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Quality Costs

 

Quality Costs - Costs incurred to ensure that a product / service is defect free and conforming to customer specifications. Following are its components.

1. Prevention Cost - The costs incurred to avoid or minimize the number of defects at first place. E.g. - improvement of manufacturing processes, workers training, quality engineering, statistical process control etc.

2. Appraisal Cost - Costs that are incurred to identify defective products before they are shipped to customers. These are also called 'Inspection Costs'. E.g. - QA cost, QC cost.

3. Cost of Poor Quality - is defined as the cost of 'not doing it right the first time' or it is the cost incurred to correct the defects in a product/service. It can be of two types.

a. Internal Failure Cost - cost of rework / corrections before the product or service is delivered to client.
b. External Failure Cost - cost of rework / replacement / warranty cost after the product or service is delivered to client. This will also include costs related to loss of trust, reputation and clientele (though these are not always easy to quantify).

 

 

An application oriented question on the topic along with responses can be seen below. The best answer was provided by Raghavendra Rao on 15th November 2017. 

 

 

Question

Q 45. Considering the four quality costs viz, Prevention costs, Appraisal Costs, Internal Failure Costs, and External Failure Costs, one would imagine incurring some prevention + appraisal costs so as to save on others.  Is there a need to strike an equilibrium between these costs? What would be your approach to reach the best scenario? What should be considered as the best scenario? 

 

Note for website visitors - Two questions are asked every week on this platform. One on Tuesday and the other on Friday.

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Prevention costs are related to training and proactive initiatives taken up to avoid any issues, Appraisal costs are those associated with the reviews, inspection and audits, internal failure costs are those related to failure happening at supplier end and external failure costs are those that are realized at customer end.

Achieving proper equilibrium among these goes hand in hand with the maturity of the system. There is a need to strike an equilibrium among between these costs. For a system starting its maturity journey key focus would be on prevention and appraisal costs to in turn have optimal internal failure and external failure costs. In the beginning of process maturity prevention costs and appraisal costs would be varied based on how failure costs are trending. As the system matures, prevention costs should be primary focus and appraisal costs and failure costs should get lean. In case of external failure cost being high, all other three costs need to be increased to make sure external impact is reduced.

Approach to reach the best scenario is to focus on Quality Improvement programs, where people, process and technology are put in to efficient use. For this system maturity initiatives like CMMi, Agile approach and other suitable frameworks can be used. For solving critical quality problems Six sigma methodology can be put in place. To improve involvement of people at all level, KAIZEN programs can be looked at. As the system matures, all the costs gets reduced to optimal level.

Best scenario would be to have zero external failure cost, low tolerance to be set for internal failure rate based on feasibility in the process and customer acceptance. Prevention cost to be kept at an optimal level considering the new process and people inducted in to process. Appraisal costs should also be ideally zero as the system in matured and best one.

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Phases of Quality Management – Associated Quality Costs

Quality Management in a business operation may be broadly divided into 4 phases:

1.     Preparatory

2.     Operational

3.     Remedial

4.     Strategic

 

Preparatory phase:

The preparatory phase starts right from pre-project activities such as Quality proposition during the ‘Request for Proposal’ stage. Once the requirement gathering is in progress, Quality Function deployment, Project ramp-up related activities such as the capability assessment of the business processes to deliver Quality, Cost and Timelines, User Acceptance Evaluation, Service Level Agreements finalization and so on.

The preparatory phase also includes the planning and set-ups required for operational controls, be it equipment, software, knowledge and skill development. It also calls for preparing for remedial actions, be it a rework queue or bay, equipment, resources etc.

Out of the above costs, the planning activities pertaining to knowledge development, the QFD and associated investments on capable equipment, mistake proofing, prototyping, initial testing and proving may be categorized as preventive costs.

The money invested for equipment, facilities for process quality checks, may be debatable as preventive of appraisal costs, but they are investments.

 

Operational phase:

During the live production / operations, there will be activities for process controls, where good SIPOC will point out the Key Process Input Variables (KPIV) that need to be controlled to get the desired Key Process Output Variables (KPOV). Any costs that go into setting up and ensuring ongoing controls will not only prevent the need for reworks, but reduce dependency on too much in-process and final inspections. Such costs will come under the “Prevention cost” category.

However, despite having the best focus on Preventive measures during the Preparatory and Operational phase, some extent of appraisal is usually unavoidable. Any inspection and rework that is done on any process output, be it interim or final will have its cost under the “Appraisal cost” head.

 

Remedial phase:

Remedial implies that a failure has occurred and corrections and corrective actions are warranted. Obviously the associated costs will fall under “Failure Costs”. Where it is an external failure, there is risk of impacting credibility with customers. It is important to have an efficient remedial system in place, since customers sometimes even tolerate about some extent of failures, provided the organization is able to swiftly react and set the problem right. A good attention and resolution of a reported problem, sometime strengthens customer confidence. Hence the investments and the timely and right remedial actions are very important for which there is bound to be a cost associated.

