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Cost of Quality

Cost of Quality

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Running a company by profit alone is like driving a car by looking in the rearview mirror.

It tells you where you’ve been, not where you are going!

Dr. E. Deming

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The goal of a Cost of Quality system is to:

Facilitate Quality Improvement that leads

to operating cost reduction Opportunities.

Cost of QualityGoal

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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.

Cost of Quality Definition

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Cost of Quality is Not:

An Exact Cost.

It is a Performance Measurement.

Cost of Quality

Iceberg

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Bugs

RecodeQual. Dept.

WarrantyCosts

Quotation Errors

Product Liability

Missed Deadlines

Configuration ErrorsComplaint Handling

Bad Market Reviews

Process SlowdownField Service

Lost Market Share

Software Patches

Returned Goods

InterfaceErrors

Help Desk

Poor Documentation

Training

Cost of Quality

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

0% 100% Defective Rate

QualityCost in Rs

Failure cost

Control cost

Total cost

MinimumOptimalAcceptable Quality Level

Contemporary View on Quality Costs

Control Cost

Failure Cost

Total Cost

0% 100%Minimum Defective RateOptimal

QualityCost in Rs

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Element Decision FlowIs Cost related toPrevention of Non-Conformance ?

Is Cost related toEvaluating theConformance ?

Is Cost related toNon-conformance ?

Is Non-Conformancefound prior toShipment ?

YES

NO

PREVENTION

APPRAISAL

INTERNAL FAILURE

EXTERNAL FAILURE

Not a Quality Cost

YES

YES

NO

NO

YES

NO

Cost of Quality

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Examples of Elements

PREVENTIONDesign Quality Progress ReviewsRequirements DocumentationSQA Training

INTERNAL FAILURERecode/Repair LaborDefect Tracking & ReportsRequirement ChangesDown Hardware

APPRAISAL Unit Testing Regression Testing Automated Test Tools User Interface Reviews

EXTERNAL FAILURE Returned Goods Liability Costs Help Desk Lost Sales/Market Share

Cost of Quality

Appraisal & Prevention Costs

Appraisal costs Prevention costsIncoming mat’l inspection Quality planningIn-process inspect & test Product design &

reviewMaintain test equipment Process design &

reviewEvaluation of stocks Job design & training

Process controlData collect/analyze/report

Quality improve. programs

Failure Costs

External failure costs Internal failure costsComplaint invest. & adjustDispositionReturn, replace or allow ScrapWarranty expense ReworkLiability RetestGoodwill Yield losses

DowntimeInventory safety

stocksDefect overtime costsExcess capacity costs

Another look at External Failure Costs

Borne by seller Given in the previous slide

Borne by buyer Death / Injury Embarrassment Might affect their customers Cost of tech support Cost of replacing product

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Corrective Action is paid for Once,

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

Corrective Action vs FailureCost of Quality

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Strategy Premise

The Strategy is based on the premise that:

For each failure there is a root cause.

Causes are preventable.

Prevention is always cheaper.

Cost of Quality

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Strategy for using Quality Costs Take direct attack on FAILURE costs,

try to drive to zero cost.

Invest in the "right" PREVENTION activities to bringabout improvements.

Reduce APPRAISAL costs according to results achieved.

Continuously evaluate and redirect PREVENTION effortsto gain further improvement.

Cost of Quality

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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.

5.

4.

Cost of Quality

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Cost ofQuality%

Total Sales

NORMAL DISTRIBUTION

TOTAL SALES

Appraisal

Prevention

InternalFailures

ExternalFailures

C O Q

Cost of Quality

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OPTIMUM DISTRIBUTIONCost of Quality

TOTAL SALES

Cost of Quality

Appraisal

Prevention

InternalFailures

ExternalFailures

Cost ofQuality%

C O Q

Quality Cost Distribution

Prevention5-10%

Appraisal15-40%

Failure50-80%

Prevention25-50%

Appraisal15-40%

Failure20-50%

TQM Program

Size of circle reflects total costs

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Benefits of Improved Quality

IncreasesRevenueSalesCapacityEmployee SatisfactionCustomer SatisfactionMarket ShareCompetitive EdgePersonal Time Away

DecreasesDefectsOverall CostsReturned GoodsEmployee TurnoverCustomer ComplaintsOwner & Mgmt. Stress

Quality Indexes

Labor index quality cost / labor hours

Cost index quality cost / manufacturing cost

Sales index quality cost / sales

Production index quality cost / units produced

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Quality Index Example

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

Total Rs. 810,400 829,200 639,300 544,400

Accounting measuresSales Rs. 4,360,000 4,450,000 5,050,000 5,190,000Mfg costs 1,760,000 1,810,000 1,880,000 1,890,000

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Quality to Sales Index

Year Sales Cost1994 18.58 46.041995 18.63 45.181996 12.66 34.001997 10.49 28.80

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

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

where, Y = yieldI = number units started in production% G = percentage good units% R = percentage of defective units

reworked

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Y = (I) (%G) + (I) (1-%G) (%R)

Product Yield Example

Start with 100 motors per day80% are good quality50% of poor quality units can be reworkedWhat is the product yield?

