NEW BOOST TO QUALITY COSTING: FROM EX POST
FAILURE APPRAISAL TO PROACTIVE PRODUCT AND
PROCESS IMPROVEMENT
Mikko Varila, Petri Suomala and Ilkka Jokioinen
Cost Management Center
Tampere University of Technology
Institute of Industrial Management
P.O. Box 541, FI-33101 Tampere, Finland
mikko.varila@tut.fi
ABSTRACT
This study reports a one-year research project the aim of which was to broaden the
scope and perspective of quality costing in a single organisation. The case research
method was applied, including several interviews and an analysis of quality cost data
from a period covering almost ten years. As a result of the project, a quality costing
system and a balanced measurement framework were created. The objective of this
paper is to discuss the needs and challenges of quality costing and measurement in an
industrial organisation. Thus, the paper refines the existing research on quality
costing, which is characterised by only few practical examples. In order to avoid
being only a means of ex post appraisal of failures, quality costing should concentrate
on how to avoid quality costs in the future. The paper demonstrates that the average
quality costs of an organisation for a given period of time can be roughly predicted
based on various indicators of volume and difficulty. This would help in setting
realistic targets but would also start a series of preventive actions. The paper suggests
that proactive quality cost information on risky customers and market areas, difficult
projects, failure-prone products, weak suppliers and other bottlenecks should be
delivered to various parts of the order-delivery process to help in predicting quality
risks and preventing them from occurring.
1
INTRODUCTION
Although quality costing has aroused a lot of interest at the theoretical level, practical
achievements in this area have remained rather modest in companies. Quality cost
functions (e.g. Ittner 1996; Anderson and Sedatole 1998; Schiffauerova and Thomson
2006) are an example of an extensive field of research which has not produced any
significant tools or improvements in practice. Furthermore, the variety of quality cost
measures has remained narrow, examples of the practical use of these measures are
scarce and the validity of these measures for decision makers has not been seriously
discussed (Mandal and Shah 2002). In fact, surprisingly few companies even report
quality-related costs (Oliver and Qu 1999). As a result of this trend, quality costing is
in danger of falling into the category of things that are “measured just for the sake of
measurement”.
1
One reason for the questionable progress of quality costing may be that it has
traditionally concentrated on monitoring and measuring the costs afterwards. In the
survey by Oliver and Qu (1999), the fact that they are regarded as a “history report”
was one reason why quality costs were not measured in companies. In the quartal
economy in which especially public companies are struggling in the focus of
shareholders and other stakeholders it is increasingly important to improve the
estimation of profits. Quality cost estimation and making allocations to prevent them
in order to buffer the budgeted economic result is one part of this estimation process.
This study reports a one-year research project the aim of which was to broaden the
scope and perspective of quality costing in a single organisation. It is a business unit
of a large Finnish machine building company, operating globally in project business.
Using interventionist case research, both the reporting systems and performance
measures for quality costing were improved. The initial state of the business unit was
typical: quality costs were reported retrospectively on the basis of a few common
aspects, such as products, projects, functions and the business unit as a whole.
Furthermore, the validity of the top-level measure, quality costs per sales, had been
questioned because of an allocation problem due to the long delay between quality
costs and the corresponding sales. The incorporation of more aspects, a more
proactive approach and better consistency with the real processes were desired.
From the very beginning, representantives of as many functions as possible – e.g.
quality, accounting and finance, sales, procurement and project management – were
involved in the project to ensure that the knowledge and needs of different interest
groups were taken into account. The actual project team consisted of the quality
manager, a quality engineer, the accounting and finance manager and two researchers.
Several interviews were carried out, including those with project managers and sales
persons. In these interviews, the sources of quality problems, the means of
overcoming them and possibilities to utilise quality cost data were considered. In
addition, quality cost data including thousands of quality feedbacks was analysed
from a period covering almost ten years (1997-2006). The analysis covered such
aspects as products, projects, various actors in the value chain and the temporal
aspect. As a result of the project, a quality costing system and a balanced
measurement framework were created.
The objective of this paper is to discuss the needs and challenges of quality costing
and measurement in an industrial organisation. The paper aims at refining the existing
research on quality costing, which is characterised by only few practical examples
(Mandal and Shah 2002; Schiffauerova and Thomson 2006).