 

Strategic phase:

Strategic initiatives could be innovative for bringing continual improvements to the process, product and service. Sometimes they could be triggered based on the learning from failures and process issues. In any case, the cost incurred for strategic initiatives would fall predominantly fall in the “Prevention cost” category.

 

Having discussed the key dimensions in a Quality framework, we will try to address the question on ‘what would be the best balance between the Preventive, Appraisal and Failure costs’

 

Many a time, we may not be able to identify all the ideal preventive steps that need to be taken up upfront. Even the best preventive plans are based on experiences and there is always a possibility of unprecedented factors.

 

The process capability of processes, including the human variations may continue to influence output Quality and makes it necessary to have adequate in-process and final checks and rework as required. Customers would be willing to pay a premium to avail reliable products and services.

 

For many products, companies give a warranty period with conditions attached. This is primarily to woo customers to buy the product with a free service assured, in case of infant moralities. Sometimes extended warranties are offered to customers at a cost.  In such cases the preventing costing needs to be such that the warranty failures are maintained to the minimum. The business advantage from such schemes is that, not only does it promote the product, but also the fact that no customer is going to be unhappy that a failure did not occur! Just like no one is going to be unhappy that a health insurance amount wasn’t utilized!

 

Increasing preventive and appraisal costs beyond a certain point may not result in increased reduction of the Failure costs. There is a need to strike an equilibrium. It is important to identify the optimal cost balance to keep the total costs, i.e. the sum of Prevention, Appraisal and Failure costs at the minimum.

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This discussion will not be complete with out reference to the above model, which has been depicted by Juran, advocating that there is a Quality level that incurs the optimum total cost of Quality. This probably is one of the first model of its kind. This could be debatable, since the quality expectations do change over time and many other models have come up since then.

 

It is also important to be abreast of competitive offerings. If someone else is able to offer a competitive price with much lower failures, it is important to revisit the entire process, technology and other factors that could be making it possible.

However, this is a continuous exercise. The failure analysis needs to be done continuously and pursuit to identify and implement preventive steps is an ongoing exercise. Accordingly the cost balancing also has to be dynamic and sensitive to both VOC and VOB.

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Need to strike an equilibrium between these costs

 

There is definitely a need to strike a balance between Prevention & Appraisal Costs on one side and Internal Failure & External Failure Costs on the other. Any investments in an organization need to be justified, preferable in a tangible manner. The best way to justify investments on Prevention & Appraisal Costs would be to assess the Internal and External Failure Costs avoided by the investment.

 

Approach to reach the best scenario

 

Data collection, consolidation, Analysis and Actionable insights from the analysis would be the way to go on optimising Cost of Quality. For all existing Prevention and Appraisal activities, there need to be costs assessed both one time and also recurring. Prevention and Appraisal actions could be training of people, process embedded checks, testing at various points of the process of components, sub-assemblies and assemblies etc. These costs will need to be assessed for a line and also per product. These costs will need to be tracked and reported monthly. Concepts of Depreciation of Facilities and Net Present Value etc. will need to be used. The Finance Team would be able to help in this regard.

 

In addition to the above, the results from the Prevention and Appraisal actions will need to be used to assess their effectiveness in eliminating or preventing poor Quality products from being produced and from reaching the market. The costs of repair and rework and retesting will need to be tracked and periodically reported. The feedback from customers including complaints will also need to be used in assessing the effectiveness of the preventive and appraisal actions. Using the two, estimates will need to be made of the quantity of poor quality products that reach the market. The historical data regarding customer rejections will obviously need to be used here. From this, the cost of recall including penalties, fines, repair, rework, rechecking and re-dispatch will need to be computed. Additionally, the cost of business lost due to poor Quality will need to be assessed from past data. For the future, the cost of business that can be lost needs to be predicted using realistic estimates. There need not be a doomsday prophet approach while doing this as this will artificially inflate the external failure costs by assuming that every faulty product reaching the customer would result in cancellation of all orders. Cost of potential business that could be lost will need to be assessed considering the customer’s brand equity, the likelihood of the customer increasing business in case of issue-free delivery and so on. Any estimated loss of business will need to be weighed down by the probability of the event happening, which will make the assessment more realistic.

 

Now the return on investment can be calculated by:

 

External and Internal Failure Costs Avoided

-------------------------------------------------------

Prevention and Appraisal Costs incurred

 

This needs to be periodically computed for different product or service lines, different customers, different products etc. These should be continually reviewed to see if the return is going too low. If for reasons like internal expertise developed, improved technology used or agreements with customers signed, the occurrence of defective products is reduced or probability of such a product reaching the customer is reduced or penalties payable to customers are reduced, then the investments in Prevention and Appraisal actions need to be reviewed and if required, optimised.

