implementation of a total quality control program contributed to a significant strategic decision. It also shows that improving quality is not a panacea. The reduction are not large enough to bear the full price reduction. Other productivity gains, such as those promised by engineering, will be needed to ensure the long-range viability of the product line.

Scenario B: New Product Analysis

Anderson as marketing manager, Brittany, the design engineer. They received the following report from the controllers office:

Report: New Product Analysis, Project #675

Estimated product life cycle: 2 years Projected sales potential: 50.000 units (life cycle) Projected life-cycle income statement: Sales (50.000 @ $ 60) $ 3.000.000 Cost of inputs: Materials: $ 800.000 Labor: $ 400.000 Scrap: $ 150.000 Inspection $ 350.000 Repair work $ 200.000 Product development $ 500.000 Selling $ 300.000 (-) Life cycle income $ 300.000 Decision Reject Reason(s): Life-cycle income is less than the company-required 18% return on sales

Cont..

Scenario B illustrates the importance of further classifying quality coasts by behavior. The scenario also reinforces the importance of identifying and reporting quality costs separately. The new product was designed to reduce its quality costs, and only by knowing the quality costs assigned could Brittany and Tara have discovered the error in lifecycle income analysis. Reporting quality costs so shat they can be used for decision making is just one objective of a good quality-costing system. Another objective is controlling quality-costsa factor critical in helping expected outcomes of decisions come to fruition. The pricing decision of Scenario A, for example, depended on the plan to reduce quality costs.

Productivity: Measurement and Control

Productivity is concerned with producing output efficiently, and it specifically addresses the relationship of output and the inputs used to produce the output. 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 anyone input is used than necessary to produce the output and (2) Given the mixes that satisfy the first condition, the least costly mix is chosen.

Partial Productivity Measurement

Productivity Measurement is simply a quantitative assessment of productivity changes. The objective to assess whether productive efficiency has increased or decreased. Productivity Measurement can be actual or prospective. Actual Measurement allows managers to assess, monitor, and control changes. Prospective Measurement is forward looking, and it serves as an input for strategic decision making, and this measurement allows the managers to compare relative benefits of different input combinations, choosing the inputs and input mix that provide the greatest benefit. Partial Productivity Measurement defined measuring productivity for one input at time or productivity of a single input is typically measured by calculating the ratio of the input to the input.

Productivity Ratio = Output/Input

Advantages of Partial Measures

Disadvantages of Partial Measures

Allows managers to focus on the use of particular input. Being easily interpreted by all within the organization and therefore easy to use for assessing the productivity performance of operating personnel. Provide feedback that operating personnel can relate to and understandmeasures that deal with the specific inputs over which they have control.

Used in isolation, can be misleading. The possible existence of trade-offs mandates a total measure of productivity for assessing the merits of productivity decisions. Because of the possibility of trade-offs, a total measure of productivity must assess the aggregate financial consequences and, therefore, should be a financial measure.

Total Productivity Measurement

Measuring productivity for all inputs at once is called Total Productivity Measurement. In practice, it may not be necessary to measure the effect of all inputs. Many firms measure the productivity of only those factors that are thought to be relevant indicators of organizational performance and success. Total Productivity Measurement requires the development of a multifactor measurement approach. A common multifactor measurement approach suggested in the productivity literature is the use of aggregate productivity indices, and have not been generally accepted.

Profile Productivity Measurement

Profile measurement provides a series or a vector of separate and distinct partial operational measures. Profiles can be compared over time to provide information about productivity changes. Example: The following data:
Description Number of motors produced Labors hours used Materials used (lbs.) 2005 120.000 40.000 1.200.000 2006 150.000 37.500 1.428.571

Description
Labor Productivity Ratio

Partial Productivity Ratio 2005 PROFILE (a) 3.000 2006 PROFILE (b) 4.000

Materials Productivity Ratio

0.100

0.105

(a) Labor: 120.000/40.000; materials: 120.000/1.200.000 (b) Labor: 150.000/37.500; materials: 150.000/1.428.571

The data provides productivity ratio profiles for each year. The 2005 profile is (3, 0.100) and the 2006 is (4, 0.105). Comparing the profiles two years, we can see that productivity increased for both labor and materials (from 3 to 4 for labor and from 0.100 to 0.105 for materials). The profile comparison provide enough information so that a manager can conclude that the new assembly process has definitely improved all productivity. The value of this improvement, however, is not revealed by the ratios.

