MacroEconomics of Quality
Issues
 Why Estimate Cost of Quality Failures?
 Quality Costs are Far Greater than Those that are Readily
Identifiable (Iceberg Principle)
 Gains to be Made if Cut Measured Quality Losses in Half
 How to Reduce Quality Losses
 Rule of “Tens”
 Eradicate Killer Re’s
 Play Offense (Prevention) vs. Defense (Detection)
 Sound Quality Practices
Why Estimate Cost of Quality Failures
Quantify the Cost of Quality Failures for
the Business
Identify magnitude of potential savings
Sensitize Management to the size of the opportunity
Help to re-expose problems we have learned to tolerate
Identify the Highest Loss Areas
Permit Prioritizing the Loss Areas for
Corrective Action
Economics of Quality: TCE Statistics 1994
TV Units Sold
Estimated Revenues
(5 x $500 per set)
Estimated Earnings
(5% of Sales)
5 million
$2.5 billion
$125 million
Economics of Quality: TCE Statistics 1994
Scrap (Measured)
$12 million
Total Cost of Quality
$72 - 600 million
(Measured & Hidden)
Cost of Scrap per TV(12/5)
$2.40 per unit
Total Cost of Quality
(M+H) per TV Sold
(6/1 to 50/1 Iceberg)
% Total Cost of Quality
per TV/Selling Price
(14.40/500 -120/500)
$14.40 - $120
# Defects per TV
?
3% - 24%
Economics of Quality: STB
Systems Statistics 1998
 Units Sold
 Estimated Revenues
6 million
$300 million
(6 x $50 per unit)
 Estimated Net Earnings $16.2 million
(5.4% of Sales)
 Scrap (Measured)
 Total Cost of Quality
(Measured & Hidden)
Cost of Scrap per Unit
(1.875/6)
 Total Cost of Quality
(M+H) per Unit Sold
(6/1 to 50/1 Iceberg)
 % Total Cost of Quality
per Unit/Selling Price
(1.875/50-15.625/50)
 # Defects per Unit
$ 1.875 million
$11.25-93.75 million
Average
$1.875
$52.5
$.3125 per unit
$.3125
$1.875 - $15.625
$8.75
3.75% -31.25%
17.5%
???
Cost of Quality Failures
ICEBERG PHENOMENON
Hidden Costs = 6 to 50 times Measured Costs
Direct/Measured Costs:

Scrap/Rework

Service Calls

Warranties/Concessions
Indirect/Hidden Costs:

Excess Inventory

Overtime

Reputation/Image
Cost of Quality Failures
Worksheet
FAILURE COST CATEGORIES
ESTIMATED
ANNUAL COSTS
$(000)
MEASURED COST OF QUALITY
 Internal
 Waste, Scrap
 Rework
 Reinspect
____________________
____________________
____________________
 External
 Warranties
 Guarantees
 Concessions
____________________
____________________
____________________
TOTAL MEASURED __________________
HIDDEN COST OF QUALITY
Internal
 Troubleshooting and failure analysis
 Evaluation to determine usability of off
specification material
 Engineering changes, redesign, buy-offs
 Costs of reviewing quality problems
(i.e.,replanning, meetings, expediting,
firefighting, reports, etc.)
 Inventory costs on held material
 Overtime because of quality problems
 Late shipment premiums (delayed collections)
 Material handling
 Tool & fixture redesign
 Machine wear
 Fringe benefits on labor
 Loss of productivity due to rework, scrap
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
__________________
HIDDEN COST OF QUALITY
External
Loss of market share due to poor quality reputation
Loss of profitability
Loss of bond credit rating
Other
____
____
____
 ______________________________________________
 ______________________________________________
 ______________________________________________
 ______________________________________________
_____
_____
_____
Total Hidden
Grand Total
____
____
WHAT IF ???
We could cut losses in half?
1/2 x $12,000,000 …………………......$6,000,000
If ICEBERG is between 6/1 to50/1……$36,000,000
to $300,000,000
Total TCE net earnings in 1994 were?
WHAT IF???
 We could cut losses in half?
 1/2 x $1,875,000
 IF ICEBERG is between 6/1 to 50/1
$937,500
$5,625,000 to
$26,250,000
$46,876,000
 Total STB Systems net earnings for 1998 estimated to be $16.2 million
Economics of Quality: STB
Systems Statistics (1997 vs. 1998)
1997
$190 million
1998
$300 million
Net Earnings (Income)
(5.4% of Sales)
$10.26 million
$16.20 million
COQ as of % of Sales
10 - 25%
10 - 25%
$19 - 47.5 million
$30 - 75 million
What if COQ cut in half?
(Savings)
$9.5 - 23.75 million
($16.63 million)
$15 - 37.55 million
($26.25 million)
Net Income with Savings
$26.89 million
$42.45 million
Sales
COQ ($)
How to Reduce Quality Losses
Rule of “Tens”
Eradicate Killer Re’s…Waste
Play Offense (Prevention) vs. Defense
(Detection)
RULE OF “TENS”
Not doing it right the first time costs ten
times as much to find and fix each time
errors escape to a subsequent stage of
handling.
$1 Design Effort
=$10 Production Cost
=$100 Assy/Test Cost
=$1000 Field Cost
The Killer Re’s
Readjust
Reapply
Recalibrate
Recertify
Recheck
Recondition
Recycle
Refinish
Reidentify
Reinspect
Relevel
Remearsure
Renormalize
Reorder
Repack
Reprocess
Reprogram
Rerun
Reschedule
Reseal
Reship
Restamp
Resock
Retap
Retest
Return
Reweld
Rewind
Rewire
Rework
Reject (The worst kind)
Computing Cost of Quality
Internal Failure
 Scrap
 Rework
 Scrap/Rework - Supplier
External Failure
 Cost to customer
 Warranty costs
 Complaint adjustments
 Returned material
Appraisal
 Inspection
 Test
 Quality audits
 Test equipment - initial cost
& maintenance
Prevention
 Quality planning
 Process planning
 Process control
 Training
Note: The listed categories provides an understanding of the COQ structure. In
general, COQ is comprised of costs due to failure, appraisal, and prevention.
The Enlightened Perspective
Internal
&
External
Failure
Appraisal
&
Prevention
Old Belief
New Belief
4s
Quality
5s
6s
Sound Quality Practices
Operational Definitions and Standards
(Metrics)
Manage by Fact
“In God we trust. But everyone else must bring data!”
Without good data, everyone is an expert
Focus on Process (Offense) vs Product
Results (Defense)
Reduce Variation
Questions?