 

Best Scenario

 

The best scenario would be one in which all Costs of Quality are dispassionately reviewed in terms of tangible benefits and not for any sentimental or passion related reasons. If Failure costs reduce, it needs to be seen as a success of Prevention and Appraisal action investments. If the existing Prevention and Appraisal costs are consistently yielding results in avoiding Internal and Failure Costs, then a calculated decision needs to be made on conducting a pilot with partly optimized investments e.g. reduce the sampling for testing. If the experiment is successful, the organization should optimize the investments in Prevention and Appraisal.

 

The overall motto should not be “Quality at any cost”, but “Quality at a cost”.

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Prevention cost:-

Total cost that helps us in prevention of a quality problem from occurring at all.

These cost are planned well before actual operation starts. This cost are generally onetime cost. Prevention cost can be categories as Cost for Good Quality

Prevention cost includes.

·        Quality management System development and it’s management

·        Quality training

·        Quality circles

·        Statistical process control

·        Quality improvement projects

·        Quality data gathering, analysis and reporting

·        Investment in quality-related information systems

·        Product-design verification

 

Appraisal cost:-

Similar to prevention cost, some cost that are incurred to keep the quality problem from occurring by different online inspections for quality attributes. This cost are incurred on daily basis. Appraisal cost can be categories as Cost for Good Quality

Appraisal cost includes

·        Test and inspection of incoming materials

·        Final product testing and inspection

·        Consumables and equipment’s for testing and inspection.

·        Labor/ Supervision of testing and inspecting activities

·        Depreciation of test equipment

·        Maintenance of test equipment

·        Test and inspection of purchased materials

·        Online Inspection

 

Internal Failure costs:-

Internal Failure cost are the total cost that are incurred to rectify the defects/defective product discovered before the product is delivered to customer.

Internal Failure cost can be categories as Cost for Poor Quality

  • Net cost of scrap

  • Rework and overhead involved for rework

  • Delay in production plan because of rework

  • Rework labor and overhead

  • Cost involved in disposal of defective products

  • Down time caused by quality problems

  • Analysis of the cause of defects in the production

  • Retesting of reworked products

External Failure costs:-

External Failure cost are the total cost that are incurred to rectify the defects/defective product discovered after it has reached customer.

External Failure cost can be categories as Cost for Poor Quality

  • Cost of field servicing and handling complaints

  • Warranty repairs and replacement costs

  • Lost sales arising from a reputation of poor quality

  • Product recalls

  • Complaints in/out of warranty

  • Loss of reputation

 

No organization will like to incur cost because of Poor quality (Internal/External Failure costs).Since there are so many tangible and intangible cost associated with it.

For an organization best scenario is to have zero Cost of Poor Quality. To achieve this, we need to invest more in prevention cost/appraisal cost.

An organization should find the right balance between prevention cost and appraisal cost, because when we invest too much on prevention cost, total production cost of our product increases. Which may not be good to be stable in a highly competitive market. We should have an acceptable target for getting customer complains, reword, and hold (Cost of Poor quality).

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Cost of poor quality (COPQ) is the cost associated with providing poor quality products or services. It does not mean the use of expensive or very high quality materials to manufacture a product. It refers to the cost that is incurred to prevent, detect and remove defects from products.

Cost of quality is a methodology and an important communication tool that enables an organization to determine the extent to which its resources are used for activities that prevent poor quality and determine the savings to be gained by implementing process improvements and to raise awareness of the importance of quality. They must be carefully managed so that the long-term effect of quality on the organization is a desirable one.

They are divided into four categories: internal failure costs, external failure costs, appraisal costs and prevention costs.

Prevention costs

Prevention costs are incurred to prevent or avoid quality problems. They are planned and incurred before actual operation and they could include training, quality engineering-Planning & Assurance, statistical process control.

Appraisal costs

Appraisal costs are associated with measuring and monitoring activities related to quality and whether they conform to specifications and could include Verification, Quality audits & Supplier Ratings.

Internal failure costs

Internal failure costs are incurred to remedy defects discovered before the product or service is delivered to the customer and they could include waste, scrap, rework, Rectification.

External failure costs

External failure costs are incurred to rectify defects discovered by customers and they could include repairs & servicing, warranty claims, complaints & returns.

 

 To discuss on equilibrium on costs let us take the example of a retailer who sells merchandise. He  invest in store “atmospherics” like lighting, merchandising, pleasant music, attractive salespeople, and even disperses fragrance in the air in order to put consumers in a good mood during the shopping process. He also uses eye-catching ads to get consumers positively disposed towards his products. This does not change the utility the consumer will get from the product. Pleasant music or merchandizing in a retail store should not directly impact the quality of a dress for example. These activities involve costs. Therefore, the question arises why retailers would incur these costs rather than offer a lower price to close a sale. This is because the customer is unable to separate the affect from true product quality. For him both are together and affects his decision to go for a particular product. The primary focus of any organizations is customer satisfaction. Customers are also known to pay a higher price for products they value. However, there are no substitutions for quality.