Profit-Linked Productivity Measurement

Description
Labor Productivity Ratio
Materials Productivity Ratio

Partial Productivity Ratios 2005 PROFILE (a) 3.000

0.100

2006 PROFILE (b) 4.000

0.088

(a) Labor: 120.000/40.000; materials: 120.000/1.200.000 (b) Labor: 150.000/37.500; materials: 150.000/1.700.000

The Profit-Linkage Rule: For the current period, calculate the cost of the inputs that would have been used in 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 due to productivity changes.

PQ: Current output/Base-period productivity ratio

Description Number of motors produced Labor hours used Materials used (lbs.) Unit selling price (motors) Wages per labor hour Cost per pound of material 2005 120.000 40.000 1.200.000 $ 50 $ 11 $2 2006 150.000 37.500 1.700.000 $ 48 $ 12 $3

Current output (2006) is 150.000 motors. Using this information, the productivity-neutral quantity for each input: PQ (labor): 150.000/3 = 50.000 hrs. PQ (materials): 150.000/0.100 = 1.500.000 lbs. Cost have been computed by multiplying each individual Input Quantity by its current price (P) and totaling: 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 is obtained by multiplying the actual quantity (AQ) by current input price (P) for each input and totaling: 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 Finally, the productivity effect on profits is computed by subtracting the total current cost from the total PQ cost. Profit-linked effect = Total PQ Cost Total Current Cost = $ 5.100.000 - $ 5.550.000 = $ 450.000 decrease in profits This calculation reveals that the net effect of the process change was unfavorable. Profit declined by $ 450.000 because of the productivity changes.

(1)
Input
Labor Materials Total

(2)
PQ X P
$ 600.000 $ 4.500.000 4 5.100.000

(3)
AQ
37.500 1.700.000

(4)
AQ X P
$ 450.000 $ 5.100.000 $ 5.550.000

(2) - (4)
(PQ X P) - (AQ X P)
$ 150.000 $ (600.000) $ (450.000)

PQ*
50.000 1.500.000

The increase in labor productivity creates a $ 150.000 increase in profits; however the drop in materials productivity caused a $ 600.000 decrease in profits. Most of the profit decrease came from an increase in materials usageapparently, waste, scrap, and spoiled unites are much greater with new process. The total profit-linked productivity measure is the sum of the individual partial measures. This property makes the profit-linked measure ideal for assessing trade-offs. As labor becomes more proficient at the new process, it is possible that the material usage could also decrease.

Price-Recovery Component
Price-Recovery Component is the difference between the total profit change and the profitlinked productivity change. To calculate PriceRecovery Component, we first need compute the change in profits for each period:
2006 Revenues
a

2005 $ 6.000.000

Difference $ 1.200.000

$ 7.200.000
b

Cost of inputs Profits

$ 5.550.000 $ 1.650.000

$ 2.840.000 $ 3.160.000

$ 2.710.000 $ (1.510.000)

a) $48 X 150.000; $50 X 120.000 b) ($12 X 37.500) + ($3 X 1.700.000); ($11 X 40.000) + ($2 X 1.200.000)

Price Recovery = Profit change - Profit linked productivity = ($1.510.000) - ($450.000) = ($1.060.000)

Quality and Productivity

Improving quality may improve productivity, and vice versa. For example, if rework is reduced by producing fewer defective units, less labor and fewer materials are used to produce the same output. Reducing the number of defensive units improves quality; reducing the amount of inputs used improves productivity.

Gainsharing
Gainsharing is providing to a companys entire workforce cash incentives that are keyed to quality and productivity gains. Example: A company has target of reducing the number of defensive units by 10% during the next quarter for a particular plant. If the goal is achieved, the company estimates that $1.000.000 will be saved. Gainsharing provides an incentive by offering a bonus to the employees equal to a percentage of the cost savings, say 20 percent.