Cost of Quality

Cost of

Quality

Running a company by profit alone is like driving a car by looking in the rearview mirror.
It tells you where youve been, not where you are going!
Dr. E. Deming
2

Cost of

Quality

Goal
The goal of a Cost of Quality system is to:
Facilitate Quality Improvement that leads
to operating cost reduction Opportunities.

Cost of

Quality

Definition
The cost difference between present operation and

the possible operation of a business with all systems and employees at 100% performance. The difference between actual revenues and what

revenues could be if all customers were always

satisfied, that is , No Unhappy Customers.
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Cost of
Cost of Quality is Not:

Quality

An Exact Cost.
It is a Performance Measurement.

Cost of Quality
Iceberg
Bugs Returned Goods Recode Qual. Dept. Warranty Costs Product Liability Missed Deadlines Complaint Handling Bad Market Reviews Poor Documentation Software Patches
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Interface Errors Quotation Errors Configuration Errors

Help Desk

Training Field Service Lost Market Share

Process Slowdown

Cost Of Quality

Cost of achieving good quality

Prevention Appraisal

Cost of poor quality

Internal failure costs External failure costs

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Traditional View on Quality

Quality Cost in Rs

Total cost Failure cost

Control cost 0% Minimum Optimal Acceptable Quality Level 100% Defective Rate

Contemporary View on Quality Costs

Quality Cost in Rs Total Cost

Failure Cost

Control Cost 0% Minimum Optimal 100% Defective Rate

Cost of
Is Cost related to Prevention of NonConformance ?

Quality
PREVENTION

Element Decision Flow

YES

NO
Is Cost related to Evaluating the Conformance ?

YES

APPRAISAL

NO
Is Cost related to Non-conformance ?

INTERNAL FAILURE
YES
Is Non-Conformance found prior to Shipment ?

YES

NO
Not a Quality Cost

NO EXTERNAL FAILURE
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Cost of

Quality
APPRAISAL Unit Testing Regression Testing Automated Test Tools User Interface Reviews EXTERNAL FAILURE Returned Goods Liability Costs Help Desk Lost Sales/Market Share

Examples of Elements
PREVENTION Design Quality Progress Reviews Requirements Documentation SQA Training

INTERNAL FAILURE Recode/Repair Labor Defect Tracking & Reports Requirement Changes Down Hardware

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Appraisal & Prevention Costs

Appraisal costs Incoming matl inspection In-process inspect & test Maintain test equipment Evaluation of stocks Data collect/analyze/report programs Quality improve. Prevention costs Quality planning Product design & review Process design & review Job design & training Process control

Failure Costs
External failure costs Complaint invest. & adjust Return, replace or allow Warranty expense Liability Goodwill Internal failure costs Disposition Scrap Rework Retest Yield losses Downtime Inventory safety stocks Defect overtime costs Excess capacity costs

Another look at External Failure Costs

Borne by seller

Given in the previous slide Death / Injury Embarrassment Might affect their customers Cost of tech support Cost of replacing product

Borne by buyer

Corrective Action vs Failure

Cost of

Quality

Corrective Action is paid for Once,

Whereas Failure to take corrective action may be paid for over and over again.

15

Cost of

Strategy Premise

Quality

The Strategy is based on the premise that:

For each failure there is a root cause.

Causes are preventable. Prevention is always cheaper.

16

Cost of

Quality

Strategy for using Quality Costs

Take direct attack on FAILURE costs, try to drive to zero cost. Invest in the "right" PREVENTION activities to bring about improvements. Reduce APPRAISAL costs according to results achieved. Continuously evaluate and redirect PREVENTION efforts to gain further improvement.

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Cost of

Quality

Recipe for Success

1. Educate & Develop: Management & Employee Support 2. Collect, Analysis and Report Cost of Quality Data 3. Involve & Support Corrective Action Teams (CAT) 4. Implement Changes recommended by CAT 5. Go to Step #2 (expand data items collected)

1.

2.

3.

4.
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5.