It’s wise therefore to create a few good systems and processes and update the higher management and the project team. Educate the team on the importance of quality. Quality is an important aspect of the project which makes it essential for a project manager to stay alert throughout the lifecycle of the project. It is the responsibility of the team to maintain the quality of the project. Poor quality should be avoided by planning the quality policies effectively. Otherwise, this may result in loss of the project as a whole—and consequently, loss of business and reputation in the market. Also go green to reduce operating costs and to reduce energy usage. Replace regular light bulbs with compact fluorescent lighting, look to reduce heating and cooling costs by improving your insulation and windows, and cut back on the amount of physical waste. Encourage employees to communicate via email or other electronic means and ask your vendors to do the same. This can drastically decrease the cost of your monthly office supply order.

Once the systemic issues with the cost of quality and significant opportunity for improvement has been identified, the best approach is to apply the Six Sigma approach to improvement using the DMAIC methodology focused on a specific process issue that is significantly impacting the Cost of Quality.

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Cost of quality includes any cost that would not be expanded if quality were perfect. This includes such obvious costs as scrap and rework, but it also includes less obvious costs such as the cost to replace defective material, the staff and equipment to process the replacement order. Specifically, quality costs are a measure of the cost associated with the achievement or non achievement of product or service quality. This include market specifications, end - product and process specification, purchase order, engineering drawing, company procedure, operating instructions. There are total four types of cost of quality:

1. Prevention Cost:   Costs incurred to prevent the occurrence of non conformances in the future such as following:

a: Marketing research

b: Customer/user perception surveys/clinics

c: Contrack Review

d: Design quality progress review

e: Field tests

f: Service design qualification

g: Supplier reviews

h: supplier rating

i:Supplier quality planning

j:Operations(manufacturing or service)

k: Quality adminstration

 

2. Appraisal Costs:  Costs incurred in measuring and controlling current production to ensure conformance to requirement, such as:

 

a: Measurement equipment

b: Qualification of supplier product

c: Source inspection and control program

d:Checking labor

e: Product audits

f: Inspection and test materials

g: Process control measurements

h: Laborartory support

i: Measurment equipment

Maintenance and clibration labor

 

3. Internal Failure Cost:  Costs genrated before a product is shipped as a result of non conformance to requirements, such as:

 

a: Product/design failure costs

b: Purchasing failure costs

c: Disposition costs

d: Rework

e: Repair

f: Extra operation

g: Rework of suplier rejects

 

4. External Failure costs:  Costs generated after a product is shipped as a result of non conformance to requirements such as:

 

a: Complaint investgation

b:return goods

c: Retrofit costs

d: Recall costs

g:Warrenty claims

h:Liability costs

i:Penalties

j:Lost sales

h:Customer goodwill

 

There is a need to strike an equilibrium between these costs. Approach to reach the best scenario:

For most organization, quality costs are hidden costs. Unmeasured quality costs tend to increase. Poor quality impacts companies in two ways; higher costs and lower customer satisfaction. The lower customer satisfaction creates price pressure and lost sales, which result in lower revenues. the combination of higher cost and lower revenue eventually brings on a crisis that may threaten the very existence of the company. Rigorous cost of quality measurement is one technique for preventing such a crisis from occurring.

 

As a rule, quality costs increase as the detection point moves further up the production and distribution chain.The lowest cost is generally obtained when errors are prevented in the first place. If non conformance occurs it is generally least expensive to detect them as soon as possible after their occurance. Beyond this there is loss incurred from additional work that may be lost. The most expensive quality costs are from nonconformance detected by customers. in addition to replacement or repair loss, a company losses customer goodwill and reputation is damaged when customer relates his experience to others.

Quality cost measurement need not be accurate to the peny to be effective. The purpose of measuring these costs is to provide broad guidelines for management decisions, making them and take an action. The very nature of cost of quality makes such accuracy impossible. It will be only possible to obtain periodic rough estimates of such costs as customer goodwill. These can be obtained using special audits, statistical sampling and other market studies. They need not be obtained every month. Annual studies are usually sufficient to indicate trends in these measures. 

 

 

 

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Striking and equilibrium between Appraisal + Prevention costs and Internal + External failure costs was an old idea, when it was believed that 'zero rejection' level can not be achieved and such efforts will lead to infinite cost. But now a days, concept has changed, attaining zero rejection level is very much feasible within reasonable cost. Hence ideal situation is spend reasonable amount of money on Appraisal and Prevention costs to attain near zero Internal and External failure rate.

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Cost of Quality = Cost of Good Quality + Cost of Poor Quality

 

Cost of Good Quality (COGQ)

 

1.       Prevention costs (PC):

Costs incurred to prevent and minimize defects, rather than finding and removing them later.

