15
Quality Costs and
Productivity:
Measurement,
Reporting, and
Control
PowerPresentation® prepared by
David J. McConomy, Queen’s University
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-1
Learning Objectives

Identify and describe the four types of
quality costs.

Prepare a quality cost report and
explain the difference between the
conventional acceptable quality level
(AQL) view and the zero defects view
of quality cost control.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-2
Learning Objectives

Explain why quality cost information is
needed and how it is used.

Explain what productivity is and
calculate the impact of productivity
changes on profits.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-3
Eight Dimensions of Quality








Performance
Aesthetics
Serviceability
Features (quality of design)
Reliability
Durability
Quality of Conformance
Fitness of Use
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-4
Quality Defined

Features (Quality of Design) refer to characteristics
of a product that differentiate functionally
similar products.
–

Example: Compare first class air travel with economy travel.
First Class typically offers more leg room, better meals
and more luxurious seats.
Quality of Conformance is a measure of how well
the product meets its requirements or
specifications.
–
Example: If a Honda Civic does what it is designed to do
and does it well, quality exists. For example, if
economy cars are designed to provide reliable, lowcost, low-maintenance transportation, the desired
quality exists.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-5
Measuring Quality Costs

Prevention costs

Appraisal costs

Internal failure costs

External failure costs
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-6
Examples of Quality Costs
Prevention costs
Appraisal Costs
Quality engineering
Quality training programs
Quality planning
Quality reporting
Supplier evaluation and selection
Quality audits
Quality circles
Field trials
Inspection of raw materials
Testing of raw materials
Packaging inspection
Supervising appraisal activities
Product acceptance
Process acceptance
Inspection of equipment
Test equipment
Design reviews
Outside endorsements
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-7
Examples of Quality Costs
Internal failure costs
Scrap
Rework
Downtime (defect related)
Reinspection
Retesting
Design changes
External failure costs
Cost of recalls
Lost sales
Returns/allowances
Warranties
Repairs
Product liability
Customer dissatisfaction
Lost market share
Complaint adjustment
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-8
Estimating Hidden Quality Costs
Hidden Quality Costs are opportunity
costs resulting from poor quality.

The Multiplier Method

The Market Research Method

Taguchi Quality Loss Function
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-9
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.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-10
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
insights into the magnitude of a company’s hidden
costs.
– Market research results can be used to project future
profit losses attributable to poor quality
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-11
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.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-12
Reporting Quality Costs
Quality Costs
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
% 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 %
65,000
$333,000
=======
2.32%
11.90%
=====
$25,000
25,000
15,000
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-13
Reporting Quality Costs
(continued)
Prevention costs
Internal failure costs
Appraisal costs
External failure costs
19.5%
25.5%
34.5%
20.5%
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-14
AQL Quality Cost Graph
Cost of Failures
Cost
Cost of Control
0
100%
Optional (AQL)
Percent Defects
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-15
Zero-Defect Graph
Total
Quality
Cost
Cost
0
Percent Defects
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
100%
15-16
Multiple-Period Quality Costs
Assume the following data:
Quality Costs
2001
2002
2003
2004
2005
$440,000
423,000
412,500
392,000
280,000
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
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
15-17
Multiple-Period Trend Graph:
Total Quality Costs
% of
Sales
20
15
10
5
0
1
2
3
4
5
Year
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-18
Multiple-Period Total Quality Costs
Total Quality Costs as a % of Sales
25
Column 2
%of Sales
20
15
10
5
0
2001
2002
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
2003
2004
2005
15-19
Multiple-Trend Analysis for
Individual Quality Costs
Assume the following quality cost data:
Prevention
2001
2002
2003
2004
2005
1Expressed
Appraisal
6.0%1
6.0
5.4
5.6
4.4
4.5%
4.0
3.6
3.2
2.4
Internal
Failure
4.5%
3.5
3.0
3.1
3.0
External
Failure
6.0%
4.5
3.0
2.6
2.3
as a % of sales
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-20
Multiple-Trend Analysis for
Individual Quality Costs
External Costs
Internal Costs
Appraisal
Prevention
25
%
of sales
20
15
10
5
0
2001
2002
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
2003
2004
2005
15-21
Productivity: Measurement and
Control
Productivity is the relationship between output and the
inputs used to produce the output.
Total productive efficiency is the point at which
two conditions are satisfied:
1. for any mix of inputs to produce a given output,
no more inputs are used than are necessary
to produce that output
2. given the mixes that satisfy the first condition,
the least costly mix is chosen.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-22
Illustration of Productivity
Improvement
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.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-23
Illustration of Productivity
Improvement
Same output, fewer inputs:
INPUTS
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
OUTPUT
15-24
Illustration of Productivity
Improvement
More outputs, same inputs:
INPUTS
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
OUTPUT
15-25
Illustration of Productivity
Improvement
• Input trade-off efficiency is when a less costly input
mix is used to produce the same output.
• Combination I: Total cost of inputs = $20,000,000
INPUTS
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
OUTPUT
15-26
Illustration of Productivity
Improvement
• Combination II: Total cost of inputs = $27,000,000
INPUTS
OUTPUT
Of the two combinations that produce the same
output, the least costly combination would be
chosen.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-27
Partial Productivity Measures

