11 -1
CHAPTER
Quality Costs and
Productivity:
Measurement,
Reporting, and
Control
11 -2
Objectives
1. Identify and describe the four types of quality
After studying this
costs.
chapter,
should
2. Prepare a quality
costyou
report
and explain the
be able
to:
difference between
the conventional
view of
acceptable quality level and the view
espoused by total quality control.
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.
11 -3
Quality Defined
A quality product
or service is one
that meets or
exceeds customer
expectations...
11 -4
Quality Defined
… on the following eight dimensions:
Performance
Durability
Aesthetics
Quality of
conformance
Serviceability
Features
Reliability
Fitness for use
11 -5
Quality Defined
… on the following eight dimensions:
Performance
Aesthetics
Serviceability
Features
Reliability
How consistently
Durability
and
well a product
The appearance
functions of
tangible products
Quality
of
Measures
the ease of
(style, beauty)
conformance
maintaining and/or
Characteristics
of a
repairing
the use
product
Fitness
product
that for
differentiate
The
probability
that the
functionally
similar
product
or service
will
products
perform
its intended
function for a specified
length of time
11 -6
Quality Defined
… on the following eight dimensions:
The length of time
Performance
aAproduct
measurefunctions
of how
a product
meets its
Aesthetics
specifications
The suitability
of the
Serviceability
product for carrying
out its advertised
Features
functions
Reliability
Durability
Quality of
conformance
Fitness for use
11 -7
Quality Defined
A defective product
is one that does not
conform to
specifications.
11 -8
Quality Defined
Zero defects
means that all
products
conform to
specifications.
11 -9
Quality Defined
The definition of quality-related activities imply
Incurred
to
four categories of quality costs:
prevent
Incurredpoor
to
1) Preventive costs
quality or
determine
services
being
Incurred
when
whether
products
2) Appraisal costs
Incurred
produced
productswhen
and
and
services
3) Internal failure costs
products
services
not
conform
to doand
services
failtoto
conform
requirements
4) External failure costs
conform to
specifications
requirements after
being delivered
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
11 -10
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
11 -11
Examples of Quality Costs
Internal failure costs
Scrap
Rework
Downtime (defect related)
Reinspection
Retesting
Design changes
11 -12
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
11 -13
11 -14
Measuring Quality Costs
Hidden Quality Costs are opportunity
costs resulting from poor quality.
 The Multiplier Method
 The Market Research Method
 Taguchi Quality Loss Function
11 -15
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.
11 -16
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.
11 -17
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.
The Taguchi Quality Loss Function
$
Cost
Lower
Specification
Limit
Target
Value
Upper
Specification
Limit
11 -18
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
11 -19
11 -20
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
Quality Cost Report
For the Year Ended March 31, 2004
Prevention costs:
Quality training
Reliability engineering
Appraisal costs:
Materials inspection
Product acceptance
Process acceptance
Internal failure costs:
Scrap
Rework
External failure costs:
Customer complaints
Warranty
Repair
Total quality costs
11
-21
11-22
Quality Costs
% of Sales
$35,000
80,000
$115,000
4.11%
$20,000
10,000
38,000
68,000
2.43
$50,000
35,000
85,000
3.04
$25,000
25,000
15,000
65,000
$333,000
2.32
11.90%
11 -22
Relative Distribution of Quality Costs
External
Failure
(19.5%)
Internal
Failure
(25.6%)
Prevention
(34.5%)
Appraisal
(20.4%)
11 -23
Quality Cost Graph
Total
Quality
Costs
Cost
Failure Costs
Control Costs
0
AOL
Percent Defects
100%
11 -24
Contemporary Quality Cost Graph
Cost
Total
Quality
Costs
Failure Costs
Control Costs
100
%
0
Percent Defects
Trend Analysis
11 -25
Assume the following data:
2000
2001
2002
2003
2004
Quality Costs
$440,000
423,000
412,500
392,000
280,000
Actual Sales
$2,200,000
2,350,000
2,750,000
2,800,000
2,800,000
% of Sales
20.0%
18.0
15.0
14.0
10.0
Multiple-Period Trend Graph:
Total Quality Costs
% of
Sales
20
15
10
5
0
1
2
3
Year
4
5
11 -26
Multiple-Trend Analysis for
Individual Quality Costs
Assume the following quality cost data:
2000
2001
2002
2003
2004
1Expressed
Prevention
Appraisal
Internal
Failure
2.0%1
3.0
3.0
4.0
4.1
2.0%
2.4
3.0
3.0
2.4
6.0%
4.0
3.0
2,5
2.0
as a % of sales
External
Failure
10.0 %
8.6
6.0
4.5
1.5
11 -27
Multiple-Period Trend Graphic:
Individual Quality Cost Categories
11 -28
Percentage 10
of Sales
9
8
7
6
5
4
3
2
1
0
Prevention
Appraisal
Internal failure
External failure
0
1
2
3
4
Year
Productivity: Measurement
and Control
Productivity is concerned
with producing output
efficiently, and is it
specifically addresses the
relationship of output and
the inputs used to produce
the outputs.
