15-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Quality Costs and Productivity: Measurement, Reporting, and Control 15 PowerPresentation®

15-1Copyright © 2004 by Nelson, a division of Thomson Canada Limited.

Quality Costs and Quality Costs and Productivity: Productivity: Measurement, Measurement, Reporting, and Reporting, and ControlControl

1515

PowerPresentation® prepared by PowerPresentation® prepared by

David J. McConomy, Queen’s UniversityDavid J. McConomy, Queen’s University


Learning ObjectivesLearning 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.


Learning ObjectivesLearning 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.


Eight Dimensions of QualityEight Dimensions of Quality

Performance Aesthetics Serviceability Features (quality of design) Reliability Durability Quality of Conformance Fitness of Use


Quality DefinedQuality 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, low- cost, low-maintenance transportation, the desired quality exists.


Measuring Quality CostsMeasuring Quality Costs

Prevention costs

Appraisal costs

Internal failure costs

External failure costs


Examples of Quality CostsExamples of Quality Costs

Prevention costs Appraisal Costs Quality engineering Inspection of raw materials

Quality training programs Testing of raw materials

Quality planning Packaging inspection

Quality reporting Supervising appraisal activities

Supplier evaluation and selection Product acceptance

Quality audits Process acceptance

Quality circles Inspection of equipment

Field trials Test equipment

Design reviews Outside endorsements


Examples of Quality CostsExamples of Quality Costs

Internal failure costs External failure costsScrap Cost of recalls

Rework Lost sales

Downtime (defect related) Returns/allowances

Reinspection Warranties

Retesting Repairs

Design changes Product liability

Customer dissatisfaction

Lost market share

Complaint adjustment


Estimating Hidden Quality CostsEstimating Hidden Quality Costs

The Multiplier Method

The Market Research Method

Taguchi Quality Loss Function

Hidden Quality Costs are opportunity costs resulting from poor quality.


The Multiplier MethodThe 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.


The Market Research MethodThe 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


The Taguchi Quality Loss The Taguchi Quality Loss FunctionFunction

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.


Reporting Quality Costs Reporting Quality Costs

Quality Costs % of Sales

Prevention costs:

Quality training $35,000

Reliability engineering 80,000 $115,000 4.11%

Appraisal costs:

Materials inspection $20,000

Product acceptance 10,000

Process acceptance 38,000 68,000 2.43%

Internal failure costs:

Scrap $50,000

Rework 35,000 85,000 3.04 %

External failure costs:

Customer complaints $25,000

Warranty 25,000

Repair 15,000 65,000 2.32% Total quality costs $333,000 11.90%

======= =====


20.5%

25.5%

34.5%

Prevention costs Appraisal costs

Internal failure costs External failure costs

19.5%

Reporting Quality Costs Reporting Quality Costs (continued)(continued)


AQL Quality Cost GraphAQL Quality Cost Graph

Cost

0Optional (AQL)

Percent Defects

100%

Cost of Failures

Cost of Control


Zero-Defect GraphZero-Defect Graph

TotalQuality

CostCost

0 Percent Defects 100%


Multiple-Period Quality CostsMultiple-Period Quality Costs

Quality Costs Actual Sales % of Sales

2001 $440,000 $2,200,000 20.0

2002 423,000 2,350,000 18.0

2003 412,500 2,750,000 15.0

2004 392,000 2,800,000 14.0

2005 280,000 2,800,000 10.0

Assume the following data:


Multiple-Period Trend Graph:Multiple-Period Trend Graph:Total Quality CostsTotal Quality Costs

5

10

15

20

0 1 2 3 4 5

% ofSales

Year


Multiple-Period Total Quality CostsMultiple-Period Total Quality Costs

Total Quality Costs as a % of Sales

0

5

10

15

20

25

2001 2002 2003 2004 2005

Column 2

%of Sales


Multiple-Trend Analysis for Multiple-Trend Analysis for Individual Quality CostsIndividual Quality Costs

Internal External

Prevention Appraisal Failure Failure

2001 6.0%1 4.5% 4.5% 6.0%

2002 6.0 4.0 3.5 4.5

2003 5.4 3.6 3.0 3.0

2004 5.6 3.2 3.1 2.6

2005 4.4 2.4 3.0 2.3

Assume the following quality cost data:

1Expressed as a % of sales


Multiple-Trend Analysis for Multiple-Trend Analysis for Individual Quality CostsIndividual Quality Costs

%

of sales

0

5

10

15

20

25

2001 2002 2003 2004 2005

External Costs

Internal Costs

Appraisal

Prevention


Productivity: Measurement and Productivity: Measurement and ControlControl

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.


Illustration of Productivity Illustration of Productivity ImprovementImprovement

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.



Same output, fewer inputs:

INPUTS OUTPUT



More outputs, same inputs:

INPUTS OUTPUT


• 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 OUTPUT




• 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.


Partial Productivity MeasuresPartial 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.


Partial Productivity MeasuresPartial Productivity MeasuresExample 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 = 100 clocks/200 hours = 0.5 clocks per hr

Materials productivity ratio = 100 clocks/50 kilogram = 2 clocks per kilogram


Partial Productivity MeasuresPartial 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 = 100 clocks/175 hrs

= 0.57 clocks per hr– Materials productivity ratio = 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.


Profile MeasurementProfile 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

20042005

Number of motors produced 120,000150,000

Labour hours used 40,00037,500

Materials used (kg) 1,200,0001,428,571


Profile Analysis with No Trade-offsProfile Analysis with No Trade-offs

Partial Productivity Ratios

2004 Profilea 2005 Profileb

Labour productivity ratio 3.000 4.000

Materials productivity ratio 0.100 0.105

aLabour: 120,000 / 40,000; Materials: 120,000 / 1,200,000bLabour: 150,000 / 37,500; Materials: 150,000 / 1,428,571


Profile Analysis with Trade-offsProfile Analysis with Trade-offs

Partial Productivity Ratios

2004 Profilea 2005 Profileb

Labour productivity ratio 3.000 4.000

Materials productivity ratio 0.100 0.088

aLabour: 120,000 / 40,000; Materials: 120,000 / 1,200,000bLabour: 150,000 / 37,500; Materials: 150,000 / 1,700,000


Profit-Linked Productivity Profit-Linked Productivity MeasurementMeasurement

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



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



Compute the profit change attributable to productivity changes.

PQ (materials) = 120/2 = 60 kgs.

PQ (labour) = 120/0.5 = 240 hrs.

Profit change:

Input

Mat’ls

Labour

PQ PQ x P AQ AQ x P (PQ x P) - (AQ x P)

60

240

$ 300

2,400

$2,700

72

228

$ 360

2,280

$2,640

$ (60)

120

$ 60

Profits have improved by $60 because of productivity changes.


Price-Recovery Component and Price-Recovery Component and GainsharingGainsharing

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.

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15-1 Copyright © 2004 by Nelson, a division of Thomson Canada Limited. Quality Costs and Productivity: Measurement, Reporting, and Control 15 PowerPresentation®