Examples: Designing and implementing a quality plan, SP, employee Training.

2.       Appraisal (Inspection) costs (AC):

Costs incurred during the manufacturing process to ensure that the product/service conforms to quality standards and performance levels.

Examples: Maintaining team of Quality inspectors, Inspection, Audits, Field Testing, testing equipment maintenance.

 

Cost of Poor Quality (COPQ)

1.       Internal failure costs (IFC):

Costs incurred to identify defective products/services not conforming to standards before delivery to customers.

Examples: Rework, Delay, Rejects, Scrap, Disposal of rejects and scrap, Downtime due to failures

2.       External failure costs (EFC):

Costs incurred when defective products/services not conforming to standards are delivered to customers.

Examples: Warranties, Customer Dissatisfaction, Product Recall, Damaged Good will, Damaged Brand Equity.

 

Increase in investments pertaining to COGQ enhances the Overall Equipment Efficiency (OEE) of the process which is a key Quality KPI.

 

Increasing investments in COGQ may have a multiplier effect to the savings in COPQ, but there will be a point of diminishing returns. I believe, the Equilibrium between COGQ and COPQ is a very delicate balance and would be dynamic one needing constant review and adjustments.

 

In my view, investments done by the management for COGQ helps to build a Quality sensitive culture in the organization. Investments by the management into ERP, PLM, MES, QMS systems and their integration and so on help the workforce understand the underlying emphasis on quality. It helps to get valuable buy-ins from the various stake holders when rolling out enterprise wide quality initiatives.

 

My approach to strike a balance between COGQ and COPQ would vary depending on the

  • initial budget and resources available at hand
  • process knowledge available.
  • Knowledge of quality issues that might come up
  1. In case of limited budget and knowledge, I would concentrate incurring more AC and reducing IFC.  
  2. Once more knowledge is gained regarding the process and defects, I would aim to implement some targeted preventive measures (i.e. PC).
  3. With the preventive measures in place if there is a reduction in defects, then I would work on optimizing my AC.
  4. I would handle any EFC’s, that may come up, and have a feedback to my PC, AC and IFC expenses.
  5. As the business grows, I would implement new technologies as part of increased PC and try to incorporate/build quality into the process to make it “right the first time”. I would still maintain a minimal AC.
  6. In case I start with an ample budget and knowledge, my approach would me to implement preventive measures followed by a combination of steps 4 and 5.

 

I would think the best scenario would be one where quality related complaints are close to none the capital investments against COGQ have been recovered. The maintenance costs for systems ensuring COGQ is constantly being repaid by sales revenue and profits are increasing. This would help in making further investments to upgrade the systems ensure COGQ.

At the point of diminishing returns any further costs (PC and AC) should be re-assessed.

 

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Q 45. Considering the four quality costs viz, Prevention costs, Appraisal Costs, Internal Failure Costs, and External Failure Costs, one would imagine incurring some prevention + appraisal costs so as to save on others.  Is there a need to strike an equilibrium between these costs? What would be your approach to reach the best scenario? What should be considered as the best scenario? 

 

Companies should the product quality at a very high level to meet the customer’s requirements at the desired quality at an optimal cost.

 

There are some terms which we should before understanding which cost is better.

 

Quality is defined as composition of characteristics that can express the ability of good product or service which can meet the customer’s requirement.

 

Quality of design refers to how closely the requirements are met to match the needs of the customer.

 

Conformance quality refers to performance of the product or service that can meet the customer requirements.

 

Quality cost is said to be the cost that is involved in creation, evaluation for confirmation of quality and failure cost. It is of 4 types Prevention cost, appraisal cost, internal failure cost and external failure cost.

 

Prevention cost:

It is the cost associated with the infrastructure of the quality control system. It ir designed in such a way to prevent the cost of poor quality.

Preventive costs are measured in the following ways.

1.    Quality planning cost: It involves the process of planning the quality system details like procedures and instructions to meet the customer requirements. It involves the planning for instructions for operations, consistent production, test, inspection and quality control.

2.    Cost of customer research and market analysis: To determine the customer’s requirements, the market research is to be conducted to gather the information about the product / service.  gather the specifications for the product / service to be delivered to meet the exact specifications set by the client. When the needs are met by the product delivered, the it is of desired quality for the product to satisfy the customer.

3.    Cost of developing the design for products: before any bulk production, if there is any new requirement change happens, sample products / sample trials to be done to prevent the huge waste / loss. Hence sample products aims at preventing the production with poor quality.

4.    Purchasing cost: companies has to evaluate the market for raw materials to be purchased. Without compromising quality, the raw material for the end product to be cost effective. For which, the companies should evaluate the suppliers and their costs.

5.    Cost of quality training and personal development: to avoid failures, company must continuously engage the employees in training for quality maintenance and product development.

