Cost of Quality. Appendix 2B. Copyright 2006, The McGraw-Hill Companies, Inc.

Cost of Quality Appendix 2B Copyright 2006, The McGraw-Hill Companies, Inc.

Learning Objective 9 (Appendix 2B) Identify the four types of quality costs and explain how they interact.

Quality of Conformance When the overwhelming majority of products produced conform to design specifications and are free from defects.

Quality Costs Components $ Conformance $ Non-Conformance $

Total Quality Cost I want my money back! Prevention Appraisal Internal Failure External Failure $ Cost of Quality (COQ)

Prevention and Appraisal Costs Prevention Costs Support activities whose purpose is to reduce the number of defects Appraisal Costs Incurred to identify defective products before the products are shipped

Internal and External Failure Costs Internal Failure Costs Incurred as a result of identifying defects before they are shipped External Failure Costs Incurred as a result of defective products being delivered to customers

Examples of Quality Costs Prevention Costs Quality training Quality circles Statistical process control activities Appraisal Costs Testing & inspecting incoming materials Final product testing Depreciation of testing equipment Internal Failure Costs Scrap Spoilage Rework External Failure Costs Cost of field servicing & handling complaints Warranty repairs Lost sales

Distribution of Quality Costs When quality of conformance is low, total quality cost is high and consists mostly of internal and external failure. Total quality costs drop rapidly as the quality of conformance increases. Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal. Total quality costs are minimized when the quality of conformance is slightly less than 100%.

Learning Objective 10 (Appendix 2B) Prepare and interpret a quality cost report.

Quality Cost Report For Years 1 and 2 Year 2 Year 1 Amount Percent* Amount Percent* Prevention costs: Systems development $ 400,000 0.80% $ 270,000 0.54% Quality training 210,000 0.42% 130,000 0.26% Supervision of prevention activities 70,000 0.14% 40,000 0.08% Quality improvement 320,000 0.64% 210,000 0.42% Total prevention cost 1,000,000 2.00% 650,000 1.30% Appraisal costs: Inspection 600,000 1.20% 560,000 1.12% Reliability testing 580,000 1.16% 420,000 0.84% Supervision of testing and inspection 120,000 0.24% 80,000 0.16% Depreciation of test equipment 200,000 0.40% 140,000 0.28% Total appraisal cost 1,500,000 3.00% 1,200,000 2.40% Internal failure costs: Net cost of scrap 900,000 1.80% 750,000 1.50% Rework labor and overhead 1,430,000 2.86% 810,000 1.62% Downtime due to defects in quality 170,000 0.34% 100,000 0.20% Disposal of defective products 500,000 1.00% 340,000 0.68% Total internal failure cost 3,000,000 6.00% 2,000,000 4.00% External failure costs: Warranty repairs 400,000 0.80% 900,000 1.80% Warranty replacements 870,000 1.74% 2,300,000 4.60% Allowances 130,000 0.26% 630,000 1.26% Cost of field servicing 600,000 1.20% 1,320,000 2.64% Total external failure cost 2,000,000 4.00% 5,150,000 10.30% Total quality cost $ 7,500,000 15.00% $ 9,000,000 18.00% Quality cost reports provide an estimate of the financial consequences of the company s current defect rate. * As a percentage of total sales. In each year sales totaled $50,000,000.

Quality Cost (in millions) Quality Cost as a Percentage of Sales Quality Cost Reports in Graphic Form $10 20 9 8 7 6 5 4 3 2 1 External Failure Internal Failure Appraisal External Failure Internal Failure Appraisal Quality reports can also be prepared in graphic form. 18 16 14 12 10 8 6 4 2 External Failure Internal Failure Appraisal External Failure Internal Failure Appraisal 0 Prevention Prevention 1 2 Year 0 Prevention Prevention 1 2 Year

Uses of Quality Cost Information Help managers see the financial significance of defects. Help managers identify the relative importance of the quality problems. Help managers see whether their quality costs are poorly distributed.

Limitations of Quality Cost Information Simply measuring quality cost problems does not solve quality problems. Results usually lag behind quality improvement programs. The most important quality cost, lost sales, is often omitted from quality cost reports.

ISO 9000 Standards ISO 9000 standards have become international measures of quality. To become ISO 9000 certified, a company must demonstrate: 1. A quality control system is in use, and the system clearly defines an expected level of quality. 2. The system is fully operational and is backed up with detailed documentation of quality control procedures. 3. The intended level of quality is being achieved on a sustained basis.

Cost of Poor Quality Copyright 2006, The McGraw-Hill Companies, Inc.