2
LITERATURE REVIEW
2.1 Definitions and categorisations of quality-related costs
Quality-related costs have been referred to by many names: quality costs, cost of
quality, cost of poor quality and failure costs. In addition, many definitions of their
content exist. Whereas some definitions, such as “the costs that would be eliminated
2
if all workers were perfect at their jobs” (see e.g. Rust 1995), are quite philosophical,
more analytical classifications are needed for actually measuring and analysing these
costs. A good starting point is to divide quality-related costs into the costs of
conformance and nonconformance (Crosby 1979). Costs of conformance are costs
incurred to make sure the product or service is right the first time. They are needed to
implement and maintain a system that aims at eliminating deficiencies, achieving
products with perceived quality, and in that way ensuring conformance to quality
standards. The costs of nonconformance are incurred to correct a problem or
irregularity. Thus, they compensate for nonconformance to quality standards. It can
also be said that costs of conformance are incurred because poor quality can exist and
costs of nonconformance because poor quality does exist (Albright and Roth 1992).
An even finer classification of quality-related costs is the traditional PAFF model (see
e.g. Feigenbaum 1961; Juran and Gryna 1993), which divides quality costs into
prevention, appraisal and (internal and external) failure costs (see Table 1). Most of
the recent quality cost literature refers to this classification at least at some level.
Since the introduction of the categories of quality-related costs, there has been a
constant debate concerning the dependencies between the different cost types.
Traditionally, it has been claimed that there is an inverse relationship between
prevention and appraisal costs and internal and external failure costs. Accordingly,
there is “economic conformance” – an optimal proportion of preventive and
corrective costs (Morse 1983). A newer continuous-improvement approach argues
that “quality is free” and may be achieved through effective quality programmes
without increasing investments in preventive activities to infinity (Ittner 1996;
Anderson and Sedatole 1998).
Table 1: Categorisation of quality-related costs (see e.g. Feigenbaum 1961; Crosby 1979; Juran
and Gryna 1993).
Top-level category
Costs of conformance
PAFF category
Prevention costs
Definition
Investments in machinery, technology and
education programmes designed to reduce
the number of defective products in the
production process
Monitoring or inspection costs of products
before they are released to customers
Failure costs incurred when defects are
discovered before the product is shipped or
the service is delivered to the customer.
Failure costs incurred after delivery of
defective goods or services
Appraisal costs
Costs of nonconformance
= the cost of poor
quality
Internal failure costs
External failure costs
Whichever of the aforementioned approaches is adopted, costs of conformance and
nonconformance are very different as cost objects. Whereas most costs of
conformance are inherent in processes designed to deliver something, costs of
nonconformance are highly unpredictable and desired to be kept at a minimum.
Basically, there must be some costs of conformance in the company to maintain
quality. That may be a reason why especially the cost of poor quality still seems to
receive more attention in the research regarding quality-related costs. In this study, we
3
concentrate on the category of failure costs, costs of non-conformance or the cost of
poor quality (COPQ).
2.2 Measuring quality costs
Despite the slogan “you get what you measure”, only a rather small proportion of
companies report and measure quality costs. Surveys have shown that this proportion
has been around 25-50 % of those companies which have responded (Oliver and Qu
1999; Schiffauerova and Thomson 2006). There has been controversy regarding
whether quality-related costs are worth measuring, because after all they can never be
completely ascertained. However, most researchers have shared the view that
measuring quality-related costs helps in understanding factors affecting quality and in
identifying targets for improvement. For example, a survey by Oliver and Qu (1999)
revealed that the most important objective in reporting quality-related costs is
identifying high-cost problem areas. According to Crosby (1979, pp. 19-20), money is
the common language of management, which is why measuring quality-related costs
makes special sense.
The significance of quality costs is easier to understand when they are proportioned to
an important figure (Crosby 1979, p. 126). Accordingly, typical quality cost measures
are ratios, where total quality costs or part of them are proportioned to a relevant
indicator of volume. The common measurement bases have been reclamation costs,
failure costs, warranty costs or total quality costs in proportion to sales, marketing
costs, variable costs, manufacturing costs or total costs (Uusi-Rauva 1996, p. 3;
Mandal and Shah 2002). In addition, performance measures may include the costs of
preventive quality work and appraisal (Schiffauerova and Thomson 2006). Mandal
and Shah (2002) point out that only a few other types of ratios are discussed, such as
those of internal failure cost to average production costs, warranty costs to sales
turnover, supplier’s appraisal cost to purchased material cost, manufacturing appraisal
costs to production cost and external failure costs to sales turnover. They also criticise
most authors for discussing the subject of defining and categorising quality costs but
skipping over the subject of how to actually measure quality costs.