Cost of

Quality
Appraisal Prevention

NORMAL DISTRIBUTION

Total Sales

Cost of Quality%
TOTAL SALES

Internal Failures External Failures

COQ
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Cost of

Quality

Cost of Quality OPTIMUM DISTRIBUTION

Appraisal

Cost of Quality%
TOTAL SALES

Prevention Internal Failures External Failures

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COQ

Quality Cost Distribution

Prevention 5-10% Prevention 25-50% Failure 50-80% TQM Program Appraisal 15-40% Appraisal 15-40%
Size of circle reflects total costs

Failure 20-50%

Benefits of Improved Quality

Decreases
Defects Overall Costs Returned Goods Employee Turnover Customer Complaints Owner & Mgmt. Stress

Increases
Revenue Sales Capacity Employee Satisfaction Customer Satisfaction Market Share Competitive Edge Personal Time Away
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Quality Indexes

Labor index

quality cost / labor hours quality cost / manufacturing cost

Cost index

Sales index

quality cost / sales

quality cost / units produced
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Production index

Quality Index Example

1994 Quality Costs Prevention Appraisal Internal failure External failure Total Rs. 27,000 155,000 386,400 242,000 Rs. 810,400 1995 41,500 122,500 469,200 196,000 829,200 1996 74,600 113,400 347,800 103,500 639,300 1997 112,300 107,000 219,100 106,000 544,400

Accounting measures Sales Rs. 4,360,000 4,450,000 5,050,000 5,190,000 Mfg costs 1,760,000 1,810,000 1,880,000 1,890,000
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Quality to Sales Index

Total quality costs * 100 / sales 8,10,400 * 100 / 43,60,000 = 18.58

Year 1994 1995 1996 1997

Sales

18.58
18.63 12.66 10.49

Cost 46.04 45.18 34.00 28.80

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Quality and the Bottom Line

Quality is an important determinant of business profitability Quality is positively & significantly related to a higher return on investment Productivity = output / input

Fewer defects increases output Quality improvement reduces inputs

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Measuring Yield & Productivity

Y = (I) (%G) + (I) (1-%G) (%R)
where, Y = yield I = number units started in production % G = percentage good units % R = percentage of defective units reworked
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Product Yield Example

Start with 100 motors per day 80% are good quality 50% of poor quality units can be reworked What is the product yield? Y = (I) (%G) + (I) (1-%G) (%R) Y = 100 (0.80) + 100 (1- 0.80) (0.50) = 90 motors
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Product Cost
(kd) (I) + (kr) (R) Y
where, kd = direct manufacturing cost kr = rework cost per unit R = reworked units Y = yield I = input
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Product Cost Example

Direct mfg cost = Rs.30 Rework cost = Rs.12 Start with 100 motors 20% defective 50% of defective motors can be reworked Product cost = (k ) (I) + (k ) (R) d r Y = (Rs.30) (100) + (Rs.12) (10) 90 motors
=
Rs.34.67 per motor
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Multistage Product Yield

Y = (I) (%g1)(%g2)...(%gn)
where I = input batch size % gi = percent good at stage i

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Multistage Product Yield

Motors are produced in a four-stage process with yields given below. If we start with 100 motors, what is our product yield?

Stage 1 2 3 4

% Good quality 0.93 0.95 0.97 0.92

Y = (I) (%g1)(%g2)...(%gn) = (100) (0.93) (0.95) (0.97) (0.92) = 78.8 motors

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What input is needed to achieve a product yield of 100 good motors?

I = Y (%g1) (%g2) (%g3) (%g4) 100 (0.93) (0.95) (0.97) (0.92)

= 126.8 motors
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Quality Productivity Ratio (QPR)

(Good quality units) (I) (proc. cost) + (I) (1-%G) (%R) (rework costs)

Prefer larger ratio Increases if processing or rework costs decrease, or if process yield increases
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QPR Example
Direct cost = Rs.30/unit Rework cost = Rs.12/unit Start with 100 motors per day 80% are good, 50% of defective units are reworked Company studies 4 changes

1. 2. 3. 4.

