Total Quality Management

Week # 7

Cost of Quality
Prepared by: Khalid Dahleez
Faculty of Commerce – the Islamic University of Gaza

This material was collected from different sources

Total Quality Management - Spring 2010 - IUG 1

Understand Quality Costs
• Understand quality costs enables you to
– Understand hidden costs
– Reduce and eliminate unnecessary cost
• Prevent problems from happening
• Management responsibility to enable this

• Quality costs are real and estimated at:

– 25% of costs in manufacturing
– 35% of costs in service industry
• Quality costs can be categorised to enable better
understanding

Total Quality Management - Spring 2010 - IUG 2

Why calculate Quality Cost

 Management will give special attention when quality is measured in

monetary terms
 Quality costing is one of the tools
◦ to provide initial assessments and hard evidence that improvement is
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
◦ Cost of quality failure is calculated as a percentage of profit or annual
turnover
◦ It is easy to understand
 By front-line operator
 By middle management

Total Quality Management - Spring 2010 - IUG 3

Benefits of using quality costing

 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

 Identification and prioritization of activities, processes and

departments in terms of corrective action, investment, or quality
improvement initiatives

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Benefits of using quality costing (2)

 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

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 COST OF QUALITY
 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.
Total Quality Management - Spring 2010 - IUG 6
 Founders Point of View
• Phillip B. Crosby (Quality is free . . . ):
• The system for causing quality is prevention, not
appraisal – Quality is Free
• The performance standard must be Zero Defects,
not "that's close enough"
• The measurement of quality is the Price of Non-
conformance.
• Cost of quality is only the measure of operational
performance
• “Quality is free. It’s not a gift, but it is free. What
costs money are the unquality things -- all the
actions that involve not doing jobs right the first
time.”

Total Quality Management - Spring 2010 - IUG 7

 Total Quality Management (TQM)

Customers will seek Improved quality that exceeds

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

Therefore,
quality is
“free”.
Total Quality Management - Spring 2010 - IUG 8
 Total Quality Management (TQM)
W. Edwards Deming proposed that
improving quality reduces cost and Quality can be and should be
improves profitability. improved continuously.

Revenues
Total Revenues & Costs

Max Profit

Cost

Max Quality

Quality
Total Quality Management - Spring 2010 - IUG 9
 Return on Quality (ROQ)
Profit is maximized at the The optimum quality level is always achieved
optimum quality level. before maximum attainable profit is reached.

Cost
Total Revenues & Costs

Revenues

Max Profit

Optimum Quality

Quality
Total Quality Management - Spring 2010 - IUG 10
 Founders Point of View
• Feigenbaum (Originator of ‘Total Quality’
concept)
Definition of Quality costs (1956)
Appraisal costs
Prevention costs
Failure costs

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Cost of Quality
 Cost of Achieving Good Quality
◦ Prevention costs
 costs incurred during product design
◦ Appraisal costs
 costs of measuring, testing, and analyzing
 Cost of Poor Quality
◦ Internal failure costs
 include scrap, rework, process failure, downtime,
and price reductions
◦ External failure costs
 include complaints, returns, warranty claims,
liability, and lost sales
Total Quality Management - Spring 2010 - IUG 12
 Prevention Costs
 Quality planning costs  Training costs
◦ costs of developing and ◦ costs of developing and
implementing quality putting on quality training
management program
programs for employees
 Product-design costs and management
◦ costs of designing  Information costs
products with quality
characteristics ◦ costs of acquiring and
 Process costs maintaining data related to
quality, and development of
◦ costs expended to make reports on quality
sure productive process
conforms to quality performance
specifications

Total Quality Management - Spring 2010 - IUG 13

Examples of prevention Cost
◦ Application screening
◦ Capability studies
◦ Controlled storage
◦ Design review
◦ Equipment maintenance &
repair
◦ Field testing
◦ Fixture design and fabrication
◦ Forecasting
◦ Housekeeping
◦ Job descriptions
◦ Market analysis
◦ Pilot projects
◦ Procedure writing
◦ Prototype testing
◦ Procedure reviews
◦ Quality incentives
◦ Safety reviews
◦ Time and motion studies
◦ Survey
◦ Quality training
◦ salesperson evaluation and
selection
◦ Personnel reviews
Total Quality Management - Spring 2010 - IUG 14
 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

Total Quality Management - Spring 2010 - IUG 15

Examples of appraisal cost
 Audit  Laboratory test
 Document checking  Personnel testing
 Diagram checking  Procedure testing
 Equipment calibration  Prototype inspection
 Final inspection  Receiving inspection
 In-process inspection  Shipping inspection

Total Quality Management - Spring 2010 - IUG 16

 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”
Total Quality Management - Spring 2010 - IUG 17
 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
Total Quality Management - Spring 2010 - IUG 18
 Defects, Scrap, Rework, Inspection,
Returns, Warranty, Quality Assurance

Prevention
Design Review, Zero Defects
Program, Supplier Training, Supplier
Evaluation, Specification Review,
Quality Audits, Preventive
Maintenance, Engineering Changes,
Product Liability, Increased Overhead
Appraisal
Vendor Surveillance, Receiving
Inspection, Product Acceptance, Process
Control, Inspection Labor, Quality
Control Labor, Testing Equipment Costs

Internal Failure External Failure

Downtime, Engineering Changes, Consumer Affairs, Purchase Changes,
Excess Inventory, Disposal Costs, Service after Sales, Product Liability, Lost
Reinsertion Market Share Delivery Delay