Schiffauerova and Thomson (2006) recommend that a performance measurement
system should include both “global” and detailed metrics. Global metrics include such
measures as “return on quality” (= increase in profit/cost of quality improvement
programme) and “quality rate” (= (input – (quality defects + startup defects +
rework))/input). Detailed metrics involve of more traditional elements of quality
costs, such as the costs of assets and materials, preventive labour and appraisal labour.
Also product-level information may be highly useful when planning concrete actions
to decrease quality costs. Because everything cannot be measured in monetary terms,
also non-financial measures are often included alongside financial ones. The most
common non-financial measures are % of units rejected, failure %, number of
reclamations and various indexes and scoring methods (Uusi-Rauva 1996, p. 54). An
important measure in the light of customer-oriented quality thinking is also customer
satisfaction.
4
2.3 Challenges of quality costing in project business
Research in the field of quality costs has been active in manufacturing business,
especially in mass production. This is natural, because it is rather well known how to
assess the quality of repetitive tasks and mass products. The situation is very different
in project business. By definition "a project is a temporary endeavor to create a
unique product, service or results" (Project Management Institute 2004). Project
business has been defined as “the part of business that relates directly or indirectly to
projects, with a purpose to achieve objectives of a firm or several firms” (Artto and
Wikström 2005).Uniqueness makes it difficult to measure the results of projects
objectively. There has been hardly any quality cost -oriented research with the focus
on project business, except for some studies related to construction business (e.g. Low
and Yeo 1998; Josephson and Hammarlund 1999; Barber et al. 2000; Love and Irani
2004). However, most of these studies discuss only which costs should be classified
as quality costs and how. Only a few actual costing systems or measures have been
proposed.
Quality cost functions have received a lot of attention in mass production (e.g. Kim
and Liao 1994; Sedatole 2003). In traditional cost functions, a measurable parameter
has to remain within tolerance limits, whereas the Taguchi model assumes that all
deviation from the optimal value is waste and the function has a hyperbolic shape
(Sedatole 2003). In terms of delivery projects, it is difficult to come up with one fixed
and measurable parameter, or even a small number of parameters, that could
determine the quality of a project. This is because a project is typically more complex
than a product or may even include multiple products. Thus, quality costs have often
been assessed qualitatively in project environment, because quantitative data is rarely
available from unique projects. For example, Malmi et al. (2004) demonstrated that
using three-stage workshops helps in determining the biggest sources of improvement
in the case of quality costs in project environment.
Morse (1983) lists several problems related to reporting of quality costs, including the
subjective nature of a large proportion of the information. A so-called timing problem
is caused by the fact that the effort and the accomplishment are probably not matched
in a single reporting period. Instead, there may be a long time delay between
manufacturing, assembling and delivering a product and the perception of its quality
costs. In addition, variations in activity may reduce the comparability of quality costs
from different periods. This may not be a problem from the financial perspective, but
improving quality requires identification of cause and effect relationships and thus
proportioning quality costs to underlying volume is necessary. However, because of
the aforementioned factors it is debatable what this volume is and in which period of
time it has been achieved. These problems are emphasised in project business, but
they are also valid in the case of mass products if the life cycles are long and there is
some heterogeneousness in production processes.
Shank and Govindarajan (1994) add that conventional reporting does not typically
help quality management and that thus specific quality cost reporting is needed. They
also suggest using nonfinancial measures as a support to quality costing in boosting
an immediate response to quality problems. In the survey by Oliver and Qu (1999),
lack of support/resources coupled with problems in creating a parallel register for
5
collecting quality-related costs were also the most important reasons for the absence
of measurement.
3
VIEWS ON QUALITY COSTS IN THE CASE ORGANISATION
3.1 Overview of the organisation and its current quality costing practices
The research project was carried out within a business unit of a large Finnish
company. The business is project-oriented and the projects are carried out both
individually and as parts of the parent company’s deliveries. The business unit has the
following main functions: R&D, sales, projects, engineering, purchasing and service.
The unit has its own production, which is basically an assembly workshop, but it
utilises also other suppliers, depending on the destination of project deliveries. The
project business is internationally networked inside and outside the organisation.
As regards quality costs, the business unit has limited itself to the registering of
internal and external failure costs. Internal failures refer in this case to quality
problems perceived by the business unit itself during the execution of a project, which
lasts approximately one year. Most of the internal failures are observed in installation,
and the cause is often engineering or installation itself. External failures are perceived
mainly by the customer during the two-year guarantee period after the project.
Problems are most often related to the functioning of a product or a process. When a
quality problem is observed, feedback is given. The failure receives a work number to
which the costs of fixing the problem are assigned.