Increase production to 200 units/day Cut processing cost to Rs.26 & rework cost to Rs.10 Increase yield to 95% Combine 2 & 3
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QPR Example

Base case, QPR = 2.88

80 10 QPR (100) 2.88 (100)(Rs.30) + (10)(Rs.12)

Case 1 - Increasing input has no effect

QPR 160 20 (100) 2.88 (200)(Rs.30) + (20)(Rs.12)

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Case 2 - Decreasing cost increases QPR

QPR 80 10 (100 ) 3 .33 (100)(Rs.2 6) + (10)(Rs.10 )

Case 3 - Increasing yield increases QPR

QPR 95 2.5 (100) 3.21 (100)(Rs.30) + (2.5)(Rs.12)

Case 4 - Cutting costs & raising yield is best

QPR 95 2 .5 (100 ) 3 .71 (100)(Rs.2 6) + (2.5)(Rs.1 0)

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Defensive Programming

Defensive programming is the practice of anticipating where failures can occur and then creating an infrastructure that tests for errors, notifies you when anticipated failures occur, and performs damagecontrol actions you have specified-- such as stopping program execution, redirecting users to a backup server, enabling debugging information you can use to diagnose the problem. This way:

problems that might otherwise go unnoticed are detected small errors that might turn into disasters are caught a lot of debugging and maintenance could be saved.

Benefits

The goal is to reach minimum quality costs at the desired outgoing quality level. Its a feed-back mechanism: quality costs data is used by the management to make decisions that will impact the quality costs. Applications of Quality Costs

Measurement Tool:

Process-Quality Analysis Tool

Quality costs provide comparative measurements for evaluating quality programs versus the value of the results achieved Quality costs can serve effectively as an analysis tool and point out where the problems are Quality costs determine how the available resources to be divided Quality costs can also be used to evaluate and assure performance in relation to the goals and objectives of the organization.

Programming Tool

Predictive Tool

Risks

Implementation Risks

Other risks:

Not being realistic and trying to achieve too much too soon. Controversial costs should be left aside, especially the first few times the company is trying to implement the qualitycosts analysis Looking only from the point of view of the company, not looking at the customers costs (example) Might result in other types of risk:

Customer Dissatisfaction Litigation

Quality-cost analysis

Quality-cost analysis looks at the costs from only the companies perspective. However, these costs might not be easily estimated When calculating the trade-off between several factors (costs one of them) it is important for the companies to realize and take into account the customers costs.

Why are the companies reluctant to implement quality-costs analysis?

Skepticism ; some companies have tried and failed or they are aware of other companies that tried and failed They dont know whom to trust; there are many advocates and agendas. They believe in Our business is different. Mediocre quality is still saleable. The confusion in languagethe belief that higher quality costs more. Certification to the ISO 9000 will solve all their issues related to quality performance.

The Quality Cost Audit

Identify all costs of achieving good quality Organize & report on quality cost scorecard Helps identify problem areas Reduce total spending Reallocate expenditures to enhance quality

Magnitude Of Quality Costs

Most firms underestimate quality costs Acctg & IS cant separate costs accurately Costs incurred by more than QC department Quality costs often over 20% of total revenues Total quality costs probably minimized when

25 - 50% of costs in prevention 50 - 80% in prevention & appraisal combined

Obtaining Quality Cost Data

Most quality data not reported by system Estimate cost components

review & analyze production documents create & maintain temporary records directly observe operations

Data may be collected but not reported to right people

Digicomp Quality Costs

External failure costs Comp. invest. & adjust 43 Return, replace or allow 610 Warranty expense 24 Liability 38 Goodwill 200 Total (14%) 915 Internal failure costs Disposition 105 Scrap 290 Rework 2150 Retest 120 Yield losses 65 Downtime 910 Inv. safety stocks 50 Defect overtime 340 Excess capacity * Total (64%) 4030

* no reliable estimates

Digicomp Quality Costs

Appraisal costs Incoming inspection In-process inspection Maintaining test equip. Evaluation of stocks Total (13%) 60 630 120 * 810 Prevention costs Quality planning Product des. & rev. Process des. & rev. Job design & train Process control Data collect/report Quality imp. prog. Total 135 90 100 75 15 95 70

(9%) Total quality costs * no reliable estimates

580 6335

Medical Insurance Claims

External failure costs Complaint investigation 310 Reprocess claims 760 Overpayment errors 410 Appeals to hearing board 90 Goodwill loss * Total (55%) 1570+ Appraisal costs Review claims Review std data Total (17%) Total Quality Costs 390 90 480 2870+ Internal failure costs Reprocess claims 375 Recheck reproc. claims 40 Forms & worksheets 5 Excess capacity 100+ Total (18%) 520 Prevention costs Quality planning 70 Training 120 Data collect/report 110 Total (10%) 300 * no reliable estimates