6.    Cost of system development and management: creating a quality control systems and methodologies for conformance of quality to meet the customer requirements.

 

Measurement cost to appraise the quality:

Measurement costs are associated with activities that are involved in inspection and testing for conformance of quality to meet the customer requirements.

Measurement cost are in the following ways.

1.    Cost of inspecting and testing the raw materials: if the raw material is of bad quality, the entire product will fail which lands up in internal and external failure cost. Eg, Travel to vendor’s place is also a cost involved in evaluation of raw materials.

2.    Cost of lab – acceptance test: If the raw materials has to be tested for its quality or its characteristics under certain experimental models, lab testing is required, which incurs cost to the company to conform the raw material purchased is of good quality.

3.    Inspection cost – It is the cost involved for cost of time or person’s wages who confirms the quality of the product while testing and inspecting.

4.    Testing cost – cost associated with technical evaluation of the product /service.

5.    Cost of setup for test and inspection: Setting up the lab / equipment’s involves cost to run the test and inspection for quality conformance.

6.    Other costs – Electricity, fuel cost, etc as well included.

 

Cost of internal failure:

Cost associated of the products / services that has failed internally during the inspection process before it reaches out to the customer.

Internal failure costs are as follows..

1.    Cost of Rework – When the defect is identified, a corrective action is taken place, which requires a rework. Eg. Extra labour, time, material and other extra resources to complete the rework and meet the standards set by the client.

2.    Material procurement cost – cost when the product is rejected or complaints raised by the customer to evaluate and rework.

3.    Cost of engineering – the production process is entirely studied for process improvements, if any internal repeated failures occurs. This involves experts cost for the process reengineering studies.

4.    Cost of wasted time – Extra time spent by the employees in reworking the product involves cost to the company.

 

External failure cost:

Cost associated with products /services that has been delivered to the customer and identified by the customer, which results in dissatisfaction.

External failure cost are as follows..

1.    Warranty complaints cost – cost of complaint includes activities alike investigate the complaint, repair and if not repairable, replace. If the product is under warranty service, the cost is a kind of rework and we might end up in losing the client due to dissatisfaction.

2.    Product liability cost – cost incurred due to liability judgements due to the product quality failures.

3.    Product recall – When the product is recalled from the market, the cost incurred in selling the product, for rework etc will be wasted and it will be a huge loss to the company.

4.    Lost sales  and reputation – if the product does not meet the customer requirements, then the bad reputation would spread as viral by the customers in the market. The market lead would not be possible.

 

Accounting of quality cost:

Informations or reports should be generated frequently on the quality costs and circulated to make the managers aware of the quality costs occurring in the company to help them make decisions.

Measurement, analysis and reporting of quality system helps them understand how closely the quality system works to prevent failure costs and meet the customer requirements. It would also help them to make future estimates.

 

Total Quality control –

Managers can compare different quality cost segments and determine its relationship. For eg. If the manager decides the preventive cost are intensified, then more failures are reduced.

Hence it helps the managers as measurement of quality tool to draw useful conclusions.

They aim to shift the failure cost into preventive cost so that the robust technology help in reducing he failure cost and manual appraisal cost. This program is called quality cost improvement program.

 

Analysis of Quality cost –

By analyzing the quality cost, the managers would be able to draw some useful information to make conclusions or decisions. Hence the analysis is important using some of the tools like ratio analysis, trend analysis, pare to analysis and cause effect diagrams.

 

Conclusion on the approach –

Cost of doing job, conducting quality programs and achiving goals to meet the customer requirements and satisfy the customer for longer effect of business in the market. Cost of quality is an important quality tool. If the company wants to meet the desired quality of the customer, then the organization should work with high quality attributes. If they cannot meet the customer needs, the failure cost and rework cost would be higher.

If the company wants to reduce the cost of poor quality from 40% to 15% , then effective quality improvement programs to be initiated and reported frequently to the managers to substantially reduce the failure cost and increase profits.

Any good organizations approach on the quality cost would be achieving high quality with robust preventive technology aspects of quality and appraisal cost even secondary to reduce the internal and external failure cost.

Ay organization to lead the market and win the customer, the failure costs should be at very minimum rate with high quality product. Hence these quality costs can never be in a equilibrium.

 

My rating for Quality cost is as follows.