The business unit has a rather advanced quality failure costing system. Each time a
quality failure is observed, feedback is given and the direct costs of fixing the
problem are assigned to a failure-specific work number. Feedback is supplied with
manifold information, which is intended to provide help in discussing quality costs
from as many perspectives as possible. Registered information includes basic
information on the project (product line, customer, destination, sales price), product
and product family, the activity/department that caused the failure, a description of the
failure and the costs incurred. During the research project, the researchers had access
to all these data.
Ex ante evaluations of quality risks in projects are mostly carried out by intuition and
actual risk analyses are seldom made. In the opening meeting of a project, the most
substantial elements of previous quality feedback related to similar types of projects
are examined. During the project, quality costs are monitored and discussed in
meetings – especially if they are considered to involve “a serious quality defect”,
which means that they are responsible for particular damage to the customer or
personal injury. According to project managers, it is possible to make project
personnel more aware of quality of operations even during a project. The biggest
source of demotivation in managing quality risks was seen to be that actions are not
carried all the way through. Issues are debated, but nothing really happens. A formal
evaluation is sometimes performed just for the sake of complying with instructions
and in such cases the results are usually poor. More pressure was called for especially
at the sales phase, where most risks are identified and determined. During projects,
6
various top5 lists, check lists and databases were considered to help in recalling
possible risks. Also, classifying risks into finer categories was seen to lead to better
understanding of them.
The following subchapters provide insight into the organisation’s quality costs from
the different perspectives of products and projects, different actors in the value chain
and time. The comments are based on interviews with project managers and
salespersons.
3.2 Products and projects are different
Even unique projects in the organisation involve products. Quality costs can be
looked at from the perspective of specific products or broader product families. In
general, some products involve more difficult construction and therefore tend to cause
more quality costs than others. Especially noteworthy in terms of quality costs are
new products. This is due to the fact that the requirements, the resources needed and
the risks are difficult to estimate because experimental information is not available.
New products can be tested to minimise the operational risks, but laboratory tests are
not always comparable with real-life applications. The sales department was blamed
for offering new products without adequate experience of their behaviour. On the
other hand, sometimes such new products are offered consciously in mutual
understanding with the customer, because references are needed. Thus, while the
rapid introduction of new products is desired, it is difficult to estimate when a product
is mature enough.
On the basis of the information in the quality cost database, projects containing new
products were compared with those that did not contain them. The comparison was
enabled by the fact that the name of a new product is commonly reported when giving
feedback on quality. Table 2 shows the differences between the two types of projects.
As can be noted, quality costs are on average three times higher in the projects that
contain new products. The number of feedback responses on quality in new product
projects is also three times higher. Naturally, it is impossible to draw an exact line
between which problems are caused by new products and which by old products.
However, the comparison suggests that new products are significant drivers of quality
costs in the organisation.
Table 2. The effect of new products on quality costs.
New products in the project?
Yes
Number of projects
Number of feedback responses on quality
Number of feedback responses on quality per project
Sum of quality costs
Quality costs per project
No
66
179
1 441
1 317
22
7
3,4 M€
3,1 M€
52 000 €
17 000 €
Some projects are more difficult to follow through than others. This may be due to the
in-built characteristics of the project, such as project type (new investment, re-build,
7
Quality costs % of sales
improvement) or a difficult application. Other challenges may be caused by the
operations of the personnel involved in the project organisation: project manager,
project sales, other project personnel and subcontractors. A comparison of quality
costs by project types (Figure 1) revealed that especially re-build and improvement
projects are problematic in terms of quality. This finding was in line with the feelings
in the quality department. Because there is typically an increase in the size of
products, it is difficult to accommodate such new products with the old production
systems. Also, previous technical drawings may no longer be usable.
External
failures
Internal
failures
Re-builds and improvements
New investments
Figure 1. Quality costs as percentages of sales by project types.
3.3 Value chain has multiple needs
The value chain in the delivery projects is long and consists of many actors. Each of
these has an effect on the quality of the project and the end product. The customer
perspective on quality is twofold. According to current philosophies on quality,
customer is the one who ultimately decides what quality is. On the other hand, the
customer may also connive at the emergence of quality problems, for example by
being negligent in communication, by providing the contractor with false or
inadequate information, by neglecting operational or maintenance instructions or by
making changes by oneself.
Many quality problems in the organisation are internally ascribed to the customer
even though the customer cannot always be charged with the cost of removing them.
