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11 -1

CHAPTER Quality Costs and


Productivity:
Measurement,
Reporting, and
Control
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Objectives
Objectives
1. Identify and describe the four types of quality costs.
After
2. Prepare a quality cost studying
After report this
and explain
studying this the difference
between the conventional
chapter, viewshould
of acceptable quality
chapter, you
you should
level and the view espoused by total quality control.
be
be able
able to:
to:
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.
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Quality Defined

A quality product
or service is one
that meets or
exceeds customer
expectations...
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Quality Defined
… on the following eight dimensions:
Performance Durability
Aesthetics Quality of
conformance
Serviceability
Fitness for use
Features
Reliability
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Quality Defined
… on the following eight dimensions:
How
How consistently
consistently
Performance Durability
and
and well
well aa product
product
The appearance
The functions
appearance of
functions of
Aesthetics Quality
tangible of
tangible products
products
Measures
Measures
(style,
conformance
(style, the
the
beauty)
beauty)ease
ease of
of
Serviceability maintaining
maintaining and/or
Characteristics
Characteristics and/or
of
of aa
repairing
Fitness
repairing
product
product
The that
that the
for
the product
use
product
differentiate
differentiate
Features The probability that
probability that the
the
functionally
functionally
product
product or similar
similar
or service
service will
will
Reliability perform
performproducts
products
its
its intended
intended
function
function for for aa specified
specified
length
length of of time
time
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Quality Defined
… on the following eight dimensions:
The length of time
Performance Durability
aAproduct
measurefunctions
of how
Aesthetics
a product meets its Quality of
specifications
The suitability of the conformance
Serviceability
product for carrying
out its advertised
Fitness for use
Features
functions
Reliability
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Quality Defined

A defective product
is one that does not
conform to
specifications.
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Quality Defined

Zero defects
means that all
products
conform to
specifications.
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Quality Defined
The definition of quality-related activities imply
four categories of quality costs: Incurred
Incurred to
to
prevent
Incurredpoor
Incurred
prevent to
poor
to
1) Preventive costs quality
quality or
determine
determine or
services
whether
services
whether being
Incurred
products
being
Incurred
productswhen
when
2) Appraisal costs
and
and Incurred
productswhen
produced
products
services
Incurred
produced
services and
when
and
3) Internal failure costs products
services
conform todo
to
products
services
conform doand
not
and
not
services
conform
requirements
services
conform
requirements fail
to
fail
toto
to
4) External failure costs
conform
conform to
specifications
specificationsto
requirements
requirements afterafter
being
being delivered
delivered
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Examples of Quality Costs
Prevention costs
Quality engineering
Quality training programs
Quality planning
Quality reporting
Supplier evaluation and selection
Quality audits
Quality circles
Field trials
Design reviews
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Examples of Quality Costs
Appraisal Costs
Inspection of raw materials
Testing of raw materials
Packaging inspection
Supervising appraisal
Product acceptance
Process acceptance
Inspection of equipment
Testing equipment
Outside endorsements
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Examples of Quality Costs

Internal failure costs


Scrap

Rework
Downtime (defect related)
Reinspection
Retesting
Design changes
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Examples of Quality Costs
External failure costs
Cost of recalls
Lost sales
Returns/allowances
Warranties
Repairs
Product liability
Customer dissatisfaction
Lost market share
Complaint adjustment
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Measuring Quality Costs


Hidden Quality Costs are
opportunity costs resulting from
poor quality.
 The Multiplier Method

 The Market Research Method

 Taguchi Quality Loss Function


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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.
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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 company’s sales force can provide
significant insight into the magnitude of a
company’s hidden costs.
Market research results can be used to project
future profit losses attributable to poor quality.
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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.
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The Taguchi Quality Loss Function
$
Cost

Lower Target Upper


Specification Value Specification
Limit Limit
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The Taguchi Quality Loss Function
L(y) = k(y – T)²
k = A proportionately constant dependent
upon the organization’s external failure
cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss
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Quality Cost Report


Unit Actual Diameter (y) y-T (y –T)² k(y-T)²
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 11 -21
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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%
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Relative Distribution of Quality Costs


External
Failure Prevention
(19.5%) (34.5%)

Internal Appraisal
Failure (20.4%)
(25.6%)
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Quality Cost Graph
Total
Cost Quality
Costs Failure Costs

Control Costs
0
AOL 100%

Percent Defects
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Contemporary Quality Cost Graph

Cost Total
Quality
Costs Failure Costs

Control Costs

0 100%
Percent Defects
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Trend Analysis

Assume
Assume the
the following
following data:
data:
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: 11 -26

Total Quality Costs


% of
Sales

20

15

10

0 1 2 3 4
5
Year
Multiple-Trend Analysis for 11 -27

Individual Quality Costs


Assume the following quality cost data:
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
1
Expressed as a % of sales
Multiple-Period Trend Graphic: 11 -28

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 11 -29

and Control

Productivity
Productivity isis concerned
concerned
with
with producing
producing output
output
efficiently,
efficiently, and
and isis itit
specifically
specifically addresses
addresses the the
relationship
relationship ofof output
output and and
the
the inputs
inputs used
used to
to produce
produce
the
the outputs.
outputs.
Productivity: Measurement 11 -30

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.
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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 4
Capital
6
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Technical Efficiency
Same Output, Fewer Inputs
Inputs: Outputs:
Labor
3 6
Capital

More Output, Same Inputs


Inputs: Outputs:
Labor 4 8
Capital
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Technical Efficiency
More Output, Fewer Inputs
Inputs: Outputs:
Labor
3 8
Capital
Technically Efficient Combination I:
Inputs: Outputs:
Labor
3 8
Capital
$20,000,000
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Technical Efficiency

Technically Efficient Combination II:


Inputs: Outputs:
Labor
2 8
Capital
$25,000,000

Of
Of the
the two
two combinations
combinations that
that produce
produce the
the same
same output,
output,
the
the least
least costly
costly combination
combination would
would be
be chosen.
chosen.
11 -35

Partial
Partial Productivity
Productivity Measurement
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.
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Profile measurement provides a


series or a vector of separate and
distinct partial operational measures.
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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
150,000/37,500
150,000/37,500
Partial Productivity Ratios
150,000/1,428,571
150,000/1,428,571
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.105
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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
150,000/37,500
150,000/37,500
Partial Productivity Ratios
150,000/1,700,000
150,000/1,700,000
2003 Profile 2004 Profile
Labor productivity ratio 3.000 4.000
Material productivity ratio 0.100 0.088
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Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
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
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Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
Measurement
Example: Kunkul provided the following data:
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
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Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
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
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Profit-Linked
Profit-Linked Productivity
Productivity
Measurement
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.
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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
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Chapter Eleven

The
The End
End
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