Managers and workers speak the language of things but Senior leaders speak the language of money... COPQ allows us to translate the

Cost of Poor Quality Prevention Appraisal: Prediction Audit Cost of Attaining Quality Appraisal: Detection Failure: Internal External Cost of Poor Quality

Definitions COPQ Overview All activities and processes that do not meet agreed performance and/or expected outcomes Costs that would disappear if every task were always performed without deficiency Actual Cost - Minimum Cost = COPQ

Traditional Cost of Poor Quality (4-5% of Sales) When quality costs are initially determined, the categories included are the visible ones as depicted in the iceberg below. Rejects Testing Costs Waste Customer Returns Inspection Costs Rework Recalls

Cost of Poor Quality As an organization gains a broader definition of poor quality, the hidden portion of the iceberg becomes apparent. Rejects Testing Costs Rework Waste Customer Returns Inspection Costs Recalls Excessive Overtime Pricing or Late Paperwork High Costs Billing Errors Excessive Field Incorrectly Completed Services Expenses Lack of Follow-up Sales Order on Current Programs Excessive Employee Turnover Planning Delays Excess Inventory Customer Allowances Complaint Handling Overdue Receivables Premium Freight Costs Excessive System Costs Unused Capacity Time with Dissatisfied Customer COPQ ranges from 15-25% of Sales Development Cost of Failed Product Hidden COPQ: The costs incurred to deal with these chronic problems

Quantifying the Potential Benefit Sigma 6 sigma 5 sigma 4 sigma 3 sigma 2 sigma Cost <10% of sales 10-15% of sales 15-20% of sales 20-30% of sales 30-40% of sales

What Does Reality Look Like? The ratio of the individual category costs to total costs varies widely. Many companies exhibit ratios which look like the following: Quality Cost Category Percent of Total Internal Failure 25 to 40 External Failure 25 to 40 Appraisal 10 to 50 Prevention.05 to 5 What's Wrong With This Picture?

Examples of Prevention Expense Quality Planning Training and Education Process Definition Customer Surveys Preproduction Reviews Technical Manuals Detailed Product Engineering Early Approval of Product Specifications Purchase Cost Targets Process Capability Studies Preventive Maintenance Supplier Qualification Job Descriptions Housekeeping Zero-Defect Program

Examples of Appraisal Expense Test Inspection Process Controls Train QA Personnel Product Audits Quality Systems Audits Customer Satisfaction Surveys and Audits Prototype Inspection Accumulating Cost Data Supplier Certification Employee Surveys Security Checks Safety Checks Reviews: Operating Expenditures Product Costs Financial Reports Capital Expenditures

Examples of Internal Failure Costs Substandard Product Scrap or Rework Re-inspection Redesign/Engineering Change Process Modifications Payroll Errors All Expediting Costs Off-Spec/Waiver Abandoned Programs Supplier Problems Scrap and rework Late deliveries Excess inventory Equipment Downtime Accidents, Injuries Absenteeism Unused Reports Missed Schedule Cost Lost Sales (any cause)

Examples of External Failure Costs Product Recall Handling Complaints Customer Service Caused by Errors Products Returned Analysis of Returns Evaluation of Field Stock Late Payments and Bad Debts Lawsuits Reports Sales and service Returns and allowances Failure Lost Sales Because of Customer Dissatisfaction!

Non-value Added Work Definition Common activities that provide no benefit to customers. Some result from internal or external failure Some are unnecessary inspection Examples Rarely used information systems Memos never read Financial reports not used Irrelevant procedures

The Hidden Organization Step 1 Test Step 2 Test Product Floor Space Analyze Analyze The Hidden Factory Fix Fix Value Added Non-Value Added Floor Space Floor Space Philip R. Thomas, Competitiveness Through Total Cycle Time. McGraw-Hill (1990) Theoretical Cycle Time: The back-to-back process time required for a single unit to complete all stages of a task without waiting, stopping, or setups.

Why Cost of Poor Quality? Reporting Tool Comparisons Trends Analytical Tool Priorities Tradeoffs Investment Tool ROI

Focus of COPQ Efforts Identify and Quantify Quality Costs Expose the Hidden Factory Ongoing Measurement System Breakthrough Improvement

Advantages of Using Quality Costs for Advantages Management Reducing the cost of poor quality is one of the best ways to increase a company's profit. Provides manageable entity and a single overview of quality. Aligns quality and goals. Prioritizes problems and provides a means to measure change/improvement. Provides a means to correctly distribute controllable quality cost for maximum profits.