Experience shows that customers in developed countries typically have more
methodicalness and long-term cumulative knowledge regarding production processes
than customers in less developed countries. On the other hand, customers in
developed countries are typically more demanding. Cultural differences and language
problems may lead to misunderstandings and thus create quality problems. In some
cultures, complaining is avoided for fear of “losing face”. Figure 2 offers an example
of regional differences in terms of quality costs. According to the salespersons, these
differences have diminished during recent years because “the world has become
smaller”. However, they were still perceived to affect the riskiness of projects.
8
Quality costs % of sales
Sometimes even personal relationships with the customer count, because close
cooperation is a necessity in this industry.
External
failures
Internal
failures
Finland
China
Figure 2. Quality costs as percentages of sales in Finland and China.
Project sales occupy a crucial position because they operate as a link between the
customer and the organisation. Although it was argued that quality failures are
difficult to avoid, sales can counteract their occurrence by considering the customers’
performance requirements and standards and taking them into account in pricing the
project. Even though a risk analysis is mandatory, it is typically carried out based on
an intuition or on risk analyses of previous projects. The capacity situation is always
checked, but there is a temptation to sell a project even when capacity was
insufficient.
During the execution of a project, the greatest challenges were connected with the
ability of engineering to understand the project as a whole. In addition to functioning
properly, a product must suit the customer’s facilities and be logistically viable. The
aforementioned negligence regarding capacity inspection may lead to a shortage of
resources, delayed tasks and deliveries and general hurriedness during the execution
of a project. Project managers play an essential role in balancing a project, in ensuring
the availability of resources and in seeing that schedules are met. Also, based on their
experience, they should try to detect possible sources of quality problems for the
project personnel to consider. Even though projects and failures are unique, there are
issues that are encountered time after time.
Suppliers are important in terms of quality, because they are responsible for the
quality of the purchased materials as well as the outsourced activities. The
organisation is sourcing all manufacturing, assembly and logistics, as well as some
engineering, from subcontractors. Engineering is responsible for most quality costs.
Especially outsourced engineering is prone to quality failures because subcontractors
may not have enough experience of the product. The quality costs in the organisation
are not monitored at the level of individual suppliers and thus assigning costs to them
was impossible. The interviewees were of the opinion that a new supplier – especially
a foreign one – is always a quality risk. However, these risks must often be taken
when it is included in a contract in foreign trade that local suppliers must be utilised to
a certain degree. On the other hand, it was admitted that failures in purchasing and
9
subcontracting are often one’s own fault; for example, one may not have provided the
supplier with enough information.
3.4 Lifecycle view of quality costs
In addition to the factors discussed above, it is essential to analyse quality costs from
the lifecycle perspective. In the case of a single project, such an analysis would
typically involve a period of several years. A project starts with an offering phase,
which often includes planning and pre-engineering. Preparation lasts typically a year,
or even longer, before the delivery contract is made and execution of the project
begins. Execution consists of several sub-phases and lasts from less than a year to one
and a half years – depending on the project type. Improvements on previous delivery
projects may be completed in a rather short period of time, but full-scale deliveries of
completely new or re-built products may take very long. Figure 3 below gives a rough
idea of the lifecycle of a typical middle-sized delivery project. Quality problems may
occur and they may also be identified in several phases of a project.
Lifecycle of a project
Year 1
Year 2
Year -1
Year 3
Test run
Planning and
preengineering
Project
execution
Full usage
Take over
Delivery contract
Start-up
(2 years guarantee period)
New products
Capacity
Subcontracting
etc.
Invoicing
Internal failure
costs
External failure
costs
Time
Figure 3: Lifecycle of a typical delivery project.
From the viewpoint of cash flows, the invoicing of a typical project takes the form of
an ”S-curve”. Especially in the case of large projects, a partial debiting method is
used. Even when internal failures occur, the process of dealing with them and fixing
the problem causes delay. That is why the internal failure costs are centred at the end
of, or even a bit after, the execution phase. External failure costs occur within the twoyear guarantee period after execution. Customers typically make reclamations at the
beginning of the guarantee period when failures are observed, and at the end of it
when they are trying to derive full advantage from the guarantees. However, all
10
invoicing does not lead equally to quality costs. Rather, several factors discussed
above affect them. A small project in terms of invoicing may cause proportionally
considerably more quality costs than a big one, which is why also the number of
projects under construction should be considered. As was noted above, the re-build
type of projects and projects with new products are more challenging. Engineering
hours and the number of personnel in different functions are rough estimates of the
general volume. Failures are more likely to occur when the work load is high, which
can be indicated for example by such measures as the number of engineering hours
and of tasks which are behind time. Common to all these measures is that they affect
the probability with which quality failures occur during the project and are later
realised as quality costs.