1.    Prevention cost should be higher

2.    Appraisal cost takes up the 2nd place.

3.    Internal failure cost can be at a very minimal % of <1%

4.    External failure cost is very bad cost to organsation, hence one should avoid it.

 

More examples of quality costs

Examples of prevention cost

  • System development
  • Quality engineering
  • Quality training
  • Quality circles
  • Statistical process control
  • Supervision of prevention
  • Quality improvement projects
  • Technical support to suppliers
  • Quality data gathering, analysis and reporting
  • Audit of the quality system

Examples of appraisal cost

  • Test and inspection of incoming materials
  • Final product testing and inspection
  • Supplies used in testing and inspection
  • Supervision of testing and inspecting activities
  • Depreciation of test equipment
  • Maintenance of test equipment
  • Plant utilities in inspection area
  • Field testing and appraisal at customer site

Examples of internal failure cost

  • Net cost of scrap
  • Net cost of spoilage
  • Rework labor and overhead
  • Reinspection of reworked products
  • Disposal of defective products
  • Down time caused by quality problems
  • Analysis of the cause of defects in the production
  • Retesting of reworked products
  • Re-entering data because of keying
  • Debugging software errors

Examples of external failure cost

  • Cost of field servicing and handling complaints
  • Warranty repairs and replacement costs
  • Liability arising from defective products
  • Lost sales arising from a reputation of poor quality
  • Returns and allowances arising from quality problems
  • Product recalls
  • Repairs and replacements beyond the warranty period

 

Refernce -http://asq.org/learn-about-quality/cost-of-quality/overview/overview.html

 

 thanks

Kavitha

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Quality Costs:

Skipping directly to the question on whether incurring on Prevention + Appraisal costs to save on other 2 costs ?

 My answer would be yes,

Incurring on P + A costs would be proactive.

 An organization can spend on system & subjects as a part of P + A costs, this would still be a kind of assets rather than incurring costs on Internal & External failure costs.

 Failure costs would be more critical in terms of cost as these cost would usually be very high. Sometimes too high.

 Is there an need to reach equilibrium on P + A costs & failure costs ?

I don’t think we should try for this. Because the failure is connected to customer & Market. It will be of more risk to even go to that stage.

 My approach would be to invest on prevention & Appraisal costs.

There could be still some chances that the failure would happen & we need to incur costs, but by extremely taking care of Prevention & Appraisal parameters,  the risks could be minimized.

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Quality is a make-or-break issue for most businesses. Companies with higher and more consistent quality do better over time. But this performance comes at a cost. Cost of the quality is not only the cost incurred from producing and fixing defects but also from ensuring that good products are made in the first time right and every time right.

Cost of Quality

Type

1.Cost of Good Quality

2.Cost of Bad Qulaity

Sub Type

1.1 Prevention Cost

1.2 Appraisal Cost

2.1 Internal Failure

2.2 External Failure

Definition

Cost  incurred to prevent or avoid quality problems /Non conformance

Cost incurred for inspection/ measuring & monitoring activities.

Costs are incurred for remedial measure to correct defects inside the facility before the product or service being delivered to customer.

Costs incurred for remedial measure after the detection of defects by customers

Example

1. Quality planning

1. Checking and testing purchased goods and services

1.Scrap (cost of product that cannot be reworked or reused)

1. Complaints Handling

2.Supplier evaluation

2.In-process and final inspection/test

2.Scrap disposal (cost of getting rid of product that cannot be reworked or reused)

2.Repairing goods and redoing services

3. New product review

3.Rework (costs of correcting quality issues on existing product)

3.Warranties

4.Error proofing

3. Field testing

4.Rework inspection (cost of inspecting a product after rework)

4.Customers’ bad will

5.Capability evaluations

4. Product, process or service audits

5.Additional material procurement (cost to replace defective or missing material)

5.Losses due to sales reductions

6.Quality improvement team meetings

6.Variability in product quality (cost of product give-away and mislabeling)

6.Environmental costs

7.Quality improvement projects

5. Calibration of measuring and test equipment

7.Downgrading (cost of lower price point of product with quality issue)

7. Product Recall/Withdrawal

8.Quality education and training

8.Supplier rework (costs attributed to supplier defects)

8. Regulatory fines and penalties

 

Prevention is better than cure. It is always better to invest in controlling the failure rather than rectifying the non-conformity. Companies that are quality leaders spend significant resources in prevention and appraisal costs. The more a company invests in implementing strong quality methods and “good quality costs” on the front end, the more likely it is to avoid the costs of poor quality on the back end which helps in increasing customer loyalty and the resulting revenue growth.

 

Striking a delicate balance between the cost of good quality and the cost of poor quality is an ideal .If the cost of quality is at high end of the range, you are not as efficient as your competitors.  If the cost of quality is below the range, you can probably increase spending on customer satisfaction and still being cheaper than your competitors.

 

As long as decrease in failure costs is greater than the corresponding increase in control costs, you can continue increasing its efforts to prevent or detect nonconforming units.  Eventually, a point is reached at which any additional increase in this effort costs more than the corresponding reduction in failure costs. This point represents the minimum level of total quality costs. It is the optimal balance between control costs and failure costs.

 

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Quality Costs, in general, are costs that are not expended if quality of the product or Service as an output of any process , were perfect as per the specification of the customer.

