Quality Cost 1

Quality cost

By Dr. Lawrence Wong

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Quality & costs

• Quality costs are all the costs incurred by a business to ensure that the total service it provide to customers conforms to the customer’s requirement

• First suggested by Quality experts Philip Crosby – In his book “Quality is Free” introduced the concept

of quality cost• Quality is free• It is not the quality that costs, but the lack of quality• He estimated 30% of a company’s expenditure are quality

costs related

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Before 1950 - 1960’s

• No special accounting procedure on quality cost was available

• Costs of quality were scattered

• Quality costs were a minority of expenditures

• It is only related to quality and inspection departments

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Quality related activities

• Costs are considered to be the efforts devoted to products that do not meet specification or which fail to meet customer satisfaction. These costs would not exist if the product has been made right in the first time.

• Quality-related activities are those which concerns with PAF– Prevention

• Effects devoted to planning the quality system

– Appraisal• Efforts to verify that quality is being obtained

– Failure• Failures resulting from inadequate systems

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Prevention Costs

• Costs incurred in planning, implementing and maintaining a quality management system that is intended to ensure conformance to quality requirement.

• These costs are related to activities which concern keeping failure and appraisal costs at a minimum

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Examples of prevention Cost

– Application screening

– Capability studies

– Controlled storage

– Design review

– Equipment maintenance & repair

– Field testing

– Fixture design and fabrication

– Forecasting

– Housekeeping

– Job descriptions– Market analysis– Pilot projects– Procedure writing– Prototype testing– Procedure reviews– Quality incentives– Safety reviews– Time and motion studies– Survey– Quality training– Vendor evaluation and

selection– Personnel reviews

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Appraisal Costs

• Costs incurred in measuring and suiting design, product, components, and materials in order to establish the design of conformance with quality requirements.

• These costs are related to appraisal of the state of products and processes in order to assess whether or not the products/process satisfy given requirement

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Examples of appraisal cost

• Audit• Document checking• Drawing checking• Equipment calibration• Final inspection• In-process inspection

• Laboratory test• Personnel testing• Procedure testing• Prototype inspection• Receiving inspection• Shipping inspection

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Failure costs

• External failure cost– Costs incurred when

products fail to conform to quality requirements after transfer of ownership to the customer

• Internal failure cost– Costs that arise where

products, components, and materials fail to conform to quality requirements before transfer of ownership to the customer

• Costs are considered to be the efforts devoted to products that do not meet specification or which fail to meet customer satisfaction. These costs would not exist if the product has been made right in the first time.

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Examples of internal failure cost

• Accidents

• Accounting error corrections

• Employee turnover

• Engineering change

• Equipment downtime

• Excess interest expense

• Excess inventory

• Excess material handling

• Excess travel expense

• Failure review

• Obsolescence due to design changes

• Overpayments

• Premium freight

• Redesign

• Re-inspection

• Repair cost

• Re-testing

• Rework

• Scrap allowances

• Sorting

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Examples of external failure cost

• Bad debts• Customer dissatisfaction• Engineering change notice• Equipment downtime• Excess installation costs• Excess interest expense• Excess inventory• Excess material handling• Excess travel expense• Failure travel expense• Failure reviews• Liability• Loss of market share

• Obsolescence due to design changes• Overpayments• Penalties• Premium freight• Price concessions• Price errors• Re-calls• Redesign• Re-inspection• Repair cost• Restocking costs• Re-testing• Rework• Scrap• Sorting• Warranty expense

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Quality cost relationship

Apparent minimumTotal quality cost

prevention

Total prevention

Apparent optimum Defect level

Failure

Appraisal

Defect level

$

LowHigh

Zone of indifference

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Why calculate Quality Cost

• Quality Costs represent 10-20% of total costs• Management will give special attention is quality is measured in

monetary terms• Quality costing is one of the tools

– to provide initial assessments and hard evidence that improvement is needed or had been made

– To monitor the effectiveness of quality improvement initiatives– To be used in a generic term by senior management, shareholders and

financial institutions, so that they can readily understand implication of quality the in term of money

– Cost of quality failure is calculated as a percentage of profit or annual turnover

– It is easy to understand• By front-line operator• By middle management

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Benefits of using quality costing

• Greater accuracy in the evaluation and forecasting of resource utilization

• Justification for investment in the prevention and appraisal of failures

• Ability to cost and compare performance across all departments functions and activities

• Identification and prioritization of activities, processes and departments in terms of corrective action, investment, or quality improvement initiatives

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Benefits of using quality costing (2)

• Ability to set cost-reduction targets and then to measure and report progress

• Ability to produce “local” data which improves understanding of resource utilization objectives and targets at all levels throughout the company

• Provision of data to support formal quality management system (including, especially; those based upon the ISO9000)

• Enable decisions about quality to be made in an objective and systematic manner

• Promoting TQM and a company-wide quality improvement culture

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Difficulties in using Quality costing

• Management have not believed in the possibilities of improvement

• Quality costing is demanding– It requires a lot of data of each activity related to quality

• Other limitations– Does not resolve quality problems– Does not provide specific actions– susceptible to short-term mismanagement– difficult to match effort and accomplishment– susceptible to measurement errors– may omit important or include inappropriate costs

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Steps in implementing quality cost

1. Involve accountants right from the outset2. Decide purpose and objectives3. Decide how to deal with overheads4. Distinguish between basic work and quality related

activities5. Collection data which offers the prospect of real gains6. Start by examining failure costs7. Evaluate the costs of inspection8. Analyze and use the data9. Collecting and reporting quality cost data

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Guideline to collecting and reporting

• Reporting cost considerations– Standardized reporting format– Clarify and simplicity in the presentation of data– Effective communication at management, department and operator

levels– Inclusion of data in the company’s overall cost reporting system

• Support from senior management– The influence and involvement of senior management is vital in acting

upon quality cost data– If there is no pressure to reduce costs against targets set and monitored

by management, then cost collection and reporting will gradually lose credibility, and an important weapon in the cause of company wide quality improvement will be lost

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Quality costs reduction

It helps business to:

• Satisfy the requirements of their customers.

• Makes the work of their employees more interesting.

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Summary

• Quality cost cannot eliminate the costs of non-conformance, it is only a tool to measure.

• Quality cost is measure of effectiveness and efficiency of a Quality Improvement Programme

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Case study

Quality cost of software design department

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Examples of quality costs by software design department

• List of Prevention costs– Design procedures

– Setting specifications

– Quality function deployment

– Reliability analysis

– Design proving

– Design reviews

• List of Appraisal costs– Design specification

– Pre-production / prototype trials

– Checking

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Examples of quality costs by design department

• List of Internal failure costs– obsolete library /

data– insufficient /

excessive data storage

– design changes– Project overspend

• List of External failure costs– software liability (i.e.

penalty, delay of payment)

– Customer complaints– Downgrading system

performance– Analysis of compliant

from customer– Orders lost