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.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-28
Partial Productivity Measures
Example 1:
In 2000, Tick-Tock Company produced 100 clocks
and used 200 direct labour hours and 50
kilograms of raw materials. Compute the labour
and materials productivity ratios.
Answer:
Labour productivity ratio
Materials productivity ratio
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
= 100 clocks/200 hours
= 0.5 clocks per hr
= 100 clocks/50 kilogram
= 2 clocks per kilogram
15-29
Partial Productivity Measures
Example 2:
In 2001, Tick-Tock Company produced 100 clocks and used
175 direct labour hours and 40 kilograms of raw materials.
Compute the partial productivity ratios. Compared to 2000,
has productivity improved?
Answer:
A. Ratios computed:
– Labour productivity ratio
–
Materials productivity ratio
= 100 clocks/175 hrs
= 0.57 clocks per hr
= 100 clocks/40 kilograms
= 2.5 clocks per kilogram
B. Ratios compared:
2000
2001
Labour
0.50
0.57
Materials
2.00
2.50
Both ratios have improved, so productivity has improved.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-30
Profile Measurement
Profile Measurement provides a series or a vector of
separate and distinct partial operational measures.
Example:
Kankul implements a new production and assembly process in
2001. Only now let’s assume that the new process affects both
labour and materials. The following data for 2000 and 2001 are
available
2004
2005
120,000
150,000
Labour hours used
40,000
37,500
Materials used (kg)
1,200,000
1,428,571
Number of motors produced
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-31
Profile Analysis with No Trade-offs
Partial Productivity Ratios
2004 Profilea 2005 Profileb
Labour productivity ratio
Materials productivity ratio
3.000
0.100
4.000
0.105
aLabour:
120,000 / 40,000; Materials: 120,000 / 1,200,000
bLabour: 150,000 / 37,500; Materials: 150,000 / 1,428,571
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-32
Profile Analysis with Trade-offs
Partial Productivity Ratios
2004 Profilea 2005 Profileb
Labour productivity ratio
Materials productivity ratio
3.000
0.100
4.000
0.088
aLabour:
120,000 / 40,000; Materials: 120,000 / 1,200,000
bLabour: 150,000 / 37,500; Materials: 150,000 / 1,700,000
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-33
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
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-34
Profit-Linked Productivity
Measurement
Example:
Tick-Tock Company provided the following data for 2000 and 2001:
2000
2001
Production (no. of clocks)
100
120
Selling price
$500
$500
Materials used (kg.)
50
72
Labour hours used
200
228
Cost per kg. of material
$5
$5
Cost per hr. of labour
$10
$10
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-35
Profit-Linked Productivity
Measurement
Compute the profit change attributable to productivity changes.
PQ (materials)
PQ (labour)
Profit change:
Input
= 120/2
= 120/0.5
PQ
= 60 kgs.
= 240 hrs.
PQ x P
AQ
AQ x P
(PQ x P) - (AQ x P)
Mat’ls
60
$ 300
72
$ 360
$ (60)
Labour
240
2,400
228
2,280
120
$2,640
$ 60
$2,700
Profits have improved by $60 because of productivity changes.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-36
Price-Recovery Component and
Gainsharing

The difference between the total profit change and
the profit-linked productivity change is called the
price-recovery component.

Gainsharing is providing to a company’s entire
workforce cash incentives that are keyed to
quality and productivity gains.
Copyright © 2004 by Nelson, a division of Thomson Canada Limited.
15-37