When individual projects are piled together, the effects of the aforementioned factors
can be examined at the organisational level. It could be seen visually that a rise in
invoicing, for example, led to a similar rise in quality costs after some delay. In the
case of internal failure costs, this delay was rather short, but regarding external failure
costs the delay was as much as 2-3 years. The same applies also to the number of
projects, the percentage of new products of sales, engineering hours, the number of
tasks late and somewhat more weakly to other factors. After visual examination the
effects and time lags between variables were considered with statistical tests. A crosscorrelation analysis of the time series was carried out with SPSS for Windows. The
purpose of the analysis was to determine the time lags between the variables as well
as the most influential variables. Table 3 shows the time lags between each variable
and internal and external failure costs where the correlation is greatest. The time lag is
expressed as the time in months between the phenomenon and costs.
Table 3. The effect of volume and load variables on quality costs.
Internal failure costs
External failure costs
Variable
Time lag
Correlation
Time lag
Correlation
Invoicing
10
0.678
31
0.515
# of projects
6
0.667
28
0.637
Engineering hours
13
0.662
30
0.469
% of new products of sales
16
0.649
38
0.741
# of tasks late
10
0.451
26
0.49
Internal failure costs
0
1
24
0.602
External failure costs
-24
0.602
0
1
1) Each time series has been calculated as a 6-month moving average.
2) Each correlation is significant with the significance level of 0.001.
The results were in line with all the preliminary assumptions regarding project
lifecycle: large volume, difficult projects, new products and heavy burden in general
will eventually lead to higher quality costs. This finding led to two questions. First,
what is the most appropriate point of comparison for quality costs and what is the
delay? Second, if correlations exist and quality costs occur with a delay, could the
future level of quality costs be predicted to some degree?
Time lags are also the possible source of a timing problem in performance
measurement. The organisation needs an overall quality measure to obtain a general
view of its quality-producing ability. The most actively used measure for this purpose
is quality cost as a percentage of sales, divided into internal and external failure costs.
11
This measure is calculated monthly. The biggest problem with the current quality cost
performance measure is that the numerator and denominator of the ratio are not
derived from the same project gamut. Because of the long lifecycle of a project, its
quality costs and invoicing are not likely to be compared within a single month. As a
result, the ratio does not proportion quality costs to a relevant indicator of volume,
even though it is intended to do so. This problem has resulted in uncertainty
concerning what the measure actually describes or whether it describes anything. On
the one hand, a cost per sales ratio is practical because of its clarity, but on the other
hand, it gives little information on the actual quality-producing ability of the business
unit.
4
DEVELOPING THE QUALITY COSTING SYSTEM
4.1 General framework
On the basis of the findings described in the previous chapter, the quality costing
system of the organisation was improved in terms of the classification of feedback on
quality, the storing, analysis and reporting of data, the framework of performance
measurement and individual measures. The purpose of the improvement was to
provide the organisation with extensive and valid tools with which to support the
entire value chain while conducting projects and to prevent quality failures. In this
section we introduce the general framework for performance measures and then in the
following subchapters describe its use in managing operations.
Figure 4. Framework for the quality measures in the case study.
The general framework consists of three dimensions: products and projects, value
chain and time (see Figure 4). The block “products” is concerned with long-term
problems related to technical specifications, whereas the block “projects” must also
12
take the current risks with certain types of projects into account. The value chain
dimension is intended for the analysis of the effect on quality of the various actors in
the different parts of the value chain. The time dimension is concerned with learning
from history, monitoring current operations and preparing for the future. The structure
of the performance measurement framework is such that the measures in the centre
are intended to be used in everyday operative management. The measures in the
branches are more detailed and intended for planning preventive or corrective actions.
An essential factor in developing the measurement system was that it is not just a
means of ex ante evaluation of past quality. Instead, it was intended to support
activities in different phases. As is illustrated in Table 4, there can be unit-level
forecasting that gives initial signals regarding possible upswings in quality costs.
Project-level analyses can be divided roughly to those carried out in project sales and
project execution. Finally, there is ex post analysis that focuses on historical aspects
and learning from the past. These phases and their contents are described in more
detail in the following subchapters.
Table 4. Phases of quality management based on the new framework.
Phase
1. Unit-level forecast
Purpose
Initial signals regarding the quality
in the future
Evaluating the risks and
desirability of a project. Budgeting
for quality costs. Pricing a project.
Methods
Probability distribution based on a
few volume variables.
Rough statistical information on
quality costs of the project types,
products, customers and market
areas.