11 -29
Productivity: Measurement
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.
11 -30
11 -31
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:
Labor
Capital
4
Outputs:
6
11 -32
Technical Efficiency
Same Output, Fewer Inputs
Inputs:
Outputs:
Labor
3
6
Capital
More Output, Same Inputs
Inputs:
Outputs:
Labor
Capital
4
8
11 -33
Technical Efficiency
More Output, Fewer Inputs
Inputs:
Outputs:
Labor
3
8
Capital
Technically Efficient Combination I:
Inputs:
Outputs:
Labor
3
Capital
$20,000,000
8
11 -34
Technical Efficiency
Technically Efficient Combination II:
Inputs:
Outputs:
Labor
2
Capital
$25,000,000
8
Of the two combinations that produce the same output,
the least costly combination would be chosen.
11 -35
Partial Productivity 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.
11 -36
Profile measurement provides a
series or a vector of separate and
distinct partial operational measures.
11 -37
Profile Productivity Measures
Example 1:
The productivity of both labor labor and materials
moves in the same direction:
Number of motors produced
Labor hours used
Materials used (lbs.)
Labor productivity ratio
Material productivity ratio
2003
120,000
40,000
1,200,000
2004
150,000
37,500
1,428,571
150,000/37,500
Partial Productivity Ratios
150,000/1,428,571
2003 Profile
2004 Profile
3.000
0.100
4.000
0.105
11 -38
Profile Productivity Measures
Example 2:
Assume the same data as Example 1 except the material
used is 1,700,000 pounds.
Number of motors produced
Labor hours used
Materials used (lbs.)
Labor productivity ratio
Material productivity ratio
2003
120,000
40,000
1,200,000
2004
150,000
37,500
1,700,000
150,000/37,500
Partial Productivity Ratios
150,000/1,700,000
2003 Profile
2004 Profile
3.000
0.100
4.000
0.088
11 -39
Profit-Linked Productivity
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
11 -40
Profit-Linked Productivity
Measurement
Example: Kunkul provided the following data:
2003
Number of motors produced 120,000
Labor hours used
40,000
Materials used (lbs.)
1,200,000
Unit selling price (motors)
$50
Wages per labor hour
$11
Cost per pound of material
$2
2004
150,000
37,500
1,700,000
$48
$12
$3
11 -41
Profit-Linked Productivity
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)
Cost of materials: (1,500,000 x $3)
Total PQ cost
$ 600,000
4,500,000
$5,100,000
The actual cost of inputs:
Cost of labor: (37,500 x $12)
Cost of materials: (1,700,000 x $3)
Total current cost
$ 450,000
5,100,000
$5,550,000
11 -42
Profit-Linked Productivity
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.
Price-Recovery Component
11 -43
The difference between the total profit change and the
profit-linked productivity change is called the pricerecovery component.
2004
Revenues
Cost of inputs
Profit
$7,200,000
5,550,000
$1,650,000
2003
Difference
$6,000,000 $ 1,200,000
2,840,000 2,710,000
$3,160,000 $-1,510,000
Price recovery = Profit change – Profit-linked productivity change
= $1,510,000 – $450,000
= $1,060,000
11 -44
Chapter Eleven
The End
11 -45