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Classifying Quality Costs

Total Quality Management - Spring 2010 - IUG 20

Total Quality Management - Spring 2010 - IUG 21
 Preventing Poor Quality (Comparison)

Prevention Costs

Benefit
Appraisal Costs

$ Repair Costs Prevention Costs

Failure Costs Appraisal Costs

• Internal Repair Costs
• External
Failure Costs

Before Quality After Quality

Cost Cost
Alignment Alignment

Total Quality Management - Spring 2010 - IUG 22

Cost of Quality (other version)
1. Like all things there is a price to pay for quality.This total cost can be
split into two fundamental areas:
 a. Non Conformance. This area covers the price paid by not having
quality systems or a quality product. Examples of this are:
(1) Rework. Doing the job over again because it wasn't right the first time.
(2) Scrap. Throwing away the results of your work because it is not up to the
required standard.
(3) Waiting. Time wasted whilst waiting for other people.
(4) Down Time. Not being able to do your job because a machine is broken.
 b. Conformance. Conformance is an aim of quality assurance. This
aim is achieved at a price. Examples of this are:
(1) Documentation. Writing work instructions, technical instructions and producing
paperwork.
(2) Training. On the job training, quality training, etc.
(3) Auditing. Internal, external and extrinsic.
(4) Planning. Prevention, do the right thing first time and poka yoke.
(5) Inspection. Vehicles, equipment, buildings and people.

Total Quality Management - Spring 2010 - IUG 23

Cost of Quality (other version)

2. These two main areas can be split further as shown below:

FIGURE 1.3

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 1-10-100 Rule

1
Prevention

10
$ $
Correction
$ $
100

Failure $
$
$
$
$
$

Total Quality Management - Spring 2010 - IUG 25

 The 1:10:100 rule:
 Re.1 spent on prevention will save Rs.10 spent on appraisal and
Rs.100 on failure costs.

 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.

 “The earlier you detect and prevent a defect the more

you can save. If you catch a two cent resistor before you
use it and throw it away, you lose two Cents. If you don’t
find it until it has been soldered into a computer
component, it may cost $10 to repair the part. If you
don’t catch the component until it is in the computer
user’s hands, the repair will cost hundreds of dollars.
Indeed, if a $5000 computer has to be repaired in the
field, the expense may exceed the manufacturing cost.”

Total Quality Management - Spring 2010 - IUG 26

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

Total Quality Management - Spring 2010 - IUG 27

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

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 Preventing Poor Quality
• Would it not make sense to prevent poor
quality products from happening?
• How can this be done?
• Whose responsibility is this?

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 How to Prevent Poor Quality
• Prepare to measure costs of quality
– Determine categories of quality costs
– Create measurement system that
captures categories of quality costs
• Assign responsibility to collect data
• Analyse collected data

Total Quality Management - Spring 2010 - IUG 30

 Determine Quality Cost Categories

• Understand your product

• Understand your process
• Understand where problems occur
• Determine precisely what goes wrong
• Determine what costs represents each
problem

Total Quality Management - Spring 2010 - IUG 31

Creating Data Collection System
• Create measurement system
– Attempt to harness existing financial
accounting system
– Manipulate existing financial data
– Collect costs as they occur
• Whatever you do ensure costs are
accurate

Total Quality Management - Spring 2010 - IUG 32

 Assign Responsibility

• Make individuals at all levels responsible

for collecting quality cost data:
– If quality cost data is required then
make it the responsibility of the person
who creates the cost to collect the
data
• If no one is responsible no one will bother

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 Analyse Collected Data
• Data on its own is useless
• You must have it analysed to be able to
extract meaning
• Determine what knowledge you require
• Develop an analysis system that provides
the knowledge you require

Total Quality Management - Spring 2010 - IUG 34

Useful Quality Cost Knowledge
• What you need to know is useful
• What you do not need to know is useless
• Only ask for knowledge you need to know
• Demand that knowledge is presented so
that it can be understood easily

Total Quality Management - Spring 2010 - IUG 35

 Management is Responsible
• Management decides what to produce in
terms of Products (goods and / or services)
• Management assigns responsibilities to
produce products
• Management is accountable for effectively
using resources to produce products

Total Quality Management - Spring 2010 - IUG 36

History of Activity-Based Costing
 Term “activity-based costing” created in 1975 by Dr. Robert
Kaplan

 Resulted from dissatisfaction with traditional accounting

categories

 Identifies activities as the fundamental cost object of an

organization

 Widely used in industries (e.g. FedEx, Texas Instruments…)

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Benefits Associated With ABC
 More precise cost information

 Improved cost control and management

 Improved insight into cost causation

 Better performance measures

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Definitions

 Activity Based Costing (ABC) is a methodology that measures the

cost and performance of resources, activities and cost objects.
Cost objects consume activities, and activities consume resources.

 Activity Based Management (ABM) is the broad discipline that

focuses on achieving customer value through the continuous
management of activities. ABM draws on ABC cost information
and performance measurement as a major (but not only) source
of information.

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The Link Between Quality and Productivity
 Effective quality improvement can be instrumental
in increasing productivity and reducing cost.

 The cost of achieving quality improvements and

increased productivity is often small.

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Summary Slide
 The following Slides are for understanding
only (subject to indirect Questions): “ 37,
38, 39, 40”

 Other slides are required and subjects to

any type of Questions

Total Quality Management - Spring 2010 41