3. Project execution
Preventing quality failures from
emerging. Offering examples and
inspiration on common quality
problems.
Exact product-, project-, customerand area-specific information.
Top5 and check lists.
4. Ex post evaluation
Analysing the realised quality
costs. Learning from the past.
Detailed analysis of quality costs
at the levels of projects, products
and activities.
2. Project sales
4.2 Unit-level forecast – initial signals
The starting point for the quality improvement effort is a signal of an upswing in
quality costs. On the basis of the results in Chapter 3.4, the changes in quality costs
can be anticipated from the perceived factors of volume and difficulty. For example,
if there is the highest correlation between the invoicing and the internal failure costs
with a time lag of ten months, these failure costs are predicted on the basis of
invoicing ten months earlier. Similar logic is used in the case of other variables. The
selection of variables was based on both strength of correlation and availability of
information. The forecast was carried out by means of linear regression separately for
internal and external failure costs. Expressed as a formula, the predictions E[x(t)] for
the two types of quality costs are:
E[Internal failure costs (t)] = A + B · Invoicing (t-∆tinv-ifc) + C · # of
projects (t-∆t#op-ifc) + D · % of new products of sales (t-∆t%onpos-ifc)
13
E[External failure costs (t)] = E + F · Invoicing (t-∆tinv-efc) + G · # of
projects (t-∆t#op-efc) + H · % of new products of sales (t-∆t%onpos-efc) + I ·
Internal failure costs (t-∆tifc-efc)
2StDev (95%)
1StDev (68%)
Forecast
08
1/
20
07
1/
20
06
1/
20
05
1/
20
1/
20
04
Quality costs € per month
In the formula, t is the period of time and ∆ti-x is the delay between the factor i and the
quality cost type x in months. A-I are constants which multiply the values of the
variables so that the error of the estimate is minimised. Regression analyses provided
good explanatory power: for internal failure costs it was 66 % and for external failure
costs 85 %. Some coefficients were not significant in multiple regression because
there was some correlation also between the independent variables. The results can be
expressed for example in the form of a probability distribution for each period of
time, as is done in the case of external failure costs in Figure 5. The black line
concentric to the dotted areas is the actual prediction. The darker dotted area
represents the values within one standard deviation and the lighter dotted area those
within two standard deviations of the mean values. The “Realised” grey line is the
actual development of external failure costs.
Realised
Figure 5. Monthly forecast for external quality costs.
The purposes of use of the predictions are manifold. They provide an initial signal
that quality problems and quality costs are on the increase. This helps in budgeting
quality costs and preparing the organisation to bear the possible financial losses. On
the other hand, they urge personnel to produce better quality when the risk of failures
is high. Finally, they help in evaluating the historical development of quality costs: if
they do not stay in the “pipe”, something abnormal has happened.
4.3 Project sales and execution – managing the risks
As seen from the interviews with project personnel, the sales phase is very important
in terms of mapping the potential sources of quality problems in a project. Sales itself
14
called for a checklist of typical risks that should be gone through when making each
sales deal. In terms of customer- and area-related risks, sales should check whether
especially high quality costs have occurred in previous projects. Furthermore, special
material requirements and processes, factory-specific standards and regulations and
the know-how of the customer should be evaluated. Product-related quality problems
are difficult to anticipate in the sales phase, but specific products with particularly bad
histories in terms of quality costs should be acknowledged. Especially, new products
increase the riskiness of a project. Re-builds and improvements are generally more
difficult project types and this should be reflected in the price if possible. In addition,
capacity must be checked and possible new suppliers noted. Quality risk analysis can
also lead to a quantitative analysis of quality costs, as shown in Figure 6. On the basis
of the historical data, an indicative estimate of a project’s quality costs can be made.
These risks should also be communicated to the project manager and other project
personnel for further analysis during the execution of the project.
PROJECT X
Base quality cost
Quality risks of the business environment
Country
Customer's know-how
Customer's ability to cooperate
Customer's process
Requirements. standards and regulations
Quality risks of products and technologies
Project type
Product line
New product
Fit
Quality risks of project execution
Tight schedule
Capacity situation
New suppliers
Difficult logistics
SWEDEN
Good
Good
Difficult
Very high
Re-build
PL1
New product 1
Hyvä
Yes
Good
Yes
No
Quality cost estimate
1.49 %
1.36 %
1.46 %
-0.20 %
-0.30 %
0.40 %
0.50 %
1.85 %
0.85 %
0.00 %
1.10 %
-0.10 %
2.30 %
2.00 %
0.00 %
0.50 %
-0.20
%
,
7.00%
Figure 6. Quality cost estimate of a project.