The overall cost of quality include:

i)                    Prevention of non – conformance to specification

ii)                  Failure to meet the specifications

iii)                Appraising a product or service for conformance to specification or requirements

 

Wherein, the costs caused due to providing poor quality of product or service have four categories- Prevention Costs( Costs incurred to keep defects at the lowest the process at “0 Defect”),Internal failure costs (Cost associated with defects that are found before the customer experience), External Failure costs (Cost associated with defects found after the customer experiences the defects) and Appraisal costs(costa incurred to determine the degree of conformance to specifications- given that the specifications may change as the need & expectation of the customers keeps changing)

It is but obvious that getting it right the first time itself will save many costs - For sure ,The internal failure costs and external failure costs will be at lowest possible and enrich the bottom line.  

Cost of Quality is a methodology that helps an organization to determine the extent of usage of it’s resources to prevent poor quality or reduce the cost of poor quality. Having this information helps to control and regulate the potential savings to be derived through process enhancement activities. Simultaneously, the organization can also take a call on how to use the derived benefits through options like passing part of the benefit to the customers (offers and promotions) or using the same in the process / service/ product enhancement programmes. Though, the best option for most is to retain the profits as it is the best proof of business excellence for the investors and internal stakeholders.

 

Most of the organizations will have quality related costs as high as 30% of sales- most of it goes unnoticed as it is hidden. Some organizations cease to exercise any effort on the same as they are unable to execute proper Quality cost management and thus get less optimal results on their investment. They loose confidence in their own quality cost reduction efforts. They then claim the cost from the Customer with higher selling price- Big mistake!!

Quality Cost Management helps organizations to prioritize their corrective measures and helps them to allocate their resources effectively to minimise undue costs. Effective quality management programs can reduce the cost of quality substantially and thus contribute to the profits. As a strategy, 10 to 15% of operational cost should be allocated as a general thumb rule towards costs of poor quality.  The equilibrium or balance has to be maintained within the 4 types of costs that constitute towards the quality costs. As mentioned earlier in this note, Keeping the defects lowest during the production or executing the service process is the best option to keep the other related costs down. So majority of the budget allocated ,should be used towards Prevention costs which are associated with design, implementation and maintenance (both planned and spontaneous) of the quality management system. The spend should be planned and incurred before actual production or operation through:

-          Determination of specifications for raw materials, processes based on need of customer, quality standards of products/ services

-          Documented plan for quality, reliable check points, control charts

-          Quality assurance through a effective quality management system

-          Training- Most important – the best things happen when you have the best trained person at the right places- “Aces at Places”

 

An judicious effort on preventive measures helps to reduce the internal and external failure costs.

Appraisal costs which are associated with the suppliers and customer’s perception of value of spend on products or services is necessary and hence quality audits at relevant process steps and VOC to assess scope for improvement or scope for cost control are of great importance-

Thus the balance is very simple – The higher focus on control of  Preventive and Appraisal costs reduces other costs of poor quality and once such quality cost system is established and becomes dynamic , it will provides the avenue for the organization to achieve better profit margins. This is pertinently the best scenario.

 

 

 

 

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Cost of Poor Quality (CoPQ)

It represents the known and unknown costs of all the defects that exist in a process.  We can divide this costs into 5 categories - Internal Failure, External Failure, Appraisal , Prevention and non-value added activity

 

Internal Failure

These are Costs that occur due to defects that are found before the product or service is provided to the customer.  Examples: Scrap, rework, retesting, downtime,...

 

External Failure

These are Costs that occur due to defects that are found after the product or service reaches to the customer.  

 

Examples :  Warranty changes , compensation,  Returned goods,  complaint corrections/adjustments,..

 

Appraisal

This is the cost of determining the degree of non conformance to quality requirements.

Eg: Inspection of Deliverables, performing Quality audits, testing  

 

Prevention

This talks about the cost of minimizing failure and appraisal costs

Eg: creating better process for eliminating defects by having proper design reviews and quality planning, having knowledge sessions /trainings, have a preventive mechanism  such as checklists or readiness list for smooth delivery.

 

Non-value added

This happens when any of the steps in a process cannot add value from the customer’s perspective.

 

Which costs need to be considered?

COPQ  is a key business metric in a Process Improvement project.  As we improve the capability of a process, we not only decrease the variation and defects, but also reduce the cost of running the process.  You can find that in below table

Sigma Level

 

DPMO

 

CoPQ (% in Sales)

 

2

308,537

30-40%

3

68,807

20-30%

4

6,210

15-20%

5

233

10- 15%

6

3.4

< 10%

 

The most important costs that we need to focus is on Prevention cost. For this we need to focus on

-          Identifying the areas for improvement and also identify the people to whom knowledge has to be given

-          Train the identified resources for providing the training

-          Identify right steps in each process and ensure only needed steps are placed

 

Prevention cost will help in

-          Avoiding failure costs – both internal and external

-          Can help to avoid customer dissatisfaction

 

Edited by R Rajesh
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