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Y = (I) (%G) + (I) (1-%G) (%R)

Y = 100 (0.80) + 100 (1- 0.80) (0.50) = 90 motors

Product Cost

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(kd) (I) + (kr) (R)

Ywhere, kd = direct manufacturing cost

kr = rework cost per unit

R = reworked units Y = yield

I = input

Product Cost Example

Direct mfg cost = Rs.30 Rework cost = Rs.12Start with 100 motors 20% defective50% of defective motors can be reworked

(kd) (I) + (kr) (R)

Y (Rs.30) (100) + (Rs.12) (10)

90 motors

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Product cost =

=

= Rs.34.67 per motor

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?

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Y = (I) (%g1)(%g2)...(%gn)

= (100) (0.93) (0.95) (0.97) (0.92)

= 78.8 motors

Stage % Good quality 1 0.93 2 0.95 3 0.97 4 0.92

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

Y(%g1) (%g2) (%g3) (%g4)

100(0.93) (0.95) (0.97) (0.92)

= 126.8 motors33

I =

=

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 ExampleDirect cost = Rs.30/unit Rework cost = Rs.12/unitStart with 100 motors per day80% are good, 50% of defective units are reworked

Company studies 4 changes 1. Increase production to 200 units/day 2. Cut processing cost to Rs.26 & rework cost to Rs.10 3. Increase yield to 95% 4. Combine 2 & 3

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QPR Example

Base case, QPR = 2.88

Case 1 - Increasing input has no effect

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88.2)100()(20)(Rs.12+0)(200)(Rs.3

20160QPR

88.2)100()(10)(Rs.12+0)(100)(Rs.3

1080QPR

Case 2 - Decreasing cost increases QPR

Case 3 - Increasing yield increases QPR

Case 4 - Cutting costs & raising yield is best

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33.3)100()(10)(Rs.10+6)(100)(Rs.2

1080QPR

21.3)100(2)(2.5)(Rs.1+0)(100)(Rs.3

5.295QPR

71.3)100(0)(2.5)(Rs.1+6)(100)(Rs.2

5.295QPR

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 damage-control 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. It’s 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:

Quality costs provide comparative measurements for evaluating quality programs versus the value of the results achieved

Process-Quality Analysis Tool Quality costs can serve effectively as an analysis tool and point out

where the problems are Programming Tool

Quality costs determine how the available resources to be divided Predictive Tool

Quality costs can also be used to evaluate and assure performance in relation to the goals and objectives of the organization.

Risks Implementation 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 quality-costs analysis

Other risks: Looking only from the point of view of the company,

not looking at the customer’s costs (example) Might result in other types of risk:

Customer Dissatisfaction Litigation

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 customer’s costs.

Quality-cost analysis

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 don’t 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 language—the 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 can’t 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 Internal failure costsComp. invest. & adjust 43 Disposition 105Return, replace or allow610 Scrap 290Warranty expense 24 Rework 2150Liability 38 Retest 120Goodwill 200 Yield losses 65Total (14%) 915 Downtime 910

Inv. safety stocks 50Defect overtime 340Excess capacity *Total (64%) 4030

* no reliable estimates

Digicomp Quality Costs

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

Data collect/report 95Quality imp. prog. 70Total (9%) 580

Total quality costs 6335

* no reliable estimates

Medical Insurance ClaimsExternal failure costs Internal failure costsComplaint investigation310 Reprocess claims 375Reprocess claims 760 Recheck reproc. claims

40Overpayment errors 410 Forms & worksheets 5Appeals to hearing board90 Excess capacity 100+Goodwill loss * Total (18%) 520Total (55%) 1570+

Appraisal costs Prevention costsReview claims 390 Quality planning 70Review std data 90 Training 120Total (17%) 480 Data collect/report 110

Total (10%) 300Total Quality Costs 2870+ * no reliable estimates