Cost of Quality
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Session 11 - Cost of Quality
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What are Quality Costs?
• A quality product or service is one that
conforms to customer expectations.
– Assume that
• Design specifications are for product
• Product meeting specifications meet customer
expectations
• Can determine adherence to specifications
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• Quality costs are costs incurred because
poor quality may or does exist
• Broad categories of quality costs
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Prevention costs
appraisal costs
Internal failure costs
External failure costs
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Uses of Quality Cost Information
• Alerting executives to potential impact
• Motivating action to improve quality
• Help determine types of activities to reduce
quality costs
• Prioritize quality improvement efforts
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Concepts of Quality
• Common misconceptions
– Productivity and quality are incompatible
– Higher quality can only be obtained at higher cost
• Webster’s Dictionary defines quality as:
– that which makes something what it is; characteristic;
attribute
– basic nature;characteristic; kind
– the degree of excellence which a thing possesses
– excellence; superiority
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Grade, Expectations,
Specifications, and Actual
Results
• Quality - “Conformance to customer
expectation” or “fitness for use”
• Three primary determinants
– Customer expectations
– Product Specifications
– Actual results
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• Grade relates to the difference in customer
expectation between products having the
same functional use.
• Customers compare products having the
same functional use and develop
expectations for the relative performance of
alternative products.
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Designing a New Product
High Grade
Step 1
Customer
Expectation
Step 2
Functional
Specification
Step 4
Step 3
Design
Specification
Manufacturing
Specification
Actual
Results
Low Grade
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Step 1 in the Design of a New
Product
• Restate customers qualitative expectations
into quantitative functional specifications
– Functional Specifications are quantitative
statements regarding the capabilities of the
product
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Step 2 in the Design of a New
Product
• Develop design specifications that meet the
functional requirements
– Design specifications will include statements
regarding the physical characteristics of the
product (engineering drawings)
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Step 3 in the Design of a New
Product
• Develop manufacturing specifications
– Manufacturing specifications specify in detail
how the product is to be produced and what its
physical characteristics should be at each step
of the production process
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Step 4 in the Design of a New
Product
• Manufacture the product using the
manufacturing specifications
– If all steps have been carried out perfectly, the
actual results is a product that meets customer
expectations
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Quality of Design/Conformance
• Ultimate test - compare customer satisfaction with actual
product
– Seldom possible; expectations are qualitative
– Design specification often used as standard
• Two possible sources of error
– Differences between customer expectations and design
specification
– Differences between design specifications and the
actual product
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Quality of Design
• Refers to the degree of conformance
between customer expectations and design
specifications for product
• Ensuring conformance is critical to proper
evaluation of product quality
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Quality of Conformance
• Degree to which a product or service
conforms to its design specification
– If specification allows no dents
– If specification allows one 1/2” scratch
– What about customer?
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Determination of Grade
• Decisions regarding grade are based on
– Organizational choice
– Market identification
• Higher grade is attained at greater cost
to producer and consumer
• High grade does not ensure high
quality or high conformance
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• If “quality” refers to grade
– positive correlation with cost
• If “quality” refers to conformance
– negative correlation with cost
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Productivity
• A measure of the efficiency of resource use
– Not the same as production - volume of output
– Ratio of outputs to inputs
• Increased productivity is the source of increases in
real wealth
• Changes in national productivity
– Government policy
– Management decisions
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Improving Quality Through
Quality
• The relationship between quality of
conformance, productivity, and
production costs
– Higher quality of conformance - lower
rejection rates
– Lower rejection rates - less waste of
materials, labor, and/or equipment time
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Quality, Productivity, and
Profitability
Lower Unit
Costs
Increased
Quality
Lower Unit
Costs
Higher Selling Price
For Quality Premium
Selling Price
Unchanged
Higher Margin
Higher Unit
Margin
Increased Profit
Consistent Sales
Volume
Increased Profit
Higher Sales
Volume
Lower Unit
Costs
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Lower
Selling
Price
Increased Sales
Volume
Session 11 - Cost of Quality
Increased Profit
Increased Profit
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Profitability
• Quality costs - basis for evaluating
investments in quality programs
– Cost Improvement
– Profit Enhancement
– Other Benefits
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Why Measure Quality Costs?
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Dollars can be added across departments/products
Total dollars more meaningful to top management
Helps identify quality problems and opportunities
Helps evaluate relative importance of quality
programs
• Demonstrate the worth of improvement programs
• Aid in budgeting quality costs
• Evaluate company’s success in achieving quality goals
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Quality Cost Reports
• Periodic summaries by:
– Organization unit
– Product
– Other segments of interest
– Organization as a whole
• Prepared
– Monthly
– Annually
– Other period of time
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• Reports may contain
– Data for current period
– Data for corresponding period last year
– Budgeted quality costs for current period
– Year-to-date information
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Quality Cost Trend Analysis
• Pie chart shows relative cost
distribution for a single period
• Bar/line charts better for showing
changes with time
• Trends of more interest to management
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Quality Cost Trend by
Quarters
Dollars (x 1000)
Cost of Quality
400
Series4
200
Series3
0
Series2
1
2
3
4
Series1
Period
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Relating Quality Costs to the
Level of Activity
• Changes in level of activity can make
interpretation difficult
• Restate quality costs as a % of some standard
measure
– Standard manufacturing costs
– Standard direct material
– Standard direct labor costs
– Standard direct labor hours
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Relating Quality Costs to
Financial Performance
• Methods vary widely
– Income statement approach; bottom line
• % of Sales
• % of profit
– Example (Hartford Insurance Group)
• Expressed in terms of labor-hours devoted to each
element
• Then restated in terms of number of persons needed
• Ultimately - number of persons needed because of
poor quality
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Uses of Quality Cost
Information
• Indicating the financial significance of quality costs
• Helping identify relative importance of quality
problems
• Indicating if there is a maldistribution of quality costs
• Establishing goals or budgets for quality costs
• Evaluating the performance of quality improvement
projects
• Evaluating capital expenditure proposals
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Limitations of Quality Cost
Information
• Quality cost measurements do not solve quality
problems
• Quality cost reports do not suggest specific actions
• Quality costs are susceptible to short-term
mismanagement
• It is difficult to match effort and accomplishment
• Important costs may be eliminated from reports
• Inappropriate costs may be included in reports
• Many quality costs are susceptible to measurement error
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Twelve Steps to System Installation
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Obtain management commitment and support
Establish an installation team
Select a single organization segment as a prototype
Obtain cooperation and support of the users/suppliers of information
Operationally define quality costs and quality categories
Identify quality costs within each category
Determine sources of quality information
Design quality cost reports and graphs
Establish procedures to accumulate information
Accumulate information, prepare and distribute reports
Eliminate bugs
Expand system
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