During project execution, more detailed information is needed for managing quality
risks. At this phase, the question is how to cope with a risk that has already been
taken. Checklists are utilised also in project execution. Each function – sales,
engineering, purchasing, manufacturing, logistics, assembly and project management
– that is involved in the execution of projects has its own list of quality problems that
are discussed in meetings. These lists consist of the most common sources of failure
at the general level. With the help of the quality cost database it is also possible to
generate more detailed top5 lists from different viewpoints. For example, Figure 7
presents a list of five feedback responses on quality related to a certain new product
which involve the most expensive solutions. The list could help engineering,
manufacturing and assembly in avoiding quality problems related to a new project in
hand. Similar lists can be generated for other new and old products and product
families, customers, countries and project types. The purpose of these lists is to
prevent the most severe quality problems related to a certain issue in a project.
15
Figure 7. An example of a top5 list for project execution.
4.4 Ex post evaluation and measurement of quality-producing ability
Finally, there is a need for post evaluation which is carried out at many levels. Project
quality costs are analysed generally as a percentage of sales. The most severe quality
problems are analysed in more detail case by case. This is carried out by the project
organisation after the completion of a project. The product organisation is interested
in particular products and their accumulated quality costs to prioritise for
improvements. The R&D organisation evaluates the quality costs of new products and
discusses whether new products have been mature enough for sale. However, in terms
of post evaluation, the biggest interest of the quality department was measuring the
quality-producing ability of the whole organisation. As was discussed in Chapter 3.4,
the measurement was challenged by the perceived time lags between invoicing and
quality costs. Therefore, it also aroused a lot of interest during the development of
performance measures.
Many approaches to solve the timing problem were tried. In the first approach,
internal and external failure costs were proportioned separately to invoicing with the
time lags obtained from the correlation analysis. Although it is easy to calculate with
this measure and to understand it, the results may be distorted because the average
time lag does not apply to all projects. The second approach tries to tackle the
problem by taking into account which invoicing actually may cause internal or
external failure costs. Thus, the denominator of the measure would be the invoicing of
the projects under construction (internal failure costs) or warranty (external failure
costs). Although all the projects under construction or warranty are not evenly prone
to cause quality costs, this approach was successful because it automatically directs
attention to the underlying projects and causes of quality problems. Finally, if it is
desired to ensure that quality costs and invoicing are compared from the same
projects, a weighted moving average has to be calculated from project-specific quality
costs per invoicing rates. This measure is reliable, but it requires that the project
should be completed and that the guarantee period should be up be fore the rate can be
calculated. Although all these measures are theoretically reasonable, they give
somewhat divergent results.
16
During the research project, the alternative approaches were evaluated mainly
theoretically and based on the opinions of the quality department. However, since the
research project, the quality department has been following the various measures and
considering their usefulness. Preliminary results indicate that comparing the quality
costs with invoicing of the underlying projects under construction or warranty
provides the biggest potential. The measure does not give dramatically different
results, but it directs attention to the underlying projects and justifies drilling down to
the actual project-specific problems behind the figures. Thus, it promotes discussion
regarding the past failures and how to prevent them in the future.
5
CONCLUSIONS
This paper reported a research project the aim of which was to broaden the scope of
quality costing in a single organisation and promote new perspectives in this area.
However, the authors anticipate that it will also provide some food for thought in
research on quality costing in general. The paper has described some of the needs of a
quality department and other organisational functions with respect to quality. These
needs seem to be highly practical, and thus it seems to be relevant to broaden the
research on quality costing in the direction of needs and challenges in constructing
quality costing and performance measurement systems in practice.
In order to avoid being only a means of ex post appraisal of failures, quality costing
should concentrate on how to avoid quality costs in the future. This is why it needs to
aim at predicting possible quality costs and offering the organisation relevant
information before failures occur. On the basis of the case results, it seems that the
average quality costs of an organisation for a given period of time can be roughly
predicted based on various indicators of volume and difficulty. This would help in
setting realistic targets. Especially it would help in preparing for a possible upswing in
quality costs and determining its cause. Thus, proactive quality cost information could
be delivered to various parts of the order-delivery process and the support functions
for preventive actions. This information would relate to risky customers and market
areas, difficult projects, failure-prone products and sub-components, weak suppliers
and bottlenecks of the process.
The paper suggests that quality costs should be analysed from many viewpoints if
they are to provide proactive and comprehensive information for different interest
groups. This sets multiple requirements and challenges for quality cost reporting, but
on the other hand will increase its usefulness by a quantum leap.
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